SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
(Check 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, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to____________
Commission file number 0-994
[GRAPHIC OMITTED]COMPANY LOGO[GRAPHIC OMITTED]
NORTHWEST NATURAL GAS COMPANY
(Exact name of registrant as specified in its charter)
OREGON 93-0256722
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
220 N.W. SECOND AVENUE, PORTLAND, OREGON 97209
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (503) 226-4211
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on which
Title of each class registered
- ------------------- ------------------------------
Common Stock, $3 1/6 par value,
and Common Share Purchase Rights New York Stock Exchange
Securities registered pursuant to
Section 12(g) of the Act:
Shares outstanding on February 28,
Title of each class 2003
- ------------------- ---------------------------------
Preferred Stock, without par value 82,500
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by 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 [ ].
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ X ] No [ ]
As of June 28, 2002, the registrant had 25,464,927 shares of its Common Stock,
$3 1/6 par value, outstanding. The aggregate market value of these shares of
Common Stock (based upon the closing price of these shares on the New York Stock
Exchange on that date) held by non-affiliates was $725,642,000.
Indicate number of shares outstanding of each of registrant's classes of common
stock as of February 28, 2003:
Common Stock, $3 1/6 par value, and Common Share Purchase Rights 25,637,524
DOCUMENTS INCORPORATED BY REFERENCE
List documents incorporated by reference and the Part of the Form 10-K into
which the document is incorporated.
Portions of the Proxy Statement of Company, to be filed in connection with the
2003 Annual Meeting of Shareholders, are incorporated by reference in Part III.
NORTHWEST NATURAL GAS COMPANY
Annual Report to Securities and Exchange Commission
on Form 10-K
For Fiscal Year Ended
December 31, 2002
TABLE OF CONTENTS
PART I Page
- ------ ----
Item 1. Business
General....................................................... 3
Gas Supply.................................................... 3
Interstate Gas Storage Services............................... 7
Regulation and Rates.......................................... 7
Additions to Infrastructure................................... 9
Pipeline Safety............................................... 9
Competition and Marketing..................................... 10
Acquisition of Portland General Electric Company.............. 12
Environment................................................... 13
Employees..................................................... 13
Available Information......................................... 14
Item 2. Properties....................................................... 14
Item 3. Legal Proceedings................................................ 14
Item 4. Submission of Matters to a Vote of Security Holders.............. 16
Additional Items
Executive Officers of the Registrant............................. 16
Other Information................................................ 17
PART II
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Item 5. Market for the Registrant's Common Equity and Related
Stockholder Matters .......................................... 18
Item 6. Selected Financial Data.......................................... 19
Item 7. Management's Discussion and Analysis of Results of Operations
and Financial Condition....................................... 21
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ...... 38
Item 8. Financial Statements and Supplementary Data...................... 41
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...................................... 75
PART III
- --------
Items 10., 11.
and 13. Incorporated by Reference to Proxy Statement..................... 75
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.................... 75
Item 14. Controls and Procedures.......................................... 76
PART IV
- -------
Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K .................................................. 77
SIGNATURES .............................................................. 82
CERTIFICATIONS .............................................................. 83
2
NORTHWEST NATURAL GAS COMPANY
PART I
ITEM 1. BUSINESS
General
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Northwest Natural Gas Company (NW Natural or the Company) was incorporated
under the laws of Oregon in 1910. The Company and its predecessors have supplied
gas service to the public since 1859. Since September 1997, it has been doing
business as NW Natural.
NW Natural is principally engaged in the distribution of natural gas. The
Oregon Public Utility Commission (OPUC) has allocated to NW Natural as its
exclusive service area a major portion of western Oregon, including the Portland
metropolitan area, most of the Willamette Valley and the coastal area from
Astoria to Coos Bay. NW Natural also holds certificates from the Washington
Utilities and Transportation Commission (WUTC) granting it exclusive rights to
serve portions of three southern Washington counties bordering the Columbia
River. Gas service is provided in 97 cities, together with neighboring
communities, in 15 Oregon counties, and in nine cities, together with
neighboring communities, in three Washington counties. The city of Portland is
the principal retail and manufacturing center in the Columbia River Basin, and
is a major port for trade with Asia.
NW Natural also is engaged in providing natural gas storage and
transportation services to interstate customers using storage capacity that has
been developed in advance of core utility customers' (residential, commercial
and industrial firm) requirements. These services prior to Jan. 1, 2001, were
immaterial. In 2001, the Federal Energy Regulatory Commission (FERC) granted NW
Natural a limited jurisdiction blanket certificate permitting it to provide
storage and transportation services to customers in interstate commerce. Under
agreements with the OPUC and WUTC, NW Natural retains the majority of the net
income before tax from interstate storage services and credits the balance to
its core utility customers. NW Natural has a contract with an independent energy
trading company that seeks to optimize the use of NW Natural's assets by trading
temporarily unused portions of its upstream pipeline transportation capacity and
gas storage capacity.
At year-end 2002, NW Natural had 503,402 residential customers, 56,087
commercial customers and 578 industrial customers. Industries served include
pulp, paper and other forest products; the manufacture of electronic,
electrochemical and electrometallurgical products; the processing of farm and
food products; the production of various mineral products; metal fabrication and
casting; and the production of machine tools, machinery and textiles.
The Company operated only one direct, active subsidiary during 2002, NNG
Financial Corporation (Financial Corporation). Financial Corporation, a wholly
owned subsidiary of the Company incorporated in Oregon, holds financial
investments including limited partnership interests in three solar electric
generating plants and two wind power electric generation projects, all located
in California, and in two low-income housing projects in Portland, Oregon.
Financial Corporation also has one active, wholly owned subsidiary, KB Pipeline
Company, which owns a 10 percent interest in a 19-mile interstate natural gas
pipeline. NW Natural is the operator of this pipeline.
A second direct, wholly owned subsidiary of the Company, Northwest Energy
Corporation (Northwest Energy), also an Oregon corporation, was formed in 2001
to serve as the holding company of NW Natural and Portland General Electric
Company (PGE) if the then-proposed acquisition of PGE had been completed. The
Company's agreement to purchase PGE was terminated in 2002. Northwest Energy had
no operations in 2002. See "Acquisition of Portland General Electric Company,"
below.
Gas Supply - General
- --------------------
NW Natural meets the needs of its core utility customers through natural
gas purchases from a variety of suppliers. NW Natural has a diverse portfolio of
short- and medium-term firm gas supply contracts which it supplements, during
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periods of peak demand, with gas from storage facilities either owned by or
contractually committed to NW Natural.
NW Natural's goal in purchasing gas for its core market is to meet
customers' needs at competitive prices. NW Natural believes that gas supplies
available from suppliers in the western United States and Canada are adequate to
serve its core market customers for the foreseeable future, and that its cost of
gas generally will track market prices.
Natural gas for NW Natural's core market is transported over the
interstate pipeline system of Williams Gas Pipeline-West (WGP), also known as
Northwest Pipeline Corporation. Most supplies also move over other pipelines
upstream of WGP's system in the U.S. and Canada. Rates for transportation are
established by the FERC for service under transportation agreements between NW
Natural and the U.S. interstate pipelines, and by Canadian federal or provincial
authorities for service under agreements with the Canadian pipelines over which
NW Natural ships gas.
The largest of the transportation agreements with WGP extends through 2013
and provides for firm transportation capacity of up to 2,148,890 therms(1) per
day. This agreement provides access to natural gas supplies in British Columbia
and the U.S. Rocky Mountains. NOTE--FOOTNOTES HAVE TO BE PREPARED AS ON A
TYPEWRITER FOR EDGAR PURPOSES.
The Company's second largest transportation agreement with WGP extends
through 2011. It provides 1,020,000 therms per day of firm transportation
capacity from the point of interconnection of the WGP and PG&E Gas Transmission
Northwest (PG&E GT-NW) systems in eastern Oregon to NW Natural's service
territory. PG&E GT-NW's pipeline runs from the U.S./Canadian border through
northern Idaho, southeastern Washington and central Oregon to the
California/Oregon border. NW Natural's total capacity on PG&E GT-NW and two
upstream pipelines in Canada (Alberta Natural Gas Company and NOVA Corporation
of Alberta, now both units of TransCanada PipeLines Limited) matches this amount
of WGP capacity northward into Alberta, Canada.
NW Natural also has an agreement with WGP that extends through 2013 for
351,550 therms per day of firm transportation capacity. This agreement accesses
gas supplies in the U.S. Rocky Mountain region.
In 2002, NW Natural entered into four long-term pipeline transportation
contracts, one commencing in November 2003 and the other three in November 2004.
A contract with Duke Energy Gas Transmission (formerly Westcoast Energy, Inc.)
(Duke Energy GT) effective Nov. 1, 2003 and extending through Oct. 31, 2014,
will provide approximately 600,000 therms per day of firm gas transportation
from northern British Columbia to a connection with WGP at the U.S.-Canadian
border. A contract with BC Gas effective Nov. 1, 2004 and extending through Oct.
31, 2020, will provide approximately 470,000 therms per day of firm gas
transportation from southeastern British Columbia to the same connection with
WGP at the U.S.-Canadian border. NW Natural's capacity with BC Gas is matched
with companion contracts for pipeline capacity on systems of Alberta Natural Gas
Company and NOVA Corporation of Alberta that connect to the gas fields of
Alberta, Canada.
The cost to NW Natural of gas to supply its core market consists of the
purchase price paid to suppliers plus charges paid to pipelines to transport the
gas to NW Natural's distribution system. While the rates for pipeline
transportation and storage services are subject to federal regulation, the
purchase price of gas is not. Although pipeline rates have been relatively
stable in recent years, natural gas commodity prices have fluctuated
dramatically. NW Natural has sought to mitigate the effect of price volatility
on core utility customers through the use of its underground storage facilities,
by entering into gas commodity-based financial hedge contracts, and by crediting
gas costs with margin revenues derived from off-system sales of commodity and
released transportation capacity in periods when core utility customers do not
fully utilize firm pipeline capacity and gas supplies.
NW Natural supplies many of its non-core customers (larger industrial
interruptible customers with full or partial dual fuel capabilities) through gas
transportation service, delivering gas purchased by these customers directly
from suppliers. (See "Gas Supply - Transportation," below.)
- ----------------------
(1) One therm is equivalent to 100 cubic feet of natural gas at an assumed
heat content of 1,000 British Thermal Units (Btu's) per cubic foot.
4
Gas Supply - Core Market Basic Supply
- -------------------------------------
NW Natural purchases gas for its core market from a variety of suppliers
located in the western United States and Canada. About 80 percent of its annual
supply comes from Canada, with the balance coming primarily from the U.S. Rocky
Mountain region. At Jan. 1, 2003, NW Natural had 22 firm contracts with 11
suppliers with remaining terms ranging from three months to three years, which
provided for a maximum of 3,768,300 therms of firm gas per day during the peak
winter season and 1,621,300 therms per day during the remainder of the year.
These contracts have a variety of pricing structures and purchase obligations.
NW Natural's largest core market gas supply contract is an agreement
expiring Nov. 1, 2003, with CanWest Gas Supply, Inc. (CanWest), an aggregator
for gas producers in British Columbia, Canada. This contract entitles NW Natural
to purchase up to 960,000 therms of firm gas per day. The contract contains a
demand and commodity pricing structure and a provision for annual renegotiations
of the commodity price to reflect then-prevailing market prices. The demand
charges reflect the reservation of firm transportation space on the Duke Energy
GT pipeline system in British Columbia. These demand charges are subject to
change as approved by the Canadian National Energy Board (NEB) in rate
proceedings similar to those conducted in the United States by the FERC. The
CanWest contract contains minimum purchase obligations.
The terms of NW Natural's other principal gas purchase agreements are
summarized as follows:
o An agreement expiring Nov. 1, 2003 with BP Canada (formerly Amoco
Canada Petroleum Company, Ltd.), on terms similar to the CanWest
agreement, entitles NW Natural to purchase up to 83,300 therms of firm
gas per day. This gas is aggregated from production in the Canadian
province of Alberta and the Yukon and Northwest Territories. This
contract contains minimum purchase obligations.
o An agreement expiring Sept. 30, 2003 with Burlington Resources Canada
(formerly Poco Petroleums, Ltd.), a Canadian producer, entitles NW
Natural to purchase up to 162,000 therms per day during the winter and
up to 115,000 therms per day during the remainder of the year of gas
produced in Alberta.
o Two agreements expiring Sept. 30, 2003 with Engage Energy (formerly
Westcoast Gas Services) entitle NW Natural to purchase up to 140,000
therms per day year-round, plus up to 92,750 therms per day as winter
season supply, of gas produced in Alberta. Pricing for supplies under
these agreements has been renegotiated annually. The current pricing
arrangement includes demand charges for upstream capacity on the
Canadian pipeline systems and a monthly reservation charge. The
commodity pricing consists of a portion of the daily contract quantity
at a fixed price and the remaining daily contract quantity tied to a
monthly Canadian index.
NW Natural's expiring long-term contracts are being renegotiated and
replaced with supply contracts for purchases of similar aggregate volume levels.
Due to evolving gas industry conditions, however, NW Natural expects most of its
replacement contracts to have terms of five years or less. It also expects most
of its replacement contracts to continue to have pricing structures providing
for annual renegotiations of the commodity price to reflect then-prevailing
market prices.
During 2002, new short-term (five-month) purchase agreements for firm gas
were entered into with six suppliers, which provided for a total of 1,350,000
therms per day during the 2002-2003 heating season. These contracts have a
variety of pricing structures and purchase obligations. NW Natural intends to
enter into new short-term purchase agreements in 2003 for equivalent volumes of
gas with these or other similar suppliers to be available during the 2003-2004
heating season.
NW Natural also buys gas on the spot market (30 days or less) as needed to
meet demand. NW Natural has flexibility under the terms of some of its firm
supply contracts enabling it to purchase spot gas in lieu of firm contract
volumes, thereby allowing it to take advantage of favorable pricing on the spot
market from time to time.
5
NW Natural continues to purchase gas from a producer in the Mist gas field
in Columbia County, Oregon, northwest of Portland. The production area is
situated near NW Natural's underground gas storage facility. The price for this
gas is tied to NW Natural's weighted average cost of gas. Current production is
approximately 23,000 therms per day from about 18 wells, supplying about 1
percent of NW Natural's total annual purchase requirements. Production from
these wells varies as existing wells are depleted and new wells are drilled.
Gas Supply - Core Market Peaking Supply
- ---------------------------------------
NW Natural supplements its firm gas supplies with gas from Company-owned
or contracted peaking facilities in which gas is stored during periods of low
demand for use during periods of peak demand. In addition to enabling NW Natural
to meet its peak demand, these facilities make it possible to lower the annual
average cost of gas by allowing NW Natural both to minimize its pipeline
transportation contract demand and to purchase gas for storage during the summer
months when prices are generally at their lowest.
NW Natural has contracts with WGP that expire in 2004 for firm gas storage
services from an underground field at Jackson Prairie near Centralia,
Washington, and a liquefied natural gas (LNG) facility at Plymouth, Washington.
Together, these facilities provide NW Natural with daily firm deliverability of
about 1.1 million therms and total seasonal capacity of about 16 million therms.
Separate contracts with WGP provide for the transportation of these storage
supplies to NW Natural's service territory. These contracts continue annually
after the end of their primary terms at NW Natural's option.
NW Natural owns and operates two LNG plants that liquefy gas during the
summer months for storage until the peak winter season. These two plants provide
a maximum daily deliverability of 1.8 million therms and a total seasonal
capacity of 17 million therms.
NW Natural also provides daily and seasonal peaking from the underground
gas storage facility it owns and operates in the Mist gas field northwest of
Portland. This facility has a maximum daily deliverability of 3.2 million therms
and a total seasonal working gas capacity of 115 million therms. NW Natural
completed its latest expansion of the Mist storage facility in December 2001.
This $10 million project increased the facility's total daily delivery capacity
by 29 percent. The increased deliverability is used to serve the needs of NW
Natural's core utility customers as well as its interstate storage service
customers (see "Interstate Gas Storage Services," below). As the needs of core
utility customers grow, the amount of the delivery capacity available for
interstate storage services will be reduced. The plan for expansion of NW
Natural's storage capability includes an extension of its South Mist Pipeline
that is scheduled for construction between 2003 and 2005, and further
development of existing storage reservoirs between 2003 and 2008.
NW Natural also has contracts with an electric generator, two industrial
customers, and one gas marketing company that together provide a total of
102,000 therms per day of year-round capacity, plus 900,000 therms per day of
recallable capacity and supply. These contracts have remaining terms ranging
from one to eight years.
Gas Supply - Hedge Program
- --------------------------
NW Natural has an active natural gas commodity-price hedge program that is
intended to reduce commodity price risk. Under this program, the Company
typically enters into commodity swap and call option agreements during the
spring and summer seasons, when natural gas prices may be lower. Gains (losses)
from commodity hedges are treated for accounting and rate purposes as reductions
(increases) to the cost of gas. The intended effect of this program is to lock
in prices for a large portion of NW Natural's gas supply portfolio for the
following year, at prevailing market prices at the time the swap and call option
agreements are entered into.
Gas Supply - Transportation
- ---------------------------
Since WGP opened its system to the transportation of customer-owned gas in
the late 1980s, most of NW Natural's large industrial customers have switched
from sales service to transportation service whereby they purchase gas directly
from suppliers and ship the gas on the Company's system and those of its
pipeline suppliers for a fee. The ability of industrial customers to switch
between sales service and transportation service has made it possible for NW
6
Natural to retain some of these customers. Periodic switching between sales and
transportation service by these customers has had an adverse effect on NW
Natural's results of operations in some years, including 2002, and a positive
effect in some other years, as industrial customers have sought to find the most
economical and reliable combination of gas supplies and delivery services (see
"Competition and Marketing," below).
Interstate Gas Storage Services
- -------------------------------
NW Natural provides gas storage services to interstate customers using
storage capacity that has been developed in advance of its core utility
customers' requirements. In 2001, the FERC authorized NW Natural to provide firm
and interruptible gas storage service and related transportation to and from the
Mist gas storage facility to customers in interstate commerce, to the extent of
any under-used storage or upstream pipeline capacity. NW Natural has entered
into contracts with eight interstate customers. The FERC limited jurisdiction
certificate enables NW Natural to make its underground gas storage capacity
available to help address the region's energy challenges, but NW Natural retains
its exemption from full FERC jurisdiction.
Regulation and Rates
- --------------------
NW Natural is subject to regulation with respect to, among other matters,
rates, systems of accounts and issuance of securities by the OPUC and the WUTC.
In 2002, 93 percent of NW Natural's utility gas deliveries and 91 percent of its
utility operating revenues were derived from Oregon customers and the balance
from Washington customers. NW Natural is exempt from the provisions of the
Natural Gas Act by order of the Federal Power Commission (now the FERC), except
with respect to the terms and conditions associated with its interstate gas
storage and related transportation services (see "Interstate Gas Storage
Services," above).
In November 2002, NW Natural filed its first general rate case in Oregon
since 1998. The filing proposes a revenue increase of $38 million per year from
Oregon operations through rate increases averaging 6.8 percent. If the increase
were approved as proposed, residential customer rates would increase by 8.9
percent and commercial rates by 4.6 percent; there would be no changes for
industrial firm or interruptible customer rates. The proposed rates are designed
to produce a return on common shareholders' equity (ROE) of 11.3 percent and to
recover increases in NW Natural's cost of service including the costs of
complying with new federal regulations regarding pipeline safety and integrity
(see "Pipeline Safety," below); expanding the Company's underground storage
facilities to meet customer growth; commencing service to Coos County, Oregon;
improving customer service; and providing for system security, insurance
coverage and employee benefits. The schedule for the case provides for
settlement conferences in March 2003, the filing of OPUC staff and intervenor
testimony in late April, hearings in August and a decision by the OPUC
determining new rates by Oct. 1. The Company is unable to determine the extent
to which its proposals will be accepted by the OPUC.
NW Natural's previous general rate increase in Oregon, which was effective
Dec. 1, 1999, authorized rates designed to produce an ROE of 10.25 percent. The
OPUC approved a revenue increase of $0.2 million per year, or 0.1 percent of
Oregon revenues. The most recent general rate increase in Washington, which was
effective Nov. 1, 2000, authorized rates designed to produce an ROE of 10.8
percent. The WUTC approved a revenue increase of $3.0 million effective Nov. 1,
2000, and a subsequent revenue increase of $1.3 million effective Oct. 1, 2001.
Notwithstanding authorized revenue levels approved by the OPUC or the
WUTC, actual revenues are dependent on weather, economic conditions, customer
growth, competition and other factors affecting gas usage in NW Natural's
service area. NW Natural's returns on average common equity from utility
operations were 10.2 percent in 2001 and 9.8 percent in 2002. The Company's
returns from consolidated operations, including subsidiary results, were 10.4
percent in 2001 and 8.7 percent in 2002.
In Oregon, NW Natural has a Purchased Gas Adjustment (PGA) tariff under
which net income derived from Oregon operations may be affected within defined
limits by changes in purchased gas costs. The PGA tariff provides for periodic
revisions in rates due to changes in the Company's cost of purchased gas. Costs
included in the PGA adjustments are based on NW Natural's projected gas
requirements and negotiated gas prices for the upcoming gas supply contract
7
year. Any resulting rate adjustments are made effective on Oct. 1. NW Natural
reduced rates under its Oregon PGA tariff by an average of 14.2 percent
effective Oct. 1, 2002.
The Oregon PGA tariff provides that 67 percent of any difference between
actual purchased gas costs and estimated purchased gas costs incorporated into
rates will be deferred for amortization in subsequent periods. If actual gas
commodity costs exceed those incorporated in rates, NW Natural subsequently will
adjust its rates upward to recover 67 percent of the deficiency from core market
customers. Similarly, if actual gas commodity costs are lower than those
reflected in rates, rates will be adjusted downward to distribute to core
utility customers 67 percent of such gas commodity cost savings. NW Natural
issued billing credits to Oregon customers in June 2002 totaling $30.2 million
due to lower than expected wholesale gas commodity costs from October 2001
through March 2002.
In Washington, NW Natural is permitted to track 100 percent of increases
and decreases in gas commodity costs, with the result that net income is not
directly affected by changes in commodity costs. NW Natural reduced rates under
its Washington PGA tariff by an average of 25 percent effective Oct. 1, 2002.
This decrease included a refund to Washington customers of $7.8, million
representing gas cost savings from July 2001 through June 2002. The refund was
issued as a one-year per-therm credit on customer bills as part of the
Washington overall rate decrease.
In both Oregon and Washington, the PGA mechanism permits NW Natural to
recover 100 percent of FERC-approved pipeline transportation cost increases.
In an order issued in 1999, the OPUC formalized a process that tests for
excessive earnings in connection with gas utilities' annual filings under their
PGA mechanisms. The OPUC confirmed NW Natural's ability to pass through 100
percent of its prudently incurred gas costs into rates. Under this order, NW
Natural is authorized to retain all of its earnings up to a threshold level
equal to its authorized ROE plus 300 basis points. One-third of any earnings
above that level will be refunded to customers. The excess earnings threshold is
subject to adjustment up or down each year depending on movements in interest
rates.
In 2002, the OPUC approved a settlement in a proceeding NW Natural
initiated in 2001 with a goal of stabilizing margin revenues in the face of
above- or below-normal consumption patterns. Pursuant to the settlement, the
OPUC authorized a mechanism for rate changes relating to the impact of price
elasticity, starting with small increases to residential and commercial rates
that became effective on Oct. 1, 2002.
Also under the settlement, the OPUC authorized NW Natural to implement a
partial decoupling mechanism effective Oct. 1, 2002. Decoupling mechanisms are
used to break the link between a utility's earnings and the energy consumed by
its customers so the utility does not have an incentive to discourage customers'
conservation efforts. The decoupling mechanism works by adding margin revenues
during periods when customer consumptions are lower than baseline consumption or
by deducting margin revenues when consumptions are higher than the baseline.
Under the partial decoupling mechanism, NW Natural uses a balancing account to
defer and subsequently amortize 90 percent of the margin differentials between
baseline usage by its residential and commercial customers and
weather-normalized actual usage by these customers. The deferred amounts are
treated as adjustments to be refunded or collected in future periods. Baseline
consumption is based on current customer consumption patterns, adjusted for
consumptions resulting from new customers. NW Natural continues to bear the risk
of weather-related variations in customer usage. The partial decoupling
mechanism will expire at the end of September 2005 unless the OPUC approves an
extension based on the results of an independent study to measure the
mechanism's effectiveness.
Also under the settlement, NW Natural agreed to adopt certain service
quality measures that establish the Company's performance goal for minimizing
complaints by customers where the Company is determined to be at fault. If NW
Natural exceeds the prescribed level of at-fault complaints, it will be subject
to penalties.
The OPUC and WUTC have implemented "integrated resource planning"
processes under which utilities develop plans defining alternative growth
scenarios and resource acquisition strategies. In 2000 and 2001, respectively,
8
the OPUC and the WUTC acknowledged and accepted NW Natural's submission of its
fourth Integrated Resource Plan. Elements of the plan include an evaluation of
supply and demand resources; the consideration of uncertainties in the planning
process and the need for flexibility to respond to changes; a primary goal of
"least cost" service; and consistency with state energy policy. Although the
OPUC's order acknowledging an earlier Integrated Resource Plan indicated the
order did not constitute ratemaking approval of any specific resource
acquisition or expenditure, the OPUC did indicate that it would give
considerable weight in prudency reviews to utility actions that are consistent
with acknowledged plans. Elements of NW Natural's fourth Integrated Resource
Plan demonstrated that the continued development of the Mist underground gas
storage facility is the least-cost option for serving customer growth. The
OPUC's acceptance of the plan indicates to the Oregon Energy Facility Siting
Council (EFSC) that NW Natural requires the South Mist Pipeline extension to
best serve its customers, thereby satisfying the requirement that NW Natural
prove the need for the facility in order to obtain the EFSC's approval to build
the pipeline extension.
Additions to Infrastructure
- ---------------------------
NW Natural expects a high level of capital expenditures for additions to
infrastructure over the next five years, reflecting projected customer growth,
system replacement, improvement and reinforcement projects and the development
of additional gas storage facilities. NW Natural's utility construction
expenditures are estimated to total between $500 million and $600 million over
the five-year period 2003 through 2007, including an estimated $148 million in
2003.
NW Natural continues to be one of the fastest growing gas utilities in the
nation (see "Competition and Marketing," below). In 2002 NW Natural grew its
customer base by more than 3 percent for the 16th year in a row, and in 2003 it
expects to continue that trend with projected capital expenditures of $31
million for the addition of new customers.
NW Natural will have significant capital requirements during the next five
years for system replacement, improvement and reinforcement projects, including
an estimated $36 million in 2003. These include requirements pursuant to new
federal legislation as well as expenditures under NW Natural's ongoing pipeline
safety program (see "Pipeline Safety," below).
The planned extension of the pipeline from NW Natural's Mist gas storage
field, designed to move more gas into growing portions of its service area (see
"Gas Supply - Core Market Peaking Supply," "Interstate Gas Storage Services" and
"Regulation and Rates," above) has an estimated total cost of $93 million,
including $55 million in 2003. The project has a scheduled completion date in
late 2004 or 2005, but the timeline for completion will depend, in part, on
obtaining necessary permits and rights-of-way. Following two years of review of
NW Natural's application, including extensive public involvement, the EFSC
granted a permit for the project, with conditions, on March 13, 2003. The
issuance of this permit potentially could be appealed under current law. NW
Natural also must obtain easements and rights-of-way for the construction of the
pipeline and may need to use condemnation proceedings to secure some of them.
In support of its utility construction program in 2003 and 2004, NW
Natural expects to experience enhanced cash flows due to income tax savings
pursuant to the Job Creation and Worker Assistance Act of 2002 (the Assistance
Act). The Assistance Act allows an additional first-year tax deduction for
depreciation equal to 30 percent of the adjusted basis of qualified property
acquired after Sept. 10, 2001 and before Sept. 11, 2004. NW Natural expects its
enhanced cash flows during the effective period of the Assistance Act to total
between $25 million and $30 million.
Pipeline Safety
- ---------------
NW Natural entered into a stipulation with the OPUC in 2001 for an
enhanced pipeline safety program that includes an accelerated bare steel
replacement program and a geo-hazard safety program. The bare steel replacement
program accelerates the replacement of NW Natural's bare steel piping over 20
years instead of 40 years. The geo-hazard safety program includes the
identification, assessment and remediation of risks to piping infrastructure
created by landslides, washouts, earthquakes or similar occurrences. The
stipulation allowed NW Natural to receive deferred accounting rate treatment
9
commencing Oct. 1, 2002, for costs associated with the programs, expected to be
approximately $1.5 million annually.
In November 2002, Congress passed the Pipeline Safety Improvement Act of
2002 (Pipeline Safety Act) and the legislation was signed into law by President
Bush in December 2002. The Pipeline Safety Act requires operators of gas
transmission pipelines to identify lines located in High Consequence Areas
(HCAs) and develop Integrity Management Programs (IMPs) to periodically inspect
the integrity of the pipelines and make repairs or replacements as necessary to
ensure the ongoing integrity of the pipelines. The legislation requires NW
Natural to complete inspection of the 50 percent highest risk pipelines located
in its HCAs within the first five years, and the remaining covered pipelines
within 10 years of the date of the enactment. The Pipeline Safety Act also
requires re-inspections of the covered pipelines every seven years thereafter
for the life of the pipelines. In January 2003, the U.S. Department of
Transportation issued proposed rules that may impose additional requirements on
pipeline operators that could result in shorter time periods for compliance and
require additional capital investment by the Company. The cost of compliance
with the legislation and rules is uncertain; however, NW Natural's IMP is
expected to cost approximately $5 million to $10 million per year beginning in
2004, and more than $100 million over the next 10 years.
The Pipeline Safety Act also applies to the 19-mile interstate natural gas
pipeline that NW Natural operates and in which Financial Corporation owns a 10
percent interest.
Competition and Marketing
- -------------------------
NW Natural has no direct competition in its service area from other
natural gas distributors. For residential customers' heating needs, however, NW
Natural competes with electricity, fuel oil, and, to a lesser extent, wood. It
also competes with electricity and fuel oil for commercial applications.
Competition among these forms of energy is based on price, reliability,
efficiency and performance.
Overall, in 2002 NW Natural maintained its competitive price advantage
compared to electricity in both the residential and commercial markets.
Throughout 2002, natural gas rates continued to be lower than rates for
electricity provided by the investor-owned utilities that serve approximately 75
percent of the homes in NW Natural's Oregon service area. NW Natural expects to
maintain a price advantage compared to electricity provided by the
investor-owned electric utilities in its service territory, in part because much
of the electricity sold by these utilities is generated from natural gas.
Although there was an increasing price advantage for gas compared to oil in the
latter half of 2002, there were fewer residential conversions from heating oil
to natural gas during all of 2002 than in most recent years. NW Natural believes
oil conversions were lower in 2002 due to weaker economic conditions, higher and
more volatile gas and oil commodity prices in the prior year, and a decline in
the remaining inventory of potential oil conversion opportunities.
The relatively low market saturation of natural gas in residential
single-family and attached dwellings in NW Natural's service territory,
estimated at 40 to 50 percent, together with the price advantage of natural gas
compared with electricity and its operating convenience over fuel oil, provides
the potential for continuing growth in the residential and commercial conversion
markets. In 2002, 18,195 net residential customers (after subtracting
disconnected or terminated services) were added, including 6,209 units of
existing residential housing that were converted from oil or electric appliances
to natural gas. Of the new heating conversions from other fuels, approximately
70 percent also converted to gas for water heating. In addition, 991 net
commercial customers were connected in 2002. The net total of all new customers
added in 2002, including a net reduction of 50 industrial sales and
transportation customers, was 19,136. This constituted a growth rate of 3.5
percent, or about twice the national average for local gas distribution
companies (LDCs) as reported by the American Gas Association.
Due to weather that was about 2 percent warmer in 2002 than in 2001, and a
decrease in weather-sensitive customer consumption due to commodity
price-related rate increases in prior years and continuing conservation efforts,
natural gas sales volumes to residential and commercial customers in 2002 were
about 1 percent lower than in 2001. Temperatures in NW Natural's service
territory in 2002, based on heating degree days, were about the same as the
20-year average.
10
As a result of the deregulation and restructuring of the energy markets
during the past decade, the natural gas industry, including producers,
interstate pipelines and LDCs, has undergone many changes. These changes, which
are continuing, are intended to promote competition where it is economically
beneficial to consumers.
Traditionally, LDCs have sold a "bundled" product that included both the
natural gas commodity and delivery to the meter. However, beginning in the late
1980s, large industrial customers sought to achieve savings by procuring their
own supplies of natural gas from producers and contracting with pipelines and
LDCs for transportation to their facilities. On the other hand, NW Natural's
ability to obtain competitively priced gas supplies has enabled it to retain its
residential and small commercial customers as sales customers. Further
deregulation of gas transportation may bring unbundled product offerings to a
greater number of these customers, such that an increasing number of suppliers
may actively compete for customers' gas commodity business. However, the final
delivery of customer-owned gas will continue to be through regulated
distribution systems such as the Company's system. NW Natural does not
anticipate a material impact on its profitability from residential or small
commercial unbundling.
Competition to serve the industrial and large commercial market in the
Pacific Northwest has been relatively steady since the early 1990s in terms of
numbers and types of competitors. Competitors consist of gas marketers,
oil/propane sellers and electric utilities. Wood-based fuels continue to lose
market share in these markets primarily due to environmental concerns and
restrictions.
The OPUC and WUTC have approved transportation tariffs under which NW
Natural may contract with customers to deliver customer-owned gas.
Transportation tariffs are available to industrial customers and are priced at
the Company's cost of providing transportation service. Generally, the Company
is unaffected financially if industrial customers transport customer-owned gas
rather than purchasing gas from NW Natural, as long as they remain on a tariff
or contract with the same quality of service. However, industrial customers may
select between firm and interruptible service, among other different levels or
qualities of service, and these choices can positively or negatively affect
margin revenue from such customers. The relative level and volatility of prices
in the natural gas commodity markets and the availability of interstate pipeline
capacity to ship customer-owned gas are among the primary factors that have
caused some industrial customers to alternate between sales and transportation
service or between higher and lower qualities of service.
Total industrial throughput, including both sales and transportation of
firm and interruptible gas, was 535 million therms in 2002, up 1 percent from
529 million therms in 2001. Favorable natural gas prices as compared to oil
commodity prices and a need for industrial emissions compliance contributed to
the increase in total industrial throughput for 2002. However, NW Natural's
industrial base includes customers in the high-tech, forest products and other
industries that are sensitive to economic conditions and were negatively
affected by the weak economy in 2002. Electric price increases also have
contributed to the closure of several aluminum and forest products mills and
resulted in the loss of several thousand jobs and production cutbacks across a
broad cross-section of process users of natural gas.
The mix within NW Natural's industrial market between sales and
transportation service was different in 2002 than in 2001. Industrial sales in
2002 were 89 million therms, representing 17 percent of total industrial
deliveries, down from 143 million therms or 27 percent of total industrial
deliveries in 2001. Most of the transfers from sales to transportation service
occurred during the second quarter of 2002, when spot prices in the gas
commodity market had declined to levels considerably lower than the weighted
average cost of gas that was embedded in NW Natural's sales rates for the year.
The mix within the industrial market between firm and interruptible
service also was different, and less favorable, in 2002 than in 2001. Industrial
deliveries under tariffs for firm service were 34 percent of total industrial
deliveries in 2002, compared to 37 percent of total industrial deliveries in
2001. Due to the generally lower margins per therm on gas delivered under
interruptible tariffs as compared to firm tariffs, total margin from firm
industrial deliveries was down by 9 percent in 2002 and total margin from the
combination of firm and interruptible deliveries was down by 6 percent. Some of
the industrial customers that switched from sales to transportation service in
2002 also switched from firm to interruptible service, or from higher-margin to
lower-margin interruptible service, at the same time.
11
NW Natural and certain of its largest industrial customers have entered
into negotiated transportation service agreements. These agreements are designed
to provide transportation rates that are competitive with the customer's
alternative capital and operating costs of installing direct connections to
WGP's interstate pipeline system, "bypassing" NW Natural's gas distribution
system. The agreements generally prohibit bypass during their terms. Due to the
cost pressures that confront a number of NW Natural's largest customers that
compete in global markets, bypass continues to be a threat. Although NW Natural
does not expect a significant number of its large customers to bypass its system
in the foreseeable future, it may experience further deterioration of margin
associated with customers' transfers to contracts with pricing designed to be
competitive with bypass.
The Pacific Northwest historically has enjoyed some of the lowest electric
rates in the nation, primarily due to the proximity of federal hydroelectric
facilities. Due to a number of environmental, economic and political limitations
on the future use of the hydroelectric infrastructure in the Pacific Northwest,
as well as the supply and price dislocations that occurred in the electricity
market in the West in 2000 and 2001, a few large gas-fired generation projects
are currently in various stages of construction or development in the region.
These projects, as well as projects for cogeneration or distributed generation
of electricity, may present opportunities for NW Natural to serve new loads. The
availability of interstate pipeline transportation capacity, gas storage
capacity and economically priced gas supplies will play significant roles in the
future development of generation projects.
NW Natural signed agreements in 2001 to supply natural gas for electric
generation to two customers, including a public utility district in Vancouver,
Washington. Gas deliveries under these contracts were less than 1 million therms
in 2002 compared to 6 million therms in 2001. Because most of the revenues from
these contracts were fixed charges rather than volumetric charges, however,
margin from the contracts totaled $4.5 million in 2002 and $4.3 million in 2001,
equivalent to 11 cents a share in each year. These contracts expired on June 30,
2002.
NW Natural is authorized by the OPUC to make upstream commodity sales when
seasonal demand is low. This often allows NW Natural to compete effectively with
independent gas marketers. Sixty-seven percent of the net revenues (gross
revenues less the actual cost of gas) generated from these sales ($2.8 million
in 2002) have been credited to Oregon core utility gas costs, with the balance
benefiting shareholders.
Acquisition of Portland General Electric Company
- ------------------------------------------------
In October 2001, the Company entered into a contract (the Stock Purchase
Agreement) with Enron Corp. (Enron) providing for the acquisition by Northwest
Energy of all of the issued and outstanding common stock of PGE, a wholly-owned
subsidiary of Enron.
In December 2001, Enron filed for reorganization under Chapter 11 of the
United States Bankruptcy Code in U.S. Bankruptcy Court for the Southern District
of New York (the Bankruptcy Court). PGE has not filed for reorganization under
Chapter 11.
In May 2002, NW Natural and Enron entered into an agreement (the
Termination Agreement) providing for the termination of the Stock Purchase
Agreement. The termination of the Stock Purchase Agreement was effective on July
1, 2002, following the consent of the lenders from whom Enron had obtained
debtor-in-possession financing and the entry of an order by the Bankruptcy Court
approving the Termination Agreement. The Termination Agreement provided for
mutual releases from any legal action associated with the Stock Purchase
Agreement.
The Company's results of operations for 2002 include a loss provision for
the costs incurred in its efforts to acquire PGE from Enron, based on the
Company's judgment that the acquisition is no longer probable. The charges
amounted to $13.9 million, or $8.4 million after tax, equivalent to 33 cents a
diluted share, representing NW Natural's transaction costs including financial
advisory and legal fees, loan arrangement fees and other costs relating to the
acquisition effort.
12
Environment
- -----------
NW Natural owns property that is the site of a former gas manufacturing
plant that was closed in 1956 (the Gasco site). The Gasco site has been under
investigation by NW Natural for environmental contamination under the Oregon
Department of Environmental Quality's (ODEQ) Voluntary Clean-Up Program. NW
Natural has recorded liabilities totaling $4.0 million for the estimated costs
of investigation and interim remediation at the Gasco site, including
consultants' fees, ODEQ oversight reimbursement and legal fees, of which $3.2
million had been spent as of Dec. 31, 2002.
NW Natural previously owned property adjacent to the Gasco site that now
is the location of a manufacturing plant owned by Wacker Siltronic Corporation
(the Wacker site). In 2000, the ODEQ issued an order requiring Wacker and NW
Natural to determine the nature and extent of releases of hazardous substances
to Willamette River sediments from the Wacker site. NW Natural has completed the
majority of the studies required under the ODEQ work plan and the agency is
reviewing data generated by the studies. NW Natural has recorded a liability of
$0.3 million for its estimated costs of the investigation and initial
remediation on the Wacker site, of which $0.2 million had been spent as of Dec.
31, 2002.
In 1998, the ODEQ and the U.S. Environmental Protection Agency (EPA)
completed a study of sediments in a 5.5 mile segment of the Willamette River
(the Portland Harbor) that includes the area adjacent to the Gasco site and the
Wacker site. In 2000, the EPA listed the Portland Harbor as a Superfund site and
notified the Company that it is a potentially responsible party. NW Natural
recorded liabilities totaling $2.3 million between 2000 and 2002, of which $1.1
million had been spent as of Dec. 31, 2002. The amount of NW Natural's liability
is based on estimates of the Company's share of the lower end of a range of
probable liability for the costs of the Remedial Investigation/Feasibility Study
for the Portland Harbor. Available information is insufficient to determine
either the total amount of liability for investigation and remediation of the
Portland Harbor or the higher end of a range for NW Natural's estimated share of
that liability.
The City of Portland has notified NW Natural that it is planning a sewer
improvement project that would include excavation within the former site of a
gas manufacturing plant (the Portland Gas site) that was owned and operated by a
predecessor of the Company between 1860 and 1913. The preliminary assessment of
this site performed by a consultant for the EPA in 1987 indicated that it could
be assumed that by-product tars may have been disposed of on site. The report
concluded, however, that it is likely that waste residues from the plant, if
present on the site, were covered by deep fill during construction of the nearby
seawall bordering the Willamette River and probably have stabilized due to
physical and chemical processes. Neither the City of Portland nor the ODEQ has
notified NW Natural whether a further investigation or potential remediation
might be required on the site in connection with the sewer project. Available
information is insufficient to determine either the total amount of liability or
a probable range, if any, of potential liability.
NW Natural has accrued all material loss contingencies relating to
environmental matters which it believes to be probable of assertion and
reasonably estimable. Due to the preliminary nature of these environmental
investigations, the range of any additional possible loss contingency cannot be
currently estimated. NW Natural expects that its costs of further investigation
and remediation for which it may be responsible with respect to the Gasco site,
the Wacker site, the Portland Harbor site and the Portland Gas site, if any,
should be recoverable, in large part, from insurance. At Dec. 31, 2002, NW
Natural had a $2.5 million receivable representing an estimate of the
environmental costs NW Natural expects to recover from insurance, including $1.4
million that was recorded in 2000 for costs relating to the Gasco site and $1.1
million that was recorded in 2002 for costs relating to the Portland Harbor
site. In the event these costs are not recovered from insurance, NW Natural will
seek recovery through future rates.
Employees
- ---------
At Dec. 31, 2002, NW Natural had 1,261 employees, of which 879 were
members of the Office and Professional Employees International Union, Local No.
11. These union employees are working under a seven-year Joint Accord labor
agreement covering wages, benefits and working conditions that will expire on
March 31, 2004.
13
Available Information
- ---------------------
The Company files annual, quarterly and special reports and other
information with the Securities and Exchange Commission (SEC). The Company makes
available on its website (http://www.nwnatural.com), free of charge, its annual
report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably
practicable after it electronically files such material with, or furnishes it
to, the SEC. In addition, copies of these documents may be requested, at no
cost, by writing or calling Shareholder Services, Northwest Natural Gas Company,
One Pacific Square, 220 N.W. Second Avenue, Portland, Oregon 97209, telephone
503-226-4211.
ITEM 2. PROPERTIES
NW Natural's natural gas distribution system consists of approximately
12,266 miles of distribution and transmission mains. In addition, the
distribution system includes service pipes, meters and regulators, and gas
regulating and metering stations. The mains and feeder lines are located in
municipal streets or alleys pursuant to valid franchise or occupation
ordinances, in county roads or state highways pursuant to valid agreements or
permits granted pursuant to statute, or on lands of others pursuant to valid
easements obtained from the owners of such lands. NW Natural also holds all
necessary permits for the crossing of the Willamette River and a number of
smaller rivers by its mains.
NW Natural owns service facilities in Portland, as well as various
satellite service centers, garages, warehouses and other buildings necessary and
useful in the conduct of its business. It leases office space in Portland for
its corporate headquarters. District offices are maintained on owned or leased
premises at convenient points in the distribution system. NW Natural owns LNG
facilities in Portland and near Newport, Oregon.
NW Natural holds interests in 5,531 net acres of underground natural gas
storage and 2,210 net acres of oil and gas leases in Oregon. NW Natural owns
depleted gas reservoirs near Mist, Oregon, that are continuing to be developed
as underground gas storage facilities. It also holds an option to purchase
future storage rights in certain other areas of the Mist gas field.
In order to reduce risks associated with gas leakage in older parts of its
system, NW Natural undertook an accelerated pipe replacement program in the
1980s under which it removed or replaced 100 percent of its cast iron main by
October 2000. In 2001, NW Natural initiated an accelerated pipe replacement
program under which it will reduce the amount of bare steel main in the system.
NW Natural considers all of its properties currently used in its
operations, both owned and leased, to be well maintained, in good operating
condition, and adequate for its present and foreseeable future needs.
NW Natural's Mortgage and Deed of Trust constitutes a first mortgage lien
on substantially all of the real property constituting its utility plant.
ITEM 3. LEGAL PROCEEDINGS
Litigation
- ----------
In November 2001, NW Natural commenced a lawsuit, Northwest Natural Gas
Company v. Cascade Resources Corporation and Curry, et. al. (United States
District Court for the District of Oregon, Case No. CV 01-1620 HU), alleging
that the defendants violated obligations regarding the use and disclosure of
confidential information and used such information to solicit and secure
underground gas storage leases in areas of interest to the Company. Among other
remedies, the Company seeks to have a constructive trust imposed on such leases
and to require the defendants to assign their interest in such leases to the
Company.
14
The defendants in this case have asserted counterclaims against the
Company alleging that by asserting that the defendants have misused confidential
information, the Company improperly interfered with the defendants' business
opportunities. The assertions include claims for violation of antitrust laws for
which the defendants seek $15 million in damages, trebled, plus punitive damages
and attorneys' fees. The Company believes these counterclaims are without merit.
The litigation is currently in the discovery stage.
From time to time the Company is subject to other claims and litigation
arising in the ordinary course of business. Although the final outcome of any
legal proceeding cannot be predicted with certainty, the Company does not expect
disposition of these matters to have a materially adverse effect on the
Company's financial position, results of operations or cash flows.
15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the fourth quarter of the year
ended Dec. 31, 2002.
ADDITIONAL ITEMS
EXECUTIVE OFFICERS OF THE REGISTRANT
Age at
Name December 31, 2002 Positions held during last five years
---- ----------------- -------------------------------------
Richard G. Reiten 63 Chairman (2000- ); Chief Executive Officer
(1997-02); President (1996-01); Chief
Operating Officer (1996).
Mark S. Dodson 57 President and Chief Executive Officer
(2003- ); President, Chief Operating
Officer and General Counsel (2001-02);
Senior Vice President, Public Affairs
and General Counsel (1998-01); Senior
Vice President (1997); Partner, Ater
Wynne Hewitt Dodson & Skerritt LLP
(1981-97).
Michael S. McCoy 59 Executive Vice President, Customer and
Utility Operations (2000- ); Senior
Vice President, Customer and Utility
Operations (1999-00); Senior Vice
President, Customer Services (1992-99).
Bruce R. DeBolt 55 Senior Vice President, Finance, and Chief
Financial Officer (1990- ).
Gregg S. Kantor 45 Senior Vice President, Public and
Regulatory Affairs (2003- );
Vice President, Public Affairs
and Communications (1998-02);
Director, Public Affairs and
Communications (1996-97).
Beth A. Ugoretz 47 Senior Vice President and General Counsel
(2003- ); Executive Vice President,
Kindercare Learning Centers, Inc.
(1997-00); Senior Vice President,
General Counsel and Secretary, Red Lions
Hotels, Inc. (1993-96).
Lea Anne Doolittle 47 Vice President, Human Resources (2000- );
Director of Compensation (1993-2000),
PacifiCorp.
Stephen P. Feltz 47 Treasurer and Controller (1999- );
Assistant Treasurer (1996-99); Manager,
General Accounting (1996-99).
Richelle T. Luther 34 Assistant Secretary (2002- ); Associate,
Stoel Rives, LLP (1997-02).
C. J. Rue 57 Secretary (1982- ); Assistant Treasurer
(1987- ).
Each executive officer serves successive annual terms; present terms end
May 22, 2003. There are no family relationships among the Company's
executive officers.
16
OTHER INFORMATION
On Sept. 24, 2002, the Audit Committee of the Board of Directors
pre-approved certain ongoing non-audit related services performed by the
Company's independent auditor, PricewaterhouseCoopers LLP, and established a
procedure for the pre-approval of any future non-audit related services
performed by its auditor. The non-audit services approved included:
o Audits of the Company's Retirement Plans, its Retirement K Savings
Plan and its Cafeteria Plan (Plan No. 507) that are required under
provisions of the Employee Retirement Income Security Act of 1974, as
amended, and audits of the Company's transfer agent and registrar
functions that are required by the New York Stock Exchange;
o Tax compliance and other tax services, including technical tax
guidance, assistance and technical support, in an amount not to exceed
$25,000 in any calendar year;
o Services related to the Company's issuance of securities, including
the issuance of comfort letters and consents relating to the issuance
of its Medium-Term Notes; and
o Such other non-audit services, in an amount not to exceed $5,000 for
each such service, as may be deemed necessary by management to support
normal business operations.
The Committee determined that the ongoing non-audit services would be
reviewed annually concurrently with the engagement of the auditor.
On Feb. 27, 2003, the Audit Committee affirmed its procedure for the
pre-approval of fees for non-audit related services and pre-approved the fees
described above to be provided in 2003.
17
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
(A) NW Natural's common stock is listed and trades on the New York Stock
Exchange under the symbol "NWN."
The quarterly high and low trades for NW Natural's common stock during the
past two years were as follows:
2002 2001
--------------- ---------------
Quarter Ended High Low High Low
- ------------------------------------------------------------------------------
March 31 $28.50 $24.20 $26.69 $23.05
June 30 30.30 27.60 25.25 21.65
September 30 30.20 23.46 25.85 22.39
December 31 30.70 25.50 26.30 22.00
The closing quotation for the common stock on Dec. 31, 2002 was $27.06.
The closing quotation on Dec. 31, 2001 was $25.50.
(B) As of Dec. 31, 2002, there were 10,026 holders of record of the
Company's common stock.
(C) NW Natural has paid quarterly dividends on its common stock in each
year since the stock first was issued to the public in 1951. Annual common
dividend payments have increased each year since 1956. Dividends per share paid
during the past two years were as follows:
Payment Date 2002 2001
------------ ------ ------
February 15 $0.315 $0.310
May 15 $0.315 $0.310
August 15 $0.315 $0.310
November 15 $0.315 $0.315
------ ------
Total per share $1.260 $1.245
It is the intention of the Board of Directors to continue to pay cash
dividends on the Company's common stock on a quarterly basis. However, future
dividends will be dependent upon NW Natural's earnings, its financial condition
and other factors.
NW Natural's Dividend Reinvestment and Stock Purchase Plan permits
registered owners of common stock to reinvest all or a portion of their
quarterly dividends in additional shares of NW Natural's common stock at the
current market price. Shareholders also may invest cash on a monthly basis, up
to $50,000 per calendar year, in additional shares at the current market price.
During 2002, dividend reinvestments and optional cash investments under the Plan
aggregated $4.4 million and resulted in the issuance of 157,288 shares of common
stock. During the 25 years the Plan has been available, the Company has issued
and sold 4,318,598 shares of common stock which produced $93.1 million in
additional capital.
18
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected financial data concerning the Company's
operations and financial condition.
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
Thousands, except per share amounts
- -----------------------------------
Sales revenues:
Residential $ 354,735 $ 329,905 $ 280,642 $ 242,952 $ 205,388
Commercial 201,475 190,236 159,660 139,425 117,889
Industrial - firm 42,965 49,662 37,378 35,857 34,303
Industrial - interruptible 15,937 34,283 23,483 17,182 15,337
Unbilled revenues (12,702) 13,774 12,661 (2,671) 8,314
---------- ---------- ---------- ---------- ----------
Total gas sales revenues 602,410 617,860 513,824 432,745 381,231
Transportation 26,020 20,637 21,491 21,351 19,958
Other 4,018 (2,325) (3,976) 1,194 2,617
---------- ---------- ---------- ---------- ----------
Total utility operating revenues 632,448 636,172 531,339 455,290 403,806
Cost of gas 353,034 364,699 273,978 212,021 173,242
---------- ---------- ---------- ---------- ----------
Net utility operating revenues 279,414 271,473 257,361 243,269 230,564
Net non-utility operating revenues 8,130 4,538 589 368 402
---------- ---------- ---------- ---------- ----------
Net operating revenues $ 287,544 $ 276,011 $ 257,950 $ 243,637 $ 230,966
========== ========== ========== ========== ==========
Net income $ 43,792 $ 50,187 $ 50,224 $ 45,296 $ 27,301
Preferred and preference redeemable
stock dividend requirements 2,280 2,401 2,456 2,515 2,577
---------- ---------- ---------- ---------- ----------
Earnings applicable to common stock $ 41,512 $ 47,786 $ 47,768 $ 42,781 $ 24,724
========== ========== ========== ========== ==========
Average common shares outstanding 25,431 25,159 25,183 24,976 24,233
========== ========== ========== ========== ==========
Basic earnings per share of common stock $ 1.63 $ 1.90 $ 1.90 $ 1.71 $ 1.02
========== ========== ========== ========== ==========
Diluted earnings per share of common stock $ 1.62 $ 1.88 $ 1.88 $ 1.70 $ 1.02
========== ========== ========== ========== ==========
Dividends per share of common stock $ 1.26 $ 1.245 $ 1.24 $ 1.225 $ 1.22
========== ========== ========== ========== ==========
Total assets - at end of period $1,342,791 $1,435,022 $1,278,713 $1,244,423 $1,191,736
========== ========== ========== ========== ==========
Ratio of earnings to fixed charges* 2.85 3.14 3.14 3.12 2.20
========== ========== ========== ========== ==========
* Computed using the Securities and Exchange Commission method. For this
purpose, earnings consist of net income before taxes plus fixed charges,
and fixed charges consist of interest on all indebtedness, the
amortization of debt expense and discount or premium, and the estimated
interest portion of rentals charged to income.
19
SELECTED FINANCIAL DATA (continued)
2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
Thousands, except customer and gas cost
per therm data
- ---------------------------------------
Capitalization - at end of period:
Common stock equity $ 483,103 $ 468,161 $ 452,309 $ 429,596 $ 412,404
Redeemable preference stock - 25,000 25,000 25,000 25,000
Redeemable preferred stock 8,250 9,000 9,750 10,564 11,499
Long-term debt 445,945 378,377 400,790 396,379 366,738
---------- ---------- ---------- ---------- ----------
Total capitalization $ 937,298 $ 880,538 $ 887,849 861,539 $ 815,641
========== ========== ========== ========== ==========
Gas sales and transportation deliveries (000 therms):
Residential 357,091 350,065 356,375 352,969 315,686
Commercial 240,155 242,293 250,380 252,382 229,124
Industrial - firm 63,215 79,778 76,559 84,630 87,275
Industrial - interruptible 26,241 63,597 56,632 52,938 51,521
Unbilled therms (6,617) 1,771 8,691 (9,343) 8,645
---------- ---------- ---------- ---------- ----------
Total gas sales 680,085 737,504 748,637 733,576 692,251
Transportation 445,999 385,783 431,136 480,570 446,165
---------- ---------- ---------- ---------- ----------
Total volumes delivered 1,126,084 1,123,287 1,179,773 1,214,146 1,138,416
========== ========== ========== ========== ==========
Customers (average for period):
Residential 492,871 474,373 456,449 435,959 413,714
Commercial 55,416 54,628 53,617 52,029 50,469
Industrial - firm 350 377 375 396 404
Industrial - interruptible 74 141 118 118 114
Transportation 190 111 125 127 122
---------- ---------- ---------- ---------- ----------
Total customers 548,901 529,630 510,684 488,629 464,823
========== ========== ========== ========== ==========
Customer statistics:
Heat requirements**
Actual degree days 4,232 4,325 4,418 4,256 4,011
20-year average degree days 4,216 4,202 4,197 4,193 4,234
Average annual use per customer in therms:
Residential 725 738 781 810 749
Commercial 4,334 4,435 4,670 4,851 4,540
Gas purchased cost per therm - net (cents) 51.07 47.19 37.68 27.85 25.09
** A degree day is the measure of the coldness of the weather experienced based
on the extent to which the average of the high and low temperatures for a
day falls below 65 degrees Fahrenheit.
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The following is management's assessment of Northwest Natural Gas
Company's financial condition including the principal factors that affect
results of operations. The discussion refers to the consolidated activities of
the Company for the three years ended Dec. 31, 2002. References in this
discussion to "Notes" are to the notes to the consolidated financial statements.
The consolidated financial statements include:
Regulated utility:
Northwest Natural Gas Company (NW Natural)
Non-regulated wholly-owned subsidiary businesses:
NNG Financial Corporation (Financial Corporation),
and its wholly-owned subsidiaries
Northwest Energy Corporation (Northwest Energy),
and its wholly-owned subsidiary
Non-regulated majority-owned subsidiary business:
Canor Energy Ltd. (Canor), sold in 2000
Together these businesses are referred to herein as the "Company"
(see "Non-utility Operations," below, and Note 2).
Highlights
- ----------
Among its accomplishments in 2002, the Company:
o grew the utility customer base by more than 3 percent for the
16th year in a row, adding 19,136 customers to NW Natural's gas
distribution system during the year;
o exceeded the prior year's customer additions from residential and
commercial conversions and residential new construction, despite
weaker economic conditions;
o reduced rates for NW Natural's customers in Oregon and Washington
due to lower purchased gas costs, and refunded $33 million to
customers from its savings on gas purchases in the past year;
o expanded service in the interstate market for gas storage
services, increasing earnings from this business segment from 8
cents a share in 2001 to 14 cents a share in 2002;
o received approval from the Oregon Public Utility Commission
(OPUC) for rate adjustments and a partial decoupling mechanism
that will help stabilize margin revenues while better aligning NW
Natural's financial interests with customers' interests in
conserving energy;
o tested and successfully qualified, under a federally-mandated
Operator Qualification rule, all 695 NW Natural employees who
work on natural gas pipelines;
o elected to terminate the October 2001 contract to acquire
Portland General Electric Company (PGE) in light of the risks
associated with the bankruptcy of PGE's parent company, Enron
Corp. (Enron); and
o paid dividends on common stock of $1.26 a share, making 2002 the
47th consecutive year in which the Company's dividend payments
have increased.
Issues and Challenges
- ---------------------
Issues and challenges the Company expects to face in 2003, as
discussed below, include the effects and uncertainties relating to a general
rate case in Oregon, volatile gas commodity prices, unusually warm temperatures
in the winter of 2002-03, continuing weak economic conditions in Oregon and
Washington, higher costs for pensions, health benefits and insurance,
uncertainties relating to the permits and rights-of-way necessary for the
21
planned extension of the pipeline from NW Natural's Mist gas storage field, and
higher capital and maintenance costs due to federal mandates in the area of
pipeline integrity.
Earnings and Dividends
- ----------------------
The Company's earnings applicable to common stock in 2002 were $41.5
million, down from $47.8 million in both 2001 and 2000. Earnings for 2002 were
reduced by a loss provision of $8.4 million after tax, representing the
Company's costs incurred in its effort to acquire PGE from Enron.
Diluted earnings per share from consolidated operations were $1.62 a
share in 2002, down from $1.88 a share in both 2001 and 2000. Excluding the
charges relating to the acquisition effort, diluted earnings per share from
consolidated operations in 2002 would have been $1.95 a share. Earnings for 2001
and 2000 were the highest and second highest on record for the Company. Earnings
in 2000 included a gain of 9 cents a share from the sale of Canor.
NW Natural earned $1.76 a diluted share from gas utility operations
in 2002, the same as the result from utility operations in 2001, compared to
$1.78 a share in 2000. Weather conditions in its service territory in 2002 were
very close to average for the year as a whole but were 2 percent warmer than
2001. Temperatures in 2001 were 2 percent warmer than 2000 and 3 percent colder
than the 20-year average. Weather in 2000 was 5 percent colder than the 20-year
average.
Results in 2002 from the Company's non-utility operations were a
loss of 14 cents a share, including earnings of 14 cents a share from gas
storage operations, charges equivalent to 33 cents a share relating to the
effort to purchase PGE, and earnings of 5 cents a share from other subsidiary
and non-utility operations. The charges relating to the PGE transaction resulted
from the termination effective July 1, 2002 of the Company's contract to
purchase PGE. Non-utility operating results for 2001 were earnings of 12 cents a
share, including 8 cents a share from gas storage operations. Non-utility
operating results for 2000 were earnings of 10 cents a share, including a gain
of 9 cents a share from the sale of Canor (see "Non-utility Operations," below).
Dividends paid on common stock were $1.26 a share in 2002 compared
to $1.245 a share in 2001 and $1.24 a share in 2000.
Application of Critical Accounting Policies
- -------------------------------------------
In preparing the Company's financial statements using generally
accepted accounting principles in the United States of America (GAAP),
management exercises judgment in the selection and application of accounting
principles, including making estimates and assumptions. Management considers its
critical accounting policies to be those which are most important to the
representation of the Company's financial condition and results of operations
and which require management's most difficult and subjective or complex
judgments, including those that could result in materially different amounts if
the Company reported under different conditions or using different assumptions.
The Company's critical accounting policies are described below. Other
significant accounting policies and recent accounting pronouncements are
discussed in Note 1.
Regulatory Accounting
---------------------
NW Natural generally uses the same accounting policies and
practices used by unregulated companies for financial reporting under GAAP.
However, sometimes these principles, such as Statement of Financial Accounting
Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of
Regulation," require different accounting treatment for regulated companies to
show the effects of regulation. For example, in setting NW Natural's retail
rates, the OPUC may not allow NW Natural to charge its customers currently to
recover certain expenses, but instead may require that these expenses be charged
to customers in the future. In this situation, SFAS No. 71 requires NW Natural
to defer these items and show them as regulatory assets on the balance sheet
until NW Natural is allowed to charge its customers. NW Natural then amortizes
these items as expense to the income statement as the charges are recovered from
customers. Similarly, certain revenue items may be deferred as regulatory
22
liabilities, which are also eventually amortized to the income statement as
rates to customers are reduced.
The conditions a regulated company must satisfy to apply the
accounting policies and practices of SFAS No. 71 include:
o an independent regulator sets rates;
o the regulator sets the rates to cover specific costs of
delivering service; and
o the service territory lacks competitive pressures to reduce rates
below the rates set by the regulator.
NW Natural applies SFAS No. 71 in accounting for its regulated
operations. The Company periodically assesses whether it can continue to apply
SFAS No. 71. If NW Natural should determine in the future that all or a portion
of its regulatory assets and liabilities no longer meet the criteria for
continued application of SFAS No. 71, then it would be required to write off the
net unrecoverable balances of its regulatory assets and liabilities as a charge
to income.
Revenue Recognition
-------------------
Utility revenues are derived primarily from the sale and
transportation of natural gas. Utility revenue from gas sales and transportation
is recognized when the gas is delivered to and received by the customer.
Estimated revenues are accrued for gas deliveries not billed to customers from
meter reading dates to month end (unbilled revenue) and are reversed the
following month when actual billings occur.
Revenues from non-utility services, including gas storage, are
recognized upon delivery of the service to customers. Revenues from non-utility
optimization contracts are recognized, after deducting for regulatory revenue
sharing, over the life of the contract for amounts guaranteed under the
contract, or as amounts are earned and reasonably estimable for amounts above
the guaranteed value.
Accounting for Derivative Instruments and Hedging Activities
------------------------------------------------------------
The Company adopted SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," on Jan. 1, 2001. This statement established
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities.
SFAS No. 133 requires that an entity recognize derivatives as either assets or
liabilities on the balance sheet and measure those instruments at fair value.
SFAS No. 133 also requires that changes in the fair value of a derivative be
recognized currently in earnings unless specific hedge accounting criteria are
met.
NW Natural's Derivatives Policy sets forth the guidelines for using
selected financial derivative products to support prudent risk management
strategies within designated parameters (see Note 1). NW Natural's primary
hedging activities, consisting of natural gas commodity price and foreign
currency exchange rate hedges, are principally accounted for as cash flow hedges
under SFAS No. 133 and subject to regulatory deferral pursuant to SFAS No. 71.
Unrealized gains and losses from mark-to-market valuations of these contracts
are not recognized in current income but are reported as non-trading derivative
assets or liabilities and offset by a corresponding deferred account balance
included under "Regulatory liabilities" or "Regulatory assets."
At Dec. 31, 2002, NW Natural had derivatives outstanding covering
its exposures to commodity and foreign currency prices (see Note 11). The fair
value of the hedge derivatives outstanding on that date was a net gain of $12.4
million, compared to a net loss of $111.9 million at Dec. 31, 2001. NW Natural
had two natural gas price swap contracts extending beyond Dec. 31, 2003, but
none extends beyond Oct. 31, 2004. None of the natural gas call option contracts
extends beyond March 31, 2003.
In 2002, NW Natural recorded net losses from commodity swap and call
option contracts of $75.5 million, compared to net gains of $57.6 million and
$56.2 million during 2001 and 2000, respectively. Gains (losses) from commodity
hedges are recorded as reductions (increases) to the cost of gas and are
included in the calculation of annual Purchased Gas Adjustment (PGA) rate
23
changes. The gain or loss on all foreign currency forward purchase contracts
relating to gas purchase obligations is included in NW Natural's cost of gas.
The fair value of derivative instruments at Dec. 31, 2002 and 2001
was determined using estimated or quoted market prices for the periods covered
by the contracts. Market prices for the natural gas swap and call option
contracts were obtained from external sources. These third-party valuations are
reviewed for reasonableness by the Company using fair value calculations for
other contracts with similar terms and conditions. The market prices for the
foreign currency forward contracts are based on currency exchange rates quoted
by The Bank of Canada.
Accounting for Pensions
-----------------------
NW Natural has two qualified non-contributory defined benefit
pension plans that cover all regular employees with more than one year of
service. These plans are funded through a trust dedicated to providing the
benefits. Net periodic pension costs are determined in accordance with SFAS No.
87, "Employers' Accounting for Pensions" (see "Financial Condition - Pension
Cost (Income) and Funding Status," below). NW Natural's pension cost consists of
service costs, interest costs, the amortization of actuarial gains and losses,
and expected long-term returns on plan assets, and is based in part on a
market-related valuation of assets. Variances between actual investment gains or
losses and expected returns on plan assets are recognized over a three-year
period from the year in which they occur, thereby reducing year-to-year
volatility.
NW Natural's accumulated benefit obligation, the fair value of plan
assets and the amount of annual pension cost are calculated based on a number of
actuarial assumptions including an expected long-term return on plan assets,
assumed rates of compensation increase and a discount rate (see Note 7). In
developing these assumptions, NW Natural evaluates input from its actuaries as
well as information available from the securities markets. The actuarial
assumptions are evaluated annually and adjusted as necessary.
Based on information from its actuaries and investment advisors, NW
Natural reduced its expected long-term return on plan assets from 9 percent to 8
percent, and reduced the discount rate used in calculating benefit obligations
from 7.25 percent to 6.75 percent, both effective as of Jan. 1, 2003. Had these
assumptions been in effect a year earlier, NW Natural would have recorded net
periodic pension cost of $2.2 million for the year, rather than pension income
of $0.1 million, and the Company's net income would have been lower by $0.8
million.
Contingencies
-------------
The Company records loss contingencies when it is probable that a
loss has been incurred and the amount of the loss is reasonably estimable.
Estimating probable losses requires analysis of uncertainties that often depend
upon judgments about potential actions by third parties. In the normal course of
business, NW Natural records accruals for loss contingencies including
allowances for uncollectible accounts receivable, environmental claims and
property damage and personal injury claims. NW Natural records receivables for
anticipated recoveries under insurance contracts when recovery is probable.
Results of Operations
- ---------------------
Regulatory Matters
------------------
NW Natural provides gas utility service in Oregon and Washington,
with Oregon representing over 90 percent of its revenues. Future earnings and
cash flows from utility operations will be determined largely by the pace of
continued growth in the residential and commercial markets and by the ability to
remain price competitive in the large industrial market, to control expenses,
and to obtain reasonable and timely regulatory ratemaking treatment for
investments made in utility plant.
NW Natural's most recent general rate increase in Oregon, which was
effective Dec. 1, 1999, authorized rates designed to produce a return on common
shareholders' equity (ROE) of 10.25 percent. The OPUC approved a revenue
increase of $0.2 million per year, or 0.1 percent of Oregon revenues.
24
On Nov. 29, 2002, NW Natural filed a new general rate case in
Oregon. The filing proposes a revenue increase of $38 million per year from
Oregon operations through rate increases averaging 6.8 percent. If the increase
were approved as proposed, residential customer rates would increase by 8.9
percent and commercial rates by 4.6 percent; there would be no changes for
industrial firm or interruptible customer rates. The proposed rates are designed
to produce an ROE of 11.3 percent and to recover increases in NW Natural's cost
of service including the costs of complying with new federal regulations
regarding pipeline safety and integrity; expanding the Company's underground
storage facilities to meet customer growth; commencing service to Coos County,
Oregon; improving customer service; and providing for system security, insurance
coverage and employee benefits. The schedule for the case provides for
settlement conferences in March 2003, the filing of OPUC staff and intervenor
testimony in late April, hearings in August and a decision by the OPUC
determining new rates by Oct. 1. The Company is unable to determine the extent
to which its proposals will be accepted by the OPUC.
In October 2000, the Washington Utilities and Transportation
Commission (WUTC) authorized a general rate increase totaling $4.3 million per
year, or 12.1 percent. The first $3.0 million per year of the revenue increase,
relating to costs allocated to Washington under a cost allocation study approved
by the WUTC and the OPUC, was effective on Nov. 1, 2000. The remaining increase
of $1.3 million per year was effective on Oct. 1, 2001. The WUTC authorized and
based rates on an ROE of 10.8 percent.
NW Natural applies rate changes each year under the PGA mechanisms
in its tariffs in Oregon and Washington. The rate increases or decreases reflect
changes in the costs of natural gas commodity purchased under contracts with gas
producers (see "Comparison of Gas Operations - Cost of Gas," below), the
application of temporary rate adjustments to amortize balances in regulatory
asset or liability accounts and the removal of temporary rate adjustments
effective the previous year. In 2002, the OPUC approved rate decreases averaging
14 percent for NW Natural's Oregon sales customers and the WUTC approved rate
decreases averaging 25 percent for NW Natural's Washington sales customers, both
effective on Oct. 1, 2002. In 2001, the OPUC approved rate increases averaging
22 percent for Oregon sales customers and the WUTC approved rate increases
averaging 21 percent for Washington sales customers, both effective on Oct. 1,
2001. In 2000, the OPUC approved rate increases averaging 23 percent for Oregon
sales customers effective on Oct. 1, 2000 and the WUTC approved rate increases
averaging 23 percent for Washington sales customers effective on Aug. 1, 2000.
In an order issued in 1999, the OPUC formalized a process that tests
for excessive earnings in connection with gas utilities' annual filings under
their PGA mechanisms. The OPUC confirmed NW Natural's ability to pass through
100 percent of its prudently incurred gas costs into rates. Under this order, NW
Natural is authorized to retain all of its earnings up to a threshold level
equal to its authorized ROE plus 300 basis points. One-third of any earnings
above that level will be refunded to customers. The excess earnings threshold is
subject to adjustment up or down each year depending on movements in interest
rates. There were no amounts identified in this process for refund to customers
with respect to NW Natural's earnings results in 2000 or 2001. NW Natural does
not expect there will be amounts identified for refund with respect to its
earnings in 2002, which will be reviewed by the OPUC in the second quarter of
2003.
In 2002, the OPUC approved a settlement in a proceeding NW Natural
initiated in 2001 with a goal of stabilizing margin revenues in the face of
above- or below-normal consumption patterns. NW Natural believes that reductions
in recent years in its customers' gas consumptions per degree day (see
"Comparison of Gas Operations - Residential and Commercial," below) were caused
by increases in the cost of purchased gas that were passed on to customers as
rate increases, and to efforts throughout the region to conserve energy. NW
Natural estimates that lower average consumptions per degree day reduced margin
from residential and commercial sales by $11 million, equivalent to 26 cents a
share, in 2001, and by $10.7 million, equivalent to 25 cents a share, in the
first nine months of 2002. Pursuant to the settlement, the OPUC authorized a
mechanism for rate changes relating to the impact of price elasticity, starting
with small increases to residential and commercial rates that became effective
on Oct. 1, 2002. These rate changes contributed an estimated $3.5 million of
margin during the fourth quarter of 2002, equivalent to 8 cents a share.
Also under the settlement, the OPUC authorized NW Natural to
implement a partial decoupling mechanism effective Oct. 1, 2002. Decoupling
mechanisms are used to break the link between a utility's earnings and the
energy consumed by its customers so the utility does not have an incentive to
discourage customers' conservation efforts. The decoupling mechanism works by
25
adding margin revenues during periods when customer consumptions are lower than
baseline consumption or by deducting margin revenues when consumptions are
higher than the baseline. Under the partial decoupling mechanism, NW Natural
uses a balancing account to defer and subsequently amortize 90 percent of the
margin differentials between baseline usage by its residential and commercial
customers and weather-normalized actual usage by these customers. The deferred
amounts are treated as adjustments to be refunded or collected in future
periods. Baseline consumption is based on current customer consumption patterns,
adjusted for consumptions resulting from new customers. NW Natural continues to
bear the risk of weather-related variations in customer usage. The partial
decoupling mechanism will expire at the end of September 2005 unless the OPUC
approves an extension based on the results of an independent study to measure
the mechanism's effectiveness.
Also under the settlement, NW Natural agreed to adopt certain
service quality measures that establish the Company's performance goal for
minimizing complaints by customers where the Company is determined to be at
fault. If NW Natural exceeds the prescribed level of at-fault complaints, it
will be subject to penalties.
26
Comparison of Gas Operations
----------------------------
The following table summarizes the composition of gas utility
volumes and revenues for the three years ended Dec. 31:
(Thousands, except customers and degree days) 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------
Utility Gas Sales and Transportation Volumes - Therms:
- ------------------------------------------------------
Residential and commercial sales 597,246 592,358 606,755
Unbilled volumes (6,617) 1,771 8,691
---------- ---------- ----------
Weather-sensitive volumes 590,629 52% 594,129 53% 615,446 52%
Industrial firm sales 63,215 6% 79,778 7% 76,559 6%
Industrial interruptible sales 26,241 2% 63,597 6% 56,632 5%
---------- --- ---------- --- ---------- ---
Total gas sales 680,085 60% 737,504 66% 748,637 63%
Transportation deliveries 445,999 40% 385,783 34% 431,136 37%
---------- --- ---------- --- ---------- ---
Total volumes sold and delivered 1,126,084 100% 1,123,287 100% 1,179,773 100%
========== === ========== === ========== ===
Utility Operating Revenues - Dollars:
- -------------------------------------
Residential and commercial sales $ 556,210 $ 520,141 $ 440,302
Unbilled revenues (12,702) 13,774 12,661
---------- ---------- ----------
Weather-sensitive revenues 543,508 86% 533,915 84% 452,963 85%
Industrial firm sales 42,965 7% 49,662 8% 37,378 7%
Industrial interruptible sales 15,937 2% 34,283 5% 23,483 5%
---------- --- ---------- --- ---------- ---
Total gas sales 602,410 95% 617,860 97% 513,824 97%
Transportation revenues 26,020 4% 20,637 3% 21,491 4%
Other revenues 4,018 1% (2,325) - (3,976) (1%)
---------- --- ---------- --- ---------- ---
Total utility operating revenues $ 632,448 100% $ 636,172 100% $ 531,339 100%
========== === ========== === ========== ===
Cost of gas sold $ 353,034 $ 364,699 $ 273,978
========== ========== ==========
Net operating revenues (utility margin) $ 279,414 $ 271,473 $ 257,361
========== ========== ==========
Total number of customers (end of period) 560,067 540,931 523,406
========== ========== ==========
Actual degree days 4,232 4,325 4,418
========== ========== ==========
20-year average degree days 4,216 4,202 4,197
========== ========== ==========
NW Natural refunded deferred gas cost savings to its Oregon
customers through billing credits in June 2002. The refunds were the customers'
67 percent portion of gas cost savings realized between October 2001 and March
2002, which had been deferred, with interest, pursuant to NW Natural's PGA
tariff in Oregon (see "Cost of Gas," below). The refunds reduced total gas sales
and total utility operating revenues for 2002 by $30.2 million and cost of gas
sold by $29.5 million. The refunds also reduced utility margin by about $0.9
million, but this amount was largely offset by corresponding reductions in
franchise tax expense and uncollectible expense with the result that the effect
of the refunds on net income was negligible.
Residential and Commercial
--------------------------
NW Natural continued to grow its customer base, with 19,136
customers added during 2002. This represents a growth rate of 3.5 percent,
compared to 3.3 percent in 2001 and 4.4 percent in 2000. In the three years
ended Dec. 31, 2002, more than 58,000 customers were added to the system,
representing an average annual growth rate of 3.9 percent.
27
Typically, 80 percent or more of NW Natural's annual operating
revenues are derived from gas sales to weather-sensitive residential and
commercial customers. Accordingly, variations in temperatures between periods
affect volumes of gas sold to these customers.
Weather conditions in 2002 were very close to average for the year.
Temperatures were 3 percent colder than average in 2001 and 5 percent colder
than average in 2000. Weather in 2002 was 2 percent warmer than 2001 and 2001
was 2 percent warmer than 2000. Average weather conditions are calculated from
the most recent 20 years of temperature data measured by heating degree-days.
The volumes of gas sold to residential and commercial customers were
1 percent lower in 2002 than in 2001 and 3 percent lower in 2001 than in 2000,
reflecting warmer weather as well as lower consumption patterns by customers due
to higher gas commodity prices included in rates in previous years. Effective
Oct. 1, 2002, the Company implemented rate increases designed to recover the
margin lost due to the changes in consumption patterns. Excluding the impact of
the refunds to Oregon customers during 2002, related revenues increased $40
million, or 7 percent, primarily due to PGA tariff rate increases effective Oct.
1, 2001 (see "Regulatory Matters," above). Revenue from residential and
commercial customers was 18 percent higher in 2001 than in 2000 due to rate
increases effective in 2000 and 2001.
In order to match revenues with related purchased gas costs, NW
Natural records unbilled revenues for gas delivered and sold to customers, but
not yet billed, through the end of the period. Amounts reported as unbilled
revenues reflect the increase or decrease in the balance of unbilled revenues
over the prior year-end. Weather conditions, rate changes and customer billing
dates from one period to the next affect year-end balances.
Industrial Sales, Transportation and Other Revenues
---------------------------------------------------
The following table summarizes the delivered volumes and margin by
market segment in the industrial market:
(Thousands) 2002 2001 2000
-------------------------------------------------------------------------------------------------
Delivered volumes by market segment (therms):
---------------------------------------------
Electric generation 3,400 42,867 3,798
Industrial sales and transportation 531,195 486,116 560,675
------------ ------------ -------------
Total volumes 534,595 528,983 564,473
============ ============ =============
Margin by market segment (dollars):
-----------------------------------
Electric generation $ 4,584 $ 4,721 $ 71
Industrial sales and transportation 40,666 43,251 46,683
------------ ------------ -------------
Total margin $ 45,250 $ 47,972 $ 46,754
============ ============ =============
Total volumes delivered to industrial and electric generation
customers were 1 percent higher in 2002 than in 2001 and 6 percent lower in 2001
than in 2000. Combined margins from these customers were 6 percent lower in 2002
than in 2001 and 3 percent higher in 2001 than in 2000.
Excluding electric generation customers, volumes delivered to
end-use industrial sales and transportation customers were 9 percent higher in
2002 than in 2001 and 13 percent lower in 2001 than in 2000. Margin from these
customers was 6 percent lower in 2002 than in 2001 and 7 percent lower in 2001
than in 2000. The decline in margin from these customers was due to migrations
of some industrial customers from higher margin firm service to lower margin
interruptible service and to plant shut-downs or cut-backs in the manufacturing
sector because of economic conditions.
28
In the electric generation market segment, margin was $4.6 million
and $4.7 million in 2002 and 2001, respectively, equivalent to 11 cents a share
in each year. More than 90 percent of the margin but only about 14 percent of
the gas deliveries in each of these years was from two customers that were
served under contracts that went into effect in the second half of 2001 and
expired at the end of the second quarter of 2002. Most of the margin from these
contracts was from fixed charges. A third electric generation customer used 3.0
million therms in 2002, 36.8 million therms in 2001 and 3.8 million therms in
2000 under contracts with low volumetric charges. Margin in the electric
generation market segment in 2000 was negligible.
Other revenues include amortizations of regulatory accounts and
miscellaneous fee income. In 2002, other revenues increased net utility
operating revenues by $4.0 million. Other revenues in 2002 included customer
late payment and collection fees ($3.1 million), amortizations of regulatory
accounts covering customer consumption under NW Natural's decoupling mechanism
($1.7 million) (see "Regulatory Matters," above), miscellaneous revenues ($1.6
million) and refunds due to sharing of income from interstate gas storage
services ($1.2 million), partially offset by amortizations from regulatory
accounts covering conservation programs ($2.1 million) and Year 2000 costs ($1.5
million).
In 2001, other revenues reduced net utility operating revenues by
$2.3 million. Other revenues in 2001 included expense amortizations of
regulatory accounts covering conservation programs ($4.9 million), Year 2000
costs ($1.2 million) and property taxes ($0.2 million), partially offset by
revenues from customer late payment and collection fees ($2.9 million) and
miscellaneous revenues ($1.3 million).
Cost of Gas
-----------
The cost per therm of gas sold was 5 percent higher in 2002 than in
2001 and 35 percent higher in 2001 than in 2000. The cost per therm of gas sold
includes current gas purchases, gas drawn from storage inventory, gains or
losses from commodity hedges, margin from off-system gas sales, demand cost
equalization, regulatory deferrals and company use.
Results for 2002 include an adjustment reducing cost of gas by $29.5
million (see "Comparison of Gas Operations," above). Excluding the impact of
this adjustment, the cost per therm of gas sold was 14 percent higher in 2002
than in 2001, primarily due to higher prices in the natural gas commodity
market. Results for 2002 also include adjustments reducing cost of gas by $2.9
million to correct the amount of deferred expenses related to the recovery of
pipeline demand charges under NW Natural's Oregon PGA mechanism. These
adjustments contributed 7 cents a share to earnings during 2002. The corrected
methodology will continue to be applied in the future.
NW Natural uses a natural gas commodity-price hedge program under
the terms of its Derivatives Policy (see Note 1) to help manage its variable
price gas commodity contracts. NW Natural recorded net losses from commodity
swap and call option contracts of $75.5 million during 2002, compared to net
gains of $57.6 million and $56.2 million in 2001 and 2000, respectively. Gains
(losses) from commodity hedges are recorded as reductions (increases) to the
cost of gas and the majority of such gains and losses are included in annual PGA
rate adjustments.
Under NW Natural's PGA tariff in Oregon, net income from Oregon
operations is affected within defined limits by changes in purchased gas costs.
NW Natural absorbs 33 percent of the higher cost of gas sold, or retains 33
percent of the lower cost, in either case as compared to projected costs built
into rates. The remaining 67 percent of the higher or lower gas costs is
recorded as deferred debits or credits (regulatory assets or liabilities) for
recovery from or refund to customers in future rates. Net savings realized from
gas commodity purchases in 2002 contributed $10.8 million of margin, equivalent
to 26 cents a share of earnings. Net savings realized from gas purchases in 2001
totaled $12.3 million, of which $8.2 million was deferred for refund to
customers and $4.1 million was reflected as an increase in margin. These gas
cost savings contributed 10 cents a share to earnings in 2001, while excess gas
costs in 2000 reduced earnings by 7 cents a share.
29
Under an agreement with the OPUC, margin from off-system gas sales
is treated as a reduction of gas costs. These sales reduced the cost of gas sold
by $2.8 million in 2002, $2.6 million in 2001 and $3.0 million in 2000.
Natural gas commodity prices have fluctuated dramatically in recent
years. NW Natural has sought to mitigate the effect of price volatility on core
utility customers through the use of its underground storage facilities, by
entering into gas commodity-based financial hedge contracts, and by crediting
gas costs with margin revenues derived from off-system sales of commodity and
released transportation capacity in periods when core utility customers do not
fully utilize firm pipeline capacity and gas supplies.
Non-utility Operations
----------------------
At Dec. 31, 2002 and 2001, the Company's non-utility operations
consisted of two direct wholly-owned subsidiaries, Financial Corporation and
Northwest Energy, and gas storage operations. One discontinued segment, Canor, a
majority-owned subsidiary, was sold in 2000 (see "Discontinued Segment," below).
Financial Corporation
---------------------
Financial Corporation's operating results in 2002 were net income of
$1.2 million, compared to $0.7 million in 2001 and $0.1 million in 2000. The
increases in net income from 2001 to 2002, and from 2000 to 2001, were due to
improved operating results from Financial Corporation's investments in limited
partnerships in wind and solar electric generation projects in California. The
Company's investment in Financial Corporation at Dec. 31, 2002, was $9.1
million, compared to $7.9 million and $7.2 million at Dec. 31, 2001 and 2000,
respectively.
Northwest Energy
----------------
Northwest Energy was formed in 2001 to serve as the holding company
for NW Natural and PGE if the acquisition of PGE had been completed. Northwest
Energy recorded a loss provision totaling $13.9 million (before tax) in 2002 for
the transaction costs incurred in connection with the effort to acquire PGE.
These charges, equivalent to 33 cents a diluted share, were based upon the
Company's judgment that the acquisition was no longer probable.
Discontinued Segment
--------------------
During 2000, the Company sold its interest in Canor at a gain of
$2.4 million, equivalent to 9 cents a share (see Note 2).
Gas Storage
-----------
NW Natural realized net income from its non-utility gas storage
business segment in 2002, after regulatory sharing and income taxes, of $3.6
million or 14 cents a share, up from $2.1 million or 8 cents a share in 2001 and
$0.1 million or negligible earnings per share in 2000. Gas storage services are
provided to upstream interstate customers using storage capacity that has been
developed in advance of core utility customers' requirements. NW Natural retains
80 percent of the income before tax from gas storage services and credits the
remaining 20 percent to a deferred regulatory account for sharing with its core
utility customers.
Results for the gas storage business segment also include revenues,
net of amounts shared with core utility customers, from a contract with an
independent energy trading company that seeks to optimize the use of NW
Natural's assets by trading temporarily unused portions of its gas storage
capacity and upstream pipeline transportation capacity.
30
Operating Expenses
------------------
Operations and Maintenance
--------------------------
Consolidated operations and maintenance expenses were $1.2 million,
or 1 percent, higher in 2002 than in 2001. The increase was caused primarily by
higher payroll costs due to wage and salary increases ($1.3 million) and higher
expenses for pension ($2.5 million) (see "Financial Condition - Pension Cost
(Income) and Funding Status," below) and health benefits ($1.2 million),
partially offset by an amount charged to a litigation reserve in 2001 ($1.7
million), lower information technology expenses ($1.0 million) and lower
uncollectible accounts expense ($0.5 million).
Consolidated operations and maintenance expenses were $6.1 million,
or 8 percent, higher in 2001 than in 2000. The increase resulted primarily from
higher payroll costs due to wage and salary increases ($1.9 million), higher
costs for employees' health and pension benefits ($1.9 million), a charge to a
litigation reserve resulting from an unfavorable decision by the Oregon Supreme
Court in a case involving a claim by a commercial customer ($1.7 million) and
higher uncollectible accounts expense ($1.0 million).
Taxes Other Than Income Taxes
-----------------------------
Taxes other than income taxes, which are principally comprised of
property, franchise and payroll taxes, increased $1.8 million, or 6 percent, in
2002. Property taxes increased $1.6 million, or 13 percent, due to higher
property tax rates and utility plant additions. Franchise taxes, regulatory fees
and payroll tax expenses accounted for the remaining $0.2 million increase in
2002.
Taxes other than income taxes increased $3.9 million, or 14 percent,
in 2001. Property taxes increased $1.8 million, or 18 percent, due to higher
property tax rates and utility plant additions. Franchise taxes, which are based
on gross revenues, increased $1.5 million, or 12 percent, reflecting higher
revenues due to NW Natural's growing customer base and rate increases effective
in late 2000 and 2001. Regulatory fees and payroll tax expenses accounted for
the remaining $0.6 million increase in 2001.
Depreciation and Amortization
-----------------------------
The Company's depreciation and amortization expense increased by
$2.5 million in 2002 and by $2.2 million in 2001, or about 5 percent in each of
these years, primarily due to corresponding increases in utility plant and
non-utility plant in service.
Depreciation and amortization expense was $3.6 million or about 7
percent lower in 2000 than in 1999, primarily due to charges to depreciation
expense in 1999 to write down NW Natural's customer information system pursuant
to the OPUC's order in its Oregon general rate case concluded in 1999.
As a percentage of average plant and property, depreciation and
amortization expense was 3.5 percent in each of 2002, 2001 and 2000.
Other Income (Expense)
----------------------
The Company's other income (expense) decreased $16.2 million in
2002, primarily due to a $13.9 million charge to a loss provision for costs
incurred in the effort to acquire PGE. Excluding the provision for PGE
acquisition costs, other income (expense) decreased $2.3 million, primarily due
to higher interest accrued on deferred regulatory account balances ($2.6
million), an increase in miscellaneous non-operating expenses ($0.6 million) and
a decrease in miscellaneous non-operating income ($0.3 million), partially
offset by an increase in earnings from investments ($1.3 million).
Other income in 2001 was $1.3 million, or $2.5 million lower than in
2000, primarily due to lower interest income accrued on deferred regulatory
account balances ($1.9 million) and lower miscellaneous non-operating income
($0.6 million).
31
Interest Charges - Net
----------------------
The Company's net interest expense in 2002 was $0.3 million, or 1
percent, higher than in 2001, primarily due to higher average balances of
long-term debt outstanding.
Net interest expense in 2001 was $0.2 million higher than in 2000.
Excluding a $1.0 million charge to interest expense due to an unfavorable
litigation decision, interest expense decreased $0.8 million in 2001 due to
lower average interest rates.
Allowance for Funds Used During Construction (AFUDC) represents the
cost of funds used during the construction of utility plant (see Note 1). In
2002, AFUDC reduced interest expense by $0.6 million compared to $1.0 million in
2001 and $0.8 million in 2000. AFUDC was calculated using weighted average rates
of 2.8 percent in 2002, 6.2 percent in 2001 and 6.0 percent in 2000 (see
"Financial Condition - Cash Flows - Financing Activities," below).
Income Taxes
------------
The effective income tax rate of 34.9 percent in 2002 includes the
effect of the tax benefit from the $13.9 million charge for costs incurred in
the effort to acquire PGE. Absent this charge, the effective tax rate for 2002
would have been 35.6 percent, compared to 35.4 percent for 2001 and 35.9 percent
for 2000 (see Note 8).
Redeemable Preferred and Preference Stock Dividend Requirements
---------------------------------------------------------------
Redeemable preferred and preference stock dividend requirements for
2002, 2001 and 2000 were lower by $0.1 million in each year compared to the
prior year due to annual sinking fund redemptions. On Dec. 31, 2002, NW Natural
redeemed in its entirety the $6.95 Series of Redeemable Preference Stock
pursuant to the mandatory redemption provisions applicable to that Series.
Financial Condition
- -------------------
Capital Structure
-----------------
The Company's goal is to maintain a capital structure comprised of
45 to 50 percent common stock equity, up to 10 percent preferred stock and 45 to
50 percent short-term and long-term debt. When additional capital is required,
debt or equity securities are issued depending upon both the target capital
structure and market conditions. These sources also are used to meet long-term
debt and preferred stock redemption requirements (see Notes 3 and 5).
Liquidity and Capital Resources
-------------------------------
At Dec. 31, 2002, the Company had $7.3 million in cash and cash
equivalents compared to $10.4 million at Dec. 31, 2001. Short-term liquidity is
provided by cash from operations and from the sale of the Company's commercial
paper notes, which are supported by commercial bank lines of credit (see
Note 6). The Company has available through Sept. 30, 2004, committed lines of
credit with four commercial banks (see "Lines of Credit," below). On Dec. 31,
2002, NW Natural redeemed all 250,000 shares of its $6.95 Series of Redeemable
Preference Stock with proceeds from the sale of commercial paper.
32
The following table shows NW Natural's contractual commitments by maturity
and type of commitment:
(Thousands) Long-term Gas Other
Payments Due in Years Commercial Preferred Long-term Capital Operating Supply Purchase
Ending Dec. 31, Paper Stock Debt Leases Leases Commitments Commitments Total
- ---------------------------------------------------------------------------------------------------------------------------------
2003 $ 69,802 $ 750 $ 20,000 $ 180 $ 2,943 $ 78,810 $10,082 $ 182,567
2004 - 750 - 20 2,675 47,600 - 51,045
2005 - 750 15,000 1 2,597 43,583 - 61,931
2006 - 750 8,000 1 1,003 39,147 - 48,901
2007 - 750 29,500 - 301 37,472 - 68,023
-------------------------------------------------------------------------------------------------------
Total 2003 - 2007 69,802 3,750 72,500 202 9,519 246,612 10,082 412,467
Thereafter - 4,500 393,445 - 4,266 160,140 - 562,351
Less: imputed interest - - - (8) - (96,817) - (96,825)
-------------------------------------------------------------------------------------------------------
Total $ 69,802 $ 8,250 $465,945 $ 194 $13,785 $309,935 $10,082 $ 877,993
=======================================================================================================
NW Natural's capital expenditures are primarily related to utility
construction resulting from customer growth and system improvements (see "Cash
Flows - Investing Activities," below). In addition, NW Natural has certain
long-term contractual commitments under capital leases, operating leases and
long-term gas supply purchase contracts that require an adequate source of
funding. NW Natural also has a contract commitment to purchase about $10.1
million in gas transmission pipe in 2003 for use in constructing an extension of
the pipeline from its Mist storage field. These capital and contractual
expenditures are financed through cash from operations and from the issuance of
short-term debt, which is periodically refinanced through the sale of long-term
debt or equity securities.
There are no credit rating triggers or stock price provisions that
require the acceleration of debt repayment under NW Natural's Mortgage and Deed
of Trust or other long-term indebtedness. Also, there are no rating triggers or
stock price provisions contained in contracts or other agreements with third
parties, except for agreements with certain counter-parties under NW Natural's
Derivatives Policy, which require the affected party to provide substitute
collateral such as cash, guaranty or letter of credit if credit ratings are
lowered to non-investment grade, or in some cases if the mark-to-market value
exceeds a certain threshold. At Dec. 31, 2002, the Company had three
commodity-price swap agreements outstanding with one counter-party which was
subject to a below investment grade ratings trigger. The Company has no other
material off-balance sheet obligations, except for certain lease and purchase
commitments (see table above and Note 12).
Commercial Paper
----------------
The Company's primary source of short-term funds is commercial paper
notes payable. Both NW Natural and Financial Corporation issue commercial paper
under agency agreements with a commercial bank. NW Natural's commercial paper is
supported by its committed bank lines of credit (see "Lines of Credit," below),
while Financial Corporation's commercial paper is supported by committed bank
lines of credit and the guaranty of NW Natural (see Note 6). NW Natural had
$69.8 million of commercial paper notes outstanding at Dec. 31, 2002, compared
to $108.3 million at Dec. 31, 2001. Financial Corporation had no commercial
paper notes outstanding at Dec. 31, 2002 or 2001.
Lines of Credit
---------------
NW Natural has lines of credit with four commercial banks totaling
$150 million. Half of the credit with each bank, totaling $75 million, is
committed and available through Sept. 30, 2003, and the other $75 million is
committed and available through Sept. 30, 2004. In addition, Financial
Corporation has available through Sept. 30, 2003, committed lines of credit with
two commercial banks totaling $20 million. Financial Corporation's lines are
supported by the guaranty of NW Natural.
33
Under the terms of these lines of credit, NW Natural and Financial
Corporation pay commitment fees but are not required to maintain compensating
bank balances. The interest rates on borrowings under these lines of credit, if
any, are based on current market rates. There were no outstanding balances under
either NW Natural's or Financial Corporation's lines of credit at Dec. 31, 2002
or 2001.
NW Natural's lines of credit require that credit ratings be
maintained in effect at all times and that notice be given of any change in its
senior unsecured debt ratings. A change in NW Natural's credit rating is not an
event of default, nor is the maintenance of a specific minimum level of credit
rating a condition to drawing upon the lines of credit. However, interest rates
on any loans outstanding under NW Natural's bank lines are tied to credit
ratings, which would increase or decrease the cost of bank debt, if any, when
ratings are changed.
The lines of credit require the Company to maintain an indebtedness
to total capitalization ratio of 65 percent or less and to maintain a net worth
at least equal to 80 percent of its net worth at Sept. 30, 2002, plus 50 percent
of the Company's net income for each subsequent fiscal quarter. Failure to
comply with either of these covenants would entitle the banks to terminate their
lending commitments and to accelerate the maturity of all amounts outstanding.
At Dec. 31, 2002, the Company was in compliance with both of these covenants.
The banks have waived through Sept. 30, 2003, a requirement that NW Natural
represent that the assets dedicated to its qualified pension plans exceed the
unfunded liabilities of the plans before it may draw upon the lines of credit.
NW Natural may be unable to draw upon the two-year portions of the
credit lines, totaling $75 million, until its notes relating to the two-year
commitments are approved by the OPUC or the WUTC, or both. NW Natural expects
that it will be able to secure such approvals, if required.
Cash Flows
----------
Operating Activities
--------------------
Continuing operations provided net cash of $124 million in 2002
compared to $72 million in 2001. The 73 percent increase was due to increased
cash from operations before working capital changes ($5.7 million) and lower
working capital requirements ($47 million). The increase in cash from continuing
operations before working capital changes was due to an increase in deferred
income taxes and investment tax credits in 2002 compared to a reduction in 2001
($22.5 million), the loss provision for the PGE transaction costs ($13.9
million) and higher depreciation and amortization ($2.4 million), largely offset
by a small increase in deferred gas cost payables in 2002 compared to a large
swing from net gas cost receivables to payables in 2001 ($26.5 million), and
lower net income in 2002 ($6.4 million). The decrease in working capital
requirements was due to an increase in accounts payable in 2002 compared to a
decrease in 2001 ($44 million), a decrease in accrued unbilled revenue in 2002
compared to an increase in 2001 ($26 million), and a decrease in accounts
receivable in 2002 compared to an increase in 2001 ($22 million), partially
offset by a decrease in accrued interest and taxes in 2002 compared to an
increase in 2001 ($40 million) and a larger increase in inventories in 2002
($6.2 million).
NW Natural's refunds to customers of approximately $30.2 million of
deferred gas cost savings in 2002 (see "Results of Operations - Comparison of
Gas Operations," above) reduced cash flows from operations by that amount, but
the reduction was more than offset by the other factors affecting cash flows
cited above.
The Job Creation and Worker Assistance Act of 2002 (the Assistance
Act), enacted on March 9, 2002, allows an additional first-year tax deduction
for depreciation equal to 30 percent of the adjusted basis of "qualified
property." The extra 30 percent depreciation deduction in the first year is an
acceleration of depreciation deductions that otherwise would have been taken in
the later years of an asset's recovery period. In general, the extra 30 percent
depreciation deduction is available for most personal property acquired after
Sept. 10, 2001, and before Sept. 11, 2004. The Company anticipates enhanced cash
flow from reduced income taxes, totaling an estimated $25 million to $30
million, during the effective period of the Assistance Act, based on actual and
projected plant investments between Sept. 11, 2001 and Sept. 10, 2004.
34
Continuing operations provided net cash of $72 million in 2001
compared to $87 million in 2000. The 18 percent decrease was due to increased
cash from operations before working capital changes ($8 million), offset by
higher working capital requirements ($24 million). The increase in cash from
continuing operations before working capital changes was due to a larger
decrease in deferred gas costs ($23 million), an increase in income from
continuing operations ($2.4 million) and an increase in depreciation and
amortization in 2001 ($2.2 million), partially offset by a decrease in deferred
investment tax credits and income taxes ($17 million) and a smaller decrease in
regulatory accounts and other ($3 million). The increase in working capital
requirements was due to a decrease in accounts payable ($82.5 million),
partially offset by smaller increases in other current assets and liabilities
($19.5 million), accounts receivable ($13 million), inventories ($10.5 million),
accrued unbilled revenues ($2 million), and a larger increase in accrued
interest and taxes ($13 million).
The Company has lease and purchase commitments relating to its
operating activities that are financed with cash flows from operations (see
"Liquidity and Capital Resources," above, and Note 12).
Investing Activities
--------------------
Cash requirements for investing activities in 2002 totaled $84
million, down from $87 million in 2001, primarily due to lower amounts of cash
used for investments in non-utility property ($6.9 million) and for the PGE
transaction ($5.2 million), partially offset by higher amounts of cash used for
the construction of utility plant ($7.6 million) and lower cash proceeds from
the sale of assets ($2.8 million). Cash requirements for utility construction in
2002 totaled $80 million, up from $72 million in 2001, primarily as a result of
capital expenditures related to NW Natural's pipeline safety program ($4.7
million) and special projects expanding service into new service areas ($3.4
million).
Cash requirements for investing activities in 2001 totaled $87
million, up from $31 million in 2000, primarily due to proceeds from the sales
in 2000 of Canor ($35 million) and a building constructed for the Port of
Portland ($20 million). Cash requirements for utility construction in 2001
totaled $72 million, down $8.5 million from 2000. The decrease in cash
requirements for utility construction in 2001 resulted primarily from the
completion of another phase in the expansion of NW Natural's Mist gas storage
system in 2000 ($8.7 million).
Investments in non-utility property in 2002 ($2.6 million) and 2001
($9.6 million) included expenditures for certain improvements to the Company's
Mist gas storage system that were primarily related to interstate storage
services.
During the five-year period 2003 through 2007, utility construction
expenditures are estimated at between $500 million and $600 million. The level
of capital expenditures over the next five years reflects projected customer
growth, system improvement projects resulting in part from requirements under
the Pipeline Safety Act (see below), and a project estimated to cost $93 million
to extend the pipeline that moves gas from NW Natural's Mist gas storage field
into growing portions of its service area. An estimated 60 percent of the
required funds are expected to be internally generated over the five-year
period; the remainder will be funded through a combination of long-term debt and
equity securities with short-term debt providing liquidity and bridge financing.
NW Natural's utility construction expenditures in 2003 are estimated
to total $148 million, up from $85 million in 2002. Projected utility
construction in 2003 includes $31 million for customer growth, up from $29
million in 2002; $36 million for system improvement and support, up from $25
million in 2002; $55 million for the extension of the Mist pipeline and related
gas storage projects, up from $9 million in 2002; and $6 million for the
construction of a gas distribution system in Coos County, Oregon, up from $1
million in 2002.
The project for the extension of the Mist pipeline has a scheduled
completion date in late 2004 or 2005. Following two years of review of NW
Natural's application, including extensive public involvement, the Oregon Energy
Facility Siting Council granted a permit for the project, with conditions, on
March 13, 2003. The issuance of this permit potentially could be appealed under
current law. NW Natural also must obtain easements and rights-of-way for the
construction of the pipeline and may need to use condemnation proceedings to
secure some of them.
35
The Company entered into a stipulation with the OPUC in 2001 for an
enhanced pipeline safety program that includes an accelerated bare steel
replacement program and a geo-hazard safety program. The bare steel replacement
program accelerates the replacement of the Company's bare steel piping over 20
years instead of 40 years. The geo-hazard safety program includes the
identification, assessment and remediation of risks to the Company's piping
infrastructure created by landslides, washouts, earthquakes or similar
occurrences. The stipulation allowed the Company to receive deferred accounting
rate treatment commencing Oct. 1, 2002, for costs associated with the programs,
expected to be approximately $1.5 million annually.
On Nov. 15, 2002, Congress passed the Pipeline Safety Improvement
Act of 2002 (Pipeline Safety Act) and the legislation was signed into law by
President Bush on Dec. 17, 2002. The Pipeline Safety Act requires operators of
gas transmission pipelines to identify lines located in High Consequence Areas
(HCAs) and develop Integrity Management Programs (IMPs) to periodically inspect
the integrity of the pipelines and make repairs or replacements as necessary to
ensure the ongoing integrity of the pipelines. The legislation requires NW
Natural to complete inspection of the 50 percent highest risk pipelines located
in its HCAs within the first five years, and the remaining covered pipelines
within 10 years of the date of the enactment. The Pipeline Safety Act also
requires re-inspections of the covered pipelines every seven years thereafter
for the life of the pipelines. On Jan. 28, 2003, the U.S. Department of
Transportation issued proposed rules that may impose additional requirements on
pipeline operators that could result in shorter time periods for compliance and
require additional capital investment by the Company. The cost of compliance
with the legislation and rules is uncertain; however, NW Natural's IMP is
expected to cost approximately $5 million to $10 million per year beginning in
2004, and more than $100 million over the next 10 years.
Financing Activities
--------------------
Cash used in financing activities in 2002 totaled $43 million,
compared to cash provided by financing activities in 2001 of $15 million.
Factors contributing to the $58 million difference were a reduction in
short-term debt in 2002 ($38 million) compared to an increase in 2001 ($52
million), the redemption of the $6.95 Series of Preference Stock in 2002 ($25
million), and a higher amount used for the retirement of long-term debt ($40.5
million in 2002 compared to $20 million in 2001), partially offset by an
increase in long-term debt issued ($90 million in 2002 compared to $18 million
in 2001) and a reduction in common stock repurchased ($5.8 million).
Cash provided by financing activities in 2001 totaled $15 million,
compared to cash used in financing activities in 2000 of $55 million. Factors
contributing to the $70 million difference were a lower amount used for the
retirement of long-term debt ($20 million in 2001 compared to $60 million in
2000) and an increase in short-term debt in 2001 ($52 million) compared to a
reduction in short-term debt in 2000 ($38 million), partially offset by a
reduction in long-term debt issued ($18 million in 2001 compared to $75 million
in 2000).
NW Natural sold $90 million of its secured Medium-Term Notes, Series
B (MTNs), in 2002 and used the proceeds to reduce long-term debt ($40.5
million), provide cash for investments in utility plant and reduce short-term
borrowings.
NW Natural sold $18 million of its secured MTNs in 2001 and used the
proceeds, together with a $52 million increase in short-term borrowings, to
reduce long-term debt ($20 million) and provide cash for investments in utility
plant.
In 2000, NW Natural commenced a program to repurchase up to 2
million shares, or up to $35 million in value, of NW Natural's common stock
through a repurchase program that has been extended through May 2003. The
purchases are made in the open market or through privately negotiated
transactions. The Company used $5.8 million for the repurchase of 246,700 shares
under the program in 2001. No shares were repurchased in 2002. Since the
program's inception the Company has repurchased 355,400 shares of common stock
at a total cost of $8.2 million.
36
Pension Cost (Income) and Funding Status
----------------------------------------
Net periodic pension costs are determined in accordance with SFAS
No. 87, "Employers' Accounting for Pensions" (see "Application of Critical
Accounting Policies - Accounting for Pensions," above). The annual pension cost
or income is allocated between operations and maintenance expense and
construction overhead.
Net periodic pension income was $0.1 million, $4.1 million and $5.4
million in 2002, 2001 and 2000, respectively. No cash contributions to NW
Natural's qualified defined benefit pension plans were required for the 2002
plan year. The fair value of the plan assets declined from $169 million at Dec.
31, 2001, to $143 million at Dec. 31, 2002, including $15 million in investment
losses, $10 million in withdrawals to pay benefits and $1 million in eligible
expenses of the plans. The present value of benefit obligations under the plans
increased from an estimated $156 million to $172 million over that period.
Despite the reduced pension income in 2002 and 2001, and the recent
reductions in the funded status of the plans, NW Natural believes it will be
able to maintain well-funded pension plans. NW Natural expects to be required to
make cash contributions estimated at $1.9 million to the plans for the 2003 plan
year, payable by September 2004, but it does not expect these or future cash
contributions to have a material adverse effect on its liquidity or financial
condition.
Ratios of Earnings to Fixed Charges
-----------------------------------
For the years ended Dec. 31, 2002, 2001 and 2000, the Company's
ratios of earnings to fixed charges, computed using the Securities and Exchange
Commission method, were 2.85, 3.14 and 3.14, respectively. For this purpose,
earnings consist of net income before taxes plus fixed charges, and fixed
charges consist of interest on all indebtedness, the amortization of debt
expense and discount or premium and the estimated interest portion of rentals
charged to income.
Contingent Liabilities
- ----------------------
Environmental Matters
---------------------
NW Natural owns property in Multnomah County, Oregon that is the
site of a former gas manufacturing plant that was closed in 1956 (the Gasco
site). The Gasco site has been under investigation by NW Natural for
environmental contamination under the Oregon Department of Environmental
Quality's (ODEQ) Voluntary Clean-Up Program. NW Natural has recorded liabilities
totaling $4.0 million for the estimated costs of investigation and interim
remediation at the Gasco site, including consultants' fees, ODEQ oversight
reimbursement and legal fees, of which $3.2 million had been spent as of Dec.
31, 2002.
NW Natural previously owned property adjacent to the Gasco site that
now is the location of a manufacturing plant owned by Wacker Siltronic
Corporation (the Wacker site). In 2000, the ODEQ issued an order requiring
Wacker and NW Natural to determine the nature and extent of releases of
hazardous substances to Willamette River sediments from the Wacker site. NW
Natural has completed the majority of the studies required under the ODEQ work
plan and the agency is reviewing data generated by the studies. NW Natural has
recorded a liability of $0.3 million for its estimated costs of the
investigation and initial remediation on the Wacker site, of which $0.2 million
had been spent as of Dec. 31, 2002.
In 1998, the ODEQ and the U.S. Environmental Protection Agency (EPA)
completed a study of sediments in a 5.5-mile segment of the Willamette River
(the Portland Harbor) that includes the area adjacent to the Gasco site and the
Wacker site. In 2000, the EPA listed the Portland Harbor as a Superfund site and
notified the Company that it is a potentially responsible party. NW Natural
recorded liabilities totaling $2.3 million between 2000 and 2002, of which $1.1
million had been spent as of Dec. 31, 2002. The amount of NW Natural's liability
is based on estimates of the Company's share of the lower end of a range of
probable liability for the costs of the Remedial Investigation/Feasibility Study
for the Portland Harbor. Available information is insufficient to determine
37
either the total amount of liability for investigation and remediation of the
Portland Harbor or the higher end of a range for NW Natural's estimated share of
that liability.
The City of Portland has notified NW Natural that it is planning a
sewer improvement project that would include excavation within the former site
of a gas manufacturing plant (the Portland Gas site) that was owned and operated
by a predecessor of the Company between 1860 and 1913. The preliminary
assessment of this site performed by a consultant for the EPA in 1987 indicated
that it could be assumed that by-product tars may have been disposed of on site.
The report concluded, however, that it is likely that waste residues from the
plant, if present on the site, were covered by deep fill during construction of
the nearby seawall bordering the Willamette River and probably have stabilized
due to physical and chemical processes. Neither the City of Portland nor the
ODEQ has notified NW Natural whether a further investigation or potential
remediation might be required on the site in connection with the sewer project.
Available information is insufficient to determine either the total amount of
liability or a probable range, if any, of potential liability.
NW Natural has accrued all material loss contingencies relating to
environmental matters that it believes to be probable of assertion and
reasonably estimable. Due to the preliminary nature of these environmental
investigations, the range of any additional possible loss contingency cannot be
currently estimated. NW Natural expects that its costs of further investigation
and remediation for which it may be responsible with respect to the Gasco site,
the Wacker site, the Portland Harbor site and the Portland Gas site, if any,
should be recoverable, in large part, from insurance. At Dec. 31, 2002, NW
Natural had a $2.5 million receivable representing an estimate of the
environmental costs NW Natural expects to recover from insurance, including $1.4
million that was recorded in 2000 for costs relating to the Gasco site and $1.1
million that was recorded in 2002 for costs relating to the Portland Harbor
site. In the event these costs are not recovered from insurance, NW Natural will
seek recovery through future rates.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's primary market risk exposures associated with
activities involving derivative financial instruments and other financial
instruments are natural gas commodity price risk, foreign currency exchange risk
and interest rate risk. Derivative financial instruments are used as tools to
mitigate certain of these market risks (see Note 11). Such instruments are used
for hedging purposes, not for trading purposes. Market risks associated with the
derivative financial instruments are monitored by management personnel who do
not directly enter into these contracts and by the Audit Committee of the Board
of Directors.
Physical and Financial Commodity, Foreign Currency and Interest Rate
Transactions
--------------------------------------------------------------------
NW Natural enters into short-term and long-term natural gas purchase
contracts with demand and commodity fixed-price and floating-price components,
along with associated short-term and long-term natural gas transportation
contracts. Foreign currency forward contracts are used to hedge against foreign
exchange rate fluctuations on purchases made under these contracts that are
denominated in Canadian dollars.
Historically, NW Natural has taken physical delivery of at least the
minimum quantities specified in its natural gas purchase contracts. The
contracts are subject to annual re-pricing, a process that is intended to
reflect anticipated market price trends during the next year. NW Natural's PGA
mechanism in Oregon provides for the recovery from customers of actual commodity
costs in comparison with established benchmark costs, except that NW Natural
absorbs 33 percent of the higher cost of gas sold, or retains 33 percent of the
lower cost, in either case as compared to projections.
At Dec. 31, 2002, differences between notional values and fair
values with respect to NW Natural's open positions in derivative financial
instruments were not material to the Company's financial position or results of
operations because of the treatment of these instruments in regulatory
mechanisms relating to gas costs (see "Results of Operations - Comparison of Gas
Operations - Cost of Gas," above, and Notes 1 and 11). However, to the degree
that market risks exist due to potential adverse changes in commodity prices and
foreign exchange rates in relation to these financial and physical contracts,
the Company considers the risks to be:
38
Commodity Price Risk
--------------------
The prices of natural gas commodity are subject to fluctuations due
to unpredictable factors including weather, pipeline transportation congestion
and other factors that affect short-term supply and demand. Natural gas
commodity swaps and call option contracts are used to convert certain long-term
gas purchase contracts from floating prices to fixed prices. At Dec. 31, 2002
and 2001, notional amounts under natural gas commodity swaps and call option
contracts totaled $180.6 million and $260.6 million, respectively. As of Dec.
31, 2002, two commodity agreements extended beyond Dec. 31, 2003. If all of the
commodity swaps and call option contracts had been settled on Dec. 31, 2002, a
gain of $12.6 million would have been realized (see Note 11).
Foreign Currency Risk
---------------------
The costs of natural gas commodity and certain pipeline services
purchased from Canadian suppliers are subject to changes in the value of
Canadian currency in relation to U.S. currency. Foreign currency forward
contracts are used to hedge against fluctuations in exchange rates with respect
to purchases of natural gas from Canadian suppliers. At Dec. 31, 2002 and 2001,
notional amounts under foreign currency forward contracts totaled $15.5 million
and $10.2 million, respectively. As of Dec. 31, 2002, no foreign currency
forward contracts extended beyond Dec. 31, 2003. If all of the foreign currency
forward contracts had been settled on Dec. 31, 2002, a loss of $0.2 million
would have been realized (see Note 11).
Interest Rate Risk
------------------
Interest rate risk relates to new debt financing needed to fund
capital requirements, including maturing debt securities, and to the issuance of
commercial paper. Interest rate risk is managed through the issuance of
fixed-rate debt with varying maturities and the reduction of debt through
optional redemption when interest rates are favorable. No derivative financial
instruments to hedge interest rates were in place at Dec. 31, 2002 or 2001.
Forward-Looking Statements
- --------------------------
This report and other presentations made by the Company from time to
time may contain forward-looking statements within the meaning of Section 21E of
the Securities Exchange Act of 1934, as amended. Forward-looking statements
include statements concerning plans, objectives, goals, strategies, future
events or performance, and other statements that are other than statements of
historical facts. The Company's expectations, beliefs and projections are
expressed in good faith and are believed to have a reasonable basis. However,
each such forward-looking statement involves uncertainties and is qualified in
its entirety by reference to the following important factors, among others, that
could cause the actual results of the Company to differ materially from those
projected in such forward-looking statements: (i) prevailing state and federal
governmental policies and regulatory actions, including those of the OPUC and
the WUTC, with respect to allowed rates of return, industry and rate structure,
purchased gas and investment recovery, acquisitions and dispositions of assets
and facilities, operation and construction of plant facilities, the maintenance
of pipeline integrity, present or prospective wholesale and retail competition,
changes in tax laws and policies and changes in and compliance with
environmental and safety laws, regulations and policies; (ii) weather conditions
and other natural phenomena; (iii) unanticipated population growth or decline,
and changes in market demand and demographic patterns; (iv) competition for
retail and wholesale customers; (v) pricing of natural gas relative to other
energy sources; (vi) risks resulting from uninsured property damage to Company
property, intentional or otherwise; (vii) unanticipated changes in interest or
foreign currency exchange rates or in rates of inflation; (viii) economic
factors that could cause a severe downturn in certain key industries, thus
affecting demand for natural gas; (ix) unanticipated changes in operating
expenses and capital expenditures; (x) unanticipated changes in future
liabilities relating to employee benefit plans; (xi) capital market conditions,
including their effect on pension costs; (xii) competition for new energy
development opportunities; (xiii) potential inability to obtain permits, rights
of way, easements or other necessary authority to construct pipelines or other
system expansions; and (xiv) legal and administrative proceedings and
settlements. All subsequent forward-looking statements, whether written or oral
and whether made by or on behalf of the Company, also are expressly qualified by
these cautionary statements.
39
Any forward-looking statement speaks only as of the date on which
such statement is made, and the Company undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which such statement is made or to reflect the occurrence of unanticipated
events. New factors emerge from time to time and it is not possible for the
Company to predict all such factors, nor can it assess the impact of each such
factor or the extent to which any factor, or combination of factors, may cause
results to differ materially from those contained in any forward-looking
statement.
40
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
TABLE OF CONTENTS
Page
----
1. Management's Responsibility for Financial Statements................ 42
2. Report of Independent Accountants................................... 43
3. Consolidated Financial Statements:
Consolidated Statements of Income for the Years Ended
December 31, 2002, 2001 and 2000.................................... 44
Consolidated Statements of Earnings Invested in the Business
for the Years Ended December 31, 2002, 2001 and 2000................ 45
Consolidated Balance Sheets, December 31, 2002 and 2001............. 46
Consolidated Statements of Cash Flows for the Years
Ended December 31, 2002, 2001 and 2000.............................. 48
Consolidated Statements of Capitalization, December 31,
2002 and 2001 ...................................................... 49
Notes to Consolidated Financial Statements.......................... 50
4. Quarterly Financial Information (unaudited)......................... 73
5. Supplementary Data for the Years Ended December 31, 2002,
2001 and 2000:
Financial Statement Schedule
Schedule II - Valuation and Qualifying Accounts and Reserves........ 74
Supplemental Schedules Omitted
All other schedules are omitted because of the absence of the conditions under
which they are required or because the required information is included
elsewhere in the financial statements.
41
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS
----------------------------------------------------
The financial statements in this report were prepared by management,
which is responsible for their objectivity and integrity. The statements have
been prepared in conformity with generally accepted accounting principles in the
United States of America and, where appropriate, reflect informed estimates
based on judgments of management. The responsibility of the Company's
independent accountants is to render an independent report on the financial
statements.
The Company's system of internal accounting controls is designed to
provide reasonable assurance that assets are safeguarded and transactions are
executed in accordance with management's authorizations, that transactions are
recorded to permit the preparation of financial statements in conformity with
orders of regulatory authorities and generally accepted accounting principles in
the United States of America and that accountability for assets is maintained.
The Company's system of internal controls has provided such reasonable
assurances during the periods reported herein. The system includes written
policies, procedures and guidelines, an organization structure that segregates
duties and an established program for monitoring the system by internal
auditors. In addition, the Company has prepared and annually distributes to its
employees a Code of Ethics covering its policies for conducting business affairs
in a lawful and ethical manner. In February 2003, the Board of Directors
approved a Financial Code of Ethics covering all senior financial executives and
managers. Ongoing review programs are carried out to ensure compliance with
these policies.
The Board of Directors, through its Audit Committee (the Committee),
oversees management's financial reporting responsibilities. The Committee meets
regularly with management, the internal auditors, and representatives of the
Company's independent accountants. Both internal auditors and independent
accountants have free and independent access to the Committee and the Board of
Directors. Each member of the Committee meets the requirements of "independent
director" as defined by New York Stock Exchange Listing Standards. The Committee
reports the results of its activities to the full Board of Directors. Annually,
the Committee selects the independent accountants.
/s/ Mark S. Dodson
------------------------------------
Mark S. Dodson
President and
Chief Executive Officer
/s/ Bruce R. DeBolt
-------------------------------------------------
Bruce R. DeBolt
Senior Vice President, Finance,
and Chief Financial Officer
42
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Northwest Natural Gas Company
In our opinion, the consolidated financial statements listed in the accompanying
table of contents present fairly, in all material respects, the financial
position of Northwest Natural Gas Company and its subsidiaries (the "Company")
at December 31, 2002 and 2001, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 2002 in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule listed in
the accompanying table of contents presents fairly, in all material respects,
the information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements and
financial statement schedule based on our audits. We conducted our audits of
these statements in accordance with auditing standards generally accepted in the
United States of America, which 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, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
As discussed in Notes 1 and 11 to the consolidated financial statements, the
Company changed its method of accounting for derivative instruments as of
January 1, 2001.
/s/PricewaterhouseCoopers LLP
- -----------------------------
Portland, Oregon
February 14, 2003
43
NORTHWEST NATURAL GAS COMPANY
CONSOLIDATED STATEMENTS OF INCOME
Thousands, except per share amounts (year ended December 31) 2002 2001 2000
- -----------------------------------------------------------------------------------------------
Operating revenues:
Gross operating revenues $641,376 $650,252 $532,110
Cost of sales 353,832 374,241 274,160
-------- -------- --------
Net operating revenues 287,544 276,011 257,950
Operating expenses:
Operations and maintenance 85,120 83,920 77,817
Taxes other than income taxes 34,076 32,240 28,351
Depreciation and amortization 52,090 49,640 47,440
-------- -------- --------
Total operating expenses 171,286 165,800 153,608
-------- -------- --------
Income from continuing operations 116,258 110,211 104,342
Other income (expense) (14,890) 1,334 3,860
Interest charges - net 34,132 33,805 33,561
-------- -------- --------
Income before income taxes 67,236 77,740 74,641
Income taxes 23,444 27,553 26,829
-------- -------- --------
Net income from continuing operations 43,792 50,187 47,812
Discontinued segment:
Gain on sale of discontinued segment - net of tax - - 2,412
-------- -------- --------
Net income 43,792 50,187 50,224
Redeemable preferred and preference stock
dividend requirements 2,280 2,401 2,456
-------- -------- --------
Earnings applicable to common stock $ 41,512 $ 47,786 $ 47,768
======== ======== ========
Average common shares outstanding 25,431 25,159 25,183
Basic earnings per share of common stock:
From continuing operations $ 1.63 $ 1.90 $ 1.80
From gain on sale of discontinued segment - - 0.10
-------- -------- --------
Total basic earnings per share $ 1.63 $ 1.90 $ 1.90
======== ======== ========
Diluted earnings per share of common stock:
From continuing operations $ 1.62 $ 1.88 $ 1.79
From gain on sale of discontinued segment - - 0.09
-------- -------- --------
Total diluted earnings per share $ 1.62 $ 1.88 $ 1.88
======== ======== ========
Dividends per share of common stock $ 1.26 $ 1.245 $ 1.24
======== ======== ========
------------------------------------
See Notes to Consolidated Financial Statements.
44
NORTHWEST NATURAL GAS COMPANY
CONSOLIDATED STATEMENTS OF EARNINGS INVESTED IN THE BUSINESS
Thousands (year ended December 31) 2002 2001 2000
- --------------------------------------------------------------------------------------------------------------------
Earnings invested in the business:
Balance at beginning of year $147,950 $134,189 $118,711
Net income 43,792 $ 43,792 50,187 $ 50,187 50,224 $ 50,224
Cash dividends paid:
Redeemable preferred and
preference stock (2,579) (2,410) (2,466)
Common stock (32,024) (31,307) (31,198)
Common stock repurchased - (2,688) (1,080)
Common stock expense (3) (21) (2)
--------- -------- --------
Balance at end of year $157,136 $147,950 $134,189
========= ======== ========
Accumulated other comprehensive
income (loss):
Balance at beginning of year $ (375) $ - $ (3,181)
Other comprehensive income (loss)
- net of tax:
Recognition of foreign currency
translation adjustment
included in gain on sale of
discontinued segment - - - - 3,181 3,181
Minimum pension liability
adjustment (2,936) (2,936) (148) (148) - -
Change in unrealized loss from
price risk management
activities 227 227 (227) (227) - -
-------- -------- -------- -------- -------- --------
Comprehensive income $ 41,083 $ 49,812 $ 53,405
======== ======== ========
Balance at end of year $ (3,084) $ (375) $ -
======== ======== ========
------------------------------------
See Notes to Consolidated Financial Statements.
45
NORTHWEST NATURAL GAS COMPANY
CONSOLIDATED BALANCE SHEETS
Thousands (December 31) 2002 2001
- --------------------------------------------------------------------------------
Assets:
Plant and property:
Utility plant $1,539,965 $1,465,079
Less accumulated depreciation 560,798 514,299
---------- ----------
Utility plant - net 979,167 950,780
---------- ----------
Non-utility property 20,832 18,203
Less accumulated depreciation and
amortization 4,404 4,007
---------- ----------
Non-utility property - net 16,428 14,196
---------- ----------
Total plant and property 995,595 964,976
---------- ----------
Other investments 12,703 23,233
---------- ----------
Current assets:
Cash and cash equivalents 7,328 10,440
Accounts receivable, less allowance for
uncollectible accounts of $1,815 in
2002 and $1,962 in 2001 46,936 64,722
Accrued unbilled revenue 44,069 57,749
Inventories of gas, materials and supplies 58,030 49,337
Prepayments and other current assets 37,645 28,086
---------- ----------
Total current assets 194,008 210,334
---------- ----------
Regulatory assets:
Income tax asset 47,975 48,469
Unamortized loss on debt redemption 6,508 6,970
Unrealized loss on non-trading derivatives - 111,641
Other 7,040 5,302
---------- ----------
Total regulatory assets 61,523 172,382
---------- ----------
Other assets:
Investment in life insurance 54,916 53,033
Fair value of non-trading derivatives 12,426 -
Other 11,620 11,064
---------- ----------
Total other assets 78,962 64,097
---------- ----------
Total assets $1,342,791 $1,435,022
========== ==========
-----------------------------------
See Notes to Consolidated Financial Statements.
46
NORTHWEST NATURAL GAS COMPANY
CONSOLIDATED BALANCE SHEETS
Thousands (December 31) 2002 2001
- ------------------------------------------------------------------------------
Capitalization and liabilities:
Capitalization (see Consolidated Statements of
Capitalization):
Common stock $ 81,023 $ 79,889
Premium on common stock 248,028 240,697
Earnings invested in the business 157,136 147,950
Accumulated other comprehensive income (loss) (3,084) (375)
---------- ----------
Total common stock equity 483,103 468,161
---------- ----------
Redeemable preference stock - 25,000
Redeemable preferred stock 8,250 9,000
Long-term debt 445,945 378,377
---------- ----------
Total capitalization 937,298 880,538
---------- ----------
Current liabilities:
Notes payable 69,802 108,291
Accounts payable 74,436 70,698
Long-term debt due within one year 20,000 40,000
Taxes accrued 7,822 22,539
Interest accrued 2,902 3,658
Other current and accrued liabilities 30,045 28,396
---------- ----------
Total current liabilities 205,007 273,582
---------- ----------
Regulatory liabilities:
Customer advances 1,791 1,985
Deferred gas costs payable 10,635 10,089
Unrealized gain on non-trading derivatives 12,426 -
---------- ----------
Total regulatory liabilities 24,852 12,074
---------- ----------
Other liabilities:
Deferred income taxes 141,732 130,424
Deferred investment tax credits 7,824 8,682
Fair value of non-trading derivatives - 111,868
Other 26,078 17,854
---------- ----------
Total other liabilities 175,634 268,828
---------- ----------
Commitments and contingencies (see Note 12) - -
---------- ----------
Total capitalization and liabilities $1,342,791 $1,435,022
========== ==========
-----------------------------------
See Notes to Consolidated Financial Statements.
47
NORTHWEST NATURAL GAS COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Thousands (year ended December 31) 2002 2001 2000
- ---------------------------------------------------------------------------------------------
Operating activities:
Net income from continuing operations $ 43,792 $ 50,187 $ 47,812
Adjustments to reconcile net income to
cash provided by continuing operations:
Depreciation and amortization 52,090 49,640 47,440
Gain on sale of assets (221) - (491)
Loss provision for PGE acquisition costs 13,873 - -
Minimum pension liability adjustment (2,936) (148) -
Unrealized gain (loss) from price risk
management activities 227 (227) -
Deferred income taxes and investment tax
credits 10,450 (12,088) 4,651
Equity in (earnings) losses of investments (988) 321 221
Allowance for funds used during construction (550) (959) (789)
Deferred gas costs - net 546 27,062 3,977
Other 4,582 1,345 4,333
--------- ---------- ----------
Cash from continuing operations before
working capital changes 120,865 115,133 107,154
Changes in operating assets and liabilities:
Accounts receivable - net of
uncollectible accounts 17,786 (3,969) (17,404)
Accrued unbilled revenue 13,680 (12,130) (14,069)
Inventories of gas, materials and
supplies (8,693) (2,454) (12,964)
Accounts payable 3,738 (40,000) 42,535
Accrued interest and taxes (24,725) 15,435 1,988
Other current assets and liabilities 1,176 (494) (20,000)
--------- ---------- ----------
Cash provided by continuing operating
activities 123,827 71,521 87,240
Investing activities:
Acquisition and construction of utility plant
assets (79,530) (71,943) (80,444)
Investment in non-utility property (2,629) (9,554) (6,923)
PGE acquisition costs (4,316) (9,557) -
Proceeds from sale of discontinued segment - - 34,756
Proceeds from sale of assets 500 3,256 21,012
Other investments 1,848 529 610
--------- ---------- ----------
Cash used in investing activities (84,127) (87,269) (30,989)
Financing activities:
Common stock issued 6,533 5,157 4,826
Common stock repurchased - (5,792) (2,441)
Redeemable preferred stock retired (750) (750) (814)
Redeemable preference stock retired (25,000) - -
Long-term debt issued 90,000 18,000 75,000
Long-term debt retired (40,500) (20,000) (60,000)
Change in short-term debt (38,489) 52,028 (37,886)
Cash dividend payments:
Redeemable preferred and preference
stock (2,579) (2,410) (2,466)
Common stock
(32,024) (31,307) (31,198)
Common stock expense (3) (21) (2)
--------- ---------- ----------
Cash provided by (used in) financing
activities (42,812) 14,905 (54,981)
Increase (decrease) in cash and cash equivalents (3,112) (843) 1,270
Cash and cash equivalents - beginning of year 10,440 11,283 10,013
--------- ---------- ----------
Cash and cash equivalents - end of year $ 7,328 $ 10,440 $ 11,283
========= ========== ==========
- ---------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 34,640 $ 33,034 $ 35,592
Income taxes $ 33,474 $ 25,201 $ 22,552
- ---------------------------------------------------------------------------------------------
Supplemental disclosure of non-cash financing activities:
Conversion to common stock:
7-1/4 % Series of Convertible Debentures $ 1,932 $ 413 $ 589
------------------------------------
See Notes to Consolidated Financial Statements
48
NORTHWEST NATURAL GAS COMPANY
CONSOLIDATED STATEMENTS OF CAPITALIZATION
Thousands, except share amounts (December 31) 2002 2001
- --------------------------------------------------------------------------------------------
Common stock equity:
Common stock - par value $3-1/6 per share,
authorized 60,000,000 shares:
outstanding - 2002, 25,586,313 shares; 2001,
25,228,074 shares $ 81,023 $ 79,889
Premium on common stock 248,028 240,697
Earnings invested in the business 157,136 147,950
Accumulated other comprehensive income (loss) (3,084) (375)
-------- --------
Total common stock equity 483,103 51% 468,161 53%
-------- --------
Redeemable preference stock, authorized 2,000,000
shares;
$6.95 Series, stated value $100 per share:
outstanding - 2002, none; 2001, 250,000 shares - - 25,000 3%
Redeemable preferred stock, authorized 1,500,000
shares;
$7.125 Series, stated value $100 per share:
outstanding - 2002, 82,500 shares;
2001, 90,000 shares 8,250 1% 9,000 1%
Long-term debt:
Medium-Term Notes
-----------------
First Mortgage Bonds:
8.050% Series A due 2002 - 10,000
6.750% Series B due 2002 - 10,000
5.550% Series B due 2002 - 20,000
6.400% Series B due 2003 20,000 20,000
6.340% Series B due 2005 5,000 5,000
6.380% Series B due 2005 5,000 5,000
6.450% Series B due 2005 5,000 5,000
6.050% Series B due 2006 8,000 8,000
6.310% Series B due 2007 20,000 -
6.800% Series B due 2007 9,500 10,000
6.500% Series B due 2008 5,000 5,000
7.450% Series B due 2010 25,000 25,000
6.665% Series B due 2011 10,000 10,000
7.130% Series B due 2012 40,000 -
8.260% Series B due 2014 10,000 10,000
7.000% Series B due 2017 40,000 40,000
6.600% Series B due 2018 22,000 22,000
8.310% Series B due 2019 10,000 10,000
7.630% Series B due 2019 20,000 20,000
9.050% Series A due 2021 10,000 10,000
7.250% Series B due 2023 20,000 20,000
7.500% Series B due 2023 4,000 4,000
7.520% Series B due 2023 11,000 11,000
7.720% Series B due 2025 20,000 20,000
6.520% Series B due 2025 10,000 10,000
7.050% Series B due 2026 20,000 20,000
7.000% Series B due 2027 20,000 20,000
6.650% Series B due 2027 20,000 20,000
6.650% Series B due 2028 10,000 10,000
7.740% Series B due 2030 20,000 20,000
7.850% Series B due 2030 10,000 10,000
5.820% Series B due 2032 30,000 -
Convertible Debentures
----------------------
7-1/4% Series due 2012 6,445 8,377
-------- --------
465,945 418,377
Less long-term debt due within one year 20,000 40,000
-------- --------
Total long-term debt 445,945 48% 378,377 43%
-------- ---- -------- ----
Total capitalization $937,298 100% $880,538 100%
======== ==== ======== ====
------------------------------------
See Notes to Consolidated Financial Statements.
49
Northwest Natural Gas Company
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
- ----------------------------------------------
Organization and Principles of Consolidation
- --------------------------------------------
The consolidated financial statements include:
Regulated utility:
Northwest Natural Gas Company (NW Natural)
Non-regulated wholly-owned subsidiary businesses:
NNG Financial Corporation (Financial Corporation),
and its wholly-owned subsidiaries
Northwest Energy Corporation (Northwest Energy),
and its wholly-owned subsidiary
Non-regulated majority-owned subsidiary business:
Canor Energy, Ltd. (Canor), sold in 2000
Together these businesses are referred to herein as the "Company."
Intercompany accounts and transactions have been eliminated.
Investments in corporate joint ventures and partnerships in which the
Company's ownership interest is 50 percent or less and over which the
Company does not exercise control are accounted for by the equity method
or the cost method (see Note 9).
Certain amounts from prior years have been reclassified to conform with
the 2002 presentation. These reclassifications had no impact on prior year
results of operations.
Use of Estimates
- ----------------
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States of America requires
management to make estimates and assumptions that affect reported amounts
in the consolidated financial statements and accompanying notes. Actual
amounts could differ from those estimates and changes would be reported in
future periods. Management believes that the estimates used are
reasonable.
Industry Regulation
- -------------------
The Company's principal business is the distribution of natural gas which
is regulated by the Oregon Public Utility Commission (OPUC) and the
Washington Utilities and Transportation Commission (WUTC). Accounting
records and practices conform to the requirements and uniform system of
accounts prescribed by these regulatory authorities in accordance with
Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for
the Effects of Certain Types of Regulation."
In applying SFAS No. 71, NW Natural has capitalized certain costs and
benefits as regulatory assets and liabilities pursuant to orders of the
OPUC or WUTC in general rate or expense deferral proceedings, to provide
for recovery of revenues or expenses from, or refunds to, utility
customers in future periods. At Dec. 31, 2002 and 2001, regulatory tax
assets were $48.0 million and $48.5 million, respectively, while other
regulatory assets and liabilities (net) were net liabilities of $11.3
million and net assets of $111.8 million, respectively.
If NW Natural should determine in the future that all or a portion of
these regulatory assets and liabilities no longer meet the criteria for
continued application of SFAS No. 71, then it would be required to write
off the net unrecoverable balances of its regulatory assets and
liabilities as a charge to income.
50
Recent Accounting Pronouncements
- --------------------------------
In August 2001, the Financial Accounting Standards Board (FASB) issued
SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143,
which is effective for fiscal years beginning after June 15, 2002,
requires that obligations associated with the retirement of a tangible
long-lived asset be recorded as a liability when those obligations are
incurred, with the amount of the liability initially measured at fair
value. The liability for the asset retirement obligation is recorded as a
capitalized cost increasing the carrying amount of the related long-lived
asset. Over time, the liability is accreted to its present value each
period and the capitalized cost is depreciated over the useful life of the
related asset.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statement
Nos. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical
Corrections," effective for financial statements issued for fiscal years
beginning after May 15, 2002. SFAS No. 145, which updates, clarifies and
simplifies existing accounting pronouncements, addresses the reporting of
debt extinguishments and accounting for certain lease modifications that
have economic effects that are similar to sale-leaseback transactions.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which replaces Emerging
Issues Task Force Issue No. 94-3, "Liability Recognition for Certain
Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS No. 146
requires companies to recognize costs associated with exit or disposal
activities, such as lease termination costs and certain employee severance
costs, when they are incurred rather than at the date of a commitment to
an exit or disposal plan. The primary effect of applying SFAS No. 146,
which is effective for all exit or disposal activities initiated after
Dec. 31, 2002, will be on the timing of recognition of costs associated
with exit or disposal activities.
The Company is currently evaluating the impact of the adoption of SFAS
Nos. 143, 145 and 146 upon its financial condition and results of
operations.
Adoption of New Accounting Standards
- ------------------------------------
Effective Jan. 1, 2002, the Company adopted SFAS No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets."
SFAS No. 141 requires business combinations initiated after June 30, 2001
to be accounted for using the purchase method of accounting. It also
specifies the types of acquired intangible assets that are required to be
recognized and reported separately from goodwill. SFAS No. 142 requires
goodwill, of which the Company had none as of Dec. 31, 2002, and other
intangibles with indefinite lives to be tested for impairment at least
annually rather than being amortized as previously required. The adoption
of SFAS No. 141 and SFAS No. 142 had no impact on the Company's financial
condition or results of operations.
The Company also adopted SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets," effective Jan. 1, 2002. SFAS No. 144
establishes a single accounting model for recognition and measurement of
the impairment of long-lived assets to be held and used, the measurement
of long-lived assets to be disposed of by sale and for segments of a
business to be disposed of. SFAS No. 144 also expands the scope of
discontinued operations to include all components of an entity that can be
distinguished from the rest of the entity and will be eliminated from the
ongoing operations of the entity in a disposal transaction. The adoption
of SFAS No. 144 had no impact on the Company's financial condition or
results of operations.
On Dec. 31, 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation-Transition and Disclosure." SFAS No. 148 amends
FASB No. 123, "Accounting for Stock-Based Compensation," to provide
alternative methods of transition for companies that voluntarily change to
the fair-value-based method of accounting for stock-based employee
compensation. In addition, SFAS No. 148 amends the disclosure requirements
51
of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on
reported results. The Company has adopted the SFAS No. 148 disclosure
requirements but continues to apply Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees," to account for
its stock-based compensation plans (see Note 4).
Utility Plant and Depreciation
- ------------------------------
Utility plant for NW Natural is stated at cost (see Note 9). When a
depreciable unit of utility plant is retired, the cost is removed from
both utility plant and accumulated depreciation together with the cost of
removal, less any salvage. No gain or loss is recognized upon normal
retirement.
NW Natural's provision for depreciation of utility property, which is
computed under the straight-line, age-life method in accordance with
independent engineering studies and as approved by regulatory authorities,
approximated 3.5 percent of average depreciable plant in each of 2002,
2001 and 2000. The depreciation rate approximates the economic life of the
utility property.
Allowance for Funds Used During Construction
- --------------------------------------------
Certain additions to utility plant include an allowance for funds used
during construction (AFUDC). AFUDC represents the cost of funds borrowed
during construction and is calculated using actual commercial paper
interest rates. If commercial paper borrowings are less than the total
costs of construction work in progress, then a composite rate of interest
on all debt, shown as a reduction to interest charges, and a return on
equity funds, shown as other income, is used to compute AFUDC. While cash
is not realized currently from AFUDC, it is realized in the ratemaking
process over the service life of the related property through increased
revenues resulting from higher rate base and higher depreciation expense.
NW Natural's weighted average AFUDC rates were 2.8 percent in 2002, 6.2
percent in 2001 and 6.0 percent in 2000.
Cash and Cash Equivalents
- -------------------------
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand and highly liquid temporary investments with original
maturity dates of three months or less.
Revenue Recognition
- -------------------
Utility revenues are derived primarily from the sale and transportation of
natural gas. Utility revenue from gas sales and transportation is
recognized when the gas is delivered to and received by the customer.
Estimated revenues are accrued for gas deliveries not billed to customers
from meter reading dates to month end (unbilled revenue) and are reversed
the following month when actual billings occur.
Revenues from non-utility services, including gas storage, are recognized
upon delivery of the service to customers. Revenues from non-utility
optimization contracts are recognized, after deducting for regulatory
revenue sharing, over the life of the contract for amounts guaranteed
under the contract, or as amounts are earned and reasonably estimable for
amounts above the guaranteed value.
Inventories
- -----------
Inventories, consisting primarily of natural gas in storage, are stated at
the lower of average cost or net realizable value.
52
Derivatives Policy
- ------------------
NW Natural's Derivatives Policy sets forth the guidelines for using
selected financial derivative products to support prudent risk management
strategies within designated parameters. The Policy allows for the use of
derivatives to manage commodity prices related to natural gas purchases,
foreign currency prices related to gas purchase commitments from Canada,
oil or propane commodity prices related to gas sales and transportation
services under rate schedules pegged to other commodities, and interest
rates related to long-term debt maturing in less than five years or
expected to be issued in future periods. NW Natural's objectives for using
derivatives are to decrease the volatility of earnings and cash flows
associated with changes in commodity prices, foreign currency prices and
interest rates. Use of derivatives is permitted only after the commodity
price, exchange rate, and interest rate exposures have been identified,
are determined to exceed defined tolerance levels and are considered to be
unavoidable because they are necessary to support normal business
activities (see Note 11). The Policy is intended to prevent speculative
risk. NW Natural does not enter into derivative instruments for trading
purposes and believes that any increase in market risk created by holding
derivatives should be offset by the exposures they modify.
The Company adopted SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," on Jan. 1, 2001. This statement establishes
accounting and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts, and for
hedging activities. SFAS No. 133 requires that an entity recognize
derivatives as either assets or liabilities on the balance sheet and
measure those instruments at fair value. SFAS No. 133 also requires that
changes in the fair value of a derivative be recognized currently in
earnings unless specific hedge accounting criteria are met.
NW Natural designates its derivatives as fair value or cash flow hedges
based upon criteria established by SFAS No. 133. For a derivative
designated as a fair value hedge, the gain or loss is recognized in
earnings in the period of change. For a derivative designated as a cash
flow hedge, the effective portion of the derivative gain or loss is
initially reported in accumulated other comprehensive income (OCI) unless
the derivative is subject to deferral under NW Natural's regulated tariffs
with the OPUC or the WUTC. The ineffective portion of the gain or loss in
a cash flow hedge is recognized in current earnings. Effectiveness is
measured by comparing changes in cash flows of the hedged item to gains or
losses on derivative instruments.
NW Natural's primary hedging activities, consisting of natural gas
commodity price and foreign currency exchange rate hedges, are principally
accounted for as cash flow hedges under SFAS No. 133 and subject to
regulatory deferral pursuant to SFAS No. 71. Unrealized gains and losses
from mark-to-market valuations of these contracts are not recognized in
current income but are reported as derivative assets or liabilities and
offset by a corresponding deferred account balance included under
"Regulatory liabilities" or "Regulatory assets." Due to their regulatory
deferral treatment, effective portions of changes in the fair value of
these derivatives are not recorded in OCI but are recognized as a
regulatory asset or liability. Ineffective portions of changes in the fair
value of these contracts are recognized in current earnings.
NW Natural documents all relationships between its hedge contracts and
hedged items, as well as its risk management objective and strategy. This
process includes specific identification of the type of contract, the
details of the hedge transaction, the nature of the risk being hedged and
how the hedging instrument's effectiveness will be measured. Both at the
inception of the hedge and on an ongoing basis, NW Natural measures the
effectiveness of the derivatives used in hedge transactions.
Income Taxes
- ------------
NW Natural uses the balance sheet method of accounting for deferred income
taxes. Deferred tax liabilities and assets reflect the expected future tax
consequences, based on enacted tax law, of temporary differences between
the tax basis of assets and liabilities and their financial reporting
amounts (see Note 8).
53
Consistent with rate and accounting orders of regulatory authorities,
deferred income taxes are not currently collected for those temporary
income tax differences where the prescribed regulatory accounting methods
do not provide for current recovery in rates. NW Natural has recorded a
regulatory tax asset for amounts pending recovery from customers in future
rates. These amounts are primarily differences between the book and tax
bases of net utility plant in service. This asset balance was $48.0
million and $48.5 million at Dec. 31, 2002 and 2001, respectively.
Investment tax credits on utility property additions and leveraged leases,
which reduce income taxes payable, are deferred for financial statement
purposes and are amortized over the life of the related property or lease.
Investment and energy tax credits generated by non-regulated subsidiaries
are amortized over a period of one to five years.
Other Income (Expense)
- ----------------------
Other income (expense) consists of interest income, gain on sale of
assets, investment income of Financial Corporation, the loss provision
related to costs incurred in connection with the effort to acquire
Portland General Electric Company (PGE) and other miscellaneous income
from merchandise sales, rents, an aircraft lease and other items.
Earnings Per Share
- ------------------
Basic earnings per share are computed based on the weighted average number
of common shares outstanding each year. Diluted earnings per share reflect
the potential effects of the conversion of convertible debentures and the
exercise of stock options. Diluted earnings are calculated as follows:
Thousands, except per share amounts 2002 2001 2000
-------------------------------------------------------------------------
Earnings applicable to common stock - basic $41,512 $47,786 $47,768
Debenture interest less taxes 285 370 389
------- ------- -------
Earnings applicable to common stock - diluted $41,797 $48,156 $48,157
======= ======= =======
Average common shares outstanding - basic 25,431 25,159 25,183
Stock options 59 32 13
Convertible debentures 324 421 442
------- ------- -------
Average common shares outstanding - diluted 25,814 25,612 25,638
======= ======= =======
Earnings per share of common stock - basic $ 1.63 $ 1.90 $ 1.90
======= ======= =======
Earnings per share of common stock - diluted $ 1.62 $ 1.88 $ 1.88
======= ======= =======
Stock-Based Compensation
- ------------------------
The Company applies APB Opinion No. 25, "Accounting for Stock Issued to
Employees," to account for its stock-based compensation plans.
Accordingly, the Company does not recognize compensation expense for the
fair value of its stock-based awards. However, the Company recognizes
compensation expense for the market value of stock awards granted under
its Long-Term Incentive Plan (LTIP) in the period when performance shares
are earned (see Note 4). The Company has elected to continue using the
intrinsic value method of accounting for its stock-based awards rather
than changing to the fair value method of accounting until a uniform
method of valuing and expensing stock options is promulgated by the FASB.
2. CONSOLIDATED SUBSIDIARY OPERATIONS AND SEGMENT INFORMATION:
- --------------------------------------------------------------
At Dec. 31, 2002, the Company had two direct wholly-owned subsidiaries,
Financial Corporation and Northwest Energy. Northwest Energy was formed in
2001 to serve as the holding company for NW Natural and PGE if the
acquisition of PGE had been completed.
54
The Company principally operates in a segment of business, "Utility,"
consisting of the distribution of natural gas. Another segment, "Gas
Storage," primarily represents natural gas storage services provided to
upstream interstate customers using storage capacity that has been
developed in advance of core utility customers' requirements. The
remaining segment, "Other," primarily consists of non-regulated
investments in alternative energy projects in California and a Boeing
737-300 aircraft leased to Continental Airlines, and deferred costs
relating to the acquisition of PGE (see Note 9).
NNG Financial Corporation
- -------------------------
Financial Corporation has several financial investments, including
investments as a limited partner in solar electric generating systems,
windpower electric generating projects and low-income housing projects.
Financial Corporation disposed of its remaining interests in certain gas
producing properties in the western United States in 2000 and its
partnership interest in a hydroelectric generating project in 2001.
Gas Storage
- -----------
Gas storage services are provided to interstate customers using storage
capacity that has been developed in advance of core utility customers'
requirements. NW Natural retains 80 percent of the income before tax from
gas storage services and credits the remaining 20 percent to a deferred
regulatory account for sharing with its core utility customers.
NW Natural also receives revenues, after deducting for amounts shared with
core utility customers, from a contract with an independent energy trading
company that seeks to optimize the use of NW Natural's assets by trading
temporarily unused portions of its gas storage and upstream pipeline
transportation capacity.
Canor Energy, Ltd.
- ------------------
In January 2000, the Company sold its interest in Canor, an Alberta,
Canada corporation that had been engaged in natural gas and oil
exploration, development and production in Alberta and Saskatchewan,
Canada. The after-tax gain from the sale was $2.4 million, net of Canadian
tax on dividends ($0.6 million) and U.S. income tax ($2.8 million), and is
shown as gain on sale of discontinued segment.
55
Segment Information
- -------------------
The following table presents information about reportable segments for
2002, 2001 and 2000. Inter-segment transactions are insignificant.
Gas
Thousands Utility Storage Other Total
------------------------------------------------------------------------
2002
----
Net operating revenues $ 279,414 $ 7,944 $ 186 $ 287,544
Depreciation and amortization 51,693 396 1 52,090
Other operating expenses 118,156 962 78 119,196
Income from operations 109,565 6,586 107 116,258
Income from financial
investments - - 988 988
Loss provision for PGE
transaction costs - - (8,414) (8,414)
Net income (loss) 47,336 3,646 (7,190) 43,792
Total assets at Dec. 31, 2002 1,308,291 16,403 18,097 1,342,791
2001
----
Net operating revenues $ 271,473 $ 4,368 $ 170 $ 276,011
Depreciation and amortization 49,413 227 - 49,640
Other operating expenses
(income) 115,708 489 (37) 116,160
Income from operations 106,352 3,652 207 110,211
Income (loss) from financial
investments - - (321) (321)
Net income 47,313 2,112 762 50,187
Total assets at Dec. 31, 2001 1,391,156 14,243 29,623 1,435,022
2000
----
Net operating revenues $ 257,361 $ 258 $ 331 $ 257,950
Depreciation and amortization 47,430 10 - 47,440
Other operating expenses 106,027 81 60 106,168
Income from operations 103,904 167 271 104,342
Income (loss) from financial
investments - - (221) (221)
Net income from continuing
operations 47,519 102 191 47,812
Gain on sale of discontinued
segment - - 2,412 2,412
Total assets at Dec. 31, 2000 1,252,747 4,919 21,047 1,278,713
3. CAPITAL STOCK:
- --------------------
Common Stock
- ------------
At Dec. 31, 2002, NW Natural had reserved 148,415 shares of common stock
for issuance under the Employee Stock Purchase Plan, 384,502 shares for
future conversions of its 7-1/4% Convertible Debentures, 568,665 shares
under its Dividend Reinvestment and Stock Purchase Plan, 1,892,014 shares
under its Restated Stock Option Plan (see Note 4), and 3,000,000 shares
under the Shareholder Rights Plan.
Redeemable Preference Stock
- ---------------------------
On Dec. 31, 2002, NW Natural redeemed all 250,000 shares of its $6.95
Series of Redeemable Preference Stock with proceeds from the sale of
commercial paper.
56
Redeemable Preferred Stock
- --------------------------
The mandatory preferred stock redemption requirements aggregate $0.8
million in each of 2003, 2004, 2005, 2006 and 2007. These requirements are
non-cumulative. At any time NW Natural is in default on any of its
obligations to make the prescribed sinking fund payments, it may not pay
cash dividends on the common stock. Upon involuntary liquidation, all
series of redeemable preferred stock are entitled to their stated value.
The redeemable preferred stock is callable at stipulated prices, plus
accrued dividends. On or after May 1, 2002, shares of the $7.125 Series
are redeemable at a price of $102.850 per share, decreasing each year
thereafter to $100 per share on or after May 1, 2008.
Stock Repurchase Program
- ------------------------
In May 2000, the Company commenced a program to repurchase up to 2 million
shares, or up to $35 million in value, of NW Natural's common stock
through a repurchase program which has been extended through May 2003. The
purchases are made in the open market or through privately negotiated
transactions. Since the program's inception the Company has repurchased
355,400 shares of common stock at a total cost of $8.2 million.
Restated Stock Option Plan
- --------------------------
At the Company's Annual Meeting in May 2002, the shareholders approved an
amendment to the Restated Stock Option Plan that increased the total
number of shares authorized for option grants from 1,200,000 to 2,400,000
shares. At Dec. 31, 2002, options on 1,428,200 shares were available for
grant and options to purchase 463,814 shares were outstanding.
57
The following table shows the changes in the number of shares of NW
Natural's capital stock and the premium on common stock for the years
2002, 2001 and 2000:
-----------Shares-------------- Premium-on
Redeemable Redeemable common
Common preference preferred stock
stock stock stock (thousands)
---------- --------- ---------- ---------
Balance, Dec. 31, 1999 25,091,938 250,000 105,643 $ 234,608
Sales to employees 14,696 - - 278
Sales to stockholders 199,920 - - 3,769
Exercise of stock
options - net 5,990 - - 81
Conversion of convertible
debentures to common 29,580 - - 495
Stock repurchases (108,700) - - (1,016)
Sinking fund purchases - - (8,143) -
---------- -------- -------- ----------
Balance, Dec. 31, 2000 25,233,424 250,000 97,500 238,215
Sales to employees 30,952 - - 498
Sales to stockholders 177,624 - - 3,854
Exercise of stock
options - net 12,289 - - 110
Conversion of convertible
debentures to common 20,485 - - 343
Stock repurchases (246,700) - - (2,323)
Sinking fund purchases - - (7,500) -
---------- -------- -------- ----------
Balance, Dec. 31, 2001 25,228,074 250,000 90,000 240,697
Sales to employees 42,862 - - 748
Sales to stockholders 157,288 - - 3,854
Exercise of stock
options - net 61,020 - - 1,105
Conversion of convertible
debentures to common 97,069 - - 1,624
Sinking fund purchases - - (7,500) -
Redemption - (250,000) - -
---------- -------- -------- ----------
Balance, Dec. 31, 2002 25,586,313 - 82,500 $ 248,028
========== ======== ======== ==========
4. STOCK-BASED COMPENSATION:
- -------------------------------
NW Natural has the following stock-based compensation plans: the Long-Term
Incentive Plan (LTIP); the Restated Stock Option Plan (Restated SOP)
(formerly the 1985 Stock Option Plan); the Employee Stock Purchase Plan
(ESPP); and the Non-Employee Directors Stock Compensation Plan (NEDSCP).
These plans are designed to promote stock ownership in NW Natural by
employees, officers and directors.
NW Natural's shareholders approved the LTIP effective Jan. 1, 2001, to
provide a flexible, competitive compensation program for eligible
officers. An aggregate of 500,000 shares of common stock was authorized
for grants under the LTIP as stock bonus, restricted stock or
performance-based stock awards. Shares awarded under the LTIP are
purchased on the open market. To date, NW Natural has granted three
performance-based awards, one based on a two-year performance period
(2001-02) and two based on three-year performance periods (2001-03 and
2002-04), and a restricted stock award. The aggregate target awards for
each of the two-year (2001-02) and three-year (2001-03) performance-based
award periods were 26,000 shares and the maximum awards were 52,000
shares. The aggregate target and maximum awards for the three-year
performance-based award period (2002-04) were 29,000 and 58,000 shares,
respectively. Final awards depend on the attainment of certain return on
equity performance goals. At Dec. 31, 2002, the two-year performance-based
award covering the period 2001-02 lapsed because the performance-based
measures were not achieved. The restricted stock award consists of 4,500
shares granted in 2001 with a vesting period of 65 months. The LTIP stock
58
awards are compensatory awards for which compensation expense is accrued
based upon the market value of performance shares earned, or a pro rata
amortization over the vesting period for restricted shares.
The Restated SOP authorizes an aggregate of 2,400,000 shares of common
stock for issuance as incentive or non-statutory stock options. These
options may be granted only to officers and key employees designated by a
committee of NW Natural's Board of Directors. All options are granted at
an option price not less than the market value at the date of grant and
may be exercised for a period not exceeding 10 years from the date of
grant. Option holders may exchange shares they have owned for at least six
months, at the current market price, to purchase shares at the option
price. Since inception in 1985, options on 1,100,921 shares of common
stock have been granted at prices ranging from $11.75 to $27.875 per
share, and options on 129,121 shares have expired.
In accordance with APB No. 25, no compensation expense is recognized for
the Restated SOP or the ESPP. If compensation expense for awards under the
Restated SOP and the ESPP had been determined based on fair value at the
grant dates using the method prescribed by SFAS No. 123, "Accounting for
Stock-Based Compensation," net income and earnings per share would have
been reduced to the pro forma amounts shown below:
2002 2001 2000
---- ---- ----
Earnings applicable to common stock ($000):
-------------------------------------------
As reported $41,512 $47,786 $47,768
Deduct: total stock-based compensation
expense determined under fair value
based method - net of tax (478) (338) (353)
------- ------- -------
Pro forma $41,034 $47,448 $47,415
======= ======= =======
Basic earnings per share
------------------------
As reported $ 1.63 $ 1.90 $ 1.90
Pro forma $ 1.61 $ 1.89 $ 1.88
Diluted earnings per share
--------------------------
As reported $ 1.62 $ 1.88 $ 1.88
Pro forma $ 1.60 $ 1.87 $ 1.86
The fair value of each stock option grant is estimated on the grant date
using the Black-Scholes option pricing model with the following weighted
average assumptions:
2002 2001 2000
---- ---- ----
Dividend yield 4.8% 4.9% 4.7%
Expected volatility 29.1% 31.0% 31.4%
Risk-free interest rate 3.6% 5.2% 5.2%
Expected life (years) 7 7 7
Present value of options granted $ 20.49 $ 17.34 $ 14.18
59
Information regarding the Restated SOP's activity is summarized as
follows:
Price per Share
------------------------
Weighted
Shares Range Average
----------------------------------
Balance, Dec. 31, 1999 290,212 $16.59-27.875 $ 24.08
Granted 153,000 20.25-22.875 20.36
Exercised (14,207) 16.59-24.00 22.63
Expired (13,000) 20.25-27.875 24.36
-------
Balance, Dec. 31, 2000 416,005 20.17-27.875 22.75
Granted 15,000 24.91 24.91
Exercised (12,289) 20.17-20.92 20.36
Expired (31,625) 20.25-27.875 24.31
-------
Balance, Dec. 31, 2001 387,091 20.25-27.875 22.79
Granted 163,750 26.07-27.85 26.35
Exercised (68,827) 20.25-27.875 21.74
Expired (18,200) 20.25-27.875 25.43
-------
Balance, Dec. 31, 2002 463,814 20.25-27.875 24.10
The weighted average characteristics of outstanding stock options at
Dec. 31, 2002 were as follows:
Outstanding Options Exercisable Options
------------------------------------------------------------------
Range of Weighted
Exercise Remaining Average
Prices Shares Life (Years) Shares Price
------------------------------------------------------------------
$20.25-27.875 463,814 6.64 244,864 $23.31
The ESPP, as amended in 2000, allows employees to purchase common stock at
85 percent of the opening market price on the subscription date which is
set annually. Each eligible employee may purchase up to 900 shares through
payroll deduction over a six to 12-month period.
Non-employee directors of the Company are awarded approximately $100,000
worth of the Company's common stock upon joining the Board pursuant to NW
Natural's NEDSCP. These initial awards vest in monthly installments over
the five calendar years following the award. On Jan. 1 of each year
thereafter, non-employee directors are awarded an additional $20,000 of
common stock which vests in monthly installments in the fifth year
following the award (after the previous award has fully vested). All
awards vest immediately upon a change in control of the Company. Unvested
shares are forfeited if the recipient ceases to be a director. The shares
awarded are purchased in the open market by the Company at the time of
award. Directors may elect to defer unvested shares into their stock
accounts under the Directors Deferred Compensation Plan. Non-employee
directors also may elect to receive shares of common stock instead of a
cash payment for their fees and retainers under a separate plan.
5. LONG-TERM DEBT:
- ---------------------
The issuance of first mortgage debt, including secured medium-term notes,
under the Mortgage and Deed of Trust (Mortgage) is limited by property
additions, adjusted net earnings and other provisions of the Mortgage. The
Mortgage constitutes a first mortgage lien on substantially all of NW
Natural's utility property.
60
The 7-1/4% Series of Convertible Debentures may be converted at any time
into 50-1/4 shares of common stock for each $1,000 face value ($19.90 per
share).
The maturities for the five years ending Dec. 31, 2007 on the long-term
debt outstanding at Dec. 31, 2002 amount to: $20 million in 2003, no
maturity in 2004, $15 million in 2005, $8 million in 2006 and $29.5
million in 2007. Holders of certain medium-term notes have put options
that, if exercised, would accelerate the maturity of long-term debt by $10
million and $20 million in 2005 and 2007, respectively.
6. NOTES PAYABLE AND LINES OF CREDIT:
- ---------------------------------------
The Company's primary source of short-term funds is commercial paper notes
payable. Both NW Natural and Financial Corporation issue commercial paper
under agency agreements with a commercial bank. NW Natural's commercial
paper is supported by its committed bank lines of credit (see below),
while Financial Corporation's commercial paper is supported by committed
bank lines of credit and the guaranty of NW Natural. The amounts and
average interest rates of commercial paper debt outstanding at Dec. 31
were as follows:
--------2002----- ---------2001------
Thousands Amount Rate Amount Rate
-----------------------------------------------------------------------
NW Natural $ 69,802 1.4% $ 108,291 2.6%
Financial Corporation - -
-------- --------
Total $ 69,802 $ 108,291
======== =========
NW Natural has lines of credit with four commercial banks totaling $150
million. Half of the credit with each bank, totaling $75 million, is
committed and available through Sept. 30, 2003, and the other $75 million
is committed and available through Sept. 30, 2004. In addition, Financial
Corporation has available through Sept. 30, 2003, committed lines of
credit with two commercial banks totaling $20 million. Financial
Corporation's lines are supported by the guaranty of NW Natural.
Under the terms of these lines of credit, NW Natural and Financial
Corporation pay commitment fees but are not required to maintain
compensating bank balances. The interest rates on borrowings under these
lines of credit, if any, are based on current market rates. There were no
outstanding balances on either the NW Natural or Financial Corporation
lines of credit as of Dec. 31, 2002 or 2001.
NW Natural's lines of credit require that credit ratings be maintained in
effect at all times and that notice be given of any change in its senior
unsecured debt ratings. A change in NW Natural's credit rating is not an
event of default, nor is the maintenance of a specific minimum level of
credit rating a condition to drawing upon the lines of credit. However,
interest rates on any loans outstanding under NW Natural's bank lines are
tied to credit ratings, which would increase or decrease the cost of bank
debt, if any, when ratings are changed. The lines of credit require that
the Company maintain an indebtedness to total capitalization ratio, as
defined in the credit agreements, of 65 percent or less. Also, effective
Oct. 1, 2002, the lines of credit require the Company to maintain a net
worth at least equal to 80 percent of its net worth at Sept. 30, 2002,
plus 50 percent of the Company's net income for each subsequent fiscal
quarter. Failure to comply with either of these covenants would entitle
the banks to terminate their lending commitments and to accelerate the
maturity of all amounts outstanding. At Dec. 31, 2002, the Company was in
compliance with both the debt to total capital covenant and the minimum
net worth covenant.
7. PENSION AND OTHER POSTRETIREMENT BENEFITS:
- -----------------------------------------------
NW Natural has two qualified non-contributory defined benefit pension
plans covering all regular employees with more than one year of service, a
non-qualified supplemental pension plan for eligible executive officers
and other postretirement benefit plans for its employees. The following
61
tables provide a reconciliation of the changes in the plans' benefit
obligations and fair value of assets over the three-year period ended Dec.
31, 2002 and a statement of the funded status and amounts recognized in
the consolidated balance sheets as of Dec. 31, 2002, 2001 and 2000:
Pension Benefits Other Postretirement Benefits
-------------------------------------- ----------------------------------
Thousands 2002 2001 2000 2002 2001 2000
--------- ---- ---- ---- ---- ---- ----
Change in benefit obligation:
Benefit obligation at Jan. 1 $ 166,751 $ 146,802 $ 136,198 $ 16,987 $ 14,069 $ 11,902
Service cost 4,637 3,964 3,475 395 325 234
Interest cost 11,807 11,332 10,312 1,174 1,116 995
Expected benefits paid (9,453) (9,152) (8,035) (979) (942) (878)
Plan amendments - 1,838 12 (300) - -
Net actuarial (gain) loss 11,382 11,967 4,840 1,180 2,419 1,816
---------- ---------- ---------- --------- ---------- ----------
Benefit obligation at Dec. 31 185,124 166,751 146,802 18,457 16,987 14,069
---------- ---------- ---------- --------- ---------- ----------
Change in plan assets:
Fair value of plan assets
at Jan. 1 168,964 190,451 193,427 - - -
Actual return on plan assets (17,082) (13,077) 4,351 - - -
Employer contributions 735 742 708 979 942 878
Benefits paid (9,453) (9,152) (8,035) (979) (942) (878)
---------- ---------- ---------- --------- ---------- ----------
Fair value of plan assets
at Dec. 31 143,164 168,964 190,451 - - -
---------- ---------- ---------- --------- ---------- ----------
Funded status:
Funded status at Dec. 31 (41,960) 2,212 43,649 (18,457) (16,987) (14,069)
Unrecognized transition
obligation - 351 701 4,226 4,795 5,232
Unrecognized prior service cost 7,371 8,575 8,022 - 172 191
Unrecognized net actuarial
(gain) loss 42,060 (2,956) (47,661) 4,437 3,405 1,061
---------- ---------- --------- --------- ---------- ----------
Net amount recognized $ 7,471 $ 8,182 $ 4,711 $ (9,794) $ (8,615) $ (7,585)
========== ========== ========= ========= ========== ==========
Amounts recognized in the
consolidated balance
sheets at Dec. 31:
Prepaid benefit cost $ 17,339 $ 17,211 $ 13,150 $ - $ - $ -
Accrued benefit liability (18,741) (9,346) (8,932) (9,794) (8,615) (7,585)
Intangible asset 4,438 169 493 - - -
Other comprehensive loss 4,435 148 - - - -
---------- ---------- --------- --------- ---------- ----------
Net amount recognized $ 7,471 $ 8,182 $ 4,711 $ (9,794) $ (8,615) $ (7,585)
========== ========== ========= ========= ========== ==========
The Company's qualified defined benefit pension plans had an accumulated
benefit obligation in excess of plan assets at Dec. 31, 2002. The plans'
aggregate accumulated benefit obligation was $172 million, $156 million
and $136 million at Dec. 31, 2002, 2001 and 2000, respectively. Plan
assets were $143 million, $169 million and $190 million, respectively. The
fair value of plan assets declined from Dec. 31, 2001 to Dec. 31, 2002 due
to $15 million in investment losses, $9.8 million in withdrawals to pay
benefits and $1.0 million in eligible expenses of the plans. The
combination of investment returns and cash contributions is expected to
provide sufficient funds to cover all benefit obligations of the plans;
the Company expects to make cash contributions to the plans totaling $1.9
million for the 2003 plan year.
The Company's non-qualified supplemental pension plan had an accumulated
benefit obligation in excess of plan assets for each of the periods
presented. The plan's aggregate accumulated benefit obligation was $12.8
million, $10.7 million and $10.4 million at Dec. 31, 2002, 2001 and 2000,
respectively. There were no plan assets in the non-qualified plan due to
62
the nature of the plan, but the Company funds its obligation with
trust-owned life insurance. The amount of the life insurance coverage is
designed to provide sufficient returns to cover the benefit obligations
and other costs of the plan.
The Company's plans for providing postretirement benefits other than
pensions also have no plan assets. The aggregate benefit obligation for
those plans was $18.5 million, $17.0 million and $14.1 million at Dec. 31,
2002, 2001 and 2000, respectively.
The following tables provide the components of net periodic cost (benefit)
for the plans for the years ended Dec. 31, 2002, 2001 and 2000, and the
assumptions used in the measurement of these costs and the Company's
benefit obligations:
------------------------------------------------------------------------------
Pension Benefits Other Postretirement Benefits
------------------------------------------------------------------------------
Thousands 2002 2001 2000 2002 2001 2000
--------- ---- ---- ---- ---- ---- ----
Service cost $ 4,637 $ 3,964 $ 3,475 $ 395 $ 325 $ 234
Interest cost 11,807 11,332 10,312 1,174 1,116 995
Expected return on plan assets (16,335) (17,198) (16,056) - - -
Amortization of transition
obligation 351 351 334 436 436 436
Amortization of prior
service cost 1,204 1,284 1,174 6 19 19
Recognized actuarial
(gain) loss (216) (2,464) (3,449) 147 75 -
----------------------------------------------------------------------------
Net periodic cost (benefit) $ 1,448 $ (2,731) $ (4,210) $ 2,158 $ 1,971 $ 1,684
==============================================================================
Weighted average assumptions
as of Dec. 31:
Discount rate 6.75% 7.25% 7.50% 6.75% 7.25% 7.50%
Expected return on plan assets 8.00% 9.00% 9.00% n/a n/a n/a
Rate of compensation increase 4.25-5.00% 4.25-5.00% 4.25-5.00% n/a n/a n/a
------------------------------------------------------------------------------------------------------------------
The assumed annual trend rates used in measuring postretirement benefits
as of Dec. 31, 2002 were 10 percent for medical and 15 percent for
prescription drugs. Medical costs were assumed to decrease gradually each
year to a rate of 4.5 percent for 2008, while prescription drug costs were
assumed to decrease gradually each year to a rate of 4.5 percent for 2013.
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plans. A one percent change in
assumed health care cost trend rates would have the following effects:
1% 1%
Thousands Increase Decrease
------------------------------------------------------------------------
Effect on the total service and interest cost
components of net periodic postretirement
health care benefit cost $ 45 $ (45)
Effect on the health care component of the
accumulated postretirement benefit obligation $ 488 $ (476)
------------------------------------------------------------------------
NW Natural's Retirement K Savings Plan (RKSP) is a qualified defined
contribution plan under Internal Revenue Code Section 401(k). NW Natural
also has a non-qualified deferred compensation plan for eligible officers
and senior managers. These plans are designed to enhance the retirement
program of employees and to assist them in strengthening their financial
63
security by providing an incentive to save and invest regularly. NW
Natural's matching contributions to these plans totaled $1.4 million in
2002 and $1.3 million in both 2001 and 2000.
Effective Jan. 1, 2002, the RKSP was amended to establish an Employee
Stock Ownership Plan (ESOP) within the RKSP by converting the existing
RKSP Company Stock Fund into an ESOP. This amendment allowed the Company
to claim a tax benefit of $0.2 million in 2002 for the dividends paid on
the Company's common stock held by the ESOP. In order to claim this
deduction, the Company was required to allow RKSP participants the option
of receiving the dividends paid on the Company's common stock in the ESOP
account in cash rather than having the dividends automatically reinvested
(see Note 8).
64
8. INCOME TAXES:
- ------------------
A reconciliation between income taxes calculated at the statutory federal
tax rate and the tax provision reflected in the financial statements is as
follows:
Thousands 2002 2001 2000
-----------------------------------------------------------------------------------------------------------------
Computed income taxes based on statutory federal income
tax rate of 35% $ 23,533 $ 27,209 $ 26,124
Increase (reduction) in taxes resulting from:
Difference between book and tax depreciation 222 222 222
Current state income tax, net of federal tax benefit 2,299 2,672 2,622
Federal income tax credits (362) (362) (357)
Amortization of investment tax credits (858) (855) (855)
Gains on Company and trust-owned life insurance (487) (576) (611)
Removal costs (573) (508) (480)
Reversal of amounts provided in prior years (240) (72) (25)
Deduction for dividends paid on certain employer
securities to an ESOP (204) - -
Other - net 114 (177) 189
--------- --------- ---------
Total provision for income taxes $ 23,444 $ 27,553 $ 26,829
========= ========= =========
Total income taxes paid $ 33,474 $ 25,201 $ 22,552
========= ========= =========
The provision for income taxes consists of the
following:
Thousands 2002 2001 2000
-------------------------------------------------------------------------------------------------------------
Income taxes currently payable:
Federal $ 9,377 $ 32,682 $ 18,228
State 1,239 5,912 2,444
--------- --------- ---------
Total 10,616 38,594 20,672
--------- --------- ---------
Deferred taxes - net:
Federal 11,476 (8,606) 7,495
State 2,210 (1,580) (483)
--------- --------- ---------
Total 13,686 (10,186) 7,012
--------- --------- ---------
Investment and energy tax credits restored:
From utility operations (800) (800) (800)
From subsidiary operations (58) (55) (55)
--------- --------- ---------
Total (858) (855) (855)
--------- --------- ---------
Total provision for income taxes $ 23,444 $ 27,553 $ 26,829
========= ========= =========
Percentage of pretax income 34.9% 35.4% 35.9%
========= ========= =========
65
Deferred tax assets and liabilities are comprised
of the following:
Thousands 2002 2001
------------------------------------------------------------------------------------------------------------
Deferred tax liabilities:
Plant and property $ 96,525 $ 84,976
Regulatory income tax asset 47,975 48,469
Regulatory liabilities 319 -
Other deferred liabilities 6,569 7,645
--------- ---------
Total 151,388 141,090
--------- ---------
Deferred tax assets:
Regulatory assets - 2,270
Minimum pension liability 1,883 -
Other deferred assets 7,773 8,396
--------- ---------
Total 9,656 10,666
--------- ---------
Net accumulated deferred income tax liability $ 141,732 $ 130,424
========= =========
A $1.9 million tax benefit associated with a charge related to accrual of
minimum pension liability was recorded in OCI for the year ended Dec. 31,
2002.
9. PROPERTY AND INVESTMENTS:
- ------------------------------
The following table sets forth the major classifications of NW Natural's
utility plant and accumulated depreciation at Dec. 31:
2002 2001
---------------------- -----------------------
Average Average
Depreciation Depreciation
Thousands Amount Rate Amount Rate
-------------------------------------------------------------------------------
Transmission and distribution $1,254,624 3.4% $1,196,824 3.4%
Utility storage 107,110 2.7% 106,500 2.6%
General 83,878 6.3% 80,411 6.0%
Intangible and other 53,291 4.3% 50,274 5.8%
---------- ----------
Utility plant in service 1,498,903 3.5% 1,434,009 3.5%
Gas stored long-term 11,301 11,301
Construction work in progress 29,761 19,769
---------- ----------
Total utility plant 1,539,965 1,465,079
Less accumulated depreciation 560,798 514,299
---------- ----------
Utility plant-net $ 979,167 $ 950,780
========== ==========
66
The following table summarizes the Company's investments in non-utility
plant at Dec. 31:
Thousands 2002 2001
------------------------------------------------------------------------
Non-utility storage $17,037 $14,480
Dock, land, oil station and other 3,795 3,723
------- -------
Total non-utility plant 20,832 18,203
Less accumulated depreciation 4,404 4,007
------- -------
Non-utility plant - net $16,428 $14,196
======= =======
------------------------------------------------------------------------
The following table summarizes the Company's investments in entities
accounted for under the equity and cost methods, and its investment in an
aircraft leveraged lease at Dec. 31:
Thousands 2002 2001
------------------------------------------------------------------------
Deferred costs for pending purchase
of PGE, net of loss provision $ - $ 9,557
Aircraft leveraged lease 6,489 6,987
Gas pipeline and other 2,950 3,234
Electric generation 3,264 3,155
Long-term notes receivable - 300
------- -------
Total investments and other $12,703 $23,233
======= =======
------------------------------------------------------------------------
Financial Corporation has ownership interests ranging from 4.0 to 5.3
percent in solar electric generation plants located near Barstow,
California. Power generated by these plants is sold to Southern California
Edison Company under long-term contracts. Financial Corporation also has
ownership interests ranging from 25 to 41 percent in windpower electric
generation projects located near Livermore and Palm Springs, California.
The wind-generated power is sold to Pacific Gas and Electric Company and
Southern California Edison Company under long-term contracts.
Financial Corporation has a 10 percent ownership interest in a 19-mile
interstate natural gas pipeline. NW Natural is the operator of this
pipeline.
In 1987, the Company invested in a Boeing 737-300 aircraft, which is
leased to Continental Airlines for 20 years under a leveraged lease
agreement.
67
10. FAIR VALUE OF FINANCIAL INSTRUMENTS:
- -----------------------------------------
The estimated fair values of NW Natural's financial instruments have been
determined using available market information and appropriate valuation
methodologies. The following are financial instruments whose carrying
values are sensitive to market conditions:
Dec. 31, 2002 Dec. 31, 2001
--------------------------------- ---------------------------------
Carrying Estimated Carrying Estimated
Thousands Amount Fair Value Amount Fair Value
--------------------------------------------------------------------------------------------------------------
Redeemable preference stock $ - $ - $ 25,000 $ 25,347
Redeemable preferred stock $ 8,250 $ 8,333 $ 9,000 $ 9,256
Long-term debt including
amount due within one year $ 465,945 $ 518,495 $ 418,377 $ 407,239
--------------------------------------------------------------------------------------------------------------
Fair value of the redeemable preference stock and the redeemable preferred
stock was estimated using quoted market prices. Interest rates for debt
with similar terms and remaining maturities were used to estimate fair
value for debt issues.
68
11. USE OF FINANCIAL DERIVATIVES:
- ----------------------------------
NW Natural enters into short-term and long-term natural gas purchase
contracts with suppliers, including contracts tied to floating prices. As
such, NW Natural is exposed to changes in commodity prices. Natural gas
prices are subject to fluctuations due to unpredictable factors including
weather, inventory levels, pipeline transportation availability, and the
economy, each of which affects short-term supply and demand. As part of
its overall strategy to maintain an acceptable level of exposure to gas
price fluctuations, NW Natural uses a targeted mix of fixed-rate and
cap-protected derivatives to hedge the exposure under floating price gas
supply contracts. Swap contracts are used to convert certain long-term gas
purchase contracts from floating prices to fixed prices, and call option
contracts are used to limit the maximum adverse impact from floating price
contracts while retaining the potential favorable impact from declining
gas prices. The prices embedded in these commodity hedge contracts are
incorporated in NW Natural's annual rate changes, pursuant to its Oregon
Purchased Gas Adjustment (PGA) tariff, thereby limiting customers'
exposure to frequent changes in purchased gas costs. The estimated fair
value gains and losses from commodity hedge contracts are recorded as a
derivative asset or liability, and are offset by a corresponding amount
recorded to a deferred regulatory asset or liability account for the
effective portion of each hedge contract. The actual gains and losses
realized at settlement of the hedge contract are used to offset the actual
purchase cost from NW Natural's physical supply contract.
Certain natural gas purchases from Canadian suppliers are invoiced in
Canadian dollars, including both commodity and demand charges, thereby
exposing NW Natural to adverse changes in foreign currency rates. Foreign
currency forward contracts are used to minimize the impact of fluctuations
in currency rates. Foreign currency contracts for commodity costs are
purchased on a month-to-month basis because the Canadian cost is priced at
the average noonday exchange rate for each month. Foreign currency
contracts for demand costs have terms ranging up to 24 months. The gains
and losses on the shorter-term currency contracts for commodity costs are
recognized immediately in cost of gas. The gains and losses on the
longer-term currency contracts for demand charges are subject to a
regulatory deferral tariff and, as such, are recorded as a derivative
asset or liability which is offset by a corresponding amount to a deferred
asset or liability account.
NW Natural did not use any derivative instruments to hedge oil or propane
prices or interest rates during 2002 or 2001.
At Dec. 31, 2002, NW Natural had the following derivatives outstanding
covering its exposures to commodity and foreign currency prices: a series
of 18 natural gas price swap contracts, three natural gas call option
contracts, and 83 foreign currency forward contracts. Each of these
contracts was designated as a cash flow hedge. NW Natural also had one
physical natural gas supply contract with an embedded derivative, which
did not qualify as a normal purchase or sales contract. The estimated fair
values and the notional amounts of derivative instruments outstanding were
as follows:
Dec. 31, 2002 Dec. 31, 2001
------------------------- -------------------------
Fair Value Notional Fair Value Notional
Thousands Gain (Loss) Amount Gain (Loss) Amount
-------------------------------------------------------------------------------------------------------------------
Fixed-price natural gas commodity swaps $ 11,422 $ 159,724 $ (110,935) $ 254,209
Fixed-price natural gas call options 717 18,084 (832) 6,390
Physical natural gas supply contract with embedded option 448 2,754 - -
Foreign currency forward purchase contracts (161) 15,525 (101) 10,223
------------------------ -------------------------
Total $ 12,426 $ 196,087 $ (111,868) $ 270,822
========================= =========================
In 2002, NW Natural realized net losses of $75.5 million from the
settlement of natural gas commodity swap and call option contracts, which
were recorded as increases to the cost of gas, compared to net gains of
69
$57.6 million during 2001. The currency exchange rate in all foreign
currency forward purchase contracts is included in NW Natural's cost of
gas at settlement; therefore, no gain or loss was recorded from the
settlement of those contracts. The change in value of cash flow hedge
contracts, not included in regulatory recovery, is included in OCI. In
2002 and 2001, the Company recognized a $0.2 million gain and a $0.2
million loss, respectively, in OCI from these changes in value of cash
flow hedge contracts.
The fair value of derivative instruments at Dec. 31, 2002 (see table
above) was determined using estimated or quoted market prices for the
periods covered by the contracts. Market prices for the natural gas
commodity-price swap and call option contracts were obtained from external
sources. NW Natural reviews these third-party valuations for
reasonableness using fair value calculations for other contracts with
similar terms and conditions. The market prices for the foreign currency
forward contracts were based on currency exchange rates quoted by The Bank
of Canada.
As of Dec. 31, 2002, NW Natural had two natural gas commodity swap
contracts extending beyond Dec. 31, 2003, but none extends beyond Oct. 31,
2004. None of the natural gas commodity call option contracts extends
beyond March 31, 2003.
12. COMMITMENTS AND CONTINGENCIES:
- -----------------------------------
Lease Commitments
-----------------
The Company leases land, buildings and equipment under agreements that
expire in various years through 2006. Rental expense under operating
leases was $4.8 million, $4.7 million and $4.9 million for the years ended
Dec. 31, 2002, 2001 and 2000, respectively. The table below reflects the
future minimum lease payments due under non-cancelable leases at Dec. 31,
2002. Such payments total $13.8 million for operating leases. The net
present value of payments on capital leases less imputed interest was $0.2
million. These commitments principally relate to the lease of the
Company's office headquarters, underground gas storage facilities,
vehicles and computer equipment.
Later
Millions 2003 2004 2005 2006 2007 years
-------------------------------------------------------------
Operating leases $2.9 $2.7 $2.6 $1.0 $0.3 $4.3
Capital leases 0.2 - - - - -
---- ---- ---- ---- ---- ----
Minimum lease payments $3.1 $2.7 $2.6 $1.0 $0.3 $4.3
==== ==== ==== ==== ==== ====
70
Purchase Commitments
--------------------
NW Natural has signed agreements providing for the availability of firm
pipeline capacity under which it must make fixed monthly payments for
contracted capacity. The pricing component of the monthly payment is
established, subject to change, by U.S. or Canadian regulatory bodies. In
addition, NW Natural has entered into long-term sale agreements to release
firm pipeline capacity. The aggregate amounts of these agreements were as
follows at Dec. 31, 2002:
Capacity Capacity
Purchase Release
Thousands Agreements Agreements
------------------------------------------------------------------
2003 $ 75,112 $ 3,698
2004 44,064 3,536
2005 40,201 3,382
2006 35,912 3,235
2007 34,380 3,092
2008 through 2023 152,093 8,047
---------- ---------
Total 381,762 24,990
Less: Amount representing interest 92,130 4,687
---------- ---------
Total at present value $ 289,632 $ 20,303
========== =========
NW Natural's total payments of fixed charges under capacity purchase
agreements in 2002, 2001 and 2000 were $86.2 million, $86.5 million and
$81.5 million, respectively. Included in the amounts for 2002, 2001 and
2000 were reductions for capacity release sales of $4.2 million, $3.8
million and $3.8 million, respectively. In addition, per-unit charges are
required to be paid based on the actual quantities shipped under the
agreements. In certain take-or-pay purchase commitments, annual
deficiencies may be offset by prepayments subject to recovery over a
longer term if future purchases exceed the minimum annual requirements. NW
Natural also has a contract commitment to purchase about $10.1 million in
gas transmission pipe in 2003 for use in constructing an extension of the
pipeline from its Mist storage field.
Environmental Matters
---------------------
NW Natural owns property in Multnomah County, Oregon that is the site of a
former gas manufacturing plant that was closed in 1956 (the Gasco site).
The Gasco site has been under investigation by NW Natural for
environmental contamination under the Oregon Department of Environmental
Quality's (ODEQ) Voluntary Clean-Up Program. NW Natural has recorded
liabilities totaling $4.0 million for the estimated costs of investigation
and interim remediation at the Gasco site, including consultants' fees,
ODEQ oversight reimbursement and legal fees, of which $3.2 million had
been spent as of Dec. 31, 2002.
NW Natural previously owned property adjacent to the Gasco site that now
is the location of a manufacturing plant owned by Wacker Siltronic
Corporation (the Wacker site). In 2000, the ODEQ issued an order requiring
Wacker and NW Natural to determine the nature and extent of releases of
hazardous substances to Willamette River sediments from the Wacker site.
NW Natural has completed the majority of the studies required under the
ODEQ work plan and the agency is reviewing data generated by the studies.
NW Natural has recorded a liability of $0.3 million for its estimated
costs of the investigation and initial remediation on the Wacker site, of
which $0.2 million had been spent as of Dec. 31, 2002.
71
In 1998, the ODEQ and the U.S. Environmental Protection Agency (EPA)
completed a study of sediments in a 5.5-mile segment of the Willamette
River (the Portland Harbor) that includes the area adjacent to the Gasco
site and the Wacker site. In 2000, the EPA listed the Portland Harbor as a
Superfund site and notified the Company that it is a potentially
responsible party. NW Natural recorded liabilities totaling $2.3 million
between 2000 and 2002, of which $1.1 million had been spent as of Dec. 31,
2002. The amount of NW Natural's liability is based on estimates of the
Company's share of the lower end of a range of probable liability for the
costs of the Remedial Investigation/Feasibility Study for the Portland
Harbor. Available information is insufficient to determine either the
total amount of liability for investigation and remediation of the
Portland Harbor or the higher end of a range for NW Natural's estimated
share of that liability.
The City of Portland has notified NW Natural that it is planning a sewer
improvement project that would include excavation within the former site
of a gas manufacturing plant (the Portland Gas site) that was owned and
operated by a predecessor of the Company between 1860 and 1913. The
preliminary assessment of this site performed by a consultant for the EPA
in 1987 indicated that it could be assumed that by-product tars may have
been disposed of on site. The report concluded, however, that it is likely
that waste residues from the plant, if present on the site, were covered
by deep fill during construction of the nearby seawall bordering the
Willamette River and probably have stabilized due to physical and chemical
processes. Neither the City of Portland nor the ODEQ has notified NW
Natural whether a further investigation or potential remediation might be
required on the site in connection with the sewer project. Available
information is insufficient to determine either the total amount of
liability or a probable range, if any, of potential liability.
NW Natural has accrued all material loss contingencies relating to
environmental matters that it believes to be probable of assertion and
reasonably estimable. Due to the preliminary nature of these environmental
investigations, the range of any additional possible loss contingency
cannot be currently estimated. NW Natural expects that its costs of
further investigation and remediation for which it may be responsible with
respect to the Gasco site, the Wacker site, the Portland Harbor site and
the Portland Gas site, if any, should be recoverable, in large part, from
insurance. At Dec. 31, 2002, NW Natural had a $2.5 million receivable
representing an estimate of the environmental costs NW Natural expects to
recover from insurance, including $1.4 million that was recorded in 2000
for costs relating to the Gasco site and $1.1 million that was recorded in
2002 for costs relating to the Portland Harbor site. In the event these
costs are not recovered from insurance, NW Natural will seek recovery
through future rates.
Litigation
----------
In November 2001, NW Natural commenced a lawsuit, (Northwest Natural Gas
Company v. Cascade Resources Corporation and Curry, et. al.) (United
States District Court for the District of Oregon, Case No. CV 01-1620 HU),
alleging that the defendants violated obligations regarding the use and
disclosure of confidential information and used such information to
solicit and secure underground gas storage leases in areas of interest to
the Company. Among other remedies, the Company seeks to have a
constructive trust imposed on such leases and to require the defendants to
assign their interest in such leases to the Company.
The defendants in this case have asserted counterclaims against the
Company alleging that by asserting that the defendants have misused
confidential information, the Company improperly interfered with the
defendants' business opportunities. The assertions include claims for
violation of antitrust laws and the defendants seek $15 million in
damages, trebled, plus punitive damages and attorneys' fees. The Company
believes these counterclaims are without merit. The litigation is
currently in the discovery stage.
From time to time the Company is subject to other claims and litigation
arising in the ordinary course of business. Although the final outcome of
any legal proceeding cannot be predicted with certainty, the Company does
not expect disposition of these matters to have a materially adverse
effect on the Company's financial position, results of operations or cash
flows.
72
NORTHWEST NATURAL GAS COMPANY
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Dollars Quarter ended
------------------------------------------------------
(Thousands, except per share amounts) March 31 June 30 Sept. 30 Dec. 31 Total
- ---------------------------------------------------------------------------------------------------- ---------------
2002
Operating revenues $278,563 $101,873 $78,717 $182,223 $641,376
Net operating revenues 110,666 56,564 38,059 82,255 287,544
Net income (loss) 34,447 (2,992) (6,008) 18,345 43,792
Basic earnings (loss) per share 1.34 (0.14) (0.26) 0.70 1.63*
Diluted earnings (loss) per share 1.32 (0.14) (0.26) 0.69 1.62*
2001
Operating revenues $217,341 $118,150 $78,359 $236,402 $650,252
Net operating revenues 91,653 54,726 37,067 92,565 276,011
Net income (loss) 25,907 4,865 (4,976) 24,391 50,187
Basic earnings (loss) per share 1.00 0.17 (0.22) 0.94 1.90*
Diluted earnings (loss) per share 0.99 0.17 (0.22) 0.93 1.88*
* Quarterly earnings (loss) per share are based upon the average number of
common shares outstanding during each quarter. Because the average number of
shares outstanding has changed in each quarter shown, the sum of quarterly
(loss) earnings per share may not equal earnings per share for the year.
Variations in earnings between quarterly periods are due primarily to the
seasonal nature of the Company's business.
73
NORTHWEST NATURAL GAS COMPANY
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
------------------------------------------------------------------------------------------------------------------------
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
------------------------------------------------------------------------------------------------------------------------
Additions Deductions
Balance at --------------------------- --------- Balance
beginning Charged to Charged to at end
of costs other Net of
period and expenses accounts write-offs period
------ ------------ -------- ---------- ------
Thousands (year ended December 31)
2002
----
Reserves deducted in balance sheet
from assets to which they apply:
Allowance for uncollectible accounts $ 1,962 $ 2,876 $ - $ 3,023 $ 1,815
2001
----
Reserves deducted in balance sheet
from assets to which they apply:
Allowance for uncollectible accounts $ 1,867 $ 3,359 $ - $ 3,264 $ 1,962
2000
----
Reserves deducted in balance sheet
from assets to which they apply:
Allowance for uncollectible accounts $ 1,669 $ 2,344 $ - $ 2,146 $ 1,867
74
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
Information called for by Part III (Items 10. (Directors and Executive
Officers of the Registrant), 11. ( Executive Compensation), and 13. (Certain
Relationships and Related Transactions)) is incorporated herein by reference to
portions of the Company's definitive proxy statement. See the Additional Item
included in Part I for information concerning executive officers of the Company.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Certain information called for by Item 12 is incorporated herein by
reference to portions of the Company's definitive proxy statement.
The following table sets forth information regarding compensation plans
under which equity securities of the Company are authorized for issuance as of
December 31, 2002:
(A) (B) (C)
Number of securities
remaining available for
Number of securities future issuance under
to be issued upon Weighted-average equity compensation
exercise of exercise price of plans (excluding
outstanding options, outstanding options, securities reflected in
Plan Category warrants and rights warrants and rights column (a))
- ---------------------------------- ------------------------ ----------------------- --------------------------
Equity compensation plans approved by
security holders
Long-Term Incentive Plan (LTIP) 52,000 N/A(1) 443,500
Restated Stock Option Plan 463,814 $27.06 1,428,200
Employee Stock Purchase Plan 22,599 $24.10 125,816
Equity compensation plans not
approved by security holders -- -- --
------- ---------
Total 538,413 $24.13 1,997,516
======= =========
- -------------------
1 Shares issued pursuant to the LTIP do not include an exercise price, but are
payable by the Company when the award criteria is satisfied.
75
ITEM 14. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures.
Within the 90 days prior to the date of the filing of this report, the
Company evaluated, under the supervision and with the participation of the
Company's management, including the Company's President and Chief Executive
Officer, and the Company's Senior Vice President, Finance, and Chief Financial
Officer, the effectiveness of the design and operation of the Company's
disclosure controls and procedures pursuant to Rules 13a-14 and 15d-14 under the
Securities Exchange Act of 1934. Based upon that evaluation, the Company's
President and Chief Executive Officer, together with the Company's Senior Vice
President, Finance, and Chief Financial Officer, concluded that the Company's
disclosure controls and procedures are effective in timely alerting them to
material information relating to the Company (including its consolidated
subsidiaries) required to be included in the Company's periodic filings with the
Securities and Exchange Commission.
(b) Changes in Internal Controls.
There have been no significant changes in the Company's internal controls
or in other factors that could significantly affect internal controls subsequent
to the date the Company carried out its evaluation.
76
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
1. A list of all Financial Statements and Supplemental Schedules is
incorporated by reference to Item 8.
2. List of Exhibits filed:
*(3a.) Restated Articles of Incorporation, as filed and
effective June 24, 1988 and amended December 8, 1992,
December 1, 1993 and May 27, 1994 (incorporated herein
by reference to Exhibit (3a.) to Form 10-K for 1994,
File No. 0-994).
*(3b.) Bylaws as amended May 23, 2002 (incorporated herein by
reference to Exhibit 3 to Form 10-Q for quarter ended
June 30, 2002, File No. 0-994).
*(4a.) Copy of Mortgage and Deed of Trust, dated as of July 1,
1946, to Bankers Trust and R. G. Page (to whom Stanley
Burg is now successor), Trustees (incorporated herein by
reference to Exhibit 7(j) in File No. 2-6494); and
copies of Supplemental Indentures Nos. 1 through 14 to
the Mortgage and Deed of Trust, dated respectively, as
of June 1, 1949, March 1, 1954, April 1, 1956, February
1, 1959, July 1, 1961, January 1, 1964, March 1, 1966,
December 1, 1969, April 1, 1971, January 1, 1975,
December 1, 1975, July 1, 1981, June 1, 1985 and
November 1, 1985 (incorporated herein by reference to
Exhibit 4(d) in File No. 33-1929); Supplemental
Indenture No. 15 to the Mortgage and Deed of Trust,
dated as of July 1, 1986 (filed as Exhibit (4)(c) in
File No. 33-24168); Supplemental Indentures Nos. 16, 17
and 18 to the Mortgage and Deed of Trust, dated,
respectively, as of November 1, 1988, October 1, 1989
and July 1, 1990 (incorporated herein by reference to
Exhibit (4)(c) in File No. 33-40482); Supplemental
Indenture No. 19 to the Mortgage and Deed of Trust,
dated as of June 1, 1991 (incorporated herein by
reference to Exhibit 4(c) in File No. 33-64014); and
Supplemental Indenture No. 20 to the Mortgage and Deed
of Trust, dated as of June 1, 1993 (incorporated herein
by reference to Exhibit 4(c) in File No. 33-53795).
*(4d.) Copy of Indenture, dated as of June 1, 1991, between the
Company and Bankers Trust Company, Trustee, relating to
the Company's Unsecured Medium-Term Notes (incorporated
herein by reference to Exhibit 4(e) in File No.
33-64014).
*(4e.) Officers' Certificate dated June 12, 1991 creating
Series A of the Company's Unsecured Medium-Term Notes
(incorporated herein by reference to Exhibit (4e.) to
Form 10-K for 1993, File No. 0-994).
*(4f.) Officers' Certificate dated June 18, 1993 creating
Series B of the Company's Unsecured Medium-Term Notes
(incorporated herein by reference to Exhibit (4f.) to
Form 10-K for 1993, File No. 0-994).
(4f.(1)) Officers' Certificate dated January 17, 2003 relating to
Series B of the Company's Unsecured Medium-Term Notes
and supplementing the Officers' Certificate dated June
18, 1993.
77
*(4g.) Rights Agreement, dated as of February 27, 1996, between
the Company and Boatmen's Trust Company (Mellon Investor
Services LLC, successor), which includes as Exhibit A
thereto the form of a Right Certificate and as Exhibit B
thereto the Summary of Rights to Purchase Common Shares
(incorporated herein by reference to Exhibit 1 to Form
8-A, dated February 27, 1996, File No. 0-994).
*(4h.) Amendment No. 1, dated October 5, 2001, to Rights
Agreement, dated February 27, 1996, between the Company
and Boatmen's Trust Company (Mellon Investor Services
LLC, successor) (incorporated herein by reference to
Exhibit 4 to Form 10-Q for quarter ended September 30,
2001, File No. 0-994).
*(10j.) Transportation Agreement, dated June 29, 1990, between
the Company and Northwest Pipeline Corporation
(incorporated herein by reference to Exhibit (10j.) to
Form 10-K for 1993, File No. 0-994).
*(10j.(1)) Replacement Firm Transportation Agreement, dated July
31, 1991, between the Company and Northwest Pipeline
Corporation (incorporated herein by reference to Exhibit
(10j.(2)) to Form 10-K for 1992, File No. 0-994).
*(10j.(2)) Firm Transportation Service Agreement, dated November
10, 1993, between the Company and Pacific Gas
Transmission Company (incorporated herein by reference
to Exhibit (10j.(2)) to Form 10-K for 1993, File No.
0-994).
*(10j.(3)) Service Agreement, dated June 17, 1993, between
Northwest Pipeline Corporation and the Company
(incorporated herein by reference to Exhibit (10j.(3))
to Form 10-K for 1994, File No. 0-994).
*(10j.(5)) Firm Transportation Service Agreement, dated June 22,
1994, between Pacific Gas Transmission Company and the
Company (incorporated herein by reference to
Exhibit (10j.(5)) to Form 10-K for 1995, File No.
0-994).
(11) Statement re computation of per share earnings.
(12) Statement re computation of ratios of earnings to fixed
charges.
(23) Consent of PricewaterhouseCoopers LLP.
(99) Certificate Pursuant to Section 906 of Sarbanes-Oxley
Act of 2002.
Executive Compensation Plans and Arrangements:
---------------------------------------------
*(10b.) Executive Supplemental Retirement Income Plan, 1995
Restatement (incorporated herein by reference to
Exhibit (10b.) to Form 10-K for 1994, File No. 0-994).
*(10b.-1) 1995 Amendment to Executive Supplemental Retirement
Income Plan (1995 Restatement) (incorporated herein by
reference to Exhibit (10b.-1) to Form 10-K for 1995,
File No. 0-994).
*(10b.-2) Amendment 1998-1 to the Executive Supplemental
Retirement Income Plan (1995 Restatement) (incorporated
herein by reference to Exhibit 10(a) to Form 10-Q for
the quarter ended September 30, 1998, File No. 0-994).
78
*(10b.-3) ESRIP Change in Control Amendment to the Executive
Supplemental Retirement Income Plan (1995 Restatement)
(incorporated herein by reference to Exhibit 10(b) to
Form 10-Q for the quarter ended September 30, 1998, File
No. 0-994).
*(10c.) Restated Stock Option Plan, as amended effective May 23,
2002 (incorporated herein by reference to Exhibit 10(a)
to Form 10-Q for quarter ended September 30, 2002, File
No. 0-994).
(10e.) Executive Deferred Compensation Plan, effective as of
January 1, 1987, Restated as of January 1, 2003.
*(10f.) Directors Deferred Compensation Plan, effective June 1,
1981, restated as of December 1, 2001(incorporated
herein by reference to Exhibit (10f.) to Form 10-K for
2001, File No. 0-994).
*(10f.-1) Amendment No. 1 to Directors Deferred Compensation Plan,
Restated as of December 1, 2001 (incorporated herein by
reference to Exhibit 10 to form 10-Q for quarter ended
June 30, 2002, File No. 0-994).
*(10g.) Form of Indemnity Agreement as entered into between the
Company and each director and executive officer
(incorporated herein by reference to Exhibit (10g.) to
Form 10-K for 1988, File No. 0-994).
*(10i.) Non-Employee Directors Stock Compensation Plan, as
amended effective October 1, 2002 (incorporated herein
by reference to Exhibit 10(b) to Form 10-Q for quarter
ended September 30, 2002, File No. 0-994).
(10k.) Executive Annual Incentive Plan, effective January 1,
2003.
*(10n.) Employment agreement dated November 2, 1995, as amended
February 27, 1996, between the Company and an executive
officer (incorporated herein by reference to Exhibit
(10n.) to Form 10-K for 1995, File No. 0-994).
*(10n.-1) Amendment dated December 18, 1997 to employment
agreement dated November 2, 1995, as previously amended
February 27, 1996, between the Company and an executive
officer (incorporated herein by reference to Exhibit
(10n.-1) to Form 10-K for 1997, File No. 0-994).
*(10n.-2) Amendment dated September 24, 1998 to employment
agreement dated November 2, 1995, as previously amended,
between the Company and an executive officer
(incorporated herein by reference to Exhibit 10(e) to
Form 10-Q for the quarter ended September 30, 1998, File
No. 0-994).
(10n.-3) Summary of Compensation Arrangements for Chairman of the
Board, March 1, 2003 - February 28, 2005.
*(10o.) Form of amended and restated executive change in control
severance agreement as entered into between the Company
and each executive officer (incorporated herein by
reference to Exhibit 10(a) to Form 10-Q for the quarter
ended June 30, 2001, File No. 0-994).
79
*(10o.(1)) Form of change in control letter agreement as entered
into between the Company and each executive officer
(incorporated herein by reference to Exhibit 10(a) to
Form 10-Q for the quarter ended September 30, 2001, File
No. 0-994).
*(10p.) Employment Agreement dated July 2, 1997, between the
Company and an executive officer (incorporated herein by
reference to Exhibit 10(a) for Form 10-Q for the quarter
ended September 30, 1997, File No. 0-994).
*(10p.-1) Amendment dated December 18, 1997 to employment
agreement dated July 2, 1997, between the Company and an
executive officer (incorporated herein by reference to
Exhibit (10p.-1) to Form 10-K for 1997, File No. 0-994).
*(10p.-2) Amendment dated September 24, 1998 to employment
agreement dated July 2, 1997, as previously amended,
between the Company and an executive officer
(incorporated herein by reference to Exhibit 10(g) to
Form 10-Q for the quarter ended September 30, 1998, File
No. 0-994).
(10p.-3) Employment Agreement dated December 20, 2002, between
the Company and an executive officer.
*(10r.) Employment agreement dated May 11, 1999, between the
Company and an executive officer (incorporated herein by
reference to Exhibit 10 to Form 10-Q for the quarter
ended June 30, 1999, File No. 0-994).
*(10u.) Separation Agreement and Mutual Release of All Claims
between the Company and an executive officer, dated
February 28, 2001 (incorporated herein by reference to
Exhibit (10u.) to Form 10-K for 2000, File No. 0-994).
*(10v.) Northwest Natural Gas Company Long-Term Incentive Plan,
as amended and restated effective July 26, 2001
(incorporated herein by reference to Exhibit 10(c) to
Form 10-Q for the quarter ended June 30, 2001, File No.
0-994).
*(10w.) Restricted stock retention agreement, dated August 1,
2001, as entered into between the Company and an
executive officer (incorporated herein by reference to
Exhibit 10(b) to Form 10-Q for the quarter ended June
30, 2001, File No. 0-994).
The Company agrees to furnish the Commission, upon request, a copy
of certain instruments defining rights of holders of long-term debt
of the Company or its consolidated subsidiaries which authorize
securities thereunder in amounts which do not exceed 10% of the
total assets of the Company.
(b) Reports on Form 8-K.
On October 9, 2002, the Company filed its Current Report on Form 8-K
relating to (1) the appointment of a new chief executive officer and
director; (2) the renewal of NW Natural's lines of credit; and (3) the
Oregon Public Utility Commission's approval of a settlement in NW
Natural's conservation tariff proceeding.
80
On February 5, 2003, the Company filed its Current Report on Form 8-K
relating to the Company's 2002 earnings (unaudited).
- -------------------
*Incorporated herein by reference as indicated
81
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.
NORTHWEST NATURAL GAS COMPANY
Date: March 24, 2003 By: /s/ Mark S. Dodson
-----------------------------------
Mark S. Dodson, President
and Chief Executive Officer
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 date indicated.
SIGNATURE TITLE DATE
- -------------------------------------------------------------------------------------------------
/s/ Mark S. Dodson Principal Executive Officer and Director March 24, 2003
- ------------------------------
Mark S. Dodson, President
and Chief Executive Officer
/s/ Bruce R. DeBolt Principal Financial Officer March 24, 2003
- ------------------------------
Bruce R. DeBolt
Senior Vice President, Finance,
and Chief Financial Officer
/s/ Stephen P. Feltz Principal Accounting Officer March 24, 2003
- ------------------------------
Stephen P. Feltz
Treasurer and Controller
/s/ John D. Carter Director )
- ------------------------------ )
John D. Carter )
)
/s/ Thomas E. Dewey, Jr. Director )
- ------------------------------ )
Thomas E. Dewey, Jr. )
)
/s/ C. Scott Gibson Director )
- ------------------------------ )
C. Scott Gibson )
)
/s/ Tod R. Hamachek Director )
- ------------------------------ )
Tod R. Hamachek )
)
/s/ Wayne D. Kuni Director )
- ------------------------------ )
Wayne D. Kuni )
)
/s/ Randall C. Pape Director ) March 24, 2003
- ------------------------------ )
Randall C. Pape )
)
/s/ Richard G. Reiten Director )
- ------------------------------ )
Richard G. Reiten )
)
/s/ Robert L. Ridgley Director )
- ------------------------------ )
Robert L. Ridgley )
)
/s/ Dwight A. Sangrey Director )
- ------------------------------ )
Dwight A. Sangrey )
)
/s/ Melody C. Teppola Director )
- ------------------------------ )
Melody C. Teppola )
)
/s/ Russell F. Tromley Director )
- ------------------------------ )
Russell F. Tromley )
)
/s/ Richard L. Woolworth Director )
- ------------------------------ )
Richard L. Woolworth )
82
CERTIFICATIONS
I, Mark S. Dodson, certify that:
1. I have reviewed this annual report on Form 10-K of Northwest Natural Gas
Company;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: March 24, 2003
/s/ Mark S. Dodson
------------------------------------
Mark S. Dodson
President and Chief Executive Officer
83
I, Bruce R. DeBolt, certify that:
1. I have reviewed this annual report on Form 10-K of Northwest Natural Gas
Company;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this annual report is
being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of
the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: March 24, 2003
/s/ Bruce R. DeBolt
------------------------------------
Bruce R. DeBolt
Senior Vice President, Finance,
and Chief Financial Officer
84
EXHIBIT INDEX
-------------
To
Annual Report on Form 10-K
For Fiscal Year Ended
December 31, 2002
Exhibit
Document Number
-------- ----------
* Restated Articles of Incorporation, as filed (3a.)
June 24, 1988 and amended December 8, 1992, December 1,
1993 and May 27, 1994
* Bylaws as amended May 23, 2002 (3b.)
* Mortgage and Deed of Trust, dated as of July 1, (4a.)
1946, as supplemented by Supplemental Indenture
Nos. 1 through 20
* Indenture, dated as of June 1, 1991, between (4d.)
the Company and Bankers Trust Company
* Officers' Certificate, dated June 12, 1991, (4e.)
creating Unsecured Medium-Term Notes Series A
* Officers' Certificate, dated June 18, 1993, (4f.)
creating Unsecured Medium-Term Notes Series B
Officers' Certificate, dated January 17, 2003, (4f.(1))
relating to Series B of the Company's Unsecured
Medium-Term Notes and supplementing the
Officers' Certificate dated June 18, 1993
* Rights Agreement, dated as of February 27, 1996, (4g.)
between the Company and Boatmen's Trust Company
(Mellon Investor Services LLC, successor)
* Amendment No. 1, dated October 5, 2001, to (4h.)
Rights Agreement, dated February 27, 1996,
between the Company and Boatmen's Trust
Company (Mellon Investor Services LLC, successor)
* Transportation Agreement, dated June 29, 1990, (10j.)
between the Company and Northwest Pipeline
Corporation
* Replacement Firm Transportation Agreement, (10j.(1))
dated July 31, 1991, between the Company and
Northwest Pipeline Corporation
* Firm Transportation Service Agreement, dated (10j.(2))
November 10, 1993, between the Company and
Pacific Gas Transmission Company
* Service Agreement, dated June 17, 1993, between (10j.(3))
Northwest Pipeline Corporation and the Company
* Firm Transportation Service Agreement, dated (10j.(5))
June 22, 1994, between Pacific Gas Transmission
Company and the Company
Statement re computation of per share earnings (11)
Statement re computation of ratios of earnings to fixed (12)
charges
Consent of PricewaterhouseCoopers LLP (23)
Certificate Pursuant to Section 906 of Sarbanes Oxley (99)
Act of 2002
Executive Compensation Plans and Arrangements
---------------------------------------------
* Executive Supplemental Retirement Income (10b.)
Plan, 1995 Restatement
* 1995 Amendment to Executive Supplemental (10b.-1)
Retirement Income Plan (1995 Restatement)
* Amendment 1998-1 to the Executive (10b.-2)
Supplemental Retirement Income Plan
(1995 Restatement)
* ESRIP Change in Control Amendment to the (10b.-3)
Executive Supplemental Retirement Income
Plan (1995 Restatement)
* Restated Stock Option Plan, as amended effective (10c.)
May 23, 2002
Executive Deferred Compensation Plan, effective (10e.)
January 1, 1987, Restated as of January 1, 2003
* Directors Deferred Compensation Plan, (10f.)
effective June 1, 1981, restated as of
December 1, 2001
* Amendment No. 1 to Directors Deferred Compensation Plan, (10f.-1)
Restated as of December 1, 2001
* Form of Indemnity Agreement entered into between (10g.)
the Company and each director and executive officer
* Non-Employee Directors Stock Compensation (10i.)
Plan, as amended effective October 1, 2002
Executive Annual Incentive Plan, effective (10k.)
January 1, 2003
* Employment agreement dated November 2, 1995, (10n.)
as amended February 27, 1996, between the
Company and an executive officer
* Amendment dated December 18, 1997 to (10n.-1)
employment agreement dated November 2, 1995,
between the Company and an executive officer
* Amendment dated September 24, 1998 to employment (10n.-2)
agreement dated November 2, 1995, as previously
amended, between the Company and an executive officer
Summary of Compensation Arrangements for Chairman (10n.-3)
of the Board, March 1, 2003 - February 28, 2005
* Form of amended and restated executive change (10o.)
in control severance agreement as entered into
between the Company and each executive officer
* Form of change in control letter agreement as (10o.(1))
entered into between the Company and each
executive officer
* Employment agreement dated July 2, 1997 (10p.)
between the Company and an executive officer
* Amendment dated December 18, 1997 to (10p.-1)
employment agreement dated July 2, 1997,
between the Company and an executive officer
* Amendment dated September 24, 1998 to employment (10p.-2)
agreement dated July 2, 1997, as previously
amended, between the Company and an executive officer
Employment Agreement dated December 20, 2002, (10p.-3)
between the Company and an executive officer
* Employment agreement dated May 11, 1999, (10r.)
between the Company and an executive officer
* Separation Agreement and Mutual Release of All (10u.)
Claims between the Company and an executive officer
* Northwest Natural Gas Company Long-Term (10v.)
Incentive Plan, as amended and restated,
effective July 26, 2001
* Restricted stock retention agreement dated (10w.)
August 1, 2001, as entered into between the
Company and an executive officer
- -------------------
* Incorporated by reference