-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, I9y3SGmzsPPIplGpdfwRB/DmZ3EiaPNyy0bWDqpg8Pi8n+Vd7ZwSXmYIvOkQqSwo fR6XTjbNtdfTf+7n57PieQ== 0000895813-98-000090.txt : 19980401 0000895813-98-000090.hdr.sgml : 19980401 ACCESSION NUMBER: 0000895813-98-000090 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: NORTHWESTERN PUBLIC SERVICE CO CENTRAL INDEX KEY: 0000073088 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC & OTHER SERVICES COMBINED [4931] IRS NUMBER: 460172280 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-10499 FILM NUMBER: 98583536 BUSINESS ADDRESS: STREET 1: 33 THIRD ST SE STREET 2: PO BOX 1318 CITY: HURON STATE: SD ZIP: 57350-1318 BUSINESS PHONE: 6053528411 10-K 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [No fee required] For the transition period from _______________ to _______________ COMMISSION FILE NO. 0-692 NORTHWESTERN PUBLIC SERVICE COMPANY (Exact name of registrant as specified in its charter) Delaware 46-0172280 (State of (IRS Employer Incorporation) Identification No.) 33 Third Street SE 57350-1605 Huron, South Dakota (Zip Code) (Address of principal office) 605-352-8411 (Registrant's telephone number) Securities registered pursuant to Section 12(b) of the Act: Common Stock, $1.75 par value and related Common Stock Purchase Rights New York Stock Exchange Company Obligated Mandatorily Redeemable New York Stock Exchange Security of Trust Holding Solely Parent Debentures, $25.00 liquidation amount Common Stock Purchase Rights New York Stock Exchange (Title of each class) (Name of each exchange on which registered) Securities registered pursuant to Section 12(g) of the Act: PREFERRED STOCK, PAR VALUE $100 (Title of Class) 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. [ X ] Yes [ ] No 2 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] State the aggregate market value of the voting stock held by nonaffiliates of the registrant. $410,378,052 as of February 18, 1998 Indicate the number of shares outstanding of each of the registrant's classes of common stock as of the latest practicable date: COMMON STOCK, PAR VALUE $1.75 17,842,524 SHARES OUTSTANDING AT FEBRUARY 18, 1998 DOCUMENTS INCORPORATED BY REFERENCE: 1997 Annual Report to Stockholders . . . . .Parts I and II Proxy Statement for 1998 Annual Meeting . . . . .Part III 3 PART I ITEM 1. BUSINESS GENERAL DEVELOPMENT OF BUSINESS Northwestern Public Service Company (Company) is a nationwide diversified energy, telecommunications and related services provider. The Company generates and distributes electric energy to 56,000 customers in eastern South Dakota. The Company also purchases, distributes, sells, and transports natural gas to 79,000 customers in central Nebraska and eastern South Dakota. Through its subsidiaries, the Company operates a nationally recognized retail and wholesale propane distribution business. In 1996, Northwestern expanded the propane operations with the acquisition of eight additional propane companies, including Empire Energy Corporation in October, then the eighth largest retail marketer of propane in the U.S., and CGI Holdings, Inc., then the eighteenth largest retail marketer of propane in the U.S. in December. Also, in December 1996, Northwestern combined all of its propane businesses into Cornerstone Propane Partners, L.P. (Cornerstone), a publicly traded master limited partnership which sold 9.8 million common units to the public on December 17, 1996, at a price of $21 per unit. Cornerstone is the fifth largest retail propane marketer in the U.S., serving approximately 360,000 customers from 298 service centers in 27 states. At December 31, 1997, the Company's majority owned subsidiaries owned all 6,597,619 subordinated units and an aggregate 2% general partner interest in the partnership, or a combined 38.5%. In January 1998, Cornerstone sold an additional 1,960,000 units to the public. After the secondary offering, the Company, through its subsidiary, owns a combined 34.8% effective interest in the Partnership. Through its other subsidiaries, the Company is engaged in additional nonregulated operations as more fully discussed in the section entitled "Nonregulated Operations". The Company was incorporated under the laws of the state of Delaware in 1923 and is qualified to conduct its utility business in the states of South Dakota, Nebraska, Iowa, and North Dakota. The Company does not currently serve any utility customers in North Dakota or Iowa. The Company has its principal office at 33 Third Street SE, Huron, South Dakota 57350-1318. Its telephone number is 605-352-8411. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS Financial information about industry segments is incorporated by reference to Note 12 of the "Notes to Consolidated Financial Statements" of the Company's 1997 Annual Report to Stockholders, filed as an Exhibit 13 hereto. 4 NARRATIVE DESCRIPTION OF BUSINESS Weather patterns have a material impact on the Company's operating performance for all three segments of its energy business. This impact is particularly relevant for natural gas and propane. Because natural gas and propane are heavily used for residential and commercial heating, the demand for these products depends upon weather patterns throughout the Company's service area. With a larger proportion of its operations related to seasonal natural gas and propane sales, a significantly greater portion of the Company's operating income is recognized in the first and fourth quarters related to higher revenues from the heating season. PROPANE BUSINESS The Company's retail and wholesale propane distribution business is competing against a number of other distributors in an unregulated business. There are, however, certain inherent barriers for customers to overcome in switching from one propane delivery service provider to another. The Company believes that its ownership of propane storage tanks installed at customers' premises, together with safety regulations which prohibit other propane distributors from filling the propane tanks and cylinders at the customers' premises, promotes long-standing relationships which are typical in the retail propane industry. The cost and inconvenience of switching tanks tend to minimize the switching by customers among suppliers on the basis of minimal price variations. Conversely, it also makes it more difficult for the Company to acquire new customers, other than through acquisitions, in areas where there are existing relationships between potential customers and other distributors. Through its subsidiaries, the Company operates a nationally recognized retail and wholesale propane distribution business. Propane complements the Company's electric and natural gas distribution businesses and adds geographical diversity to its operations. On October 7, 1996, the Company completed the acquisition of Empire Energy Corporation (Energy), a retail distributor of propane. Energy maintained 168 retail branches serving approximately 130,000 customers in 10 states, primarily in southeast and midwest regions of the United States. On December 17, 1996, a wholly owned subsidiary of Northwestern Growth Corporation acquired CGI Holdings, Inc. (Coast). Immediately after the acquisition the Company combined the propane distribution businesses of Coast, Energy, Myers and Synergy into Cornerstone. As part of an IPO on the same date, Cornerstone sold a total of 9,821,000 Common Units at a price to the public of $21 a unit. At December 31, 1997, Cornerstone's capital consists of 11,127,000 Common Units, 6,597,619 subordinated units (Subordinated Units) representing limited partner interests and a 2% general partner interest. The Company's majority owned subsidiaries own all 6,597,619 Subordinated Units and an aggregate 2% general partner interest in the Partnership, or a combined 38.5% effective interest in the Partnership. In January 5 1998, Cornerstone sold an additional 1,960,000 units at a price to the public of $22.125 per unit. After the secondary offering the Company, through its subsidiary, owns a combined 34.8% effective interest in the Partnership. The net proceeds from the sale of 9,821,000 Common Units of Cornerstone and the net proceeds from the issuance of Cornerstone Senior Notes were used to repay term and revolving debt of Coast, Energy and Synergy, including accrued interest and any prepayment premiums which were assumed by the Partnership. In addition, the preferred stock of Synergy was redeemed at a premium. As a result of these repayments, the Company recorded a one-time after tax gain of $.09 per share from the prepayment of the term debt and redemption of preferred stock investment in Synergy. Additional information regarding the acquisitions is incorporated by reference to Note 2 of the "Notes to Consolidated Statements" of the Company's 1997 Annual Report to Stockholders, filed as an Exhibit 13 hereto. SALES. On a consolidated basis, 81% of the Company's 1997 operating revenues were from the sale of propane. Similar to its electric and natural gas businesses, no single customer accounts for a significant portion of the Company's propane sales. Propane sales were 32% retail and 68% to wholesale customers. Agricultural uses of propane include tobacco curing, crop drying, and poultry breeding. Other customers include industrial customers who use propane to fire furnaces, as a cutting gas, and in other process applications. Other industrial customers include large scale heating accounts, local gas utility customers who maintain a standby propane capability for use during peak demand periods, and customers who use propane as a feedstock in manufacturing processes. SUPPLY AND DISTRIBUTION. The Company purchases propane from various suppliers, including major domestic oil companies and independent producers of natural gas liquid and oil and made occasional spot market transactions. The majority of the propane purchases were on a contractual basis under one-year agreements subject to annual renewal. The largest supplier provided approximately 13% of the total volumes purchased under contract. The percentage of contract purchases may vary from year to year depending on a number of factors. Supply contracts generally provide for pricing in accordance with posted prices at the time of delivery or contract prices established at major storage points, and some contracts include a pricing formula that typically is based on such market prices. The Company has established relationships with a number of suppliers and believes it will have ample sources of supply under comparable terms to draw upon to meet the necessary propane requirements if it were to discontinue purchasing propane from its largest suppliers. The Company has not experienced a shortage that has prevented it from satisfying its own customers' needs and does not foresee any significant shortage in the supply of propane that would cause a disruption in meeting the needs of the Company's customers as well. 6 The Company primarily uses common carriers and railroad tank cars to transport propane from refineries, natural gas processing plants or pipeline terminals to the Company's bulk storage plants. The transportation of propane requires specialized equipment. The trucks and railroad cars utilized for this purpose carry specialized steel tanks that maintain the propane in a liquefied state. Propane delivery to customers is made by means of bulk delivery tank trucks owned by the Company. Propane is stored by the customers on their premises in stationary steel tanks generally ranging in capacity from 120 to 1,000 gallons, with large users having tanks with a capacity of 30,000 gallons. A majority of the propane storage tanks used by the Company's residential and commercial customers are owned by the Company. In addition, a certain number of Company owned tanks are provided to customers under a leasing agreement. ELECTRIC BUSINESS Pursuant to the South Dakota Public Utilities Act, the South Dakota Public Utilities Commission (PUC) assigned as the Company's electric service territory the communities and adjacent rural areas in which the Company provides electric service in South Dakota. The Company has the right to provide electric service to present and future electric customers in its assigned service territory for so long as the service provided is deemed adequate. Under the South Dakota Public Utilities Act, effective July 1, 1976, the Company is not required to obtain or renew municipal franchises to provide electric service within its assigned service territory. ELECTRIC SALES. On a consolidated basis, 8% of the Company's 1997 operating revenues were from the sale of electric energy. All of the Company's electric revenues are derived from customers in South Dakota. The Company has relatively few large customers in its service territory. By customer category, 33% of 1997 total electric sales was from residential sales, 50% was from commercial and industrial sales, 1% was from street lighting and sales to public authorities, and 16% was from sales for resale. Sales for resale primarily include power pool sales to other utilities. Power pool sales fluctuate from year to year depending on a number of factors including the Company's availability of excess short-term generation and the ability to sell the excess power to other utilities in the power pool. The Company also sells power and energy at wholesale to certain municipalities for resale and to various governmental agencies. In 1997, these sales accounted for less than 1% of total electric sales. CAPABILITY AND DEMAND. The Company shares in the ownership of the Big Stone Generating Plant (Big Stone), located near Big Stone City in northeastern South Dakota. In North Dakota, the Company maintains transmission facilities to interconnect with electric transmission lines of other utilities and shares in the ownership of the Coyote I Electric Generating Plant (Coyote), located near Beulah, 7 North Dakota. In Iowa, the Company shares in the ownership of Neal Electric Generating Unit #4 (Neal), located near Sioux City, Iowa. At December 31, 1997, the aggregate net summer peaking capacity of all Company-owned electric generating units was 310,259 kw, consisting of 106,390 kw from Big Stone (the Company's 23.4% share), 42,700 kw from Coyote (the Company's 10.0% share), 54,169 kw from Neal (the Company's 8.7% share), and 107,000 kw from internal combustion turbine units and small diesel units, used primarily for peaking purposes. In addition to those plant facilities, the Company entered into an agreement in 1995 to purchase up to 14,950 kw of firm capacity from Basin Electric Cooperative to assist in meeting peak capacity demands. The Company has also contracted with Nebraska Public Power District to purchase various amounts of firm capacity to further assist in supplying peak energy demands. The Company is a summer peaking utility. The 1997 peak demand of 270,089 kw occurred on July 16, 1997. Total system capability at the time of peak was 325,209 kw. The reserve margin for 1996 was 17%. The minimum reserve margin requirement as determined by the members of the Mid-Continent Area Power Pool (MAPP), of which the Company is a member, is 15%. MAPP is an area power pool arrangement consisting of utilities and power suppliers having transmission interconnections located in a 9-state area in the North Central region of the United States and in two Canadian provinces. The objective of MAPP is to accomplish coordination of planning and operation of generation and interconnecting transmission facilities to provide reliable and economical electric service to members' customers, consistent with reasonable utilization of natural resources and protection of the environment. While benefiting from the advantages of the planning, coordination, and operations of MAPP, each member has the right and obligation to own or otherwise provide the facilities to meet its own requirements. The terms and conditions of the MAPP agreement and transactions between MAPP members are subject to the jurisdiction of the Federal Energy Regulatory Commission (FERC). The Company also has interconnections with the transmission facilities of Otter Tail Power Company, Montana-Dakota Utilities Co., Northern States Power Company, and Western Area Power Administration; and has emergency interconnections with transmission facilities of East River Electric Cooperative, Inc. and West Central Electric Cooperative. These interconnections and pooling arrangements enable the Company to arrange purchases or sales of substantial quantities of electric power and energy with other pool members and to participate in the benefits of pool arrangements. The Company has finalized an integrated resource plan to identify how it will meet the electric energy needs of its customers. The plan includes estimates of customer usage and programs to provide for economic, reliable, and timely supplies of energy. The plan does not anticipate the need for additional baseload generating capacity for at least the next ten years. 8 FUEL SUPPLY. Lignite and sub-bituminous coal were utilized by the Company as fuel for virtually all of the electric energy generated during 1997. North Dakota lignite is the primary fuel at Coyote. The Company burned Montana sub-bituminous coal at Big Stone during 1997. During 1997, the average heating value of lignite burned was 6,949 BTU per pound at Coyote. The sulfur content of this lignite is typically between 0.8% and 1.2%. The Montana sub-bituminous coal burned at Big Stone contained an average heating value of 8,734 BTU per pound and a sulfur content between 0.55% and 0.75%. Neal burned Wyoming sub- bituminous coal which had an average heating value of 8,457 BTU per pound during 1997. Typically, the sulfur content of this coal is between 0.30% and 0.40%. The Company's fuel costs have remained relatively stable. The average cost by type of fuel burned is shown below for the periods indicated: Cost Per Million BTU % of 1997 Year Ended December 31 Megawatt ----------------------- Hours Fuel Type 1995 1996 1997 Generated ---- ---- ---- --------- Lignite - Big Stone $1.09 - - 0% Sub-bituminous - Big Stone 1.00 $.95 .93 56% Lignite - Coyote** .83 .86 .91 16% Sub-bituminous - Neal .76 .75 .71 28% Natural Gas 1.80 2.24 2.33 * Oil 3.96 4.65 4.64 * * Combined for approximately one percent. ** Includes pollution control reagent. During 1997, the average delivered cost per ton of lignite was $11.66 to Coyote. The average cost per ton of sub-bituminous coal received at Big Stone for 1997 was $15.99. The average cost for coal delivered to Neal was $11.56 per ton for 1997. Such amounts include severance taxes imposed by the states of North Dakota and Montana and a production tax imposed by the state of Wyoming. While the effect on the Company's fuel costs of future changes in severance or production taxes cannot be predicted, any changes in the Company's fuel costs may be passed on to its customers through the operation of the fuel adjustment clause. This feature of the Company's electric rates is more fully discussed in the section entitled "Regulation". The continued delivery of lignite and sub-bituminous coal to the three large steam generating units in which the Company is part owner is reasonably assured by contracts covering various periods of the operating lives of these units. The contract for delivery of Montana sub-bituminous coal to Big Stone expires in 1999, further evaluations will be conducted during the contract term to select a coal supply for periods beyond 1999. The contract for delivery of lignite to Coyote, which expires in 2016, provides for an adequate fuel supply for the 9 estimated economic life of that plant. Neal receives Wyoming sub- bituminous coal under a long-term contract which expires in 1998. The Company, along with the other owners of Neal, is studying options for the supply of coal for periods beyond the expiration date. Following test burns in 1990 and 1991, the owners of the Big Stone Plant received approval from the South Dakota Department of Environment and Natural Resources to burn tire derived fuel (TDF) and refuse derived fuel (RDF). The quantity of TDF and RDF that was burned in 1996 is insignificant when compared to total coal consumption at the plant. The fossil fuel supplies for Big Stone and Neal are delivered via unit trains belonging to the respective plants' owners and locomotives of the Burlington Northern Railroad and the Union Pacific Railroad, respectively. The lignite supply for Coyote is delivered via conveyor at this "mine-mouth" plant. In early 1996, the Company and its partners at Big Stone executed a fifteen year operating lease agreement for unit train cars. This agreement was effective late in 1996. The prior unit train cars were sold to another third party independent of the leasing transaction. While the Company has no firm contract for diesel fuel for its other electric generating plants, it has been able to purchase its diesel fuel requirements in recent years from local suppliers and currently has in storage an amount adequate to satisfy its normal requirements for such fuel. Additional information relating to jointly owned plants is incorporated by reference to Note 8 of the "Notes to Consolidated Statements" of the Company's 1997 Annual Report to Stockholders filed as an Exhibit 13 hereto. NATURAL GAS BUSINESS The Company has nonexclusive municipal franchises to provide gas service in the Nebraska and South Dakota communities in which it provides such service. The maximum term permitted under Nebraska law for such franchises is 25 years while the maximum term permitted under South Dakota law is 20 years. The Company's policy is to seek renewal of a franchise in the last year of its term. The Company has never been denied the renewal of any of these franchises and does not anticipate that any future renewals would be withheld. NATURAL GAS SALES AND DEMAND. On a consolidated basis, 8% of the Company's 1997 operating revenues were from the sale of natural gas. During 1997, the Company derived 57% of its natural gas revenues from South Dakota and 43% from Nebraska. The Company's peak daily sendout was 125,279 MMBTU. CAPABILITY AND SUPPLY. The Company owns and operates natural gas distribution systems serving 38,829 customers in eastern South Dakota. In 1996 the Company completed construction of a new natural gas pipeline in northern South Dakota which increased capacity by 15,000 MMBTU per day. In 1995, the Company executed a service agreement with 10 Cibola Energy Services Corporation (Cibola) whereby Cibola coordinates supply and transportation services. The pipeline and storage capacity is provided under service agreements with Northern Natural Gas Company. These agreements provide for firm deliverable pipeline capacity of approximately 57,200 MMBTU per day in South Dakota. In Nebraska, the Company owns and operates natural gas distribution systems serving 39,702 retail customers in the village of Alda and the cities of Grand Island, Kearney, and North Platte. The Company purchases all of its natural gas for these systems through KN Gas Marketing, Inc. (KN) under a service agreement entered in 1995 with all supply and transportation services coordinated through a subsidiary of the Company. These agreements provide for firm deliverable pipeline capacity of approximately 58,000 MMBTU per day in Nebraska. In 1992, FERC issued Order 636. Order 636 required, among other provisions, that all companies with natural gas pipelines separate natural gas supply or production services from transportation service and storage businesses. This allowed gas distribution companies, such as the Company, and individual customers to purchase gas directly from producers, third parties, and various gas marketing entities and transport it through the suppliers' pipelines. The Company has operated under the restructured environment during the past three years. To supplement firm gas supplies, the Company's service agreements with Cibola and KN also provide for underground natural gas storage services to meet the heating season and peak day requirements of its gas customers. In addition, the Company also owns and operates five propane-air plants with a total rated capacity of 14,000 MMBTU per day, or approximately 10% of peak day requirements. The propane-air plants provide an economic alternative to pipeline transportation charges to meet the peaks caused by customer demand on extremely cold days. A few of the Company's industrial customers purchase their natural gas requirements directly from gas marketing firms for transportation and delivery through the Company's distribution system. Transportation rates have been designed to make the Company economically indifferent as to whether the Company sells and transports gas or only transports gas. HVAC, TELECOMMUNICATIONS AND RELATED SERVICES The Company, through its subsidiary Northwestern Growth Corporation, has a preferred stock investment in the unconsolidated affiliate companies, ServiCenter USA and Communication Systems USA. ServiCenter USA is a premier provider of heating, ventilating, air conditioning, plumbing and related services for residential and business customers in the U.S. Communication Systems USA is a leading provider of telecommunication and data services to business customers. 11 COMPETITION AND BUSINESS RISK The Company's strategy centers upon the development, acquisition and expansions of operations offering integrated energy, telecommunications and related products and services within the Northwestern companies. In addition to maintaining a strong competitive position in electric, natural gas and propane distribution businesses, the Company intends to pursue development and acquisitions that have long-term growth potential. While such investments and acquisitions can involve increased risk in comparison to the Company's energy distribution businesses, they offer the potential for enhanced investment returns. Propane ------- Weather conditions have a significant impact on propane demand for both heating and agricultural purposes. The majority of Cornerstone's customers rely heavily on propane as a heating fuel. Actual weather conditions can vary substantially from year to year, significantly affecting Cornerstone's financial performance. Furthermore, variations in weather in one or more regions in which Cornerstone operates can significantly affect the total volumes sold by Cornerstone and the margins realized on such sales and consequently, Cornerstone's results of operations. These conditions may also impact Cornerstone's ability to meet various debt covenant requirements and affect Cornerstone's ability to pay distributions on the subordinated units and to the general partners. The retail propane business is a margin-based business in which gross profits depend on the excess of sales prices over propane supply costs. Consequently, Cornerstone's profitability is sensitive to changes in wholesale propane prices. Propane is a commodity, the market price of which can be subject to volatile changes in response to changes in supply or other market conditions. As it may not be possible to immediately pass on to customers rapid increases in the wholesale cost of propane, such increases could reduce Cornerstone's gross profits. Cornerstone's profitability is affected by the competition for customers among all participants in the retail propane business. Some of Cornerstone's competitors are larger or have greater financial resources than Cornerstone. Should a competitor attempt to increase market share by reducing prices, Cornerstone's financial condition and results of operations could be materially adversely affected. In addition, propane competes with other sources of energy, some of which may be less costly per equivalent energy value. Electric and Natural Gas ------------------------ The electric and natural gas industries continue to undergo numerous transformations, and the Company is operating in an increasingly competitive marketplace. The FERC, which regulates interstate and wholesale electric transmissions, opened up 12 transmission grids and mandated that utilities must allow others equal access to utility transmission systems. Various state regulatory bodies are supporting initiatives to redefine the electric energy market and are experimenting with retail wheeling, which gives some retail customers the ability to choose their supplier of electricity. Traditionally, utilities have been vertically integrated, providing bundled energy services to customers. The potential for continued unbundling of customer services exists, allowing customers to buy their own electricity and natural gas on the open market and having it delivered by the local utility. The growing pace of competition in the energy industry has been a primary focus of management over the last few years. The Company's future financial performance will be dependent on the effective execution of operating strategies to address a more competitive and changing energy marketplace. Business strategies focus on enhancing the Company's competitive position, on expanding energy sales and markets with new products and services for customers and increasing shareholder value. The Company has realigned various areas of its business to support customer services and marketing functions. A new marketing plan, an expanded line of integrated customer products and services, additional staff and new technologies are part of the Company's strategy for providing responsive and superior customer service. To strengthen the Company's competitive position, new technologies have and will be added that enable employees to better serve customers. The Company is centralizing activities to improve efficiency and customer responsiveness and business processes are being reengineered to apply best-practices methodologies. Long-term supply contracts have been renegotiated to lower customers' energy costs and new alliances help reduce expenses and add innovative work approaches. As described in Note 1 to the consolidated financial statements, the Company complies with the provisions of Statement of Financial Accounting Standards No. 71 (SFAS 71), "Accounting for the Effects of Certain Types of Regulation". SFAS 71 provides for the financial reporting requirements of the Company's regulated electric and natural gas operations which requires specific accounting treatment of certain costs and expenses that are related to the Company's regulated operations. Criteria that could give rise to the discontinuance of SFAS 71 include (1) increasing competition that restricts the Company's ability to establish prices to recover specific costs and (2) a significant change in the manner in which rates are set by regulators from cost-based regulation to another form of regulation. The Company periodically reviews these criteria to ensure the continuing application of SFAS 71 is appropriate. Based on a current evaluation of the various factors and conditions that are expected to impact future cost recovery, the Company believes that its regulatory assets, including those related to generation, are probable of future recovery. This evaluation of recovery must be updated for any change which might occur in the Company's current regulatory environment. 13 HVAC, Telecommunications and Related Services --------------------------------------------- The markets served by ServiCenter USA for residential and commercial heating, ventilating, air conditioning, plumbing and other related services are highly competitive. The principal competitive factors in these segments of the industry are (1) timeliness, reliability and quality of services provided, (2) range of products and services provided, (3) name recognition and market share and (4) pricing. Many of ServiCenter's competitors in the HVAC business are small, owner-operated companies typically located and operated in a single geographic area. There are only a small number of national companies engaged in providing residential and commercial services in the service lines, which the Company intends to focus. Future competition in both the residential and commercial service lines may be encountered from other newly formed or existing public or private service companies with aggressive acquisition programs, the unregulated business segments of regulated gas and electric utilities or from newly deregulated utilities in those industries entering into various service areas. The market served by Communication Systems USA in the telecommunications and data services industry is also a highly competitive market. The Company believes that (1) market acceptance of the Company's products and services, (2) pending and future legislation affecting the telecommunications and data industry, (3) name recognition and market share, (4) larger competitors and (5) the Company's ability to provide integrated communication and data solutions for customers in a dynamic industry area all factors that could affect the Company's future operating results. Other ----- The Company utilizes software and various technologies throughout its business that will be affected by the date change in the year 2000. The Company has assessed and is continuing to assess the impact of the year 2000 issue on its reporting systems and operations. The majority of the Company's financial reporting and operational systems are year 2000 compliant. The cost of the modifications of the remaining systems is not expected to be material. REGULATION The Company is a "public utility" within the meaning of the Federal Power Act and the South Dakota Public Utilities Act and, as such, is subject to the jurisdiction of, and regulation by, FERC with respect to issuance of securities, the PUC with respect to electric service territories, and both FERC and the PUC with respect to rates, service, accounting records, and in other respects. The State of Nebraska has no centralized regulatory agency which has jurisdiction over the Company's operations in that state; however, the Company's natural gas rates are subject to regulation by the municipalities in which it operates. 14 Under the South Dakota Public Utilities Act, effective July 1, 1976, a requested rate increase may be implemented by the Company 30 days after the date of its filing unless its effectiveness is suspended by the PUC and, in such event, can be implemented subject to refund with interest six months after the date of filing, unless sooner authorized by the PUC. The Company's electric rate schedules provide that it may pass along to all classes of customers qualified increases or decreases in the cost of fuel used in its generating stations and in the cost of fuel included in purchased power. A purchased gas adjustment provision in its gas rate schedules permits the Company to pass along to gas customers increases or decreases in the cost of purchased gas. The Company filed no electric rate cases in South Dakota during the three years ended December 31, 1997. A natural gas increase was implemented in South Dakota on November 15, 1994. Effective April 1, 1995, the Company implemented increased rates related to its Nebraska natural gas service area as a result of a negotiated settlement with representatives of the four communities in which the Company operates. On April 24, 1996, FERC issued its final rule (Order No. 888) on wholesale electric transmission open access and recovery of stranded costs. On July 9, 1996, the Company filed proposed tariffs with FERC in compliance with Order 888. Under the proposed tariffs, which became effective on July 10, 1996, eligible transmission service customers can choose to purchase transmission services from a variety of options ranging from full use of the transmission network on a firm long-term basis to a fully interruptible service available on an hourly basis. The proposed tariffs also include a full range of ancillary services necessary to support the transmission of energy while maintaining reliable operations of the Company's transmission system. The Company is awaiting final approval of the proposed tariffs by FERC. FERC has approved the Company's Request for Waiver of the requirements of FERC Order No. 889 as it relates to the Standards of Conduct. The Standards of Conduct require companies to physically separate their transmission operations/reliability functions from their marketing/merchant functions. The Request for Waiver is based on criteria established by FERC, exempting small public utilities as defined by the United States Small Business Administration. ENVIRONMENTAL MATTERS The Company is subject to regulation with regard to air and water quality, solid waste disposal, and other environmental considerations by Federal, state, and local governmental authorities. The application of governmental requirements to protect the environment involves or may involve review, certification, issuance of permits, or similar action by government agencies or authorities, including the United States Environmental Protection Agency (EPA), the South Dakota Department of Environment and Natural Resources (DENR), the North Dakota State Department of Health, and the Iowa Department of Environmental Quality, as well as compliance with decisions of the courts. 15 CLEAN AIR ACT. The Clean Air Act Amendments of 1990 (the Clean Air Act) stipulate limitations on sulfur dioxide and nitrogen oxide emissions from coal-fired power plants which will require the purchase of additional emission allowances or a reduction in sulphur dioxide emissions beginning in the year 2000 from the Big Stone Plant. The Company believes it can economically meet the sulfur dioxide emission requirements of the Clean Air Act by the required compliance dates. With regard to the Clean Air Act's nitrogen oxide emission requirements, the Neal wall-fired boiler is expected to meet the emission limitations for such boilers. The Clean Air Act does not yet specify nitrogen oxide limitations for boilers with cyclone burners such as those used at Big Stone and Coyote because practical low- nitrogen oxide cyclone burner technology does not exist. It requires the EPA to establish nitrogen oxide emission limitations for cyclone boilers including taking into account that the cost to accomplish such limits be comparable to retrofitting low-nitrogen oxide burner technology to other types of boilers. In addition, the Clean Air Act also requires future studies to determine what controls, if any, should be imposed on coal-fired boilers to control emissions of certain air toxics other than sulfur and nitrogen oxides. Because of the uncertain nature of cyclone boiler nitrogen oxide and air toxic emission limits, the Company cannot now determine the additional costs, if any, it may incur due to these provisions of the Clean Air Act. PCBs. The Company has met or exceeded the removal and disposal requirements of equipment containing polychlorinated biphenyls (PCBs) as required by state and Federal regulations. The Company will use some PCB-contaminated equipment for its remaining useful life, and dispose of the equipment according to pertinent regulations that govern that use and disposal of this equipment. PCB-contaminated oil is burned for energy recovery at a permitted facility. STORAGE TANKS. The South Dakota DENR and the EPA adopted regulations imposing requirements upon the owners and operators of above ground and underground storage tanks. The Company's fuel oil storage facilities at its generating plants in South Dakota are affected by the above ground tank regulations, and the Company has instituted procedures for compliance. SITE REMEDIATION. The Company conducted an investigation of a manufactured gas plant (MGP) site and took remedial action during 1995 by permanently removing the residues contained in the soil through a thermal desorption process. In May 1996, EPA Region VIII (which includes South Dakota, North Dakota, Colorado, Utah, Wyoming, and Montana) selected the Company to receive an Outstanding Achievement Award for Leadership and Innovation. EPA Region VIII chose recipients who had demonstrated protection and enhancement of Region VIII's environment. Adjustments of the Company's natural gas rates to reflect the costs associated with the remediation were approved by the PUC. OTHER. In addition to the Clean Air Act, the Company is also subject to other environmental regulations. The Company believes that 16 it is in compliance with all presently applicable environmental protection requirements and regulations. However, the Company is unable to forecast the effect which future environmental regulations may ultimately have upon the cost of its utility related facilities and operations. No administrative or judicial proceedings involving the Company are now pending or known by the Company to be contemplated under presently effective environmental protection requirements. SITING. The states of South Dakota, North Dakota, and Iowa have enacted laws with respect to the siting of large electric generating plants and transmission lines. The South Dakota PUC, the North Dakota Public Service Commission, and the Iowa Utilities Board have been granted authority in their respective states to issue site permits for nonexempt facilities. PROPANE TRANSPORTATION AND SAFETY MATTERS. The Company's propane operations are subject to various Federal, state, and local laws governing the transportation, storage and distribution of propane, occupational health and safety, and other matters. All states in which the Company operates have adopted fire safety codes that regulate the storage and distribution of propane. In some states, these laws are administered by state agencies, and in others they are administered on a municipal level. Certain municipalities prohibit the underground installation of propane furnaces and appliances, and certain states are considering the adoption of similar regulations. The Company currently meets or exceeds Federal regulations requiring that all persons employed in the handling of propane gas be trained in proper handling and operating procedures. All employees have participated, or will participate within 90 days of their employment date, in hazardous materials training. The Company has established ongoing training programs in all phases of product knowledge and safety including participation in the National Propane Gas Association's (NPGA) Certified Employee Training Program. CAPITAL SPENDING AND FINANCING The Company's primary ongoing capital requirements include the funding of its energy business construction and expansion programs, the funding of debt and preferred stock retirements and sinking fund requirements, and the funding of its corporate development and investment activities. The emphasis of the Company's construction activities is to undertake those projects that most efficiently serve the expanding needs of its customer base, enhance energy delivery capabilities, expand its current customer base, and provide for the reliability of energy supply. Capital expenditure plans are subject to continual review and may be revised as a result of changing economic conditions, variations in sales, environmental requirements, investment opportunities, and other ongoing considerations. Expenditures for maintenance and construction activities for 1997, 1996, and 1995 were $22.4 million, $35.2 million, and $29.6 million, respectively. Capital expenditures during 1997 included maintenance expenditures related to Cornerstone propane operations. Construction expenditures 17 during 1996 and 1995 included expenditures related to an operations center expected to provide cost savings and operating efficiencies through consolidation of activities, and the expansion of the Company's natural gas system into additional communities in eastern South Dakota. In addition, 1997, 1996 and 1995 included $4.1 million, $7.3 million and $4.7 million, respectively, of maintenance capital expenditures related to propane. Total capital expenditures for 1998, excluding propane operations, are estimated to be $13.8 million. The majority of the projected expenditures will be spent on enhancements of the electric and gas distribution systems. Estimated electric and natural gas related expenditures for the years 1998 through 2002 are expected to be $61.5 million. Nonregulated maintenance capital expenditures for 1998 are estimated to be $3.8 million. Estimated nonregulated maintenance capital expenditures for the years 1998 through 2002 are expected to be $19.0 million. Capital requirements for the mandatory retirement of long-term debt and mandatory preferred stock sinking fund redemption totaled $1,244,000, $400,000, and $600,000 for the years ended 1997, 1996, and 1995, respectively. It is expected that such mandatory retirements will be $7.8 million in 1998, $7.8 million in 1999, $8.9 million in 2000, $8.5 million in 2001, and $8.3 million in 2002. The balance on the Cornerstone working capital facility was reduced in January, 1998 using the proceeds of a secondary offering of 1,960,000 units which were sold to the public at a price of $22.125 per unit, resulting in net proceeds of $40.7 million. The Company anticipates that future capital requirements will be met by both internally generated cash flows, available investments and available external financing. The Company plans to continue to evaluate and pursue opportunities to enhance shareholder return through nonregulated business investments. Nonregulated projects are expected to be financed from the existing investment portfolio and from other available financing options. Information relating to capital resources and liquidity is incorporated by reference to "Management's Discussion and Analysis" of the Company's 1997 Annual Report to Stockholders, filed as an Exhibit 13 hereto. NONREGULATED OPERATIONS NORTHWESTERN GROWTH CORPORATION (NGC). NGC was incorporated under the laws of South Dakota in 1994 to pursue and manage nonutility investments and development activities. NGC owns the controlling general partner of Cornerstone. Other NGC assets include a portfolio of marketable securities and the investments of subsidiaries: Northwestern Networks, Inc., which holds a common stock investment in LodgeNet Entertainment Corporation, a provider of television entertainment and information systems to hotels and motels, and Northwestern Systems, Inc., which owns 100% of the common stock of Lucht Inc., a firm that develops, manufactures, and markets multi- image photographic printers and other related equipment, and Franklin Industries Co., a remanufacturer of steel products. In 1997, NGC formed ServiCenter USA to acquire heating, ventilating, air conditioning, plumbing and related services to companies in the U. S. 18 Also in late 1997, Northwestern formed Communication Systems USA to acquire and consolidate companies providing telecommunications and data services to business customers. Although the primary focus of NGC's investment program will be to continue to seek growth opportunities in the energy, energy equipment, and energy services industries, NGC will also continue to pursue opportunities in existing and emerging growth entities in non-energy industries that meet the Company's return on investments and capital gain requirements. NORTHWESTERN SERVICES CORPORATION (NSC) was incorporated under the laws of South Dakota in 1997 to market integrated residential and commercial products and services. NORTHWESTERN ENERGY CORPORATION. Northwestern Energy Corporation markets natural gas and energy related services, and has interests in nonregulated energy holdings. GRANT, INC. Grant, Inc., which holds title to property not used in the Company's utility business, was incorporated in South Dakota in 1972. Additional information relating to nonregulated business is incorporated by reference to "Management's Discussion and Analysis" of the Company's 1997 Annual Report to Stockholders, filed as an Exhibit 13 hereto. EMPLOYEES At December 31, 1997, the Company had 444 utility employees. A three-year collective bargaining agreement which was negotiated in 1997, covers operating and clerical employees. The Company has never experienced a work stoppage or strike and considers its relationship with its employees to be very good. At December 31, 1997, the Company had 2,206 employees involved in its propane operations. Approximately 30 of these employees are represented by unions. Cornerstone has not experienced any work stoppage or other significant labor problems and believes it has a good relationship with its employees. At December 31, 1997, the Company had 145 employees involved in its manufacturing operations. None of these employees is represented by unions. The Company has not experienced any work stoppage or other significant labor problems and believes it has a good relationship with its employees. EXECUTIVE OFFICERS OF THE REGISTRANT M. D. Lewis, Chairman, President and Chief Executive Officer, age 50 Chairman since May 1, 1997; President and Chief Executive Officer since February 1994; formerly Executive Vice President from May 1993, to February 1994; Executive Vice President-Corporate Services 1992-1993; Vice President-Corporate Services 1987-1992; Assistant Corporate Secretary 1982-1993. Mr. Lewis also serves 19 as Chairman of Northwestern Growth Corporation, Cornerstone Propane GP, Inc., ServiCenter USA, Communication Systems USA, Northwestern Energy Corporation and Northwestern Services Corporation. R. R. Hylland, Executive Vice President, age 37 Executive Vice President since May, 1996. Formerly Executive Vice President - Strategic Development November 1995-May 1996; Vice President-Strategic Development from August 1995 to November 1995; Vice President Corporate Development from 1993-1995; Vice President-Finance from 1991-1995; Treasurer from 1990-1994; Mr. Hylland also serves as Vice Chairman and Chief Executive Officer of Northwestern Growth Corporation and Vice Chairman of ServiCenter USA, Communication Systems USA and Cornerstone Propane GP, Inc., since January, 1998. Formerly President and Chief Operating Officer of Northwestern Growth Corporation, September 1994-January 1998. Mr. Hylland is also a member of the board of directors of Northwestern Public Service, Northwestern Growth Corporation, LodgeNet Entertainment Corporation, and Lucht, Inc. A. D. Dietrich, Vice President - Administration and Corporate Secretary, age 47 Vice President-Administration since November 1994; Corporate Secretary since October 1989; formerly Vice President-Legal May 1990-November 1994. A. R. Donnell, Vice President - Energy Operations, age 54 Vice President-Energy Operations since November 1994; formerly Vice President-Electric Operations July 1987-November 1994. T. A. Gulbranson, Vice President - Energy Services, age 50 Vice President - Customer Services since January 1996; Mr. Gulbranson also serves as President and Chief Operating Officer of Northwestern Services Corporation since May 1997; formerly Vice President November 1994-January 1996; Vice President- Corporate Services May 1993-November 1994; Vice President- Community Development 1988-1993. Mr. Gulbranson also is a member of the board of directors of Northwestern Growth Corporation and Lucht, Inc. R. F. Leyendecker, Vice President - Market Development, age 52 Vice President-Market Development since January 1996; Mr. Leyendecker also serves as President and Chief Operating Officer of Northwestern Energy Corporation since September 1996; formerly Vice President-Energy Services November 1994-January 1996; Vice President-Rates & Regulation 1987-November 1994. Mr. Leyendecker also is a member of the board of directors of Northwestern Growth Corporation and Lucht, Inc. 20 W. K. Lotsberg, Vice President - Public Affairs, age 55 Vice President-Public Affairs since May 1994; formerly Vice President-Consumer Affairs March 1989-May 1994. D. K. Newell, Chief Financial Officer and Vice President - Finance, age 41 Chief Financial Officer and Vice President - Finance since July 1996. Formerly Vice President - Finance, July 1995-June 1996. Prior to joining the Company in July 1995, Mr. Newell served as CFO, Vice President - Finance and Treasurer with Energy Fuels Corporation. Mr. Newell also has served as President and COO of Northwestern Growth Corporation since January 1998. Formerly Executive Vice President of Northwestern Growth Corporation July 1995 - January 1998. Mr. Newell also is a member of the board of directors of Northwestern Growth Corporation, Cornerstone Propane GP, Inc., ServiCenter USA and Communication Systems USA, Lucht, Inc. and Franklin Industries. R. A. Thaden, Vice President - Communications and Treasurer, age 46 Vice President-Communications since February 1997; formerly Treasurer November 1994 - May 1997; Manager-Corporate Accounting 1987-November 1994. Ms. Thaden also has served as Vice President of Northwestern Growth Corporation since September 1995. Formerly Treasurer of Northwestern Growth Corporation September 1995-May 1997. D. A. Monaghan, Controller and Treasurer, age 30 Controller and Treasurer since June 1997. Mr. Monaghan also serves as Treasurer of Northwestern Growth Corporation, Northwestern Services Corporation and Northwestern Energy Corporation. Formerly Controller November 1996-May 1997. Prior to joining the Company in November 1996, Mr. Monaghan was an audit and consulting manager with the regional public accounting firm Baird, Kurtz & Dobson. All of the executive officers of the registrant serve at the discretion of the Board and are elected annually by the Board of Directors following the Annual Meeting of Stockholders. No family relationships exist between any officers of the Company. ITEM 2. PROPERTIES PROPANE PROPERTY As of December 31, 1997 the Company operated 298 service centers consisting of appliance showrooms, bulk storage plants, warehousing space, maintenance facilities, garages, and storage depots of large propane tanks with associated distribution equipment. These service center facilities are located in 27 states comprised of Texas, New Mexico, Oklahoma, Mississippi, Tennessee, Arkansas, Missouri, Vermont, New Hampshire, New York, Maryland, New Jersey, Virginia, North 21 Carolina, South Carolina, Ohio, Florida, California, Alaska, Kansas, Utah, Indiana, Arizona, Georgia, Alabama, Kentucky, and Louisiana. ELECTRIC PROPERTY The Company's electric properties consist of an interconnected and integrated system. The Company, Otter Tail Power Company (Otter Tail), and Montana-Dakota Utilities Co. (MDU) jointly own Big Stone, a 455,783 kilowatt (kw) nameplate capacity coal-fueled electric generating plant and related transmission facilities. Big Stone is operated by Otter Tail for the benefit of the owners. The Company owns 23.4% of the Big Stone Plant. The Company is one of four power suppliers which jointly own Coyote, a 455,783 kw nameplate capacity lignite-fueled electric generating plant and related transmission facilities located near Beulah, North Dakota. The Company has a 10% interest in Coyote, which is operated by MDU for the benefit of the owners. The Company is one of 14 power suppliers which jointly own Neal, a 639,999 kw nameplate capacity coal-fueled electric generating plant and related transmission facilities located near Sioux City, Iowa. MidAmerican Energy Company is principal owner of Neal and is the operator of the unit. The Company has an 8.7% interest in Neal. The Company has an undivided interest in these jointly owned facilities and is responsible for its proportionate share of the capital and operating costs while being entitled to its proportionate share of the power generated. Each participant finances its own investment. The Company's interest in each plant is reflected in the Consolidated Balance Sheet on a pro rata basis, and its share of operating expenses is reflected in the Consolidated Statement of Income and Retained Earnings. In addition to its interest in Big Stone, Coyote and Neal, the Company owns and operates 19 fuel oil and gas-fired units for peaking and reserve capacity. As of December 31, 1997, the aggregate nameplate capacity of all Company-owned electric generating units was 327,419 kw, with an aggregate net summer peaking capacity of 310,259 kw and a net winter peaking capacity of 331,969 kw. In addition to owned capacity, the Company entered into two contractual agreements to purchase firm capacity to assist in meeting peak energy needs. The Company's interconnected transmission system consists of 321.8 miles operating at 115 kilovolts (kv) and 900.6 miles operating at 69 kv and 34.5 kv. The Company also owns three segments of transmission line, which are not tied to its internal system, in connection with its joint ownership in the three large steam generating plants. These lines consist of 18.2 miles of 230 kv line from Big Stone, 25.4 miles of 345 kv line from Neal, and 23.1 miles of 345 kv line from Coyote. In addition to these lines, the Company owns 1,758.6 miles of distribution lines serving customers in more than 100 communities and adjacent rural areas. The Company owns 40 22 transmission substations with a total rated capacity of 1,111,417 kilovolt amperes (kva), two mobile substations with a total rated capacity of 5,500 kva and 80 distribution substations with a total rated capacity of 350,949 kva. GAS PROPERTY On December 31, 1997, the Company owned 1,111 miles of distribution mains and appurtenant facilities in South Dakota. The Company also owns propane-air facilities in Aberdeen, Brookings, Huron, and Mitchell, South Dakota, having a total rated capacity of 15,280 MMBTU per day, which are operated for standby and peak shaving purposes only. On December 31, 1997, the Company owned 673 miles of distribution mains and appurtenant facilities in Nebraska. The Company also owns propane-air facilities at Kearney and North Platte, Nebraska, having a total rated capacity of 9,380 MMBTU per day, which are operated for standby and peak shaving purposes only. CHARACTER OF OWNERSHIP All mortgage bonds issued under the Company's General Mortgage Indenture and Deed of Trust dated as of August 1, 1993 (the "Indenture") are secured by a first mortgage lien on the Company's properties used in the generation, production, transmission or distribution of electric energy or the distribution of natural gas in any form and for any purpose, with certain exceptions expressly provided in the Indenture. The principal offices and properties of the Company are held in fee and are free from other encumbrances, subject to minor exceptions, none of which is of such a nature as substantially to impair the usefulness to the Company of such properties. In general, the electric lines and natural gas lines and mains are located on land not owned in fee, but are covered by necessary consents of various governmental authorities or by appropriate rights obtained from owners of private property. These consents and rights are deemed adequate for the purposes for which they are being used. ITEM 3. LEGAL PROCEEDINGS The Company is a party to various pending proceedings and suits, but in the judgment of management after consultation with counsel for the Company, the nature of such proceedings and suits, and the amounts involved do not depart from the routine litigation and proceedings incident to the kind of business conducted by the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No issues were submitted to a vote of security holders during the last quarter of the period covered by this report. 23 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock, which is traded under the ticker symbol NPS, is listed on the New York Stock Exchange. The following are the high and low sale prices for the common stock for each full quarterly periods with the two most recent years and the dividends paid per share during each such period: QUARTERLY COMMON STOCK DATA Prices Cash ------ Dividends Declared High Low -------- ---- --- 1996 ---- First Quarter $ 15-1/8 $ 13-3/4 $ .22 Second Quarter 14-13/16 13-3/8 .22 Third Quarter 15-9/16 13-7/16 .22 Fourth Quarter 18-1/4 15 .23 1997 ---- First Quarter $19-3/4 $16-15/16 $ .23 Second Quarter 22-1/4 18-5/16 .23 Third Quarter 21-1/4 17-3/4 .23 Fourth Quarter 23-1/2 18-7/16 .2425 Certain other information required by this Item 5 is incorporated by reference to Note 13 of the "Notes to Consolidated Financial Statements" of the Company's 1997 Annual Report to Stockholders, filed as an Exhibit 13 hereto. ITEM 6. SELECTED FINANCIAL DATA The information required by this Item 6 is incorporated by reference to "Financial Statistics" on the Company's 1997 Annual Report to Stockholders, filed as an Exhibit 13 hereto. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this Item 7 is incorporated by reference to "Management's Discussion and Analysis" of the Company's 1997 Annual Report to Stockholders, filed as an Exhibit 13 hereto. 24 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this Item 8 is incorporated by reference to the Company's financial statements and related footnotes, of the Company's 1997 Annual Report to Stockholders, filed as an Exhibit 13 hereto. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There have been no changes in accountants or disagreements on accounting principles or practices or financial statement disclosures. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) IDENTIFICATION OF DIRECTORS The information regarding directors required by this Item 10 is incorporated by reference to the information under "Election of Directors" and "Reports to the Securities and Exchange Commission" in the Company's definitive Proxy Statement dated March 20, 1998, filed with the Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934. The information relating to the Company's executive officers required by this Item 10 is set forth under the caption "Executive Officers of the Registrant" following Item 1 of this Annual Report on Form 10-K. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item 11 is incorporated by reference to the information under "Compensation of Directors and Executive Officers" in the Company's definitive Proxy Statement dated March 20, 1998, and filed with the Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item 12 is incorporated by reference to the information under "Securities Ownership by Directors and Officers" in the Company's definitive Proxy Statement dated March 20, 1998, and filed with the Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934. 25 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Company has no relationships or transactions covered by this item. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) DOCUMENTS FILED AS PART OF THIS REPORT 1. Financial Statements Report of Independent Public Accountants Consolidated Statements of Income and Retained Earnings for the Three Years Ended December 31, 1997 Consolidated Statement of Cash Flows for the Three Years Ended December 31, 1997 Consolidated Balance Sheets, December 31, 1997 and 1996 Notes to Consolidated Financial Statement Quarterly Unaudited Financial Data for the Two Years Ended December 31, 1997 2. Financial Statement Schedules The following supplemental financial data included herein should be read in conjunction with the financial statements referenced above: Report of Independent Public Accountants Schedule II - Valuation and Qualifying Accounts Schedules other than those listed above are omitted because of the absence of the conditions under which they are required or because the information required is included in the financial statements or the notes thereto. 3. Exhibits The exhibits listed on the Exhibit Index of this Annual Report on Form 10-K are filed herewith or are incorporated herein by reference. (b) REPORTS ON FORM 8-K No reports on Form 8-K were filed during the quarter ended December 31, 1997. 26 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. NORTHWESTERN PUBLIC SERVICE COMPANY (Registrant) /s/ M. D. Lewis ------------------------------------- M. D. Lewis, Chairman, President and Chief Executive Officer March 20th, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ M. D. Lewis March 20, 1998 ------------------------------------- M. D. Lewis, Chairman, President and Chief Executive Officer /s/ R. R. Hylland March 20, 1998 ------------------------------------- R. R. Hylland, Director and Executive Vice President /s/ D. K. Newell March 20, 1998 ------------------------------------- D. K. Newell, Vice President-Finance (Principal Financial Officer) /s/ David A. Monaghan March 20, 1998 ------------------------------------ David A. Monaghan, Controller and Treasurer (Principal Accounting Officer) /s/ Jerry W. Johnson March 20, 1998 ------------------------------------- Jerry W. Johnson, Director /s/ Aelred J. Kurtenbach March 20, 1998 ------------------------------------- Aelred J. Kurtenbach, Director 27 /s/ Herman Lerdal March 20, 1998 ------------------------------------- Herman Lerdal, Director /s/ Larry F. Ness March 20, 1998 ------------------------------------- Larry F. Ness, Director /s/ Raymond M. Schutz March 20, 1998 ------------------------------------- Raymond M. Schutz, Director /s/ Bruce I. Smith March 20, 1998 ------------------------------------- Bruce I. Smith, Director /s/ Gary Olson March 20, 1998 ------------------------------------- Gary Olson, Director /s/ Gary G. Drook March 20, 1998 ------------------------------------- Gary G. Drook, Director /s/ Randy G. Darcy March 20, 1998 ------------------------------------- Randy G. Darcy Director 28 ARTHUR ANDERSEN LLP REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Northwestern Public Service Company: We have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Northwestern Public Service Company's annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 30, 1998. Our audit was made for the purpose of forming an opinion on those financial statements taken as a whole. The schedule listed in the table of contents of financial statements is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. /s/ Arthur Andersen LLP Minneapolis, Minnesota, January 30, 1998 29 SCHEDULE II
NORTHWESTERN PUBLIC SERVICE COMPANY AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS Column C Column A Column B Additions Column D Column E -------- -------- --------- -------- -------- Balance Beginning Charged to Charged Balance of Period Costs and to Other Deductions End Description (F1) Expenses Expenses (F2) of Period ----------- --------- ---------- -------- ---------- --------- FOR THE YEAR ENDED DECEMBER 31, 1997 ------------------------------------ RESERVES DEDUCTED FROM APPLICABLE ASSETS: Uncollectible accounts $5,368,654 $1,521,846 $ - $(2,578,189) $4.312.311 ========== ========== ========== ============ ========== OTHER DEFERRED CREDITS: Reserve for decommissioning costs $8,299,823 $ 512,850 $ - $ - $8,812,673 ========== ========== ========== ========== ========== FOR THE YEAR ENDED DECEMBER 31, 1996 ------------------------------------ RESERVES DEDUCTED FROM APPLICABLE ASSETS: Uncollectible accounts $8,704,698 $3,109,374 $ - $(6,445,418) $5,368,654 ========== ========== ========== ============ ========== OTHER DEFERRED CREDITS: Reserve for decommissioning costs $7,788,482 $ 511,341 $ - $ - $8,299,823 ========== ========== ========== ============ ========== FOR THE YEAR ENDED DECEMBER 31, 1995 ------------------------------------ RESERVES DEDUCTED FROM APPLICABLE ASSETS: Uncollectible accounts $5,907,675 $ 827,909 $ - $ (310,681) $6,424,903 ========== ========== ========== ============ ========== OTHER DEFERRED CREDITS: Reserve for decommissioning costs $7,278,173 $ 510,309 $ - $ - $7,788,482 ========== ========== ========== ============ ==========
(F1) The beginning balance for 1996 and 1995 were restated to reflect the propane acquisitions that occurred during those periods. (F2) All deductions from reserves were for purposes for which such reserves were created. 30 EXHIBIT INDEX ------------- (3) ARTICLES OF INCORPORATION AND BY-LAWS 3(a)(1) Registrant's Restated Certificate of Incorporation, dated February 7, 1990, is incorporated by reference to Exhibit 3(a)(1) to Form 10-K for the year ended December 31, 1989, Commission File No. 0-692. 3(a)(2) Certificate of Retirement of Preferred Stocks, dated January 13, 1992, is incorporated by reference to Exhibit 3(a)(2) to Form 10-K for the year ended December 31, 1991, Commission File No. 0-692. 3(a)(3) Certificate of Amendment of Restated Certificate of Incorporation, dated May 16, 1996, is incorporated by reference to Exhibit 3(a)(3) to Form 10-K for the year ended December 31, 1996, Commission File No. 0- 692. 3(a)(4) Certificate of Retirement of Preferred Stocks, dated June 20, 1996, is incorporated by reference to Exhibit 3(a)(4) to Form 10-K for the year ended December 31, 1996, Commission File No. 0-692. 3(b) Registrant's By-Laws, as amended, dated August 7, 1996, are in incorporated by reference to Exhibit 3(b) to Form 10-K for the year ended December 31, 1996, Commission File No. 0-692. (4) INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES 4(a)(1) General Mortgage Indenture and Deed of Trust, dated as of August 1, 1993, from the Company to The Chase Manhattan Bank (National Association), as Trustee, is incorporated by reference to Exhibit 4(a) of Form 8-K, dated August 16, 1993, Commission File No. 0-692. 4(a)(2) Supplemental Indenture, dated August 15, 1993, from the Company to The Chase Manhattan Bank (National Association), as Trustee, is incorporated by reference to Exhibit 4(b) of Form 8-K, dated August 16, 1993, Commission File No. 0-692. 31 4(a)(4) Supplemental Indenture, dated August 1, 1995, from the Company to The Chase Manhattan Bank (National Association), as Trustee, is incorporated by reference to Exhibit 4(b) of Form 8-K, dated August 30, 1995, Commission File No. 0-692. 4(a)(5) Supplemental Indenture, dated September 1, 1995, from the Company to The Chase Manhattan Bank (National Association), as Trustee, concerning the New Mortgage Bonds, 6.99% Series due 2002, is incorporated by reference to Exhibit (4)(a)(5) to Form 10-K for the year ended December 31, 1995, Commission File No. 0-692. 4(b)(1) Preferred Securities Guarantee Agreement, dated August 3, 1995, between the Company and Wilmington Trust Company is incorporated by reference to Exhibit 1(d) of Form 8-K, dated August 30, 1995, Commission File No. 0-692. 4(b)(2) Declaration of Trust of NWPS Capital Financing I is incorporated by reference to Exhibit 4(d) of Form 8-K, dated August 30, 1995, Commission File No. 0-692. 4(b)(3) Amended and Restated Declaration of Trust of NWPS Capital Financing I is incorporated by reference to Exhibit 4(e) of Form 8-K, dated August 30, 1995, Commission File No. 0-692. 4(b)(4) Subordinated Debt Securities Indenture, dated August 1, 1995, between the Company and The Chase Manhattan Bank (National Association), as Trustee, is incorporated by reference to Exhibit 4(f) of Form 8-K, dated August 30, 1995, Commission File No. 0-692. 4(b)(5) First Supplemental Indenture, dated August 1, 1995, to the Subordinated Debt Securities Indenture is incorporated by reference to Exhibit 4(g) of Form 8-K, dated August 30, 1995, Commission File No. 0-692. 4(c)(1) Copy of Sale Agreement between Company and Mercer County, North Dakota, dated June 1, 1993, related to issuance of Pollution Control Refunding Revenue Bonds (Northwestern Public Service Company Project) Series 1993, is incorporated by reference to Exhibit 4(b)(1) of 32 Registrant's report on Form 10-Q for the quarter ending June 30, 1993, Commission File No. 0-692. 4(c)(2) Copy of Loan Agreement between Company and Grant County, South Dakota, dated June 1, 1993, related to issuance of Pollution Control Refunding Revenue Bonds (Northwestern Public Service Company Project) Series 1993A, is incorporated by reference to Exhibit 4(b)(2) of Registrant's report on Form 10-Q for the quarter ending June 30, 1993, Commission File No. 0-692. 4(c)(3) Copy of Loan Agreement between Company and Grant County, South Dakota, dated June 1, 1993, related to issuance of Pollution Control Refunding Revenue Bonds (Northwestern Public Service Company Project) Series 1993B, is incorporated by reference to Exhibit 4(b)(3) of Registrant's report on Form 10-Q for the quarter ending June 30, 1993, Commission File No. 0-692. 4(c)(4) Copy of Loan Agreement between Company and City of Salix, Iowa, dated June 1, 1993, related to issuance of Pollution Control Refunding Revenue Bonds (Northwestern Public Service Company Project) Series 1993, is incorporated by reference to Exhibit 4(b)(4) of Registrant's report on Form 10-Q for the quarter ending June 30, 1993, Commission File No. 0-692. 4(c)(5) Copy of Rights Agreement, dated as of December 11, 1996, between the Company and Norwest Bank Minnesota, N.A. as Rights Agent, is incorporated by reference to Exhibit I, to Form 8-A, dated December 13, 1996, Commission File No. 0-692. (10) MATERIAL CONTRACTS 10(a)(1)* Supplemental Income Security (Retirement) Plan for Directors, Officers and Managers, as amended January 1, 1997, is incorporated by reference to Exhibit 10(a)(1) to Form 10-K for the year ended December 31, 1996, Commission File No. 0-692. 10(a)(2)* Deferred Compensation Plan for Non-employee Directors adopted November 6, 1985, is incorporated by reference to Exhibit 10(g)(2) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692. 33 10(a)(3)* Pension Equalization Plan, dated August 5, 1987, is incorporated by reference to Exhibit 10(g)(4) to Form 10-K for the year ended December 31, 1988, Commission File No. 0-692. 10(a)(5)* Long-term Incentive Compensation Plan (Phantom Stock Unit Plan) for Directors and Officers, dated February 1, 1989, as amended May 7, 1997, is incorporated by reference to Exhibit 10(a)(i) to Form 10-Q for the quarter ended March 31, 1997, Commission File No. 0-692. 10(a)(7)* Annual Performance Incentive Plan (NorthSTAR Plan) for all eligible employees, as amended February 4, 1998. (13) REPORT FURNISHED TO SECURITY HOLDERS Annual Report for fiscal year ended December 31, 1997, furnished to stockholders of record on March 9, 1998. 21 SUBSIDIARIES OF THE REGISTRANT Subsidiaries of the Registrant 27 Financial Data Schedule ______________ * Management contract or compensatory plan or arrangement. EX-10 2 EXHIBIT 10(a)(7) ---------------- NORTHWESTERN PUBLIC SERVICE COMPANY NorthSTAR PLAN I. OBJECTIVE The Northwestern Public Service Company NorthSTAR Plan ("Plan") is established to accomplish the following objectives: (1) to motivate and reward outstanding performance by Northwestern Public Service Company (the "Company") and its employees by providing additional compensation to eligible employees who influence the profitability of the Company; (2) to compare the Company's performance to established annual objectives; (3) to compare individual performance to established annual objectives; (4) to focus on stockholder and ratepayer interests and (5) to support long-term objectives by achieving short-term goals. II. ADMINISTRATION The Plan shall be administered by the Company. The Nominating and Compensation Committee ("Committee") of the Company's Board of Directors ("Board"), shall have responsibility and authority with respect to the Plan, including the following: (1) approving performance measures and the measurement scale used; (2) reviewing eligibility for Plan participation; (3) approving the size of the performance fund ("Performance Fund"); and (4) reviewing and approving awards for all Executive Officers. III. ELIGIBILITY FOR PARTICIPATION Employees eligible to participate in the Plan are those full-time employees who have completed one year of service with the Company and 35 who have been selected for participation by Company management. To be eligible for an award, an employee must be employed with the Company on December 31st of the year for which the award is based, except as hereafter provided in Subsection (b). All Participants will be eligible to participate in the Plan for that calendar year unless any of the following circumstances occur: (a) The Participant at any time is discharged from employment with the Company for cause ("Cause"). "Cause" shall mean (i) a Participant's conviction of any criminal violation involving dishonesty, fraud, or breach of trust, or (ii) a Participant's willful engagement in any misconduct in the performance of his duty that materially injures the Company, or (iii) failure to adequately perform his duties; or (b) The Participant's employment with the Company has terminated for any reason other than death, permanent disability, or retirement on or after the age of sixty- two (62) years or such earlier date as the Board, in its discretion, shall designate. For the purposes of this Section, a Participant will be considered to terminate employment by reason of "permanent disability" if, in the determination of the Board, he is subject to a physical or mental condition which is expected to render the Participant unable to perform his usual duties or any comparable duties for the Company. IV. DETERMINATION OF PERFORMANCE AWARD AMOUNTS (a) A Performance Award ("Award") shall be awarded under the Plan to each Participant based on performance for the applicable calendar year which shall be determined by reference to the measures of performance for that year. Company management will develop 36 schedules for translating results of objectives (i), (ii), and (iii) into threshold, target, and maximum achievement levels. These schedules must be approved by the Committee. (i) Company Performance as Measured by Customer Satisfaction (25% weight) The Company will measure customer satisfaction through the use of transaction surveys conducted during the year. (ii) Performance vs. Operating Budget (25% Weight) The Company will measure the net income of the electric and gas operations, as compared to the operating budget. (iii) Company Performance vs. Annual Objective (25% Weight) Under this objective, Earnings Per Share, will be the primary earnings per share of the Company as it appears in the approved budget for the Company. (iv) Performance vs. Individual Objectives (25% Weight) Each year, Participants will establish several major individual and department goals for review and approval by their supervisor and by the Manager - Human Resources. At the end of each year, Participants will provide to their supervisor and to the Manager - Human Resources an explanation regarding the degree to which each goal has been achieved. The supervisor and the Manager - Human Resources will review the Participant's explanations and will then recommend the achievement level for each Participant to the Chief Executive Officer, who will determine the achievement level eligible for an Award. (b) At the end of each calendar year, percentages will be computed and totaled for each Participant for each of the Measures of Performance. Each Participant will receive an Award for the 37 applicable calendar year equal to a percentage of his base salary on December 31st, less any applicable taxes. Threshold is defined as a composite twenty-five percentage level, Target as a composite fifty percentage level, and Maximum as a composite one hundred percentage level. The total amount of all awards made to Participants shall not exceed seven percent (7%) of the Company's net after tax income for that year. (c) All Executive Officer Awards shall be reviewed, and must be approved, by the Committee. All Awards for other Company employees shall be reviewed, and must be approved, by the Chief Executive Officer of the Company. (d) Annual base salary adjustments, as appropriate, will continue to be made by the Company to individual employees predicated on merit, performance, cost-of-living and such other factors as the Company normally has considered without regard to Awards awarded under the Plan. (e) Awards shall be paid to each Participant in a single sum as promptly as practicable after approved. V. PARTICIPANT'S DEATH (a) In the event of the death of the Participant, any unpaid Award held for the Participant shall be paid as promptly as practicable in a single sum to the Participant's designated Beneficiary. (b) In the event the Participant has not designated a Beneficiary, or if no designated Beneficiary is living at the date of death of the Participant, the unpaid Award shall be paid as promptly 38 as practicable in a single sum to the duly appointed executor or administrator of the Participant's estate. (c) For purposes of this Section, "Beneficiary" shall mean any individual, corporation, partnership, association, trust or unincorporated organization designated by a Participant in writing filed with the Company as the recipient of the Participant's Award in the event of the Participant's death prior to its payment. Such designation may be changed by the Participant at any time in writing filed with the Company without the consent of or notice to any Beneficiary previously designated. VI. CONTINUITY OF THE PLAN Although it is the present intention of the Company to continue the Plan in effect for an indefinite period of time, the Board reserves the right to terminate the Plan in its entirety as of the end of any calendar year or other fiscal year of the Company or to modify the Plan as it exists from time to time, provided that no such action shall adversely affect any Awards previously awarded under the Plan. VII. MISCELLANEOUS PROVISIONS (a) No Award payable under the Plan shall be subject in any manner to transfer, assignment, pledge, or hypothecation in any manner by operation of law or otherwise, other than by will or by the laws of descent and distribution nor be subject to execution, attachment or similar process. (b) Neither the Plan nor any action taken hereunder shall be construed as giving any Participant any right to be retained in the employ of the Company. 39 (c) The Plan shall at all times be entirely unfunded and no provision shall at any time be made with respect to segregating assets of the Company for payment of any Awards hereunder. No Participant or any other person shall have any interest in any particular assets of the Company by reason of the right to receive an Award under the Plan and any such Participant or any other person shall have only the rights of a general unsecured creditor of the Company with respect to any rights under the Plan. (d) Except when otherwise required by the context, any masculine terminology in this document shall include the feminine, and any singular terminology shall include the plural. (e) This Plan shall be governed by the laws of the State of South Dakota. IN WITNESS WHEREOF, the Company has executed this revised NorthSTAR Plan as of the 4th day of February, 1998. NORTHWESTERN PUBLIC SERVICE COMPANY By__________________________________________ M. D. Lewis Chairman, President & CEO By__________________________________________ Herman Lerdal, Chairman Nominating and Compensation Committee EX-13 3 EXHIBIT 13 ---------- Management's Discussion and Analysis Results of Operations Earnings and Dividends Earnings for 1997 were $23.4 million or $1.31 per share, compared to $22.9 million or $1.28 per share for 1996. Earnings per share for 1996 included $.09 related to a one-time gain from proceeds pertaining to the Cornerstone refinancing transactions. The earnings increase was primarily due to propane acquisitions, improved electric and natural gas returns and increased investment income. Earnings in 1996 were $1.28 per share compared to $1.11 in 1995. The increase was primarily due to slightly colder weather, propane acquisitions, improved natural gas returns, the one-time gain referred to above and increased investment income. Earnings for 1995 included propane operations since August 1995. In November 1996, the Company's Board of Directors elected to increase annual dividends per share from $.88 to $.92. Subsequently, in November 1997, the board approved a five cent per share increase in annual dividends from $.92 to $.97. The Company's financial strength, operating performance, the success of its growth strategies and competitive changes in the industry will be factors considered by the Company's Board of Directors when evaluating future dividend payments. 41 Business Segment Summary ------------------------
Years Ended December 31, (In Thousands of Dollars) Increase Increase 1997 1996 (Decrease) 1995 (Decrease) ---- ---- --------------------- ---- ------------------- REVENUES: Propane $743,038 $175,102 $567,936 324.3% $ 38,883 $136,219 350.3% Electric 76,727 73,417 3,310 4.5% 74,857 (1,440) (1.9%) Natural gas 77,561 72,269 5,292 7.3% 64,483 7,786 12.1% Manufacturing 20,744 23,221 (2,477) (10.7%) 26,747 (3,526) (13.2%) OPERATING INCOME: Propane $ 23,605 $ 18,947 $ 4,658 24.6% $ 5,604 $13,343 238.1% Electric 27,177 24,475 2,702 11.0% 26,003 (1,528) (5.9%) Natural gas 7,231 5,684 1,547 27.2% 3,862 1,822 47.2% Manufacturing 984 1,312 (328) (25.0%) 2,628 (1,316) (50.1%) OPERATING DATA: Propane sales-retail (000 gallons) 220,833 141,388 79,445 56.2% 37,805 103,583 274.0% Propane sales- wholesale (000 gallons) 479,055 18,617 460,438 2,473.2% - 18,617 - Electric sales-retail (000 mwh) 1,114 1,083 31 2.9% 1,071 12 1.1% Natural gas throughput (000 mmbtu) 16,411 16,321 90 .6% 15,204 1,117 7.3%
Propane ------- Propane for 1997 includes a full year of operations from Cornerstone Propane Partners, L.P. Propane for 1996 includes revenues from Cornerstone since December 18, 1996, Empire Energy Corporation since October 7, 1996, and Synergy Group Incorporated for all of 1996. As of December 31, 1997, the Company owned a combined 38.5% interest in Cornerstone, which changed to a combined 34.8% interest after considering the secondary offering at Cornerstone in January 1998. Because of the heavy use of propane for heating, propane sales are extremely weather sensitive. The majority of propane revenues occur in the first and fourth quarters when propane is heavily sold for residential and commercial heating. In the first quarter of 1997, weather averaged 13% warmer than normal in Cornerstone's market areas. During the last quarter of 1997, weather averaged slightly colder than normal in Cornerstone's retail propane service areas. While weather factors generally measure the directional impact of temperatures on the business, other factors such as geographic mix, magnitude and duration of temperature and weather conditions can also impact sales. In 1996, weather throughout Synergy's propane service area was approximately 5% colder than normal, while weather throughout Empire 42 Energy's area was approximately 3% colder than normal since acquisition. Operating revenue from propane sales increased in 1997 to $743.0 million from $175.1 million in 1996. The large increase in sales is primarily due to a full year of the retail and significant wholesale operations of Cornerstone and acquisitions during 1997. Operating income increased in 1997 to $23.6 million from $18.9 million in 1996. The increase in operating income is primarily attributable to a full year of operations of Cornerstone partially offset by warmer than normal temperatures in 1997 combined with higher product costs. Operating revenue from propane sales increased in 1996 to $175.1 million from $38.9 million in 1995. Operating income increased in 1996 to $18.9 million from $5.6 million in 1995. The increase in sales and operating income are primarily due to a full year of operations from Synergy, which was acquired in August 1995, the acquisition of Empire Energy in October 1996 and the formation of Cornerstone in December 1996. The increases are also partly due to slightly colder than normal weather in the Company's propane market areas. Electric -------- In 1997, retail electric mwh sales grew by 3% reflecting weather, which was slightly warmer than the previous year. Electric revenues increased due to the increased retail mwh sales and an increase in wholesale sales. Operating income increased primarily due to the increase in sales volumes combined with decreases in maintenance and operating expenses. In 1996, retail electric mwh sales grew by 1% even though weather during the summer was approximately 20% cooler than the previous year. Electric revenues decreased slightly due to a decline in wholesale sales. Operating income decreased due to the slight decrease in revenues combined with increases in growth-related costs in expanded customer services, marketing functions and property taxes. Property taxes increased significantly in 1996 due primarily to changes in South Dakota's tax regulations. Natural Gas ----------- One of the predominant factors affecting the Company's natural gas operations is weather patterns during the winter heating season. Because natural gas is heavily used for residential and commercial heating, the demand for this product depends upon weather conditions. In 1997, the 7.3% increase in natural gas revenues over 1996 primarily reflects higher market prices for natural gas supply, which were passed on to customers through the purchased gas adjustment, a 1.5% increase in gas customers and differing weather patterns during the year. During the first quarter of 1997, weather was approximately 7% colder than 1996, while weather during the last quarter of 1997 was approximately 15% warmer than the prior year. The increase in operating income reflects the increased revenues resulting from the 43 expanding customer base and colder first quarter weather combined with decreased operating and maintenance expenses. In 1996, the increase in natural gas revenues over 1995 reflects the effects of cooler weather, higher market prices for natural gas supply and a slight increase in customers. The increase in gas operating income reflected a 7.3% increase in throughput, offset by slightly higher operating expenses. The increase in other operating expenses was primarily due to growth-related costs in the expanded energy services and marketing functions. Maintenance expense decreased slightly while property taxes increased due to changes in South Dakota's tax regulations. Manufacturing ------------- Manufacturing revenues and operating income are related to the Company's ownership interest in Lucht Inc., a company that manufactures photographic processing and imaging equipment used by high-volume photo processing laboratories. Operating income in 1997 decreased when compared to 1996 due to softness in photographic processing and imaging equipment sales within the photo finishing industry. Operating income in 1996 decreased when compared to 1995 due to delays in product development. Other Income Statement Items ---------------------------- Other income increased in 1997 over 1996 due to increased investment income resulting from the investment of cash proceeds received from the prepayment and redemption transactions from the Cornerstone formation and the gain on the sale of a portion of a common stock investment. Investment income also increased as a result of the Company's preferred stock investment in an unconsolidated affiliate company, ServiCenter USA. ServiCenter USA was founded by Northwestern Growth Corporation, a wholly owned subsidiary of Northwestern, and provides heating, ventilating, air conditioning, plumbing and related services for residential and business customers in the U.S. Other income increased in 1996 over 1995 primarily due to a one-time gain realized by the Company related to the Cornerstone transaction. The gain is attributed to redemption premiums related to the financing transactions of the propane operations. Other income also includes the gain on the sale of a portion of a common stock investment. Liquidity and Capital Resources ------------------------------- During 1997, cash flow from operations, net of dividends paid, together with proceeds from the 1996 Cornerstone equity and debt offerings and other external financing activities, provided the funds for propane and other acquisition activities, construction expenditures and other requirements. 44 Operating Activities -------------------- Cash flow from operating activities in 1997 increased 3% from 1996 primarily due to growth in the Company's earnings. Liquidity is also provided from the availability of substantial cash and investment balances. Cash equivalents and marketable securities totaled $108.6 million, $179.9 million and $44.7 million at December 31, 1997, 1996 and 1995. Investment Activities - Financing Activities -------------------------------------------- The Company's principal investment and financing activities in 1997 were related to increased corporate development investments including the development of the preferred stock investment in ServiCenter USA and the redemption of $7.5 million of 8.9% series general mortgage bonds and $15 million of 8.824% series general mortgage bonds. Working capital and other financial resources are also provided by unused lines of credit, which are generally used to support commercial paper borrowings, a primary source of short-term financing. At December 31, 1997, the Company had no outstanding borrowings under its lines of credit or commercial paper borrowings. Unused short-term lines of credit totaled $32 million at December 31, 1997. Cornerstone maintains a Bank Credit Facility, which provides for up to $50 million in working capital borrowings and $75 million for acquisition borrowings subject to certain loan covenants and other limitations. At December 31, 1997 and 1996, Cornerstone had outstanding working capital borrowings of $23.5 million and $12.5 million. At December 31, 1997, Cornerstone had outstanding acquisition borrowings of $10.4 million and no outstanding acquisition borrowings at December 31, 1996. In addition, the Company's other nonregulated businesses maintain credit agreements with various banks for revolving and term loans. The Company will continue to review the economics of retiring or refunding remaining long-term debt and preferred stock to minimize long-term financing costs. The Company will continue to make investments in the unconsolidated affiliates, ServiCenter USA and Communication Systems USA. Also, the Company may make other significant acquisition investments in related industries that would require the Company to raise additional equity and incur debt financing, which are therefore subject to certain risks and uncertainties. The Company's financial coverages are at levels in excess of those required for the issuance of additional debt and preferred stock. Capital Requirements -------------------- The Company's primary capital requirements include the funding of its energy business construction, maintenance and expansion programs, the funding of debt and preferred stock retirements, sinking fund 45 requirements and the funding of its corporate development and investment activities. The emphasis of the Company's construction activities is to undertake those projects that most efficiently serve the expanding needs of its customer base, enhance energy delivery and reliability capabilities through system replacement and provide for the reliability of energy supply. Capital expenditure plans are subject to continual review and may be revised as a result of changing economic conditions, variations in sales, environmental requirements, investment opportunities and other ongoing considerations. Expenditures for maintenance and construction activities for 1997, 1996 and 1995 were $22.4 million, $35.2 million and $29.6 million. Capital expenditures during 1997 included maintenance expenditures related to Cornerstone propane operations. Construction expenditures during 1996 and 1995 included expenditures related to an operations center expected to provide enhanced customer service capability, cost savings and operating efficiencies through consolidation of activities and the expansion of the Company's natural gas system in eastern South Dakota. In addition, 1997, 1996 and 1995 included $4.1 million, $7.3 million and $4.7 million of maintenance capital expenditures related to propane operations. Total capital expenditures for 1998, excluding propane operations, are estimated to be $13.8 million. The majority of the projected expenditures will be spent on enhancements of the electric and gas distribution systems. Estimated electric and natural gas related expenditures for the years 1998 through 2002 are expected to be $61.5 million. Nonregulated maintenance capital expenditures for 1998 are estimated to be $3.8 million. Estimated nonregulated maintenance capital expenditures for the years 1998 through 2002 are expected to be $19.0 million. Capital requirements for the mandatory retirement of long-term debt and mandatory preferred stock sinking fund redemption totaled $1,244,000, $400,000, and $600,000 for the years ended 1997, 1996 and 1995, respectively. It is expected that such mandatory retirements will be $7.8 million in 1998, $7.8 million in 1999, $8.9 million in 2000, $8.5 million in 2001 and $8.3 million in 2002. The Cornerstone working capital facility was paid in January, 1998 using the proceeds of a secondary offering of 1,960,000 units which were sold to the public at a price of $22.125 per unit, resulting in net proceeds of $40.7 million. The Company anticipates that future capital requirements will be met by existing investments and marketable securities, internally generated cash flows and available external financing. COMPETITION AND BUSINESS RISK Northwestern's strategy centers upon the development, acquisition and expansions of operations offering integrated energy, telecommunications and related products and services within the Northwestern companies. In addition to maintaining a strong competitive position in electric, natural gas and propane distribution businesses, the Company intends to pursue development and acquisitions that have long-term growth potential. While such investments and acquisitions can involve increased risk in comparison to the Company's energy distribution businesses, they offer the potential for enhanced investment returns. 46 Propane ------- Weather conditions have a significant impact on propane demand for both heating and agricultural purposes. The majority of Cornerstone's customers rely heavily on propane as a heating fuel. Actual weather conditions can vary substantially from year to year, significantly affecting Cornerstone's financial performance. Furthermore, variations in weather in one or more regions in which Cornerstone operates can significantly affect the total volumes sold by Cornerstone and the margins realized on such sales and, consequently, Cornerstone's results of operations. These conditions may also impact Cornerstone's ability to meet various debt covenant requirements and affect Cornerstone's ability to pay common and subordinated unit distributions. The retail propane business is a margin-based business in which gross profits depend on the excess of sales prices over propane supply costs. Consequently, Cornerstone's profitability will be sensitive to changes in wholesale propane prices. Propane is a commodity, the market price of which can be subject to volatile changes in response to changes in supply or other market conditions. As it may not be possible to immediately pass on to customers rapid increases in the wholesale cost of propane, such increases could reduce Cornerstone's gross profits. Cornerstone's profitability is affected by the competition for customers among all participants in the retail propane business. Some of Cornerstone's competitors are larger or have greater financial resources than Cornerstone. Should a competitor attempt to increase market share by reducing prices, Cornerstone's financial condition and results of operations could be materially adversely affected. In addition, propane competes with other sources of energy, some of which may be less costly per equivalent energy value. Electric and Natural Gas ------------------------ The electric and natural gas industries continue to undergo numerous transformations and the Company is operating in an increasingly competitive marketplace. The FERC, which regulates interstate and wholesale electric transmissions, opened up transmission grids and mandated that utilities must allow others equal access to utility transmission systems. Various state regulatory bodies are supporting initiatives to redefine the electric energy market and are experimenting with retail wheeling, which gives some retail customers the ability to choose their supplier of electricity. Traditionally, utilities have been vertically integrated, providing bundled energy services to customers. The potential for continued unbundling of customer services exists, allowing customers to buy their own electricity and natural gas on the open market and having it delivered by the local utility. The growing pace of competition in the energy industry has been a primary focus of management over the last few years. The Company's 47 future financial performance will be dependent on the effective execution of operating strategies to address a more competitive and changing energy marketplace. Business strategies focus on enhancing the Company's competitive position, on expanding energy sales and markets with new products and services for customers and increasing shareholder value. The Company has realigned various areas of its business to support customer services and marketing functions. A new marketing plan, an expanded line of integrated customer products and services, additional staff and new technologies are part of the Company's strategy for providing responsive and superior customer service. To strengthen the Company's competitive position, new technologies have and will be added that enable employees to better serve customers. The Company is centralizing activities to improve efficiency and customer responsiveness and business processes are being reengineered to apply best-practices methodologies. Long-term supply contracts have been renegotiated to lower customers' energy costs and new alliances help reduce expenses and add innovative work approaches. As described in Note 1 to the consolidated financial statements, the Company complies with the provisions of Statement of Financial Accounting Standards No. 71 (SFAS 71), Accounting for the Effects of Certain Types of Regulation . SFAS 71 provides for the financial reporting requirements of the Company's regulated electric and natural gas operations which requires specific accounting treatment of certain costs and expenses that are related to the Company's regulated operations. Criteria that could give rise to the discontinuance of SFAS 71 include 1) increasing competition that restricts the Company's ability to establish prices to recover specific costs and 2) a significant change in the manner in which rates are set by regulators from cost-based regulation to another form of regulation. The Company periodically reviews these criteria to ensure the continuing application of SFAS 71 is appropriate. Based on a current evaluation of the various factors and conditions that are expected to impact future cost recovery, the Company believes that its regulatory assets, including those related to generation, are probable of future recovery. This evaluation of recovery must be updated for any change which might occur in the Company's current regulatory environment. HVAC, Telecommunications and Related Services --------------------------------------------- The markets served by ServiCenter USA for residential and commercial heating, ventilating, air conditioning, plumbing and other related services are highly competitive. The principal competitive factors in these segments of the industry are 1) timeliness, reliability and quality of services provided, 2) range of products and services provided, 3) name recognition and market share and 4) pricing. Many of ServiCenter's competitors in the HVAC business are small, owner- operated companies typically located and operated in a single geographic area. There are only a small number of national companies engaged in providing residential and commercial services in the service lines, which the Company intends to focus. Future competition in both the residential and commercial service lines may be encountered from other newly formed or existing public or private 48 service companies with aggressive acquisition programs, the unregulated business segments of regulated gas and electric utilities or from newly deregulated utilities in those industries entering into various service areas. The market served by Communication Systems USA in the telecommunications and data services industry is also a highly competitive market. The Company believes that 1) market acceptance of the Company's products and services, 2) pending and future legislation affecting the telecommunications and data industry, 3) name recognition and market share, 4) larger competitors and 5) the Company's ability to provide integrated communication and data solutions for customers in a dynamic industry are all factors that could affect the Company's future operating results. Other ----- The Company utilizes software and various technologies throughout its business that will be affected by the date change in the year 2000. The Company has assessed and is continuing to assess the impact of the year 2000 issue on its reporting systems and operations. The majority of the Company's financial reporting and operational systems are year 2000 compliant. The cost of the modifications of the remaining systems is not expected to be material. This Annual Report contains forward looking statements within the meaning of the securities laws. The Company cautions that, while it believes such statements to be based on reasonable assumptions and makes such statements in good faith, there can be no assurance that the actual results will not differ materially from such assumptions or that the expectations set forth in the forward looking statements derived from such assumptions will be realized. Investors should be aware of important factors that could have a material impact on future results. These factors include, but are not limited to, weather, the federal and state regulatory environment, the economic climate, regional, commercial, industrial and residential growth in the service territories served by the Company and its subsidiaries, customers' usage patterns and preferences, the speed and degree to which competition enters the Company's industries, the timing and extent of changes in commodity prices, changing conditions in the capital and equity markets and other uncertainties, all of which are difficult to predict and many of which are beyond the control of the Company. Report of Management The management of Northwestern Public Service Company is responsible for the integrity and objectivity of the financial information contained in this annual report. The consolidated financial statements, which necessarily include some amounts which are based on informed judgments and estimates of management, have been prepared in conformity with generally accepted accounting principles. 49 In meeting this responsibility, management maintains a system of internal accounting controls, which is designed to provide reasonable assurance that the assets of the Company are safeguarded and that transactions are executed in accordance with management's authorization and are recorded properly for the preparation of financial statements. This system is supported by written policies, selection and training of qualified personnel, an appropriate segregation of responsibilities within the organization and a program of internal auditing. The Board of Directors, through its Audit committee which is comprised entirely of outside directors, oversees management's responsibilities for financial reporting. The Audit committee meets regularly with management and the independent public accountants to make inquiries as to the manner in which each is performing its responsibilities. The independent public accountants and the internal audit staff have unrestricted access to the Audit committee, without management's presence, to discuss auditing, internal accounting control and financial reporting matters. Arthur Andersen LLP, an independent public accounting firm, has been engaged annually to perform an audit of the Company's financial statements. Their audit is conducted in accordance with generally accepted auditing standards and includes examining, on a test basis, supporting evidence, assessing the Company's accounting principles and significant estimates made by management, and evaluating the overall financial statement presentation to the extent necessary to allow them to report on the fairness, in all material respects, of the operating results and financial condition of the Company. Merle D. Lewis Richard R. Hylland Chairman, President and Executive Vice President Chief Executive Officer Report of Independent Public Accountants To the Stockholders and Board of Directors of Northwestern Public Service Company: We have audited the accompanying consolidated balance sheets of NORTHWESTERN PUBLIC SERVICE COMPANY (a Delaware corporation) AND SUBSIDIARIES as of December 31, 1997 and 1996, and the related consolidated statements of income and retained earnings and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well 50 as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Northwestern Public Service Company and Subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Minneapolis, Minnesota January 30, 1998 51 Consolidated Statements of Income and Retained Earnings Years Ended December 31, (In Thousands Except Per Share Amounts) 1997 1996 1995 ---- ---- ---- Operating Revenues: Electric $ 76,727 $ 73,417 $ 74,857 Propane 743,038 175,102 38,883 Natural gas 77,561 72,269 64,483 Manufacturing 20,744 23,221 26,747 -------- -------- -------- 918,070 344,009 204,970 -------- -------- -------- Operating Expenses: Fuel and purchased power 14,560 13,347 14,305 Propane gas sold 612,305 101,360 18,527 Purchased natural gas sold 55,035 51,171 46,430 Manufacturing cost of goods sold 13,145 14,548 17,163 Other operating expenses 119,919 80,556 43,190 Maintenance 5,881 5,919 6,020 Depreciation and amortization 31,235 19,414 14,633 Property and other taxes 6,993 7,276 6,605 -------- -------- -------- 859,073 293,591 166,873 -------- -------- -------- Operating Income: Electric 27,177 24,475 26,003 Propane 23,605 18,947 5,604 Natural gas 7,231 5,684 3,862 Manufacturing 984 1,312 2,628 -------- -------- -------- 58,997 50,418 38,097 -------- -------- -------- Interest Expense, net (31,476) (18,668) (11,694) Investment Income and Other 11,564 9,719 3,029 -------- -------- -------- Income Before Income Taxes and Minority Interest 39,085 41,469 29,432 Income Taxes (11,111) (15,415) (10,126) -------- -------- -------- Income Before Minority Interest 27,974 26,054 19,306 Minority Interest (1,710) - - -------- -------- -------- 52 Consolidated Statements of Income and Retained Earnings (continued) Years Ended December 31, (In Thousands Except Per Share Amounts) 1997 1996 1995 ---- ---- ---- Net Income 26,264 26,054 19,306 Minority Interest on Preferred Securities of Subsidiary Trust (2,641) (2,641) (1,057) Dividends on Cumulative Preferred Stock (212) (550) (259) -------- -------- -------- Earnings on Common Stock 23,411 22,863 17,990 Retained Earnings, beginning of year 66,144 59,159 55,373 Dividends on Common Stock (16,640) (15,878) (14,204) -------- -------- -------- Retained Earnings, end of year $ 72,915 $ 66,144 $ 59,159 -------- -------- -------- Average Shares Outstanding 17,843 17,840 16,261 Earnings Per Average Common Share $ 1.31 $ 1.28 $ 1.11 -------- -------- -------- Dividends Declared Per Average Common Share $ .933 $ .890 $ .873 -------- -------- -------- 53 Consolidated Statements of Cash Flows Years Ended December 31, (In Thousands Except Per Share Amounts) 1997 1996 1995 ---- ---- ---- Operating Activities: Net Income $ 26,264 $ 26,054 $ 19,306 Items not affecting cash: Depreciation and amortization 31,235 19,414 14,633 Deferred income taxes 4,439 5,830 2,540 Minority interest in net income of consolidated subsidiaries 1,710 - - Investment tax credits (559) (561) (563) Changes in current assets and liabilities, net of effects from acquisitions: Trade accounts receivable (363) (333) (3,898) Inventories 8,325 (4,374) (327) Other current assets - (4,308) (2,641) Accounts payable (11,364) 15,712 (1,719) Accrued expenses (4,793) 4,644 2,678 Other current liabilities 11,738 (143) 3,329 Other, net (3,965) (1,032) 2,029 -------- -------- -------- Cash flows from operating activities 62,667 60,903 35,367 -------- -------- -------- Investment Activities: Property additions (22,400) (35,170) (29,637) Sale (purchase) of noncurrent investments, net 36,621 (107,426) (5,669) Purchase of net assets, net of cash acquired (16,697) (24,481) (109,528) Purchase working capital adjustments, net - - (10,607) Subsidiary acquisitions and formation (42,239) (2,040) (5,405) -------- -------- -------- Cash flows for investment activities (44,715) (169,117) (160,846) -------- -------- -------- Financing Activities: Dividends on common and preferred stock (16,852) (16,428) (14,463) Issuance of nonrecourse subsidiary debt 29,499 - - Repayment of nonrecourse subsidiary debt (7,544) - - Minority interest on preferred securities of subsidiary trust (2,641) (2,641) (1,057) Issuance of long-term debt - 21,654 86,600 54 Consolidated Statements of Cash Flows (Continued) Years Ended December 31, (In Thousands Except Per Share Amounts) 1997 1996 1995 ---- ---- ---- Repayment of long-term debt (22,500) (340) (3,157) Issuance of preferred securities of subsidiary trust - - 31,213 Issuance of preferred stock - - 3,650 Retirement of preferred stock (2,687) (10) (30) Subsidiary payment of common unit distributions (17,708) - - Issuance of common stock - - 31,022 Short-term borrowings (repayments) - 35,500 (6,300) -------- -------- ------- Cash flows from (for) financing activities (40,433) 37,735 127,478 -------- -------- -------- Cornerstone Propane Partners Formation Transactions: Acquisition of CGI Holdings, net of $2,568,000 of cash acquired - (68,962) - Issuance of Cornerstone Propane Partners common units - 191,804 - Issuance of long-term debt - 220,000 - Repayment of long-term debt and short-term borrowings - (229,571) - Other fees and expenses - (10,554) - -------- -------- -------- Cash flows from Cornerstone Propane Partners formation transactions - 102,717 - -------- -------- -------- Increase (Decrease) in Cash and Cash Equivalents (22,481) 32,238 1,999 Cash and Cash Equivalents, beginning of year 36,790 4,552 2,553 -------- -------- -------- Cash and Cash Equivalents, end of year $ 14,309 $ 36,790 $ 4,552 -------- -------- -------- Supplemental Cash Flow Information: Cash paid during the year for: Income taxes $ 8,940 $ 6,271 $ 5,972 Interest $ 30,909 $ 18,645 $ 8,381 Noncash transactions during the year for: Assumption of debt as part of acquisitions $ 1,551 $149,516 $ 2,345 55 Consolidated Balance Sheets December 31. (In Thousands) 1997 1996 ---- ---- Assets Property: Electric $ 356,836 $ 350,419 Natural gas 85,874 80,905 Propane 275,911 248,556 Manufacturing 2,270 2,142 ----------- ----------- 720,891 682,022 Less-Accumulated depreciation (175,269) (162,909) ----------- ----------- 545,622 519,113 ----------- ----------- Current Assets: Cash and cash equivalents 14,309 36,790 Trade accounts receivable, net 90,749 89,259 Inventories 36,015 43,826 Other 15,335 27,814 ----------- ----------- 156,408 197,689 Other Assets: Investments 121,587 159,333 Deferred charges and other 58,435 40,260 Goodwill and other intangibles, net 224,071 197,321 ----------- ----------- 404,093 396,914 ----------- ----------- $1,106,123 $1,113,716 ----------- ----------- CAPITALIZATION AND LIABILITIES Capitalization: Common stock equity $ 166,596 $ 163,805 Nonredeemable cumulative preferred stock 2,600 2,600 Redeemable cumulative preferred stock 1,150 1,150 Company obligated mandatorily redeemable security of trust holding solely parent debentures 32,500 32,500 Long-term debt 156,350 183,850 ----------- ----------- 359,196 383,905 Preferred stock of subsidiary - 2,500 Minority interest in subsidiaries 199,722 186,714 Long-term debt of subsidiaries 268,931 240,563 ----------- ----------- 827,849 813,682 ----------- ----------- 56 Consolidated Balance Sheets (Continued) December 31. (In Thousands) 1997 1996 ---- ---- Commitments and Contingencies (Notes 8, 9, 10) Current Liabilities: Long-term debt due within one year 7,814 1,244 Accounts payable 89,064 99,394 Accrued expenses 12,899 16,596 Other 34,787 35,533 ----------- ----------- 144,564 152,767 Deferred Credits: Accumulated deferred income taxes 72,884 70,894 Unamortized investment tax credits 8,901 9,460 Other 51,925 66,913 ----------- ----------- 133,710 147,267 ----------- ----------- $1,106,123 $1,113,716 ----------- ----------- 57 Notes to Consolidated Financial Statements 1. SIGNIFICANT ACCOUNTING POLICIES Nature of Operations: -------------------- Northwestern Public Service Company is a nationwide diversified energy, telecommunications and related services provider. The Company is engaged in the regulated energy business of production, purchase, transmission, distribution and sale of electricity and the delivery of natural gas. The Company serves 55,805 electric customers in eastern South Dakota and 78,531 natural gas customers in eastern South Dakota and central Nebraska. To provide baseload electric power, the Company jointly owns three coal-fired generating plants with other utilities. Through the acquisitions of Synergy Group Incorporated (Synergy) and Myers Propane Gas Company (Myers) in 1995 and Empire Energy Corporation (Energy) in 1996, the Company engaged in retail propane distribution business located throughout the United States. In December 1996, a wholly owned subsidiary acquired CGI Holdings, Inc. (Coast) and combined the propane distribution businesses of Coast, Energy, Myers and Synergy (the Partnership Formation) into Cornerstone Propane, L.P. (the Operating Partnership), a Delaware limited partnership, and a subsidiary of Cornerstone Propane Partners, L.P. (Cornerstone), a Delaware limited partnership, formed to acquire and operate these propane businesses and assets. Cornerstone and the Operating Partnership are collectively referred to herein as the Partnership. In December 1996, as part of an initial public offering (IPO), Cornerstone sold a total of 9,821,000 common units (Common Units) representing limited partner interests. The Company through its majority owned subsidiaries retained an initial effective 2% general partner interest and a 39% limited partnership interest in the Partnership. A wholly owned subsidiary of the Company serves as the general partner (General Partner) of the Partnership and manages and operates the Partnership's business. (For a detailed description of the Partnership Formation and related transactions, see Note 2). As part of a secondary offering in January 1998, Cornerstone sold an additional 1,960,000 common units. Subsequent to the second offering, the Company owns a combined 34.8% interest in the Partnership. The Company's manufacturing operations are comprised of Lucht Inc., a wholly owned subsidiary that develops, manufactures and markets multi- image photographic printers and other related equipment. In 1997, Northwestern formed ServiCenter USA to acquire heating, ventilating, air conditioning, plumbing and related services companies in the U.S. Also in late 1997, Northwestern formed Communication Systems USA to acquire and consolidate companies providing telecommunications and data services to business customers. Basis of Consolidation: ---------------------- The accompanying consolidated financial statements include the accounts of Northwestern Public Service Company and all wholly and majority owned or controlled subsidiaries, including the Partnership. All significant intercompany balances and transactions have been 58 eliminated from the consolidated financial statements. The Company's regulated businesses are subject to various state and federal agency regulation. The public unitholders' interest in Cornerstone's net assets subsequent to the Partnership Formation is reflected as a minority interest in the consolidated balance sheets. For purposes of determining the minority interest in Cornerstone, Common Units held by the public and considered to be outstanding as of December 31, 1997 and 1996 are 11,127,000 and 9,821,000. Use of Estimates: ---------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Revenue Recognition and Gas Costs: --------------------------------- Electric and natural gas revenues are based on billings rendered to customers rather than on meters read or energy delivered. Customers are billed monthly on a cycle basis. Revenues from propane sales are recognized principally when fuel products are shipped or delivered to customers. Manufacturing revenue is recognized as equipment is shipped or delivered to customers. The commodity cost portion of natural gas purchased from wholesale suppliers but not yet billed to customers is charged to deferred gas costs. This account is subsequently credited in future periods as customers are billed for natural gas used in prior periods. This method has the approximate effect of matching costs with revenues in any financial reporting period. The demand cost portion of natural gas costs, which is comprised of numerous components, is expensed as incurred. The Company and its subsidiaries have propane and natural gas supply agreements with various suppliers for the purchase of these products in the normal course of their operations. Cash Equivalents: ---------------- The Company generally considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. Depreciation and Maintenance: ---------------------------- Depreciation is computed using the straight-line method based on the estimated useful lives of the various classes of property. Depreciation provisions, as a percentage of the average balance of depreciable property, were 4.7% in 1997, 4.2% in 1996 and 3.6% in 59 1995. The percentages include propane related depreciation provision and depreciable property whose estimated useful lives principally range from 5 to 40 years. Depreciation rates include a provision for the Company's share of the estimated costs to decommission three coal-fired generating plants at the end of the useful life of each plant. The annual provision for such costs is included in depreciation expense, while the accumulated provisions are included in other deferred credits. The costs of maintenance, repairs and replacements of minor property items are charged to maintenance expense accounts. Costs of renewals and betterments of electric and natural gas property units are charged to property accounts. The costs of units of electric and natural gas property removed from service, net of removal costs and salvage, are charged to accumulated depreciation. No profit or loss is recognized in connection with ordinary retirements of depreciable electric and natural gas property. Goodwill and Other Intangibles: ------------------------------ The excess of the cost of businesses acquired over the fair market value of all tangible and intangible assets acquired, net of liabilities assumed, has been recorded as goodwill, which is being amortized on a straight-line basis over 40 years. Other intangibles, consisting principally of costs of covenants not to compete, are being amortized over the estimated periods benefited, which do not exceed 10 years. Goodwill and other intangibles are reflected net of accumulated amortization at December 31, 1997 and 1996 of $6,214,000 and $1,199,000. The Company's policy is to review property, goodwill and other intangible assets for possible impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. If such review indicates that the carrying amount is not recoverable, the Company's policy is to reduce the carrying amount of these assets to fair value. Investments and Fair Value of Financial Instruments: --------------------------------------------------- The Company's investments consist primarily of short maturity fixed income securities and corporate preferred and common stocks. In addition, the Company has investments in privately held entities and ventures, safe harbor leases and various money market and tax exempt investment programs. These investments are accounted for in accordance with Statement of Financial Accounting Standards No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities." SFAS 115 requires that certain investments in debt and equity securities be reported at fair value. The Company's securities are classified under the provisions of SFAS 115. As of December 31, 1997, the fair value, cost and the gross unrealized gain of the Company's available for sale investments were 60 $64,849,000, $62,197,000 and $2,652,000 for preferred stock investments and $29,470,000, $23,094,000 and $6,376,000 for marketable securities. As of December 31, 1996, the fair value, cost and the gross unrealized gain of the Company's available for sale investments were $31,742,000, $31,740,000 and $2,000 for preferred stock investments and $16,264,000, $1,118,000 and $15,146,000 for marketable equity securities. The unrealized gain, net of tax, at December 31, 1997 and 1996, was $5,862,000 and $9,846,000, respectively. Held to maturity securities are reported at cost, which approximated fair value and at December 31, 1997 and 1996, was $27,268,000 and $111,327,000. The Company uses the specific identification method for determining the cost basis of its investments in available for sale securities. Gross proceeds and realized gains and losses on sales of its available for sale securities were not material in 1997, 1996 and 1995. Based on current market rates for debt of similar credit quality and remaining maturities or quoted market prices for certain issues, the face value of the Company's long-term debt approximates its market value. Income Taxes: ------------ Deferred income taxes relate primarily to the difference between book and tax methods of depreciating property, taxable income derived from safe harbor leases, the difference in the recognition of revenues for book and tax purposes and natural gas costs, which are deferred for book purposes but expensed currently for tax purposes. For book purposes, investment tax credits were deferred and are being amortized as a reduction of income tax expense over the useful lives of the property which generated the credits. Regulatory Assets and Liabilities: --------------------------------- The Company is subject to the provisions of Statement of Financial Accounting Standards No. 71 (SFAS 71), "Accounting for the Effects of Certain Types of Regulations." Regulatory assets represent probable future revenue to the Company associated with certain costs, which will be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future reductions in revenues associated with amounts that are to be credited to customers through the ratemaking process. If all or a separable portion of the Company's operations becomes no longer subject to the provisions of SFAS 71, an evaluation of future recovery from related regulatory assets and liabilities would be necessary. In addition, the Company would determine any impairment to the carrying costs of deregulated plant and inventory assets. 61 New Accounting Standards: ------------------------ Financial Accounting Standards Board Statement No. 128, "Earnings per Share" (Statement No. 128), issued in February 1997 and effective for fiscal years ending after December 15, 1997, established and simplified standards for computing and presenting earnings per share. Implementation of Statement No. 128 did not have a material impact on the Company's computation or presentation of earnings per share. Reclassifications: ----------------- Certain 1996 and 1995 amounts have been reclassified to conform to the 1997 presentation. Such reclassifications had no impact on net income or common stock equity as previously reported. Shares outstanding and earnings per share amounts have been adjusted to reflect the May 1997 stock split. 2. MASTER LIMITED PARTNERSHIP OFFERING AND BUSINESS ACQUISITIONS Master Limited Partnership Offering: ----------------------------------- On December 17, 1996, a wholly owned subsidiary of Northwestern Growth Corporation acquired Coast. Immediately after the acquisition the Company combined the propane distribution businesses of Coast, Energy, Myers and Synergy into Cornerstone. As part of an IPO on the same date, Cornerstone sold a total of 9,821,000 Common Units at a price to the public of $21 a unit. At December 31, 1997, Cornerstone's capital consisted of 11,127,000 Common Units, 6,597,619 subordinated units (Subordinated Units) representing limited partner interests and a 2% aggregate general partner interest. At December 31, 1997, the Company's majority owned subsidiaries owned all 6,597,619 Subordinated Units and an aggregate 2% general partner interest in the Partnership, or a combined 38.5% effective interest in the Partnership. In January 1998, Cornerstone sold an additional 1,960,000 units at a price to the public of $22.125 per unit. After the secondary offering the Company, through its subsidiary, owns a combined 34.8% effective interest in the partnership. The net proceeds of $191.8 million from the sale of 9,821,000 Common Units of Cornerstone and the net proceeds from the issuance of $220 million face value of Cornerstone Senior Notes were used to repay term and revolving debt of Coast, Energy and Synergy, including accrued interest and any prepayment premiums which were assumed by the Partnership. In addition, the preferred stock of Synergy was redeemed at a premium. As a result of these repayments, the Company recorded a one-time after tax gain of $.09 per share from the prepayment of the term debt and redemption of preferred stock investment in Synergy. The Partnership makes distributions to its partners with respect to each fiscal quarter of the Partnership in an aggregate amount equal to its Available Cash for such quarter. Available Cash generally means, with respect to any fiscal quarter of the Partnership, all cash on 62 hand at the end of such quarter plus all additional cash on hand as of the date of determination resulting from borrowings subsequent to the end of such quarter, less the amount of cash reserves established by the General Partner in its reasonable discretion for future cash requirements. These reserves are retained for the proper conduct of the Partnership's business, for the payment of debt principal and interest and for distributions during the next four quarters. Distributions by the Partnership, in an amount equal to 100% of its Available Cash, will generally be made 98% to the Common and Subordinated unitholders and 2% to the General Partners. Distributions are subject to the payment of incentive distributions in the event Available Cash exceeds the Quarterly Distribution of $.594 on all units. To the extent there is sufficient Available Cash, the holders of Common Units have the right to receive the Minimum Quarterly Distribution, plus any arrearages, prior to the distribution of Available Cash to holders of Subordinated Units. Common Units will not accrue arrearages for any quarter after the Subordination Period (as defined below), and Subordinated Units will not accrue any arrearages with respect to distributions for any quarter. The Subordination Period will generally extend until the first day of any quarter beginning on or after December 31, 2001, in respect of which a) distributions of Available Cash from operating surplus equal or exceed the Minimum Quarterly Distribution on each of the outstanding Common and Subordinated units for each of the three consecutive four-quarter periods immediately preceding such date, b) the adjusted operating surplus generated during each of the three consecutive four-quarter periods immediately preceding such date equals or exceeds the Minimum Quarterly Distribution on each of the Common and Subordinated units and the related distribution on the general partner interests in the Partnership during such periods and c) there are no outstanding Common Unit arrearages. In addition, 1,649,405 Subordinated Units will convert into Common Units for any quarter ending on or after December 31, 1999, and an additional 1,649,405 Subordinated Units will convert into Common Units for any quarter ending on or after December 31, 2000, if a) distributions of Available Cash from operating surplus on each of the outstanding Common and Subordinated units equal or exceed the Minimum Quarterly Distribution for each of the three consecutive four-quarter periods immediately preceding such date, b) the adjusted operating surplus generated during the immediately preceding two consecutive four-quarter periods equals or exceeds the Minimum Quarterly Distribution on all of the Common and Subordinated units outstanding during that period and c) there are no arrearages on the Common Units. The Partnership will make distributions of its Available Cash approximately 45 days after the end of each quarter ending March, June, September and December to holders of record on the applicable record dates. For the quarter ended December 31, 1997, Cornerstone elected not to make the subordinated unit distributions. 63 Business Acquisitions: --------------------- On August 15, 1995, the Company completed the acquisition of Synergy, a retail distributor of propane. Synergy maintained 152 retail branches serving approximately 200,000 customers in 23 states, primarily in suburban and rural areas of the eastern and south-central regions of the United States. In conjunction with the acquisition, the Company sold certain retail property outlets to Energy, which was later acquired in October 1996. The Synergy transaction represented an initial cash investment by the Company of approximately $137.5 million, but after the sale of certain retail property outlets, the total net cash acquisition investment by the Company was $105.6 million. The Company made debt and preferred stock investments in SYN Inc., the entity created to acquire Synergy. Northwestern Growth Corporation, one of the Company's wholly owned subsidiaries, owned control of SYN Inc. common stock. The acquisition was accounted for under the purchase method of accounting. The total net purchase price was comprised of consideration paid of $105.6 million cash, issuance of $1.25 million in long-term debt and the assumption of certain liabilities and other long-term debt. The cost in excess of the fair value of the net tangible and intangible assets acquired and the costs related to arranging the debt financing for the acquisition of $31.7 million was recorded as an intangible asset and was amortized on a straight-line method over 40 years. The allocation of the purchase price to the acquired assets and liabilities of Synergy was based on fair value of the related assets and liabilities. The Company has asserted claims under the acquisition agreement for post-closing adjustments related to the acquisition of Synergy. The Company's investments in SYN Inc. were funded primarily by financings undertaken in 1995. During the third quarter of 1995, the Company issued $60 million of 7.10% general mortgage bonds due August 1, 2005, 1.3 million shares of 8 1/8% preferred securities of subsidiary trust and 1.2 million shares of common stock. On December 7, 1995, the Company acquired majority control of Myers through the issuance of 42,890 shares of common stock and 11,500 shares of 6 1/2% redeemable cumulative preferred stock. Myers is a retail distributor of propane serving approximately 4,500 customers in and around Sandusky, Ohio. The total purchase price of $4.8 million was comprised of the securities issued by the Company and seller financing. The acquisition was accounted for under the purchase method of accounting. The cost in excess of fair value of the net assets acquired of $1.9 million was classified as goodwill and was amortized on a straight-line method over 40 years. On October 7, 1996, the Company completed the acquisition of Energy, a retail distributor of propane. Energy maintained 168 retail branches serving approximately 130,000 customers in 10 states, primarily in southeast and midwest regions of the United States. The total purchase price of $120 million was comprised of cash, assumption of certain liabilities including long-term debt of $94 million and transaction related costs. The cost in excess of the fair value of the net 64 tangible assets acquired was classified as goodwill and was amortized on a straight-line method over 40 years. The allocation of the purchase price to the acquired assets and liabilities of Energy was based on fair value of the related assets and liabilities. Had the acquisitions of Coast, Energy, Myers and Synergy and the Partnership Formation occurred on January 1, 1995, combined unaudited pro forma results for the year ended December 31, 1996, as prescribed under Accounting Principles Board Opinion No. 16 (APB 16), "Business Combinations," would have been: revenues $770,031,000, net income $18,771,000 and earnings per share $1.05. The pro forma disclosures required under APB 16 are not indicative of past or future operating results. Since the acquisitions and Partnership Formation, the Company has implemented significant cost reduction measures principally related to elimination of certain employee positions, corporate administrative expenses and other specifically identified operating expenses that have not been reflected in the pro forma information under the provisions of APB 16. 3. SHORT-TERM BORROWINGS The Company may issue short-term debt in the form of bank loans and commercial paper as interim financing for general corporate purposes. The bank loans may be obtained under short-term lines of credit. The Company's aggregate lines of credit available are $32 million at December 31, 1997. The Company pays an annual fee generally equivalent to 1/4% of the unused lines. There were no line of credit borrowings or commercial paper outstanding at December 31, 1997 and 1996. 4. LONG-TERM DEBT Substantially all of the Company's electric and gas utility plant is subject to the lien of the indentures securing its general mortgage bonds and pollution control obligations. General mortgage bonds of the Company may be issued in amounts limited by property, earnings and other provisions of the mortgage indenture. In March 1997, the Company retired early the $7.5 million outstanding of the 8.9% series general mortgage bonds. In July 1997, the Company retired early the $15 million outstanding of the 8.824% series general mortgage bonds. The following table summarizes the Company's general mortgage bonds and pollution control obligations at December 31 (in thousands): 65 Series Due 1997 1996 ------ --- ---- ---- General mortgage bonds - 8.824% 1998 $ - $ 15,000 8.9% 1999 - 7,500 6.99% 2002 25,000 25,000 7.10% 2005 60,000 60,000 7% 2023 55,000 55,000 Pollution control obligations - 5.85%, Mercer Co., ND 2023 7,550 7,550 5.90%, Salix, IA 2023 4,000 4,000 5.90%, Grant Co., SD 2023 9,800 9,800 Less current maturities (5,000) - ------- -------- $156,350 $183,850 In conjunction with the Partnership Formation in December 1996, the Partnership issued $220 million in First Mortgage Notes (Notes). These Notes are collateralized by substantially all of the assets of the Partnership and ranks pari passu with the Bank Credit Facility. The Notes bear interest at a fixed rate of 7.53% payable semi-annually and mature in the year 2010 with eight equal annual installments beginning in the year 2003. The Partnership may, at its options and under certain circumstances following the disposition of assets, be required to offer to prepay the Notes in whole or in part. The Note agreement contains restrictive covenants applicable to the Partnership including a) restrictions on the incurrence of additional indebtedness, b) restrictions on the ratio of consolidated cash flow to consolidated interest expense of the Partnership, as defined, and c) restrictions on certain liens, loans and investments, payments, mergers, consolidations, sales of assets and other transactions. Generally, as long as no default exists or would result, the Partnership is permitted to make cash distributions not more frequently than quarterly in an amount not to exceed available cash, as defined, for the immediately preceding calendar quarter. The Partnership also entered into a Bank Credit Facility in December 1996 with a group of commercial banks. The Bank Credit Facility consists of a $50 million Working Capital Credit Facility and a $75 million Acquisition Facility to finance propane business acquisitions. There were $23,500,000 and $12,500,000 of borrowings outstanding under the Working Capital Facility and the Acquisition Facility at December 31, 1997. There were $10,445,000 of borrowings outstanding under the Working Capital Facility at December 31,1996. There were no outstanding borrowings on the Acquisition Facility at December 31, 1996. The Bank Credit Facility bears interest at a variable rate tied to a certain Eurodollar index or prime rate, plus a variable margin for either rate which depends upon the Partnership's ratio of consolidated debt to consolidated cash flow. The Bank Credit Facility matures in December 1999. The Bank Credit Facility is collateralized by substantially all the assets of the Partnership and ranks pari passu with the First Mortgage Notes. The Bank Credit Facility contains 66 restrictive covenants applicable to the Partnership including a) restrictions on the incurrence of additional indebtedness, b) restrictions on the ratio of consolidated cash flow to consolidated interest expense of the Partnership, as defined, and c) restrictions on certain liens, loans and investments, payments, mergers, consolidations, sales of assets and other transactions. They also require that the Partnership maintain a ratio of total funded indebtedness to consolidated cash flow, as defined. Generally, as long as no default exists or would result, the Partnership is permitted to make cash quarterly distributions in an amount not to exceed Available Cash, as defined. Lucht Inc. has a credit agreement with a bank whereby it may borrow up to $8 million in revolving and term loans. Balances of $3,070,000 and $3,290,000 were outstanding under the revolving and term loan as of December 31, 1997 and 1996, at a weighted average interest rate of 8%. Borrowings under the agreement are collateralized by all receivables, inventories, property and other assets of Lucht and are nonrecourse to the Company. SYN Inc. had a credit agreement with a bank whereby it could borrow up to $30 million in revolving loans. The facility was repaid in conjunction with the Partnership Formation. The balance of other nonrecourse debt is comprised of the debt assumed and issued in conjunction with acquisitions of retail propane distribution centers of $10,524,000 and $8,072,000 at December 31, 1997 and 1996. Annual scheduled consolidated retirements of long-term debt during the next five years are $7,814,000 in 1998, $7,770,000 in 1999, $8,870,000 in 2000, $8,452,000 in 2001 and $8,300,000 in 2002. 5. CAPITAL STOCK TRANSACTIONS AND RETAINED EARNINGS AVAILABILITY As part of financing the Synergy acquisition, the Company issued 1.2 million shares of common stock in 1995. The Company also issued 1.3 million shares of 8 1/8% preferred securities of subsidiary trust, which mature in September 2025. In financing the Myers acquisition, the Company issued 42,890 shares of common stock and 11,500 shares of redeemable cumulative preferred stock. Preferred stock transactions for the three years ended December 31, 1997, have also included redemptions to satisfy mandatory sinking fund requirements. The following table summarizes the capital stock transactions that occurred during the year (in thousands): 67 Preferred Common Additional Stock Stock Paid in Capital --------- ------ --------------- Balance 12-31-95 $3,760 $31,220 $56,595 Mandatory sinking fund redemption (10) - - ------ ------- ------- Balance 12-31-96 3,750 31,220 56,595 Common stock - 4 - ------ ------- ------- Balance 12-31-97 $3,750 $31,224 $56,595 ====== ======= ======= There were 2,500 shares of subsidiary preferred stock outstanding at December 31, 1996 and 1995. The subsidiary preferred stock was redeemed in January 1997. In December 1996, the Company's Board of Directors declared, pursuant to a stockholders' rights plan, a dividend distribution of one Right on each outstanding share of the Company's common stock. Each Right becomes exercisable, upon the occurrence of certain events, at an exercise price of $50 per share, subject to adjustment. The Rights are currently not exercisable and will be exercisable only if a person or group of affiliated or associated persons (Acquiring Person) either acquires ownership of 15% or more of the Company's common stock or commences a tender or exchange offer that would result in ownership of 15% or more. In the event the Company is acquired in a merger or other business combination transaction or 50% or more of its consolidated assets or earnings power are sold, each Right entitles the holder to receive such number of shares of common stock of the Acquiring Person having a market value of two times the then current exercise price of the Right. The Rights, which expire in December 2006, are redeemable in whole, but not in part, at a price of $.005 per Right, at the Company's option at any time until any Acquiring Person has acquired 15% or more of the Company's common stock. 68 6. COMMON AND PREFERRED STOCK EQUITY The following table summarizes the Company's common and preferred stock equity at December 31(dollars in thousands, except par value):
1997 1996 ---- ---- COMMON STOCK EQUITY: Common stock, $1.75 par value, 50,000,000 and 40,000,000 shares authorized at December 31, 1997 and 1996; 17,842,524 and 17,840,244 shares outstanding at December 31, 1997 and 1996 $ 31,224 $ 31,220 Additional paid-in capital 56,595 56,595 Retained earnings 72,915 66,144 Unrealized gain on investments, net 5,862 9,846 --------- --------- $ 166,596 $ 163,805 ========= ========= CUMULATIVE PREFERRED STOCK: $100 par value, 1,000,000 shares authorized; 37,500 shares outstanding Nonredeemable 4 1/2% Series $ 2,600 $ 2,600 Redeemable 6 1/2% Series 1,150 1,150 --------- ---------- $ 3,750 $ 3,750 ========= ==========
7. INCOME TAXES Income tax expense is comprised of the following (in thousands):
1997 1996 1995 ---- ---- ---- Federal income - Current tax expense $ 4,620 $ 9,174 $ 7,849 Deferred tax expense 6,512 5,830 2,540 Investment tax credit (559) (561) (563) State income 538 972 300 -------- -------- -------- $ 11,111 $ 15,415 $ 10,126 ======== ======== ========
69 The following table reconciles the Company's effective income tax rate to the federal statutory rate:
1997 1996 1995 ---- ---- ---- Federal statutory rate 35% 35% 35% State income, net of federal benefit 1 2 - Amortization of investment tax credit (2) (1) (2) Dividends received deduction (2) (1) (5) Other, net 1 2 6 ----- ----- ----- 33% 37% 34% ===== ===== =====
The components of the net deferred federal income tax liability recognized in the Company's Consolidated Balance Sheet are related to the following temporary differences at December 31 (in thousands): 1997 1996 ---- ---- Excess tax depreciation $(79,366) $(77,032) Safe harbor leases (4,514) (5,630) Property basis and life differences (12,902) (6,480) Asset sales (4,273) (3,967) Regulatory assets (3,057) (3,489) Regulatory liabilities 4,512 4,189 Unbilled revenue 5,746 3,596 Unamortized investment tax credit 3,491 3,491 Unrealized gain on investments (3,399) (5,302) Other, net 20,878 19,730 -------- -------- $(72,884) $(70,894) ======== ======== 8. JOINTLY OWNED PLANTS The Company has an ownership interest in three major electric generating plants, all of which are operated by other utility companies. The Company has an undivided interest in these facilities and is responsible for its proportionate share of the capital and operating costs while being entitled to its proportionate share of the power generated. The Company's interest in each plant is reflected in the Consolidated Balance Sheet on a pro rate basis and its share of operating expenses is reflected in the Consolidated Statement of Income and Retained Earnings. The participants each finance their own investment. The Company has long-term coal contracts for delivery of lignite coal to Coyote I and sub-bituminous coal to Neal #4. The lignite coal contract for Big Stone expired in mid-1995 and the plant owners negotiated a contract for minimum annual purchases of 1.2 million tons of Montana sub-bituminous coal for the period of mid-1995 through 1999. The lignite contract for Coyote I is a total requirements contract with a minimum obligation of 30,000 tons per week except during scheduled or forced outages. Neal #4 has a contract for 70 delivery of sub-bituminous coal with an annual minimum purchase requirement of 1.8 million tons. Information relating to the Company's ownership interest in these facilities at December 31, 1997, is as follows (dollars in thousands): Big Stone Neal #4 Coyote I ----------------------------------- Utility plant in service $46,585 $34,993 $46,610 Accumulated depreciation $24,740 $17,889 $20,124 Construction work in progress $ 323 $ 333 $ 396 Total plant capacity - mw $ 449 $ 624 $ 427 Company's share 23.4% 8.7% 10.0% In-service date 1975 1979 1981 Coal contract expiration date 1999 1998 2016 9. EMPLOYEE RETIREMENT BENEFIT The Company maintains a noncontributory defined benefit pension plan covering substantially all employees. The benefits to which an employee is entitled under the plan are derived using a formula based on the number of years of service and compensation levels as defined. The Company determines the annual funding for its plan using the frozen initial liability cost method. The Company's annual contribution is funded in accordance with the requirements of ERISA. Assets of the plan consist primarily of debt and equity securities. The components of net periodic pension cost for the years ended December 31, 1997, 1996 and 1995 were as follows (in thousands):
1997 1996 1995 ---- ---- ---- Service cost $ 981 $ 958 $ 755 Interest cost on projected benefit obligation 3,500 3,506 3,144 Actual return on assets (10,024) (5,745) (10,082) Net amortization and deferral 5,669 1,608 6,475 --------- -------- --------- Net periodic pension cost $ 126 $ 327 $ 292 ========= ======== =========
71 The following table reflects the funded status of the Company's pension plan as of December 31, 1997, 1996 and 1995 (in thousands):
1997 1996 1995 ---- ---- ---- Actuarial present value of: Accumulated benefit obligation Vested $ 48,244 $ 43,950 $ 39,946 Nonvested 1,674 1,577 1,417 --------- -------- --------- 49,918 45,527 41,363 Provision for future pay increases 4,738 4,531 5,488 --------- -------- --------- Projected benefit obligation 54,656 50,058 46,851 Plan assets at fair value 64,390 56,507 52,762 --------- -------- --------- Projected benefit obligation less than plan assets (9,734) (6,449) (5,911) Unrecognized transition obligation (1,237) (1,392) (1,547) Unrecognized net gain 6,845 4,821 5,381 --------- -------- --------- Prepaid pension cost $ (4,126) $ (3,020) $ (2,077) ========= ======== =========
The assumptions used in calculating the projected benefit obligation for 1997, 1996 and 1995 were as follows:
1997 1996 1995 ---- ---- ---- Discount rate 7.00% 7.25% 7.75% Expected rate of return on assets 8.50% 8.50% 8.50% Long-term rate of increase in compensation levels 3% 3% 3%
The Company provides an employee savings plan which permits all employees to defer receipt of compensation as provided in Section 401(k) of the Internal Revenue Code. Under the plan, any employee may elect to direct up to 12 percent of their gross compensation be contributed to the plan. The Company contributes 50 cents for every one dollar contributed by the employee, up to a maximum Company contribution of three percent of the employee's gross compensation. Costs incurred under the plan were $575,000, $594,000 and $479,000 in 1997, 1996 and 1995. The Company also provides an Employee Stock Ownership Plan (ESOP) for full-time employees. The ESOP is funded primarily with federal income tax savings, which arise from tax laws applicable to such employee benefit plans. Certain Company contributions and shares of stock acquired by the ESOP are allocated to participants' accounts in proportion to the compensation of employees during the particular year for which allocation is made. Costs incurred under the plan were $901,000, $849,000 and $810,000 in 1997, 1996 and 1995. The Company also has various supplemental retirement plans for outside directors and selected management employees. The plans are nonqualified defined benefit plans that provide for certain amounts of salary continuation in the event of death before or after retirement 72 or certain supplemental retirement benefits in lieu of any death benefits. In addition, the Company provides life insurance benefits to beneficiaries of all eligible employees who represent a reasonable insurable risk. To minimize the overall cost of plans providing life insurance benefits, the Company has obtained life insurance coverage that is sufficient to fund benefit obligations. Costs incurred under the plans were $1,159,000, $1,291,000 and $648,000 in 1997, 1996 and 1995. Cornerstone provides employee savings plans, which permits all employees to defer receipt of compensation as provided in Section 401(k) of the Internal Revenue Code. Under the plans, any employee may elect to direct a percentage of their gross compensation be contributed to the plans. Cornerstone, at its discretion, may match a portion of the employee contribution. Lucht has a 401(k) retirement plan, whereby it matches participant contributions in an amount equal to 50% of each participant's contribution. Company contributions to the plan were not material. 10. ENVIRONMENTAL MATTERS The Company is subject to environmental regulations from numerous entities. The Clean Air Act Amendments of 1990 (the Act) stipulate limitations on sulfur dioxide and nitrogen oxide emissions from coal- fired power plants. The Company believes it can economically meet such sulfur dioxide emission requirements at its generating plants by the required compliance dates and that it is in compliance with all presently applicable environmental protection requirements and regulations. The Company is also subject to other environmental regulations including matters related to former manufactured gas plant sites. In 1995, the Company remediated a site located at Huron, South Dakota through thermal desorption of residues in the soil. Adjustments of the Company's natural gas rates to reflect the costs associated with the remediation were approved through the regulatory process. The Company is pursuing recovery from insurance carriers. No administrative or judicial proceedings involving the Company are now pending or known by the Company to be contemplated under present environmental protection requirements. 11. CUMULATIVE PREFERRED STOCK AND PREFERENCE STOCK The provisions of the 6 1/2% Series stock contain a five-year put option exercisable by the holders of the securities and a 10-year redemption option exercisable by the Company. In any event, redemption will occur at par value. The cumulative preferred stock, 4 1/2% Series, may be redeemed in whole or in part at the option of the Board of Directors at any time upon at least 30 days notice at $110.00 per share, plus accrued dividends. In the event of involuntary dissolution, all Company preferred stock outstanding would have a preferential interest of $100 per share, plus accumulated dividends, before any distribution to common stockholders. The Company is also authorized to issue a maximum of 1,000,000 shares of preference stock at a par value of $50 per share. No preference shares have ever been issued. 73 12. SEGMENTS OF BUSINESS The four primary segments of the Company's business are its electric, natural gas distribution, propane and manufacturing operations. The following table summarizes certain information specifically identifiable with each segment as of or for the years ended December 31 (in thousands):
1997 1996 1995 ---- ---- ---- Depreciation and Amortization Expense: Electric $ 11,317 $ 10,620 $ 10,503 Natural Gas 2,584 2,492 2,185 Propane 16,784 5,730 1,562 Manufacturing 550 572 383 ------------ ----------- --------- $ 31,235 $ 19,414 $ 14,633 ------------ ----------- --------- Maintenance Capital Expenditures: Electric $ 12,334 $ 19,598 $ 17,868 Natural Gas 5,876 8,172 6,521 Propane 4,056 7,349 4,726 Manufacturing 134 51 522 ------------ ----------- --------- $ 22,400 $ 35,170 $ 29,637 ------------ ----------- --------- Assets: Identifiable Electric $ 228,011 $ 223,262 $ 218,006 Natural Gas 78,919 66,213 59,384 Propane 622,077 611,707 173,665 Manufacturing 14,641 14,946 16,409 Corporate assets 162,475 197,588 91,257 ----------- ----------- --------- $ 1,106,123 $ 1,113,716 $ 558,721 ----------- ----------- ---------
Identifiable assets include all assets that are used directly in each business segment. Corporate assets consist of assets not directly assignable to a business segment, i.e., cash, investments, certain accounts receivable, prepayments and other miscellaneous current and deferred assets. 74 13. QUARTERLY FINANCIAL DATA (UNAUDITED)
(In Thousands Except Per Share Amounts) First Second Third Fourth ---------------------------------------------------------------------------------------------------- 1997: Operating revenues $284,406 $165,451 $185,084 $283,129 Operating income 27,932 4,497 4,033 22,535 Net income 10,523 3,158 3,722 8,861 Average shares 17,842 17,843 17,843 17,843 Earnings per average common share $ .55 $ .14 $ .17 $ .45 -------- -------- -------- -------- 1996: Operating revenues $ 97,219 $ 56,681 $ 49,705 $140,404 Operating income 23,813 6,436 4,652 15,517 Net income 13,309 3,353 1,301 8,091 Average shares 17,840 17,840 17,840 17,840 Earnings per average common share $ .70 $ .14 $ .03 $ .41 -------- -------- -------- --------
75 FINANCIAL AND OPERATING STATISTICS
1997 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- ---- INCOME STATEMENT DATA (000) Operating revenues $ 918,070 $ 344,009 $ 204,970 $ 157,266 $ 153,257 $ 119,197 Operating income 58,997 50,418 38,097 30,536 27,273 24,809 Net income 26,264 26,054 19,306 15,440 15,191 13,721 Earnings per share $ 1.31 $ 1.28 $ 1.11 $ 1.00 $ 0.98 $ 0.88 ------------------------------------------------------------------------------------------------------------------------- COMMON STOCK DATA Average share outstanding at year end(000) 17,843 17,840 16,261 15,354 15,354 15,354 Dividends paid per common share $ .933 $ .890 $ .873 $ .835 $ .815 $ .795 Annual dividend rate at year end $ .97 $ .92 $ .88 $ .85 $ .83 $ .81 Book value per share at year end $ 9.34 $ 9.18 $ 8.56 $ 7.47 $ 7.14 $ 6.98 Market price per common at year end $ 23.00 $ 17.13 $ 14.00 $ 13.38 $ 14.38 $ 14.00 Price earnings ratio 17.6x 13.4x 12.7x 13.4x 14.7x 15.8x Dividend payout ratio (from ongoing operations) 71.2% 74.8% 79.0% 83.5% 83.2% 89.8% Return on average common equity 14.1% 14.4% 13.7% 13.1% 13.7% 12.8% Common shareholders at year end 8,845 8,750 8,738 8,132 8,231 8,279 ------------------------------------------------------------------------------------------------------------------------- RATIOS Interest coverage 5.4* 4.3* 4.3* 5.1* 5.1* 4.1 Ratio of earnings to fixed charges 3.0 3.2 3.4 3.4 3.5 3.4 Ratio of earnings to fixed charges, including dividends and minority interest on preferred securities 2.6 2.7 3.1 3.4 3.5 3.3 ------------------------------------------------------------------------------------------------------------------------- BALANCE SHEET Total assets (000) $1,106,123 $1,113,716 $ 558,721 $ 359,066 $ 343,574 $ 308,194 Long-term debt (000) 161,350 183,850 183,850 123,850 123,850 105,350 Redeemable preferred stock (000) 1,150 1,150 1,160 40 70 100 Capitalization ratios**: Common Stock equity 45.7% 42.7% 41.0% 47.6% 46.4% 49.8% Preferred securities of subsidiary trust 8.9% 8.4% 8.7% - - - Preferred stock 1.0% 1.0% 1.0% 1.1% 1.1% 1.2% Long-term debt 44.4% 47.9% 49.3% 51.3% 52.5% 49.0% ------------------------------------------------------------------------------------------------------------------------- 76 FINANCIAL AND OPERATING STATISTICS (continued) 1997 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- ---- ELECTRIC OPERATIONS Total customers 55,805 55,600 55,310 54,863 54,288 53,773 Retail sales (000 kwh) 1,114,192 1,082,704 1,071,328 1,018,509 964,477 894,077 Sales for resale (000 kwh) 212,848 75,334 127,172 182,032 191,170 159,785 Electricity generated (000 kwh) 1,364,680 1,101,211 1,232,054 1,235,640 1,179,716 1,088,783 Electricity purchased (000 kwh)*** 54,171 171,615 75,777 67,440 80,937 60,323 Total system capability at peak (kw) 325,259 321,522 326,162 309,480 307,442 290,045 Total system peak load (kw) 270,099 260,159 272,722 229,922 237,188 191,591 Residential revenue per kwh sold (cents) 7.35 7.35 7.43 7.57 7.60 7.81 ------------------------------------------------------------------------------------------------------------------------- PROPANE OPERATIONS Total Customers 380,000 360,000 156,000 - - - Retail sales (000 gallons) 220,833 141,388 37,805 - - - Wholesale Sales (000 gallons) 479,055 18,617 - - - - Percent colder (warmer) than previous year (3.9) 8.1 18.7 - - - ------------------------------------------------------------------------------------------------------------------------- NATURAL GAS OPERATIONS Total Customers 78,531 77,478 76,464 74,982 73,228 70,934 Total sales (000 mmbtu) 14,017 15,340 14,353 13,770 14,478 12,044 Transported volumes (000 mmbtu) 2,394 981 851 980 333 296 Percent colder (warmer) than previous year- SD (1.4) 7.5 (1.2) (4.2) 16.4 (9.4) Percent colder (warmer) than previous year-NE (0.7) (2.2) 8.1 (9.7) 22.6 (16.2) ------------------------------------------------------------------------------------------------------------------------- EMPLOYEES Electric and natural gas 444 436 441 452 473 463 Propane (includes seasonal workers) 2,206 1,995 858 - - - Manufacturing 145 150 174 163 168 185
* New General Mortgage Indenture executed in August 1993. ** Reflects capitalization of the Company excluding nonrecourse capitalization of subsidiaries. *** Includes short-term power pool purchases. EX-21 4 EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT State of Jurisdiction of Incorporation Name or Limited Partnership ---- ----------------------- Northwestern Public Service Company Delaware Grant, Inc. South Dakota Northwestern Growth Corporation South Dakota Northwestern Networks, Inc. South Dakota Northwestern Systems, Inc. South Dakota Lucht Inc. Delaware Cornerstone Propane GP, Inc. California SYN Inc. (1) Delaware Cornerstone Propane Partners, L.P.(2) Delaware Limited Partnership ServiCenter USA, Inc.(3) Delaware Communication Systems USA, Inc. Delaware Northwestern Energy Corporation South Dakota Nekota Resources Inc. South Dakota Northwestern Services Corporation South Dakota (1) Cornerstone Propane GP, Inc. owns 82.5% of the common stock of SYN Inc. (2) Cornerstone Propane GP, Inc. and SYN Inc. own a combined partnership interest of 38.5% of Cornerstone Propane Partners, L.P. consisting of a 36.5% limited partner interest and a 2% general partner interest. (3) Northwestern Growth Corporation owns 5.2% of the common stock and 92% of the preferred stock of ServiCenter USA, Inc. EX-27 5
UT 12-MOS DEC-31-1997 DEC-31-1997 PER-BOOK 545,622,000 121,587,000 156,408,000 282,506,000 0 1,106,123,000 31,224,000 56,595,000 78,777,000 166,596,000 0 3,750,000 425,281,000 0 0 0 7,814,000 0 0 0 506,682,000 1,106,123,000 918,070,000 11,111,000 859,073,000 870,184,000 47,886,000 11,564,000 59,450,000 31,476,000 27,974,000 2,853,000 23,411,000 16,640,000 11,969,240 62,667,000 1.31 1.31
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