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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 December 31, 2004
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 offices) (Zip Code)
Registrant's telephone number, including area code (406)-791-7500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
Indicate by checkmark whether the registrant is an accelerated filer (as defined
in Rule 12b-2 of the Exchange Act). Yes No X
----- -----
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 February 10, 2005
(Common stock, $.15 par value) 2,599,438 shares
ENERGY WEST, INCORPORATED
INDEX TO FORM 10-Q
Page No.
--------
Part I - Financial Information
Item 1 - Financial Statements
Condensed Consolidated Balance Sheets (Unaudited)
as of December 31, 2004, December 31, 2003
(As Restated) and June 30, 2004 2
Condensed Consolidated Statements of Operations
(Unaudited) - three months ended December
31, 2004 and 2003 (As Restated) and six months
ended December 31, 2004 and 2003 (As Restated) 3
Condensed Consolidated Statements of Cash Flows
(Unaudited) - six months ended December 31,
2004 and 2003 (As Restated) 4
Notes to Condensed Consolidated Financial
Statements 5
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 14
Item 3 - Quantitative and Qualitative Disclosures about
Market Risk 36
Item 4 - Controls and Procedures 37
Part II - Other Information
Item 1 - Legal Proceedings 38
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds 39
Item 3 - Defaults upon Senior Securities 39
Item 4 - Submission of Matters to a Vote of Security Holders 39
Item 5 - Other Information 39
Item 6 - Exhibits 39
Signatures 41
1
Part I - FINANCIAL INFORMATION
Item 1 - Financial Statements
ENERGY WEST, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
DECEMBER 31,
--------------------------- JUNE 30,
2004 2003 2004
----------- ------------- -----------
(AS RESTATED)
(SEE NOTE 1)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 4,979,766 $ 1,598,221 $ 1,322,702
Accounts and notes receivable, less $257,143, $216,159, and $300,814,
respectively, allowance for bad debt 13,065,766 12,470,289 6,729,020
Derivative assets 124,131 207,343 199,248
Natural gas and propane inventories 7,896,274 4,456,921 5,183,046
Materials and supplies 411,662 379,353 350,764
Prepayments and other 324,837 496,535 370,379
Deferred income taxes 1,036,532 1,139,829 526,899
Income tax receivable 999,451 1,881,027 1,268,243
Recoverable cost of gas purchases 564,575 1,099,197 788,407
----------- ----------- -----------
Total current assets 29,402,994 23,728,715 16,738,708
PROPERTY, PLANT AND EQUIPMENT, NET 38,874,483 38,473,678 38,605,644
NOTE RECEIVABLE 253,944 461,060 407,538
DEFERRED CHARGES 5,062,031 5,661,271 5,488,415
OTHER ASSETS 165,187 247,956 204,772
----------- ----------- -----------
TOTAL ASSETS $73,758,639 $68,572,680 $61,445,077
=========== =========== ===========
LIABILITIES AND CAPITALIZATION
CURRENT LIABILITIES:
Current portion of long-term debt $ 2,977,891 $ 537,533 $ 972,706
Line of credit 14,629,304 20,629,304 6,729,304
Accounts payable 3,768,601 4,104,642 3,611,080
Derivative liabilities 2,304,963 1,032,034 1,684,676
Accrued and other current liabilities 8,138,341 3,886,066 3,726,982
----------- ----------- -----------
Total current liabilities 31,819,100 30,189,579 16,724,748
----------- ----------- -----------
OTHER OBLIGATIONS:
Deferred income taxes 4,763,007 5,146,630 4,529,381
Deferred investment tax credits 323,813 344,875 334,344
Other long-term liabilities 4,606,799 4,541,160 4,758,893
----------- ----------- -----------
Total other obligations 9,693,619 10,032,665 9,622,618
----------- ----------- -----------
LONG-TERM DEBT 19,400,793 14,688,684 21,697,286
----------- ----------- -----------
COMMITMENTS AND CONTINGENCIES (NOTE 4 AND 7)
STOCKHOLDERS' EQUITY:
Common stock; $.15 par value, 3,500,000 shares authorized,
2,599,438; 2,595,250 and 2,598,506 shares outstanding at December 31,
2004, 2003, and June 30, 2004 respectively 389,923 389,294 389,783
Preferred stock; $.15 par value, 1,500,000 shares authorized, no shares
outstanding -- -- --
Capital in excess of par value 5,083,232 5,056,425 5,077,687
Retained earnings 7,371,972 8,216,033 7,932,955
----------- ----------- -----------
Total stockholders' equity 12,845,127 13,661,752 13,400,425
----------- ----------- -----------
TOTAL CAPITALIZATION 32,245,920 28,350,436 35,097,711
----------- ----------- -----------
TOTAL LIABILITIES AND CAPITALIZATION $73,758,639 $68,572,680 $61,445,077
=========== =========== ===========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
2
ENERGY WEST, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------------- ---------------------------
2004 2003 2004 2003
----------- ------------- ----------- -------------
(AS RESTATED) (AS RESTATED)
(SEE NOTE 1) (SEE NOTE 1)
REVENUES:
Natural gas operations $14,228,550 $12,665,598 $19,436,226 $ 17,328,606
Propane operations 3,022,491 2,141,177 3,875,102 3,323,078
Gas and electric--wholesale 5,535,177 7,722,500 11,257,684 14,255,691
Pipeline operations 101,931 96,416 186,286 205,766
----------- ----------- ----------- ------------
Total revenues 22,888,149 22,625,691 34,775,298 35,113,141
----------- ----------- ----------- ------------
EXPENSES:
Gas purchased 12,318,308 10,350,050 16,177,664 14,094,032
Gas and electric--wholesale 5,344,597 7,559,897 11,128,265 13,246,928
Distribution, general, and administrative 2,557,149 2,928,240 4,852,833 5,501,965
Maintenance 160,837 115,086 293,631 224,420
Depreciation and amortization 587,954 614,842 1,182,270 1,232,474
Taxes other than income 383,634 164,618 767,443 428,480
----------- ----------- ----------- ------------
Total expenses 21,352,479 21,732,733 34,402,106 34,728,299
----------- ----------- ----------- ------------
OPERATING INCOME 1,535,670 892,958 353,192 384,842
OTHER INCOME 141,295 65,790 207,470 258,407
INTEREST EXPENSE 721,945 647,013 1,474,189 1,093,110
----------- ----------- ----------- ------------
INCOME (LOSS) BEFORE INCOME TAXES 955,020 311,735 (913,527) (449,861)
INCOME TAX EXPENSE (BENEFIT) 388,623 113,108 (358,230) (154,868)
----------- ----------- ----------- ------------
NET INCOME (LOSS) $ 566,397 $ 198,627 $ (555,297) $ (294,993)
=========== =========== =========== ============
INCOME (LOSS) PER COMMON SHARE:
Basic $ 0.22 $ 0.08 $ (0.21) $ (0.11)
Diluted $ 0.22 $ 0.08 $ (0.21) $ (0.11)
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING:
Basic 2,598,937 2,595,641 2,598,937 2,595,641
Diluted 2,598,937 2,595,641 2,598,937 2,595,641
The accompanying notes are an integral part of these condensed
consolidated financial statements.
3
FORM 10-Q
ENERGY WEST, INCORPORATED AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
SIX MONTHS ENDED
DECEMBER 31,
----------------------------
2004 2003
----------- --------------
(AS RESTATED)
(SEE NOTE 1)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (555,297) $ (294,993)
Adjustments to reconcile net income (loss) to
net cash used in operating activities:
Depreciation and amortization, including deferred
charges and financing costs 1,599,010 1,442,785
Gain on sale of assets -- (333,988)
Investment tax credit (10,531) (10,531)
Deferred gain on sale of assets (11,814) (11,814)
Deferred income taxes (276,006) 213,927
Changes in assets and liabilities:
Accounts and notes receivable (6,183,152) (4,598,656)
Derivative assets 75,117 416,293
Natural gas and propane inventories (2,713,228) (3,418,231)
Accounts payable 157,522 (4,737,139)
Derivative liabilities 620,287 167,104
Recoverable/refundable cost of gas purchases 223,831 (32,088)
Prepayments and other 45,542 (143,553)
Other assets & liabilities 1,028,919 (2,003,788)
----------- ------------
Net cash used in operating activities (5,999,800) (13,344,672)
----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Construction expenditures (1,507,112) (1,055,820)
Proceeds from sale of assets -- 840,216
Customer advances received for construction 26,260 13,600
Increase from contributions in aid of
construction 29,782 2,133
----------- ------------
Net cash used in investing activities (1,451,070) (199,871)
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of long-term debt (291,308) (140,606)
Debt issuance cost -- (1,180,114)
Proceeds from lines of credit 8,900,000 27,832,346
Repayments of lines of credit (1,000,758) (13,307,630)
Proceeds from other short term borrowings 3,500,000 --
----------- ------------
Net cash provided by financing activities 11,107,934 13,203,996
----------- ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,657,064 (340,547)
CASH AND CASH EQUIVALENTS:
Beginning of period 1,322,702 1,938,768
----------- ------------
End of period $ 4,979,766 $ 1,598,221
=========== ============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
4
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
December 31, 2004
Note 1 - Restatement of Financial Results and Summary of the Business
Restatement of Financial Results
As previously disclosed in its Annual Report on Form 10-K, the Company has
corrected its accounting and previous valuation of certain contracts of Energy
West Resources, Inc. ("EWR") and, as a result, restated the accompanying
unaudited condensed consolidated financial statements as of December 31, 2003
and for the three and six month periods ended December 31, 2003.
The Company's review of EWR's contracts included an evaluation of a gas purchase
agreement and a gas sales agreement entered into during fiscal year 2002
involving counterparties who are affiliated with each other. The gas purchase
agreement had previously been reflected in the Company's financial statements as
a derivative asset. The gas sales agreement was previously classified by the
Company as a normal sales contract, and therefore was not reflected on the
Company's financial statements as a derivative liability. The Company determined
that a shorter period similar to that of the gas sales agreement should have
been used in the determination of the fair value of the gas purchase agreement
and that the gas sales agreement does not qualify for the "normal purchase and
sale" exception. As a result, the condensed consolidated financial statements
for the period ended December 31, 2003 have been restated to reflect a
significantly reduced fair value for the gas purchase agreement and the gas
sales agreement as a derivative liability at its estimated fair value.
None of the adjustments affects the Company's cash flows or cash balances. The
Company's cumulative gain (loss) in the portfolio of contracts valued on a
mark-to-market basis will be realized in later periods as contracts settle or
are performed and/or as natural gas prices change.
As discussed in the table that follows, the condensed consolidated balance sheet
at December 31, 2003, and the condensed consolidated statements of operations
for the quarter ended December 31, 2003 and the six months ended December 31,
2003, have been restated from amounts previously reported to reflect the
reclassification and revaluation of the gas purchase and gas sale contracts
discussed above.
5
A summary of the significant effects of the restatement is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, 2003 DECEMBER 31, 2003
------------------------- -------------------------
AS AS
PREVIOUSLY PREVIOUSLY
REPORTED AS RESTATED REPORTED AS RESTATED
----------- ----------- ------------ -----------
CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS
Gas and electric - wholesale* $ 8,297,247 $ 7,722,500 $14,622,547 $14,255,691
Total revenues 22,811,826 22,625,691 35,091,385 35,113,141
Operating income 1,079,093 892,958 363,086 384,842
Income (loss) before taxes 497,870 311,735 (471,617) (449,861)
Income tax expense (benefit) 184,696 113,108 (163,235) (154,868)
Net income (loss) 313,174 198,627 (308,382) (294,993)
Income (loss) per common share:
Basic 0.12 0.08 (0.12) (0.11)
Diluted 0.12 0.08 (0.12) (0.11)
AS OF DECEMBER 31, 2003
-------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
----------- -----------
CONDENSED CONSOLIDATED BALANCE SHEET
ASSETS
Derivative assets $ 2,218,412 $ 207,343
Deferred income taxes 309,679 1,139,829
Total current assets* 24,270,812 23,728,715
LIABILITIES AND CAPITALIZATION
Derivative liabilities 884,628 1,032,034
Total current liabilities* 29,356,145 30,189,579
Retained earnings 9,544,357 8,216,033
Total stockholders' equity 14,990,077 13,661,752
* Amounts reflect reclassification adjustment to conform to current year
presentation as previously reported.
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 considered necessary for a fair presentation have
been included. Operating results for the three month period ended December 31,
2004 and the six month period ended December 31, 2004 are not necessarily
indicative of the results that may be expected for the fiscal year ending June
30, 2005. The financial statements should be read in conjunction with the
audited consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the fiscal year ended June 30, 2004.
Certain non-regulated, non-utility operations are conducted by three wholly
owned subsidiaries of the Company: Energy West Propane, Inc. ("EWP"); EWR; and
Energy West Development, Inc. ("EWD"). EWP is engaged in wholesale and retail
distribution of bulk propane in Arizona.
6
EWR conducts certain marketing activities involving the sale of natural gas in
Montana and Wyoming and electricity in Montana, and owns certain natural gas
production properties in Montana. EWD owns a natural gas gathering system that
is located in both Montana and Wyoming and an interstate natural gas
transportation pipeline that runs between Montana and Wyoming. EWD also owns
natural gas production properties in Montana. The Company's reporting segments
are: Natural Gas Operations, Propane Operations, EWR and Pipeline Operations.
EWD began operations of an interstate natural gas transmission pipeline on July
1, 2003. The revenue and expenses associated with this transmission pipeline are
included in the Pipeline Operations segment.
New Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (the "FASB") issued a
revision of Statement of Financial Accounting Standards ("SFAS") No. 123,
Accounting for Stock-Based Compensation. The revised statement requires public
entities to measure liabilities incurred to employees in share-based payment
transactions at fair value. This Statement is effective for public entities as
of the beginning of the first interim or annual reporting period that begins
after June 15, 2005. Management is currently evaluating the impact that the
adoption of this standard will have on the consolidated financial statements.
Reclassification
Certain prior year amounts have been reclassified to conform to the current
year presentation.
Note 2 - Derivative Instruments and Hedging Activity
Management of Risks Related to Derivatives -- The Company and its subsidiaries
are subject to certain risks related to changes in certain commodity prices and
risks of counterparty performance. The Company has established policies and
procedures to manage such risks. The Company has a Risk Management Committee,
comprised of Company officers and management to oversee the Company's risk
management program as defined in its risk management policy. The purpose of the
risk management program is to minimize adverse impacts on earnings resulting
from volatility of energy prices, counterparty credit risks, and other risks
related to the energy commodity business.
In order to mitigate the risk of natural gas market price volatility related to
firm commitments to purchase or sell natural gas or electricity, from time to
time the Company and its subsidiaries have entered into hedging arrangements.
Such arrangements may be used to protect profit margins on future obligations to
deliver gas at a fixed price, or to protect against adverse effects of potential
market price declines on future obligations to purchase gas at fixed prices.
Quoted market prices for natural gas derivative contracts of the Company and its
subsidiaries are generally not available. Therefore, to determine the net
present value of natural gas derivative contracts, the Company uses internally
developed valuation models that incorporate independently available current and
forecasted pricing information.
7
As of December 31, 2004, these derivative contracts were reflected on the
Company's consolidated balance sheet as derivative assets and liabilities at an
approximate fair value as follows:
ASSETS LIABILITIES
-------- -----------
Contracts maturing during fiscal year 2005 $105,274 $1,153,123
Contracts maturing during fiscal years 2006 and 2007 -- 844,828
Contracts maturing during fiscal years 2008 and 2009 18,857 307,012
-------- ----------
Total $124,131 $2,304,963
======== ==========
During the first six months of fiscal year 2005, the Company entered into two
new contracts that require mark-to-market accounting under Statement of
Financial Accounting Standards ("SFAS") No. 133 (See Note 4).
Natural Gas and Propane Operations -- In the case of the Company's regulated
divisions, gains or losses resulting from derivative contracts are subject to
deferral under regulatory procedures of the public service regulatory
commissions of Montana, Wyoming and Arizona. Therefore, related derivative
assets and liabilities are offset with corresponding regulatory liability and
asset amounts included in "Recoverable Cost of Gas Purchases", pursuant to SFAS
No. 71, Accounting for the Effects of Certain Types of Regulation. As of
December 31, 2004, the Company's regulated operations have no contracts meeting
the mark-to-market accounting requirements.
NOTE 3 - INCOME TAXES
Income tax expense (benefit) differs from the amount computed by applying the
federal statutory rate to pre-tax income (loss) as demonstrated in the following
table:
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------ ------------------------
2004 2003 2004 2003
-------- ------------- -------- -------------
Tax expense (benefit) at statutory rate of 35% $336,103 $115,347 $(316,048) $(149,372)
State income tax expense (benefit), net of federal tax benefit 39,074 15,538 (50,926) (27,476)
Amortization of deferred investment tax credits (5,265) (5,265) (10,531) (10,531)
Other 18,711 (12,512) 19,275 32,511
-------- -------- --------- ---------
Total income tax expense (benefit) $388,263 $113,108 $(358,230) $(154,868)
======== ======== ========= =========
NOTE 4 - LINES OF CREDIT AND LONG-TERM DEBT
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. When 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 has greater need for short-term borrowing
8
during periods when internally generated funds are not sufficient to cover all
capital and operating requirements, including costs of gas purchased 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 and
fall months and the Company's short-term borrowing needs for financing customer
accounts receivable are greatest during the winter months.
The Company substantially restructured its credit facilities during fiscal year
2004. On September 30, 2003, the Company established a $23.0 million revolving
credit facility with LaSalle Bank National Association (the "Lender"), replacing
a previous short-term line of credit. The Montana Public Service Commission
("MPSC") order granting approval of the $23.0 million credit facility restricts
the use of the proceeds to utility purposes, and requires the Company to provide
monthly reports to the MPSC with respect to the financial condition of the
Company. The Company continues to be subject to these MPSC requirements.
On March 31, 2004, the Company entered into a restated credit agreement with the
Lender. Pursuant to the restated credit agreement, the previous $23.0 million
revolving credit facility was replaced with a $15.0 million revolving credit
facility, a $6.0 million term loan maturing on March 31, 2009, and a $2.0
million term loan maturing on September 30, 2004 (collectively referred to as
the "LaSalle Facility").
As of August 30, 2004, the Company and the Lender amended certain covenants
under the LaSalle Facility as follows: (1) increased the total debt to capital
ratio from .65 to .70, (2) allowed the exclusion of extraordinary expenses
incurred by the Company for legal fees and costs of the PPL Montana, LLC
("PPLM") litigation, expenses and costs associated with the credit facilities,
proxy contest costs, and the costs of adoption of the shareholder rights plan,
in determining the interest coverage ratio, and (3) waived compliance with the
ratios referred to in (1) and (2) above as of June 30, 2004 in addition to a
shareholder's acquisition of more than 15% of the outstanding common stock of
the Company.
As of November 30, 2004, the Company executed an agreement with the Lender
providing for (i) an extension of the revolving facility until November 28,
2005; (ii) an extension of the date to consummate infusions of new equity of at
least $2.0 million and to repay the $2.0 million term loan to October 1, 2005;
(iii) a conditional waiver of the deadline to deliver audited financial
statements for fiscal year 2004 and the deadline to deliver financial statements
for the fiscal quarter ended September 30, 2004; (iv) a waiver of the technical
default that otherwise would have been caused by the restatement of financial
results of prior periods; (v) modification of interest rates applicable to the
$2.0 million term loan; (vi) a limitation of $1.0 million on total loans and
additional capital investment from the Company to EWR; and (vii) waivers of
certain financial covenant defaults as of September 30, 2004.
As of February 14, 2005, the Lender under the LaSalle Facility waived compliance
with the total debt to capital ratio as of December 31, 2004. In addition, the
Lender waived compliance with financial covenants relating to the interest
coverage ratio and indebtedness to third parties which resulted from the
Company's sale of gas inventory in the second quarter and related agreement to
purchase gas in the third quarter.
Borrowings under the LaSalle Facility are secured by liens on substantially all
of the assets of the Company and its subsidiaries. The Company's obligations
under certain other notes and industrial development revenue obligations are
secured on an equal and ratable basis with the Lender in the collateral granted
to secure the borrowings under the LaSalle Facility with the exception of the
first $1.0 million of debt under the LaSalle Facility.
9
Under the LaSalle Facility the Company may elect to pay interest on portions of
the amounts outstanding under the $15.0 million revolving line of credit at the
London interbank offered rate (LIBOR), plus 250 basis points, for interest
periods selected by the Company. For all other balances outstanding under the
$15.0 million revolving line of credit, the Company pays interest at the rate
publicly announced from time to time by LaSalle Bank as its "prime rate" (the
"Prime Rate"). For the $6.0 million term loan under the LaSalle Facility, the
Company may elect to pay interest at either the applicable LIBOR rate plus 350
basis points ("bps") or at the Prime Rate plus 200 bps. For the $2.0 million
term loan under the LaSalle Facility, the Company pays interest at the Prime
Rate plus 200 bps through March 31, 2005; the Prime Rate plus 300 bps from April
1, 2005 through June 30, 2005; and the Prime Rate plus 400 bps from and after
July 1, 2005. The Company also pays a commitment fee of 35 bps for the daily
unutilized portion of the $15.0 million revolving credit facility.
During the quarter ended September 30, 2004, the Company entered into an
interest rate swap agreement related to the LaSalle Facility. The interest rate
swap agreement converts a declining notional amount of variable rate debt to a
fixed rate of 7.4%. The amortizing notional principal amount begins at
$2,933,333 on August 9, 2004 and amortizes to $2,016,666 as of March 31, 2009.
The effect of the interest rate swap, therefore, is to fix the rate of interest
at 7.4% for that portion of the $6.0 million term loan under the LaSalle
Facility.
The LaSalle Facility requires the Company to maintain compliance with a number
of financial covenants, including meeting limitations on annual capital
expenditures and maintaining a total debt to total capital ratio and an interest
coverage ratio, as defined. At December 31, 2004, the Company was in compliance
with the financial covenants under the LaSalle Facility other than the total
debt to capital ratio, which was waived by the Lender. The LaSalle Facility also
restricts the Company's ability to pay dividends during any period to a certain
percentage of cumulative earnings of the Company over that period, and restricts
open positions and Value at Risk (VaR) in the Company's wholesale operations.
At December 31, 2004, the Company had approximately $5.0 million of cash on
hand. In addition, at December 31, 2004, the Company had borrowed approximately
$14.6 million under the LaSalle Facility revolving line of credit. The Company's
short-term borrowings under its lines of credit during the three months ended
December 31, 2004 had a daily weighted average interest rate of 5.54% per annum.
The Company's net availability at December 31, 2004, was approximately $0.4
million under the LaSalle Facility revolving line of credit.
In addition to the LaSalle Facility, the Company has outstanding certain notes
and industrial development revenue obligations (collectively "Long Term Notes
and Bonds"). The Company's Long Term Notes and Bonds are made up of three
separate debt issues: $8.0 million of Series 1997 notes bearing interest at an
annual rate of 7.5%; $7.8 million of Series 1993 notes bearing interest at
annual rates ranging from 6.20% to 7.60%; and Cascade County, Montana Series
1992B Industrial Development Revenue Obligations in the amount of $1.8 million
bearing interest at annual rates ranging from 6.0% to 6.5%. The Company's
obligations under the Long Term Notes and Bonds are secured on an equal and
ratable basis with the Lender in the collateral granted to secure the LaSalle
Facility with the exception of the first $1.0 million of debt under the LaSalle
Facility.
Under the terms of the Long Term Notes and Bonds, the Company is subject to
certain restrictions, including restrictions on total dividends and
distributions, liens and secured indebtedness, and asset sales, and is
restricted from incurring additional long-term indebtedness if it does not meet
certain debt to interest and debt to capital ratios.
10
The total amount outstanding under all of the Company's long-term debt
obligations was approximately $22.4 million and $15.2 million, at December 31,
2004 and December 31, 2003, respectively. The portion of such obligations due
within one year was approximately $2,978,000 and $538,000 at December 31, 2004,
and December 31, 2003, respectively.
During November 2004, the Company sold gas held in inventory for $3,500,000 and
entered into a gas purchase agreement to repurchase the same quantity of gas
during January 2005 with the same counterparty for $3,580,000. The Company
accounted for the agreement as a financing transaction. Accordingly, the
proceeds from the sale are recorded as a short term borrowing, the related gas
inventory is included in the Company's gas inventory, and the Company recorded
the difference between sale and repurchase price as interest expense in the
accompanying unaudited condensed consolidated financial statements.
The Company also recognized the fair value of the gas purchase agreement as a
derivative liability as of December 31, 2004. The fair value of the gas purchase
agreement as of December 31, 2004 was $743,500 and is reflected as a reduction
of revenue in the accompanying unaudited condensed consolidated financial
statements.
During January 2005, the Company repurchased the gas for $3,580,000 in
accordance with the terms of the gas purchase agreement. In accordance with
mark-to-market accounting, the Company reversed the derivative liability upon
the fulfillment of its obligation under the gas purchase agreement and will
reflect the related revenue of $743,500 in the unaudited condensed consolidated
financial statements for the three months ending March 31, 2005. Therefore, the
net effect of these two transactions for fiscal year 2005 will be an increase to
interest expense of $80,000.
NOTE 5 - NOTE RECEIVABLE
On August 21, 2003, EWP sold the majority of its wholesale propane assets in
Montana and Wyoming consisting of approximately $782,000 in storage and other
related assets and approximately $352,000 in inventory and accounts receivable.
The Company received cash of $750,000 and a promissory note for approximately
$620,000 to be repaid over a four year period, which is secured by the wholesale
propane assets sold. The balance due on the promissory note as of December 31,
2004 was approximately $409,000, of which $254,000 is included in Long-Term
Notes Receivable and the balance is included in Current Assets.
NOTE 6 -- DEFERRED CHARGES
Deferred Charges consist of the following:
DECEMBER 31, DECEMBER 31, JUNE 30,
2004 2003 2004
------------ ------------ ----------
Regulatory asset for property taxes $2,690,505 $2,880,448 $2,806,660
Regulatory asset for income taxes 458,753 458,753 458,753
Regulatory asset for deferred environmental
remediation costs 472,119 496,253 485,066
Other regulatory assets 75,152 81,603 77,858
Unamortized debt issue costs 1,365,502 1,744,214 1,660,078
---------- ---------- ----------
Total $5,062,031 $5,661,271 $5,488,415
========== ========== ==========
NOTE 7 - 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 an office facility for Company field
personnel and storage location for certain equipment and materials. 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.
11
The Company has completed its remediation of soil contaminants at the plant site
and in April of 2002 received a closure letter from Montana Department of
Environmental Quality ("MDEQ") approving the completion of such remediation
program.
The Company and its consultants continue to work with the MDEQ relating to the
remediation plan for water contaminants. The MDEQ has established regulations
that allow water contaminants at a site to exceed standards if it is technically
impracticable to achieve those standards. Although the MDEQ has not established
guidance respecting the attainment of a technical waiver, the U.S. Environmental
Protection Agency ("EPA") has developed such guidance. The EPA guidance lists
factors which render mediations technically impracticable. The Company has filed
a request for a waiver from complying with certain standards with the MDEQ.
At December 31, 2004, the Company had incurred cumulative costs of approximately
$1,963,000 in connection with its evaluation and remediation of the site. On May
30, 1995, the Company received an order from the MPSC allowing for recovery of
the costs associated with the evaluation and remediation of the site through a
surcharge on customer bills. As of December 31, 2004, the Company had recovered
approximately $1,491,000 through such surcharges.
On April 15, 2003, the MPSC issued an Order to Show Cause Regarding the
Environmental Surcharge. The MPSC determined that the initial order allowing the
collection of the surcharge was intended by the MPSC to cover only a two year
collection period, after which it would contemplate additional filings by the
Company, if necessary. The Company responded to the Show Cause Order and the
MPSC subsequently ordered the termination of the Environmental Surcharge on
August 20, 2003. The Company filed a request with the commission to continue the
collection of the surcharge until all expenses have been recovered. This request
was approved by the MPSC and the surcharge was reinstated in September 2004. The
Company is required, under the Commission's most recent order, to file with the
MPSC every two years for approval to continue the recovery of the surcharge.
LEGAL PROCEEDINGS
From time to time the Company is involved in litigation relating to claims
arising from its operations in the normal course of business. The Company
utilizes various risk management strategies, including maintaining liability
insurance against certain risks, employee education and safety programs and
other processes intended to reduce liability risk.
In addition to other litigation referred to above, the Company or its
subsidiaries are involved in the following described litigation.
On June 17, 2003, EWR and PPL Montana, LLC ("PPLM") reached agreement on a
settlement of a lawsuit involving a wholesale electricity supply contract. Under
the terms of the settlement, EWR paid PPLM a total of $3,200,000, consisting of
an initial payment of $1,000,000 on June 17, 2003, and a second payment of
$2,200,000 on September 30, 2003, terminating all proceedings in the case. EWR
had established reserves and accruals in fiscal year 2001 of approximately
$3,032,000 to pay a potential settlement with PPLM and the remaining $168,000
12
was charged to operating expenses in fiscal year 2003.
On August 8, 2003, the Company reached agreement with the Montana Department of
Revenue ("DOR") to settle a claim that the Company had under-reported its
personal property for the years 1997 - 2002 and that additional property taxes
and penalties should be assessed. The settlement amount is being paid in ten
annual installments of $243,000 each, and began November 30, 2003.
The Company initially determined that it was entitled to recover the amounts
paid in connection with the DOR settlement through future rate adjustments as a
result of legislation permitting "automatic adjustments" to rates to recover
such property tax increases. The MPSC, however, interpreted the new legislation
as allowing recovery of only a portion of the higher property taxes. Rates
recovering the portion of the higher taxes permitted under the MPSC's
interpretation of the legislation went into effect on January 1, 2004. The
Company has since obtained rate relief which includes full recovery of the
property tax associated with the DOR settlement.
NOTE 8 - SEGMENTS OF OPERATIONS
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31 DECEMBER 31
------------------------- --------------------------
2004 2003 2004 2003
---------- ------------- ---------- -------------
Gross margin (operating revenue
less cost of gas purchased):
Natural gas operations $3,575,172 $3,343,439 $5,328,788 $5,008,476
Propane operations 1,357,561 1,113,286 1,804,876 1,549,176
EWR 190,580 162,603 129,419 1,008,763
Pipeline operations 101,931 96,416 186,286 205,766
---------- ---------- ---------- ----------
5,225,244 4,715,744 7,449,369 7,772,181
---------- ---------- ---------- ----------
Operating income (loss):
Natural gas operations 1,137,072 777,953 582,037 (122,489)
Propane operations 595,668 248,199 321,273 75,817
EWR (260,935) (174,402) (651,516) 332,343
Pipeline operations 63,865 41,208 101,398 99,171
---------- ---------- ---------- ----------
1,535,670 892,958 353,192 384,842
---------- ---------- ---------- ----------
Net income (loss):
Natural gas operations 424,934 238,485 (213,319) (469,527)
Propane operations 307,355 84,107 106,619 (59,739)
EWR (198,972) (154,613) (491,937) 108,808
Pipeline operations 33,080 30,648 43,340 125,465
---------- ---------- ---------- ----------
$ 566,397 $ 198,627 $ (555,297) $ (294,993)
========== ========== ========== ==========
13
NOTE 9 - ACCRUED AND OTHER CURRENT LIABILITIES
Accrued and other current liabilities consist of the following:
DECEMBER 31, DECEMBER 31, JUNE 30,
2004 2003 2004
------------ ------------- ----------
Property tax settlement--current portion (Note 7) $ 243,000 $ 243,000 $ 243,000
Payable to employee benefit plans 340,982 309,482 545,375
Accrued vacation 402,723 438,008 394,219
Customer deposits 429,987 431,407 407,635
Accrued incentives 616,865 788,594 524,642
Accrued interest 108,870 172,573 103,047
Accrued taxes other than income 648,373 580,530 520,536
Deferred payments from levelized billing 1,045,682 641,497 496,897
Other short-term borrowing 3,500,000 -- --
Other 801,859 280,975 491,631
---------- ---------- ----------
Total $8,138,341 $3,886,066 $3,726,982
========== ========== ==========
NOTE 10 - OTHER LONG TERM LIABILITIES
Other long-term liabilities consist of the following:
DECEMBER 31, DECEMBER 31, JUNE 30,
2004 2003 2004
------------ ------------- ----------
Asset retirement obligation $ 602,351 $ 570,947 $ 586,229
Contribution in aid of construction 1,255,321 1,068,937 1,225,539
Customer advances for construction 629,849 551,610 603,589
Accumulated postretirement obligation 299,656 235,068 269,100
Deferred gain on sale leaseback of assets 35,453 59,081 47,267
Regulatory liability for income taxes 83,161 83,161 83,161
Property tax settlement (Note 7) 1,701,008 1,942,249 1,944,008
Other -- 30,107 --
---------- ---------- ----------
Total $4,606,799 $4,541,160 $4,758,893
========== ========== ==========
NOTE 11 - SUBSEQUENT EVENT
On January 3, 2005, EWR elected its one time option to reclassify certain sale
contracts which had previously been classified as mark-to-market derivative
contracts under SFAS No. 133. The contracts were reclassified as "normal
purchase and sale" contracts. The derivative liability on these contracts as of
January 3, 2005 was $1,238,765. This amount will be amortized into revenue over
the life of the existing sales contracts, which is approximately 4 years.
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following gives effect to the restatement of the Company's condensed
consolidated financial statements as discussed in Note 1.
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
FORWARD-LOOKING STATEMENTS
The following Management's Discussion and Analysis and other portions of this
quarterly report on Form 10-Q contain various "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of
14
1934, as amended, which represent the Company's expectations or beliefs
concerning future events. Forward-looking statements such as "anticipates,"
"believes," "expects," "planned," "scheduled" or similar expressions and
statements regarding the required restructuring of our debt, our operating
capital requirements, negotiations with our lender, recovery of property tax
payments, the Company's environmental remediation plans, and similar statements
that are not historical are forward-looking statements that involve risks and
uncertainties. Although the Company believes these forward-looking statements
are based on reasonable assumptions, statements made regarding future results
are subject to a number of assumptions, uncertainties and risks that could cause
future results to be materially different from the results stated or implied in
this document.
Such forward-looking statements, as well as other oral and written
forward-looking statements made by or on behalf of the Company from time to
time, including statements contained in the Company's filings with the
Securities and Exchange Commission and its reports to shareholders, involve
known and unknown risks and other factors which may cause the Company's actual
results in future periods to differ materially from those expressed in any
forward-looking statements. See "Risk Factors" below. Any such forward looking
statement is qualified by reference to these risk factors. The Company cautions
that these risk factors are not exclusive. The Company does not undertake to
update any forward looking statements that may be made from time to time by or
on behalf of the Company except as required by law.
RISK FACTORS
The major factors which will affect the Company's future results include general
and regional economic conditions, weather, customer retention and growth, the
ability to meet competitive pressures and to contain costs, the adequacy and
timeliness of rate relief, cost recovery and necessary regulatory approvals, and
continued access to capital markets. In addition, changes in the competitive
environment, particularly related to the Company's propane and energy marketing
segments, could have a significant impact on the performance of the Company.
The regulatory structure in which the Company operates is in transition.
Legislative and regulatory initiatives, at both the federal and state levels,
are designed to promote competition. The changes in the gas industry have
allowed certain customers to negotiate gas purchases directly with producers or
brokers. To date, open access in the gas industry has not had a negative impact
on earnings or cash flow of the Company's regulated segment. The Company's
regulated natural gas and propane vapor operations follow Statement of Financial
Accounting Standards (SFAS) No. 71 "Accounting for the Effects of Certain Types
of Regulation," and the financial statements reflect the effects of the
different rate-making principles followed by the various jurisdictions
regulating the Company. The economic effects of regulation can result in
regulated companies recording costs that have been or are expected to be allowed
in the ratemaking process in a period different from the period in which the
costs would be charged to expense by an unregulated enterprise. When this
occurs, costs are deferred as assets in the balance sheet (regulatory assets)
and recorded as expenses in the periods when those same amounts are reflected in
rates. Additionally, regulators can impose liabilities upon a regulated company
for amounts previously collected from customers and for amounts that are
expected to be refunded to customers (regulatory liabilities). If the Company's
natural gas and propane vapor operations
15
were to discontinue the application of SFAS No. 71, the accounting impact would
be an extraordinary, non-cash charge to operations that could be material to the
financial position and results of operation of the Company. However, the Company
is unaware of any circumstances or events in the foreseeable future that would
cause it to discontinue the application of SFAS No. 71.
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
various instruments with the Company. Credit risk may be concentrated to the
extent that one or more groups of counterparties have similar economic, industry
or other characteristics that would cause their ability to meet contractual
obligations to be similarly affected by changes in market or other conditions.
In addition, credit risk includes not only the risk that a counterparty may
default due to circumstances relating directly to it, but also the risk that a
counterparty may default due to circumstances which relate to other market
participants which have a direct or indirect relationship with such
counterparty. The Company seeks to mitigate credit risk by evaluating the
financial strength of potential counterparties. However, despite mitigation
efforts, defaults by counterparties may occur from time to time.
Among the risks involved in natural gas marketing is the risk of nonperformance
by counterparties to contracts for purchase and sale of natural gas. EWR is
party to certain contracts for purchase or sale of natural gas at fixed prices
for fixed time periods. Some of these contracts are recorded as derivatives,
valued on a mark-to-market basis. At December 31, 2004, the net fair value of
the contracts was a derivative liability of approximately $2.2 million.
In addition to the factors discussed above, the following are important factors
that could cause actual results to differ materially from any results projected,
forecasted, estimated or budgeted:
- - Fluctuating energy commodity prices, including prices for fuel and
purchased power;
- - The possibility that regulators may not permit the Company to pass through
all such increased costs to customers;
- - Fluctuations in wholesale margins due to uncertainty in the wholesale
propane and power markets;
- - Changes in general economic conditions in the United States and changes in
the industries in which the Company conducts business;
- - Changes in federal or state laws and regulations to which the Company is
subject, including tax, environmental and employment laws and regulations;
- - The impact of FERC and state public service commission statutes and
regulations, including allowed rates of return, and the resolution of other
regulatory matters;
- - The ability of the Company and its subsidiaries to obtain governmental and
regulatory approval of various expansion or other projects;
16
- - The costs and effects of legal and administrative claims and proceedings
against the Company or its subsidiaries;
- - Conditions of the capital markets the Company utilizes to access capital to
finance operations;
- - The ability to raise capital in a cost-effective way;
- - The ability to meet financial covenants imposed by lenders to be able to
draw down on revolving lines of credit;
- - The effect of changes in accounting policies, if any;
- - The ability to manage growth of the Company;
- - The ability to control costs;
- - The ability of each business unit to successfully implement key systems,
such as service delivery systems;
- - The ability of the Company and its subsidiaries to develop expanded markets
and product offerings as well as their ability to maintain existing
markets;
- - The ability of customers of the energy marketing and trading business to
obtain financing for various projects;
- - The ability of customers of the energy marketing and trading business to
obtain governmental and regulatory approval of various projects;
- - Future utilization of pipeline capacity, which can depend on energy prices,
competition from alternative fuels, the general level of natural gas and
propane demand, decisions by customers not to renew expiring natural gas or
propane contracts, and weather conditions; and
- - Global and domestic economic repercussions from terrorist activities and
the government's response thereto.
17
GENERAL BUSINESS DESCRIPTION
Energy West, Incorporated (the "Company") is a regulated public utility, with
certain non-utility operations conducted through its subsidiaries. The Company
was originally incorporated in Montana in 1909. The Company has four business
segments:
Natural Gas Operations Distribute natural gas to approximately 33,000
customers through regulated utilities operating in
and around Great Falls and West Yellowstone,
Montana, and Cody, Wyoming. The approximate
population of the service territories is 100,000.
Propane Operations Distribute propane to approximately 7,600
customers through regulated utilities operating
underground vapor systems in and around Payson,
Pine and Strawberry, Arizona. Non-regulated
operations include retail distribution of bulk
propane to approximately 2,200 customers in the
same Arizona communities. The approximate
population of the service territories is 40,000.
Energy West Resources,Inc. Market approximately 3 billion cubic feet ("BCF")
(EWR) of natural gas to commercial and industrial
customers in Montana and Wyoming and manage
midstream supply and production assets for
transportation customers and utilities. EWR also
has an ownership interest in production and
gathering assets.
Pipeline Operations (Energy Owns the Shoshone interstate and the Glacier
West Development, Inc. gathering pipeline assets located in Montana and
(EWD)) Wyoming. Certain natural gas producing wells owned
by EWD are being operated, managed, and reported
in EWR.
18
ENERGY WEST, INCORPORATED AND SUBSIDIARIES
DECEMBER 31, 2004
The following discussion of the Company's financial condition and results of
operations should be read in conjunction with the condensed consolidated
financial statements and Notes thereto and other financial information included
elsewhere in this report and the Company's Annual Report on Form 10-K for the
year ended June 30, 2004. The following gives effect to the restatement of the
unaudited condensed consolidated financial statements as of December 31, 2003
and for the three and six month periods ended December 31, 2003 as described in
Note 1 to the unaudited condensed consolidated financial statements. Results of
operations for interim periods are not necessarily indicative of results to be
attained for any future period.
FISCAL QUARTER ENDED DECEMBER 31, 2004 COMPARED TO FISCAL QUARTER ENDED DECEMBER
31, 2003
Net Income
The Company's net income for the second quarter of fiscal year 2005 was $566,000
compared to net income of $199,000 in the second quarter of fiscal year 2004, an
increase of $367,000. This increase was primarily due to rate increases in the
Natural Gas Division and higher sales volumes in the Propane Division.
Revenues
The Company's revenues for the second quarter of fiscal year 2005 were
$22,888,000 compared to $22,626,000 in the second quarter of fiscal year 2004,
an increase of $262,000. EWR gas revenues decreased by $2,188,000 due to a
decrease in volumes sold, a decrease in electric revenue and a decrease in
production revenue, offset by a $152,000 favorable change in the fair value of
derivatives under mark-to-market accounting. The increase in revenues of the
Natural Gas Operations was $1,563,000 due primarily to a $1,331,000 rise in gas
costs and $232,000 in rate relief from the 2004 general rate filing. Propane
Operations experienced an increase in revenues of $881,000 due to higher sales
volumes and prices.
Gross Margin
Gross margin, which is defined as revenue less gas purchases and costs of gas
and electricity (wholesale), increased $509,000 from $4,716,000 in the second
quarter of fiscal year 2004 to $5,225,000 in the second quarter of fiscal year
2005. EWR's margin increased by $28,000 due to a mark-to-market gain of $152,000
as a result of a change in derivative values, and an increase in electricity
margin. These increases were offset by a $140,000 decrease primarily
attributable to the reduction in gas margin. The Propane Operations' margins
increased $244,000 due primarily to increases in volumes and prices in Arizona
offset by margin decreases from the sale of wholesale propane assets of Rocky
Mountain Fuels ("RMF") in August 2003. Natural Gas margins
19
increased $232,000 primarily due to rate relief related to the 2004 general rate
filing in Great Falls. The Pipeline Operation experienced a gross margin
increase of $6,000 due to the re-opening of the Glacier line and new shippers on
the line.
Expenses Other Than Gas Purchased
Expenses other than gas purchased decreased by $133,000, from $3,823,000 in the
second quarter of fiscal year 2004 to $3,690,000 in the second quarter of fiscal
year 2005. The primary reasons for this change were (1) decreases of $373,000
for legal and professional fees incurred during the second quarter of fiscal
year 2005, which include fees related to the accounting restatement, compared to
fees related to the proxy contest and bank financing costs incurred in the
second quarter of fiscal year 2004, (2) decreases in depreciation expense of
$31,000, partially offset by (3) increases in taxes other than income of
$219,000, primarily due to higher property taxes. These increases in property
taxes are being recovered in rates.
Other Income
Other income for the second quarter of fiscal year 2005 was $141,000 compared to
$66,000 for the second quarter of fiscal year 2004, an increase of $75,000. EWR
settled a dispute resulting in $58,000 of other income, which increased $61,000
from the second quarter of fiscal year 2004. Other Propane income of $9,000
increased primarily due to interest income generated from the sale of propane
assets that occurred on August 21, 2003. Other Natural Gas income had an
increase of $6,000.
Interest Expense
Interest expense for the second quarter of fiscal year 2005 was $722,000
compared to $647,000 for the second quarter of fiscal year 2004, an increase of
$75,000 due to increased borrowings and higher interest rates in fiscal year
2005.
Income Tax Expense
Income tax expense for the second quarter of fiscal year 2004 was $113,000
compared to $389,000 for the second quarter of fiscal year 2005, an increase of
$276,000. This increase was due to higher pretax income in the second quarter of
fiscal year 2005.
SIX MONTHS ENDED DECEMBER 31, 2004 COMPARED TO SIX MONTHS ENDED DECEMBER 31,
2003
Net Loss
The Company's net loss for the first six months of fiscal year 2005 was $555,000
compared to a net loss of $295,000 in the first six months of fiscal year 2004,
an increase of $260,000. This increase was primarily due to lower gross margins
totaling $323,000, an increase in interest expense of $381,000 and a decrease
in other income of $51,000, partially offset by decreased operating expenses of
$291,000 and a decrease in income taxes of $203,000.
20
Revenues
The Company's revenues for the first six months of fiscal year 2005 were
$34,755,000 compared to $35,113,000 in the first six months of fiscal year 2004,
a decrease of $358,000. The increase in Natural Gas Operations was $2,107,000
due primarily to a $1,787,000 rise in gas costs and $320,000 in rate relief from
the 2004 general rate filing. EWR revenues decreased by $2,998,000 due to a
decrease in volumes sold, a decrease of $131,000 due to an unfavorable change in
the fair value of derivatives under mark-to-market accounting, and decreases in
electric and production revenue. The Propane Operations experienced an increase
of $552,000 due to higher sales volume and prices.
Gross Margin
Gross margin, which is defined as revenue less gas purchases and costs of gas
and electricity (wholesale), decreased $323,000, from $7,772,000 in the first
six months of fiscal year 2004 to $7,449,000 in the first six months of fiscal
year 2005. EWR's margin decreased by $879,000 due to lower volumes, a $131,000
decrease due to an unfavorable change in the fair value of derivatives under
mark-to-market accounting, and decreases in electric and production margin.
Natural Gas margins increased $320,000 primarily due to rate relief related to
the 2004 general rate filing in Great Falls. The Propane Operations margin
increased $256,000 due primarily to increases in volumes and prices in Arizona
offset by the loss of margins due to the sale of the wholesale propane assets of
RMF in August 2003. EWD experienced a gross margin decrease of $20,000 due to
the Glacier line being out of operation part of the year.
Expenses Other Than Gas Purchased
Expenses other than gas purchased decreased by $291,000, from $7,387,000 in the
first six months of fiscal year 2004 to $7,096,000 in the first six months of
fiscal year 2005. The primary reasons for this change were (1) decreases of
$736,000 for legal and professional fees incurred during the first six months of
fiscal year 2005, which includes fees related to the accounting restatement,
compared to fees related to the proxy contest, bank financing and PPLM
litigation costs incurred in the first six months of fiscal year 2004, (2) a net
decrease in depreciation expense of $50,000, offset by (3) increases in taxes
other than income of $339,000, primarily due to higher property taxes (which are
recovered in rates), (4) increases in general and administrative expenses of
$87,000.
Other Income
Other Income for the first six months of fiscal year 2005 was $207,000 compared
to $258,000 for the first six months of fiscal year 2004, a decrease of $51,000.
The Pipeline Operations had a decrease of $121,000 due to the sale of certain
non-operating real estate assets located in Montana during the first six months
of fiscal year 2004. EWR had an increase of $58,000 from a
21
contract settlement. Other income in the Propane Operations of $25,000 increased
primarily due to interest income generated from the sale of propane assets that
occurred on August 21, 2003. Natural Gas Operations had a decrease in other
income of $13,000 due to the sale of vehicles during the six months ended
December 31, 2003.
Interest Expense
Interest expense for the first six months of fiscal year 2005 was $1,474,000
compared to $1,093,000 for the first six months of fiscal year 2004, an increase
of $381,000, due to increased borrowings and higher interest rates in fiscal
year 2005.
Income Tax Benefit
Income tax benefit for the first six months of fiscal year 2004 was $155,000
compared to an income tax benefit of $358,000 for the first six months of fiscal
year 2005, an increase of $203,000. This increase was due to a higher pretax
loss in the first six months of fiscal year 2005, compared to the first six
months of fiscal year 2004.
OPERATING RESULTS OF THE COMPANY'S NATURAL GAS OPERATIONS
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
--------------------------- ---------------------------
2004 2003 2004 2003
----------- ------------- ----------- -------------
Natural Gas Revenues $14,228,550 $12,665,598 $19,436,226 $17,328,606
Natural Gas Purchased 10,653,378 9,322,159 14,107,438 12,320,130
----------- ----------- ----------- -----------
Gross Margin 3,575,172 3,343,439 5,328,788 5,008,476
Operating Expenses 2,438,100 2,565,486 4,746,751 5,130,965
----------- ----------- ----------- -----------
Operating Income (Loss) 1,137,072 777,953 582,037 (122,489)
Other Income 33,558 27,459 47,704 60,934
----------- ----------- ----------- -----------
Income (Loss) Before Interest and Taxes $ 1,170,630 $ 805,412 $ 629,741 $ (61,555)
=========== =========== =========== ===========
FISCAL QUARTER ENDED DECEMBER 31, 2004 COMPARED TO FISCAL QUARTER ENDED DECEMBER
31, 2003
Natural Gas Revenues and Gross Margin
Operating revenues for the second quarter of fiscal year 2005 were approximately
$14,229,000 compared to approximately $12,666,000 for the second quarter of
fiscal year 2004, an increase of approximately $1,563,000. The increase in
revenues is primarily due to a $1,331,000 rise in gas costs and $232,000 in rate
relief from the 2004 general rate filing.
22
Gas costs increased to $10,653,000 in the second quarter of fiscal year 2005
from $9,322,000 in the second quarter of fiscal year 2004, an increase of
approximately $1,331,000, or 14%, due to higher commodity cost compared to the
same quarter of the previous year.
Gross margin, which is defined as operating revenues less gas purchased, was
approximately $3,575,000 for the second quarter of fiscal year 2005, compared to
a gross margin of approximately $3,343,000 for the second quarter of fiscal year
2004. The increase of $232,000 in gross margin is primarily due to rate relief
from the 2004 general rate filing in the Great Falls area, offset by warmer than
normal weather in November and December of fiscal year 2005.
Natural Gas Operating Expenses
Operating expenses decreased approximately $127,000, from $2,565,000 in the
second quarter of fiscal year 2004 to $2,438,000 in the second quarter of fiscal
year 2005. The decrease in operating expenses is primarily a result of decreases
of approximately $90,000 for legal and professional fees incurred during the
second quarter of fiscal year 2005 compared to fees related to the proxy contest
and bank financing costs incurred in the second quarter of fiscal year 2004.
SIX MONTHS ENDED DECEMBER 31, 2004 COMPARED TO SIX MONTHS ENDED DECEMBER 31,
2003
Natural Gas Revenues and Gross Margin
Natural gas operating revenues in the first six months of fiscal year 2005 were
approximately $19,436,000 compared to approximately $17,329,000 for the first
six months of fiscal year 2004, an increase of approximately 12%. The increase
is primarily due to a $1,787,000 rise in gas costs and $320,000 in rate relief
from the 2004 general rate filing.
Gas costs increased from $12,320,000 for the first six months of fiscal year
2003 to $14,107,000 for the first six months of fiscal year 2004, an increase of
$1,787,000. This increase is due to higher prices of natural gas compared to the
first six months of fiscal year 2004.
Gross margin, which is defined as operating revenues less gas purchased, was
approximately $5,329,000 for the first six months of fiscal year 2005, compared
to a gross margin of approximately $5,008,000 for the first six months of fiscal
year 2004. The increase in margin is primarily related to rate relief generated
from the 2004 general rate case in Great Falls offset by warmer than normal
weather in November and December of fiscal year 2005.
Natural Gas Operating Expenses
Operating expenses from Natural Gas Operations decreased approximately $384,000,
from $5,131,000 for first six months of fiscal year 2004 to $4,747,000 for the
first six months of fiscal year 2005. The decrease in operating expenses is
related primarily to decreases of (1) $503,000
23
for legal and financing activities associated with costs for a proxy contest,
financing activities, and PPLM lawsuit incurred in the prior year, (2) $217,000
in general administrative and maintenance costs primarily due to salary
reductions of $57,000, reduction in insurance expense of $50,000, and other cost
saving measures, and (3) $7,000 decrease in depreciation. Offsetting these
decreases is an increase in taxes other than income of $343,000 primarily
related to property tax increases in Great Falls, which is being recovered
through rates.
Natural Gas Other Income
Other income decreased from $61,000 for the first six months of fiscal year 2003
to $48,000 for the first six months of fiscal year 2004, a decrease of $13,000.
OPERATING RESULTS OF THE COMPANY'S PROPANE OPERATIONS
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-------------------------- --------------------------
2004 2003 2004 2003
---------- ------------- ---------- -------------
Propane Revenues $3,022,491 $2,141,177 $3,875,102 $3,323,078
Propane Purchased 1,664,930 1,027,891 2,070,226 1,773,902
---------- ---------- ---------- ----------
Gross Margin 1,357,561 1,113,286 1,804,876 1,549,176
Operating Expenses 761,893 865,087 1,483,603 1,473,359
---------- ---------- --------- ----------
Operating Income 595,668 248,199 321,273 75,817
Other Income 51,202 42,340 103,231 77,935
---------- ---------- ---------- ----------
Income Before Interest and Taxes $ 646,870 $ 290,539 $ 424,504 $ 153,752
========== ========== ========== ==========
FISCAL QUARTER ENDED DECEMBER 31, 2004 COMPARED TO FISCAL QUARTER ENDED DECEMBER
31, 2003
Propane Operating Revenues and Gross Margin
Revenues for the second quarter of fiscal year 2005 were $3,022,000 compared to
$2,141,000 for the second quarter of fiscal year 2004, an increase of $881,000
or 41%. This increase was primarily attributable to higher prices in the propane
market and an increase in sales volumes of 27% due to colder weather in the
Arizona market. RMF sold its wholesale propane assets during the first quarter
of fiscal year 2004, and discontinued sales in the northwestern United States.
RMF maintained one customer in Arizona after the sale, but had no sales to this
customer in fiscal year 2004 due to a shortage of inventory in Arizona. In the
second quarter of fiscal year 2005 however, RMF had sales of $251,000 to this
customer in Arizona. Cost of
24
sales for the second quarter of fiscal year 2005 were $1,665,000 compared to
$1,028,000 in the second quarter of fiscal year 2004. This increase of $637,000
is due to increased prices and volumes. These factors combined to create a gross
margin increase in the Propane Operations of $245,000, from $1,113,000 in the
second quarter fiscal year 2004 to $1,358,000 in the second quarter of fiscal
year 2005.
Propane Operating Expenses
Propane operating expenses for the second quarter of fiscal year 2005 were
$762,000 compared to $865,000 for the second quarter of fiscal year 2004. This
savings of $103,000 was primarily attributable to a $10,000 decrease in general
and administrative expenses, a $2,000 decrease in maintenance expense, a $19,000
decrease in taxes other than income taxes, and a $74,000 decrease in legal and
financing activities related to the proxy contest and financing costs, offset by
a $3,000 increase in depreciation expense.
Propane Other Income
Other income increased $9,000 from $42,000 in the second quarter fiscal year
2004 to $51,000 in the second quarter fiscal year 2005, primarily due to
interest income generated on the note receivable from the sale of propane assets
that occurred on August 21, 2003.
SIX MONTHS ENDED DECEMBER 31, 2004 COMPARED TO SIX MONTHS ENDED DECEMBER 31,
2003
Propane Revenues and Gross Margin
Revenues for the first six months of fiscal year 2005 were $3,875,000 compared
to $3,323,000 for the first six months of fiscal year 2004, an increase of
$552,000 or 17%. The Arizona operations experienced an increase in volumes of
12% while RMF volumes decreased 64% due to the sale of wholesale propane assets
on August 21, 2003, which resulted in the loss of customers in the northwestern
United States. Coupled with the volume fluctuations were higher propane prices
resulting in higher revenues per volume sold. Cost of sales for the first six
months of fiscal year 2005 were $2,070,000 compared to $1,774,000 in the first
six months of fiscal year 2004. This increase of $296,000 is due to increased
prices and volumes. These factors combined to create a gross margin increase in
the Propane Operations of $256,000, from $1,549,000 in the first six months of
fiscal year 2004 to $1,805,000 in the first six months of fiscal year 2005.
Propane Operating Expenses
Propane operating expenses for the first six months of fiscal year 2005 were
$1,484,000 compared to $1,473,000 for the first six months of fiscal year 2004.
The sale of RMF's operating assets in August 2003 resulted in an offset to
expenses of $185,000 in 2004 not repeated in fiscal year 2005. This increase was
offset by to a $151,000 decrease from professional services in fiscal year 2004
that were related to the proxy contest, financing costs, and PPLM litigation,
and a $23,000 decrease in depreciation, maintenance, and taxes other than income
taxes.
25
Propane Other Income
Other income increased $25,000 from $78,000 in the first six months of fiscal
year 2004 to $103,000 in the first six months of fiscal year 2005 primarily due
to interest income on the note receivable generated from the sale of propane
assets that occurred on August 21, 2003.
OPERATING RESULTS OF THE COMPANY'S EWR MARKETING OPERATIONS
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-------------------------- ---------------------------
2004 2003 2004 2003
---------- ------------- ----------- -------------
EWR Revenues $5,535,177 $7,722,500 $11,257,684 $14,255,691
EWR Purchases 5,344,597 7,559,897 11,128,265 13,246,928
---------- ---------- ----------- -----------
Gross Margin 190,580 162,603 129,419 1,008,763
Operating Expenses 451,515 337,005 780,935 676,420
---------- ---------- ----------- -----------
Operating Income (Loss) (260,955) (174,402) (651,516) 332,343
Other Income (Expense) 56,535 (4,009) 56,535 (1,384)
---------- ---------- ----------- -----------
Income (Loss) Before Interest and Taxes $ (204,400) $ (178,411) $ (594,981) $ 330,959
========== ========== =========== ===========
FISCAL QUARTER ENDED DECEMBER 31, 2004 COMPARED TO FISCAL QUARTER ENDED DECEMBER
31, 2003
EWR Gas Revenues and Gross Margin
Revenues decreased by $2,188,000 from $7,723,000 in the second quarter of fiscal
year 2004 to $5,535,000 in the second quarter of fiscal year 2005. Gas revenues
decreased by $2,235,000 due to a 40% decrease in volumes sold, a $3,000 decrease
in electric revenue and a decrease in net production of $102,000. The decreases
were offset by $152,000 due to a favorable change in the fair value of
derivatives under mark-to-market accounting.
Purchases decreased by $2,215,000 from $7,560,000 in the second quarter of
fiscal year 2004 to $5,345,000 in the second quarter of 2005. Gas cost
decreased by $2,195,000 due to a 37% decrease in volumes purchased. EWR also
experienced a rise in the cost of electricity of $20,000.
Gross margin increased by $28,000. The increase is due to a mark-to-market gain
of $152,000 as a result of the change in derivative values, and a $16,000
increase in electricity margin. The increases were offset by a decrease in gas
margins of $112,000 due to a decrease in volumes sold, and by a decrease of
$22,000 in production margin.
EWR Operating Expenses
Operating expenses increased by $115,000, from $337,000 in the second quarter
of fiscal year 2004 to $452,000 in the second quarter of 2005. This increase is
primarily due to an increase in professional services of $211,000 resulting from
the review of the gas purchase and gas sale contracts and related accounting
restatement. The increase is offset by a decrease of $15,000 in salary and
employee benefits, $34,000 in overhead, $3,000 in bad debt expense, $24,000 in
depreciation and depletion, $5,000 in cost of letters of credit, $5,000 in
publications and business fees, $3,000 in taxes other than income, $3,000 for
insurance and $4,000 in various general and administrative accounts.
26
EWR Other Income
Other income increased $61,000 due primarily to the settlement of a contract
dispute.
SIX MONTHS ENDED DECEMBER 31, 2004 COMPARED TO SIX MONTHS ENDED DECEMBER 31,
2003
EWR Gas Revenues and Gross Margin
Revenues decreased by $2,998,000 from $14,256,000 in the first six months of
fiscal year 2004 to $11,258,000 in the first six months of fiscal year 2005. Gas
revenues decreased by $2,732,000 due to a 24% decrease in volumes sold, a
decrease of $131,000 as a result of an unfavorable change in the fair value of
derivatives under mark-to-market accounting, an $80,000 decrease in electric
revenue, and a decrease in net production of $55,000.
Purchases decreased by $2,119,000 from $13,247,000 in the first six months of
fiscal year 2004 to $11,128,000 in the first six months of fiscal year 2005. Gas
cost decreased by $2,115,000 due to a 28% decrease in volumes purchased. EWR
also experienced a rise in the cost of electricity of $4,000.
Margin decreased by $879,000 due to decreases of $653,000 in gas margin as a
result of lower sales volumes, a $131,000 decrease due to an unfavorable change
in the fair value of derivatives under mark-to-market accounting, a decrease in
electric margin of $75,000 due primarily to the termination of an agreement
under which the Company provided billing services, and a decrease in production
margin of $20,000.
EWR Operating Expense
Operating expenses increased by $105,000, from $676,000 in the first six months
of fiscal year 2004 to $781,000 in the first six months of fiscal year 2005.
This increase is primarily due to an increase in professional services of
$315,000 resulting from the review of the gas purchase and gas sale contracts
and related accounting restatement, and a $3,000 increase in general and
administrative expense. The increase is offset by a decrease of $57,000 in
salary and employee benefits, $66,000 in overhead, $18,000 in bad debt expense,
$37,000 in depreciation and depletion, $13,000 in cost of letters of credit,
$7,000 decrease in publications and business fees, $4,000 in taxes other than
income, $5,000 for insurance, and $6,000 in phone expenses.
27
EWR Other Income
Other income increased by $58,000 primarily due to the settlement of a contract
dispute.
OPERATING RESULTS OF THE COMPANY'S PIPELINE OPERATIONS
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------ ------------------------
2004 2003 2004 2003
-------- ------------- -------- -------------
Pipeline Revenues $101,931 $96,416 $186,286 $205,766
Pipeline Purchases -- -- -- --
-------- ------- -------- --------
Gross Margin 101,931 96,416 186,286 205,766
Operating Expenses 38,066 55,208 84,888 106,595
-------- ------- -------- --------
Operating Income 63,865 41,208 101,398 99,171
Other Income -- -- -- 120,922
-------- ------- -------- --------
Income Before Interest and Taxes $ 63,865 $41,208 $101,398 $220,093
======== ======= ======== ========
FISCAL QUARTER ENDED DECEMBER 31, 2004 COMPARED TO FISCAL QUARTER ENDED DECEMBER
31, 2003
Pipeline Gross Margin
Gross margin from Pipeline Operations increased by $6,000 from $96,000 in the
second quarter of fiscal 2004 to $102,000 in the second quarter of fiscal year
2005. This increase is due to the re-opening of the Glacier line and new
shippers.
28
Pipeline Operating Expenses
Operating expenses decreased by $17,000, from $55,000 in the second quarter of
fiscal year 2004 to $38,000 in the second quarter of fiscal year 2005. This
decrease was due primarily to decreases of $6,000 in labor, $9,000 in corporate
overhead expenses, $1,000 in salary, $1,000 in maintenance, $3,000 in outside
services and $2,000 in various general and administrative expense. The decrease
was partially offset by a $3,000 increase in property taxes and a $2,000
increase in depreciation.
Pipeline Other Income
EWD had no other income in the second quarter of fiscal year 2004 or in fiscal
year 2005.
SIX MONTHS ENDED DECEMBER 31, 2004 COMPARED TO SIX MONTHS ENDED DECEMBER 31,
2003
Pipeline Gross Margin
Gross margin from Pipeline Operations decreased by $19,000 from $206,000 in the
second quarter of fiscal year 2004 to $186,000 in the second quarter of fiscal
year 2005. The decrease is a result of the Glacier line being out of operation
due to hydrocarbon and water dew points being out of specifications. EWD
contracted with Summit Energy to construct a processing plant that will process
the gas to pipeline specifications. The plant became operational during the
first week of November 2004.
Pipeline Operating Expense
Operating expenses from the Pipeline Operations decreased by $22,000 from
$107,000 for the first six months of fiscal year 2004 to $85,000 for the first
six months of fiscal year 2005. This decrease was due primarily to decreases of
$14,000 in labor, $16,000 in corporate overhead expenses, $12,000 in salary, and
$3,000 in various general and administrative expenses. The decrease was
partially offset by a $14,000 increase in property taxes, $7,000 for maintenance
on the Glacier line and a $2,000 increase in depreciation.
Pipeline Other Income
Other income for the first six months of fiscal year 2004 included the sale of
certain non-operating real estate assets located in Montana, which resulted in a
gain of $121,000.
29
CASH FLOWS ANALYSIS FOR THE SIX MONTHS ENDED DECEMBER 31, 2004 COMPARED TO THE
SIX MONTHS ENDED DECEMBER 31, 2003
CASH FLOWS USED IN OPERATING ACTIVITIES
Cash flows used in operations during the six months ended December 31, 2004 were
improved approximately $7.3 million compared to the six months ended December
31, 2003. The Company's change in operating cash flows was driven by the
following events and factors:
- Decrease in net income for the six months ended December 31, 2004,
- Settlement payment of $2.2 million to PPL in the first quarter of
fiscal year 2004,
- Higher inventory purchases in the first six months of the prior year
compared to the first six months ended December 31, 2004,
- Increase in cash flows resulting from fluctuations in accounts
payable,
- Decrease in cash flows resulting from fluctuations in accounts
receivable
The amount of debt has substantially increased resulting in higher interest
costs, which will continue to unfavorably impact operating cash flows. The
Company is currently required to retire debt through the use of proceeds
generated from the sale of equity securities under the terms of the LaSalle
Facility.
The Company is attempting to improve operating cash flows by improving the
efficiency of the core businesses, increasing revenues through utility rates,
retiring debt and restructuring existing debt obligations.
CASH FLOWS USED IN INVESTING ACTIVITIES
Cash flows used in investing activities in the six months ended December 31,
2004 increased approximately $1,251,000 from the six months ended December 31,
2003. These changes are primarily due to (1) increased construction expenditures
of $451,000 and (2) the prior year period included approximately $840,000 in
proceeds from the sale of wholesale propane assets.
CASH FLOWS FROM FINANCING ACTIVITIES
Cash flows from financing activities decreased approximately $2.1 million in the
six months ended December 31, 2004 from the six months ended December 31, 2003
mainly due to decreased advances and increased repayments against the line of
credit under the LaSalle Facility and proceeds from short term borrowings.
30
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
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. When 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 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 purchased 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 and
fall months and the Company's short-term borrowing needs for financing customer
accounts receivable are greatest during the winter months.
The Company substantially restructured its credit facilities during fiscal year
2004. On September 30, 2003, the Company established a $23.0 million revolving
credit facility with LaSalle Bank National Association (the "Lender"), replacing
a previous short-term line of credit. The MPSC order granting approval of the
$23.0 million credit facility imposes restrictions on the use of the proceeds to
utility purposes, and requires the Company to provide monthly reports to the
MPSC with respect to the financial condition of the Company. The Company
continues to be subject to these MPSC requirements.
On March 31, 2004, the Company entered into a restated credit agreement with the
Lender. Pursuant to the restated credit agreement, the previous $23.0 million
revolving credit facility was replaced with a $15.0 million short-term revolving
credit facility, a $6.0 million term loan maturing on March 31, 2009, and a $2.0
million term loan maturing on September 30, 2004 (collectively referred to as
the "LaSalle Facility").
As of August 30, 2004, the Company and the Lender amended certain covenants
under the LaSalle Facility as follows: (1) increased the total debt to capital
ratio from .65 to .70, (2) allowed the exclusion of extraordinary expenses
incurred by the Company for legal fees and costs of the PPLM litigation,
expenses and costs associated with the credit facilities, proxy contest costs,
and the costs of adoption of the shareholder rights plan, in determining the
interest coverage ratio, and (3) waived compliance with the ratios referred to
in (1) and (2) above as of June 30, 2004 in addition to a shareholder's
acquisition of more than 15% of the outstanding common stock of the Company.
During the quarter ended September 30, 2004, the Company entered into an
interest-rate swap agreement related to the LaSalle Facility. The interest-rate
swap agreement converts a declining notional amount of variable rate debt to a
fixed rate of 7.4%. The amortizing notional principal amount begins at
$2,933,333 on August 9, 2004 and amortizes to $2,016,666 as of March 31, 2009.
The effect of the interest rate swap, therefore, is to fix the rate of interest
at 7.4% for that portion of the Company's term loan under the LaSalle Facility.
As of November 30, 2004, the Company executed an agreement with the Lender under
the LaSalle Facility providing for (i) an extension of the revolving facility
until November 28, 2005; (ii) an extension of the date to consummate infusions
of new equity of at least $2.0 million and to repay the $2.0 million term loan
to October 1, 2005; (iii) a conditional waiver of the deadline to deliver
audited financial statements for fiscal year 2004 and the deadline to deliver
financial statements for the fiscal quarter ended September 30, 2004; (iv) a
waiver of the technical default that otherwise would have been caused by the
restatement of financial results of prior periods; (v) modification of interest
rates applicable to the $2.0 million term loan; (vi) a limitation of $1.0
31
million on total loans and additional capital investment from the Company to
EWR; and (vii) waivers of certain financial covenant defaults as of September
30, 2004.
As of February 14, 2005, the Lender under the LaSalle Facility waived compliance
with the total debt to capital ratio as of December 31, 2004. In addition, the
Lender waived compliance with financial covenants relating to the interest
coverage ratio and indebtedness to third parties which resulted from the
Company's sale of gas inventory in the second quarter and related agreement to
purchase gas in the third quarter.
Borrowings under the LaSalle Facility are secured by liens on substantially all
of the assets of the Company and its subsidiaries. The Company's obligations
under certain other notes and industrial development revenue obligations are
secured on an equal and ratable basis with the Lender in the collateral granted
to secure the borrowings under the LaSalle Facility with the exception of the
first $1.0 million of debt under the LaSalle Facility.
Under the LaSalle Facility the Company may elect to pay interest on portions of
the amounts outstanding under the $15.0 million revolving line of credit at the
London interbank offered rate (LIBOR), plus 250 basis points, for interest
periods selected by the Company. For all other balances outstanding under the
$15.0 million revolving line of credit, the Company pays interest at the rate
publicly announced from time to time by LaSalle Bank as its "prime rate" (the
"Prime Rate"). For the $6.0 million term loan under the LaSalle Facility, the
Company may elect to pay interest at either the applicable LIBOR rate plus 350
basis points or at the Prime Rate plus 200 basis points. Pursuant to the
November 30, 2004 amendment to the LaSalle Facility, the interest rate on the
$2.0 million term loan will be the Prime Rate plus 200 basis points through
March 31, 2005; the Prime Rate plus 300 basis points from April 1, 2005 through
June 30, 2005; and the Prime Rate plus 400 basis points from and after July 1,
2005. The Company also pays a commitment fee of 35 basis points for the daily
unutilized portion of the $15.0 million revolving credit facility.
The LaSalle Facility requires the Company to maintain compliance with a number
of financial covenants, including meeting limitations on annual capital
expenditures, maintaining a total debt to total capital ratio and an interest
coverage ratio. At December 31, 2004, the Company was in compliance with the
financial covenants under the LaSalle Facility other than the total debt to
capital ratio, which was waived by the Lender. The LaSalle Facility also
restricts the Company's ability to pay dividends during any period to a certain
percentage of cumulative earnings of the Company over that period, and restricts
open positions and Value at Risk (VaR) in the Company's wholesale operations.
In June 2003, the Company's Board of Directors suspended the Company's dividends
to allow for strengthening of the Company's balance sheet. No determination has
been made with respect to resumption of cash dividend payments.
At December 31, 2004, the Company had approximately $5.0 million of cash on
hand. In addition, at December 31, 2004, the Company had borrowed approximately
$14.6 million under the LaSalle Facility revolving line of credit. The Company's
short-term borrowings under its lines of credit during the first quarter of
fiscal year 2005 had a daily weighted average interest rate of 5.54% per annum.
The Company's net availability at December 31, 2004, was approximately $0.4
million under the LaSalle Facility revolving line of credit. As discussed above,
the Company's short-term borrowing needs for purchases of gas inventory and
capital expenditures are greatest during the summer and fall months. The
Company's cash availability normally increases in January as monthly heating
bills are paid and gas purchases to build inventory are no longer necessary.
32
In addition to the LaSalle Facility, the Company has outstanding certain notes
and industrial development revenue obligations (collectively "Long Term Notes
and Bonds"). The Company's Long Term Notes and Bonds are made up of three
separate debt issues: $8.0 million of Series 1997 notes bearing interest at an
annual rate of 7.5%; $7.8 million of Series 1993 notes bearing interest at
annual rates ranging from 6.20% to 7.60%; and Cascade County, Montana Series
1992B Industrial Development Revenue Obligations in the amount of $1.8 million
bearing interest at annual rates ranging from 6.0% to 6.5%. The Company's
obligations under the Long Term Notes and Bonds are secured on an equal and
ratable basis with the Lender in the collateral granted to secure the LaSalle
Facility with the exception of the first $1.0 million of debt under the LaSalle
Facility.
Under the terms of the Long Term Notes and Bonds, the Company is subject to
certain restrictions, including restrictions on total dividends and
distributions, liens and secured indebtedness, and asset sales, and is
restricted from incurring additional long-term indebtedness if it does not meet
certain debt to interest and debt to capital ratios.
In the event that the Company's obligations under the LaSalle Facility were
declared immediately due and payable as a result of an event of default, such
acceleration also could result in events of default under the Company's Series
1993 Notes and Series 1997 Notes. In such circumstances, an event of default
under either series of notes would occur if (a) the Company were given notice to
that effect either by the trustee under the indenture governing such series of
notes, or the holders of at least 25% in principal amount of the notes of such
series then outstanding, and (b) within 10 days after such notice from the
trustee or the note holders to the Company, the acceleration of the Company's
obligations under the LaSalle Facility has not been rescinded or annulled and
the obligations under the LaSalle Facility have not been discharged. There is no
similar cross-default provision with respect to the Cascade County, Montana
Series 1992B Industrial Development Revenue Bonds and the related Loan Agreement
between the Company and Cascade County, Montana. If the Company's obligations
were accelerated under the terms of any of the LaSalle Facility, the Series 1993
Notes or the Series 1997 Notes, such acceleration (unless rescinded or cured)
could result in a loss of liquidity and cause a material adverse effect on the
Company and its financial condition.
The total amount outstanding under all of the Company's long term debt
obligations was approximately $22.4 million at December 31, 2004. The portion of
such obligations due within one year was approximately $3.0 million at December
31, 2004.
The Company is currently evaluating its options with respect to raising equity
capital to fund the repayment of the $2.0 million term loan, which matures on
October 1, 2005.
33
A table of the Company's long-term debt obligations, as well as other long-term
commitments and contingencies, as of December 31, 2004, are listed below
according to maturity dates.
Payments Due by Period
------------------------------------------------------------------
Less
than 2 - 3 4 - 5 After 5
Contractual Obligations Total 1 year Years years Years
- ----------------------- ----------- ---------- ----------- ----------- -----------
Long-Term Debt $22,370,984 $2,975,000 $ 2,080,000 $ 1,630,000 $15,685,984
Capital Lease Obligations $ 7,700 2,891 4,809 0 0
Transportation and Storage Obligation 25,694,729 5,683,858 8,653,816 8,517,792 2,839,264
----------- ---------- ----------- ----------- -----------
Total Obligations $48,073,413 $8,661,749 $10,738,625 $10,147,792 $18,525,248
=========== ========== =========== =========== ===========
CONTRACTS ACCOUNTED FOR AT FAIR VALUE
Management of Risks Related to Derivatives -- The Company and its subsidiaries
are subject to certain risks related to changes in certain commodity prices and
risks of counterparty performance. The Company has established policies and
procedures to manage such risks. The Company has a Risk Management Committee
(RMC), comprised of Company officers and management to oversee the Company's
risk management program as defined in its risk management policy. The purpose of
the risk management program is to minimize adverse impacts on earnings resulting
from volatility of energy prices, counterparty credit risks, and other risks
related to the energy commodity business.
In order to mitigate the risk of natural gas market price volatility related to
firm commitments to purchase or sell natural gas or electricity, from time to
time the Company and its subsidiaries have entered into hedging arrangements.
Such arrangements may be used to protect profit margins on future obligations to
deliver gas at a fixed price, or to protect against adverse effects of potential
market price declines on future obligations to purchase gas at fixed prices.
The Company accounts for certain of such purchase or sale agreements in
accordance with SFAS No. 133. Under SFAS No. 133, such contracts are reflected
in the Company's financial statements as derivative assets or derivative
liabilities and valued at "fair value," determined as of the date of the balance
sheet. Fair value accounting treatment is also referred to as "mark-to-market"
accounting. Mark-to-market accounting results in disparities between reported
earnings and realized cash flow, because changes in the derivative values are
reported in the Company's Consolidated Statement of Operations as an increase or
(decrease) in "Revenues - Gas and Electric - Wholesale" without regard to
whether any cash payments have been made between the parties to the contract. If
such contracts are held to maturity, the cash flow from the contracts and their
hedges are realized over the life of the contracts. SFAS No. 133 requires that
contracts for purchase or sale at fixed prices and volumes must be valued at
fair value (under mark-to-market accounting) unless the contracts qualify for
treatment as a "normal purchase or sale."
34
Quoted market prices for natural gas derivative contracts of the Company are
generally not available. Therefore, to determine the net present value of
natural gas derivative contracts, the Company uses internally developed
valuation models that incorporate independently available current and forecasted
pricing information.
As of December 31, 2004, these agreements were reflected on the Company's
consolidated balance sheet as derivative assets and liabilities at an
approximate fair value as follows:
ASSETS LIABILITIES
-------- -----------
Contracts maturing during fiscal year 2005 $105,274 $1,153,123
Contracts maturing during fiscal years 2006 and 2007 -- 844,828
Contracts maturing during fiscal years 2008 and 2009 18,857 307,012
-------- ----------
Total $124,131 $2,304,963
======== ==========
During the first six months of fiscal year 2005, the Company entered into two
new contracts that require mark-to-market accounting under SFAS No. 133 (See
Note 4).
Regulated Operations -- In the case of the Company's regulated divisions, gains
or losses resulting from derivative contracts are subject to deferral under
regulatory procedures approved by the public service regulatory commissions of
the States of Montana and Wyoming. Therefore, related derivative assets and
liabilities are offset with corresponding regulatory liability and asset amounts
included in "Recoverable Cost of Gas Purchases", pursuant to SFAS No. 71,
Accounting for the Effects of Certain Types of Regulation.
CRITICAL ACCOUNTING POLICIES
The Company believes that its critical accounting policies are as follows:
Effects of Regulation -- The Company follows SFAS No. 71, Accounting for the
Effects of Certain Types of Regulation, and its financial statements reflect the
effects of the different rate-making principles followed by the various
jurisdictions regulating the Company. The economic effects of regulation can
result in regulated companies recording costs that have been or are expected to
be allowed in the rate-making process in a period different from the period in
which the costs would be charged to expense by an unregulated enterprise. When
this occurs, costs are deferred as assets in the balance sheet (regulatory
assets) and recorded as expenses in the periods when those same amounts are
reflected in rates. Additionally, regulators can impose liabilities upon a
regulated utility for amounts previously collected from customers and for
amounts that are expected to be refunded to customers (regulatory liabilities).
Costs recovered through rates include income taxes, property taxes,
environmental remediation and costs of gas.
Recoverable/ Refundable Costs of Gas and Propane Purchases -- The Company
accounts for purchased gas costs in accordance with procedures authorized by the
MPSC, the Wyoming Public Service Commission ("WPSC") and the Arizona Corporation
Commission ("ACC") under which purchased gas and propane costs that are
different from those provided for in present rates are accumulated and recovered
or credited through future rate changes.
35
Derivatives -- The Company accounts for certain derivative contracts that are
used to manage risk in accordance with SFAS No. 133.
Contracts that are required to be valued as derivatives under SFAS No. 133 are
reflected at "fair value" under the mark-to-market method of accounting. The
market prices or fair values used in determining the value of the Company's
portfolio are management's best estimates utilizing information such as closing
exchange rates, over-the-counter quotes, historical volatility and the potential
impact on market prices of liquidating positions in an orderly manner over a
reasonable amount of time under current market conditions. As additional
information becomes available, or actual amounts are determinable, the recorded
estimates may be revised. As a result, operating results can be affected by
revisions to prior accounting estimates. Operating results can also be affected
by changes in underlying factors used in the determination of fair value of
portfolio such as the following:
- There is variability in mark-to-market earnings due to changes in the
market price for gas. The Company's portfolio is valued based on
current and expected future gas prices. Changes in these prices can
cause fluctuations in earnings.
- The Company discounts derivative assets and liabilities using
risk-free interest rates adjusted for credit standing in accordance
with SFAS No. 133, which is more fully described in Statement of
Financial Accounting Concepts No. 7, "Using Cash Flow Information and
Present Value in Accounting Measurement" (SFAS Concept 7).
Other activities consist of the purchasing of gas for utility operations, which
fall under the normal purchases and sales exception, and entering into
transactions to hedge risk associated with these purchases. These activities
require that management make certain judgments regarding election of the normal
purchases and sales exceptions and qualification of hedge accounting by
identifying hedge relationships and assessing hedge effectiveness.
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. The
sensitivity analyses presented do not consider the effects that such adverse
changes may have on overall economic activity nor do they consider additional
actions management may take to mitigate the Company's exposure to such changes.
Actual results may differ. See Note 1 to the consolidated financial statements
set forth in the Company's Annual Report on Form 10-K for the year ended June
30, 2004 for a description of the Company's accounting policies and other
information related to these financial instruments.
36
Commodity Price Risk
The Company seeks to protect itself against natural gas price fluctuations by
limiting the aggregate level of net open positions that are exposed to market
price changes. Open positions are to be managed with policies designed to limit
the exposure to market risk, with regular reporting to management of potential
financial exposure. The Company's risk management committee has limited the
types of contracts the Company will consider to those related to physical
natural gas deliveries. Therefore, management believes that the Company's
results of operations are not significantly exposed to changes in natural gas
prices.
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
100 basis point change in market rates applied to the balance of the notes
payable would change interest expense by approximately $150,000 annually.
Credit Risk
Credit risk relates to the risk of loss that the Company would incur as a result
of non-performance by counterparties of their contractual obligations under the
various instruments with the Company. Credit risk may be concentrated to the
extent that one or more groups of counterparties have similar economic, industry
or other characteristics that would cause their ability to meet contractual
obligations to be similarly affected by changes in market or other conditions.
In addition, credit risk includes not only the risk that a counterparty may
default due to circumstances relating directly to it, but also the risk that a
counterparty may default due to circumstances which relate to other market
participants which have a direct or indirect relationship with such
counterparty. The Company seeks to mitigate credit risk by evaluating the
financial strength of potential counterparties. However, despite mitigation
efforts, defaults by counterparties may occur from time to time.
ITEM 4. CONTROLS AND PROCEDURES
Company's management has evaluated, with the participation of the Chief
Executive Officer and the Principal Financial Officer, the effectiveness of the
disclosure controls and procedures as of the end of the period covered by this
Quarterly Report on Form 10-Q for the three months ended December 31, 2004.
Based on this evaluation, although the Company had a deficiency that gave rise
to a restatement of the consolidated financial statements (see Restatement of
Financial Results in Note 1 to the condensed consolidated financial statements);
the Chief Executive Officer and the Principal Financial Officer have concluded
that the disclosure controls and procedures that are now in place at the Company
are effective to ensure that information we are required to disclose in reports
that we file or submit under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms.
37
The Company corrected its accounting with regard to certain natural gas
agreements following a review which identified accounting treatment issues with
the agreements. During the first quarter of fiscal year 2005, the Company's
independent auditors advised the Company that they had identified a material
weakness in the Company's internal control over financial reporting in
connection with energy contracts. During fiscal year 2004 and the first quarter
of fiscal year 2005, the Company implemented changes in the internal control
over financial reporting to address the material weakness. Those changes
involved implementation of procedures respecting the contracting for gas under
natural gas purchase and sale agreements, including establishing a separation
between the deal-making function and the accounting and contract administration
functions, establishment of record systems and procedures that require
reconciliation of actual performance by the contracting parties against the
prices, quantities and other material terms specified in the agreements, and
preparation of redundant documentation for every agreement regarding its
classification pursuant to SFAS 133. The procedures are designed to make sure
that all obligations entered into on behalf of the Company or its subsidiaries
receive proper review and that those agreements are enforced and performed
according to their terms and conditions. The procedures are also designed to
ensure that the Company complies with applicable accounting requirements.
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.
In addition to other litigation referred to above, the Company or its
subsidiaries are involved in the following described litigation.
On June 17, 2003, EWR and PPL Montana, LLC ("PPLM") reached agreement on a
settlement of a lawsuit involving a wholesale electricity supply contract. Under
the terms of the settlement, EWR paid PPLM a total of $3,200,000, consisting of
an initial payment of $1,000,000 on June 17, 2003, and a second payment of
$2,200,000 on September 30, 2003, terminating all proceedings in the case. EWR
had established reserves and accruals in fiscal year 2001 of approximately
$3,032,000 to pay a potential settlement with PPLM and the remaining $168,000
was charged to operating expenses in fiscal year 2003.
On August 8, 2003, the Company reached agreement with the Montana Department of
Revenue ("DOR") to settle a claim that the Company had under-reported its
personal property for the years 1997 - 2002 and that additional property taxes
and penalties should be assessed. The settlement amount is being paid in ten
annual installments of $243,000 each, beginning November 30, 2003.
38
The Company initially determined that it was entitled to recover the amounts
paid in connection with the DOR settlement through future rate adjustments as a
result of legislation permitting "automatic adjustments" to rates to recover
such property tax increases. The MPSC, however, interpreted the new legislation
as allowing recovery of only a portion of the higher property tax rates. Rates
recovering the portion of the higher taxes permitted under the MPSC's
interpretation of the legislation went into effect on January 1, 2004. The
Company has since obtained rate relief which includes full recovery of the
property tax associated with the DOR settlement.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds - Not
Applicable
Item 3. Defaults upon Senior Securities - See Liquidity and Capital Resources
above
Item 4. Submission of Matters to a Vote of Security Holders - Not Applicable
Item 5. Other Information - Not Applicable
Item 6. Exhibits
Exhibits for the second quarter ended December 31, 2004:
3.1 Amended and Restated Bylaws (incorporated by reference to Exhibit 3.2
to the Current Report of Form 8-K filed with the Commission on January
4, 2005).
10.1(a) Letter Agreement to Credit Agreement entered into on October 20, 2004,
by and among the Company, its subsidiaries and LaSalle Bank National
Association ("LaSalle") (incorporated by reference to Exhibit 10.1 to
the Current Report on Form 8-K filed with the Commission on October
21, 2004).
10.1(b) Letter Agreement to Credit Agreement entered into on November 2, 2004,
by and among the Company, its subsidiaries and LaSalle (incorporated
by reference to Exhibit 10.1 to the Current Report on Form 8-K filed
with the Commission on November 5, 2004).
10.1(c) Third Amendment to Credit Agreement dated as of November 2, 2004, by
and among the Company, its subsidiaries and LaSalle (incorporated by
reference to Exhibit 10.2 to the Current Report on Form 8-K filed with
the Commission on November 5, 2004).
10.1(d) Limited Waiver and Fourth Amendment to Credit Agreement dated as of
November 30, 2004, by and among the Company, its subsidiaries and
LaSalle (incorporated by reference to Exhibit 10.1 to the Current
Report on Form 8-K filed with the Commission on December 6, 2004).
10.1(e) Limited Waiver under Amended and Restated Credit Agreement dated
February 14, 2005, by and among the Company, its subsidiaries and
LaSalle.
31.1 Certification of the Principal Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
39
31.2 Certification of the Principal Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.1 Certification of the Principal Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
32.2 Certification of the Principal Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (filed herewith).
40
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/ David A. Cerotzke
- ----------------------------------------
David A. Cerotzke
President and Chief Executive Officer February 14, 2005
(principal executive officer)
/s/ M. Shawn Shaw
- ----------------------------------------
M. Shawn Shaw February 14, 2005
Principal Financial Officer
(principal financial officer
and principal accounting officer)
41