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, 2001
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 [ ]
At November 6, 2001, 25,173,403 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, 2001
Summary of Information Reported
The registrant submits herewith the following information:
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements Page
Number
(1) Consolidated Statements of Income for the
three and nine-month periods ended Sept. 30,
2001 and 2000 3
(2) Consolidated Statements of Earnings Invested
in the Business for the nine-month periods
ended Sept. 30, 2001 and 2000 4
(3) Consolidated Balance Sheets at Sept. 30, 2001
and 2000 and Dec. 31, 2000 5
(4) Consolidated Statements of Cash Flows for the
nine-month periods ended Sept. 30, 2001 and
2000 7
(5) Consolidated Statements of Capitalization at
Sept. 30, 2001 and 2000 and Dec. 31, 2000 8
(6) 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 26
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 26
Item 5. Other Information 26
Item 6. Exhibits and Reports on Form 8-K 28
Signature 28
2
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
(1) Consolidated Statements of Income
(Thousands, Except Per Share Amounts)
(Unaudited)
Three Months Ended Nine Months Ended
Sept. 30, Sept. 30,
----------------------------- ---------------------
2001 2000 2001 2000
---- ---- ---- ----
Operating Revenues:
Gross operating revenues $ 78,359 $ 61,255 $413,850 $334,040
Cost of sales 41,292 25,689 230,404 159,500
-------- -------- -------- --------
Net operating revenues 37,067 35,566 183,446 174,540
Operating Expenses:
Operations and maintenance 18,749 18,770 60,778 56,347
Taxes other than income taxes 6,265 5,305 22,224 19,691
Depreciation, depletion and amortization 12,567 12,173 36,982 35,391
-------- -------- -------- --------
Total operating expenses 37,581 36,248 119,984 111,429
-------- -------- -------- --------
Income (Loss) from Operations (514) (682) 63,462 63,111
Other Income 240 1,268 837 3,383
Interest Charges - net 8,306 8,399 24,492 24,900
-------- -------- -------- --------
Income (Loss) Before Income Taxes (8,580) (7,813) 39,807 41,594
Income Tax (Benefit) Expense (3,604) (2,945) 14,011 14,772
-------- -------- -------- --------
Net Income (Loss) from Continuing Operations (4,976) (4,868) 25,796 26,822
Discontinued Segment:
Gain (loss) on sale of discontinued segment - net of tax -- (17) -- 2,418
-------- -------- -------- --------
Net Income (Loss) (4,976) (4,885) 25,796 29,240
Redeemable preferred and preference stock
dividend requirements 595 604 1,807 1,848
-------- -------- -------- --------
Earnings (Loss) Applicable to Common Stock $ (5,571) $ (5,489) $ 23,989 $ 27,392
======== ======== ======== ========
Average Common Shares Outstanding 25,133 25,203 25,148 25,175
Basic Earnings (Loss) Per Share of Common Stock:
From continuing operations $ (0.22) $ (0.22) $ 0.95 $ 0.99
From gain on sale of discontinued segment -- -- -- 0.10
-------- -------- -------- --------
Total basic earnings (loss) per share $ (0.22) $ (0.22) $ 0.95 $ 1.09
======== ======== ======== ========
Diluted Earnings (Loss) Per Share of Common Stock:
From continuing operations $ (0.22) $ (0.22) $ 0.95 $ 0.99
From gain on sale of discontinued segment -- -- -- 0.09
-------- -------- -------- --------
Total diluted earnings (loss) per share $ (0.22) $ (0.22) $ 0.95 $ 1.08
======== ======== ======== ========
Dividends Per Share of Common Stock $ 0.31 $ 0.31 $ 0.93 $ 0.93
======== ======== ======== ========
------------------------------
See Notes to Consolidated Financial Statements
3
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
(2) Consolidated Statements of Earnings Invested in the Business
(Thousands)
(Unaudited)
Nine Months Ended Sept. 30, 2001 2000
- -----------------------------------------------------------------------------------------------------------------------
Earnings Invested in the Business:
Balance at Beginning of Period $ 134,189 $ 118,711
Net Income 25,796 $ 25,796 29,240 $ 29,240
Cash Dividends Paid:
Redeemable preferred and preference stock (1,816) (1,858)
Common stock (23,377) (23,393)
Common Stock Repurchased (2,688) (674)
---------- ----------
Balance at End of Period $ 132,104 $ 122,026
========== ==========
Accumulated Other Comprehensive Income (Loss):
Balance at Beginning of Period $ -- $ (3,181)
Other comprehensive income - net of tax:
Recognition of foreign currency
translation adjustment included
in gain on sale of discontinued segment -- -- 3,181 3,181
------------------------------ ----------------------------
Comprehensive Income $ 25,796 $32,421
========== =======
Balance at End of Period $ -- $ --
========= =========
-----------------------
See Notes to Consolidated Financial Statements
4
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
(3) Consolidated Balance Sheets
(Thousands)
(Unaudited) (Unaudited)
Sept. 30, Sept. 30, Dec. 31,
2001 2000 2000
- -----------------------------------------------------------------------------------------------
Assets:
Plant and Property :
Utility plant $ 1,455,695 $ 1,387,887 $ 1,406,970
Less accumulated depreciation 507,284 467,637 478,138
----------- ----------- -----------
Utility plant - net 948,411 920,250 928,832
----------- ----------- -----------
Non-utility property 8,653 3,572 8,649
Less accumulated depreciation and depletion 3,523 3,440 3,451
----------- ----------- -----------
Non-utility property - net 5,130 132 5,198
----------- ----------- -----------
Total plant and property 953,541 920,382 934,030
----------- ----------- -----------
Investments 13,978 14,999 14,526
Current Assets:
Cash and cash equivalents 8,074 9,472 11,283
Accounts receivable 29,072 20,792 62,620
Allowance for doubtful accounts (1,290) (1,405) (1,867)
Accrued unbilled revenue 10,152 8,655 45,619
Inventories of gas, materials and supplies 54,492 49,237 46,883
Prepayments and other current assets 33,289 25,570 22,834
----------- ----------- -----------
Total current assets 133,789 112,321 187,372
Regulatory Assets:
Income tax asset 49,515 51,060 49,515
Deferred gas costs receivable 8,464 17,610 16,973
Unrealized loss on non-trading derivatives 119,700 -- --
Unamortized loss on debt redemption 7,086 7,556 7,433
Other 5,824 12,431 9,524
----------- ----------- -----------
Total regulatory assets 190,589 88,657 83,445
----------- ----------- -----------
Other Assets:
Investment in life insurance 51,281 47,625 49,112
Other 11,885 9,289 10,228
----------- ----------- -----------
Total other assets 63,166 56,914 59,340
----------- ----------- -----------
Total Assets $ 1,355,063 $ 1,193,273 $ 1,278,713
=========== =========== ===========
-----------------------
See Notes to Consolidated Financial Statements
5
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
(3) Consolidated Balance Sheets
(Thousands)
(Unaudited) (Unaudited)
Sept. 30, Sept. 30, Dec. 31,
2001 2000 2000
- -----------------------------------------------------------------------------------------
Capitalization and Liabilities:
Capitalization:
Common stock $ 319,022 $ 317,179 $ 318,120
Earnings invested in the business 132,104 122,026 134,189
---------- ---------- ----------
Total common stock equity 451,126 439,205 452,309
Redeemable preference stock 25,000 25,000 25,000
Redeemable preferred stock 9,000 9,750 9,750
Long-term debt 398,449 376,022 400,790
---------- ---------- ----------
Total capitalization 883,575 849,977 887,849
---------- ---------- ----------
Current Liabilities:
Notes payable 78,862 72,488 56,263
Accounts payable 39,900 39,831 110,698
Long-term debt due within one year 20,000 30,000 20,000
Taxes accrued 8,113 4,290 8,066
Interest accrued 9,690 8,480 2,696
Other current and accrued liabilities 24,309 21,740 23,638
---------- ---------- ----------
Total current liabilities 180,874 176,829 221,361
Regulatory Liabilities 1,956 1,698 1,720
Other Liabilities:
Deferred income tax liabilities 142,485 140,171 141,656
Non-trading derivative liabilities 119,700 -- --
Deferred investment tax credits 9,081 9,905 9,538
Other 17,392 14,693 16,589
---------- ---------- ----------
Total other liabilities 288,658 164,769 167,783
---------- ---------- ----------
Commitments and Contingencies -- -- --
---------- ---------- ----------
Total Capitalization and Liabilities $1,355,063 $1,193,273 $1,278,713
========== ========== ==========
-----------------------
See Notes to Consolidated Financial Statements
6
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
(4) Consolidated Statements of Cash Flows
(Thousands)
(Unaudited)
Nine Months Ended Sept. 30, 2001 2000
- -----------------------------------------------------------------------------------------------------------------
Operating Activities:
Net income from continuing operations $ 25,796 $ 26,822
Adjustments to reconcile net income to cash provided by operations:
Depreciation, depletion and amortization 36,982 35,391
Gain on sale of assets -- (237)
Deferred income taxes and investment tax credits 372 3,533
Equity in losses of investments 182 19
Allowance for funds used during construction (667) (471)
Deferred gas costs receivable 8,509 3,340
Regulatory accounts and other - net 1,260 266
-------- --------
Cash from continuing operations before working capital changes 72,434 68,663
Changes in operating assets and liabilities:
Accounts receivable - net 32,971 23,962
Accrued unbilled revenue 35,467 22,895
Inventories of gas, materials and supplies (7,609) (15,318)
Accounts payable (70,798) (28,332)
Accrued interest and taxes 7,041 3,996
Other current assets and liabilities (9,784) (23,945)
-------- --------
Cash Provided By Continuing Operating Activities 59,722 51,921
-------- --------
Investing Activities:
Acquisition and construction of utility plant assets (55,822) (60,141)
Investment in non-utility property -- (2,536)
Proceeds from sale of discontinued segment -- 34,762
Proceeds from sale of assets -- 20,087
Investments 362 1,010
-------- --------
Cash Used In Investing Activities (55,460) (6,818)
-------- --------
Financing Activities:
Common stock issued 3,665 3,590
Common stock repurchased (5,792) (1,508)
Redeemable preferred stock retired (750) (814)
Long-term debt issued 18,000 50,000
Long-term debt retired (20,000) (50,000)
Change in short-term debt 22,599 (21,661)
Cash dividend payments:
Redeemable preferred and preference stock (1,816) (1,858)
Common stock (23,377) (23,393)
-------- --------
Cash Used in Financing Activities (7,471) (45,644)
-------- --------
Decrease In Cash and Cash Equivalents (3,209)
(541)
Cash and Cash Equivalents - Beginning of Period 11,283 10,013
-------- --------
Cash and Cash Equivalents - End of Period $ 8,074 $ 9,472
======== ========
_________________________________________________________________________________________________________________
Supplemental Disclosure of Cash Flow Information:
Cash paid during the period for:
Interest $ 17,582 $ 21,017
Income Taxes $ 25,202 $ 22,552
_________________________________________________________________________________________________________________
Supplemental Disclosure of Non-cash Financing Activities:
Conversion to common stock:
7-1/4 % Series of Convertible Debentures $ 341 357
-----------------------
See Notes to Consolidated Financial Statements
7
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
(5) Consolidated Statements of Capitalization
(Thousands, Except Per Share Amounts)
(Unaudited) (Unaudited)
Sept. 30, 2001 Sept. 30, 2000 Dec. 31, 2000
- -------------------------------------------------------------------------------------------------------
COMMON STOCK EQUITY:
Common stock - par value $3-1/6 per share $ 79,671 $ 79,831 $ 79,905
Premium on common stock 239,351 237,348 238,215
Earnings invested in the business 132,104 122,026 134,189
-------- -------- --------
Total common stock equity 451,126 51% 439,205 52% 452,309 51%
REDEEMABLE PREFERENCE STOCK:
$6.95 Series, stated value $100 per share 25,000 3% 25,000 3% 25,000 3%
REDEEMABLE PREFERRED STOCK:
$7.125 Series, stated value $100 per share 9,000 1% 9,750 1% 9,750 1%
LONG-TERM DEBT:
Medium-Term Notes
First Mortgage Bonds:
5.960% Series B due 2000 -- 5,000 --
5.980% Series B due 2000 -- 5,000 --
6.620% Series B due 2001 -- 10,000 10,000
8.050% Series A due 2002 10,000 10,000 10,000
6.750% Series B due 2002 10,000 10,000 10,000
5.550% Series B due 2002 20,000 20,000 20,000
6.400% Series B due 2003 20,000 20,000 20,000
6.340% Series B due 2005 5,000 5,000 5,000
6.380% Series B due 2005 5,000 5,000 5,000
6.450% Series B due 2005 5,000 5,000 5,000
6.050% Series B due 2006 8,000 -- --
6.800% Series B due 2007 10,000 10,000 10,000
6.500% Series B due 2008 5,000 5,000 5,000
7.450% Series B due 2010 25,000 -- 25,000
6.665% Series B due 2011 10,000 -- --
8.260% Series B due 2014 10,000 10,000 10,000
7.000% Series B due 2017 40,000 40,000 40,000
6.600% Series B due 2018 22,000 22,000 22,000
8.310% Series B due 2019 10,000 10,000 10,000
7.630% Series B due 2019 20,000 20,000 20,000
9.050% Series A due 2021 10,000 10,000 10,000
7.250% Series B due 2023 20,000 20,000 20,000
7.500% Series B due 2023 4,000 4,000 4,000
7.520% Series B due 2023 11,000 11,000 11,000
7.720% Series B due 2025 20,000 20,000 20,000
6.520% Series B due 2025 10,000 10,000 10,000
7.050% Series B due 2026 20,000 20,000 20,000
7.000% Series B due 2027 20,000 20,000 20,000
6.650% Series B due 2027 20,000 20,000 20,000
6.650% Series B due 2028 10,000 10,000 10,000
7.740% Series B due 2030 20,000 20,000 20,000
7.850% Series B due 2030 10,000 10,000 10,000
Unsecured:
8.47% Series A due 2001 -- 10,000 10,000
Convertible Debentures
7-1/4% Series due 2012 8,449 9,022 8,790
-------- -------- --------
418,449 406,022 420,790
Less long-term debt due within one year 20,000 30,000 20,000
-------- -------- --------
Total long-term debt 398,449 45% 376,022 44% 400,790 45%
-------- --- -------- --- -------- ---
TOTAL CAPITALIZATION $883,575 100% $849,977 100% $887,849 100%
======== === ======== === ======== ===
-----------------------
See Notes to Consolidated Financial Statements
8
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
(6) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Financial Statements
The information presented in the consolidated financial statements is
unaudited, but includes all adjustments, consisting of only normal recurring
accruals, which the management of the Company considers necessary for a fair
presentation of the results of such periods. These consolidated financial
statements should be read in conjunction with the financial statements and
related notes included in the Company's 2000 Annual Report on Form 10-K, as
amended (2000 Form 10-K). A significant part of the business of the Company is
of a seasonal nature; therefore, results of operations for the interim periods
are not necessarily indicative of the results for a full year.
Certain amounts from prior periods have been reclassified to conform
with the 2001 presentation. These reclassifications had no impact on prior
period results of operations.
As referred to herein, the "Company" consists of Northwest Natural Gas
Company (NW Natural), a regulated utility, and non-regulated subsidiary
businesses, NNG Financial Corporation (Financial Corporation), a wholly-owned
subsidiary, and Canor Energy, Ltd. (Canor), a majority owned subsidiary that was
reclassified as a discontinued segment and sold in the first quarter of 2000.
2. Revenue Recognition
NW Natural's utility revenues are derived primarily from the sale and
transportation of natural gas. NW Natural recognizes utility revenue from gas
sales and transportation when the gas is delivered to customers. Estimated
revenues are accrued for gas deliveries not billed to customers from meter
reading dates to month end (unbilled revenue) and are reversed in the following
month when actual billings occur.
Revenues from non-utility services, including gas storage services, are
recognized upon delivery of the service to customers. Guaranteed minimum
obligations for gas storage services are recognized over the term of the
contract.
3. Derivatives Policy
NW Natural's Derivatives Policy allows the use of selected financial
derivative products to support prudent risk management strategies within
designated parameters for natural gas commodity prices, for foreign currency
exchange rates related to NW Natural's natural gas purchase commitments, for oil
or propane commodity prices related to natural gas sales or transportation under
rate schedules pegged to commodities other than natural gas, and for interest
rates on outstanding long-term debt instruments maturing in less than five
years. The objective is to use derivative products to structure "hedge"
positions as defined by the policy. Use of derivatives is permitted only after
the purchase price, exchange rate, oil or propane index price, and interest rate
exposures have been identified, are determined to exceed defined tolerance
levels and are considered to be unavoidable because they are necessary or
support normal business activities.
The Derivatives Policy is intended to decrease NW Natural's net
exposures to commodity price, exchange rate and interest rate risks (market
risks) by using hedging strategies and derivative structures within certain
9
limitations. The policy is intended to prevent speculative risk. NW Natural
believes that any increase in market risk created by the use of the derivatives
should be offset by the exposures they modify.
4. New Accounting Standards
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS
No. 141 requires business combinations initiated after June 30, 2001 to be
accounted for using the purchase method of accounting. It also specifies the
types of acquired intangible assets that are required to be recognized and
reported separately from goodwill. SFAS No. 142 requires goodwill and other
intangibles with indefinite lives to be tested for impairment at least annually
rather than being amortized as previously required. SFAS No. 142 is effective
for fiscal years beginning after Dec. 15, 2001. Implementation of these
statements is not expected to have a material impact on the Company's financial
position or results of operations upon adoption effective January 1, 2002; the
Company is evaluating the impact they may have on its financial condition or
results of operations in light of the pending acquisition of Portland General
Electric Company (see Note 10, below).
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143, which is effective for fiscal years
beginning after June 15, 2002, requires that obligations associated with the
retirement of a tangible long-lived asset be recorded as a liability when those
obligations are incurred, with the amount of the liability initially measured at
fair value. The liability for the asset retirement obligation is recorded as a
capitalized cost increasing the carrying amount of the related long-lived asset.
Over time, the liability is accreted to its present value each period and the
capitalized cost is depreciated over the useful life of the related asset. The
Company is currently evaluating the impact of this statement upon its financial
position or results of operations.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which is effective for fiscal
years beginning after Dec. 15, 2001. SFAS No. 144 develops a single accounting
model for all long-lived assets disposed of and requires that these assets be
measured at the lower of book value or fair value less selling costs. SFAS No.
144 also expands the scope of discontinued operations to include all components
of an entity that can be distinguished from the rest of the entity and will be
eliminated from the ongoing operations of the entity in a disposal transaction.
Implementation of this statement is not expected to have a material impact upon
the Company's financial position or results of operations.
5. Adoption of New Accounting Standard
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedge accounting. It requires
that an entity measure all derivatives at fair value and recognize those
derivatives as either assets or liabilities on the balance sheet. If the
derivative is designated as a fair value hedge, the net changes in the fair
value of the derivative and of the hedged item attributable to the hedged risk
are recognized in current earnings. If the derivative is designated as a cash
flow hedge, the effective portions of changes in the fair value of the
derivative are recorded in other comprehensive income (OCI), or in deferred
asset accounts for regulated activities, and recognized in the income statement
when the hedged item affects earnings. Ineffective portions of changes in the
fair value of cash flow hedges are recognized in current earnings. Some of NW
Natural's gas purchase, sales and transportation contracts are derivative
instruments as defined under SFAS No. 133. However, the FASB issued SFAS No.
138, "Accounting for Certain Derivative Instruments and Certain Hedging
Activities," which amended portions of SFAS No. 133. Among other things, SFAS
10
No. 138 provides an exception for contracts intended for the normal purchase and
normal sale of something other than a financial instrument or derivative
instrument, for which physical delivery is probable.
The Company adopted SFAS No. 133, as amended, on Jan. 1, 2001. NW
Natural's primary derivatives hedging activities are being accounted for as cash
flow hedges under this statement. Unrealized gains or losses resulting from
mark-to-market valuations of the underlying hedge contracts are subject to
deferral under NW Natural's tariffs with the Oregon Public Utility Commission
(OPUC) and the Washington Utilities and Transportation Commission (WUTC).
Pursuant to SFAS No. 71, "Accounting for the Effects of Certain Types of
Regulation," contracts representing unrealized gain or loss positions are
reported as derivative assets or liabilities and are offset by a corresponding
deferred account included under "Regulatory Assets" or "Regulatory Liabilities."
Due to their regulatory deferral treatment, effective portions of changes in the
fair value of these derivatives are not recorded in OCI, but are deferred as a
regulatory asset or liability. Ineffective portions of changes in the fair value
are recognized in earnings. Effectiveness is measured by comparing changes in
cash flows of the hedged item to gains or losses on derivative instruments.
NW Natural formally documents all relationships between hedging
contracts and hedged items, as well as its risk management objective and
strategy for undertaking the hedge. This process includes specific
identification of the hedging contract and the hedge transaction, the nature of
the risk being hedged and how the hedging instrument's effectiveness will be
measured. Both at the inception of the hedge and on an ongoing basis, NW Natural
measures effectiveness of the derivatives used in hedging transactions.
NW Natural enters into short-term and long-term natural gas purchase
contracts with demand and commodity fixed-price and variable-price components,
along with associated short-term and long-term natural gas transportation
contracts. The prices of natural gas commodity are subject to fluctuations due
to unpredictable factors including weather, pipeline transportation congestion
and the economy, each of which affects short-term supply and demand. NW Natural
uses natural gas commodity swap and cap agreements to convert certain of its
long-term purchase contracts from floating prices to fixed prices.
Many of the purchases made under these gas purchase contracts are
priced in Canadian dollars. The costs of natural gas commodity and pipeline
services purchased from certain Canadian suppliers are subject to changes in the
value of Canadian currency in relation to U.S. currency. NW Natural uses foreign
currency forward contracts to hedge against fluctuations in currency exchange
rates with respect to its purchases of natural gas from suppliers in Canada.
The adoption of SFAS No. 133 effective Jan. 1, 2001, resulted in the
Company recording a one-time transition adjustment by debiting a derivative
asset account and crediting an offsetting regulatory asset account on the
balance sheet for approximately $165 million. This transition adjustment
represented the initial recognition of the fair values of hedge derivatives
outstanding on the adoption date.
At Sept. 30, 2001, NW Natural had two types of natural gas commodity
cash flow hedges open: a series of 18 natural gas price swap agreements and five
call option agreements. NW Natural realized net losses from commodity swap and
call option contracts of $8.7 million in the third quarter of 2001, compared to
net gains of $7.3 million in the third quarter of 2000. The net decrease in the
fair value of these hedge derivatives for the nine months ended Sept. 30, 2001
was $284.7 million, including net gains of $78.2 million realized as reductions
to the cost of gas upon settlement of certain cash flow hedges, compared to net
gains of $10.5 million during the first nine months of 2000. During the nine
months ended Sept. 30, 2001, the amount of hedge ineffectiveness recognized in
earnings from derivatives that were designated and qualify as cash flow hedges
was negligible. All remaining outstanding derivative instruments in these
11
categories at Sept. 30, 2001 were determined to be 100 percent effective (see
Part I, Item 2., "Results of Operations - Cost of Gas," below).
The estimated fair values of derivative hedge instruments outstanding
at Jan. 1 and Sept. 30, 2001 are presented below:
Jan. 1, Sept. 30,
-------- ---------
2001 2001
-------- ---------
Unrealized fair market value gain (loss) ($000)
Fixed-price natural gas commodity price swaps $ 122,588 $(119,632)
Fixed-price natural gas call options 41,980 9
Foreign currency forward contracts 405 (77)
--------- ----------
Total unrealized gain (loss) on non-trading derivative instruments $ 164,973 $(119,700)
========= ==========
The fair value of fixed-price contracts as of Sept. 30, 2001 was
estimated based on market prices for the periods covered by the contracts. The
net differential between the prices in each contract and market prices for
future periods, as adjusted for estimated basis, where applicable, has been
applied to the volumes stipulated in each contract to arrive at an estimated
future value. As of Sept. 30, 2001, a total of 11 natural gas price swap
contracts and two natural gas call option contracts have periods that extend
beyond Sept. 30, 2002, but none extends longer than Sept. 30, 2003.
NW Natural did not have any hedge contracts outstanding at Sept. 30,
2001, relating to interest rates or to oil or propane prices.
NW Natural recorded a $0.1 million loss for the first nine months of
2001, representing the change in value of an embedded derivative relating to a
contract for an equipment financing program under which NW Natural guarantees a
minimum level of return for the lender.
6. Segment Reporting
The Company principally operates in a business segment consisting of
the distribution of natural gas ("Utility"). Another segment, which was
immaterial prior to Jan. 1, 2001, represents natural gas storage services
provided to upstream customers using storage capacity not required from time to
time for service to utility customers ("Gas Storage"). The remaining segment
primarily consists of non-regulated investments in alternative energy projects
in California, oil and gas exploration properties which were sold in 2000 and a
Boeing 737-300 aircraft leased to Continental Airlines ("Other").
12
The following table presents information about the reportable segments
for the three and nine months ended Sept. 30, 2001 and 2000. 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
- --------------------------------------------------------------------------- -----------------------------------------------
2001
- ----
Net operating revenues $ 36,351 $ 662 $ 54 $ 37,067 $ 180,671 $ 2,654 $ 121 $ 183,446
Depreciation, depletion
and amortization 12,543 24 -- 12,567 36,910 72 -- 36,982
Other operating expenses 24,891 130 (7) 25,014 82,863 216 (77) 83,002
Income (loss) from operations (1,083) 508 61 (514) 60,898 2,366 198 63,462
Income (loss) from financial
investments -- -- 51 51 -- -- (182) (182)
Net income (loss) from
continuing operations (5,537) 280 281 (4,976) 23,762 1,365 669 25,796
Total assets 1,330,137 4,847 20,079 1,355,063 1,330,137 4,847 20,079 1,355,063
2000
- ----
Net operating revenues $ 35,434 $ 68 $ 64 $ 35,566 $ 174,161 $ 140 $ 239 $ 174,540
Depreciation, depletion
and amortization 12,268 -- (95) 12,173 35,391 -- -- 35,391
Other operating expenses 24,028 14 33 24,075 75,983 64 (9) 76,038
Income (loss) from operations (862) 54 126 (682) 62,787 76 248 63,111
Income (loss) from financial
investments -- -- 92 92 -- -- (19) (19)
Net income (loss) from
continuing operations (5,128) 24 236 (4,868) 26,660 46 116 26,822
Gain (loss) on sale of
discontinued segment -- -- (17) (17) -- -- 2,418 2,418
Total assets 1,172,879 -- 20,394 1,193,273 1,172,879 -- 20,394 1,193,273
7. Discontinued Segment
In January 2000, the Company sold its interest in Canor, an Alberta,
Canada corporation that had been engaged in natural gas and oil exploration,
development and production in Alberta and Saskatchewan, Canada. The Company
realized an after-tax gain from the sale of Canor of $2.4 million, net of
Canadian tax on dividends ($0.6 million) and U.S. income tax ($2.8 million) (see
Part II, Item 8., Note 2, "Canor Energy, Ltd.," in the 2000 Form 10-K).
Proceeds from the sale of Canor are reflected in the Consolidated
Statement of Cash Flows for 2000 (Investing Activities) as proceeds from sale of
discontinued segment.
8. Lines of Credit
Effective Oct. 1, 2001, NW Natural has available through Sept. 30,
2002, committed lines of credit with four commercial banks totaling $150 million
which are used as backup lines for NW Natural's commercial paper program. In
addition, Financial Corporation has available through Sept. 30, 2002, committed
lines of credit with two commercial banks totaling $20 million. Financial
Corporation's lines are supported by the guaranty of NW Natural.
13
9. Contingencies
Environmental Matters
---------------------
NW Natural owns property in Linnton, Oregon that is the site of a
former gas manufacturing plant that was closed in 1956 (the Linnton site). NW
Natural previously owned property adjacent to the Linnton site that now is the
location of a manufacturing plant owned by Wacker Siltronic Corporation (the
Wacker site). The Linnton site and the Wacker site have been under investigation
by NW Natural under program oversight by the Oregon Department of Environmental
Quality (ODEQ). In 1998, the ODEQ and the U.S. Environmental Protection Agency
(EPA) completed a study of sediments in a 5.5 mile segment of the Willamette
River (the Portland Harbor) that includes the area adjacent to the Linnton site
and the Wacker site. In 2000, the EPA listed the Portland Harbor as a Superfund
site. See Part II, Item 8., Note 12, "Notes to Consolidated Financial
Statements," in the 2000 Form 10-K.
The Company has accrued all material loss contingencies which
it believes to be probable of assertion, including those relating to the Linnton
site, the Wacker site and the Portland Harbor Superfund site. However, due to
the preliminary nature of these environmental investigations, the range of any
additional possible loss cannot be currently estimated. NW Natural expects that
its costs of investigation and any remediation for which it may be responsible
with respect to the Linnton site, the Wacker site and the Portland Harbor
Superfund site should be recoverable, in large part, from insurance. In the
event these costs are not recovered from insurance, NW Natural will seek
recovery through future rates.
Litigation
----------
NW Natural is party to a lawsuit, Northwest Natural Gas Company v.
Chase Gardens, Inc. (Lane County Circuit Court Case No. 16-91-01370), involving
claims by a commercial customer. In 1999, the Oregon Supreme Court ruled in NW
Natural's favor on the larger of the two claims in the case, and the Oregon
Court of Appeals ruled in NW Natural's favor on the smaller (contract) claims.
The Oregon Supreme Court initially declined to review the Court of Appeals'
decision on the contract claims, including a verdict against NW Natural in the
amount of $2.0 million plus interest. On reconsideration, however, in December
2000 the Supreme Court agreed to review the Court of Appeals' decision on the
contract claims and is expected to issue an opinion in 2001. See Part I, Item
3., "Legal Proceedings," in the 2000 Form 10-K.
10. Subsequent Events
On Oct. 5, 2001, NW Natural and Enron Corp., an Oregon corporation
(Enron), entered into a Stock Purchase Agreement (the Stock Purchase Agreement)
providing for the acquisition, by a wholly-owned subsidiary of NW Natural formed
to serve as a holding company (Holding Company), of all of the issued and
outstanding common stock of Portland General Electric Company, an Oregon
corporation and wholly-owned subsidiary of Enron (PGE). The transaction is
expected to close in the fourth quarter of 2002, following the receipt of
required regulatory approvals as well as the approval of NW Natural's
shareholders.
To facilitate this transaction, NW Natural, Holding Company and a
wholly-owned subsidiary of Holding Company have entered into an Agreement and
Plan of Merger and Reorganization (the Plan of Merger) whereby NW Natural will
become a subsidiary of Holding Company. Following the establishment of the
holding company structure, Holding Company will acquire the PGE Shares, and, as
a result, will own two operating utilities - PGE and NW Natural. Pursuant to the
Plan of Merger, each outstanding share of common stock of NW Natural will be
converted into one share of common stock of Holding Company. NW Natural's
outstanding shares of preferred stock and preference stock will remain
outstanding. Holding Company will have two classes of common equity - common
stock and Class B common stock. Each class of common equity will have identical
rights in all respects except that the Class B common stock is non-voting. Each
14
share of Class B common stock will be convertible at any time into one share of
common stock except that the conversion cannot result in any holder of such
converted stock beneficially owning 5 percent or more of the outstanding shares
of common stock.
Under the terms of the Stock Purchase Agreement, Enron will sell PGE to
Holding Company for $1.8 billion, comprised of $1.55 billion in cash and $250
million of equity securities to be issued to Enron ($50 million in the form of
common stock and Class B common stock of Holding Company and $200 million in the
form of FELINE PRIDES(SM) of Holding Company). In addition, a $75 million
payment obligation from Enron to PGE, remaining from Enron's purchase of PGE in
1996, will be cancelled. PGE will retain its approximately $1.1 billion in
existing debt and preferred stock.
The cash portion of the purchase price will be raised through loans to
Holding Company from commercial banks and institutional lenders arranged,
pursuant to a written financing commitment (the Financing Commitment), by
Merrill Lynch and Credit Suisse First Boston. The Stock Purchase Agreement
provides that, if the closing has not occurred by Dec. 8, 2002, NW Natural and
Holding Company have the obligation to use their best efforts to obtain an
extension of the Financing Commitment or enter into or extend a new financing
commitment which provides for similar financing, and Holding Company shall
accept any such extended Financing Commitment or new financing commitment if the
funding conditions and other terms are not materially adverse to Holding Company
in comparison to the Financing Commitment originally issued.
The proposed transaction is subject to certain customary closing
conditions, including, without limitation, (i) the absence of any injunction,
order, law or regulation preventing consummation of the sale of the PGE Shares,
(ii) receipt by Enron, NW Natural and Holding Company of required regulatory
approvals, (iii) the approval of NW Natural's shareholders, (iv) the
availability of the debt financing described above on the conditions stated in
the Stock Purchase Agreement, (v) performance of obligations of Enron and NW
Natural pursuant to the Stock Purchase Agreement, and (vi) the accuracy of
Enron's and NW Natural's representations and warranties. Required regulatory
approvals include the Oregon Public Utility Commission, the Washington Utilities
and Transportation Commission, the Federal Energy Regulatory Commission, the
Nuclear Regulatory Commission and the Securities and Exchange Commission.
Holding Company will be exempt from registration under the Public Utility
Holding Company Act of 1935, as amended.
15
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The consolidated financial statements include:
Regulated utility:
Northwest Natural Gas Company (NW Natural)
Non-regulated subsidiary businesses:
NNG Financial Corporation (Financial Corporation), a
wholly-owned subsidiary
Canor Energy, Ltd. (Canor), a majority-owned subsidiary,
reclassified as a discontinued segment and sold in the first
quarter of 2000
Together these businesses are referred to herein as the "Company" (see
"Non-utility Operations," below, and Part II, Item 8., Note 2, "Notes to
Consolidated Financial Statements," in the Company's 2000 Annual Report on Form
10-K, as amended (2000 Form 10-K)).
The following is management's assessment of the 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, 2001 and 2000.
Earnings and Dividends
- ----------------------
The Company incurred a loss of 22 cents a diluted share for each of the
quarters ended Sept. 30, 2001 and 2000. The loss applicable to common stock was
$5.6 million in the third quarter of 2001 and $5.5 million in the third quarter
of 2000. A third quarter loss is customary for NW Natural, reflecting low
summertime use of natural gas.
NW Natural lost 24 cents a diluted share from gas utility operations in
the third quarter of 2001, compared to a loss of 23 cents a share in the same
period in 2000. Operating margin from gas utility operations was $0.9 million,
or 3 percent, higher in the third quarter of 2001, but this improvement was more
than offset by higher utility operating expenses. Non-utility operating results
for the third quarter of 2001 were earnings of 2 cents a share compared to
earnings of 1 cent a share from these operations in 2000.
The Company earned $24.0 million, or 95 cents a diluted share, in the
nine months ended Sept. 30, 2001, compared to $27.4 million, or $1.08 a diluted
share, in the same period in 2000. Year-to-date, NW Natural earned 87 cents a
share from utility operations compared to 98 cents a share in the same period in
2000. Weather in the first nine months of the year was 7 percent colder than the
20-year average and 2 percent colder than in 2000. However, reflecting the
effect of rate increases in the fall of 2000 to recover higher gas costs,
residential and commercial customers' consumptions per heating degree day were
about 9 percent lower during the first nine months of 2001 than in the same
period of 2000 and, as a result, gas deliveries to these customers were 1
percent lower. Operating expenses in the first nine months of 2001 were up 8
percent over the equivalent period in 2000 due to higher costs for payroll,
depreciation, health and pension benefits, franchise taxes and uncollectible
accounts.
Non-utility operating results for the nine months ended Sept. 30, 2001,
were earnings of 8 cents a share, including 5 cents a share from gas storage
services. Non-utility operating results for the first nine months of 2000 were
negligible, but the Company recorded a gain equivalent to 9 cents a diluted
share from the sale of a discontinued segment (Canor). See "Non-utility
Operations," below.
16
Dividends paid on common stock were 31 cents a share for each of the
three-month periods ended Sept. 30, 2001 and 2000. In October 2001, the
Company's Board of Directors declared a quarterly dividend of 31.5 cents a share
on the common stock, payable Nov. 15, 2001, to shareholders of record on Oct.
31, 2001. With this increase, the current indicated annual dividend rate is
$1.26 a share.
Results of Operations
- ---------------------
Regulatory Developments
-----------------------
On Sept. 25, 2001, the Oregon Public Utility Commission (OPUC)
approved, effective Oct. 1, 2001, rate increases averaging 21.7 percent for NW
Natural's Oregon sales customers. On Sept. 26, 2001, the Washington Utilities
and Transportation Commission (WUTC) approved, effective Oct. 1, 2001, rate
increases averaging 21.3 percent for NW Natural's Washington sales customers.
These rate increases reflect increases in the costs of natural gas commodity
purchased under contracts with gas producers. On Sept. 21, 2001, the WUTC
approved, effective Oct. 1, 2001, rate increases averaging 2.6 percent for NW
Natural's Washington customers representing the remaining portion of a general
rate increase authorized in October 2000.
Even with the commodity-related increases approved in Oregon and
Washington, and the general rate increase approved in Washington, NW Natural
expects to continue to enjoy a price advantage as compared to electricity
provided by the investor-related electric utilities in its service territory.
17
Comparison of Gas Operations
----------------------------
The following table summarizes the composition of gas utility volumes
and revenues:
Thousands Three Months Ended Nine Months Ended
(Except customers and degree days) Sept. 30, Sept. 30,
---------------------------- -----------------------------
2001 2000 2001 2000
---------------------------- -----------------------------
Gas Sales and Transportation Volumes - Therms:
Residential and commercial sales 54,505 53,886 440,483 436,220
Unbilled volumes (485) 2,036 (45,386) (36,367)
--------- --------- --------- ---------
Weather-sensitive volumes 54,020 55,922 395,097 399,853
Industrial firm sales 17,962 14,632 60,256 56,541
Industrial interruptible sales 18,969 14,213 47,528 42,733
--------- --------- --------- ---------
Total gas sales 90,951 84,767 502,881 499,127
Transportation deliveries 85,328 102,085 289,667 339,745
--------- --------- --------- ---------
Total volumes sold and delivered 176,279 186,852 792,548 838,872
========= ========= ========= =========
Utility Operating Revenues - Dollars:
Residential and commercial sales $ 50,830 $ 42,319 $ 369,117 $ 300,666
Unbilled revenues (179) 1,412 (34,163) (22,924)
--------- --------- --------- ---------
Weather-sensitive revenues 50,651 43,731 334,954 277,742
Industrial firm sales 10,451 6,747 35,117 25,805
Industrial interruptible sales 9,347 5,621 23,845 16,315
--------- ---------
Total gas sales 70,449 56,099 393,916 319,862
Transportation revenues 5,777 5,039 14,495 16,232
Other revenues (41) (26) (2,289) (2,542)
--------- ---------
Total utility operating revenues $ 76,185 $ 61,112 $ 406,122 $ 333,552
========= ========= ========= =========
Cost of gas sold $ 39,834 $ 25,678 $ 225,451 $ 159,391
========= ========= ========= =========
Total number of customers (end of period) 527,719 510,219 527,719 510,219
========= ========= ========= =========
Actual degree days 82 107 2,768 2,702
========= ========= ========= =========
20-year average degree days 98 96 2,595 2,604
========= ========= ========= =========
Residential and Commercial
--------------------------
NW Natural continues to experience solid customer growth, with 17,500
customers added since Sept. 30, 2000, for a growth rate of 3.4 percent. In the
three years ended Dec. 31, 2000, more than 65,000 customers were added to the
system, representing an average annual growth rate of 4.6 percent.
Typically, 75 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. Average weather conditions are
calculated from the most recent 20 years of temperature data measured by heating
degree-days. Weather conditions in the third quarter of 2001 were 16 percent
warmer than average and 23 percent warmer than in the third quarter of 2000. For
18
the first nine months of 2001, weather was 7 percent colder than average and 2
percent colder than in the first nine months of 2000.
Volumes of gas sold to residential and commercial customers were 1.9
million therms, or 3 percent, lower in the third quarter of 2001 than in the
third quarter of 2000. Related revenues increased $6.9 million, or 16 percent,
primarily due to rate increases averaging 23 percent during 2000. (See Part II,
Item 7, "Results of Operations - Regulatory Matters," in the 2000 Form 10-K.)
Customer growth in the residential and commercial segments since Sept. 30, 2000
contributed an estimated $0.8 million in additional margin revenues during the
third quarter of 2001.
NW Natural believes the recent reductions in its customers' gas
consumptions per degree day are caused by NW Natural's higher cost of purchased
gas, which it passed on to customers as rate increases last fall, and to efforts
throughout the region to conserve energy. NW Natural has filed with the OPUC for
approval of a new regulatory mechanism that is intended to stabilize margin
revenues in the face of variable consumption patterns, thereby reducing future
earnings volatility. If approved, this mechanism would increase margin revenues
during periods when residential and commercial customers' consumptions are less
than the average assumed in the Company's 1998 general rate case. Conversely,
margin revenues would be reduced when consumptions are higher than that average.
The mechanism also would allow NW Natural to be more proactive in encouraging
customers' efforts to use energy efficiently in their homes and businesses and
in managing their energy bills. NW Natural expects the OPUC to rule on its
filing by the end of 2001.
Industrial, Transportation and Other Revenues
---------------------------------------------
Total volumes delivered to industrial firm, industrial interruptible,
and transportation customers were 7 percent lower in the third quarter of 2001
than in the same period of 2000. Margin from these customers decreased from
$10.5 million in the third quarter of 2000 to $10.3 million in the third quarter
of 2001. The primary factor contributing to this decrease was a $0.3 million
decrease in margin from customers who used oil during this period because the
cost of oil was lower than the cost of natural gas purchased on the spot market.
Besides its core market, another developing market for NW Natural is
the delivery of natural gas for use in the generation of electricity. A number
of new generation projects are in service or are being developed in NW Natural's
service area in order to help meet the demand for power in the western United
States. NW Natural commenced gas deliveries in July 2001 to Clark Public Utility
District in Vancouver, Washington, for a one-year term of service.
Other revenues include amortizations from regulatory accounts and
miscellaneous fees charged to gas sales customers (see Part II, Item 8., Note 1,
"Notes to Consolidated Financial Statements," in the 2000 Form 10-K). Other
revenues decreased slightly during the third quarter of 2001 compared to the
third quarter of 2000. Year-to-date, other revenues increased $0.3 million
compared to the first nine months of 2000.
Cost of Gas
-----------
The cost per therm of gas sold was 45 percent higher during the third
quarter of 2001 than in the third quarter of 2000, primarily due to higher
prices in the natural gas commodity market. The cost of gas sold includes
current gas purchases, gas drawn from storage inventory, gains or losses from
commodity hedges, demand cost equalization, regulatory deferrals and company
use.
Results for the nine months ended Sept. 30, 2001 include an adjustment
reducing the cost of gas and a partially offsetting adjustment reducing interest
income (see "Other Income (Expense)," below). These adjustments were based on a
19
clarification of the treatment of gas storage inventory, approved by the OPUC
effective June 30, 2001, under NW Natural's Purchased Gas Adjustment (PGA)
mechanism in Oregon. Excluding this year-to-date adjustment ($1.4 million), the
cost per therm of gas sold was 41 percent higher during the first nine months of
2001, compared to the same period in 2000.
NW Natural has continued to use an active natural gas commodity hedge
program conducted under the terms its Derivatives Policy (see Item 1, Note 3.,
"Notes to Consolidated Financial Statements," above) to help manage its gas
commodity costs. NW Natural realized net losses from commodity swap and call
option contracts of $8.7 million in the third quarter of 2001, compared to net
gains of $7.3 million in the third quarter of 2000. Year-to-date, NW Natural
realized net gains of $78.2 million, compared to net gains of $10.5 million
during the first nine months of 2000. Gains (losses) from commodity hedges are
recorded as reductions (increases) to the cost of gas. The cost of gas sold also
was reduced by off-system gas sales of $1.6 million and $1.9 million for the
first nine months of 2001 and 2000, respectively. Under an agreement with the
OPUC, revenues from these sales are treated as a reduction of gas costs.
NW Natural has a PGA tariff in Oregon under which its net income from
Oregon operations is affected only 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 projections.
The remaining 67 percent of the higher or lower gas costs is recorded as
deferred debits or credits (regulatory assets or liabilities) for recovery from
or refund to customers in future rates. NW Natural deferred $7.4 million of
higher gas costs during the first nine months of 2001 and expects to recover
these amounts from customers during the next two years. The combined impact of
NW Natural's higher gas costs and its partially offsetting off-system gas sales
under the PGA sharing mechanism reduced year-to-date 2001 earnings by about 1
cent a share.
Non-utility Operations
----------------------
At Sept. 30, 2001 and 2000, the Company had one active wholly-owned
subsidiary, Financial Corporation. One discontinued segment, Canor, a
majority-owned subsidiary, was sold in January 2000 (see "Discontinued Segment,"
below).
Financial Corporation
---------------------
Financial Corporation's operating results for the three months ended
Sept. 30, 2001 were net income of $0.3 million, equivalent to 1 cent a share,
compared to income of $0.2 million, or 1 cent a share, for the third quarter of
2000. Year-to-date, operating results were net income of $0.6 million compared
to income of $0.1 million for the comparable period in 2000. Nine-month results
were weaker last year due to adjustments totaling $0.6 million to Financial
Corporation's deferred income tax accounts recorded in the second quarter of
2000. Financial Corporation's net assets at Sept. 30, 2001 were $7.8 million
compared to $7.2 million at Sept. 30, 2000.
Discontinued Segment
--------------------
During 2000, the Company sold its interest in Canor at a gain of $2.4
million, equivalent to 9 cents a diluted share (see Item 1, Note 7., "Notes to
Consolidated Financial Statements," above, and Part II, Item 7., "Results of
Operations - Discontinued Segment," in the 2000 Form 10-K).
Gas Storage Services
--------------------
NW Natural realized net income from gas storage services of $0.3
million, or 1 cent a share, in the three months ended Sept. 30, 2001, and $1.4
million, or 5 cents a share, year-to-date. NW Natural provides gas storage
20
services to customers using storage capacity not required from time to time for
utility services. Net income from gas storage services for the three and nine
months ended Sept. 30, 2000 was negligible.
Operating Expenses
------------------
Operations and Maintenance
--------------------------
Operations and maintenance expenses increased $4.4 million, or 8
percent, in the nine months ended Sept. 30, 2001, compared to the same period in
2000. Key factors that contributed to the increases in the current year-to-date
period were higher costs for employees' health and pension benefits ($1.5
million), higher uncollectible accounts expense ($1.0 million), higher payroll
costs due to wage and salary increases ($1.9 million) and increases in
weatherization program costs ($0.3 million).
Taxes Other than Income Taxes
-----------------------------
Taxes other than income taxes increased $2.5 million, or 13
percent, in the first nine months of 2001, compared to the same period in 2000.
Franchise tax expense increased $1.1 million due to higher utility operating
revenues and property taxes increased $1.0 million due to utility plant
additions. Regulatory fees and payroll tax expenses also increased slightly.
Depreciation, Depletion and Amortization
----------------------------------------
The Company's depreciation, depletion and amortization expense in
the nine months ended Sept. 30, 2001, increased $1.6 million, or 4 percent,
compared to the first nine months of 2000. The increase was primarily due to a 5
percent increase in utility plant in service. Depreciation, depletion and
amortization expense was approximately 3 percent of average plant and property
for each of the nine month periods ended Sept. 30, 2001 and 2000.
Other Income (Expense)
----------------------
The Company's other income (expense) decreased $1.0 million
and $2.5 million in the three and nine month periods ended Sept. 30, 2001,
respectively, compared to the same periods in 2000. The decreases in both
periods were primarily due to lower interest income on deferred regulatory
account balances and lower miscellaneous non-operating income and investment
income from Company-owned life insurance policies. An adjustment in June 2001,
relating to the treatment of gas storage inventory under NW Natural's PGA
mechanism, reduced interest income for the first nine months of 2001 by $0.4
million (see "Cost of Gas," above).
Interest Charges - net
----------------------
The Company's net interest expense decreased by $0.4 million, or 2
percent, in the nine months ended Sept. 30, 2001, compared to the same period in
2000, due to lower average balances of short term debt outstanding and lower
average interest rates.
Income Taxes
------------
The effective corporate income tax rates from continuing operations for
the three months ended Sept. 30, 2001 and 2000, were 42.0 percent and 37.7
percent, respectively. Year-to-date, the effective corporate income tax rate
from continuing operations was 35.2 percent, compared to 35.5 percent for the
first nine months of 2000.
21
Financial Condition
- -------------------
Capital Structure
-----------------
NW Natural's capital expenditures are primarily related to
utility construction resulting from customer growth and system improvements. NW
Natural finances these expenditures from cash provided by operations and from
short-term borrowings which are periodically refinanced through the sale of
long-term debt or equity securities. In addition to its capital expenditures,
the weather-sensitive nature of revenue derived from gas usage by NW Natural's
residential and commercial customers influences the Company's financing
requirements from one quarter to the next. Short-term liquidity is satisfied
primarily through the sale of commercial paper, which is supported by commercial
bank lines of credit (see Part II, Item 8., Note 6, "Notes to Consolidated
Financial Statements," in the 2000 Form 10-K).
The Company's long-term goal is to maintain a capital structure
comprised of 45 to 50 percent common stock equity, 5 to 10 percent preferred and
preference stock and 45 to 50 percent short-term and long-term debt. When
additional capital is required, the Company issues debt or equity securities
depending upon both the target capital structure and market conditions. The
Company also uses these sources to meet long-term debt and preferred stock
redemption requirements (see Part II, Item 8., Notes 3 and 5, "Notes to
Consolidated Financial Statements," in the 2000 Form 10-K).
Cash Flows
----------
Operating Activities
--------------------
Continuing operations provided net cash of $59.7 million in the
nine months ended Sept. 30, 2001, compared to $51.9 million in the first nine
months of 2000. The 15 percent increase was due to increased cash from
operations before working capital changes ($3.8 million) and lower working
capital requirements ($4.0 million). The increase in cash from continuing
operations before working capital changes was due to a larger decrease in
deferred gas costs ($5.2 million), an increase in depreciation, depletion and
amortization in 2001 ($1.6 million) and a larger decrease in regulatory accounts
and other ($1.0 million), partially offset by a smaller decrease in deferred
investment tax credits and income taxes ($3.2 million) and lower income from
continuing operations ($1.0 million). The decrease in working capital
requirements was due to a larger decrease in accounts payable ($42.5 million),
partially offset by a smaller increase in other current assets and liabilities
($14.1 million) and larger decreases in accrued unbilled revenues ($12.6
million) and accounts receivable ($9.0 million), and a larger increase in
accrued interest and taxes ($3.0 million).
The Company has lease and purchase commitments relating to its
operating activities which are financed with cash flows from operations (see
Part II, Item 8., Note 12, "Notes to Consolidated Financial Statements," in the
2000 Form 10-K).
Investing Activities
--------------------
Cash requirements for utility construction in the first nine
months of 2001 totaled $55.8 million, down $4.3 million from the first nine
months of 2000.
NW Natural's construction expenditures for 2001 were initially
estimated at $75 million. In April 2001, however, the Company accelerated plans
for an additional $10 million investment in storage facilities, increasing the
projected total construction budget for 2001 to $85 million. Over the five-year
period 2001 through 2005, these expenditures are estimated at between $450
million and $500 million. The level of capital expenditures over the next five
years reflects projected high customer growth, a major system reinforcement
22
project and the development of additional underground gas storage facilities. An
estimated 60 percent of the required funds is expected to be internally
generated over the five-year period, with the remainder funded through a
combination of long-term debt and equity securities, with short-term debt
providing liquidity and bridge financing.
No investments in non-utility property were made during the first
nine months of 2001. The $2.5 million investment in non-utility property in the
first nine months of 2000 consisted of final costs for the construction of the
new headquarters building for the Port of Portland. The discontinued segment
provided net cash of $34.8 million in the first quarter of 2000 from sale of the
Company's interest in Canor.
Financing Activities
--------------------
Cash used for financing activities in the first nine months of
2001 totaled $7.5 million, a reduction of $38.2 million from the first nine
months of 2000. Proceeds from the sales of $18 million of Medium-Term Notes,
Series B, in June 2001, together with a $22.6 million increase in short-term
borrowings year-to-date, were used to reduce long-term debt ($20 million) and
provide cash for investments in utility plant. Internally generated cash,
including proceeds from the sale of Canor ($34.8 million), was used to reduce
short-term debt ($21.7 million) in the first nine months of 2000. The Company
issued $50 million of long-term debt and retired the same amount during the
first nine months of 2000.
In May 2000, the Company commenced a program to repurchase up
to 2 million shares, or up to $35 million in value, of NW Natural's common stock
through a repurchase program which has been extended through May 2002. The
purchases are made in the open market or through privately negotiated
transactions. The Company used $5.8 million for the repurchase of 246,700 shares
under the program in the first nine months of 2001. There were no shares
repurchased during the three months ended Sept. 30, 2001, while the Company was
negotiating for the purchase of Portland General Electric Company (see
"Acquisition of Portland General Electric Company," below). The Company has
repurchased 355,400 shares of common stock at a total cost of $8.2 million from
the program's inception through Sept. 30, 2001.
Commercial Paper
----------------
The Company's primary source of short-term funds is commercial paper.
Both NW Natural and Financial Corporation issue commercial paper under agency
agreements with a commercial bank. The commercial paper is supported by bank
lines of credit (see "Lines of Credit," below). Financial Corporation's
commercial paper is supported by the guaranty of NW Natural (see Part II, Item
8., Note 6, "Notes to Consolidated Financial Statements," in the 2000 Form
10-K). NW Natural had $78.9 million of commercial paper notes outstanding at
Sept. 30, 2001, compared to $72.5 million and $56.3 million at Sept. 30 and Dec.
31, 2000, respectively. Financial Corporation had no commercial paper notes
outstanding at Dec. 31, 2000, or Sept. 30, 2001 or 2000.
Lines of Credit
---------------
NW Natural has available through Sept. 30, 2002, committed lines of
credit with four commercial banks totaling $150 million which are used as backup
lines for the commercial paper program. In addition, Financial Corporation has
available through Sept. 30, 2002, committed lines of credit with two commercial
banks totaling $20 million. Financial Corporation's lines are supported by the
guaranty of NW Natural.
23
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 are based on current market
rates as negotiated. There were no outstanding balances on either the NW Natural
or Financial Corporation lines of credit as of Dec. 31, 2000, or Sept. 30, 2001
or 2000.
Ratios of Earnings to Fixed Charges
-----------------------------------
For the nine months and 12 months ended Sept. 30, 2001, and the 12
months ended Dec. 31, 2000, the Company's ratios of earnings to fixed charges,
computed using the Securities and Exchange Commission method, were 2.51, 3.04
and 3.14, respectively. For this purpose, earnings consist of net income before
taxes plus fixed charges, and fixed charges consist of interest on all
indebtedness, the amortization of debt expense and discount or premium and the
estimated interest portion of rentals charged to income.
New Accounting Standards
------------------------
In June 2001 the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." In
August 2001 the FASB adopted SFAS No. 143, "Accounting for Asset Retirement
Obligations." In October 2001 the FASB adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." See Item 1, Note 4., "Notes to
Consolidated Financial Statements," above. SFAS Nos. 141, 142 and 144 will be
effective for the Company for fiscal years beginning after Dec. 15, 2001, and
SFAS No. 143 will be effective for the Company for fiscal years beginning after
June 15, 2002. The Company is evaluating the impact SFAS Nos. 141, 142 and 143
may have on its financial position in light of its proposed acquisition of
Portland General Electric Company (see "Acquisition of Portland General Electric
Company," below). Implementation of SFAS No. 144 is not expected to have a
material impact on the Company's financial position.
Acquisition of Portland General Electric Company
------------------------------------------------
On Oct. 5, 2001, the Company and Enron Corp., an Oregon corporation
(Enron), entered into a Stock Purchase Agreement (the Stock Purchase Agreement)
providing for the acquisition, by a wholly-owned subsidiary of the Company (now
named Northwest Energy Corporation, but which will be finally named at a later
date) formed to serve as a holding company (Holding Company), of all of the
issued and outstanding common stock (the PGE Shares) of Portland General
Electric Company, an Oregon corporation and wholly-owned subsidiary of Enron
(PGE). The transaction is expected to close in the fourth quarter of 2002,
following the receipt of required regulatory approvals as well as the approval
of the Company's shareholders.
To facilitate this transaction, NW Natural, Holding Company and a
wholly-owned subsidiary of Holding Company have entered into an Agreement and
Plan of Merger and Reorganization (the Plan of Merger) whereby NW Natural will
become a subsidiary of Holding Company. Following the establishment of the
holding company structure, Holding Company will acquire the PGE Shares, and, as
a result, will own two operating utilities - PGE and NW Natural. Pursuant to the
Plan of Merger, each outstanding share of common stock of NW Natural will be
converted into one share of common stock of Holding Company. NW Natural's
outstanding shares of preferred stock and preference stock will remain
outstanding. Holding Company will have two classes of common equity - common
stock and Class B common stock. Each class of common equity will have identical
rights in all respects except that the Class B common stock is non-voting. Each
share of Class B common stock will be convertible at any time into one share of
common stock except that the conversion cannot result in any holder of such
converted stock beneficially owning 5 percent or more of the outstanding shares
of common stock.
24
Under the terms of the Stock Purchase Agreement, Enron will sell PGE to
Holding Company for $1.8 billion, comprised of $1.55 billion in cash and $250
million of equity securities to be issued to Enron ($50 million in the form of
common stock and Class B common stock of Holding Company and $200 million in the
form of FELINE PRIDES(SM) of Holding Company). In addition, a $75 million
payment obligation from Enron to PGE, remaining from Enron's purchase of PGE in
1996, will be cancelled. PGE will retain its approximately $1.1 billion in
existing debt and preferred stock.
The cash portion of the purchase price will be raised through loans to
Holding Company from commercial banks and institutional lenders arranged,
pursuant to a written financing commitment (the Financing Commitment), by
Merrill Lynch and Credit Suisse First Boston. The Stock Purchase Agreement
provides that, if the closing has not occurred by Dec. 8, 2002, NW Natural and
Holding Company have the obligation to use their best efforts to obtain an
extension of the Financing Commitment or enter into or extend a new financing
commitment which provides for similar financing and Holding Company shall accept
any such extended Financing Commitment or new financing commitment if the
funding conditions and other terms are not materially adverse to Holding Company
in comparison to the Financing Commitment originally issued.
The proposed transaction is subject to certain customary closing
conditions, including, without limitation, (i) the absence of any injunction,
order, law or regulation preventing consummation of the sale of the PGE Shares,
(ii) receipt by Enron, NW Natural and Holding Company of required regulatory
approvals, (iii) the approval of NW Natural's shareholders, (iv) the
availability of the debt financing described above on the conditions stated in
the Stock Purchase Agreement, (v) performance of obligations of Enron and NW
Natural pursuant to the Stock Purchase Agreement, and (vi) the accuracy of
Enron's and NW Natural's representations and warranties. Required regulatory
approvals include the Oregon Public Utility Commission, the Washington Utilities
and Transportation Commission, the Federal Energy Regulatory Commission, the
Nuclear Regulatory Commission and the Securities and Exchange Commission.
Holding Company will be exempt from registration under the Public Utility
Holding Company Act of 1935, as amended.
Forward-Looking Statements
- --------------------------
This report and other presentations made by the Company from time to
time may contain forward-looking statements within the meaning of Section 21E of
the Securities Exchange Act of 1934, as amended. Forward-looking statements
include statements concerning plans, objectives, goals, strategies, future
events or performance, and other statements which are other than statements of
historical facts. The Company's expectations, beliefs and projections are
expressed in good faith and are believed by the Company 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
that could cause the actual results of the Company to differ materially from
those projected in such forward-looking statements: (i) prevailing governmental
policies and regulatory actions, including those of the OPUC and the WUTC, with
respect to allowed rates of return, industry and rate structure, purchased gas
and investment recovery, acquisitions and dispositions of assets and facilities,
operation and construction of plant facilities, present or prospective wholesale
and retail competition, changes in tax laws and policies and changes in and
compliance with environmental and safety laws and policies; (ii) risks and
uncertainties relating to delays in obtaining, or adverse conditions contained
in, regulatory approvals necessary for the plan of reorganization and
acquisition of PGE; (iii) failure to realize the synergies and other benefits
expected from the acquisition of PGE; (iv) weather conditions and other natural
phenomena; (v) unanticipated population growth or decline, and changes in market
demand and demographic patterns; (vi) competition for retail and wholesale
customers; (vii) pricing of natural gas relative to other energy sources; (viii)
unanticipated changes in interest or foreign currency exchange rates or in rates
of inflation; (ix) unanticipated changes in operating expenses and capital
expenditures; (x) capital market conditions; (xi) competition for new energy
development opportunities; and (xii) legal and administrative proceedings and
settlements. All subsequent forward-looking statements, whether written or oral
25
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 2000 Form 10-K.
PART II. OTHER INFORMATION
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
See "Item 5, Other Information - Amendment to Rights Agreement," below,
for a description of an amendment to the Rights Agreement, dated Feb. 27, 1996
(the Rights Agreement), with Mellon Investor Services LLC, as successor Rights
Agent, relating to the Company's common share purchase rights.
Item 5. OTHER INFORMATION
Acquisition of Portland General Electric Company
------------------------------------------------
As previously reported, on Oct. 5, 2001, the Company and Enron Corp.,
an Oregon corporation (Enron), entered into a Stock Purchase Agreement (the
Stock Purchase Agreement) providing for the acquisition, by a wholly-owned
subsidiary of the Company (now named Northwest Energy Corporation, but which
will be finally named at a later date) formed to serve as a holding company
(Holding Company), of all of the issued and outstanding common stock (the PGE
Shares) of PGE. The transaction is expected to close in the fourth quarter of
2002, following the receipt of required regulatory approvals as well as the
approval of the Company's shareholders.
To facilitate this transaction, NW Natural, Holding Company and a
wholly-owned subsidiary of Holding Company (Merger Sub) have entered into an
Agreement and Plan of Merger and Reorganization (the Plan of Merger) whereby NW
Natural will become a subsidiary of Holding Company. Following the establishment
of the holding company structure, Holding Company will acquire the PGE Shares,
and, as a result, will own two operating utilities - PGE and NW Natural.
Pursuant to the Plan of Merger, each outstanding share of common stock of NW
Natural will be converted into one share of common stock of Holding Company. NW
Natural's outstanding shares of preferred stock and preference stock will remain
outstanding. Holding Company will have two classes of common equity - common
stock and Class B common stock. Each class of common equity will have identical
rights in all respects except that the Class B common stock is non-voting. Each
share of Class B common stock will be convertible at any time into one share of
common stock except that the conversion cannot result in any holder of such
converted stock beneficially owning 5 percent or more of the outstanding shares
of common stock.
Under the terms of the Stock Purchase Agreement, Enron will sell PGE to
Holding Company for $1.8 billion, comprised of $1.55 billion in cash and $250
million of equity securities to be issued to Enron ($50 million in the form of
common stock and Class B common stock of Holding Company and $200 million in the
26
form of FELINE PRIDES(SM) of Holding Company). In addition, a $75 million
payment obligation from Enron to PGE, remaining from Enron's purchase of PGE in
1996, will be cancelled. PGE will retain its approximately $1.1 billion in
existing debt and preferred stock.
The cash portion of the purchase price will be raised through loans to
Holding Company from commercial banks and institutional lenders arranged,
pursuant to a written financing commitment (the Financing Commitment), by
Merrill Lynch and Credit Suisse First Boston. The Stock Purchase Agreement
provides that, if the closing has not occurred by Dec. 8, 2002, NW Natural and
Holding Company have the obligation to use their best efforts to obtain an
extension of the Financing Commitment or enter into or extend a new financing
commitment which provides for similar financing, and Holding Company shall
accept any such extended Financing Commitment or new financing commitment if the
funding conditions and other terms are not materially adverse to Holding Company
in comparison to the Financing Commitment originally issued.
The proposed transaction is subject to certain customary closing
conditions, including, without limitation, (i) the absence of any injunction,
order, law or regulation preventing consummation of the sale of the PGE Shares,
(ii) receipt by Enron, NW Natural and Holding Company of required regulatory
approvals, (iii) the approval of NW Natural's shareholders, (iv) the
availability of the debt financing described above on the conditions stated in
the Stock Purchase Agreement, (v) performance of obligations of Enron and NW
Natural pursuant to the Stock Purchase Agreement, and (vi) the accuracy of
Enron's and NW Natural's representations and warranties. Required regulatory
approvals include the Oregon Public Utility Commission, the Washington Utilities
and Transportation Commission, the Federal Energy Regulatory Commission, the
Nuclear Regulatory Commission and the Securities and Exchange Commission.
Holding Company will be exempt from registration under the Public Utility
Holding Company Act of 1935, as amended.
Amendment to Rights Agreement
-----------------------------
The Company also amended the Rights Agreement, which establishes the
terms and conditions of the Company's common share purchase rights, to confirm
that neither the Plan of Merger nor the agreement of Holding Company in the
Stock Purchase Agreement to issue equity securities to Enron and its affiliates
will cause the rights to be exercisable. In particular, the amendment provides
that, for purposes of the Rights Agreement, neither Holding Company nor Merger
Sub will be deemed to be an "Acquiring Person" (as defined in the Rights
Agreement) and that no "Shares Acquisition Date" or "Distribution Date" (as both
such terms are defined in the Rights Agreement) shall be deemed to have occurred
by reason of the execution and delivery of the Plan of Merger. The amendment
also provides that for purposes of the Rights Agreement, neither Enron, Enron NW
Assets LLC, a Delaware limited liability company, nor any Designated Transferee
(as such term is defined in the Stock Purchase Agreement) shall be deemed to be
an "Acquiring Person" and that no "Shares Acquisition Date" or "Distribution
Date" for purposes of the Rights Agreement shall be deemed to have occurred by
reason of the execution and delivery of the Stock Purchase Agreement.
Interstate Storage Service
--------------------------
On Nov. 5, 2001, the Federal Energy Regulatory Commission (FERC)
authorized NW Natural to provide interstate gas storage services from its Mist
underground gas storage field under cost-based rates, subject to refund upon
further review of these rates. The FERC had granted a certificate for the
services in May 2001.
27
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 4 - Amendment No. 1, dated as of October 5, 2001, to Rights
Agreement, dated as of February 27, 1996, between the Company and Boatmen's
Trust Company (Mellon Investor Services LLC, successor)
Exhibit 10(a) - Form of change in control letter agreement as
entered into between the Company and each executive
officer
Exhibit 10(b) - Executive Deferred Compensation Plan, 2001
Restatement
Exhibit 11 - Statement re: Computation of Per Share Earnings
Exhibit 12 - Computation of Ratio of Earnings to Fixed Charges
(b) Reports on Form 8-K
No Current Reports on Form 8-K were filed during the quarter ended
Sept. 30, 2001. However, on Oct. 9, 2001, the Company filed its Current Report
on Form 8-K relating to its proposed acquisition of Portland General Electric
Company.
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 14, 2001 /s/ Stephen P. Feltz
-----------------------------
Stephen P. Feltz
Principal Accounting Officer
Treasurer and Controller
28
NORTHWEST NATURAL GAS COMPANY
EXHIBIT INDEX
To
Quarterly Report on Form 10-Q
For Quarter Ended
September 30, 2001
Exhibit
Document Number
- -------- ------
Amendment No. 1, dated as of October 5, 2001, to Rights Agreement,
dated as of February 27, 1996, between the Company and Boatmen's Trust
Company (Mellon Investor Services LLC, successor) 4
Form of change in control letter agreement
as entered into between the Company and each executive officer 10(a)
Executive Deferred Compensation Plan, 2001 Restatement 10(b)
Statement re: Computation of Per Share Earnings 11
Computation of Ratios of Earnings to Fixed Charges 12