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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 SEPTEMBER 30, 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
[GRAPHIC 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 November 7, 2003, 25,858,818 shares of the registrant's Common Stock, $3-1/6
par value (the only class of Common Stock) were outstanding.
NORTHWEST NATURAL GAS COMPANY
September 30, 2003
Summary of Information Reported
The registrant submits herewith the following information:
PART I. FINANCIAL INFORMATION
Page
Item 1. Consolidated Financial Statements Number
Consolidated Statements of Income for the three-month
and nine-month periods ended Sept. 30, 2003 and 2002 3
Consolidated Statements of Earnings Invested in the Business
for the nine-month periods ended Sept. 30, 2003 and 2002 4
Consolidated Balance Sheets at Sept. 30, 2003 and 2002
and Dec. 31, 2002 5
Consolidated Statements of Cash Flows for the nine-month
periods ended Sept. 30, 2003 and 2002 7
Consolidated Statements of Capitalization at Sept. 30, 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 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk 31
Item 4. Controls and Procedures 32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 32
Item 5. Other Information 33
Item 6. Exhibits and Reports on Form 8-K 34
Signature 34
2
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Statements of Income
(Unaudited)
Three Months Ended Nine Months Ended
Thousands, except per share amounts Sept. 30, Sept. 30,
- ---------------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---- ---- ---- ----
Operating revenues:
Gross operating revenues $ 69,481 $ 78,717 $ 393,509 $ 459,153
Cost of sales 30,016 40,658 196,907 253,864
----------- ------------ ----------- ------------
Net operating revenues 39,465 38,059 196,602 205,289
Operating expenses:
Operations and maintenance 22,801 19,685 70,203 62,087
Taxes other than income taxes 6,719 6,781 24,886 25,635
Depreciation and amortization 13,556 13,035 40,060 38,633
----------- ------------ ----------- ------------
Total operating expenses 43,076 39,501 135,149 126,355
----------- ------------ ----------- ------------
Income (loss) from operations (3,611) (1,442) 61,453 78,934
Other income (expense) 771 248 1,535 (14,179)
Interest charges - net 8,426 8,652 26,498 25,378
----------- ------------ ----------- ------------
Income (loss) before income taxes (11,266) (9,846) 36,490 39,377
Income tax expense (benefit) (4,720) (3,838) 12,170 13,930
----------- ------------ ----------- ------------
Net income (loss) (6,546) (6,008) 24,320 25,447
Redeemable preferred and preference stock
dividend requirements - 582 294 1,767
----------- ------------ ----------- ------------
Earnings (loss) applicable to common stock $ (6,546) $ (6,590) $ 24,026 $ 23,680
=========== ============ =========== ============
Average common shares outstanding 25,777 25,492 25,692 25,389
Basic earnings (loss) per share of common stock $ (0.25) $ (0.26) $ 0.94 $ 0.93
Diluted earnings (loss) per share of common stock $ (0.25) $ (0.26) $ 0.93 $ 0.93
Dividends per share of common stock $ 0.315 0.315 $ 0.945 $ 0.945
--------------------------------------------------
See Notes to Consolidated Financial Statements
3
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Statements of Earnings Invested in the Business
(Unaudited)
Nine Months Ended Sept. 30,
-------------------------------------------------------
Thousands 2003 2002
- --------------------------------------------------------------------------------------------------------------
Earnings invested in the business:
Balance at beginning of period $ 157,136 $ 147,950
Net income 24,320 $ 24,320 25,447 $ 25,447
Cash dividends paid:
Redeemable preferred and preference stock (303) (1,776)
Common stock (24,251) (23,980)
----------- ------------
Balance at end of period $ 156,902 $ 147,641
=========== ============
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 - - 291 291
-------------------------------------------------------
Comprehensive income $ 24,320 $ 25,738
=========== ===========
Balance at end of period $ (3,084) $ (84)
=========== ===========
--------------------------------------------------
See Notes to Consolidated Financial Statements
4
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Balance Sheets
Sept. 30, Sept. 30,
2003 2002 Dec. 31,
Thousands (Unaudited) (Unaudited) 2002
- --------------------------------------------------------------------------------------------
Assets:
Plant and property:
Utility plant $ 1,625,211 $ 1,514,489 $ 1,539,965
Less accumulated depreciation 594,570 548,696 560,798
----------- ----------- -----------
Utility plant - net 1,030,641 965,793 979,167
----------- ----------- -----------
Non-utility property 22,915 20,831 20,832
Less accumulated depreciation and amortization 4,741 3,976 4,404
----------- ----------- -----------
Non-utility property - net 18,174 16,855 16,428
----------- ----------- -----------
Total plant and property 1,048,815 982,648 995,595
----------- ----------- -----------
Other investments 13,175 13,174 12,703
----------- ----------- -----------
Current assets:
Cash and cash equivalents 6,978 19,701 7,328
Accounts receivable 28,325 26,106 48,751
Allowance for uncollectible accounts (1,341) (1,636) (1,815)
Accrued unbilled revenue 11,723 15,193 44,069
Inventories of gas, materials and supplies 56,891 55,367 58,030
Prepayments and other current assets 28,580 30,793 37,645
----------- ----------- -----------
Total current assets 131,156 145,524 194,008
----------- ----------- -----------
Regulatory assets:
Income tax asset 47,975 48,469 47,975
Unrealized loss on non-trading derivatives 6,535 4,090 --
Unamortized costs on debt redemptions 7,906 6,624 6,508
Other 6,943 5,782 7,040
----------- ----------- -----------
Total regulatory assets 69,359 64,965 61,523
----------- ----------- -----------
Other assets:
Investment in life insurance 58,407 54,155 54,916
Fair value of non-trading derivatives -- -- 12,426
Other 15,667 12,229 11,620
----------- ----------- -----------
Total other assets 74,074 66,384 78,962
----------- ----------- -----------
Total assets $ 1,336,579 $ 1,272,695 $ 1,342,791
=========== =========== ===========
--------------------------------------------------
See Notes To Consolidated Financial Statements
5
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Balance Sheets
Sept. 30, Sept. 30,
2003 2002 Dec. 31,
Thousands (Unaudited) (Unaudited) 2002
- --------------------------------------------------------------------------------------------
Capitalization and liabilities:
Capitalization:
Common stock $ 81,854 $ 80,834 $ 81,023
Premium on common stock 253,494 246,690 248,028
Earnings invested in the business 156,902 147,641 157,136
Accumulated other comprehensive income (loss) (3,084) (84) (3,084)
----------- ----------- -----------
Total common stock equity 489,166 475,081 483,103
Redeemable preference stock -- 25,000 --
Redeemable preferred stock -- 8,250 8,250
Long-term debt 450,794 446,033 445,945
----------- ----------- -----------
Total capitalization 939,960 954,364 937,298
----------- ----------- -----------
Current liabilities:
Notes payable 85,200 -- 69,802
Accounts payable 53,028 45,400 74,436
Long-term debt and redeemable preferred
stock due within one year 7,678 40,000 20,000
Taxes accrued 8,058 8,514 7,822
Interest accrued 10,294 10,655 2,902
Other current and accrued liabilities 28,771 25,379 30,045
----------- ----------- -----------
Total current liabilities 193,029 129,948 205,007
----------- ----------- -----------
Regulatory liabilities:
Customer advances 1,790 1,818 1,791
Deferred gas costs payable 11,853 15,957 10,635
Unrealized gain on non-trading derivatives -- -- 12,426
----------- ----------- -----------
Total regulatory liabilities 13,643 17,775 24,852
----------- ----------- -----------
Other liabilities:
Deferred income taxes 144,315 138,130 141,732
Deferred investment tax credits 7,415 8,169 7,824
Fair value of non-trading derivatives 6,535 4,026 --
Other 31,682 20,283 26,078
----------- ----------- -----------
Total other liabilities 189,947 170,608 175,634
----------- ----------- -----------
Other commitments and contingencies (see Note 7) -- -- --
----------- ----------- -----------
Total capitalization and liabilities $ 1,336,579 $ 1,272,695 $ 1,342,791
=========== =========== ===========
--------------------------------------------------
See Notes To Consolidated Financial Statements
6
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended Sept. 30,
-----------------------------
Thousands 2003 2002
- --------------------------------------------------------------------------------------------------------------
Operating activities:
Net income from operations $ 24,320 $ 25,447
Adjustments to reconcile net income to cash provided by operations:
Depreciation and amortization 40,060 38,633
(Gain) loss on sale of assets 10 (221)
Loss for PGE acquisition costs -- 13,699
Unrealized gain from price risk management activities -- 291
Deferred income taxes and investment tax credits 2,174 7,193
Undistributed earnings from equity investments (560) (1,220)
Allowance for funds used during construction (1,176) (406)
Deferred gas costs - net 1,218 5,868
Other (3,058) (450)
--------- ---------
Cash from operations before working capital changes 62,988 88,834
Changes in operating assets and liabilities:
Accounts receivable - net of allowance for uncollectible accounts 19,952 40,252
Accrued unbilled revenue 32,346 42,556
Inventories of gas, materials and supplies 1,139 (6,030)
Accounts payable (21,408) (25,298)
Accrued interest and taxes 7,628 (7,028)
Other current assets and liabilities 7,791 (5,890)
--------- ---------
Cash provided by operating activities 110,436 127,396
--------- ---------
Investing activities:
Acquisition and construction of utility plant assets (90,049) (53,271)
Investment in non-utility property (2,083) (2,628)
PGE acquisition costs -- (4,142)
Proceeds from sale of assets 18 500
Other investments 88 1,609
--------- ---------
Cash used in investing activities (92,026) (57,932)
--------- ---------
Financing activities:
Common stock issued 6,146 5,094
Redeemable preferred stock retired (750) (750)
Long-term debt issued 40,000 90,000
Long-term debt retired (55,000) (20,500)
Change in short-term debt 15,398 (108,291)
Cash dividend payments:
Redeemable preferred and preference stock (303) (1,776)
Common stock (24,251) (23,980)
--------- ---------
Cash used in financing activities (18,760) (60,203)
--------- ---------
Increase (decrease) in cash and cash equivalents (350) 9,261
Cash and cash equivalents - beginning of period 7,328 10,440
--------- ---------
Cash and cash equivalents - end of period $ 6,978 $ 19,701
========= =========
- ------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest and preferred dividends $ 19,080 $ 18,177
Income taxes $ 9,600 $ 27,912
- ------------------------------------------------------------------------------------------------------------
Supplemental disclosure of non-cash financing activities:
Conversion to common stock:
7-1/4 % Series of Convertible Debentures $ 151 $ 1,844
--------------------------------------------------
See Notes to Consolidated Financial Statements
7
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Statements of Capitalization
Sept. 30, 2003 Sept. 30, 2002
Thousands, except share amounts (Unaudited) (Unaudited) Dec. 31, 2002
- ------------------------------------------------------------------------------------------------------ -----------------------
Common stock equity:
Common stock - par value $3-1/6 per share $ 81,854 $ 80,834 $ 81,023
Premium on common stock 253,494 246,690 248,028
Earnings invested in the business 156,902 147,641 157,136
Accumulated other comprehensive income (loss) (3,084) (84) (3,084)
-------- --------- ----------
Total common stock equity 489,166 52% 475,081 50% 483,103 51%
Redeemable preference stock:
$6.95 Series, stated value $100 per share - - 25,000 2% - -
Redeemable preferred stock:
$7.125 Series, stated value $100 per share 7,678 1% 8,250 1% 8,250 1%
Long-term debt:
Medium-Term Notes
First Mortgage Bonds:
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 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 9,500 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
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 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 30,000
5.660% Series B due 2033 40,000 - -
Convertible Debentures
7-1/4% Series due 2012 6,294 6,533 6,445
---------- --------- ---------
Total long-term debt 450,794 48% 486,033 51% 465,945 50%
Less long-term debt and preferred stock due within
one year 7,678 (1%) 40,000 (4%) 20,000 (2%)
---------- ------ --------- ----- --------- -----
Total capitalization $ 939,960 100% $ 954,364 100% $ 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 for each period reported. 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 in this report, 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.
Certain amounts from prior periods have been reclassified to conform,
for comparison purposes, with the current financial statement presentation.
These reclassifications had no impact on prior period consolidated results of
operations.
2. New Accounting Standards
Adopted 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, if reasonably estimable, for an ARO in the period in which it is
incurred. 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 cannot estimate the ARO because
the settlement date is indeterminable. In addition, NW Natural continues to
accrue for future asset retirement costs (removal costs) on many long-lived
assets through a charge to depreciation expense allowed in rates, and the
resulting regulatory liabilities are recognized as accruals to accumulated
depreciation. At the time when removal costs are incurred, accumulated
depreciation is charged with the costs of removal and the book cost of the asset
being retired in accordance with industry practice. Because estimated removal
costs meet the requirements of SFAS No. 71, "Accounting for the Effects of
Certain Types of Regulation," the Company's accumulated removal costs are not
classified as liabilities, except for future retirements which meet the criteria
of legal obligations under SFAS No. 143. At Sept. 30, 2003, the Company had $133
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.
9
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
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 April 2003, the Financial Accounting Standards Board (FASB) issued
SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities." SFAS No. 149 primarily amends SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," to clarify the definition of a
derivative and to require derivative instruments that include up-front cash
payments to be classified as financing activity in the statement of cash flows.
SFAS No. 149 is effective for contracts entered into or modified after June 30,
2003, and for hedging relationships designated after June 30, 2003. The adoption
of SFAS No. 149 did not have a material impact on the Company's financial
condition or results of operations.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity." SFAS
No. 150 establishes standards for how an issuer classifies and measures in its
financial statements certain financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 requires an issuer to classify a financial
instrument that is within the scope of the Statement as a liability if that
financial instrument embodies an obligation of the issuer. SFAS No. 150 is
effective for financial instruments entered into or modified after May 31, 2003
and otherwise is effective at the beginning of the first interim periods
beginning after June 15, 2003, except for mandatory redeemable financial
instruments of nonpublic entities. The adoption of SFAS No. 150 resulted in the
Company reclassifying dividends on its redeemable preferred stock as interest
expense, thus affecting the Company's reported net income (loss) for the current
three- and nine- month periods only. The reclassification did not have a
material impact on the Company's financial condition or results of operations. A
transition adjustment of $178,000 was recorded upon adoption of SFAS No. 150 in
order to recognize the redemption premium for the redeemable preferred stock.
The redemption premium was deferred and is included in unamortized costs on debt
redemptions in the accompanying Consolidated Balance Sheets.
In November 2002, the FASB issued FASB Interpretation No. (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.
In connection with the settlement of litigation involving leases in the Mist gas
storage field, NW Natural agreed to defend and indemnify a party against claims
relating to the validity and enforceability of certain transferred leases.
However, NW Natural will have no obligation to defend or indemnify the party
from any claims for recovery of punitive or other exemplary damages.
Accordingly, the application of FIN 45 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
10
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. 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 had no 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 2003, NW Natural granted LTIP awards covering a new three-year
performance period (2003-05). The aggregate target award and maximum award were
30,000 and 60,000 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 the common stock as of the distribution date. At Sept. 30, 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 SFAS 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 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. Because NW
Natural grants stock options at market value, no compensation expense was
recognized in the results of operations for the nine months ended Sept. 30,
2003.
As of Sept. 30, 2003, options on 1,429,500 shares were available for
grant and options to purchase 354,244 shares were outstanding under the Restated
SOP. Options granted generally have 10-year terms and vest ratably over a
three-year period following the date of grant. The Company did not grant any
options to purchase shares during the nine months ended Sept. 30, 2003.
11
If compensation expense for all stock-based compensation 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 Nine Months Ended
Sept. 30, Sept. 30,
----------------------- ------------------------
Thousands, except per share amounts 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------- ------------------------
Earnings (loss) applicable to common stock:
- -------------------------------------------
As reported $ (6,546) $ (6,590) $ 24,026 $ 23,680
Deduct: total stock-based compensation expense determined
under fair value based method for all awards - net of tax
(66) (87) (199) (310)
--------- --------- ---------- ----------
Pro forma $ (6,612) $ (6,677) $ 23,827 $ 23,370
========= ========= ========== ==========
Basic earnings (loss) per share:
- --------------------------------
As reported $ (0.25) $ (0.26) $ 0.94 $ 0.93
Pro forma $ (0.26) $ (0.26) $ 0.93 $ 0.92
Diluted earnings (loss) per share:
- ----------------------------------
As reported $ (0.25) $ (0.26) $ 0.93 $ 0.93
Pro forma $ (0.26) $ (0.26) $ 0.92 $ 0.92
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 options is
amortized to expense 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 acceptable 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 Sept. 30, 2003, NW Natural had 30 natural gas price swap contracts,
three natural gas call option contracts, and 69 foreign currency forward
contracts covering its exposures to natural gas commodity prices and foreign
currency exchange rates, respectively. 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:
Sept. 30, 2003 Dec. 31, 2002
--------------------------- --------------------------
Fair Value Notional Fair Value Notional
Thousands Gain (Loss) Amount Gain (Loss) Amount
- --------------------------------------------------------------------------------------------------------------------------------
Fixed-price natural gas commodity swap contracts $ (6,839) $ 352,304 $ 11,422 $ 159,724
Fixed-price natural gas call option contracts - 33,007 717 18,084
Physical natural gas supply contract with embedded derivative - - 448 2,754
Foreign currency forward purchase contracts 304 17,668 (161) 15,525
--------------------------- --------------------------
Total $ (6,535) $ 402,979 $ 12,426 $ 196,087
=========================== ==========================
12
5. Long Term Debt and Redeemable Preferred Stock
NW Natural has redeemed certain of its long-term debt, including all $4
million of the 7.50% Series B Medium-Term Notes (MTNs) due 2023, all $11 million
of the 7.52% Series B MTNs due 2023, and all $20 million of the 7.25% Series B
MTNs due 2023. These MTNs were redeemed in the third quarter of 2003 at 103.75
percent, 103.76 percent and 103.65 percent of their respective principal
amounts. The Company redeemed these MTNs with available cash or with the
proceeds from sales of commercial paper. The Company also gave notice, in
October 2003, that it was exercising the early redemption provision applicable
to all of the remaining shares of its $7.125 Series of Redeemable Preferred
Stock with an aggregate stated value of $7.5 million, at a redemption price
equivalent to 102.375 percent, effective as of Nov. 14, 2003. Early redemption
premiums are recognized as unamortized costs on debt redemptions pursuant to
SFAS No. 71. The Company intends to re-finance the preferred stock and the
long-term debt redeemed earlier this year through the sale of new long-term debt
in the fourth quarter of 2003, and the early redemption premiums will be
amortized to expense over the life of the new debt.
The maturities on the long-term debt and redeemable preferred stock
outstanding, for each of the 12-month periods through Sept. 30, 2008 amount to:
$7.7 million in 2004, including optional redemption premiums; $15 million in
2005; $8 million in 2006; $29.5 million in 2007; and $5 million in 2008. Holders
of certain MTNs have put options that, if exercised, would accelerate the
maturity of long-term debt by $10 million and $20 million in the 12-month
periods ending Sept. 30, 2006 and 2007, respectively.
6. 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 and
asset optimization services under a contract with an independent energy trading
company. 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 includes costs relating to the
terminated acquisition of PGE.
13
The following table presents information about the reportable segments
for the three- and nine-month periods ended Sept. 30, 2003 and 2002.
Inter-segment transactions are insignificant.
Three Months Ended Sept. 30, Nine Months Ended Sept. 30,
----------------------------------------------- -------------------------------------------------
Thousands Utility Gas Storage Other Total Utility Gas Storage Other Total
- -------------------------------------------------------------------------------- -------------------------------------------------
2003
- ----
Net operating revenues $ 37,332 $ 2,094 $ 39 $ 39,465 $ 189,449 $ 7,025 $ 128 $ 196,602
Depreciation and amortiza-
tion 13,446 110 -- 13,556 39,723 337 -- 40,060
Other operating expenses 29,290 186 44 29,520 94,462 531 96 95,089
Income (loss) from
operations (5,404) 1,798 (5) (3,611) 55,264 6,157 32 61,453
Income from financial
investments -- -- 315 315 -- -- 560 560
Net income (loss) (7,831) 975 310 (6,546) 20,197 3,427 696 24,320
Total assets at Sept. 30, 2003 1,298,967 19,475 18,137 1,336,579 1,298,967 19,475 18,137 1,336,579
2002
- ----
Net operating revenues $ 36,519 $ 1,504 $ 36 $ 38,059 $ 199,434 $ 5,722 $ 133 $ 205,289
Depreciation and amortization 12,926 109 -- 13,035 38,334 299 -- 38,633
Other operating expenses 26,248 187 31 26,466 86,933 684 105 87,722
Income (loss) from operations (2,655) 1,208 5 (1,442) 74,167 4,739 28 78,934
Income from financial
investments -- -- 605 605 -- -- 1,220 1,220
Net income (loss) (6,940) 424 508 (6,008) 30,110 2,402 (7,065) 25,447
Total assets at Sept. 30, 2002 1,238,215 16,500 17,980 1,272,695 1,238,215 16,500 17,980 1,272,695
7. Commitments and Contingencies
Environmental Matters
---------------------
NW Natural accrues 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 several of these environmental investigations, the
range of any additional possible loss contingency cannot be currently estimated.
On May 27, 2003, the Oregon Public Utility Commission (OPUC) approved
NW Natural's request for deferral of environmental costs associated with five
specific sites, including the Gasco, Wacker, Portland Gas and Portland Harbor
sites. See Part II, Item 8., Note 12, in the 2002 Form 10-K. The authorization,
effective for a 12-month period beginning April 7, 2003, allows NW Natural to
defer and seek recovery of unreimbursed environmental costs in a future general
rate case. Through Sept. 30, 2003, NW Natural has recorded $0.7 million of these
costs in a deferred regulatory account. Additionally, on a cumulative basis
through Sept. 30, 2003, the Company has accrued environmental costs totaling
$7.9 million relating to the five sites, including $5.7 million that has already
been disbursed. In addition, the Company currently estimates insurance
recoveries related to these sites of $3.6 million and has recorded this amount
as a receivable.
NW Natural will first seek to recover 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, from insurance. If these costs are not recovered from insurance,
then NW Natural will seek recovery through future rates.
On June 30, 2003, the Company filed a Feasibility Scoping Plan and an
Ecological and Human Health Risk Assessment with the Oregon Department of
Environmental Quality (ODEQ), which outlined a range of remedial alternatives
for the most contaminated portion of the Gasco site. See Part II, Item 8., Note
12, in the 2002 Form 10-K. NW Natural will work with the ODEQ to determine the
appropriate remedial action from among
14
the alternatives. Based upon the proposed actions in the draft plan, the Company
estimates its range of liability, including the cost of investigation, from
feasible alternatives at between $1.7 million and $7 million. NW Natural has a
recorded liability of $1.7 million, excluding regulatory deferred costs of $0.1
million, as of Sept. 30, 2003, for its estimated costs of investigation and
remediation related to the Gasco site. See Item 2., "Management's Discussion and
Analysis of Results of Operations and Financial Condition - Application of
Critical Accounting Policies - Critical Estimates."
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 and Part II, Item 1., "Legal Proceedings," in the Company's Form
10-Q for the quarters ended March 31 and June 30, 2003. In June 2003, the court
denied the motion of Enerfin Resources Northwest Limited Partnership (Enerfin),
the remaining defendant in the Action, seeking to allow it to make cross-claims
against Cascade in the case. In July, Enerfin filed a Motion for Summary
Judgment seeking dismissal of claims made by NW Natural against it. The Company
opposed the motion and a final decision is pending.
On March 13, 2003, the Oregon Energy Facility Siting Council (EFSC)
issued a Final Order and Site Certificate (Site Certificate) pursuant to which
the EFSC approved construction of the Company's proposed South Mist Pipeline
Extension (SMPE) along a designated route. See Part II, Item 7., "Financial
Condition - Investing Activities," in the 2002 Form 10-K. In May, two parties in
the contested case before EFSC separately appealed the issuance of the Site
Certificate to the Oregon Supreme Court. (Supreme Court Nos. 550428 and 550434
(consolidated)). The appeals were argued before the Supreme Court on July 22,
2003. On Nov. 6, 2003, the Supreme Court ruled on the appeals, affirming EFSC's
issuance of the Site Certificate.
The Company is subject to other claims and litigation arising in the
ordinary course of business. Although the final outcome of any such legal
proceeding cannot be predicted with certainty, the Company does not expect
disposition of these matters to have a material impact on the Company's
financial condition or results of operations.
Enron Gas Supply Contract
-------------------------
On Oct. 16, 2003, NW Natural received a demand letter from Enron North
America Corp. (Enron) seeking payment of $1.1 million allegedly owed pursuant to
a gas supply contract between NW Natural and Enron which was in effect when
Enron filed for bankruptcy in December 2001. The contract was terminated upon
the bankruptcy and NW Natural does not believe that any amounts are owed to
Enron under the contract.
15
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 and nine months ended Sept. 30, 2003 and 2002. Unless
otherwise indicated, references in the discussion to Notes are to the notes to
the consolidated financial statements in Part II, Item 8. of 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 Note 2 in the 2002 Form 10-K).
In addition to presenting results of operations and earnings amounts in
total, certain measures are expressed in cents per share on a diluted basis (see
Note 1 in the 2002 Form 10-K). These amounts reflect factors that directly
impact the Company's earnings. The Company believes this per share information
is useful because it enables readers to better understand the impact of these
factors on the Company's earnings.
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, and from time to time to
update or revise, assumptions, 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 used
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.
Critical Estimates
------------------
Within the context of the Company's critical accounting policies,
management is not currently aware of any reasonably likely events or
circumstances that would result in materially different amounts being reported.
16
In addition to critical accounting estimates described in the 2002 Form
10-K, NW Natural recorded an additional loss contingency totaling $1.7 million
in the second quarter of 2003 for an estimate of environmental remediation costs
at its Gasco site (see Note 7 to the accompanying Consolidated Financial
Statements). The amount of NW Natural's current accrual is based on estimates at
the lower end of the range of probable liability for the costs of remedial
alternatives outlined in the Feasibility Scoping Plan and the Ecological and
Human Health Risk Assessment. If the costs of remedial activity were assumed at
the higher end of the range, then the Company would have accrued an additional
$5.3 million liability. However, the Company does not believe that a change in
the estimate would have a material impact on the Company's financial condition
or results of operations, because NW Natural expects to recover these additional
costs from insurance. In the event that additional costs are not recovered from
insurance, then NW Natural will seek to recover those costs through future
utility rates, subject to approval by the Oregon Public Utility Commission
(OPUC). The OPUC granted NW Natural the ability to defer its environmental costs
at the Gasco site, effective for a 12-month period beginning April 7, 2003,
which allows it to seek recovery of unreimbursed costs (see Note 7 to the
accompanying Consolidated Financial Statements). Although NW Natural expects to
recover its deferred costs from insurance or future utility rates, there can be
no assurance that the OPUC will approve future recovery.
Earnings and Dividends
- ----------------------
The Company incurred a loss applicable to common stock of $6.5 million
in the quarter ended Sept. 30, 2003, compared to a loss of $6.6 million in the
third quarter of 2002. The loss for the third quarter of 2003 was equivalent to
25 cents a diluted share, compared to a loss of 26 cents a diluted share for the
third quarter of 2002. A third quarter loss is customary for NW Natural,
reflecting low summertime use of natural gas.
Gas utility margin and income from non-utility operations were higher
in the third quarter of 2003 than in the third quarter of 2002, and interest
expense was lower, but these improvements were approximately offset by higher
utility operating expenses.
NW Natural lost $7.8 million or 30 cents a diluted share from gas
utility operations in the third quarter of 2003, compared to a loss of $7.5
million or 29 cents a share in the third quarter of 2002. The Company earned
$1.0 million or 4 cents a diluted share from its gas storage business segment in
this year's third quarter, compared to $0.4 million or 1 cent a share from the
gas storage segment in the third quarter of 2002. The Company also earned $0.3
million or about 1 cent a diluted share from its subsidiary and other
non-utility operations in the third quarter of 2003, compared to earnings of
$0.5 million or 2 cents a share in the third quarter of 2002.
For the nine months ended Sept. 30, 2003, the Company's earnings
applicable to common stock were $24.0 million, or 93 cents a diluted share,
compared to earnings of $23.7 million, also equivalent to 93 cents a diluted
share, in the first nine months of 2002.
NW Natural earned $19.9 million or 77 cents a diluted share from gas
utility operations in the first nine months of 2003, compared to $28.3 million
or $1.11 a share in the first nine months of 2002. Weather conditions in NW
Natural's service territory in the first nine months of the year were 6 percent
warmer than average and 10 percent warmer than last year. The Company earned
$3.4 million or 13 cents a diluted share from its gas storage business segment
in the first nine months of 2003, compared to $2.4 million or 9 cents a share in
the first nine months of 2002; and earned $0.7 million or about 3 cents a
diluted share from its subsidiary and other non-utility operations in the first
three quarters of this year, compared to a loss of $7.1 million or 27 cents a
share in the first three quarters of last year. The results for the first nine
months of 2002 included a charge of $13.7 million before tax, equivalent to 32
cents a diluted share, for the Company's transaction costs incurred in
connection with its efforts to acquire Portland General Electric Company (PGE)
from Enron Corp.
Dividends paid on common stock were 31.5 cents a share for each of the
three-month periods ended Sept. 30, 2003 and 2002. In October 2003, the
Company's Board of Directors declared a quarterly dividend of 32.5 cents a share
on the common stock, payable Nov. 14, 2003 to shareholders of record on Oct. 31,
2003. With this increase, the current indicated annual dividend rate is $1.30 a
share.
17
Results of Operations
- ---------------------
Regulatory Developments
-----------------------
In November 2002, NW Natural filed a general rate case with the 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).
On Aug. 22, 2003, the OPUC entered an order approving stipulations
filed by NW Natural with the OPUC Staff and other parties covering all of the
issues in the Oregon general rate case. The order includes, among other things,
(i) the settlement of NW Natural's cost of service, including all operations and
maintenance expenses, (ii) projected investments for the prospective test year,
(iii) a capital structure including 49.5 percent common equity, (iv) a return on
equity of 10.2 percent, (v) a rate redesign that shifted $4 million of margin
revenue requirement from industrial rate schedules to residential and commercial
rate schedules, and (vi) the adoption of a weather normalization mechanism. The
order authorized a revenue increase of $13.9 million per year, of which $6.2
million went into effect on Sept. 1, 2003, and the remainder will go into effect
as all or portions of NW Natural's South Mist Pipeline Extension (SMPE) project
and its Coos County distribution system project are completed and go into
service between Dec. 1, 2003 and Dec. 1, 2004.
The weather normalization mechanism approved by the OPUC will be
applied to NW Natural's Oregon residential and commercial customers' bills
between November and May of each heating season, beginning in November 2003. The
mechanism adjusts customers' bills to reflect "normal" weather using the 25-year
average temperature of each day of the billing period. The mechanism is intended
to stabilize NW Natural's recovery of its fixed costs and to reduce fluctuations
in customers' bills due to colder- or warmer-than-average weather.
On Sept. 23, 2003, the OPUC approved rate increases effective Oct. 1,
2003 averaging 4.5 percent for NW Natural's Oregon residential sales customers,
and on Sept. 24, 2003, the Washington Utilities and Transportation Commission
(WUTC) approved a rate increase effective Oct. 1, 2003 of 5.5 percent for NW
Natural's Washington residential sales customers. The rate increases in Oregon
and Washington reflect changes in NW Natural's cost of gas under its Purchased
Gas Adjustment (PGA) mechanisms, the application of temporary rate adjustments
to amortize regulatory balancing accounts, and the removal of temporary rate
adjustments effective the previous year. These changes are all part of NW
Natural's annual PGA tariff filing (see "Comparison of Gas Operations--Cost of
Gas," below). In addition to the PGA increase, Washington rates were affected by
the removal of a credit to customers for the refund of the previous year's gas
cost savings, resulting in an additional 11.3 percent average increase in rates.
The Company intends to file a general rate case with the WUTC in the
fourth quarter of 2003, enabling a full review of NW Natural's cost and rate
structures, with new rates expected to be implemented by the end of 2004. The
amount of the general rate increase to be requested has not been determined.
18
Comparison of Gas Operations
----------------------------
The following table summarizes the composition of gas utility volumes
and revenues for the three months and nine months ended Sept. 30, 2003 and 2002:
Three Months Ended Nine Months Ended
Sept. 30, Sept. 30,
--------------------------------------------------------
(Thousands) 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------------------
Utility gas sales and transportation volumes - therms:
- ------------------------------------------------------
Residential and commercial sales 51,719 53,100 418,093 446,392
Unbilled volumes (3,767) 1,940 (39,922) (44,589)
--------- --------- ---------- ----------
Weather-sensitive volumes 47,952 55,040 378,171 401,803
Industrial firm sales 11,155 10,544 37,676 49,974
Industrial interruptible sales 13,087 2,444 25,075 22,724
--------- --------- ---------- ----------
Total gas sales
72,194 68,028 440,922 474,501
Transportation deliveries 101,158 107,927 309,234 325,275
--------- --------- ---------- ----------
Total volumes sold and delivered 173,352 175,955 750,156 799,776
========= ========= ========== ==========
Three Months Ended Nine Months Ended
Sept. 30, Sept. 30,
--------------------------------------------------------
(Thousands, except customers and degree-days) 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------------------
Utility operating revenues - dollars:
- --------------------------------------
Utility residential and commercial sales $ 51,099 $ 58,954 $ 362,576 $ 423,509
Unbilled revenues (2,909) 2,062 (33,129) (42,564)
--------- --------- ---------- ----------
Weather-sensitive revenues 48,190 61,016 329,447 380,945
Industrial firm sales 6,778 8,198 22,463 35,089
Industrial interruptible sales 6,421 1,595 12,364 14,166
--------- --------- ---------- ----------
Total gas sales 61,389 70,809 364,274 430,200
Transportation revenues 3,857 5,984 14,710 19,867
Other revenues 2,084 363 7,331 2,442
--------- --------- ---------- ----------
Total utility operating revenues 67,330 77,156 386,315 452,509
Cost of gas sold 29,998 40,637 196,866 253,075
--------- --------- ---------- ----------
Net utility operating revenues (margin) $ 37,332 $ 36,519 $ 189,449 $ 199,434
========= ========= ========== ==========
Total number of customers (end of period) 564,488 546,644 564,488 546,644
========= ========= ========== ==========
Actual degree-days 43 75 2,456 2,724
========= ========= ========== ==========
20-year average degree-days 93 97 2,603 2,607
========= ========= ========== ==========
NW Natural refunded deferred gas cost savings to its Oregon customers
through billing credits in June 2002. These 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 gross operating
revenues for the first nine months of 2002 by $30.4 million, and reduced both
cost of gas and deferred gas costs payable by $29.5 million. The refunds also
reduced margin by about $0.9 million, but this amount was almost entirely offset
by corresponding reductions in franchise tax expense and uncollectible accounts
expense such that the effect of the refunds on net income was negligible.
19
Residential and Commercial Sales
- --------------------------------
NW Natural continues to experience strong customer growth, with 17,844
customers added since Sept. 30, 2002, for a growth rate of 3.3 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. The third (summer) quarter of 2003 was
warmer than average and warmer than the third quarter of 2002. Weather in the
first nine months of 2003 was 6 percent warmer than average, compared to 4
percent colder than average in the first nine months of 2002. Average weather
conditions are calculated for this purpose from the most recent 20 years of
temperature data measured by heating degree-days.
The OPUC has approved a weather normalization mechanism that will be
applied to NW Natural's Oregon residential and commercial customers' bills
between November and May of each heating season beginning in November 2003 (see
"Results of Operations - Regulatory Developments," above). Customers may opt out
of the mechanism during a defined period each year. NW Natural expects less than
10 percent of its residential and commercial customers to opt out of the
mechanism during its first year.
Volumes of gas sold to residential and commercial customers in the
third quarter of 2003 were 7.1 million therms, or 13 percent, lower than in the
third quarter of 2002, reflecting the warmer weather and weak economic
conditions in the commercial market, partially offset by customer growth and the
price elasticity effects of lower rates. Related revenues decreased $12.8
million, or 21 percent, primarily due to lower volumes and rates effective Oct.
1, 2002.
Gas sales to residential and commercial customers in the first nine
months of 2003 were 23.6 million therms, or 6 percent, lower than in the first
nine months of 2002, reflecting warmer weather that was partially offset by
customer growth and the price elasticity effects of lower rates. Related
revenues decreased $51.5 million, or 14 percent, primarily due to lower volumes
and the lower rates effective Oct. 1, 2002. Excluding the impact of gas cost
refunds of $26.6 million to Oregon customers in the nine months ended Sept. 30,
2002 (see "Comparison of Gas Operations," above), related revenues decreased
$78.1 million or 19 percent. These refunds reduced gross operating revenues by
$30.4 million in the first nine months of 2002 compared to the same period in
2003, but the impact on net operating revenues was less than $1 million and the
impact on net income was negligible. See "Comparison of Gas Operations," above.
NW Natural's rate decreases in October 2002 were primarily related to
substantial reductions in gas commodity costs and were applied through the
Company's PGA mechanisms in Oregon and Washington (see Part II, Item 7.,
"Results of Operations - Regulatory Matters," in the 2002 Form 10-K). At the
same time, NW Natural also applied small, partially offsetting rate increases in
Oregon designed to recover the margin lost due to changes in residential and
commercial consumption patterns in recent years. These rate increases
contributed an estimated $0.5 million of margin in the third quarter of 2003 and
$6.5 million of margin in the first nine months of 2003, equivalent to about 1
cent a diluted share of earnings in the third quarter and 15 cents a share in
the nine-month period.
20
Industrial Sales and Transportation Revenues
--------------------------------------------
The following table summarizes the delivered volumes and margin in the
industrial and electric generation markets:
Three Months Ended Nine Months Ended
Sept. 30, Sept. 30,
-------------------------- -------------------------
(Thousands) 2003 2002 2003 2002
------------------------------------------------------------------------------------------------------------------
Delivered volumes - therms:
---------------------------
Industrial sales and transportation 125,804 121,156 370,150 393,368
Electric generation - 71 1,667 3,400
--------- --------- ---------- ----------
Total volumes 125,804 121,227 371,817 396,768
========= ========= ========== ==========
Margin - dollars:
Industrial sales and transportation $ 8,668 $ 9,080 $ 27,551 $ 30,939
Electric generation - 11 6 4,584
--------- --------- ---------- ----------
Total margin $ 8,668 $ 9,091 $ 27,557 $ 35,523
========= ========= ========== ==========
Total volumes delivered to industrial and electric generation customers
in the third quarter of 2003 were 4.6 million therms, or 4 percent, higher than
in the same period of 2002. Combined margins from these customers in the third
quarter of 2003 were $0.4 million, or 5 percent, lower than in the same period
of 2002. The increase in volumes was primarily due to deliveries to a
high-volume customer served on a new, low-margin contract for gas transportation
to a cogeneration facility, while the decline in margin was due to shifts by
other customers from higher-margin to lower-margin sales or transportation
schedules.
Total volumes delivered to industrial and electric generation customers
in the nine months ended Sept. 30, 2003 were 25 million therms, or 6 percent,
lower than in the same period in 2002. Combined margins were $8.0 million, or 22
percent, lower. The decline in volumes was due to a combination of warmer
weather and weaker economic conditions. The greater percentage decline in margin
was due to shifts by some customers during 2002 and 2003 from higher-margin
sales or transportation schedules to lower-margin transportation schedules, and
to the inclusion of $4.6 million of margin from electric generation customers,
equivalent to 11 cents a share of earnings, in the results for the first nine
months of 2002. One-year contracts for service to two customers in the electric
generation market went into effect in the second half of 2001 and expired on
June 30, 2002.
Volumes delivered to end-use industrial sales and transportation
customers, excluding electric generation customers, in the nine months ended
Sept. 30, 2003 were 6 percent lower than in the same period in 2002. Margin from
these customers in the nine months ended Sept. 30, 2003 was 11 percent lower
than in the same period in 2002. The decline in volumes was due to the warmer
weather and weaker economic conditions, while the greater percentage decline in
margin was due to customers' shifts from higher-margin to lower-margin sales or
transportation schedules. Sales in the industrial interruptible market were up
10 percent in the nine-month period, however, and up substantially in the
three-month period, due to transfers by some interruptible transportation
customers to sales service in the second quarter of 2003 when commodity prices
in the spot gas market rose to levels higher than the gas price built into NW
Natural's interruptible sales rates.
NW expects the overall margin decline in the industrial market to
continue, due in part to a $4 million shift from industrial rate schedules to
residential and commercial rate schedules based on an analysis of cost of
service that was approved in the Oregon general rate case.
21
Other Revenues
--------------
Other revenues include revenues recognized from a variety of sources
other than the sale and transportation of gas (see Note 1 in the 2002 Form
10-K), including deferrals to and amortizations from regulatory accounts and
miscellaneous customer fees.
Other revenues contributed $2.1 million to utility operating revenues
in the third quarter of 2003, compared to $0.4 million in the third quarter of
2002. The $1.7 million increase in other revenues in the third quarter of 2003
came primarily from revenue deferrals under NW Natural's partial decoupling
mechanism ($1.5 million) (see Part II, Item 7., "Results of Operations -
Regulatory Matters," in the 2002 Form 10-K).
Other revenues contributed $7.3 million to utility operating revenues
in the first nine months of 2003, compared to $2.4 million in the first nine
months of 2002. The $4.9 million increase was primarily due to higher revenue
deferrals under the partial decoupling mechanism ($3.0 million) and
amortizations of interstate storage credits ($1.8 million).
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 in periods when core utility customers do not fully
utilize firm pipeline capacity and gas supplies.
As of June 30, 2003, the Company had replaced all of its expiring
long-term contracts with supply contracts for gas purchases of similar aggregate
volume levels. All of the replacement contracts have terms of five years or less
and contain commodity price provisions that are tied directly to monthly market
index prices for the term of the contract. The Company engages in financial
swaps that are intended to have the effect of converting these monthly market
index prices into fixed prices for most of its gas purchases under these
contracts.
The cost per therm of gas sold was 30 percent lower during the third
quarter of 2003 than in the third quarter of 2002. Year-to-date, the cost per
therm of gas sold was 16 percent lower than in the first nine months of 2002.
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 the nine months ended Sept. 30, 2002 include an adjustment reducing
cost of gas by $29.5 million (see "Comparison of Gas Operations," above).
Excluding the impact of this adjustment, cost per therm of gas sold was 25
percent lower in the first nine months of 2003 compared to the same period in
2002.
Results for the nine months ended Sept. 30, 2002 also included
adjustments reducing cost of gas relating to amounts of deferred expenses for
the recovery of pipeline demand charges under NW Natural's PGA mechanism. These
adjustments totaled $2.9 million, contributing 7 cents a share to earnings in
the second quarter of 2002, of which $2.6 million or 6 cents a share applied to
periods prior to 2002. The rate methodology represented in the adjustments
continues to be applied in the Company's accounting for pipeline demand charges.
NW Natural's recorded amount of unaccounted-for gas for the nine months
ended Sept. 30, 2003 was 0.20 percent of gas receipts, compared to 0.61 percent
for the nine months ended Sept. 30, 2002. Unaccounted-for gas is the difference
between the amount of gas the Company receives from all sources, including
pipeline deliveries and withdrawals from storage, and the amount of gas it
delivers to customers or other delivery points. Unaccounted-for gas may be
caused in part by physical gas leakage, but it also may be due to cumulative
inaccuracies in gas metering, estimates of unbilled gas or other causes. The
Company considers a normal amount of unaccounted-for gas to be 0.50 percent of
its total gas receipts during a period, but the amount may vary within a range
around this estimate. In the first nine months of 2003, the lower estimated
amount of unaccounted-for gas had the effect of reducing cost of gas and
22
increasing margin by $1.7 million as compared to the equivalent nine-month
period a year earlier. In the third quarter of 2003, NW Natural revised its
estimate of unbilled gas from the second quarter of 2003 with the net effect of
reducing margin for the third quarter by a total of about $0.8 million.
Reflecting this revision, the margin reduction due to unaccounted-for gas was
$0.4 million higher in the third quarter of 2003 than in the third quarter of
2002.
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 $5 million and $36 million from commodity swap and
call option contracts during the three- and nine-month periods ended Sept. 30,
2003, respectively, compared to net losses of $25 million and $70 million in the
same periods in 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
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 third quarter
of 2003 were slightly lower than the gas costs embedded in rates, with the
effect that NW Natural's share of the lower costs increased margin by $0.1
million, equivalent to less than 1 cent a share of earnings. For the third
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 $0.9 million of margin, equivalent to 2 cents a
share of earnings. In the first nine months of 2003, NW Natural's gas costs 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 savings realized
from gas commodity purchases contributed $0.4 million of margin, equivalent to 1
cent a share of earnings. The equivalent result in the first nine months of 2002
was net savings of $11 million, equivalent to 26 cents a share of earnings.
Due to the warm weather and the reduced gas requirements of its
industrial sales customers during the first nine months of 2003, 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 off-system gas
sales. The Company's purchase prices for this gas had been locked in through
commodity swap and call option agreements entered into last year at levels lower
than current market prices. 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 off-system gas
sales in the third quarter of 2003 was $0.4 million, equivalent to 1 cent a
share of earnings, compared to margin of $0.7 million or 2 cents a share of
earnings in the third quarter of 2002. In the first nine months of 2003, NW
Natural's share of the margin from off-system gas sales contributed $4.9 million
of margin, equivalent to 12 cents a share of earnings. The equivalent result in
the first nine months of 2002 was margin of $0.8 million, or 2 cents a share of
earnings.
Non-utility Operations
----------------------
At Sept. 30, 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 $1.0 million or
4 cents a share in the three months ended Sept. 30, 2003, compared to $0.4
million or 1 cent a share for the comparable period in 2002. For the first nine
months of 2003, operating results were net income of $3.4 million, compared to
net income of $2.4 million for the comparable period in 2002. Gas storage
services are provided to off-system 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
23
and credits the remaining 20 percent to a deferred regulatory account for
distribution to 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. 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
Sept. 30, 2003 were net income of $0.2 million, compared to net income of $0.5
million for the comparable period in 2002. The results in the third quarters of
both 2003 and 2002 were equivalent to 1 cent a share of earnings for the
Company. For the first nine months of 2003, operating results were net income of
$0.6 million, compared to $1.2 million for the comparable period in 2002. The
lower net income in the current nine-month period was primarily due to lower
income from Financial Corporation's investments in limited partnerships in wind
and solar electric generation projects in California and lower miscellaneous
receivables. The Company's investment balances in Financial Corporation at Sept.
30, 2003 and 2002 were $9.7 million and $9.1 million, 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 nominal expenses for corporate development activities in the
first nine months of 2003.
Operating Expenses
------------------
Operations and Maintenance
--------------------------
Consolidated operations and maintenance expenses increased $3.1
million, or 16 percent, and $8.1 million, or 13 percent, in the three- and nine-
month periods ended Sept. 30, 2003, respectively, compared to the same periods
in 2002.
For the three-month period ended Sept. 30, 2003, the increase includes:
$1.5 million for wage and salary increases, vacation accruals and incentive
bonus accruals; $1.1 million due to higher pension costs, including the impact
of changes in actuarial assumptions and lower returns on pension assets; $0.2
million due to higher insurance premiums for health care and prescription drug
coverage; and $0.2 million due to higher premiums for business risk insurance;
offset by a decrease of $0.3 million in uncollectible accounts expense. Vacation
accruals in the three-month period include a $0.5 million charge in connection
with the termination of a vacation banking benefit for non-union employees.
The nine-month period includes increases of: $3.2 million due to wage
and salary increases, vacation accruals and incentive bonus accruals; $2.8
million due to higher pension costs, including the impact of changes in
actuarial assumptions and lower returns on pension assets; $0.9 million due to
higher insurance premiums for health care and prescription drug coverage; and
$0.7 million due to higher business risk insurance renewal premiums. These cost
increases were partially offset by a decrease in uncollectible accounts expense
of $1.2 million due to lower net write-offs of accounts receivable compared to
last year when customer bills and subsequent write-offs were impacted by higher
gas prices and colder weather.
24
Taxes Other than Income Taxes
-----------------------------
Taxes other than income taxes, which are principally comprised of
franchise, property and payroll taxes, decreased $0.1 million, or 1 percent, and
$0.7 million, or 3 percent, in the three- and nine- month periods ended Sept.
30, 2003, respectively, compared to the same periods in 2002.
For the three-month period ended Sept. 30, 2003, franchise taxes, which
are based on gross revenues, decreased $0.2 million, or 10 percent, reflecting
lower gross revenues due to lower rates, warmer weather and other factors.
Payroll taxes increased $0.1 million, or 15 percent, due to wage and salary
increases. Property taxes increased by $0.1 million, or 3 percent, due to an
increase in utility plant additions.
For the nine-month period ended Sept. 30, 2003, franchise taxes
decreased $1.1 million, or 10 percent, reflecting lower gross revenues due to
lower rates, warmer weather and other factors. Property taxes increased $0.4
million, or 4 percent, due to an increase in utility plant additions.
Depreciation and Amortization
-----------------------------
Depreciation and amortization expense increased $0.5 million, or 4
percent, and $1.4 million, or 4 percent, in the three- and nine- month periods
ended Sept. 30, 2003, respectively, compared to the same periods in 2002. Total
depreciable plant and property in service at Sept. 30, 2003 was up 5 percent
from a year earlier. As a percentage of average plant and property, depreciation
and amortization expense was approximately 3 percent for each of the nine-month
periods ended Sept. 30, 2003 and 2002.
Other Income (Expense)
----------------------
Other income (expense) improved by $0.5 million and $15.7 million in
the three- and nine-month periods ended Sept. 30, 2003, respectively, compared
to the same periods in 2002. Excluding the effect of the $13.7 million charge
for costs incurred in the effort to acquire PGE, the Company's other income was
$2.0 million higher in the nine months ended Sept. 30, 2003, than in the same
period in 2002, primarily due to reductions in interest charges on deferred
regulatory account balances and an increase in gains from Company-owned life
insurance. Interest expense on deferred regulatory account balances in the
three- and nine-month periods ended Sept. 30, 2003 was $0.2 million and $0.7
million, respectively, compared to $0.4 million and $2.3 million in the same
periods of 2002. These improvements reflect lower net credit balances
outstanding in deferred regulatory accounts. Gains from Company-owned life
insurance were $1.5 million higher in the first nine months of 2003 than in the
first nine months of 2002, while income from partnership investments held by
Financial Corporation was $0.7 million lower.
Interest Charges - net
----------------------
The Company's net interest expense decreased by $0.2 million, or 3
percent, in the three months ended Sept. 30, 2003. The Company reclassified
dividends of $0.1 million on its redeemable preferred stock as interest expense
in the three months ended Sept. 30, 2003 (see Note 2 to the accompanying
Consolidated Financial Statements). The Company's net interest expense increased
by $1.1 million, or 4 percent, in the nine months ended Sept. 30, 2003, compared
to the same period in 2002, primarily due to higher average balances of
long-term debt outstanding during the period.
Income Taxes
------------
The effective corporate income tax rates were 41.9 percent and 33.4
percent for the three- and nine- month periods ended Sept. 30, 2003,
respectively. The effective corporate income tax rates were 39.0 percent and
35.4 percent for the three- and nine-month periods ended Sept. 30, 2002. In the
nine-month period ended Sept. 30, 2002, the Company recorded a $13.7 million
PGE-related charge. Excluding the effect of this charge, the effective corporate
income tax rate would have been 36.3 percent.
25
For the three- and nine-month periods ended Sept. 30, 2003, the
effective corporate tax rate was impacted by tax benefits associated with the
exercise of non-qualified stock options, dividends reinvested in certain
employer stock and gains recognized on company-owned life insurance. These tax
benefits increased $0.9 million and $1.6 million for the three- and nine-month
periods ended Sept. 30, 2003, compared to comparable periods in 2002. For the
three-month period ended Sept. 30, 2003, the higher book loss combined with the
increased tax benefit resulted in an effective tax rate that is not necessarily
indicative of an effective tax rate on a year-to-date basis. For the nine-month
period ended Sept. 30, 2003, the increased tax benefit resulted in a combined
federal and state tax savings of approximately $0.7 million. Excluding these
increased tax benefits recognized in the nine-month period ended Sept. 30, 2003,
the effective corporate income tax rate would have been 35.2 percent.
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 Notes 3 and 5 in the 2002 Form 10-K).
Liquidity and Capital Resources
-------------------------------
At Sept. 30, 2003, the Company had $7.0 million in cash and cash
equivalents compared to $19.7 million at Sept. 30, 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 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
contractual commitments under capital leases, operating leases and gas supply
purchase and other contracts that require an adequate source of funding. 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.
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.
Off-Balance Sheet Arrangements
------------------------------
The Company has no material off-balance sheet financing arrangements.
26
Contractual Obligations
-----------------------
The following table shows the present value of NW Natural's long-term
contractual obligations by maturity and type of obligation:
(Thousands) Payments Due in Years Ending Sept. 30,
----------------------------------------------------------------
Contractual Obligations 2004 2005 2006 2007 2008 Thereafter Total
------------------------------------------------------------------------------------------------------------------------------
Commercial paper $ 85,200 $ - $ - $ - $ - $ - $ 85,200
Long-term debt - 15,000 8,000 29,500 5,000 393,294 450,794
Capital leases 148 104 85 28 - - 365
Operating leases 2,935 2,646 1,596 193 166 3,345 10,881
Gas supply commitments 52,663 52,838 48,785 46,644 44,645 209,630 455,205
Other contractual commitments 23,776 4,000 - - - - 27,776
-------------------------------------------------------------------------------------------
Total $ 164,722 $ 74,588 $ 58,466 $ 76,365 $ 49,811 $ 606,269 $ 1,030,221
===========================================================================================
Other contractual commitments consist of obligations under a contract
NW Natural has entered into with a general contractor totaling about $27.8
million in 2003 and 2004 providing for the construction of an extension of the
pipeline from the Mist gas storage field. This and other capital and long-term
contractual obligations 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.
Holders of certain Medium-Term Notes (MTNs) have put options that, if
exercised, would accelerate the maturity of long-term debt by $10 million and
$20 million in the 12-month periods ending Sept. 30, 2006 and 2007,
respectively.
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 in the 2002 Form
10-K). NW Natural had $85.2 million in commercial paper notes outstanding at
Sept. 30, 2003, compared to none outstanding at Sept. 30, 2002 and $69.8 million
outstanding at Dec. 31, 2002. Financial Corporation had no commercial paper
notes outstanding at Sept. 30, 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, 2004, and the other $75 million is
committed and available through Sept. 30, 2005. In addition, Financial
Corporation has available through Sept. 30, 2004, committed lines of credit with
two commercial banks totaling $10 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 Sept. 30,
2003 or 2002, or at Dec. 31, 2002.
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
27
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, 2003, 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. The Company was in compliance with both of these covenants
at Sept. 30, 2003, and with the equivalent covenants in the prior year's lines
of credit at Dec. 31, 2002.
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.
Optional Redemptions of Long-Term Debt and Redeemable Preferred Stock
---------------------------------------------------------------------
In the third quarter of 2003, NW Natural exercised early redemption
provisions applicable to certain of its long-term debt, including all $4 million
of the 7.50% Series B MTNs due 2023, all $11 million of the 7.52% Series B MTNs
due 2023, and all $20 million of the 7.25% Series B MTNs due 2023. These MTNs
were redeemable in the third quarter of 2003 at 103.75 percent, 103.76 and
103.65 percent of their respective principal amounts. The Company redeemed each
of the series of MTNs with available cash or with the proceeds from sales of
commercial paper. The Company also gave notice, in October 2003, that it was
exercising the early redemption provision applicable to all of the remaining
shares of its $7.125 Series of Redeemable Preferred Stock with an aggregate
stated value of $7.5 million, at a redemption price equivalent to 102.375
percent, effective as of Nov. 14, 2003. The Company intends to redeem the
preferred stock with the proceeds from sales of commercial paper and to
re-finance this long-term debt and preferred stock through the sale of new
long-term debt in the fourth quarter of 2003.
Cash Flows
----------
Operating Activities
--------------------
Cash provided by operating activities was $110.4 million in the nine
months ended Sept. 30, 2003, compared to $127.4 million in the first nine months
of 2002. The $17.0 million, or 13 percent, decrease was due to a decrease in
cash from operations before working capital changes ($25.8 million), partially
offset by an increase in working capital ($8.8 million). The decrease in cash
from operations before working capital changes compared to the first nine months
of 2002 was primarily due to non-cash adjustments to net income in 2002,
including the loss recorded for PGE costs ($13.7 million), combined with a
smaller increase in deferred income taxes and investment tax credits ($5.0
million), a smaller increase in deferred gas costs ($4.7 million) and a larger
increase in other assets and liabilities ($2.6 million). The increase in working
capital was primarily due to an increase in accrued interest and taxes ($14.7
million) compared to a decrease in 2002, a decrease in other current assets and
liabilities ($13.7 million) compared to an increase in 2002, a decrease in
inventories ($7.2 million) compared to an increase in 2002, and a smaller
decrease in accounts payable ($3.9 million), partially offset by smaller
decreases in accounts receivable ($20.3 million) and in accrued unbilled revenue
($10.2 million).
NW Natural's refunds to customers of approximately $30.4 million of
deferred gas cost savings in the nine months ended Sept. 30, 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 other
factors affecting cash flows in the first nine months of 2002.
Investing Activities
--------------------
Cash requirements for investing activities in the first nine months of
2003 totaled $92.0 million, up from $57.9 million in the same period of 2002.
Cash requirements for utility construction totaled $90.0 million, up $36.8
28
million from the first nine months of 2002. The increase in cash requirements
for utility construction in the first nine months of 2003 was primarily the
result of capital expenditures relating to NW Natural's SMPE project to extend
the pipeline from its Mist gas storage field ($20.5 million) and other special
projects to serve new customer load or new service areas ($7.0 million).
Investments in non-utility property during the first nine months of
2003 totaled $2.1 million, down from $2.6 million during the first nine months
of 2002.
NW Natural's utility construction expenditures in 2003 currently are
estimated to total $129 million, up from $85 million in 2002. Projected utility
construction in 2003 includes $36 million for customer growth, up from $29
million in 2002; $31 million for system improvement and support, up from $25
million in 2002; $31 million for this year's portion of the SMPE project and
related gas storage facilities, up from $9 million in 2002; and $6 million for
this year's portion of a project to construct a gas distribution system in Coos
County, Oregon, up from $1 million in 2002. Following denial by the Oregon
Supreme Court of a motion by the appellants to stay the effect of the SMPE
project site certificate, NW Natural proceeded with construction of an initial
segment of the SMPE project pending resolution of appeals from the order
approving its site certificate for the project (see Note 7 to the accompanying
Consolidated Financial Statements).
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 the SMPE project 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 nine months of 2003
totaled $18.6 million, down from $60.2 million in the same period of 2002.
Factors contributing to the $41.6 million difference were an increase in
short-term debt in the first nine months of 2003 ($15.4 million), compared to a
reduction in the first nine months of 2002 ($108.3 million), partially offset by
a $50 million decrease in long-term debt issued and a $34.5 million increase in
long-term debt retired.
In February 2003, NW Natural sold $40 million of its 5.66% Series B
secured 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.
In March 2002, NW Natural sold $60 million of secured MTNs and used the
proceeds, together with internally generated cash, to reduce short-term debt by
$108.1 million in the first quarter of 2002.
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 (see Part II, Item
7., "Financial Condition - Cash Flows - Financing Activities," in the 2002 Form
10-K). No shares were repurchased in 2002 or in the first nine months 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.
29
Ratios of Earnings to Fixed Charges
-----------------------------------
For the nine months and 12 months ended Sept. 30, 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 2.29, 2.71
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.
Contingent Liabilities
- ----------------------
Environmental Matters
---------------------
NW Natural accrues all material loss contingencies relating to
environmental matters that it believes to be probable of assertion and
reasonably estimable. See Note 12 in the 2002 Form 10-K. Due to the preliminary
nature of several of these environmental investigations, the range of any
additional possible loss contingency cannot be currently estimated.
On May 27, 2003, the OPUC approved NW Natural's request for deferral of
environmental costs associated with five specific sites, including the Gasco,
Wacker, Portland Gas and Portland Harbor sites. See Note 12 in the 2002 Form
10-K. The authorization, effective for a 12-month period beginning April 7,
2003, allows NW Natural to defer and seek recovery of unreimbursed environmental
costs in a future general rate case. Through Sept. 30, 2003, NW Natural has
recorded $0.7 million of these costs in a deferred regulatory account.
NW Natural will first seek to recover 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, from insurance. If these costs are not recovered from insurance,
then NW Natural will seek recovery through future rates.
On June 30, 2003, the Company filed a Feasibility Scoping Plan and an
Ecological and Human Health Risk Assessment with the Oregon Department of
Environmental Quality (ODEQ), which outlined a range of remedial alternatives
for the most contaminated portion of the Gasco site. See Note 12 in the 2002
Form 10-K. NW Natural will work with the ODEQ to determine the appropriate
remedial action from among the alternatives. Based upon the proposed actions in
the draft plan, the Company estimates its range of liability, including the cost
of investigation, from feasible alternatives at between $1.7 million and $7
million. NW Natural has a recorded liability of $1.7 million, excluding
regulatory deferred costs of $0.1 million, as of Sept. 30, 2003, for its
estimated costs of investigation and remediation related to the Gasco site. See
"Application of Critical Accounting Policies - Critical Estimates," above.
Enron Gas Supply Contract
-------------------------
On Oct. 16, 2003, NW Natural received a demand letter from Enron North
America Corp. (Enron) seeking payment of $1.1 million allegedly owed pursuant to
a gas supply contract between NW Natural and Enron which was in effect when
Enron filed for bankruptcy in December 2001. The contract was terminated upon
the bankruptcy and NW Natural does not believe that any amounts are owed to
Enron under the contract.
30
Forward-Looking Statements
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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, the
WUTC and the U.S. Department of Transportation's Office of Pipeline Safety, 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, leases or other interests or other necessary authority to
construct pipelines, develop storage or complete 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.
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.
With respect to interest rate risk, during the three-month period ended
Sept. 30, 2003 the Company redeemed $35 million in long-term debt securities
with an average coupon rate of 7.36 percent and original maturities in 2023,
pursuant to optional redemption provisions. The Company used available cash or
the proceeds from sales of commercial paper to redeem these debt securities. The
Company intends to refinance this debt through the sale of new long-term debt
securities during the fourth quarter of 2003. The Company has not entered into
derivative financial transactions such as Treasury locks to hedge interest rate
changes during the period before the debt is refinanced. Therefore, it is
uncertain whether the Company's refinancing cost will be lower than the cost of
the securities redeemed. The Company does not expect, however, that there would
be a material impact on its results of operations, cash flows or financial
condition if there were to be a sudden increase in market interest rates before
the refinancing is completed.
31
Item 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
As of Sept. 30, 2003, the principal executive officer and principal
financial officer of the Company have evaluated the effectiveness of the design
and operation of the Company's disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended
(Exchange Act)). Based upon that evaluation, the principal executive officer and
principal financial officer of the Company have concluded that such disclosure
controls and procedures are effective in timely alerting them to any material
information relating to the Company and its consolidated subsidiaries required
to be included in the Company's reports filed with or furnished to the
Securities and Exchange Commission under the Exchange Act.
(b) Changes in Internal Control Over Financial Reporting
There has been no significant change in the Company's internal control
over financial reporting that occurred during the Company's most recent fiscal
quarter that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
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 and Part II, Item 1., "Legal Proceedings," in the Company's Form
10-Q for the quarters ended March 31 and June 30, 2003. In June 2003, the court
denied the motion of Enerfin Resources Northwest Limited Partnership (Enerfin),
the remaining defendant in the Action, seeking to allow it to make cross-claims
against Cascade in the case. In July, Enerfin filed a Motion for Summary
Judgment seeking dismissal of claims made by NW Natural against it. The Company
opposed the motion and a final decision is pending.
On March 13, 2003, the Oregon Energy Facility Siting Council (EFSC)
issued a Final Order and Site Certificate (Site Certificate) pursuant to which
the EFSC approved construction of the Company's proposed South Mist Pipeline
Extension (SMPE) along a designated route. See Part II, Item 7., "Financial
Condition - Investing Activities," in the 2002 Form 10-K. In May, two parties in
the contested case before EFSC separately appealed the issuance of the Site
Certificate to the Oregon Supreme Court. (Supreme Court Nos. 550428 and 550434
(consolidated)). The appeals were argued before the Supreme Court on July 22,
2003. On Nov. 6, 2003, the Supreme Court ruled on the appeals, affirming EFSC's
issuance of the Site Certificate.
The Company is subject to other claims and litigation arising in the
ordinary course of business. Although the final outcome of any such legal
proceeding cannot be predicted with certainty, the Company does not expect
disposition of these matters to have a material impact on the Company's
financial condition or results of operations.
32
Item 5. OTHER INFORMATION
Company Information
-------------------
The Company's Internet website (www.nwnatural.com) now features a
Corporate Governance module that includes the following corporate governance
materials:
o Corporate Governance Standards;
o Statement of Policy on Director Independence Standards;
o Board Committee Charters;
o Code of Ethics;
o Standards of Conduct;
o Financial Code of Ethics;
o Inside Information and Trading Policy; and
o Information for contacting the Company's non-management directors.
33
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit (3) - Bylaws of the Company, as amended September 25, 2003
Exhibit (11) - Statement re: Computation of Per Share Earnings
Exhibit (12) - Computation of Ratio of Earnings to Fixed Charges
Exhibit (31.1) - Rule 13a - 14(a)/15d-14(a) Certification of
Principal Executive Officer (required by Section 302
of the Sarbanes-Oxley Act of 2002).
Exhibit (31.2) - Rule 13a - 14(a)/15d-14(a) Certification of
Principal Financial Officer (required by Section 302
of the Sarbanes-Oxley Act of 2002).
Exhibit (32.1) - Section 1350 Certification of Principal
Executive Officer and Principal Financial Officer
(required by Section 906 of the Sarbanes-Oxley Act
of 2002).
(b) Reports on Form 8-K
On July 29, Aug. 22, and Nov. 4, 2003, respectively, the Company filed
or furnished, as applicable, its Current Reports on Form 8-K relating to: (a)
earnings for the quarter and six months ended June 30, 2003 (unaudited); (b) the
entering of an order by the Oregon Public Utility Commission (OPUC) approving
the stipulations as filed by the Company with the OPUC staff and other parties
covering all of the issues in the Company's Oregon general rate case; and (c)
earnings for the quarter and nine months ended Sept. 30, 2003 (unaudited).
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: November 12, 2003 /s/ Stephen P. Feltz
-----------------------------
Stephen P. Feltz
Principal Accounting Officer
Treasurer and Controller
34
NORTHWEST NATURAL GAS COMPANY
EXHIBIT INDEX
To
Quarterly Report on Form 10-Q
For Quarter Ended
Sept. 30, 2003
Exhibit
Document Number
- -------- ------
Bylaws of the Company, as amended September 25, 2003 (3)
Statement re: Computation of Per Share Earnings (11)
Computation of Ratio of Earnings to Fixed Charges (12)
Certification of Principal Executive Officer Pursuant to
Rule 13a-14(a)/15d-14(a), Section 302 of the
Sarbanes-Oxley Act of 2002 (31.1)
Certification of Principal Financial Officer Pursuant to
Rule 13a-14(a)/15d-14(a), Section 302 of the
Sarbanes-Oxley Act of 2002 (31.2)
Certification of Principal Executive Officer and Principal
Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 (32.1)