EWSTD Energy West (MM)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended December 31, 2007

or

o		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

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. þ Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  o	Accelerated filer  o	Non-accelerated filer  o	Smaller reporting company  ý
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). o Yes þ No

The number of shares outstanding of the registrant’s common stock as of February 11, 2008 was 4,345,425 shares.

As used in this Form 10-Q, the terms “company”, “Energy West”, “Registrant”, “we”, “us”, and “our” mean Energy West, Incorporated and its consolidated subsidiaries as a whole, unless the context indicates otherwise. Except as otherwise stated, the information in this Form 10-Q is as of December 31, 2007.

 

 

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, 2007, December 31, 2006 and June 30, 2007			3
Condensed Consolidated Statements of Operations (unaudited)- three months ended December 31, 2007 and 2006, and six months ended December 31, 2007 and 2006			4
Condensed Consolidated Statements of Cash Flows – (unaudited) six months ended December 31, 2007 and 2006			5
Notes to Condensed Consolidated Financial Statements			6
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations			17
Item 3 — Quantitative and Qualitative Disclosures about Market Risk			30
Item 4 — Controls and Procedures			31
Part II — Other Information
Item 4 — Submission of Matters to a Vote of Security Holders			31
Item 6 — Exhibits			32
Signatures
EX-3.1(E)
EX-10.1
EX-10.2
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I — FINANCIAL INFORMATION

The accompanying notes are an integral part of these condensed financial statements.

The accompanying notes are an integral part of these condensed consolidated financial statements.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

December 31, 2007

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of Energy West, Incorporated and its subsidiaries (collectively, the “Company”) 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 and six month periods ended December 31, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2008. 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, 2007.

Energy West, Incorporated is a regulated public utility, with certain non-utility operations conducted through its subsidiaries. We were originally incorporated in Montana in 1909. We currently have five reporting segments:

NOTE 1 — 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, 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.

During the first six months of fiscal 2008, the Company has not entered into any new contracts requiring mark-to-market accounting under Statement of Financial Accounting Standards (“SFAS”) No. 133 Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”). However, existing derivatives as of December 31, 2007 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 2009		$	64,186			$	64,357

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, North Carolina and Maine. 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, 2007, the Company’s regulated operations have no contracts meeting the mark-to-market accounting requirements.

Other tax benefit for fiscal year 2008 includes an adjustment for prior year actual tax expense from amounts that had been estimated and accrued.

In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes detailed guidance for the financial statement recognition, measurement and disclosure of uncertain tax positions recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” Tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized upon the adoption of FIN 48 and in subsequent periods. FIN 48 is effective for fiscal years beginning after December 15, 2006 and the provisions of FIN 48 are to be applied to all tax positions upon initial adoption of the Interpretation. Upon adopting FIN 48, the Company had no unrecognized tax benefits that would have a material impact to the Company’s financial statements for any open tax years. During the first six months of fiscal year 2008, no adjustments were recognized for uncertain tax positions.

The Company recognizes interest accrued related to unrecognized tax benefits in interest expense and penalties in operating expense. No interest and penalties related to unrecognized tax benefits were accrued at December 31, 2007.

The tax years 2002 through 2006 remain open to examination by the major taxing jurisdictions in which we operate, although no material changes to unrecognized tax positions are expected within the next twelve months.

NOTE 3 — LINES OF CREDIT AND LONG-TERM DEBT

We fund our operating cash needs, as well as dividend payments and capital expenditures, primarily through cash flow from operating activities and short-term borrowing. Historically, to the extent cash flow has not been sufficient

to fund these expenditures, we have used the working capital line of credit portion of the credit facility with LaSalle Bank, N.A. (“LaSalle”). We have 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, our short-term borrowing needs for purchases of gas inventory and capital expenditures are greatest during the summer and fall months and our short-term borrowing needs for financing customer accounts receivable are greatest during the winter months.

LaSalle Line of Credit — On June 29, 2007, the Company established its new five-year unsecured credit facility with LaSalle, replacing a previous $20.0 million one-year facility with LaSalle which was scheduled to expire in November 2007. The new credit facility includes an annual commitment fee equal to 0.20% of the unused portion of the facility and interest on amounts outstanding at the London Interbank Offered Rate, plus 120 to 145 basis points, for interest periods selected by the Company.

Long-term Debt — $13.0 million 6.16% Senior Unsecured Notes — On June 29, 2007, the Company issued 6.16% Senior Unsecured Notes in the aggregate principal amount of $13.0 million, due June 29, 2017. The proceeds of these notes were used to refinance our existing notes. With this refinancing, we expensed the remaining debt issue costs of $991,000 in fiscal 2007, and incurred approximately $400,000 in new debt issue costs to be amortized over the life of the new note.

Debt Covenants — The Company’s 6.16% Senior Unsecured Note and LaSalle credit facility agreements contain various covenants, which include, among others, limitations on total dividends and distributions made in the immediately preceding 60-month period to 75% of aggregate consolidated net income for such period, restrictions on certain indebtedness, limitations on asset sales, and maintenance of certain debt-to-capital and interest coverage ratios. At December 31, 2007, the Company believes it was in compliance with the financial covenants under its new debt agreements.

At December 31, 2007, the Company had approximately $1.9 million of cash on hand. In addition, at December 31, 2007, the Company had $6.5 million in borrowings under the LaSalle Credit Facility revolving line of credit. The Company’s net availability at December 31, 2007, was $13.5 million under the LaSalle Facility revolving line of credit.

The total amount outstanding under all of the Company’s long-term debt obligations was $13.0 million and approximately $17.3 million at December 31, 2007, and December 31, 2006, respectively. The portion of such obligations due within one year was $0 and $1.1 million at December 31, 2007, and December 31, 2006, respectively.

NOTE 4 — ACQUISITIONS AND EXTRAORDINARY GAIN

On October 1, 2007, the Company completed the acquisition of Frontier Utilities of North Carolina, Inc. (“Frontier Utilities”), which operates a natural gas utility in and around Elkin, North Carolina through its subsidiary, Frontier Energy, LLC. The purchase price was $4.5 million in cash, plus adjustment for taxes and working capital, resulting in a total purchase price of approximately $4.9 million. On December 1, 2007, the Company completed the acquisition of Penobscot Natural Gas Company, Inc. (“Penobscot Natural Gas”) for a purchase price of approximately $285,000, plus adjustment for working capital, resulting in a total purchase price of approximately $435,000. Penobscot Natural Gas is the parent company of Bangor Gas Company LLC, which operates a natural gas utility in and around Bangor, Maine.

The results of operations for Frontier Utilities and Penobscot Natural Gas have been included in the consolidated financial statements since the dates of acquisition.

Under Financial Accounting Standards (“FAS”) 141, the Company has recorded these stock acquisitions as if the net assets of the targets were acquired. For income tax purposes, the Company is permitted to “succeed” to the operations of the acquired companies, whereby the Company may continue to depreciate the assets at their historical tax cost bases. As a result, the Company may continue to depreciate approximately $79.0 million of capital assets using the useful lives and rates employed by both Frontier Utilities and Penobscot Natural Gas. This treatment results in a potential future federal and state income tax benefit of approximately $16.9 million over a 24-year period using applicable federal and state income tax rates. Under Internal Revenue Code Section 382, our ability to recognize tax deductions as a result of this tax benefit will be limited during the first 5 years following the acquisitions.

Following FAS 109, our balance sheet at December 31, 2007 reflects a gross deferred tax asset of approximately $16.9 million, offset by a valuation allowance of approximately $5.3 million, resulting in a net deferred tax asset associated with the acquisition of approximately $11.5 million.

The excess of the net deferred tax assets received in the transactions over the total purchase consideration has been reflected as an extraordinary gain of approximately $6.8 million on the accompanying statement of income in accordance with the provisions of FAS 141.

The preparation of the Company’s financial statements requires management to make significant estimates. The deferred tax asset, valuation allowance and related extraordinary gain requires a significant amount of judgment and is a significant estimate. The estimate is based on projected future tax deductions, future taxable income, estimated limitations under the Internal Revenue Code, an estimated valuation allowance, and other assumptions. It is possible that this estimate could change and the change could be material.

NOTE 5 — DISCONTINUED OPERATIONS

On July 17, 2006, we entered into an Asset Purchase Agreement among our company, our subsidiary Energy West Propane, Inc. (EWP), and SemStream, L.P. Pursuant to the Asset Purchase Agreement, our company and EWP agreed to sell, and SemStream agreed to buy, (i) all of the assets and business operations associated with our regulated propane gas distribution system operated in the cities and outlying areas of Payson, Pine, and Strawberry, Arizona (the “Regulated Business”), and (ii) all of the assets and business operations of EWP that are associated with certain “non-regulated” propane assets in the same geographic area (the “Non-Regulated Business,” and together with the Regulated Business, the “Business”).

Pursuant to the Purchase and Sale Agreement, the sale was conditioned on approval by the Arizona Corporation Commission, or “ACC”, with the closing to occur on the first day of the month after receipt of ACC approval. This approval was received on March 13, 2007, and the closing date of the transaction was April 1, 2007.

SemStream purchased only the assets and business operations of our Company and EWP that pertain to the Business within the state of Arizona, and that also pertain to the Energy West Propane - Arizona division of our company and/or EWP (collectively, the “Arizona Assets”). Pursuant to the Asset Purchase Agreement, SemStream paid a cash purchase price of $15.0 million for the Arizona Assets, plus final working capital adjustments of approximately $3.0 million.

The assets and liabilities of the discontinued operations are presented separately under the captions “Assets Held for Sale” and “Liabilities Held for Sale”, respectively, in the accompanying Balance Sheets at December 31, 2006 and consist of the following:

The following table details the line item “Income from Discontinued Operations” that appears on the face of the Statements of Operations for the three and six month periods ending December 31, 2006, as well as for the Propane Operations data appearing in Item 2.

Regulatory assets will be recovered over a period of approximately seven to twenty years.

The property tax asset does not earn a return in the rate base; however the property tax is recovered in rates over a ten-year period starting January 1, 2004. The income taxes and environmental remediation costs earn a return equal to that of the Company’s rate base. No other assets earn a return or are recovered in the rate structure. Other regulatory assets include rate case costs to be amortized over the period approved by the appropriate regulatory agency.

NOTE 7 — CONTINGENCIES

Environmental Contingency — We own property on which we operated a manufactured gas plant from 1909 to 1928. We currently use this site as an office facility for 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 that have been classified by the Federal government and the State of Montana as hazardous to the environment.

We have completed our remediation of soil contaminants at the plant site. In April 2002 we received a closure letter from the Montana Department of Environmental Quality, or “MDEQ,” approving the completion of such remediation program.

We and our consultants worked 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 (the “EPA”) has developed such guidance. The EPA guidance lists factors that render remediation technically impracticable. We have filed with the MDEQ a request for a waiver from complying with certain standards.

At December 31, 2007, we had incurred cumulative costs of approximately $2.1 million in connection with our evaluation and remediation of the site. On May 30, 1995, we received an order from the Montana Public Service Commission (“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, 2007, we had recovered approximately $1.9 million through such surcharges. As of December 31, 2007, the cost remaining to be recovered through the on-going rate is $216,000.

We are required to file with the MPSC every two years for approval to continue the recovery of these costs through a surcharge. During fiscal 2007, the MPSC approved the continuation of the recovery of these costs with its order dated May 15, 2007.

Derivative Contingencies — Among the risks involved in natural gas marketing is the risk of nonperformance by counterparties to contracts for purchase and sale of natural gas. Our marketing and production operation’s subsidiary

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.

Legal Proceedings —We are party to certain legal proceedings in the normal course of our business, that, in the opinion of management, are not material to our business or financial condition.

December 31, 2006 information presented differs from prior presentations due to the reclassification of certain propane items from “Accrued and other current liabilities” to “Liabilities held for sale.”

NOTE 10 — OTHER LONG TERM LIABILITIES

     Other long-term liabilities consist of the following:

December 31, 2006 information presented differs from prior presentations due to the reclassification of certain propane items from “Other long term liabilities” to “Liabilities held for sale.”

NOTE 11 — STOCK OPTIONS AND SHAREHOLDER RIGHTS PLANS

2002 Stock Option Plan — The Energy West Incorporated 2002 Stock Option Plan (the “Option Plan”) provides for the issuance of up to 300,000 shares of our common stock to certain key employees. As of December 31, 2007, there are 67,500 options outstanding, 169,500 shares issued under this plan have been exercised, and 63,000 shares are available for future grants under this plan. Additionally, our 1992 Stock Option Plan (the “1992 Option Plan”), which expired in September 2002, provided for the issuance of up to 150,000 shares of our common stock pursuant to options issuable to certain key employees. Under the 2002 Option Plan and the 1992 Option Plan (collectively, “the Option Plans”), the option price may not be less than 100% of the common stock fair market value on the date of grant (in the event of incentive stock options, 110% of the fair market value if the employee owns more than 10% of our outstanding common stock). Pursuant to the Option Plans, the options vest over four to five years and are

exercisable over a five to ten-year period from date of issuance. When the 1992 Option Plan expired in September 2002, 18,900 shares remained unissued and were no longer available for issuance.

SFAS No. 123 Disclosures — Effective July 1, 2005, we have adopted the provisions of SFAS No. 123 Accounting for Stock-Based Compensation . The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing.

In the fiscal quarters ended December 31, 2007 and 2006, 30,000 and 15,000 options were granted, respectively. At December 31, 2007 and 2006, a total of 67,500 and 225,750 options were outstanding, respectively.

A summary of the status of our stock option plans as of December 31, 2007, and June 30, 2007 and 2006 and changes during the periods ended on these dates is presented below.

The weighted average fair value of options granted during the quarters ending December 31, 2007 and 2006 was $2.34 and $1.45, respectively. There were 15,000 new options granted in each of the first and second quarters of fiscal year 2008.

The following information applies to options outstanding at December 31, 2007:

NOTE 12 — NEW ACCOUNTING PRONOUNCEMENTS

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets—an amendment to FASB Statement No. 140 (“SFAS 156”). SFAS 156 requires that all separately recognized servicing rights be initially measured at fair value, if practicable. In addition, this statement permits an entity to choose between two measurement methods (amortization method or fair value measurement method) for each class of separately recognized servicing assets and liabilities. This new accounting standard is effective January 1, 2007. We do not expect the adoption of SFAS 156 to have an impact on our results of operations or financial condition.

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (“FIN 48”). This interpretation clarifies the application of SFAS 109 by defining a criterion that an individual tax position must meet for any part of the benefit of that position to be recognized in an enterprise’s financial statements and also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods and disclosure. FIN 48 is effective for our fiscal year commencing July 1, 2007. We have completed our review and assessment of the impact of adoption of FIN 48. This is discussed in Note 2 — Income Tax Expense.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework and gives guidance regarding the methods used for measuring fair value, and expands disclosures about fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the impact of adopting SFAS 157 on our consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 provides the option to report certain financial assets and liabilities at fair value, with the intent to mitigate volatility in financial reporting that can occur when related assets and liabilities are recorded on different bases. SFAS 159 also amends SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities,” by providing the option to record unrealized gains and losses on held-for-sale and held-to-maturity securities currently. The effective date of SFAS 159 is for fiscal years beginning after November 15, 2007. The implementation of SFAS 159 is not expected to have a material impact on our results of operations or financial position.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations, (“SFAS 141R”). SFAS 141R provides standards that will improve, simplify, and converge internationally the accounting for business combinations in consolidated financial statements. The effective date of SFAS 141R is for fiscal years beginning after December 15, 2008. We are currently evaluating the impact of adopting SFAS 141R on our consolidated financial statements.

We have reviewed all other recently issued, but not yet effective, accounting pronouncements and do not believe any such pronouncements will have a material impact on our financial statements.

ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

This quarterly report on Form 10-Q contains 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 1934, as amended, which represent our company’s expectations or beliefs concerning future events. Forward-looking statements generally include words such as “anticipates,” “believes,” “expects,” “planned,” “scheduled” or similar expressions and statements concerning our operating capital requirements, negotiations with our lender, recovery of property tax payments, our environmental remediation plans, and similar statements that are not historical are forward-looking statements that involve risks and uncertainties. Although we believe 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 us from time to time, including statements contained in filings with the Securities and Exchange Commission and its reports to shareholders, involve known and unknown risks and other factors that may cause our company’s actual results in future periods to differ materially from those expressed in any forward-looking statements. See “Risk Factors” in the our Annual Report on Form 10-K for the fiscal year ended June 30, 2007 filed with the Securities and Exchange Commission. Any such forward looking statement is qualified by reference to these risk factors. We caution that these risk factors are not exclusive. We do not undertake to update any forward looking statements that may be made from time to time by or on behalf of us except as required by law.

Executive Overview

Energy West is a natural gas utility with operations in Montana, Wyoming, North Carolina and Maine. We distribute 23 billion cubic feet (bcf) of natural gas to approximately 36,000 residential, commercial and industrial customers. In addition to our core natural gas distribution business, we also market approximately 1.6 bcf of natural gas to commercial and industrial customers in Montana and Wyoming and we own the Shoshone interstate and the Glacier gathering pipelines located in Montana and Wyoming. We also have an ownership interest in 165 natural gas producing wells and gas gathering assets that provide our marketing and production operations a natural hedge when gas prices are greater than the cost of production.

Our primary source of revenue and operating margin has been derived from the distribution of natural gas and propane to end-use residential, commercial and industrial customers. We also derive revenues by providing gas supply and load management services to certain industrial and commercial customers through our gas marketing and production subsidiary on an “unregulated” basis.

We continue to focus on expanding and improving our core business — utility service, pipelines, and natural gas production. Significant cost reductions have helped us strengthen our balance sheet, increase net income, restore dividends to our shareholders and keep rates to our customers low. Net income for the first six months of fiscal year 2008 was $7.9 million, compared to net income of $1.1 million for the first six months of fiscal year 2007. The $7.9 million included an extraordinary gain of $6.8 million. This gain was a one-time event associated with the acquisition of Penobscot Natural Gas in Maine, and Frontier Utilities of North Carolina. (See Note 4 in “Notes to Consolidated Financial Statements.”)

Earnings from continuing operations increased from $1,117,000 during the first six months of fiscal year 2007 to $1,124,000 during the first six months of fiscal year 2008. This was the result of savings in several areas, including interest and income tax expense. Earnings also benefited from the acquisition of Frontier Utilities, which was included in income starting October 1, 2007, and Penobscot Natural Gas, starting December 1, 2007. These improvements were offset by one-time charges of approximately $500,000 associated with the realignment of our management team.

We strive to mitigate the effect of higher commodity prices through increased use of both underground storage and our pipeline network. Our utility business has been concentrating on enhancing productivity in our operations and reducing our general, administrative, and overhead expenses. Our improved profitability has afforded us the opportunity to keep rates to our customers low and to increase the dividend payments to our shareholders since resuming dividend payments in October 2005.

In July 2006, we entered into an agreement to sell certain of our assets related to our Arizona propane business for cash of approximately $15.0 million plus net working capital. This sale was complete on April 1, 2007. We used the proceeds from this transaction to reduce our outstanding debt and strengthen our balance sheet. We believe that this will enable us to take advantage of opportunities to enhance or expand our existing operations and to acquire additional businesses or assets on favorable terms as and when those opportunities arise such as the recent acquisitions of Frontier Utilities and Penobscot Natural Gas. Additionally, we recently announced the pending purchase of Cut Bank Gas Company.

Recent Events

During the past three months, we have continued our efforts to expand our distribution operations by completing two important acquisitions. On October 1, 2007, we completed our acquisition of Frontier Utilities and on December 1, 2007, we completed our acquisition of Penobscot Natural Gas. We are now in the process of integrating oversight of those utility operations with management of our Montana and Wyoming distribution operations.

Further, on December 20, 2007 we announced the execution of a stock purchase agreement among Energy West and certain shareholders of Cut Bank Gas Company, a natural gas utility serving Cut Bank, Montana, for the sale of 83.16% of the outstanding shares of Cut Bank Gas Company for a purchase price of $500,000 in shares of common stock of Energy West. In addition, Energy West will offer to purchase the remaining shares of Cut Bank Gas Company for a purchase price of $66.44 per share or approximately $100,000 in shares of common stock of Energy West. The acquisition is subject to the approval of the MPSC and is expected to be completed in three to six months. The acquisition is scheduled to close on the last business day of the month after all closing conditions have been satisfied, including MPSC approval, as the case may be. However, there can be no assurances the acquisition will be closed in this timeframe, or at all.

During the first six months of fiscal year 2008, our Marketing and Production Operations segment invested a total of approximately $576,000 for a 19.8% ownership interest in Kykuit Resources, LLC (“Kykuit”), a developer and operator of oil, gas and mineral leasehold estates located in Montana. Richard M. Osborne, our Chairman of the Board, and Steven A. Calabrese, one of our directors, also own interests in Kykuit. John D. Oil and Gas Company, a publicly-held oil and gas exploration company of which Mr. Osborne is the Chairman of the Board and Chief Executive Officer and Mr. Calabrese is a director, is an owner and the managing member of Kykuit. Kykuit holds a 75% interest in certain oil, gas and mineral leasehold estates located in Montana, and has entered a Joint Venture Development Agreement with the 25% owner, Hemus, Ltd., to develop and operate those leasehold estates.

Notwithstanding our investment in Kykuit, our primary focus continues to be our Natural Gas Operations segment. Our acquisitions of Frontier Utilities and Penobscot Natural Gas, pending acquisition of Cut Bank Gas Company and sale of our Arizona propane operations are representative of our focus on expanding our gas utility operations by identifying additional local distribution companies for potential acquisition. Other than Kykuit, we have no plans for additional investments in our marketing and production operations.

In summary, in future periods we intend to maintain the increased earnings that we have built during the last three years and we will continue to sharpen our focus on opportunities and strategies that improve shareholder value.

QUARTERLY RESULTS OF CONSOLIDATED OPERATIONS

Fiscal Quarter Ended December 31, 2007 Compared to Fiscal Quarter Ended December 31, 2006

The following discussion of our 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 our Annual Report on Form 10-K for the fiscal year ended June 30, 2007. The following gives effect to the unaudited Condensed Consolidated Financial Statements as of December 31, 2007 and for the three month period ended December 31, 2007. Results of operations for interim periods are not necessarily indicative of results to be attained for any future period.

Net Income — Our net income for the second quarter of fiscal year 2008 was approximately $7.9 million compared to net income of approximately $1.3 million in the second quarter of fiscal year 2007, an improvement of $6.6 million, or 500%. This improvement was primarily due to the recognition of an extraordinary gain of $6.8 million in the second quarter of fiscal year 2008. This gain resulted from the recognition of a net deferred tax asset (after

valuation reserve) of $11.5 million from the purchase of Frontier Utilities in North Carolina and Penobscot Natural Gas in Maine. We expect to realize tax benefits in future years, and therefore recorded a deferred tax asset, and a corresponding gain, reduced by the total purchase consideration paid for the companies. (See Note 4 to our Condensed Consolidated Financial Statements for further discussion of the deferred tax asset and the acquisition.) Coupled with the extraordinary gain were decreases in interest expense of $98,000, increases in margin of $1.2 million and reductions in tax expense of $315,000. These improvements were partially offset by an increase in operating expenses of $1.7 million and elimination of the net income in propane or discontinued operations of approximately $157,000.

Revenues — Our revenues for the second quarter of fiscal year 2008 were approximately $20.8 million compared to approximately $18.0 million in the second quarter of fiscal year 2007, an increase of $2.8 million, or 16%. The increase was primarily attributable to: (1) an increase in our marketing and production operation’s production revenue of $1.1 million due primarily to higher sales volumes in our Wyoming market, (2) a natural gas revenue increase of $1.6 million, of which $2.6 million was due to the acquisition of gas operations in Maine and North Carolina, offset by a $1.0 million decrease in the existing natural gas operations from lower volumes and prices, and (3) decreased revenues in our pipeline operations of $6,000 due to a decrease in gathering volumes on the Glacier line.

Gross Margin — Gross margin increased $1.2 million, from approximately $4.6 million in the second quarter of fiscal year 2007 to approximately $5.7 million in the second quarter of fiscal year 2008. Our marketing and production operation’s margin decreased $87,000 due to a $44,000 increase in margin from gas production as a result of higher volumes produced, and a $68,000 increase due to increased sales in our Wyoming market. This was offset partially by a decrease of $26,000 in electricity sales, due to the expiration of our last remaining electricity sales contract.

Our pipeline operations’ margins decreased $6,000 due to lower volumes on the Glacier line. Our natural gas operations’ margins increased $1.1 million, of which $1.3 million was due to the acquisition of gas operations in Maine and North Carolina, offset by an $186,000 decrease in the existing natural gas operations from lower volumes and prices.

Expenses Other Than Cost of Goods Sold — Expenses other than cost of sales increased by $1.7 million in the second quarter of fiscal year 2008 as compared to the second quarter of fiscal year 2007. The primary reasons for this increase were (1) increases in the Company’s distribution, general and administrative costs of $1.4 million, of which approximately $850,000 was related to operations in Maine and North Carolina, and approximately $550,000 was attributable to expenses associated with the realignment of the Energy West management team and other outside legal and consultant fees, (2) increases in depreciation and amortization of $37,000, (3) increases in maintenance of $50,000, and (4) increases of $150,000 for taxes other than income.

Other Income — Other income increased by $25,000 from $77,000 in the second quarter of fiscal year 2007 to $102,000 in the second quarter of fiscal year 2008, all attributable to our natural gas operations.

Interest Expense — Interest expense decreased by approximately $98,000 during the second quarter of fiscal year 2008 from the second quarter of fiscal year 2007 due to a decrease in both short-term and long-term borrowings, a decrease in interest rates, and a decrease in amortization of debt issue costs due to the refinancing of our long-term debt.

Income Tax Expense — Income tax expense decreased $315,000 in the second quarter of fiscal year 2008 as compared to the second quarter of fiscal year 2007 due to a decrease in taxable income, coupled with adjustments to tax expense for prior year actual tax expense from amounts that had been estimated and accrued.

Discontinued Operations

Formerly reported as our propane operations, we sold our Arizona propane assets as of April 1, 2007. A small portion of our propane operations was income and expense associated with MRP, our unregulated Montana wholesale operation that supplies propane to our affiliated company reported in our natural gas operations. MRP is now being reported in our marketing and production operations.

Income from discontinued operations before income tax — There was no gain or loss from propane operations in fiscal year 2008 due to the timing of the sale of propane assets. In fiscal year 2007, there was income before income taxes of approximately $255,000 from propane operations.

Income Tax Expense — Income tax expense decreased by $98,000 due to the timing of the sale of propane assets.

Extraordinary Gain — The extraordinary gain of $6.8 million reported in the second quarter of fiscal year 2008 related to the acquisitions of Frontier Utilities and Penobscot Natural Gas. We recognized a deferred tax asset, net of valuation allowance, from these acquisitions. The difference between the estimated deferred tax asset (net of valuation reserve) and the total purchase consideration resulted in the non-taxable extraordinary gain (See Note 4 to our Condensed Consolidated Financial Statements).

Six Months Ended December 31, 2007 Compared To Six Months Ended December 31, 2006

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 fiscal year ended June 30, 2007. The following gives effect to the unaudited Condensed Consolidated Financial Statements as of December 31, 2007 and for the six month period ended December 31, 2007. Results of operations for interim periods are not necessarily indicative of results to be attained for any future period.

Net Income — The Company’s net income for the six months ended December 31, 2007 was approximately $7.9 million compared to net income of approximately $1.1 million for the six months ended December 31, 2006, an increase of $6.8 million, or 618%. This improvement was primarily due to the recognition of an extraordinary gain of $6.8 million in the second quarter of fiscal year 2008. This gain resulted from the recognition of a deferred tax asset of $11.5 million from the purchase of assets in Maine and North Carolina. We expect to realize tax benefits in future years, and therefore recorded a deferred tax asset, (net of valuation reserve) and a corresponding gain, reduced by the total consideration paid for the assets. (See Note 4 for further discussion of the deferred tax asset.) Coupled with the extraordinary gain were decreases in interest expense of $274,000, increases in margin of $1.1 million and reductions in tax expense of $391,000. These improvements were partially offset by an increase in operating expenses of $1.8 million.

Revenues — The Company’s revenues for the six months ended December 31, 2007 were approximately $28.3 million compared to approximately $26.5 in the six months ended December 31, 2006, an increase of $1.8 million, or 7%. The increase was primarily attributable to: (1) an increase in our marketing and production operation’s production revenue of $1.1 million due primarily to higher sales volumes in our Wyoming market, offset by decreases in production and electricity revenue of $83,000 and $90,000 respectively, (2) a natural gas revenue increase of $925,000, of which $2.6 million was due to the acquisition of gas operations in Maine and North Carolina, offset by a $1.7 million decrease in the existing natural gas operations from lower volumes and prices, and (3) decreased revenues in our pipeline operations of $12,000 due to a decrease in gathering volumes on the Glacier line.

Gross Margin — Gross margin increased $1.1 million, from approximately $7.3 million in the first six months of fiscal year 2007 to approximately $8.4 million in the first six months of fiscal year 2008. Our marketing and production operations’ margin increased $17,000 due to an $184,000 increase in retail gas sales from increased volumes in our Wyoming market. This increase was offset by a decrease of $33,000 in electricity sales due to the expiration of our last remaining electricity sales contract, and a $129,000 decrease in margin from gas production as a result of higher production costs.

Our pipeline operation’s margins decreased $12,000 due to lower volumes on the Glacier line. Our natural gas operation’s margins increased $1.1 million, of which $1.3 million was due to the acquisition of gas operations in Maine and North Carolina, offset by a $196,000 decrease in the existing natural gas operations from lower volumes and prices.

Expenses Other Than Cost of Goods Sold — Expenses other than cost of sales increased by $1.8 million in the first six months of fiscal year 2008 as compared to the first six months of fiscal year 2007. The primary reasons for this increase were (1) increases in the Company’s distribution, general and administrative costs of $1.5 million, of which approximately $850,000 was related to operations in Maine and North Carolina, and approximately $650,000 was attributable to expenses associated with the realignment of the Energy West management team and other outside legal and consultant fees; (2) increases of $49,000 in depreciation and amortization, (3) increases of $81,000 in maintenance, and (4) increases of $188,000 in taxes other than income taxes.

Other Income — Other income increased by $52,000 from $138,000 in the first six months of fiscal year 2007 to $190,000 in the first six months of fiscal year 2008, all attributable to our natural gas operations.

Interest Expense — Interest expense decreased by approximately $274,000 during the first six months of fiscal year 2008 from the first six months of fiscal year 2007 due to a decrease in both short-term and long-term borrowings, a decrease in interest rates, and a decrease in amortization of debt issue costs due to the refinancing of our long-term debt.

Income Tax Expense — Income tax expense decreased $391,000 in the first six months of fiscal year 2008 as compared to the first six months of fiscal year 2007 due to a decrease in taxable income, coupled with adjustments to tax expense for prior year actual tax expense from amounts that had been estimated and accrued.

Discontinued Operations

Formerly reported as propane operations, we sold our Arizona propane assets as of April 1, 2007. A small portion of our propane operations was income and expense associated with MRP, our unregulated Montana wholesale operation that supplies propane to our affiliated company reported in our natural gas operations. MRP is now being reported in our marketing and production operations.

Income from discontinued operations before income tax — There was no gain or loss from propane operations in fiscal year 2008 due to the timing of the sale of propane assets. In fiscal year 2007, there was a loss before income taxes of approximately $67,000 from propane operations.

Income Tax Benefit — Income tax benefit decreased by $25,000 due to the timing of the sale of propane assets.

Extraordinary Gain —The extraordinary gain of $6.8 million reported in the first six months of fiscal year 2008 is related to the acquisitions of Frontier Utilities and Penobscot Natural Gas. We recognized a deferred tax asset, net of valuation allowance, from these acquisitions. The difference between the deferred tax asset, net of a valuation reserve, and our total purchase consideration resulted in the non-taxable extraordinary gain (See Note 4 to our Condensed Consolidated Financial Statements).

Operating Results of our Natural Gas Operations

For comparative purposes, the following table separates results of operations for our recent acquisitions in Maine and North Carolina from the other natural gas operations. Energy West’s ownership of Frontier Utilities of North Carolina began October 1, 2007. Our ownership of Penobscot Utilities in Bangor, Maine began December 1, 2007. The results of these two operations are combined in the New Acquisitions column below. The Total Less New Acquisitions is comparable to 2006 results.

Fiscal Quarter Ended December 31, 2007 Compared to Fiscal Quarter Ended December 31, 2006

Natural Gas Revenues and Gross Margins — The Natural Gas Operation’s revenues without new acquisitions in the second quarter of fiscal year 2008 decreased to approximately $13.5 million from approximately $14.5 million in the second quarter of fiscal year 2007. This $1.0 million decrease was primarily due to lower volumes in the second quarter of fiscal year 2008 compared to the second quarter of fiscal year 2007, coupled with overall lower rates.

Gas purchases in Natural Gas Operations (without new acquisitions) decreased by $795,000 from approximately $10.6 million in the second quarter of fiscal year 2007 to approximately $9.8 million in the second quarter of fiscal year 2008. The decrease in gas cost reflects lower commodity prices during the current fiscal year, coupled with slightly lower volumes.

Gross margin (without new acquisitions) was approximately $3.7 million for the second quarter of fiscal year 2008 compared to approximately $3.9 million in the second quarter of fiscal year 2007. The decrease of $186,000 is primarily due to slightly lower volumes in the current fiscal year.

Natural Gas Operating Expenses — Natural Gas Segment’s operating expenses (without new acquisitions) were approximately $3.0 million for the second quarter of fiscal year 2008 as compared to approximately $2.2 million for second quarter of fiscal year 2007. The $710,000 increase is due to a $626,000 increase in payroll and other distribution, general and administrative expenses, including expenses associated with the realignment of our management team, and increases in outside legal and consulting fees. Depreciation and taxes other than income taxes increased $28,000 and $55,000, respectively.

Natural Gas Other Income — Other income increased by $27,000 from $77,000 in the second quarter of fiscal year 2007 to $104,000 in the second quarter of fiscal year 2008. This was due primarily to increased service sales in Great Falls, Montana and Cody, Wyoming.

Natural Gas Interest Expense — Interest expense was $106,000 lower in the second quarter of fiscal year 2008 due to a decrease in both short-term and long-term borrowings, a decrease in interest rates, and a decrease in amortization of debt issue costs due to the refinancing of our long-term debt.

Natural Gas Income Tax Expense — Income tax expenses (without new acquisitions) are $351,000 lower in the second quarter of fiscal year 2008 due to lower taxable income, coupled with an adjustment to tax expense for prior year actual tax expense from amounts that had been estimated and accrued.

Six Months Ended December 31, 2007 Compared to Six Months Ended December 31, 2006

For comparative purposes, the following table separates results of operations for our new acquisitions in Maine and North Carolina from the other natural gas operations. Energy West’s ownership of Frontier Utilities of North Carolina began October 1, 2007. Our ownership of Penobscot Natural Gas in Bangor, Maine began December 1, 2007. The results of these two operations are combined in the New Acquisitions column below. The Total Less New Acquisitions is comparable to 2006 results.

Natural Gas Revenues and Gross Margins — The Natural Gas Operation’s operating revenues without new acquisitions in the first six months of fiscal year 2008 decreased to approximately $18.5 million from approximately $20.2 million in the first six months of fiscal year 2007. This $1.7 million decrease was primarily due to lower volumes in the first six months of fiscal year 2008 compared to the first six months of fiscal year 2007, coupled with overall lower rates.

Gas purchases in Natural Gas Operations (without new acquisitions) decreased by $1.4 million from approximately $14.1 million in the first six months of fiscal year 2007 to approximately $12.7 million in the first six months of fiscal year 2008. The decrease in gas cost reflects lower commodity prices during the current fiscal year, coupled with slightly lower volumes.

Gross margin (without new acquisitions) was approximately $5.9 million for the first six months of fiscal year 2008 compared to approximately $6.1 million in the first six months of fiscal year 2007. The decrease of $196,000 is primarily due to slightly lower volumes in the current fiscal year.

Natural Gas Operating Expenses — Natural Gas Segment’s operating expenses (without new acquisitions) were approximately $5.3 million for the first six months of fiscal year 2008 as compared to approximately $4.5 million for the first six months of fiscal year 2007. The $786,000 decrease is due to a $636,000 increase in payroll and other distribution, general and administrative expenses, including expenses associated with the realignment of our management team, and increases in outside legal and consulting fees. Depreciation, maintenance, and taxes other than income taxes increased $28,000, $29,000 and $93,000, respectively.

Natural Gas Other Income — Other income increased by $52,000 from $138,000 in the first six months of fiscal year 2007 to $190,000 in the first six months of fiscal year 2008. This was due primarily to increased service sales in Great Falls, Montana and Cody, Wyoming.

Natural Gas Interest Expense — Interest expense was $360,000 lower in the first six months of fiscal year 2008 due to a decrease in both short-term and long-term borrowings, a decrease in interest rates, and a decrease in amortization of debt issue costs due to the refinancing of our long-term debt.

Natural Gas Income Tax Expense — Income tax expenses are $233,000 lower in the first six months of fiscal year 2008 due to lower taxable income, coupled with an adjustment to tax expense for prior year actual tax expense from amounts that had been estimated and accrued.

Operating Results of our Marketing and Production Operations

Fiscal Quarter Ended December 31, 2007 Compared to Fiscal Quarter Ended December 31, 2006

Marketing and Production Revenues and Gross Margins — Revenues in Marketing and Production Operations increased $1.1 million from approximately $3.5 million in the second quarter of fiscal year 2007 to approximately $4.6 million in the second quarter of fiscal year 2008. Retail gas revenues increased by $1.2 million due primarily to higher sales volumes in our Wyoming market. Revenue from electricity sales decreased by $51,000 due to the expiration of our last remaining electricity customer contract.

The gross margin in our marketing and production operation’s second quarter of fiscal year 2008 of $693,000 represents an increase of $85,000, or 14%, from gross margin earned in the second quarter of fiscal year 2007. Gross margin from gas production increased by $44,000 due to an increase in volumes produced in the second quarter of fiscal year 2008 as compared to the second quarter of fiscal year 2007. Gross margin from retail gas sales increased by $68,000 due to higher sales volumes in our Wyoming market. Offsetting these increases is a decrease in margin from electricity sales of $26,000 due to the expiration of our last remaining electricity customer contract.

Marketing and Production Operating Expenses — Operating expenses in Marketing and Production Operations increased approximately $38,000 from $127,000 for the second quarter of fiscal year 2007 to $165,000 for the second quarter of fiscal year 2008. This change is caused primarily by increases in depreciation and increases in administrative expenses associated with the realignment of the Energy West management team.

Marketing and Production Interest Expense — Interest expense increased by $11,000 due to change in the method of allocation of short term interest. Marketing and Production Operation’s borrowings to purchase stored gas resulted in these short-term interest charges. This increase in borrowings was offset by a decrease in company wide short-term and long-term borrowings, a decrease in interest rates, and a decrease in amortization of debt issue costs due to the refinancing of our long-term debt.

Marketing and Production Income Tax Expense — Income tax expense in the second quarter of fiscal year 2008 is $77,000, a $94,000 decrease from $171,000 in the second quarter of fiscal year 2007 due to adjustment to tax expense for prior year actual tax expense from amounts that had been estimated and accrued.

Six Months Ended December 31, 2007 Compared to Six Months Ended December 31, 2006

Marketing and Production Revenues and Gross Margins — Revenues increased $900,000 from approximately $6.1 million in the six months ended December 31, 2006 to approximately $7.0 million in the six months ended December 31, 2007. Retail gas revenues increased by $1,060,000 due primarily to higher sales volumes in our Wyoming market. This is offset by a decrease in production revenue of $83,000 and a decrease in electricity revenue of $90,000 due to the expiration of our last remaining electricity customer contract.

Gross margin increased $17,000 from approximately $1.07 million in the first six months of fiscal 2007 to approximately $1.09 million in the first six months of fiscal 2008. Gross margin from gas production decreased by $129,000 due to higher production costs and margin from electricity sales decreased by $33,000 due to the expiration of our last remaining electricity sales contract. These decreases are offset by an increase in gross margin from retail gas sales of $184,000 due primarily to higher sales volumes in our Wyoming market.

Marketing and Production Operating Expenses — Operating expenses increased $61,000, from approximately $260,000 for first six months of fiscal 2007 to approximately $321,000 for the first six months of fiscal 2008. This change is caused primarily by increases in depreciation and administrative expenses associated with the realignment of the Energy West management team.

Marketing and Production Interest Expense — Interest expense decreased by $17,000 due to a decrease in short-term borrowings, a decrease in interest rates, and a decrease in amortization of debt issue costs due to the refinancing of our long-term debt.

Marketing and Production Income Tax Expense — Income tax expense in the first six months of fiscal year 2008 is $135,000, a $148,000 decrease from $283,000 in the first six months of fiscal year 2007 due primarily to adjustment to tax expense for prior year actual tax expense from amounts that had been estimated and accrued.

Operating Results of our Pipeline Operations