Annual Report (Form 10-K), fiscal year 1994

Item 1. Business
GENERAL
Allegheny & Western Energy Corporation (Allegheny or the Company) is a West Virginia corporation which was incorporated in 1981. The Company is a diversified natural gas company whose principal subsidiary, Mountaineer Gas Company (Mountaineer), is the largest natural gas distribution utility in West Virginia. Allegheny is also engaged in non-utility enterprises directly and through subsidiaries, including developmental drilling and production of natural gas in West Virginia and the marketing of natural gas directly to consumers in West Virginia. The Company's past exploration and production activities in the Appalachian Basin of West Virginia have been conducted for its own account and through joint ventures with third parties and limited partnerships. Allegheny has performed no drilling activities since fiscal 1992. Allegheny's field services operations consist of the administration and operation of producing properties in West Virginia for which Allegheny is the operator.
Mountaineer provides natural gas service to approximately 200,000 residential, commercial, industrial and wholesale customers in 45 counties in West Virginia, including the cities of Charleston, Beckley, Huntington and Wheeling. Mountaineer owns and operates approximately 3,600 miles of natural gas distribution pipelines in West Virginia. Acquired in 1984 from The Columbia Gas System, Inc., Mountaineer is regulated by the Public Service Commission of West Virginia (PSCWV). In March 1993, Mountaineer, through its wholly-owned subsidiary Mountaineer Gas Services, Inc. (MGS), acquired all of the West Virginia assets of Hallwood Energy Partners, L.P. and Hallwood Consolidated Resources Corporation (Hallwood). These assets included approximately 13.5 billion cubic feet (Bcf) of net natural gas reserves, approximately 274 miles of natural gas transmission facilities and approximately 19,600 net acres of undeveloped leaseholds. The transaction was approved by the PSCWV, and MGS began operating the properties on April 1, 1993. MGS was formed for the purpose of holding and operating the acquired assets. Substantially all natural gas produced by MGS is sold to Mountaineer based on prices approved by the PSCWV.
Allegheny's non-regulated gas marketing subsidiary, Gas Access Systems, Inc. (G.A.S.), sells natural gas directly to industrial, commercial and municipal customers in West Virginia. G.A.S. markets natural gas produced by Allegheny as well as supplies obtained from other producers and wholesalers located in West Virginia and the continental United States.
In November 1990, Allegheny entered into an agreement with a third party whereby the Company acquired a 50% interest in petroleum prospecting licenses, which were granted in February 1991 and became effective in August 1991, covering approximately 2.6 million acres in the North Island, New Zealand including
acreage both onshore and offshore. The Company has formed a New Zealand subsidiary, A&W Exploration New Zealand, Limited (AWENZ) which holds the Company's interests in the petroleum prospecting licenses. During fiscal 1992, AWENZ acquired an additional 9.5% interest in the prospecting licenses.
As of June 30, 1994, Allegheny's and MGS's combined net proved reserves were approximately 26.7 Bcf of natural gas and 28,000 barrels of oil, based on reports from independent petroleum engineers. See discussion of "Net Proved Oil and Gas Reserves" under Item 2.



Item 2. Properties
Utility Properties
Mountaineer owns and operates a gas distribution system consisting of approximately 3,600 miles of underground distribution mains, ranging in size from one inch to twenty inches in diameter, together with service lines, and metering and regulating equipment. The mains are located on easements or private rights-of-way. In addition, Mountaineer owns equipment, garages, offices, shops and various metering and regulating buildings in its service area.
Mountaineer's investment in its distribution system is considered suitable and adequate to deliver gas supplies to its consumers. Mountaineer, as is typical within the industry, provides for an ongoing maintenance and replacement program.
Transmission Facilities
MGS owns and operates approximately 274 miles of a natural gas transmission system located in West Virginia. This transmission system ranges in size from two to ten inches in diameter and is located on easements or private rights-of-way.
Oil and Gas Field Offices
Allegheny's drilling and production operations are directed from its offices in Charleston, West Virginia, with field operations facilities in Chelyan, West Virginia.
MGS's producing operations are directed from its offices in Charleston, West Virginia.
Reserves
Allegheny's oil and gas reserves as of June 30, 1994 have been estimated by the independent petroleum engineering firms of Wright & Company, Inc. and Forrest A. Garb & Associates, Inc. MGS's gas reserves have been estimated by the firm of Wright & Company, Inc.
The following table presents estimates of net proved reserves of oil and gas (all of which are developed) for the periods
indicated:
The over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
DIVIDENDS
On October 6, 1988, the Company announced that it would discontinue the payment of cash dividends on its common stock for the foreseeable future. The dividend policy of the Company is
reviewed each quarter and is subject to change by the Company; however, under the terms of the Company's Term Credit and Revolving Credit Agreement, signed on September 24, 1990, the Company may not declare dividends in excess of 25% of cumulative consolidated net income after June 30, 1990. (See Note 4 to the accompanying consolidated financial statements.)
The deficiency in working capital at June 30, 1994 is attributable to Mountaineer's requirement of significant working capital funds to finance the acquisition of the West Virginia assets of Hallwood by MGS in fiscal 1993 and to fund fiscal 1994 capital expenditures. Management believes it has sufficient lines-of-credit in place to meet maturities of long-term debt and working capital requirements.
Capital Expenditures
Capital expenditures were approximately $13.3 million and $22.3 million for the fiscal years ended June 30, 1994 and 1993. Substantially all of the Company's fiscal 1994 capital expenditures were attributable to the Company's gas distribution operations. Such expenditures were financed primarily by
internally generated funds and short-term borrowings.
Fiscal 1995 Expenditures
The extent of Allegheny's drilling activities in fiscal 1995, if any, will depend upon, among other factors, the market price of natural gas, Allegheny's available funds, Allegheny's ability to raise funds in the capital markets and Allegheny's ability to attract industry partners. While Allegheny's plans are subject to change in light of the foregoing, management does not currently anticipate that Allegheny will undertake any new exploration or development drilling during fiscal 1995. Allegheny is continuing to seek attractive acquisition candidates in order to expand its operations; however it is impossible to determine what expenditures may be required to fund these activities, if successful.
Utility construction expenditures are estimated to be approximately $13.7 million.
MGS's natural gas drilling expenditures are expected to be $1.0 million.
Management believes that the Company has sufficient internally generated funds, working capital resources and lines-of-credit to meet these anticipated capital expenditures.
Dividend Restrictions
Mountaineer's outstanding debt obligations restrict the amount of dividends that Mountaineer can pay to the Company (see Note 4 to the accompanying consolidated financial statements). As of June 30, 1994, under the most restrictive terms of its debt obligations, Mountaineer would be permitted to pay dividends of $11.7 million to the Company. The limitations on Mountaineer's ability to pay dividends are not expected to have a significant impact on the Company's ability to meet its cash requirements.
Seasonality of Business
Mountaineer's retail gas distribution sales are highly seasonal and fluctuate significantly dependent upon weather conditions experienced in Mountaineer's service area. Typically, the weather conditions result in higher operating revenues and net income from October through March and lower operating revenues and either net losses or reduced net income from April through September. Weather conditions also have a significant impact on Mountaineer's cash flow requirements. Typically, cash expenditure requirements are greatest during May through January in preparation for and during the winter heating season due to gas purchase requirements. Cash inflows are at their highest levels typically from January through April due to heating requirements of Mountaineer's customers. Mountaineer utilizes lines-of-credit and internally generated funds to meet its seasonal capital requirements.
OTHER
Impact of Inflation
Fluctuations in prices and costs are primarily a matter of supply and demand with respect to oil and gas operations and, to a much lesser degree, inflation. The inflationary impact on gas distribution operations is considered in periodic rate cases. On October 29, 1993, the PSCWV issued the October 1993 Order, which was effective November 1, 1993, regarding Mountaineer's request in January 1993 for increased base rates. The October 1993 Order, among other matters, provided for a 10.1% return on equity and rate increases which would generate additional annual revenues of approximately $3,400,000 under normal operating conditions. In its original filing, Mountaineer requested a return on equity of 12.3% and rate increases that would result in increased annual revenues of $7,500,000. On November 8, 1993, Mountaineer filed a petition for reconsideration of several issues contained in the October 1993 Order, including the granted rate of return on equity and the rate recovery mechanism of OPEB costs. On March 30, 1994, the PSCWV issued the March 1994 Final Order in this rate case, after reconsidering several issues raised by various parties to the rate case. In the March 1994 Final Order the PSCWV granted an increase in the authorized return on equity to 10.55% and established a tracking mechanism for certain OPEB costs.
Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes"
In February 1992, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." The Company adopted the provisions of SFAS No. 109 effective July 1, 1993 and elected not to restate the financial statements of prior years. The adoption of SFAS No. 109 required the Company to convert from the deferred method to the liability method to recognize deferred taxes. Under the liability method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Deferred tax assets and liabilities are adjusted for future changes in tax rates. Under the deferred method, deferred tax expense was based on items of income and expense that were reported in different years in the financial statements and tax returns and were measured at the tax rate in effect in the year the difference originated. As permitted by SFAS No. 109, the Company elected not to restate the financial statements of any prior years, but to record the cumulative effect of the change in accounting for income taxes in the year of adoption. The recording of the cumulative effect of this change in accounting for income taxes did not impact pre-tax income from continuing operations; however, net income increased approximately $1,562,000, or $.20 per share. The increase in net income was primarily the result of reduced currently enacted tax rates compared to those in effect at the time the deferred taxes were previously recognized. The adoption of SFAS No. 109 by Mountaineer resulted in an increase in accumulated deferred income taxes which was offset by a corresponding increase in a
regulatory asset account, which resulted from the recording of certain deferred taxes which were not previously recognized due to state ratemaking practices. This amount (approximately $8,539,000 at June 30, 1994) has been reflected in other assets.
Statement of Financial Accounting Standards No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions"
Effective July 1, 1993, Mountaineer adopted SFAS No. 106, "Employers Accounting for Postretirement Benefits Other Than Pensions" (OPEB). SFAS No. 106 significantly changes the accounting, measurement and disclosure practices with respect to OPEB's. SFAS No. 106 requires that the expected cost of OPEB's be charged to expense during the period of an employee's service rather than expensing such costs as claims are incurred. Under Mountaineer's medical and life insurance plan for retired employees, the attribution period is equivalent to the 10-year period prior to the employee reaching eligible retirement age. As permitted by SFAS No. 106, Mountaineer has elected to amortize the accumulated postretirement benefit obligation existing at the date of adoption ("transition obligation") over a 20-year period. Prior to fiscal 1994, Mountaineer recognized postretirement health care and life insurance benefits in the year the benefits were paid. The cost of retirees' benefits paid in fiscal 1994, 1993 and 1992 was approximately $297,000, $525,000 and $347,000, respectively. Retiree benefits recognized by Mountaineer pursuant to the requirements of SFAS No. 106 were $1,117,000 in fiscal 1994.
As part of the October 1993 Order, the PSCWV ruled that the permitted rate recovery mechanism for OPEB's will be a modified accrual method (see Note 8 to the accompanying consolidated financial statements). The modified accrual method allows for the recovery of current service costs on an accrual basis and recovery of the transition obligation on a cash basis. Accounting for the transition obligation on a cash method is not an acceptable accounting method under generally accepted accounting principles. Mountaineer is recording its other postretirement benefit expense in accordance with SFAS No. 106, which is in excess of the permitted rate recovery as a result of the PSCWV's ruling. Mountaineer currently estimates that the amount of SFAS No. 106 expense (net of those amounts expected to be capitalized) in excess of the modified accrual basis would be approximately $300,000 in fiscal 1995 and would accumulate to approximately $3,000,000 over the remaining nineteen year amortization period for transition costs. These amounts will be recovered through rates in later years when the cash basis of prior service costs exceeds the accrual basis of such costs.
Statement of Financial Accounting Standards No. 112, "Employers' Accounting for Postemployment Benefits"
In November 1992, the FASB issued SFAS No. 112, "Employers Accounting for Postemployment Benefits." This statement requires employers to recognize any obligation which exists to provide benefits to former or inactive employees after employment, but before retirement. Such benefits include, but are not limited to,
salary continuations, supplemental unemployment, severance disability (including workers' compensation), job training, counseling and continuation of benefits such as health care and life insurance. Currently, the Company provides only for workers' compensation benefits which would qualify as postemployment benefits under this standard.
The Company will adopt this statement in fiscal 1995. The adoption of SFAS No. 112 is not expected to have a material impact on the Company's results of operations.
Item 8.







Item 8.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Consolidated Financial Statements - Allegheny & Western Energy Corporation and Subsidiaries
Report of Independent Public Accountants 26
Consolidated Balance Sheets as of June 30, 1994 and 1993 27
Consolidated Statements of Income for the Years Ended June 30, 1994, 1993 and 1992 29
Consolidated Statements of Changes in Stockholders' Equity for the Years Ended June 30, 1994, 1993 and 1992 30
Consolidated Statements of Cash Flows for the Years Ended June 30, 1994, 1993 and 1992 31
Notes to Consolidated Financial Statements 32
Report of Independent Public Accountants
To the Directors and Stockholders of Allegheny & Western Energy Corporation:
We have audited the accompanying consolidated balance sheets of ALLEGHENY & WESTERN ENERGY CORPORATION (a West Virginia corporation) and subsidiaries as of June 30, 1994 and 1993 and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended June 30, 1994. These consolidated financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements and schedules 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 as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Allegheny & Western Energy Corporation and subsidiaries as of June 30, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1994, in conformity with generally accepted accounting principles.
As discussed in Notes 6 and 8, effective July 1, 1993, the Company changed its method of accounting for income taxes and other postretirement benefits pursuant to standards promulgated by the Financial Accounting Standards Board.
Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedules listed under Item 14(a)(2) are presented for purposes of complying with the Securities and Exchange Commission's rules and are not a required part of the basic consolidated financial statements. These schedules have been subjected to the auditing procedures applied in our audits of the basic consolidated financial statements and, in our opinion, fairly state, in all material respects, the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole.
Arthur Andersen LLP
Houston, Texas, August 24, 1994.
The combined scheduled annual maturities of long-term debt are as follows:
(5) SHORT-TERM BORROWINGS AND LINES-OF-CREDIT
Mountaineer had unsecured short-term bank lines-of-credit totaling $57.5 million, $30 million and $22.5 million in fiscal 1994, 1993 and 1992, respectively. During fiscal 1994, the
maximum outstanding daily balance was $37,220,700 and the average daily balance was $17,156,300. The weighted average interest rate was 3.44% on the balance outstanding in fiscal 1994. During fiscal 1993, the maximum outstanding daily balance was $9,243,800 and the average daily balance was $1,407,000. The weighted average interest rate was 3.40% on the balance outstanding in fiscal 1993. During fiscal 1992, the maximum outstanding daily balance was $44,000 and the average daily balance was $400. The weighted average interest rate was 5.3% on the balance outstanding in fiscal 1992. There was $18,702,900 and $7,638,700 outstanding on these lines-of-credit at June 30, 1994 and 1993, respectively. The interest rate on these borrowings at June 30, 1994 and 1993 was 4.8% and 3.3%, respectively. There were no outstanding borrowings on these lines-of-credit at June 30, 1992.
Allegheny has $5,000,000 available under the Revolving Credit Agreement entered into in September 1990. The interest rate is either a base rate which approximates the prime rate or a certificate of deposit rate plus 1-1/2% per annum. No borrowings were made on this facility in fiscal 1994, 1993 or 1992.
(6) TAXES ON INCOME
Effective July 1, 1993, the Company prospectively adopted SFAS No. 109. SFAS No. 109 requires the Company to utilize the liability method to recognize deferred taxes. Under this method, deferred tax assets and liabilities are based on differences between financial reporting and tax bases of assets and liabilities and the differences are measured at enacted tax rates and laws that will be in effect when the differences are expected to reverse. Deferred tax assets and liabilities are adjusted for future changes in tax rates. Prior to the adoption of SFAS No. 109, deferred taxes were measured using tax rates for the year in which timing differences arose and were not adjusted for changes in tax rates.
The cumulative effect of adopting SFAS No. 109 on the Company and its nonregulated subsidiaries as of July 1, 1993, was to increase net income approximately $1,562,000 ($.20 per share) in the first quarter of fiscal 1994. The increase in net income was primarily the result of reduced currently enacted tax rates compared to those in effect at the time the deferred taxes were recognized. Pre-tax income from continuing operations of the Company and its nonregulated subsidiaries was not affected by the change in the method of accounting for income taxes. The adoption of SFAS No. 109 by Mountaineer resulted in an increase in accumulated deferred income taxes which was offset by a corresponding increase in a regulatory asset to account for certain temporary differences for which deferred taxes had not previously been recognized due to state ratemaking practices. This amount (approximately $8,539,000 at June 30, 1994) has been reflected in other assets in the accompanying balance sheets.
Significant components of the Company's deferred tax assets and liabilities as of June 30, 1994 are as follows:
Components of taxes on income are as follows:
A reconciliation of the Federal statutory rate to taxes on income is as follows:
In August 1993, the Revenue Reconciliation Act of 1993 was enacted into law which, among other changes, increased the top marginal tax rate for corporations with taxable incomes in excess of $10 million to 35%. The Company does not currently anticipate that it will be subject to the increased marginal rate.
(7) RETIREMENT PLANS
The Retirement Income Plan for the Company (the Plan) covers all qualified employees 21 years of age and over. Employees become fully vested upon completion of five years of credited service, as defined by the Plan. Retirement income is based on credited years of service and level of compensation. The Plan is subject to the provisions of the Employee Retirement Income Security Act of 1974 (ERISA). The determination of contributions is made in consultation with an actuary and is based upon anticipated
earnings of the Plan, mortality and turnover experience, the funded status of the Plan and anticipated future compensation levels. The Company's funding policy is to be in compliance with ERISA guidelines and to make annual contributions to the Plan to assure that all employees' benefits will be fully provided for by the time they retire. Funds contributed to the Plan have been invested primarily in government securities and corporate bonds and equity securities of large, well-established corporations.
The following table sets forth the Plan's funded status and amounts recognized in the Company's consolidated balance sheets at June 30, 1994 and 1993:
Net pension cost for fiscal years ended June 30, 1994, 1993 and 1992 included the following components:
The expected long-term rate of return used in the calculations was 8.25% for fiscal 1994 and 1993 and 9% for fiscal 1992. The weighted average discount rate used in the calculations was 8.0% for fiscal 1994, 1993 and 1992.
The Company has a Key Executives' Supplemental Retirement Benefit Plan (the "SERP") for its key executive employees. The SERP provides for the payment of compensation for varying periods of time upon an executive employee reaching a specified retirement age or becoming permanently disabled while employed by the Company or its subsidiaries. The Company funds the SERP through the purchase of individual life insurance contracts of which the Company is the sole beneficiary, and the specific level of compensation will be dependent upon the performance of the life insurance contracts. In addition, the Company will provide benefits to the employee's beneficiary should the employee die while employed by the Company or its subsidiaries. Benefits to be paid upon retirement will not vest unless the employee continues to be employed by the Company or its subsidiaries through the specified retirement age. Should a change in control (as defined in the SERP) of the Company occur, the employee will become entitled to a portion of his retirement benefit for each year of participation in the SERP, except for certain executives having employment contracts, who will be entitled to full retirement benefits. This portion is based upon the number of years of participation in the SERP in proportion to the total number of years until retirement for such employee from the time he or she became a participant in the SERP. The Board of Directors, in its sole discretion, may terminate the SERP at any time, in whole or in part. The costs associated with the SERP are being accrued over the respective executive employee's remaining years of service to retirement.
(8) POSTRETIREMENT MEDICAL AND LIFE INSURANCE BENEFITS
Mountaineer provides certain medical and life insurance benefits for retired employees. Substantially all of Mountaineer's employees may become eligible for these benefits if they choose to retire early after reaching age 55 while working for Mountaineer. The medical benefits are provided until age 65 at which time these employees become eligible for Medicare and medical benefits from Mountaineer are no longer provided. Life insurance benefits of approximately two times annual salary are provided while an employee is active and working at Mountaineer. On the date of an employee's retirement and on the date the
employee reaches age 70, life insurance benefits decrease to approximately 80% and 40% of annual salary, respectively. These benefits are provided to retirees who meet the service requirements of ten continuous years of service prior to retirement at age 55 or five continuous years of service prior to retirement at age 65.
Effective July 1, 1993, Mountaineer adopted SFAS No. 106, "Employers Accounting for Postretirement Benefits Other Than Pensions" (OPEB). SFAS No. 106 significantly changes the accounting, measurement and disclosure practices with respect to OPEB's. SFAS No. 106 requires that the expected cost of OPEB's be charged to expense during the period of an employee's service rather than expensing such costs as claims are incurred. Under the plan, the attribution period is equivalent to the 10-year period prior to the employee reaching eligible retirement age. As permitted by SFAS No. 106, Mountaineer has elected to amortize the accumulated postretirement benefit obligation existing at the date of adoption ("transition obligation") over a 20-year period. Prior to fiscal 1994, Mountaineer recognized postretirement health care and life insurance benefits in the year the benefits were paid. The cost of retirees' benefits paid in fiscal 1994, 1993 and 1992 was approximately $297,000, $525,000 and $347,000, respectively. Retiree benefits recognized by Mountaineer pursuant to the requirements of SFAS No. 106 were $1,117,000 in fiscal 1994.
The following table sets forth the plan's funded status, as determined by an independent actuary, as of July 1, 1993 and June 30, 1994:
The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 11% in 1994, declining gradually to 5.5% in 2005 and remaining at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by one percent in each year would increase the aggregated service and interest cost by $49,000 and accumulated postretirement benefit obligation as of June 30, 1994 by $218,000. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 8%. The average assumed annual rate of salary increase for the life insurance benefit plan was 5%.
As part of a PSCWV rate order dated October 29, 1993, the PSCWV ruled that the permitted rate recovery mechanism for OPEB's will be a modified accrual method. The modified accrual method allows for the recovery of current service costs on an accrual basis and recovery of the transition obligation on a cash basis. Accounting for the transition obligation on a cash method is not an acceptable accounting method under generally accepted accounting principles. Mountaineer is recording its other postretirement benefit expense in accordance with SFAS No. 106, which is in excess of the permitted rate recovery as a result of the PSCWV's ruling. Mountaineer currently estimates that the amount of SFAS No. 106 expense (net of those amounts expected to be capitalized) in excess of the modified accrual basis would be approximately $300,000 in fiscal 1995 and would accumulate to approximately $3,000,000 over the remaining nineteen year amortization period for transition costs. These amounts will be recovered through rates in later years when the cash basis of prior service costs exceeds the accrual basis of such costs.
(9) LEASING ARRANGEMENTS
The Company, primarily through its subsidiary, Mountaineer, leases buildings, office space, and equipment under various short-term and long-term agreements. Total expense for leases
for the fiscal years ended June 30, 1994, 1993 and 1992 was $852,000, $935,000 and $1,048,000, respectively. At June 30, 1994, the net minimum annual rental commitments for all noncancellable leases were as follows:
(10) STOCK OPTION PLAN
The Company's 1987 Stock Option Plan (the 1987 Plan), as amended, provides that a combined total of 1,500,000 incentive and non- qualified options to purchase shares of the Company's common stock may be granted to certain key employees by the Board of Directors. Incentive options must be granted with an exercise price equal to the fair market value of a share of common stock on the date of grant. Non-qualified options may be granted at prices determined by the Board of Directors. Options granted expire five to ten years from date of grant and may include vesting provisions; however, in the event of a change in control of the Company (as defined in the 1987 Plan), options granted vest immediately. The 1987 Plan also provides that employees may be granted stock appreciation rights (SAR's) at the discretion of the Board of Directors. No SAR's have been granted under the 1987 Plan.
Information relative to the stock option plan for the fiscal years ended June 30, 1994, 1993, and 1992 is as follows:
The options outstanding as of June 30, 1994 expire at various dates through 2000.
(11) COSTS INCURRED IN OIL AND GAS PROPERTY ACQUISITION, EXPLORATION, AND DEVELOPMENT ACTIVITIES (UNAUDITED)
Costs incurred by the Company in oil and gas property acquisition, exploration, and development activities are presented below:
Property acquisition costs include costs incurred to purchase, lease, or otherwise acquire a property. During fiscal 1993, these costs included the natural gas producing properties acquired from Hallwood (see Note 3). Exploration costs include the costs of geological and geophysical activity, carrying and retaining undeveloped property, dry holes, leasehold impairment allowances, and drilling and equipping exploratory wells. Development costs include costs incurred to gain access to and prepare development well locations for drilling, to drill and equip development wells, and to provide facilities to extract,
treat, gather, and store oil and gas.
(12) OIL AND GAS CAPITALIZED COSTS (UNAUDITED)
Aggregate capitalized costs for the Company related to oil and gas property acquisition, exploration and development activities, with applicable accumulated depletion, depreciation, and amortization are presented below:
Unproved properties include costs to acquire acreage which has not been allocated to producing properties. Proved developed properties include the capitalized costs of producing properties, well support equipment and the Company's gas gathering systems, which primarily transport natural gas production from Company operated wells.
(13) RESULTS OF OPERATIONS FOR OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED)
The results of operations for oil and gas producing activities are presented below:
The increase in revenues from oil and gas producing activities is due primarily to MGS's natural gas sales being in place for all of fiscal 1994 versus only three months of fiscal 1993.
Production costs include those costs incurred to operate and maintain productive wells and related equipment and include costs such as labor, repairs and maintenance, materials, supplies, fuel consumed, insurance and production taxes. In addition, production costs include certain administrative expenses which the Company determines are directly related to oil and gas operations, and are net of well tending fees which are included in field service revenues in the accompanying consolidated income statements. The increase in production costs in fiscal 1994 is due primarily to MGS's operations being in place for all of fiscal 1994 versus only three months of fiscal 1993. The reduction in production expenses in fiscal 1993 reflects the discontinuance of TEX-HEX operations and the efforts to reduce field operations expenses at Allegheny.
Exploration expenses include the costs of geological and geophysical activity, carrying and retaining undeveloped property, dry holes and leasehold impairment allowances.
Depletion, depreciation, and amortization expense includes costs associated with capitalized acquisition, exploration, and development costs, and the depreciation applicable to support equipment.
The income tax benefit is computed at the statutory Federal and state income tax rate and is reduced to the extent of permanent differences, which have been recognized in the Company's tax provision, including the utilization of Federal tax credits permitted for fuel produced from a non-conventional source.
(14) NET PROVED OIL AND GAS RESERVES (UNAUDITED)
Estimates of net proved oil and gas reserves (all of which are developed) of the Company, all of which are within the United States, are as follows:
These estimates are based primarily on the reports of independent petroleum engineers. The estimates include only those amounts considered to be proved reserves and do not include additional amounts that may result from extensions of currently proved areas or amounts that may result from new discoveries in the future. Proved developed reserves are those reserves that are expected to be recovered through existing wells with existing equipment and operating methods.
In fiscal 1992, the Company changed the method by which it computes its net proved reserves of oil and gas attributable to the Company's interest in producing properties in which other third parties participate. Beginning in fiscal 1992, the Company determines the economic life of such reserves based, in part, upon operating costs that include general and administrative expenses charged to such properties. Prior to fiscal 1992, the Company excluded such expenses when determining economic life. The impact of this change reduced the economic life, which, in turn, reduced the estimated reserves. This change resulted in a reduction of approximately 2,400,000 Mcf in natural gas reserves and 16,000 Bbl in oil reserves, which is reflected in the above table within the fiscal 1992 revision of previous estimates.
(15) STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS AND CHANGES THEREIN RELATING TO PROVED OIL AND GAS RESERVES (UNAUDITED)
Summarized in the table below is information for the Company with respect to the standardized measure of discounted future net cash flows relating to proved oil and gas reserves. Future cash inflows are derived by applying current oil and gas prices to estimated future production. Future production costs, likewise, are derived based on current costs, assuming continuation of existing economic conditions. Future income tax expenses are computed at the Company's anticipated statutory tax rate in effect at the end of each fiscal year to the future pre-tax net cash flows, less the tax basis of the properties, and gives effect to permanent differences and tax credits related to the properties. The future income tax expense reflected below excludes the benefit of the Federal tax credit available from production of fuel from non-conventional sources. Utilization of the tax credit is permitted to the extent the Company is in a regular tax-paying position. Future income tax expense may be lower to the extent the tax credit is utilized.
The following table summarizes the principal sources of changes in the standardized measure of discounted future net cash flows:
It is necessary to emphasize that the data presented above should not be viewed as representing the expected cash flow from, or current value of, existing proved reserves since the computations are based on a large number of estimates and arbitrary assumptions. Reserve quantities cannot be measured with precision and their estimation requires many judgmental determinations and frequent revisions. The required projection of production and related expenditures over time requires further assumptions with respect to pipeline availability, rates of demand, and governmental control, among other factors. Furthermore, actual future prices and costs are likely to be substantially different from the current prices and costs utilized in the computation of reported amounts. In addition, the reported data are applicable only to oil and gas reserves classified as proved; no amounts are included with respect to additional reserves that may become proved in the future. Any analysis or evaluation of the reported amounts should give specific recognition to the computational methods utilized and the limitations inherent therein.
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of financial instruments as of June 30 are as follows:
The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate fair value:
Cash and equivalents, accounts receivable and short-term borrowings: The carrying amounts approximate fair value due to the nature and short-term maturity of these instruments.
Short-term investments: Fair value is based on quoted market prices.
Long-term debt: Fair value is estimated using discounted cash flow analyses based on current incremental borrowing rates for similar types of borrowing arrangements.
(17) RELATED PARTY TRANSACTIONS
The Company's field services revenue includes revenue from partnerships and joint ventures in which the Company is the general partner or operator.
Certain officers and directors of the Company and their relatives and other related parties participate as limited partners in certain partnerships in which the Company is the general partner.
(18) QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly consolidated financial results are as follows:
In the fourth quarter of fiscal 1994, Mountaineer recorded a $17 million charge to revenues relating to Mountaineer's passthrough to its customers of refunds received from Mountaineer's pipeline suppliers. This charge was offset by a corresponding reduction in cost of gas distributed, resulting in no impact on the Company's profitability.
Mountaineer's natural gas distribution operations are significantly affected by weather-related heating requirements. Therefore, results for interim periods are not comparable and are not necessarily indicative of what may be expected for a full year.
The Company records an interim provision (benefit) for income taxes based upon its estimated annual effective rate. Differences between net statutory rates and effective rates are caused primarily by book amortization of an acquisition adjustment, Federal nonconventional fuel credits and the treatment of certain temporary differences for ratemaking
purposes.
(19) COMMITMENTS AND CONTINGENCIES
Gas Transmission Matters
In 1992, the FERC issued Order No. 636 et. seq., (the 636 Orders). The 636 Orders required substantial restructuring of the service obligations of interstate pipelines. Among other things, the 636 Orders mandated "unbundling" of existing pipeline gas sales services and replaced existing statutory abandonment procedures, as applied to firm transportation contracts of more than one year, with a right-of-first-refusal mechanism. Mandatory unbundling required pipelines to sell separately the various components of their previous gas sales services (gathering, transportation and storage services, and gas supply). To address concerns raised by utilities about reliability of service to their service territories, the 636 Orders required pipelines to offer a no-notice transportation service in which firm transporters can receive delivery of gas up to their contractual capacity level on any day without prior scheduling. In addition, the 636 Orders provided for a mechanism for pipelines to recover prudently incurred transition costs associated with the restructuring process.
All of Mountaineer's pipeline suppliers have filed their restructuring plans with the FERC. The FERC has reviewed these plans; however, there are several issues which remain subject to further action by either the FERC or reviewing courts, including the ultimate sharing of transition costs, the level of no-notice protection and the impact on service reliability, and rate design implementation. Mountaineer's largest pipeline supplier, Columbia Transmission Corporation (Columbia Transmission), received orders from the FERC which approved its proposed restructuring filing with certain modifications. One of the FERC modifications prohibited Columbia Transmission from recovering contract rejection claims it may incur in its bankruptcy proceeding as part of its transition costs. Columbia Transmission and others have filed for appellate review of this disallowance. In addition, Columbia Transmission filed a revised compliance plan with the FERC on October 22, 1993, which was placed into effect on November 1, 1993, subject to further modification.
As a consequence of the November 1, 1993 restructuring, Mountaineer has replaced the bundled firm sales service it previously received from Columbia Transmission with gas purchase arrangements negotiated with unregulated suppliers and firm transportation and storage agreements with Columbia Transmission. Interim supply arrangements are in place, negotiations for long- term supplies are underway and the Company is reviewing its current level of firm service contracts to determine if additional capacity is necessary to provide reliable service to its customers. Unresolved issues include whether the new unbundled transportation and storage services provided by Columbia Transmission, and the replacement natural gas supplies provided by others, will result in the same degree of service
reliability as the bundled firm sales service Columbia Transmission has provided to Mountaineer in the past. Because of these issues and others, Mountaineer has petitioned for appellate review of both the 636 Orders and the orders approving the implementation of Columbia Transmission's restructuring pursuant to the 636 Orders. Mountaineer's management continues to actively participate in Columbia Transmission's compliance filings in order to protect Mountaineer's interests, ensure the continued reliability of service to its customers and minimize future transition costs.
Until Mountaineer's pipeline suppliers' rate filings to implement restructuring, including subsequent filings to recover transition costs, are fully approved by the FERC, the ultimate amount of the costs associated with restructuring cannot be ascertained. However, Mountaineer's management anticipates that the amount of restructuring costs that will be passed through to Mountaineer will be significant. Mountaineer will attempt to obtain approval from the PSCWV to recover any such approved restructuring costs from its customers. On the basis of previous state regulatory proceedings involving the recovery of gas purchase costs and take-or-pay obligations, Mountaineer believes that the costs passed through from its pipeline suppliers will be recovered from ratepayers, although there can be no assurance that this will be the case.
On July 31, 1991, Columbia Transmission and The Columbia Gas System, Inc. (the Columbia Companies) filed for protection under Chapter 11 of the Bankruptcy Code. The Columbia Companies stated that the primary basis for their filing was the failure of Columbia Transmission to acquire natural gas through existing producer contracts under terms and conditions, including price, which would permit Columbia Transmission to compete in the marketplace. Columbia Transmission's filing could affect its relationship with Mountaineer. Although Mountaineer only purchased 1% of its gas supplies from Columbia Transmission during fiscal 1994, Mountaineer relies upon Columbia Transmission for the delivery of a majority of Mountaineer's gas supplies.
On January 18, 1994, Columbia Transmission filed a proposed plan of reorganization in the bankruptcy proceedings, but requested the Bankruptcy Court to defer all further proceedings on such plan pending further discussions with Columbia Transmission's major creditors and official committees, including the official committee of customers which Mountaineer chairs. The plan, if ultimately approved by the Bankruptcy Court and accepted by Columbia Transmission's customers, would inter alia, (i) pay Columbia Transmission's customers 100% of certain refund amounts ordered by the FERC, but at a lower interest rate than provided by the FERC, (ii) pay Columbia Transmission's customers 90% of certain other refunds ordered by the FERC, and (iii) require any customer accepting the plan to waive its entitlement to all other refund amounts and to not oppose Columbia Transmission's recovery from such customers of approximately $250 million in certain costs to be filed with the FERC. Discussions on the proposed plan are at a preliminary stage and Columbia Transmission is in the process of providing additional information necessary to
evaluate the proposal. However, at this stage, various aspects of the proposal appear unacceptable to the official committee of customers.
In addition, the United States Court of Appeals of the District of Columbia Circuit recently granted an appeal filed by Mountaineer and others which challenged Columbia Transmission's right to recover through FERC-approved rates over $120 million in take-or-pay costs from its customers. Once the court s decision becomes final, the case will be remanded to the FERC for further proceedings to determine the level of refunds owed Columbia Transmission's customers. The refund amount determined may have a significant bearing on Columbia Transmission's proposed plan of reorganization and any negotiated resolution thereof.
Mountaineer is vigorously opposing Columbia Transmission's efforts to recover costs related to its Chapter 11 bankruptcy proceedings. The outcome of these proceedings could materially affect Mountaineer's prices to its customers. Mountaineer is reviewing its options, including the level of Columbia Transmission's role in providing service to Mountaineer in the future. Mountaineer's management continues to be actively involved in this process in order to minimize any adverse impact on the interests of Mountaineer or its customers.
Legal Matters
Cameron Gas Company and C. Richard Coleman, et al. vs. Allegheny & Western Energy Corporation, Mountaineer Gas Company and Gas Access Systems, Inc. was filed on December 31, 1992, in the Circuit Court of Marshall County, West Virginia. Plaintiffs allege unlawful and/or tortious conduct and violations of the Racketeer Influenced and Corrupt Organizations Act (RICO) and the West Virginia Anti-Trust Act, arising out of the termination of a gas sales agreement and seek $30 million compensatory damages and $90 million punitive damages. Upon the petition of the Company, the case was removed to the United States District Court for the Northern District of West Virginia. On February 19, 1993, the Company filed responsive dispositive pleadings to the complaint, including a motion to dismiss. By Order issued March 31, 1994, and clarified by Order issued April 18, 1994, the West Virginia anti-trust claim against Allegheny & Western Energy Corporation, Mountaineer Gas Company and Gas Access Systems, Inc. was dismissed with prejudice. In addition, the RICO claim was dismissed against Allegheny & Western Energy Corporation with prejudice. On April 14, 1994, Mountaineer filed a general denial to plaintiffs' complaint and a counterclaim seeking at least $150,000 in compensatory and $2.0 million in punitive damages for the willful withholding by Cameron of monies collected by Cameron as agent for certain of the Company's customers and intended to be paid to the Company for services rendered by the Company. In response to the April 18, 1994 Order, the plaintiffs filed an amended complaint to which the Company has filed responsive pleadings, including a motion to dismiss, and a counterclaim. The pleadings remain pending before the Court for disposition. Discovery has commenced. No trial date has been set. The Company believes Cameron's claims are without merit and plans to
vigorously defend this matter and does not believe that this matter is reasonably likely to have a material adverse effect on the financial position and results of operations of the Company.
The Company has been named as a defendant in various other legal actions which arise primarily in the ordinary course of business. In management's opinion, these outstanding claims are unlikely to result in a material adverse effect on the Company's financial position and results of operations.
Performance Bonds
To acquire the petroleum prospecting licenses in New Zealand, AWENZ and its partner posted a performance bond of NZ $500,000 (US $297,500 as of June 30, 1994), which is a normal requirement of the Minister of Energy. Should AWENZ and its partner not perform their commitments as required by the license, the government of New Zealand could elect to call the bonds, which would require the payment by AWENZ of 59.5% of such amount. To the best of management's knowledge, all such commitments currently required by the licenses have been performed.
Rate Matters
On March 30, 1994, the PSCWV issued a final order which put Mountaineer on notice that in its next rate case, any savings generated by Mountaineer's participation in a consolidated tax return would be passed through to Mountaineer's ratepayers unless persuasive legal or accounting arguments are presented to the PSCWV to convince them to act otherwise. Management is unable to determine what impact the consolidated tax savings issue will have on Mountaineer's future results of operations.
(20) ACCOUNTING PRONOUNCEMENTS NOT EFFECTIVE
In November 1992, the FASB issued SFAS No. 112 "Employers Accounting for Postemployment Benefits." This statement requires employers to recognize any obligation which exists to provide benefits to former or inactive employees after employment, but before retirement. Such benefits include, but are not limited to, salary continuations, supplemental unemployment, severance disability (including workers' compensation), job training, counseling and continuation of benefits such as health care and life insurance. Currently, the Company provides only for workers' compensation benefits which would qualify as postemployment benefits under this standard.
The Company will adopt this statement in fiscal 1995. The adoption of SFAS No. 112 is not expected to have a material impact on the Company's results of operations.
Item 9.

Item 9. Disagreements on Accounting and Financial Disclosure
None
PART III
Item 10.



Item 10. Directors and Executive Officers of the Registrant
Information concerning the directors of the Company is hereby incorporated by reference to the Company's definitive proxy statement filed with the Commission pursuant to Regulation 14A within 120 days after the close of the Company's fiscal year. Information concerning the executive officers of the Company is contained in Item 1 of this report.
Item 11.

Item 11. Executive Compensation
This information is hereby incorporated by reference to the Company's definitive proxy statement filed with the Commission pursuant to Regulation 14A within 120 days after the close of the Company's fiscal year.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management
This information is hereby incorporated by reference to the Company's definitive proxy statement filed with the Commission pursuant to Regulation 14A within 120 days after the close of the Company's fiscal year.
Item 13.

Item 13. Certain Relationships and Related Transactions
This information is hereby incorporated by reference to the Company's definitive proxy statement filed with the Commission pursuant to Regulation 14A within 120 days after the close of the Company's fiscal year.
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) (1) Financial Statements:
See Index to Consolidated Financial Statements on page 25.
(2) The following financial statement schedules for the years ended June 30, 1994, 1993 and 1992 are submitted herewith:
Schedule V - Property, Plant and Equipment
Schedule VI - Accumulated Depletion, Depreciation and Amortization of Property, Plant and Equipment
Schedule VIII - Valuation and Qualifying Accounts
Schedule X - Supplementary Income Statement Information
All other schedules are omitted because they are not required, inapplicable, or the information is included in the consolidated financial statements or notes thereto.
(3) Exhibits:
See Exhibit Index for list of exhibits filed with this report.
(b) Reports on Form 8-K:
None
All other required captions are less than one percent of sales.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ALLEGHENY & WESTERN ENERGY CORPORATION (Registrant)
/s/ John G. McMillian John G. McMillian Chairman of the Board of Directors, President and Chief Executive Officer
Date: September 27, 1994
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 Company and in the capacities and on the dates indicated:
/s/ John G. McMillian /s/ W. Merwyn Pittman John G. McMillian W. Merwyn Pittman Director, Chairman of the Board Vice President, Chief of Directors, President and Financial Officer and Chief Executive Officer Treasurer
/s/ Michael S. Berman /s/ Henry Tauber Michael S. Berman Henry Tauber Director Director
/s/ Sidney S. Lindley /s/ Jack H. Vaughn Sidney S. Lindley Jack H. Vaughn Director Director
/s/ Rush Moody, Jr. /s/ Harold M. Wit Rush Moody, Jr. Harold M. Wit Director Director