SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
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 No. 0-994
[LOGO OMITTED][NW NATURAL]
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
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 whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [x] No [ ]
At May 8, 2003, 25,663,184 shares of the registrant's Common Stock, $3-1/6 par
value (the only class of Common Stock) were outstanding.
NORTHWEST NATURAL GAS COMPANY
March 31, 2003
Summary of Information Reported
The registrant submits herewith the following information:
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements Page
Number
Consolidated Statements of Income for the three-month
periods ended March 31, 2003 and 2002 3
Consolidated Statements of Earnings Invested in the Business
for the three-month periods ended March 31, 2003 and 2002 4
Consolidated Balance Sheets at March 31, 2003 and 2002
and Dec. 31, 2002 5
Consolidated Statements of Cash Flows for the three-month
periods ended March 31, 2003 and 2002 7
Consolidated Statements of Capitalization at March 31, 2003
and 2002 and Dec. 31, 2002 8
Notes to Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis of Results of Operations
and Financial Condition 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk 25
Item 4. Controls and Procedures 25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 6. Exhibits and Reports on Form 8-K 26
Signature 26
Certifications 27
2
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Statements of Income
(Unaudited)
Three Months Ended
March 31,
-----------------------
Thousands, except per share amounts 2003 2002
- -------------------------------------------------------------------------------------------------------
Operating revenues:
Gross operating revenues $ 206,539 $ 278,563
Cost of sales 107,951 167,897
--------- ---------
Net operating revenues 98,588 110,666
Operating expenses:
Operations and maintenance 24,071 22,169
Taxes other than income taxes 10,817 12,002
Depreciation and amortization 13,166 12,814
--------- ---------
Total operating expenses 48,054 46,985
--------- ---------
Income from operations 50,534 63,681
Other income (expense) (584) (870)
Interest charges - net 8,946 8,149
--------- ---------
Income before income taxes 41,004 54,662
Income taxes 14,600 20,215
--------- ---------
Net income 26,404 34,447
Redeemable preferred and preference stock dividend requirements 147 595
--------- ---------
Earnings applicable to common stock $ 26,257 $ 33,852
========= =========
Average common shares outstanding 25,617 25,266
Basic earnings per share of common stock $ 1.03 $ 1.34
Diluted earnings per share of common stock $ 1.01 $ 1.32
Dividends per share of common stock $ 0.315 $ 0.315
--------------------------------------------------
See Notes to Consolidated Financial Statements
3
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Statements of Earnings Invested in the Business
(Unaudited)
Three Months Ended March 31,
--------------------------------------------------------------
Thousands 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings invested in the business:
Balance at beginning of period $ 157,136 $ 147,950
Net income 26,404 $ 26,404 34,447 $ 34,447
Cash dividends paid:
Redeemable preferred and preference stock (147) (594)
Common stock (8,063) (7,953)
--------- ---------
Balance at end of period $ 175,330 $ 173,850
========= =========
Accumulated other comprehensive income (loss):
Balance at beginning of period $ (3,084) $ (375)
Other comprehensive income - net of tax:
Change in unrealized gain from price risk
management activities -- -- 430 430
--------------------------- --------------------------
Comprehensive income $ 26,404 $ 34,877
========= =========
Balance at end of period $ (3,084) $ 55
========= =========
--------------------------------------------------
See Notes to Consolidated Financial Statements
4
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Balance Sheets
March 31, March 31,
2003 2002 Dec. 31,
Thousands (Unaudited) (Unaudited) 2002
- ---------------------------------------------------------------------------------------------------------------
Assets:
Plant and property:
Utility plant $ 1,563,162 $ 1,478,725 $ 1,539,965
Less accumulated depreciation 573,355 525,805 560,798
----------- ----------- -----------
Utility plant - net 989,807 952,920 979,167
----------- ----------- -----------
Non-utility property 22,176 18,494 20,832
Less accumulated depreciation and amortization 4,518 3,774 4,404
----------- ----------- -----------
Non-utility property - net 17,658 14,720 16,428
----------- ----------- -----------
Total plant and property 1,007,465 967,640 995,595
----------- ----------- -----------
Other investments 12,462 25,074 12,703
----------- ----------- -----------
Current assets:
Cash and cash equivalents 45,468 30,084 7,328
Accounts receivable 60,396 81,503 48,751
Allowance for uncollectible accounts (2,709) (3,648) (1,815)
Accrued unbilled revenue 30,548 39,860 44,069
Inventories of gas, materials and supplies 32,873 33,396 58,030
Prepayments and other current assets 24,610 24,100 37,645
----------- ----------- -----------
Total current assets 191,186 205,295 194,008
----------- ----------- -----------
Regulatory assets:
Income tax asset 47,975 48,469 47,975
Unrealized loss on non-trading derivatives -- 48,666 --
Unamortized costs on debt redemptions 6,392 6,855 6,508
Other 4,665 4,232 7,040
----------- ----------- -----------
Total regulatory assets 59,032 108,222 61,523
----------- ----------- -----------
Other assets:
Investment in life insurance 55,264 53,418 54,916
Fair value of non-trading derivatives 22,264 -- 12,426
Other 12,381 11,168 11,620
----------- ----------- -----------
Total other assets 89,909 64,586 78,962
----------- ----------- -----------
Total assets $ 1,360,054 $ 1,370,817 $ 1,342,791
=========== =========== ===========
--------------------------------------------------
See Notes To Consolidated Financial Statements
5
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Balance Sheets
March 31, March 31,
2003 2002 Dec. 31,
Thousands (Unaudited) (Unaudited) 2002
- ---------------------------------------------------------------------------------------------------------------
Capitalization and liabilities:
Common stock $ 81,214 $ 80,130 $ 81,023
Premium on common stock 249,340 242,245 248,028
Earnings invested in the business 175,330 173,850 157,136
Accumulated other comprehensive income (loss) (3,084) 55 (3,084)
----------- ----------- -----------
Total common stock equity 502,800 496,280 483,103
Redeemable preference stock -- 25,000 --
Redeemable preferred stock 8,250 9,000 8,250
Long-term debt 485,926 438,236 445,945
----------- ----------- -----------
Total capitalization 996,976 968,516 937,298
----------- ----------- -----------
Current liabilities:
Notes payable -- 163 69,802
Accounts payable 77,250 59,592 74,436
Long-term debt due within one year 20,000 40,000 20,000
Taxes accrued 7,348 30,280 7,822
Interest accrued 11,073 9,847 2,902
Other current and accrued liabilities 30,745 26,673 30,045
----------- ----------- -----------
Total current liabilities 146,416 166,555 205,007
----------- ----------- -----------
Regulatory liabilities:
Customer advances 1,790 1,824 1,791
Deferred gas costs payable 12,908 30,262 10,635
Unrealized gain on non-trading derivatives 22,264 -- 12,426
----------- ----------- -----------
Total regulatory liabilities 36,962 32,086 24,852
----------- ----------- -----------
Other liabilities:
Deferred income taxes 146,684 128,886 141,732
Deferred investment tax credits 7,286 8,138 7,824
Fair value of non-trading derivatives -- 48,463 --
Other 25,730 18,173 26,078
----------- ----------- -----------
Total other liabilities 179,700 203,660 175,634
----------- ----------- -----------
Commitments and Contingencies (see Note 6) -- -- --
----------- ----------- -----------
Total capitalization and liabilities $ 1,360,054 $ 1,370,817 $ 1,342,791
=========== =========== ===========
--------------------------------------------------
See Notes To Consolidated Financial Statements
6
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Statements of Cash Flows
(Unaudited)
Three Months Ended
March 31,
------------------------------
Thousands 2003 2002
- --------------------------------------------------------------------------------------------------------------
Operating activities:
Net income from operations $ 26,404 $ 34,447
Adjustments to reconcile net income to cash provided by operations:
Depreciation and amortization 13,166 12,814
Gain on sale of assets -- (221)
Unrealized gain from price risk management activities -- 430
Deferred income taxes and investment tax credits 4,414 (2,082)
Equity in (earnings) losses of investments 260 (138)
Allowance for funds used during construction (189) (148)
Deferred gas costs - net 2,273 20,173
Other 1,033 424
------------------------------
Cash from operations before working capital changes 47,361 65,699
Changes in operating assets and liabilities:
Accounts receivable - net of uncollectible accounts (10,751) (13,133)
Accrued unbilled revenue 13,521 17,889
Inventories of gas, materials and supplies 25,157 15,941
Accounts payable 2,814 (11,106)
Accrued interest and taxes 16,949 13,930
Other current assets and liabilities 4,483 2,097
------------------------------
Cash provided by operating activities 99,534 91,317
------------------------------
Investing activities:
Acquisition and construction of utility plant assets (23,503) (15,039)
Investment in non-utility property (1,344) (291)
PGE acquisition costs -- (2,334)
Proceeds from sale of assets -- 500
Other investments (19) 518
------------------------------
Cash used in investing activities (24,866) (16,646)
Financing activities:
Common stock issued 1,484 1,648
Long-term debt issued 40,000 60,000
Change in short-term debt (69,802) (108,128)
Cash dividend payments:
Redeemable preferred and preference stock (147) (594)
Common stock (8,063) (7,953)
------------------------------
Cash used in financing activities (36,528) (55,027)
Increase in cash and cash equivalents 38,140 19,644
Cash and cash equivalents - beginning of period 7,328 10,440
------------------------------
Cash and cash equivalents - end of period $ 45,468 $ 30,084
==============================
- --------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 737 $ 1,923
Income taxes $ -- $ 14,111
- --------------------------------------------------------------------------------------------------------------
Supplemental disclosure of non-cash financing activities:
Conversion to common stock:
7-1/4 % Series of Convertible Debentures $ 19 $ 141
--------------------------------------------------
See Notes to Consolidated Financial Statements
7
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Statements of Capitalization
March 31, 2003 March 31, 2002
Thousands, except share amounts (Unaudited) (Unaudited) Dec. 31, 2002
- ---------------------------------------------------------------------------------------------------------------------------------
Common Stock Equity:
Common stock - par value $3-1/6 per share $ 81,214 $ 80,130 $ 81,023
Premium on common stock 249,340 242,245 248,028
Earnings invested in the business 175,330 173,850 157,136
Accumulated other comprehensive income (loss) (3,084) 55 (3,084)
--------- --------- ---------
Total common stock equity 502,800 50% 496,280 51% 483,103 51%
Redeemable Preference Stock:
$6.95 Series, stated value $100 per share -- -- 25,000 3% -- --
Redeemable Preferred Stock:
$7.125 Series, stated value $100 per share 8,250 1% 9,000 1% 8,250 1%
Long-Term Debt:
Medium-Term Notes
-----------------
First Mortgage Debt:
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 20,000
6.340% Series B due 2005 5,000 5,000 5,000
6.380% Series B due 2005 5,000 5,000 5,000
6.450% Series B due 2005 5,000 5,000 5,000
6.050% Series B due 2006 8,000 8,000 8,000
6.310% Series B due 2007 20,000 20,000 20,000
6.800% Series B due 2007 9,500 10,000 9,500
6.500% Series B due 2008 5,000 5,000 5,000
7.450% Series B due 2010 25,000 25,000 25,000
6.665% Series B due 2011 10,000 10,000 10,000
7.130% Series B due 2012 40,000 40,000 40,000
8.260% Series B due 2014 10,000 10,000 10,000
7.000% Series B due 2017 40,000 40,000 40,000
6.600% Series B due 2018 22,000 22,000 22,000
8.310% Series B due 2019 10,000 10,000 10,000
7.630% Series B due 2019 20,000 20,000 20,000
9.050% Series A due 2021 10,000 10,000 10,000
7.250% Series B due 2023 20,000 20,000 20,000
7.500% Series B due 2023 4,000 4,000 4,000
7.520% Series B due 2023 11,000 11,000 11,000
7.720% Series B due 2025 20,000 20,000 20,000
6.520% Series B due 2025 10,000 10,000 10,000
7.050% Series B due 2026 20,000 20,000 20,000
7.000% Series B due 2027 20,000 20,000 20,000
6.650% Series B due 2027 20,000 20,000 20,000
6.650% Series B due 2028 10,000 10,000 10,000
7.740% Series B due 2030 20,000 20,000 20,000
7.850% Series B due 2030 10,000 10,000 10,000
5.820% Series B due 2032 30,000 -- 30,000
5.660% Series B due 2033 40,000 -- --
Convertible Debentures
----------------------
7-1/4% Series due 2012 6,426 8,236 ` 6,445
--------- --------- ---------
505,926 478,236 465,945
Less long-term debt due within one year 20,000 40,000 20,000
--------- --------- ---------
Total long-term debt 485,926 49% 438,236 45% 445,945 48%
--------- --- --------- --- --------- ---
Total Capitalization $ 996,976 100% $ 968,516 100% $ 937,298 100%
========= === ========= === ========= ===
----------------------------------------------------
See Notes to Consolidated Financial Statements
8
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Financial Statements
The information presented in the consolidated financial
statements is unaudited, but includes all material adjustments, including normal
recurring accruals, that the management of the Company considers necessary for a
fair presentation of the results of such periods. These consolidated financial
statements should be read in conjunction with the financial statements and
related notes included in the Company's 2002 Annual Report on Form 10-K (2002
Form 10-K). A significant part of the business of the Company is of a seasonal
nature; therefore, results of operations for interim periods are not necessarily
indicative of the results for a full year.
As referred to herein, the "Company" consists of Northwest
Natural Gas Company (NW Natural), a regulated utility, and non-regulated
wholly-owned subsidiary businesses NNG Financial Corporation (Financial
Corporation) and Northwest Energy Corporation (Northwest Energy). Northwest
Energy was formed in 2001 to serve as the holding company for NW Natural and
Portland General Electric Company (PGE) if the acquisition of PGE had been
completed.
2. New Accounting Standards
Effective Jan. 1, 2003, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 requires the recognition of an Asset Retirement
Obligation (ARO) for legal obligations associated with the retirement of
tangible long-lived assets, including the recording of fair value of the
liability for an ARO in the period in which it is incurred if a reasonable
estimate of fair value can be made. The ARO liability 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
the Company's judgment, it does not have any material legal obligations
associated with the retirement of its tangible long-lived assets, except for
certain assets with indefinite system lives for which the Company could not
estimate the ARO because the settlement date was indeterminable. In addition, NW
Natural's accounting records conform to certain regulatory requirements in
accordance with SFAS No. 71, "Accounting for the Effects of Certain Types of
Regulation," and accordingly NW Natural has been recognizing asset retirement
costs (removal costs) on many regulated, long-lived assets through a charge to
depreciation expense allowed in rates, with a corresponding accrual to
accumulated depreciation. These estimated removal costs meet the requirements of
SFAS No. 71 and are included in accumulated depreciation. As of Dec. 31, 2002,
the Company had approximately $125 million of estimated removal costs in excess
of normal depreciation costs included in accumulated depreciation in the
consolidated balance sheets. The adoption of SFAS No. 143 did not have a
material impact on the Company's financial condition or results of operations.
Effective Jan. 1, 2003, the Company also adopted SFAS No. 145,
"Rescission of FASB Statement Nos. 4, 44 and 64, Amendment of FASB Statement No.
13 and Technical Corrections," and 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. 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. 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 was
effective for all exit or disposal activities initiated after Dec. 31, 2002, is
9
on the timing of recognition of costs associated with exit or disposal
activities. The adoption of SFAS Nos. 145 and 146 did not have a material impact
on the Company's financial condition or results of operations.
In November 2002, the Financial Accounting Standards Board
(FASB) issued FASB Interpretation No. 45 (FIN 45), "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN 45 clarifies the requirements of FASB Statement No.
5, "Accounting for Contingencies," relating to the guarantor's accounting for,
and disclosure of, the issuance of certain types of guarantees. A guarantor must
recognize a liability for the fair value of an obligation assumed under a
guarantee. FIN 45 also provides for additional disclosures by a guarantor in its
interim and annual financial statements about the obligations associated with
guarantees issued. The recognition provisions of FIN 45 are effective for any
guarantees issued or modified after Dec. 31, 2002. The application of FIN 45 as
of Jan. 1, 2003 did not have a material impact on the Company's financial
condition or results of operations.
In January 2003, the FASB issued FIN 46, "Consolidation of
Variable Interest Entities." FIN 46 provides guidance on the identification of,
and the financial reporting for, entities over which control is achieved through
means other than voting rights, known as variable-interest entities. FIN 46
provides guidance for determining whether consolidation is required under the
"controlling financial interest" model of Accounting Bulletin No. 51. Certain
variable interest entities must be consolidated by the primary beneficiary if
the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 was effective immediately for all new
variable interest entities created or acquired after Jan. 31, 2003. For variable
interest entities created or acquired prior to Feb. 1, 2003, the provisions of
FIN 46 must be applied for the first interim or annual period beginning after
June 15, 2003. The Company did not have interests in any variable-interest
entities during any of the current reporting periods, such that the application
of FIN 46 as of Jan. 1, 2003 did not have a material impact on the Company's
financial condition or results of operations.
3. Stock-Based Compensation
NW Natural has stock-based compensation plans including the
Long-Term Incentive Plan (LTIP), the Restated Stock Option Plan (Restated SOP),
the Employee Stock Purchase Plan and the Non-Employee Directors Stock
Compensation Plan (see Part II, Item 8., Note 4, in the 2002 Form 10-K). These
plans are designed to promote stock ownership in NW Natural by employees,
officers and directors.
During the first quarter of 2003, NW Natural granted LTIP
awards covering a new three-year performance period (2003-05). The aggregate
target award and maximum award were 28,000 and 56,000 shares, respectively.
Following the end of the performance period, actual awards are distributed based
on the attainment of certain return on equity performance goals. During the
performance period, the Company recognizes compensation expense and liability
for the LTIP awards based on performance levels achieved or expected to be
achieved and the estimated market value of common stock as of the distribution
date. At March 31, 2003, no compensation expense or liability had been accrued
for the new LTIP grant.
In December 2002, the FASB issued SFAS No. 148, "Accounting
for Stock-Based Compensation -- Transition and Disclosure -- an amendment of
FASB Statement No. 123," which amends FASB Statement No. 123, "Accounting for
Stock-Based Compensation," to provide alternative methods of transition for a
voluntary change to the fair-value-based method of accounting for stock-based
employee compensation. In addition, SFAS No. 148 amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in 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.
SFAS No. 123 encourages, but does not require, companies to record compensation
expense for stock-based compensation plans at fair value.
The Company adopted the SFAS No. 148 disclosure requirements
but has continued to account for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," for its stock-based employee
compensation. Under the Restated SOP, NW Natural grants employee stock options
10
for a fixed number of shares to officers and certain key employees with an
exercise price equal to or greater than the market value of the shares at the
date of grant. Inasmuch as NW Natural grants stock options at market value, no
compensation expense was recognized in the results of operations for the three
months ended March 31, 2003.
As of March 31, 2003, options on 1,429,500 shares were
available for grant and options to purchase 454,014 shares were outstanding.
Options granted generally have 10-year terms and vest ratably over a three-year
period following date of grant.
If compensation expense for these plans had been determined
consistent with the method prescribed by SFAS No. 123, the Company's net income
and earnings per share would have been reduced to the pro forma amounts shown
below:
Three Months Ended
March 31,
---------------------
Thousands, except per share amounts 2003 2002
- ------------------------------------------------------------------------------------------------------------
Earnings applicable to common stock:
- ------------------------------------
As reported $ 26,257 $ 33,852
Deduct: total stock-based compensation expense determined
under fair value based method for all awards - net of tax (61) (113)
-------- --------
Pro forma $ 26,196 $ 33,739
======== ========
Basic earnings per share:
- -------------------------
As reported $ 1.03 $ 1.34
Pro forma $ 1.02 $ 1.34
Diluted earnings per share:
- ---------------------------
As reported $ 1.01 $ 1.32
Pro forma $ 1.01 $ 1.31
The effects of applying SFAS No. 123 to pro forma disclosures
may not be representative of the effects on reported net income for future
periods until all options outstanding are included in the pro forma disclosures.
For purposes of pro forma disclosures, the estimated market value of stock-based
compensation plans for stock options is amortized to expense primarily over the
vesting period.
4. Use of Financial Derivatives
NW Natural utilizes derivative instruments to manage commodity
prices related to natural gas purchases, foreign currency prices related to gas
purchase commitments from Canada and interest rate risks related to long-term
debt maturing in less than five years or expected to be issued in future
periods. 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. 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. See Part II, Item 7., "Accounting for Derivative
Instruments and Hedging Activities," and Part II, Item 8., Notes 1 and 11, in
the 2002 Form 10-K.
At March 31, 2003, NW Natural had the following derivatives
outstanding covering its exposures to natural gas commodity and foreign currency
exchange rates: a series of 15 natural gas price swap contracts and 88 foreign
currency forward contracts. Each of these contracts was designated as a cash
flow hedge. The estimated fair values and the notional amounts of derivative
instruments outstanding were as follows:
11
March 31, 2003 Dec. 31, 2002
----------------------- -------------------------
Fair Value Notional Fair Value Notional
Thousands Gain (Loss) Amount Gain (Loss) Amount
- ------------------------------------------------------------------------------------------------------------------------------
Fixed-price natural gas commodity swap contracts $ 22,001 $ 162,080 $ 11,422 $ 159,724
Fixed-price natural gas call option contracts -- -- 717 18,084
Physical natural gas supply contract with embedded derivative -- -- 448 2,754
Foreign currency forward purchase contracts 263 25,576 (161) 15,525
----------------------- ------------------------
Total $ 22,264 $ 187,656 $ 12,426 $ 196,087
======================= ========================
5. Segment Information
The Company principally operates in a segment of business,
"Utility," consisting of the distribution of natural gas. Another segment, "Gas
Storage," represents natural gas storage services provided to interstate
customers using storage capacity that has been developed in advance of core
utility customers' requirements, and results 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. 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 now-terminated acquisition of PGE.
The following table presents information about the reportable
segments for the three months ended March 31, 2003 and 2002. Inter-segment
transactions are insignificant.
Three Months Ended March 31,
-------------------------------------------------------
Thousands Utility Gas Storage Other Total
- --------------------------------------------------------------------------------------------------------------
2003
- ----
Net operating revenues $ 96,005 $ 2,544 $ 39 $ 98,588
Depreciation and amortization 13,052 114 - 13,166
Other operating expenses 34,683 183 22 34,888
Income from operations 48,270 2,247 17 50,534
Income (loss) from financial investments - - (260) (260)
Net income (loss) 25,172 1,275 (43) 26,404
Total assets at March 31, 2003 1,324,698 17,634 17,722 1,360,054
2002
- ----
Net operating revenues $ 108,838 $ 1,774 $ 54 $ 110,666
Depreciation and amortization 12,723 91 - 12,814
Other operating expenses 33,900 249 22 34,171
Income from operations 62,221 1,428 32 63,681
Income from financial investments - - 138 138
Net income 33,453 786 208 34,447
Total assets at March 31, 2002 1,326,968 14,453 29,396 1,370,817
12
6. Commitments and Contingencies
Environmental Matters
---------------------
NW Natural has accrued all material loss contingencies
relating to environmental matters that it believes to be probable of assertion
and reasonably estimable. See Part II, Item 8., Note 12, in the 2002 Form 10-K.
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 the 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. In the event these costs are not
recovered from insurance, NW Natural will seek recovery through future rates.
Litigation
----------
In April 2003, NW Natural settled and agreed with Cascade
Resources Corporation and Al Curry (collectively, Cascade) to dismiss their
respective claims in 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) (the Action). See Part I, Item 3., "Legal
Proceedings," in the 2002 Form 10-K. In the settlement, Cascade transferred all
of its records, rights and interests in certain leases, including gas storage
leases, in Columbia County, Oregon to NW Natural and agreed to refrain from
certain competitive activities in the area. The counterclaims against NW Natural
described in the 2002 Form 10-K will be dismissed and Enerfin Resources
Northwest Limited Partnership (Enerfin) will be the remaining defendant in the
Action. NW Natural paid Cascade $0.5 million and agreed to defend and indemnify
Cascade against claims by Enerfin relating to the validity and enforceability of
the transferred leases. However, NW Natural will have no obligation to defend or
indemnify Cascade from any claims for recovery of punitive or other exemplary
damages.
Enerfin recently filed a motion seeking to allow it to make
cross-claims against Cascade. Enerfin's cross-claims allege misconduct by
Cascade in obtaining oil and gas production rights in some of the leases subject
to the settlement agreement. Enerfin's cross-claims seek to obtain the ownership
of oil and gas production (but not gas storage) rights in the leases subject to
the settlement. In the alternative, Enerfin seeks damages from Cascade of $12
million together with a demand for $24 million in punitive damages.
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 operation or cash flows.
13
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Item 2. 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 months ended March 31, 2003 and 2002. References in
the discussion to "Notes" are to the notes to the consolidated financial
statements in the Company's 2002 Annual Report on Form 10-K (2002 Form 10-K).
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
Together these businesses are referred to herein as the
"Company" (see "Non-utility Operations," below, and Part II, Item 8., Note 2, in
the 2002 Form 10-K).
Application of Critical Accounting Policies
- -------------------------------------------
Management's discussion and analysis of the Company's results
of operations and financial condition are based upon the consolidated financial
statements, which have been prepared in accordance with generally accepted
accounting principles in the United States of America. The preparation of these
financial statements requires management to make estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosures.
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. These critical accounting policies
are described in the 2002 Form 10-K (see "Part II, Item 7., "Application of
Critical Accounting Policies - Regulatory Accounting, Revenue Recognition,
Accounting for Derivative Instruments and Hedging Activities, Accounting for
Pensions, and Contingencies," in the 2002 Form 10-K). Because of the uncertainty
inherent in these matters, actual results could differ materially from the
estimates developed from applying these critical accounting policies.
Within the context of these critical accounting policies,
management is not currently aware of any reasonably likely events or
circumstances that would result in materially different amounts being reported.
14
Earnings and Dividends
- ----------------------
The Company's earnings applicable to common stock were $26.3
million in the quarter ended March 31, 2003, down from $33.9 million in the
quarter ended March 31, 2002. Diluted earnings per share from consolidated
operations were $1.01 a share in the first quarter of 2003, down from $1.32 a
share in last year's first quarter.
Warm weather depressed sales and operating margin in the first
quarter of 2003. NW Natural earned $0.97 a diluted share from gas utility
operations in the first quarter, compared to $1.28 a share in the same period in
2002. Weather conditions in NW Natural's service territory in the first quarter
of 2003 were 8 percent warmer than the 20-year average and 12 percent warmer
than the first quarter of 2002. The Company estimates that warmer weather and
related factors reduced residential and commercial sales in the first quarter of
2003 by about 32 million therms and margin revenues (gross operating revenues
minus cost of gas) by about $11.7 million, equivalent to 28 cents a share.
Non-utility operating results for the quarter ended March 31,
2003 were earnings of 4 cents a share, the same as the result from these
operations in the same period of 2002. See "Non-utility Operations," below.
Dividends paid on common stock were 31.5 cents a share for
each of the three-month periods ended March 31, 2003 and 2002. In April 2003,
the Company's Board of Directors declared a quarterly dividend of 31.5 cents a
share on the common stock, payable May 15, 2003, to shareholders of record on
April 30, 2003. The current indicated annual dividend rate is $1.26 a share.
Results of Operations
- ---------------------
Regulatory Developments
-----------------------
In November 2002, NW Natural filed a general rate case with
the Oregon Public Utility Commission (OPUC), proposing a revenue increase of $38
million per year from Oregon operations through rate increases averaging 6.8
percent (see Part II, Item 7., "Results of Operations - Regulatory Matters," in
the 2002 Form 10-K). The proposed rates were designed to recover NW Natural's
forecasted cost of service for a prospective test year beginning Oct. 1, 2003.
The filing proposed a return on equity (ROE) of 11.3 percent on a capital
structure including 50 percent common equity and 50 percent long-term debt and
preferred stock.
On April 28, 2003, NW Natural filed a stipulation in the case
representing a partial settlement between the Company and the OPUC Staff
(Staff). The stipulation includes agreements with the Staff with respect to many
elements of NW Natural's cost of service, including all operations and
maintenance expenses and rate base investments for the prospective test year.
The partial settlement does not include the issues of ROE, capital structure,
the revenue forecast, NW Natural's proposal for a weather normalization
mechanism, rate design, or the allocation of any revenue increase among customer
classes (rate spread). If the stipulation is approved by the OPUC, and if the
OPUC adopts NW Natural's positions on the remaining contested issues, the effect
would be to reduce NW Natural's proposed revenue increase from $38 million to
about $26 million.
Also on April 28, 2003, the Staff and other parties filed
their testimony in the case. The Staff presented its litigation positions on
issues not settled by the stipulation, proposing an overall revenue reduction of
$0.6 million, or about 0.1 percent. The Staff's positions include a revenue
forecast $10 million higher than NW Natural's forecast for the prospective test
period; a proposed ROE of 9.5 percent; and a proposed capital structure
including 48 percent common equity and 52 percent long-term debt and preferred
stock.
The schedule for the case provides for the filing of rebuttal
testimony by NW Natural in June, 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 the stipulation between NW Natural and the Staff, or NW Natural's
proposals on the remaining contested issues, will be accepted by the OPUC.
15
Comparison of Gas Operations
----------------------------
The following table summarizes the composition of gas utility
volumes and revenues for the three months ended March 31:
(Thousands, except customers and degree days) 2003 2002
- ---------------------------------------------------------------------------------------------------------------
Utility Gas Sales and Transportation Volumes - Therms:
- ------------------------------------------------------
Residential and commercial sales 236,323 262,937
Unbilled volumes (16,562) (18,622)
---------- ----------
Weather-sensitive volumes 219,761 64% 244,315 62%
Industrial firm sales 14,554 4% 23,755 6%
Industrial interruptible sales 3,685 1% 14,375 4%
---------- --- ---------- ----
Total gas sales 238,000 69% 282,445 72%
Transportation deliveries 109,160 31% 110,732 28%
---------- --- ---------- ----
Total volumes sold and delivered 347,160 100% 393,177 100%
========== === ========== ====
Utility Operating Revenues - Dollars:
- -------------------------------------
Residential and commercial sales $ 200,513 $ 259,491
Unbilled revenues (13,940) (17,895)
---------- ----------
Weather-sensitive revenues 186,573 91% 241,596 88%
Industrial firm sales 8,666 4% 17,865 6%
Industrial interruptible sales 1,844 1% 9,896 4%
---------- --- ---------- ----
Total gas sales 197,083 96% 269,357 98%
Transportation revenues 5,805 3% 6,452 2%
Other revenues 1,051 1% 173 -
---------- --- ---------- ---
Total utility operating revenues $ 203,939 100% $ 275,982 100%
========== === ========== ===
Cost of gas sold $ 107,934 $ 167,144
========== ==========
Net operating revenues (utility margin) $ 96,005 $ 108,838
========== ==========
Total number of customers (end of period) 565,892 546,806
========== ==========
Actual degree days 1,683 1,920
========== ==========
20-year average degree days 1,838 1,836
========== ==========
Residential and Commercial
--------------------------
NW Natural continues to experience rapid customer growth, with
19,086 customers added since March 31, 2002 for a growth rate of 3.5 percent. 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.
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
will affect volumes of gas sold to these customers. Weather conditions in the
first quarter of 2003 were 8 percent warmer than average and 12 percent warmer
than the first quarter of 2002. 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 24.6 million therms, or 10 percent, lower in the first quarter of
2003 than in the first quarter of 2002, primarily reflecting warmer weather
partially offset by customer growth. Related revenues decreased $55 million, or
23 percent, primarily due to the lower sales volumes and net rate decreases
effective Oct. 1, 2002. Customer growth in the residential and commercial
segments since March 31, 2002, contributed an estimated 7 million therms in
16
sales volumes and $2.7 million in additional margin during the first quarter of
2003. Effective Oct. 1, 2002, the Company implemented small rate increases
designed to recover the margin lost due to changes in consumption patterns.
These rate changes contributed an estimated $4 million of margin during the
first quarter of 2003, equivalent to about 10 cents a share.
Industrial Sales and Transportation Revenues
--------------------------------------------
The following table summarizes the delivered volumes and
margin in the industrial and electric generation markets:
(Thousands) 2003 2002
-----------------------------------------------------------------------------------------------
Delivered volumes - therms:
---------------------------
Industrial sales and transportation 125,732 145,636
Electric generation 1,667 3,226
------- -------
Total volumes 127,399 148,862
======= =======
Margin - dollars:
-----------------
Industrial sales and transportation $ 9,746 $ 12,407
Electric generation 6 2,334
------- --------
Total margin $ 9,752 $ 14,741
======= ========
Total volumes delivered to industrial and electric generation
customers were 21 million therms, or 14 percent, lower in the first quarter of
2003 than in the same period of 2002. Combined margins from these customers were
$5.0 million, or 34 percent, lower in the first quarter of 2003 compared to the
same period of 2002.
Volumes delivered to end-use industrial sales and
transportation customers, excluding electric generation customers, in the first
quarter of 2003 were 14 percent lower than in the same period in 2002. Margin
from these customers in the first quarter of 2003 was 21 percent lower than in
the same period in 2002. The decline in volumes was due to a combination of
warmer weather and weaker economic conditions, while the greater percentage
decline in margin was due to shifts by some customers during 2002 from
higher-margin sales or transportation schedules to lower-margin transportation
schedules.
In the electric generation market, margin in the first
quarter of 2003 was negligible, compared to $2.3 million from this market in the
same period of 2002. The difference is equivalent to an earnings reduction of 5
cents a share. One-year contracts for service to two customers in this market
went into effect in the second half of 2001. These customers did not extend the
contracts beyond their expiration dates on June 30, 2002; spot market
electricity prices by then had gone down and wholesale power supplies were more
readily available.
Other Revenues
--------------
Other revenues increased utility operating revenues by $1.1
million in the first quarter of 2003, compared to $0.4 million in the same
period of 2002. Other revenues include amortizations of regulatory accounts and
miscellaneous fee income (see Part II, Item 8., Note 1, in the 2002 Form 10-K).
In the first quarter of 2003, other revenues included customer late payment and
collection fees of $1.0 million, miscellaneous revenues of $0.6 million and
amortizations of regulatory accounts covering customer consumption under NW
Natural's decoupling mechanism of $0.5 million, partially offset by
amortizations from regulatory accounts covering conservation programs of $0.9
million and Year 2000 costs of $0.2 million. In the first quarter of 2002, other
revenues included customer late payment and collection fees of $1.1 million and
miscellaneous revenues of $0.4 million, partially offset by amortizations from
regulatory accounts covering conservation programs of $0.8 million and Year 2000
costs of $0.5 million.
17
Cost of Gas
-----------
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 sales of commodity and released
transportation capacity to on-system or off-system customers through negotiated
short-term transactions (upstream sales) in periods when core utility customers
do not fully utilize firm pipeline capacity and gas supplies.
The cost per therm of gas sold was 23 percent lower during the
first quarter of 2003 than in the first quarter of 2002, primarily due to lower
natural gas commodity prices. The cost per therm of gas sold includes current
gas purchases, gas drawn from storage inventory, gains or losses from commodity
hedges, margin from upstream gas sales, demand cost equalization, regulatory
deferrals and company use.
NW Natural uses a natural gas commodity-price hedge program
under the terms of its Derivatives Policy to help manage its variable price gas
commodity contracts (see Part II, Item 7., "Critical Accounting Policies -
Accounting for Derivative Instruments and Hedging Activities," in the 2002 Form
10-K). NW Natural recorded net gains of $23 million from commodity swap and call
option contracts during the first quarter of 2003, compared to net losses of $28
million in the first quarter of 2002. Gains and losses from commodity hedges are
included in cost of gas, and the majority of such gains and losses are reflected
in annual Purchased Gas Adjustment (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 regulatory assets or liabilities for recovery from or
refund to customers in future rates. NW Natural's gas costs in the first quarter
of 2003 were slightly lower than the gas costs embedded in rates, despite rising
gas prices in the spot market, with the effect that NW Natural's share of the
savings increased margin by $0.6 million, equivalent to about 1 cent a share of
earnings. For the first quarter of 2002, NW Natural's gas costs were much lower
than the projected costs built into rates and the Company's share of the savings
realized from gas commodity purchases contributed $8.7 million of margin,
equivalent to 21 cents a share of earnings.
Due to the warm weather and the reduced gas requirements of
its industrial sales customers during the first quarter, NW Natural was able to
use gas supplies that were under contract for the winter season, but were not
required for delivery to core market customers, to make upstream gas sales. The
purchase prices for this gas had been locked-in through commodity swap and call
option agreements entered into last year at levels much lower than current
market prices, so the gas could be sold in the interstate market at a gain.
Under the PGA tariff, the margin from these sales is treated as a reduction to
the cost of gas, with the effect that 67 percent is deferred for refund to NW
Natural's customers and the remaining 33 percent is retained by the Company. NW
Natural's share of the margin from upstream gas sales in the first quarter of
2003 was $4.0 million, equivalent to 9 cents a share of earnings, compared to
$0.2 million or less than 1 cent a share in the first quarter of 2002.
Non-utility Operations
----------------------
At March 31, 2003 and 2002, the Company's non-utility
operations consisted of gas storage operations and two wholly-owned
subsidiaries, Financial Corporation and Northwest Energy.
Gas Storage
-----------
NW Natural realized net income from its non-utility gas
storage business segment, after regulatory sharing and income taxes, of $1.3
million or 5 cents a share in the three months ended March 31, 2003, up from
$0.8 million or 3 cents a share in the three months ended March 31, 2002. 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 distribution to its core utility customers.
18
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. NW Natural retains 80
percent of the pre-tax income from the optimization of storage and pipeline
transportation capacity when the costs of such capacity have not been included
in core utility rates, or 33 percent of the pre-tax income from such capacity
when the costs have been included in core utility rates. The remaining 20
percent and 67 percent, respectively, are credited to a deferred regulatory
account for distribution to NW Natural's core utility customers.
Financial Corporation
---------------------
Financial Corporation's operating results for the three months
ended March 31, 2003 were a net loss of less than $0.1 million, compared to net
income of $0.2 million for the first quarter of 2002. The negligible loss in the
first quarter of 2003 compares to earnings of 1 cent a share for the same period
in 2002. The lower net income was primarily due to a net decrease in operating
results from Financial Corporation's investments in limited partnerships in wind
and solar electric generation projects in California. These investments generate
the majority of their operating revenues during the second and third quarters;
therefore, results of operations from the first quarter are not necessarily
indicative of the results for a full year. The Company's investment balances in
Financial Corporation at March 31, 2003 and 2002 were $9.0 million and $8.1
million, respectively.
Northwest Energy
----------------
Northwest Energy was formed in 2001 to serve as the holding
company for NW Natural and Portland General Electric Company (PGE) if the
acquisition of PGE had been completed. Northwest Energy recorded nominal
expenses for corporate development activities in the first quarter of 2003.
Operating Expenses
------------------
Operations and Maintenance
--------------------------
Consolidated operations and maintenance expenses were $1.9
million, or 9 percent, higher in the first quarter of 2003 compared to the same
period in 2002. The increase was primarily due to higher payroll costs, which
increased $2.7 million due to higher wages and salaries, higher bonus accruals
and higher pension costs. Pension costs increased $0.8 million due to lower
returns on pension plan assets and changes in actuarial assumptions. Partially
offsetting these increases was a reduction in uncollectible accounts expense,
which decreased by $0.9 million due to lower gas bills and improved collection
results.
Taxes Other than Income Taxes
-----------------------------
Taxes other than income taxes, which are principally comprised
of franchise, property and payroll taxes, were $1.2 million, or 10 percent,
lower in the first quarter of 2003 compared to the same period in 2002.
Franchise taxes, which are based on gross revenues, decreased $1.4 million, or
23 percent, reflecting lower gross revenues due to lower rates, warmer weather
and other factors. Property taxes increased $0.2 million, or 7 percent, due to
an increase in utility plant additions.
19
Depreciation and Amortization
-----------------------------
Depreciation and amortization expense increased $0.4 million,
or 3 percent, compared to the same period in 2002. Total depreciable plant and
property in service at March 31, 2003 increased 6 percent from a year earlier,
compared to an increase of 9 percent over the 12-month period ended March 31,
2002. As a percentage of average plant and property, depreciation and
amortization expense was approximately 1 percent for each of the three months
ended March 31, 2003 and 2002.
Other Income (Expense)
----------------------
Other income (expense) improved by $0.3 million in the first
quarter of 2003 compared to the same period in 2002, primarily due to a
reduction in interest expense on deferred regulatory account balances. The first
quarter of 2003 included net interest expense of $0.4 million on regulatory
account balances, reflecting lower credit balances outstanding in regulatory
liability accounts, compared to net interest expense of $0.9 million on such
balances in the first quarter of 2002. Other income (expense) in the first
quarter of 2003 also included an increase in gains from Company-owned life
insurance of $0.1 million, offset by a $0.4 million decrease in income from
partnership investments.
Interest Charges - net
----------------------
The Company's net interest expense increased $0.8 million, or
10 percent, in the first quarter of 2003 compared to the first quarter of 2002.
Interest expense on long-term debt was $0.9 million higher due to higher
balances outstanding during the period.
Income Taxes
------------
The effective corporate income tax rate from operations was
35.6 percent for the three-month period ended March 31, 2003, compared to 37.0
percent for the three-month period ended March 31, 2002. The decrease was
primarily due to a $13.7 million decrease in income before income taxes.
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
"Liquidity and Capital Resources," below, and Part II, Item 8., Notes 3 and 5,
in the 2002 Form 10-K).
Liquidity and Capital Resources
-------------------------------
At March 31, 2003, the Company had $45.5 million in cash and
cash equivalents compared to $30.1 million at March 31, 2002. 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 "Lines of Credit," below, and Part II, Item 8., Note 6, in the 2002 Form
10-K).
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 purchase commitment to purchase $8.1 million in
gas transmission pipe for use in constructing an extension of the pipeline from
its Mist gas storage field. These capital and contractual expenditures are
financed through cash from operations and from the issuance of short-term debt,
20
which is periodically refinanced through the sale of long-term debt or equity
securities.
Neither NW Natural's Mortgage and Deed of Trust nor the
indentures under which other long-term debt is issued contain credit rating
triggers or stock price provisions that require the acceleration of debt
repayment. 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 March 31, 2003, the Company had four commodity-price swap agreements
outstanding with one counter-party which was subject to a below investment grade
ratings trigger. Except for certain lease and purchase commitments, the Company
has no other material off-balance sheet obligations.
The following table shows NW Natural's contractual obligations
by maturity and type of obligation:
(Thousands) Long-term Gas Other
Payments Due in Years Commercial Preferred Long-term Capital Operating Supply Purchase
Ending March 31, Paper Stock Debt Leases Leases Commitments Commitments Total
- -------------------------------------------------------------------------------------------------------------------------------
2004 $ - $ 750 $ 20,000 $ 103 $ 2,946 $ 68,076 $ 8,085 $ 99,960
2005 - 750 - 4 2,671 48,258 - 51,683
2006 - 750 15,000 1 2,597 45,377 - 63,725
2007 - 750 28,000 1 1,003 41,631 - 71,385
2008 - 750 9,500 - 301 39,867 - 50,418
-------------------------------------------------------------------------------------------------------
Total 2004 - 2008 - 3,750 72,500 109 9,518 243,209 8,085 337,171
Thereafter - 4,500 413,426 - 4,266 170,658 - 592,850
Less: imputed interest - - - (4) - (101,116) - (101,120)
-------------------------------------------------------------------------------------------------------
Total $ - $ 8,250 $ 485,926 $ 105 $ 13,784 $ 312,751 $ 8,085 $ 828,901
=======================================================================================================
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 Part II, Item 8., Note
6, in the 2002 Form 10-K). NW Natural had no commercial paper notes outstanding
at March 31, 2003, compared to $0.2 million and $69.8 million at March 31, 2002
and Dec. 31, 2002, respectively. Financial Corporation had no commercial paper
notes outstanding at March 31, 2003 or 2002, or at Dec. 31, 2002.
Lines of Credit
---------------
NW Natural has lines of credit with four commercial banks
totaling $150 million. Half of the credit facility 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
March 31, 2003 or 2002, or at Dec. 31, 2002.
21
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 consolidated 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 March 31, 2003 and 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 Washington Utilities and
Transportation Commission (WUTC), or both. NW Natural expects that it will be
able to secure such approvals, if required.
Cash Flows
----------
Operating Activities
--------------------
Operations provided net cash of $99.5 million in the three
months ended March 31, 2003, compared to $91.3 million in the first three months
of 2002. The $8.2 million, or 9 percent, increase was due to lower working
capital requirements ($26.5 million) and decreased cash from operations before
working capital changes ($18.3 million). The decrease in working capital
requirements was primarily due to an increase in accounts payable in the first
quarter of 2003 compared to a decrease in the first quarter of 2002 ($13.9
million), a larger decrease in inventories ($9.2 million), a larger increase in
accrued interest and taxes ($3.0 million), and smaller decreases in other
current assets and liabilities ($2.4 million) and accounts receivable ($2.4
million), partially offset by a smaller decrease in accrued unbilled revenue
($4.4 million). The decrease in cash from operations before working capital
changes was due to a smaller increase in deferred gas costs ($17.9 million) and
lower net income ($8.0 million), partially offset by an increase in deferred
income taxes and investment tax credits in the first quarter of 2003 compared to
a decrease in the first quarter of 2002 ($6.5 million), and decreases in income
from equity investments before income taxes ($0.4 million) and depreciation and
amortization ($0.4 million).
Investing Activities
--------------------
Cash requirements for investing activities in the first
quarter of 2003 totaled $24.9 million, up from $16.6 million in the same period
of 2002. Cash requirements for utility construction totaled $23.5 million, up
$8.5 million from the first quarter of 2002. The increase in cash requirements
for utility construction in the first quarter of 2003 was primarily the result
of capital expenditures related to NW Natural's extension of the pipeline from
its Mist gas storage field ($4.4 million) and special projects expanding service
into new service areas ($3.8 million).
Investments in non-utility property during the first quarter
of 2003 totaled $1.3 million, up from $0.3 million during the first quarter of
2002. The increase was due to investment in facilities in support of the
Company's interstate gas storage operations.
NW Natural's utility construction expenditures in 2003 are
estimated to total $153 million, up from $85 million in 2002. Projected utility
construction in 2003 includes $31 million for customer growth, up from $29
million in 2002; $41 million for system improvement and support, up from $25
million in 2002; $55 million for the extension of the Mist pipeline and related
22
gas storage, 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.
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 Improvement Act of 2002, 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. See
Part II, Item 8., "Financial Condition - Cash Flows - Investing Activities," in
the 2002 Form 10-K. 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.
Financing Activities
--------------------
Cash used in financing activities in the first quarter of 2003
totaled $36.5 million, compared to $55.0 million in the first quarter of 2002.
Factors contributing to the $18.5 million difference were a smaller reduction in
short-term debt in the first quarter of 2003 ($69.8 million) compared to a
larger reduction in the first quarter of 2002 ($108.1 million), partially offset
by a $20 million decrease in long-term debt issued.
In February 2003, NW Natural sold $40 million of its secured
5.66% Series B Medium-Term Notes (MTNs) due 2033, and used the proceeds,
together with internally generated cash, to reduce short-term debt by $69.8
million in the first quarter of 2003.
NW Natural sold $60 million of its secured MTNs, Series B in
March 2002 and used the proceeds, together with internally generated cash, to
reduce short-term debt by $108.1 million in the first quarter of 2002.
NW Natural may exercise call options in the third of quarter
of 2003 on certain of its long-term debt, including $20 million of the 7.25%
Series B MTNs due 2023, $4 million of the 7.50% Series B MTNs due 2023 and $11
million of the 7.52% Series B MTNs due 2023, that are each callable in the third
quarter at 103.65%, 103.75% and 103.76% of their respective principal amounts.
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 2004. 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 or in the first
quarter of 2003. Since the program's inception, the Company has repurchased
355,400 shares of common stock at a total cost of $8.2 million.
Ratios of Earnings to Fixed Charges
-----------------------------------
For the three months and 12 months ended March 31, 2003 and
the 12 months ended Dec. 31, 2002, the Company's ratios of earnings to fixed
charges, computed using the Securities and Exchange Commission method, were
5.31, 2.44 and 2.85, 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. A significant part
of the business of the Company is of a seasonal nature; therefore, the ratio of
earnings to fixed charges for the interim period is not necessarily indicative
of the results for a full year.
23
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.
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.
24
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes to the information
provided in Part II, Item 7A., "Quantitative and Qualitative Disclosures About
Market Risk," in the 2002 Form 10-K.
Item 4. 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 Rule 13a-14(c) 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.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Litigation
In April 2003, NW Natural settled and agreed with Cascade
Resources Corporation and Al Curry (collectively, Cascade) to dismiss their
respective claims in 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) (the Action). See Part I, Item 3., "Legal
Proceedings," in the 2002 Form 10-K. In the settlement, Cascade transferred all
of its records, rights and interests in certain leases, including gas storage
leases, in Columbia County, Oregon to NW Natural and agreed to refrain from
certain competitive activities in the area. The counterclaims against NW Natural
described in the 2002 Form 10-K will be dismissed and Enerfin Resources
Northwest Limited Partnership (Enerfin) will be the remaining defendant in the
Action. NW Natural paid Cascade $0.5 million and agreed to defend and indemnify
Cascade against claims by Enerfin relating to the validity and enforceability of
the transferred leases. However, NW Natural will have no obligation to defend or
indemnify Cascade from any claims for recovery of punitive or other exemplary
damages.
Enerfin recently filed a motion seeking to allow it to make
cross-claims against Cascade. Enerfin's cross-claims allege misconduct by
Cascade in obtaining oil and gas production rights in some of the leases subject
to the settlement agreement. Enerfin's cross-claims seek to obtain the ownership
of oil and gas production (but not gas storage) rights in the leases subject to
the settlement. In the alternative, Enerfin seeks damages from Cascade of $12
million together with a demand for $24 million in punitive damages.
25
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 operation or cash flows.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit (10) - Firm Service Agreement between the Company and
Westcoast Energy Inc. dated as of April 1, 2003
Exhibit (11) - Statement re: Computation of Per Share Earnings
Exhibit (12) - Computation of Ratio of Earnings to Fixed Charges
Exhibit (99) - Certifications Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
On February 5, 2003, April 2, 2003 and May 1, 2003, the
Company filed or furnished its Current Reports on Form 8-K relating,
respectively, to: (a) the Company's 2002 earnings (unaudited); (b) the lowering
of its earnings guidance for the quarter ended March 31, 2003; and (c) earnings
for the quarter ended March 31, 2003 (unaudited) and the status of the Company's
Oregon general rate case.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
NORTHWEST NATURAL GAS COMPANY
(Registrant)
Dated: May 13, 2003 /s/ Stephen P. Feltz
-------------------------------------
Stephen P. Feltz
Principal Accounting Officer
Treasurer and Controller
26
CERTIFICATIONS
I, Mark S. Dodson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Northwest Natural
Gas Company;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 quarterly 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 quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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
function):
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
quarterly 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: May 13, 2003
/s/ Mark S. Dodson
-------------------------------------
Mark S. Dodson
President and Chief Executive Officer
27
I, Bruce R. DeBolt, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Northwest Natural
Gas Company;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 quarterly 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 quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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
function):
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
quarterly 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: May 13, 2003
/s/ Bruce R. DeBolt
----------------------------------
Bruce R. DeBolt
Senior Vice President, Finance,
and Chief Financial Officer
28
NORTHWEST NATURAL GAS COMPANY
EXHIBIT INDEX
To
Quarterly Report on Form 10-Q
For Quarter Ended
March 31, 2003
Exhibit
Document Number
- -------- ------
Firm Service Agreement between the Company and Westcoast Energy Inc. (10)
dated as of April 1, 2003
Statement re: Computation of Per Share Earnings (11)
Computation of Ratios of Earnings to Fixed Charges (12)
Certificate Pursuant to Section 906 of the Sarbanes -
Oxley Act of 2002 (99)