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 JUNE 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][GRAPHIC OMITTED]
NORTHWEST NATURAL GAS COMPANY
(Exact name of registrant as specified in its charter)
OREGON 93-0256722
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
220 N.W. SECOND AVENUE, PORTLAND, OREGON 97209
(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number, including area code: (503) 226-4211
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 August 8, 2003, 25,738,408 shares of the registrant's Common Stock, $3-1/6
par value (the only class of Common Stock) were outstanding.
NORTHWEST NATURAL GAS COMPANY
June 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 six-month periods ended June 30, 2003 and 2002 3
Consolidated Statements of Earnings Invested in the Business
for the six-month periods ended June 30, 2003 and 2002 4
Consolidated Balance Sheets at June 30, 2003 and 2002
and Dec. 31, 2002 5
Consolidated Statements of Cash Flows for the six-month
periods ended June 30, 2003 and 2002 7
Consolidated Statements of Capitalization at June 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 30
Item 4. Controls and Procedures 30
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 31
Item 4. Submission of Matters to a Vote of Security Holders 32
Item 5. Other Information 32
Item 6. Exhibits and Reports on Form 8-K 33
Signature 33
2
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Statements of Income
(Unaudited)
Three Months Ended Six Months Ended
Thousands, except per share amounts June 30, June 30,
- -----------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---- ---- ---- ----
Operating revenues:
Gross operating revenues $ 117,489 $ 101,873 $ 324,028 $ 380,436
Cost of sales 58,940 45,309 166,891 213,206
--------- --------- --------- ----------
Net operating revenues 58,549 56,564 157,137 167,230
Operating expenses:
Operations and maintenance 23,331 20,233 47,402 42,402
Taxes other than income taxes 7,350 6,852 18,167 18,854
Depreciation and amortization 13,338 12,784 26,504 25,598
--------- --------- --------- ----------
Total operating expenses 44,019 39,869 92,073 86,854
--------- --------- --------- ----------
Income from operations 14,530 16,695 65,064 80,376
Other income (expense) 1,348 (13,557) 764 (14,427)
Interest charges - net 9,126 8,577 18,072 16,726
--------- --------- --------- ----------
Income (loss) before income taxes 6,752 (5,439) 47,756 49,223
Income tax expense (benefit) 2,290 (2,447) 16,890 17,768
--------- --------- --------- ----------
Net income (loss) 4,462 (2,992) 30,866 31,455
Redeemable preferred and preference stock
dividend requirements 147 590 294 1,185
--------- --------- --------- ----------
Earnings (loss) applicable to common stock $ 4,315 $ (3,582) $ 30,572 $ 30,270
========= ========= ========= ==========
Average common shares outstanding 25,682 25,410 25,649 25,338
Basic earnings (loss) per share of common stock $ 0.17 $ (0.14) $ 1.19 $ 1.19
Diluted earnings (loss) per share of common stock $ 0.17 $ (0.14) $ 1.18 $ 1.18
Dividends per share of common stock $ 0.315 $ 0.315 $ 0.63 $ 0.63
--------------------------------------------------
See Notes to Consolidated Financial Statements
3
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Statements of Earnings Invested in the Business
(Unaudited)
Six Months Ended June 30,
---------------------------------------------------------
Thousands 2003 2002
- ---------------------------------------------------------------------------------------------------------------------
Earnings invested in the business:
Balance at beginning of period $ 157,136 $ 147,950
Net income 30,866 $ 30,866 31,455 $ 31,455
Cash dividends paid:
Redeemable preferred and preference stock (299) (1,194)
Common stock (16,144) (15,957)
------------ ------------
Balance at end of period $ 171,559 $ 162,254
============ ============
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 - - 95 95
---------------------------------------------------------
Comprehensive income $ 30,866 $ 31,550
========== =========
Balance at end of period $ (3,084) $ (280)
============= ============
--------------------------------------------------
See Notes to Consolidated Financial Statements
4
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Balance Sheets
June 30, June 30,
2003 2002 Dec. 31,
Thousands (Unaudited) (Unaudited) 2002
---------------------------------------------------------------------------------------------------------------
Assets:
Plant and property:
Utility plant $ 1,592,613 $ 1,494,819 $ 1,539,965
Less accumulated depreciation 584,636 537,152 560,798
------------ ------------ -----------
Utility plant - net 1,007,977 957,667 979,167
------------ ------------ -----------
Non-utility property 23,008 20,793 20,832
Less accumulated depreciation and amortization 4,631 3,863 4,404
------------ ------------ -----------
Non-utility property - net 18,377 16,930 16,428
------------ ------------ -----------
Total plant and property 1,026,354 974,597 995,595
------------ ------------ -----------
Other investments 12,833 13,290 12,703
------------ ------------ -----------
Current assets:
Cash and cash equivalents 24,059 34,519 7,328
Accounts receivable 34,137 31,320 48,751
Allowance for uncollectible accounts (2,315) (2,731) (1,815)
Accrued unbilled revenue 14,579 13,133 44,069
Inventories of gas, materials and supplies 35,405 30,793 58,030
Prepayments and other current assets 22,559 22,281 37,645
------------ ------------ -----------
Total current assets 128,424 129,315 194,008
------------ ------------ -----------
Regulatory assets:
Income tax asset 47,975 48,469 47,975
Unrealized loss on non-trading derivatives -- 41,408 --
Unamortized costs on debt redemptions 6,277 6,739 6,508
Other 6,661 4,430 7,040
------------ ------------ -----------
Total regulatory assets 60,913 101,046 61,523
------------ ------------ -----------
Other assets:
Investment in life insurance 57,660 54,140 54,916
Fair value of non-trading derivatives 22,842 -- 12,426
Other 16,841 12,266 11,620
------------ ------------ -----------
Total other assets 97,343 66,406 78,962
------------ ------------ -----------
Total assets $ 1,325,867 $ 1,284,654 $ 1,342,791
============ ============ ===========
--------------------------------------------------
See Notes To Consolidated Financial Statements
5
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Balance Sheets
June 30, June 30,
2003 2002 Dec. 31,
Thousands (Unaudited) (Unaudited) 2002
---------------------------------------------------------------------------------------------------------------
Capitalization and liabilities:
Common stock $ 81,467 $ 80,638 $ 81,023
Premium on common stock 251,129 245,324 248,028
Earnings invested in the business 171,559 162,254 157,136
Accumulated other comprehensive income (loss) (3,084) (280) (3,084)
------------ ------------ -----------
Total common stock equity 501,071 487,936 483,103
Redeemable preference stock - 25,000 -
Redeemable preferred stock 7,500 8,250 8,250
Long-term debt 450,858 416,183 445,945
------------ ------------ -----------
Total capitalization 959,429 937,369 937,298
------------ ------------ -----------
Current liabilities:
Notes payable 16,600 - 69,802
Accounts payable 55,284 48,590 74,436
Long-term debt due within one year 35,000 50,000 20,000
Taxes accrued 5,238 2,057 7,822
Interest accrued 2,950 2,887 2,902
Other current and accrued liabilities 29,716 25,497 30,045
------------ ------------ -----------
Total current liabilities 144,788 129,031 205,007
------------ ------------ -----------
Regulatory liabilities:
Customer advances 1,770 1,879 1,791
Deferred gas costs payable 13,510 10,315 10,635
Unrealized gain on non-trading derivatives 22,842 - 12,426
------------ ------------ -----------
Total regulatory liabilities 38,122 12,194 24,852
------------ ------------ -----------
Other liabilities:
Deferred income taxes 144,769 137,965 141,732
Deferred investment tax credits 7,255 8,070 7,824
Fair value of non-trading derivatives - 41,540 -
Other 31,504 18,485 26,078
------------ ------------ -----------
Total other liabilities 183,528 206,060 175,634
------------ ------------ -----------
Commitments and Contingencies (see Note 7) - - -
------------ ------------ -----------
Total capitalization and liabilities $ 1,325,867 $ 1,284,654 $ 1,342,791
============ ============ ===========
--------------------------------------------------
See Notes To Consolidated Financial Statements
6
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended June 30,
------------------------------
Thousands 2003 2002
- ---------------------------------------------------------------------------------------------------------------
Operating activities:
Net income from operations $ 30,866 $ 31,455
Adjustments to reconcile net income to cash provided by operations:
Depreciation and amortization 26,504 25,598
Gain on sale of assets -- (221)
Loss for PGE acquisition costs -- 13,699
Unrealized gain from price risk management activities -- 95
Deferred income taxes and investment tax credits 2,468 6,929
Equity in (earnings) losses of investments (245) (615)
Allowance for funds used during construction (358) (273)
Deferred gas costs - net 2,875 226
Other (1,950) (776)
--------- ---------
Cash from operations before working capital changes 60,160 76,117
Changes in operating assets and liabilities:
Accounts receivable - net of uncollectible accounts 15,114 36,133
Accrued unbilled revenue 29,490 44,616
Inventories of gas, materials and supplies 22,625 18,544
Accounts payable (19,152) (22,108)
Accrued interest and taxes 4,145 (21,253)
Other current assets and liabilities 8,076 2,740
--------- ---------
Cash provided by operating activities 120,458 134,789
--------- ---------
Investing activities:
Acquisition and construction of utility plant assets (56,089) (32,356)
Investment in non-utility property (816) (2,590)
PGE acquisition costs -- (4,142)
Proceeds from sale of assets -- 500
Other investments 115 888
--------- ---------
Cash used in investing activities (56,790) (37,700)
--------- ---------
Financing activities:
Common stock issued 3,458 3,682
Redeemable preferred stock retired (750) (750)
Long-term debt issued 40,000 60,000
Long-term debt retired (20,000) (10,500)
Change in short-term debt (53,202) (108,291)
Cash dividend payments:
Redeemable preferred and preference stock (299) (1,194)
Common stock (16,144) (15,957)
--------- ---------
Cash used in financing activities (46,937) (73,010)
--------- ---------
Increase in cash and cash equivalents 16,731 24,079
Cash and cash equivalents - beginning of period 7,328 10,440
--------- ---------
Cash and cash equivalents - end of period $ 24,059 $ 34,519
========= =========
- ---------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 18,009 $ 17,357
Income taxes $ 9,200 $ 27,912
- ---------------------------------------------------------------------------------------------------------------
Supplemental disclosure of non-cash financing activities:
Conversion to common stock:
7-1/4 % Series of Convertible Debentures $ 87 $ 1,694
--------------------------------------------------
See Notes to Consolidated Financial Statements
7
NORTHWEST NATURAL GAS COMPANY
PART I. FINANCIAL INFORMATION
Consolidated Statements of Capitalization
June 30, 2003 June 30, 2002
Thousands, except share amounts (Unaudited) (Unaudited) Dec. 31, 2002
- --------------------------------------------------------------------------------------------------------------------
Common Stock Equity:
Common stock - par value $3-1/6 per share $ 81,467 $ 80,638 $ 81,023
Premium on common stock 251,129 245,324 248,028
Earnings invested in the business 171,559 162,254 157,136
Accumulated other comprehensive income (loss) (3,084) (280) (3,084)
----------- ----------- -----------
Total common stock equity 501,071 52% 487,936 52% 483,103 51%
Redeemable Preference Stock:
$6.95 Series, stated value $100 per share - - 25,000 3% - -
Redeemable Preferred Stock:
$7.125 Series, stated value $100 per share 7,500 1% 8,250 1% 8,250 1%
Long-Term Debt:
Medium-Term Notes
First Mortgage Bonds:
6.750% Series B due 2002 - 10,000 -
5.550% Series B due 2002 - 20,000 -
6.400% Series B due 2003 - 20,000 20,000
6.340% Series B due 2005 5,000 5,000 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 20,000
7.500% Series B due 2023* 4,000 4,000 4,000
7.520% Series B due 2023* 11,000 11,000 11,000
7.720% Series B due 2025 20,000 20,000 20,000
6.520% Series B due 2025 10,000 10,000 10,000
7.050% Series B due 2026 20,000 20,000 20,000
7.000% Series B due 2027 20,000 20,000 20,000
6.650% Series B due 2027 20,000 20,000 20,000
6.650% Series B due 2028 10,000 10,000 10,000
7.740% Series B due 2030 20,000 20,000 20,000
7.850% Series B due 2030 10,000 10,000 10,000
5.820% Series B due 2032 30,000 - 30,000
5.660% Series B due 2033 40,000 - -
Convertible Debentures
7-1/4% Series due 2012 6,358 6,683 6,445
----------- ----------- -----------
485,858 466,183 465,945
Less long-term debt due within one year 35,000* 50,000 20,000
----------- ----------- -----------
Total long-term debt 450,858 47% 416,183 44% 445,945 48%
----------- --- ----------- --- ----------- ---
Total Capitalization $ 959,429 100% $ 937,369 100% $ 937,298 100%
=========== === =========== === =========== ===
* To be redeemed in the third quarter of 2003
----------------------------------------------------
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 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's accounting
records conform to certain regulatory requirements in accordance with SFAS No.
71, "Accounting for the Effects of Certain Types of Regulation." Accordingly, NW
Natural recognizes estimated asset retirement costs (removal costs) on many
regulated, long-lived assets through a charge to depreciation expense allowed in
rates, with a corresponding accrual to accumulated depreciation. As of June 30,
2003, the Company had $130 million of estimated removal costs in excess of
normal depreciation costs included in accumulated depreciation in the
consolidated balance sheets. The adoption of SFAS No. 143 did not have a
material impact on the Company's financial condition or results of operations.
Effective Jan. 1, 2003, the Company also adopted SFAS No. 145,
"Rescission of FASB Statement Nos. 4, 44 and 64, Amendment of FASB Statement No.
13 and Technical Corrections," and SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which replaces Emerging Issues
Task Force Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
9
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 November 2002, the Financial Accounting Standards Board (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 (see Part II., Item
1., "Legal Proceedings"), 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. After analyzing the likelihood of obligations arising under the
indemnity, NW Natural determined that no accrual is required under FIN 45.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities." FIN 46 provides guidance on the identification of, and the
financial reporting for, entities over which control is achieved through means
other than voting rights, known as variable interest entities. FIN 46 provides
guidance for determining whether consolidation is required under the controlling
financial interest model of Accounting Bulletin No. 51. Certain variable
interest entities must be consolidated by the primary beneficiary if the equity
investors in the entity do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. FIN 46 was effective immediately for all new variable interest
entities created or acquired after Jan. 31, 2003. For variable interest entities
created or acquired prior to Feb. 1, 2003, the provisions of FIN 46 must be
applied for the first interim or annual period beginning after June 15, 2003.
The Company did not have interests in any variable interest entities during any
of the current reporting periods, such that the application of FIN 46 did not
have a material impact on the Company's financial condition or results of
operations.
Recent Accounting Pronouncements
In April 2003, the 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 is not expected to
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
10
instruments of nonpublic entities. The adoption of SFAS No. 150 will result in
the Company reclassifying dividends on its redeemable preferred stock as
interest expense, but such reclassification will not have a material impact on
the Company's financial condition or results of operations.
3. Stock-Based Compensation
NW Natural has stock-based compensation plans including the Long-Term
Incentive Plan (LTIP), the Restated Stock Option Plan (Restated SOP), the
Employee Stock Purchase Plan and the Non-Employee Directors Stock Compensation
Plan (see Part II, Item 8., Note 4, in the 2002 Form 10-K). These plans are
designed to promote stock ownership in NW Natural by employees, officers and
directors.
During the first quarter of 2003, NW Natural granted LTIP awards
covering a new three-year performance period (2003-05). The aggregate target
award and maximum award were 28,000 and 56,000 shares, respectively. Following
the end of the performance period, actual awards are distributed based on the
attainment of certain return on equity performance goals. During the performance
period, the Company recognizes compensation expense and liability for the LTIP
awards based on performance levels achieved or expected to be achieved and the
estimated market value of the common stock as of the distribution date. At June
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. Inasmuch as NW
Natural grants stock options at market value, no compensation expense was
recognized in the results of operations for the six months ended June 30, 2003.
As of June 30, 2003, options on 1,429,500 shares were available for
grant and options to purchase 426,764 shares were outstanding. 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 six months ended June 30, 2003.
11
If compensation expense for these plans had been determined consistent
with the method prescribed by SFAS No. 123, the Company's net income and
earnings per share would have been reduced to the pro forma amounts shown below:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- --------------------
Thousands, except per share amounts 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------------
Earnings (loss) applicable to common stock:
As reported $ 4,315 $ (3,582) $ 30,572 $ 30,270
Deduct: additional stock-based compensation expense as determined
under fair value based method for all awards - net of tax (71) (110) (132) (223)
--------- ---------- -------- --------
Pro forma $ 4,244 $ (3,692) $ 30,440 $ 30,047
========= ========== ======== ========
Basic earnings (loss) per share:
As reported $ 0.17 $ (0.14) $ 1.19 $ 1.19
Pro forma $ 0.17 $ (0.15) $ 1.19 $ 1.19
Diluted earnings (loss) per share:
As reported $ 0.17 $ (0.14) $ 1.18 $ 1.18
Pro forma $ 0.17 $ (0.15) $ 1.18 $ 1.18
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 defined tolerance levels and are considered to be unavoidable because
they are necessary to support normal business activities. NW Natural does not
enter into derivative instruments for trading purposes and believes that any
increase in market risk created by holding derivatives should be offset by the
exposures they modify. See Part II, Item 7., "Accounting for Derivative
Instruments and Hedging Activities," and Part II, Item 8., Notes 1 and 11, in
the 2002 Form 10-K.
At June 30, 2003, NW Natural had 21 natural gas price swap contracts
and 77 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:
June 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 $ 22,587 $ 199,426 $ 11,422 $ 159,724
Fixed-price natural gas call option contracts - - 717 18,084
Physical natural gas supply contract with embedded derivative - - 448 2,754
Foreign currency forward purchase contracts 255 15,946 (161) 15,525
---------------------- -----------------------
Total $ 22,842 $ 215,372 $ 12,426 $ 196,087
====================== =======================
12
5. Long Term Debt
NW Natural has exercised optional redemption provisions applicable to
certain of its long-term debt, including all $4 million of the 7.50% Series B
Medium-Term Notes (MTN) 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 are
redeemable 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 the
7.50% and 7.52% Series on July 1 and will redeem the 7.25% Series on Aug. 18, in
each case with the proceeds from sales of commercial paper. NW Natural intends
to refinance this debt through the sale of new long-term debt in the third or
fourth quarter of 2003.
Including the optional redemption of the MTNs discussed above, the
maturities for each of the 12-month periods ending June 30 for the five years
ending June 30, 2008 on the long-term debt outstanding amount to: $35.0 million
in 2004; no maturity in 2005; $23.0 million in 2006; $29.5 million in 2007; and
no maturity in 2008. Holders of certain MTNs have put options that, if
exercised, would accelerate the maturity of long-term debt by $10.0 million and
$20.0 million in the 12-month periods ending June 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.
The following table presents information about the reportable segments
for the three- and six-month periods ended June 30, 2003 and 2002. Inter-segment
transactions are insignificant.
Three Months Ended June 30, Six Months Ended June 30,
-------------------------------------------- ------------------------------------------------
Thousands Utility Gas Storage Other Total Utility Gas Storage Other Total
- ------------------------------------------------------------------------ ------------------------------------------------
2003
Net operating revenues $ 56,112 $ 2,387 $ 50 $ 58,549 $ 152,117 $ 4,931 $ 89 $ 157,137
Depreciation and amortiza-
tion 13,225 113 - 13,338 26,277 227 - 26,504
Other operating expenses 30,489 162 30 30,681 65,172 345 52 65,569
Income from operations 12,398 2,112 20 14,530 60,668 4,359 37 65,064
Income from financial
investments - - 505 505 - - 245 245
Net income 2,869 1,177 416 4,462 28,028 2,452 386 30,866
Total assets at June 30,
2003 1,287,283 20,495 18,089 1,325,867 1,287,283 20,495 18,089 1,325,867
2002
Net operating revenues $ 54,077 $ 2,444 $ 43 $ 56,564 $ 162,915 $ 4,218 $ 97 $ 167,230
Depreciation and amortiza-
tion 12,685 99 - 12,784 25,408 190 - 25,598
Other operating expenses 26,785 248 52 27,085 60,685 497 74 61,256
Income (loss) from
operations 14,607 2,097 (9) 16,695 76,822 3,531 23 80,376
Income from financial
investments - - 477 477 - - 615 615
Loss for PGE acquisition
costs - - (8,347) (8,347) - - (8,347) (8,347)
Net income (loss) 3,616 1,192 (7,800) (2,992) 37,050 1,978 (7,573) 31,455
Total assets at June 30,
2002 1,250,435 16,572 17,647 1,284,654 1,250,435 16,572 17,647 1,284,654
13
7. Commitments and Contingencies
Environmental Matters
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 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, as
of June 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."
NW Natural has accrued all material loss contingencies relating to
environmental matters that it believes to be probable of assertion and
reasonably estimable. See Part II, Item 8., Note 12, in the 2002 Form 10-K. Due
to the preliminary nature of these environmental investigations, the range of
any additional possible loss contingency cannot be currently estimated.
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 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. As of June 30,
2003, NW Natural has recorded $0.6 million of these costs in a deferred
regulatory account. Additionally, on a cumulative basis through June 30, 2003,
the Company has accrued environmental costs totaling $7.9 million relating to
the five sites, including $5.5 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 expects that the costs of further investigation and
remediation for which it may be responsible with respect to the Gasco site, the
Wacker site, the Portland Harbor site and the Portland Gas site, if any, should
be recoverable, in large part, from insurance. In the event these costs are not
recovered from insurance, NW Natural will seek recovery through future rates.
Litigation
In April 2003, NW Natural settled and agreed with Cascade Resources
Corporation and Al Curry (collectively, Cascade) to dismiss their respective
claims in Northwest Natural Gas Company v. Cascade Resources Corporation and
Curry, et al. (United States District Court for the District of Oregon, Case No.
CV 01-1620 HU) (the Action). See Part I, Item 3., "Legal Proceedings," in the
2002 Form 10-K and Part II, Item 1., "Legal Proceedings," in the Company's Form
10-Q for the quarter ended March 31, 2003. In the settlement, Cascade
transferred all of its records, rights and interests in certain leases,
including gas storage leases, in Columbia County, Oregon to NW Natural and
agreed to refrain from certain competitive activities in the area. The
counterclaims against NW Natural described in the 2002 Form 10-K have been
dismissed and Enerfin Resources Northwest Limited Partnership (Enerfin) is the
remaining defendant in the Action. NW Natural paid Cascade $0.5 million and
agreed to defend and indemnify Cascade against claims by Enerfin relating to the
validity and enforceability of the transferred leases. However, NW Natural will
have no obligation to defend or indemnify Cascade from any claims for recovery
of punitive or other exemplary damages. In June 2003, the court denied Enerfin's
motion 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 expects to oppose the motion.
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
14
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 and a final decision is pending. On July 30, 2003, the Supreme Court denied
a motion filed by one of the appellants to stay construction of the SMPE.
From time to time the Company is subject to other claims and litigation
arising in the ordinary course of business. Although the final outcome of any
such legal proceeding cannot be predicted with certainty, the Company does not
expect disposition of these matters to have a materially adverse effect on the
Company's financial position, results of operation or cash flows.
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 six months ended June 30, 2003 and 2002. Unless
otherwise indicated, references in the discussion to Notes are to the notes to
the consolidated financial statements in the Company's 2002 Annual Report on
Form 10-K (2002 Form 10-K).
The consolidated financial statements include:
Regulated utility:
Northwest Natural Gas Company (NW Natural)
Non-regulated wholly-owned subsidiary businesses:
NNG Financial Corporation (Financial Corporation),
and its wholly-owned subsidiaries
Northwest Energy Corporation (Northwest Energy),
and its wholly-owned subsidiary
Together these businesses are referred to herein as the Company (see
"Non-utility Operations," below, and Part II, Item 8., Note 2, in the 2002 Form
10-K).
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
Part II, Item 8., 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 estimates and judgments that
affect the reported amounts of assets, liabilities, revenues and expenses, and
related disclosures.
Management considers its critical accounting policies to be those which
are most important to the representation of the Company's financial condition
and results of operations and which require management's most difficult and
subjective or complex judgments, including those that could result in materially
different amounts if the Company reported under different conditions or using
different assumptions. These critical accounting policies are described in the
2002 Form 10-K (see Part II, Item 7., "Application of Critical Accounting
Policies - Regulatory Accounting, Revenue Recognition, Accounting for Derivative
Instruments and Hedging Activities, Accounting for Pensions, and Contingencies,"
in the 2002 Form 10-K). Because of the uncertainty inherent in these matters,
actual results could differ materially from the estimates developed from
applying these critical accounting policies.
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 addition, the Company is authorized by the Oregon
Public Utility Commission (OPUC) to defer these costs as a regulatory asset and,
in the event these costs are not recovered from insurance, would seek to recover
them through future utility rates.
Earnings and Dividends
The Company's earnings applicable to common stock were $4.3 million in
the quarter ended June 30, 2003, compared to a loss of $3.6 million in the
quarter ended June 30, 2002. Earnings per share from consolidated operations
were 17 cents a diluted share in the second quarter of 2003, compared to a loss
of 14 cents a share in last year's second quarter. The results for the second
quarter of 2002 included a charge of $13.7 million before tax, equivalent to 32
cents a diluted share, for NW Natural's transaction costs incurred through June
30, 2002 in its efforts to acquire Portland General Electric Company (PGE) from
Enron Corp.
NW Natural earned $2.7 million or 11 cents a diluted share from gas
utility operations in the second quarter of 2003, compared to $2.9 million or 12
cents a share in the second quarter of 2002. The Company earned $1.2 million or
5 cents a diluted share from its gas storage business segment in this year's
second quarter, about the same as its results from the gas storage business in
the second quarter of 2002. The Company also earned $0.4 million or about 1 cent
a diluted share from its subsidiary and other non-utility operations in the
second quarter of 2003, compared to a loss of $7.7 million or 31 cents a share
in the second quarter of 2002 which included the $13.7 million charge for PGE
transaction costs.
For the six months ended June 30, 2003, NW Natural's earnings
applicable to common stock were $30.6 million, or $1.18 a diluted share,
compared to earnings of $30.3 million, also equivalent to $1.18 a diluted share,
in the first six months of 2002. The results for the first six months of 2002
included the charge equivalent to 32 cents a diluted share for the PGE
transaction costs, as reported above.
NW Natural earned $27.7 million or $1.07 a diluted share from gas
utility operations in the first six months of 2003, compared to $35.9 million or
$1.40 a share in the first six months of 2002. Weather conditions in NW
Natural's service territory in the first half of the year were 4 percent warmer
than average and 9 percent warmer than last year. The Company earned $2.5
million or 10 cents a diluted share from its gas storage business segment in the
first six months of 2003, compared to $2.0 million or 8 cents a share in the
first six months of 2002; and $0.4 million or about 1 cent a diluted share from
its subsidiary and other non-utility operations in the first half of this year,
compared to a loss of $7.6 million or 30 cents a share in the first half of last
year.
Dividends paid on common stock were 31.5 cents a share for each of the
three-month periods ended June 30, 2003 and 2002. In July 2003, the Company's
Board of Directors declared a quarterly dividend of 31.5 cents a share on the
common stock, payable Aug.15, 2003, to shareholders of record on July 31, 2003.
The current indicated annual dividend rate is $1.26 a share.
Results of Operations
Regulatory Developments
In November 2002, NW Natural filed a general rate case with the 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).
17
In April 2003, NW Natural filed stipulations in the case representing a
partial settlement between the Company and the OPUC Staff (Staff). The
stipulations included agreements with the Staff with respect to many elements of
NW Natural's cost of service, including all operations and maintenance expenses
and rate base investments for the prospective test year.
On Aug. 5, 2003, NW Natural filed additional stipulations with the
Staff and the other active parties covering the remaining issues in the case.
The proposed settlement embodying all of the stipulations would authorize a
revenue increase of $13.9 million per year. The settlement incorporates a
capital structure including 49.5 percent common equity, a return on equity of
10.2 percent, and the adoption of a weather normalization mechanism in
substantially the form proposed by NW Natural. If approved by the OPUC,
approximately $6.2 million of the $13.9 million total revenue increase would go
into effect on Sept. 1, 2003, and the remainder would 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 Company is unable to determine the
extent to which the settlement among NW Natural, the Staff and the other parties
in the case will be accepted by the OPUC.
Comparison of Gas Operations
The following table summarizes the composition of gas utility volumes
and revenues for the three and six months ended June 30, 2003. Separate
schedules have been presented for "Utility Operating Revenues - Dollars" to
reflect the impact with and without billing credits in June 2002 relating to
deferred gas costs savings, as discussed below:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------------------------
(Thousands) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Utility Gas Sales and Transportation Volumes - Therms:
Residential and commercial sales 130,051 130,355 366,374 393,292
Unbilled volumes (19,593) (27,907) (36,155) (46,529)
--------- --------- --------- ---------
Weather-sensitive volumes 110,458 102,448 330,219 346,763
Industrial firm sales 11,967 15,675 26,521 39,430
Industrial interruptible sales 8,303 5,905 11,988 20,280
--------- --------- --------- ---------
Total gas sales 130,728 124,028 368,728 406,473
Transportation deliveries 98,916 106,616 208,076 217,348
--------- --------- --------- ---------
Total volumes sold and delivered 229,644 230,644 576,804 623,821
========= ========= ========= =========
18
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------------------------
(Thousands, except customers and degree-days) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Utility Operating Revenues - Dollars (with cost of gas
adjustments):
Residential and commercial sales $ 110,964 $ 105,064 $ 311,477 $ 364,555
Unbilled revenues (16,280) (26,731) (30,220) (44,626)
---------- ----------- ---------- ----------
Weather-sensitive revenues 94,684 78,333 281,257 319,929
Industrial firm sales 7,019 9,026 15,685 26,891
Industrial interruptible sales 4,099 2,675 5,943 12,571
---------- ----------- ---------- ----------
Total gas sales 105,802 90,034 302,885 359,391
Transportation revenues 5,048 7,431 10,853 13,883
Other revenues 4,196 1,906 5,247 2,079
---------- ----------- ---------- ----------
Total utility operating revenues 115,046 99,371 318,985 375,353
Cost of gas sold 58,934 45,294 166,868 212,438
---------- ----------- ---------- ----------
Net utility operating revenues (margin) $ 56,112 $ 54,077 $ 152,117 $ 162,915
========== =========== ========== ==========
Total number of customers (end of period) 566,955 548,589 566,955 548,589
========== =========== ========== ==========
Actual degree-days 730 729 2,413 2,649
========== =========== ========== ==========
20-year average degree-days 672 674 2,510 2,510
========== =========== ========== ==========
NW Natural refunded approximately $29.9 million of deferred gas cost
savings to its Oregon customers through billing credits in June 2002. The
refunds were the customers' 67 percent portion of gas cost savings realized
between October 2001 and March 2002 and had been deferred, with interest,
pursuant to NW Natural's Purchased Gas Adjustment (PGA) tariff in Oregon (see
"Cost of Gas," below). The refunds reduced gross operating revenues for the
first six months of 2002 by $29.9 million, and reduced both cost of gas and
deferred gas costs payable by $29.0 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
For comparison purposes, the following table illustrates the
pro forma results without the revenue effect of the billing credits in June
2002:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------------------------------
(Thousands) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Utility Operating Revenues - Dollars (without cost of gas
adjustments):
Residential and commercial sales $ 110,964 $ 130,996 $ 311,477 $ 390,487
Unbilled revenues (16,280) (26,731) (30,220) (44,626)
---------- ----------- ---------- ----------
Weather-sensitive revenues 94,684 104,265 281,257 345,861
Industrial firm sales 7,019 11,956 15,685 29,821
Industrial interruptible sales 4,099 3,669 5,943 13,565
---------- ----------- ---------- ----------
Total gas sales 105,802 119,890 302,885 389,247
Transportation revenues 5,048 7,431 10,853 13,883
Other revenues 4,196 1,906 5,247 2,079
---------- ----------- ---------- ----------
Total utility operating revenues 115,046 129,227 318,985 405,209
Cost of gas sold 58,934 74,248 166,868 241,392
---------- ----------- ---------- ----------
Net utility operating revenues (margin) $ 56,112 $ 54,979 $ 152,117 $ 163,817
========== =========== ========== ==========
NW Natural issued billing credits totaling approximately $3.1 million
to Oregon customers in the second quarter of 2003, representing the customers'
share of net income from interstate storage operations and margin from an asset
optimization contract in 2002 (see Part II, Item 7., "Results of Operations -
Non-utility Operations - Gas Storage," in the 2002 Form 10-K). Similarly, NW
Natural issued billing credits totaling approximately $1.2 million to Oregon
customers in the second quarter of 2002, representing the customers' share of
income and margin from these sources in 2001. The billing credits reduced
utility operating revenues for the first six months of 2003 and 2002 by $3.1
million and $1.2 million, respectively.
Residential and Commercial
NW Natural continues to experience rapid customer growth, with 18,366
customers added since June 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. Weather conditions in the second quarter
of 2003 were 9 percent cooler than average, compared to 8 percent cooler than
average in the second quarter of 2002. Weather in the first six months of 2003
was 4 percent warmer than average and 9 percent warmer than the first six months
of 2002. Average weather conditions are calculated from the most recent 20 years
of temperature data measured by heating degree-days.
Volumes of gas sold to residential and commercial customers in the
second quarter of 2003 were 8.0 million therms, or 8 percent, higher than in the
second quarter of 2002, reflecting slightly cooler weather, lower rates and
customer growth. Related revenues, excluding the impact of $29.9 million
refunded to Oregon customers in June 2002, decreased $9.6 million, or 9 percent,
primarily due to net rate decreases effective Oct. 1, 2002. Customer growth in
the residential and commercial segments since June 30, 2002, contributed an
estimated 2.8 million therms in sales volumes and $1.3 million in additional
margin.
20
Gas sales to residential and commercial customers in the first six
months of 2003 were 16.5 million therms, or 5 percent, lower than in the first
half of 2002, reflecting warmer weather that was partially offset by the impact
of lower rates and customer growth. Related revenues, again excluding the impact
of refunds to Oregon customers in June 2002, decreased $64.6 million, or 19
percent, primarily due to the net rate decreases effective Oct. 1, 2002.
Customer growth in the residential and commercial segments since June 30, 2002,
contributed an estimated 9.6 million therms in sales volumes and $4.0 million in
additional margin.
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 $2.0 million of margin in the second quarter of 2003
and $6.0 million of margin in the first half of 2003, equivalent to about 5
cents a diluted share of earnings in the second quarter and 14 cents a share in
the six-month period.
Industrial Sales and Transportation Revenues
The following table summarizes the delivered volumes and margin in the
industrial and electric generation markets:
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
(Thousands) 2003 2002 2003 2002
------------------------------------------------------------------------------------------------
Delivered volumes - therms:
Industrial sales and transportation 119,186 128,093 244,918 273,729
Electric generation - 103 1,667 3,329
------- ------- ------- -------
Total volumes 119,186 128,196 246,585 277,058
======= ======= ======= =======
Margin - dollars:
Industrial sales and transportation $ 9,131 $ 9,452 $ 18,877 $ 21,859
Electric generation - 2,239 6 4,573
------- ------- ------- -------
Total margin $ 9,131 $ 11,691 $ 18,883 $ 26,432
======= ======== ======== ========
Total volumes delivered to industrial and electric generation customers
were 9 million therms, or 7 percent, lower in the second quarter of 2003 than in
the same period of 2002. Combined margins from these customers were $2.6
million, or 22 percent, lower in the second quarter of 2003 compared to the same
period of 2002. In the six months ended June 30, 2003, volumes were 30 million
therms, or 11 percent, lower than in the same period in 2002. Combined margins
were $7.5 million, or 29 percent, lower in the six months ended June 30, 2003
than in the same period in 2002.
Volumes delivered to end-use industrial sales and transportation
customers, excluding electric generation customers, in the six months ended June
30, 2003 were 11 percent lower than in the same period in 2002. Margin from
these customers in the six months ended June 30, 2003 was 14 percent lower than
in the same period in 2002. The decline in volumes was due to a combination of
warmer weather and weaker economic conditions, while the greater percentage
decline in margin was due to shifts by some customers during 2002 from
higher-margin sales or transportation schedules to lower-margin transportation
schedules.
In the electric generation market, margin in the six months ended June
30, 2003 was negligible, compared to $4.6 million from this market in the same
period in 2002. The difference is equivalent to an earnings reduction of 11
cents a share. One-year contracts for service to two customers in this market
expired on June 30, 2002 and were not renewed; spot market electricity prices by
then had gone down and wholesale power supplies were more readily available.
21
Other Revenues
Other revenues include revenues recognized from a variety of sources
other than the sale and transportation of gas (see Part II, Item 8., Note 1, in
the 2002 Form 10-K), including deferrals to and amortizations from regulatory
accounts and miscellaneous customer fees.
Other revenues contributed $4.2 million to utility operating revenues
in the second quarter of 2003, compared to $1.9 million in the second quarter of
2002. The $2.3 million increase in other revenues in the first quarter of 2003
came primarily from higher amortizations of interstate storage credits ($1.8
million) and revenue deferrals under NW Natural's partial decoupling mechanism
($0.9 million)(see Part II, Item 7., "Results of Operations - Regulatory
Matters," in the 2002 Form 10-K), partially offset by lower amounts of revenue
deferrals for lost margin under a high-efficiency furnace program ($0.2 million)
and a decrease in customer late payment charges ($0.1 million).
Other revenues contributed $5.3 million to utility operating revenues
in the first six months of 2003, compared to $2.1 million in the first six
months of 2002. The $3.2 million increase was primarily due to higher
amortizations of interstate storage credits ($1.8 million) and revenue deferrals
under the partial decoupling mechanism ($1.4 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 (upstream sales) 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 intends to engage 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 23 percent higher during the second
quarter of 2003 than in the second quarter of 2002. Results for the three months
ended June 30, 2002 included an adjustment reducing cost of gas by $29.0 million
(see "Comparison of Gas Operations," above). Excluding the impact of this
adjustment, the cost per therm of gas sold decreased 25 percent in the second
quarter of 2003 compared to the second quarter of 2002. In the first six months
of 2003, the cost per therm of gas sold was 13 percent lower than in the first
six months of 2002, and was 24 percent lower than the first six months of 2002
excluding the cost of gas adjustment. The cost per therm of gas sold includes
current gas purchases, gas drawn from storage inventory, gains or losses from
commodity hedges, margin from upstream gas sales, demand cost equalization,
regulatory deferrals and company use.
Results for the three months ended June 30, 2002 also included
adjustments reducing cost of gas relating to corrections in the 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 methodology represented in
the corrections continues to be applied in the Company's accounting for pipeline
demand charges.
22
NW Natural's recorded amount of unaccounted-for gas for the six months
ended June 30, 2003 was negligible, compared to 0.73 percent of gas receipts for
the six months ended June 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 measurements or other causes. The Company considers a normal
amount of unaccounted-for gas to be 0.5 percent of its total gas receipts during
a period, but the amount may vary within a range around this level. The lower
estimated amount of unaccounted-for gas in the first six months of 2003 had the
effect of reducing cost of gas and increasing margin by $2.1 million as compared
to the equivalent six-month period a year earlier.
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 $8 million and $31 million from commodity swap and
call option contracts during the three- and six-month periods ended June 30,
2003, respectively, compared to net losses of $18 million and $45 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 second
quarter of 2003 were slightly higher than the gas costs embedded in rates, with
the effect that NW Natural's share of the higher costs decreased margin by $0.3
million, equivalent to a loss of about 1 cent a share. For the second 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 $1.6 million of margin, equivalent to 3 cents a share of
earnings. In the first six 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 $0.3 million of margin, equivalent to 1 cent
a share of earnings. The equivalent result in the first half of 2002 was net
savings of $10.3 million, equivalent to 24 cents a share of earnings.
Due to the warm weather and the reduced gas requirements of its
industrial sales customers during the first six 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 upstream 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 upstream gas
sales in the second quarter of 2003 was $0.6 million, equivalent to 2 cents a
share of earnings, compared to a loss of $0.1 million or less than 1 cent a
share loss in the second quarter of 2002. In the first six months of 2003, NW
Natural's share of the margin from upstream gas sales contributed $4.6 million
of margin, equivalent to 10 cents a share of earnings. The equivalent result in
the first half of 2002 was margin of $0.1 million, less than 1 cent a share of
earnings.
Non-utility Operations
At June 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 $1.2 million or
5 cents a share in the three months ended June 30, 2003 and 2002. For the first
23
six months of 2003, operating results were net income of $2.5 million, compared
to net income of $2.0 million for the comparable period in 2002. Gas storage
services are provided to upstream interstate customers using storage capacity
that has been developed in advance of core utility customers' requirements. NW
Natural retains 80 percent of the income before tax from gas storage services
and credits the remaining 20 percent to a deferred regulatory account for
distribution to its core utility customers.
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
June 30, 2003 were net income of $0.4 million, compared to net income of $0.5
million for the comparable period in 2002. The results in the second quarters of
both 2003 and 2002 were equivalent to 1 cent a share of earnings for the
Company. For the first six months of 2003, operating results were net income of
$0.4 million, compared to $0.7 million for the comparable period in 2002. The
lower net income in the current six-month period was primarily due to lower
income from miscellaneous receivables and a net decrease in operating results
from Financial Corporation's investments in limited partnerships in wind and
solar electric generation projects in California. These investments generate the
majority of their operating revenues during the second and third quarters;
therefore, results of operations for the first six months of the year are not
necessarily indicative of the results for a full year. The Company's investment
balances in Financial Corporation at June 30, 2003 and 2002 were $9.4 million
and $8.6 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
second quarter of 2003.
Operating Expenses
Operations and Maintenance
Consolidated operations and maintenance expenses increased $3.1
million, or 15 percent, and $5.0 million, or 12 percent, in the three- and
six-month periods ended June 30, 2003, respectively, compared to the same
periods in 2002. The six-month period includes increases of: $2.5 million
primarily due to wage and salary increases and incentive bonus accruals; $1.5
million primarily due to higher pension and postretirement benefit costs,
including the impact of changes in actuarial assumptions and lower returns on
pension assets; $0.7 million primarily due to higher insurance premiums for
health care and prescription drug coverage; and $0.5 million primarily due to
higher business risk insurance renewal premiums. These cost increases were
partially offset by a decrease in uncollectible accounts expense of $0.9 million
primarily 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.
Taxes Other than Income Taxes
Taxes other than income taxes, which are principally comprised of
franchise, property and payroll taxes, were $0.7 million, or 4 percent, lower in
the first six months of 2003 compared to the same period in 2002. Franchise
24
taxes, which are based on gross revenues, decreased $0.9 million, or 10 percent,
reflecting lower gross revenues due to lower rates, warmer weather and other
factors. Property taxes increased $0.3 million, or 4 percent, due to an increase
in utility plant additions.
Depreciation and Amortization
Depreciation and amortization expense increased $0.9 million, or 4
percent, in the first six months of 2003 compared to the same period in 2002.
Total depreciable plant and property in service at June 30, 2003 was up 5
percent from a year earlier. As a percentage of average plant and property,
depreciation and amortization expense was approximately 2 percent for each of
the six-month periods ended June 30, 2003 and 2002.
Other Income (Expense)
Other income (expense) improved by $14.9 million and $15.2 million in
the three- and six-month periods ended June 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
(expense) increased $1.2 million in the second quarter of 2003 and increased
$1.5 million in the six months ended June 30, 2003, compared to the same periods
in 2002, primarily due to reductions in interest charges on deferred regulatory
account balances and an increase in gains from Company-owned life insurance. In
the three- and six-month periods ended June 30, 2003, other income (expense)
included interest expense on deferred regulatory account balances of $0.4
million and $0.7 million, respectively, compared to $1.0 million and $1.9
million in the same periods of 2002. These decreases reflect lower net credit
balances outstanding in deferred regulatory accounts. Other income (expense) in
the first six months of 2003 also included an increase in gains from
Company-owned life insurance of $0.7 million, partially offset by a $0.4 million
decrease in income from partnership investments.
Interest Charges - net
The Company's net interest expense increased by $0.5 million, or 6
percent, and $1.3 million, or 8 percent, in the three-month and six-month
periods ended June 30, 2003, respectively, compared to the same periods in 2002.
Interest expense on long-term debt was $0.5 million higher in each of the three-
and six-month periods ended June 30, 2003 primarily due to higher balances
outstanding during the period.
Income Taxes
The effective corporate income tax rates for the three months ended
June 30, 2003 and 2002, were 33.9 percent and 45.0 percent, respectively. The
higher rate in the three-month period ended June 30, 2002 was primarily due to
the $13.7 million charge for costs incurred in the effort to acquire PGE. The
effective corporate income tax rate for the six months ended June 30, 2003 was
35.4 percent, compared to 36.1 percent for the first six months of 2002.
Excluding the effect of the $13.7 million PGE-related charge, the effective
corporate income tax rates for the three- and six-month periods ended June 30,
2002 were 35.2 percent and 36.7 percent, respectively.
Financial Condition
Capital Structure
The Company's goal is to maintain a capital structure comprised of 45
to 50 percent common stock equity, up to 10 percent preferred stock and 45 to 50
percent short-term and long-term debt. When additional capital is required, debt
or equity securities are issued depending upon both the target capital structure
and market conditions. These sources also are used to meet long-term debt and
preferred stock redemption requirements (see "Liquidity and Capital Resources,"
below, and Part II, Item 8., Notes 3 and 5, in the 2002 Form 10-K).
25
Liquidity and Capital Resources
At June 30, 2003, the Company had $24.1 million in cash and cash
equivalents compared to $34.5 million at June 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 Part II, Item 8., Note 6, in the 2002 Form 10-K).
NW Natural's capital expenditures are primarily related to utility
construction resulting from customer growth and system improvements (see "Cash
Flows - Investing Activities," below). In addition, NW Natural has certain
contractual commitments under capital leases, operating leases and gas supply
purchase 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.
Contractual Obligations
The following table shows NW Natural's long-term contractual
obligations by maturity and type of obligation:
(Thousands)
Payments Due in Years Commercial Preferred Long-term Capital Operating Gas Supply
Ending June 30, Paper Stock Debt Leases Leases Commitments Total
- ------------------------------------------------------------------------------------------------------------------------------
2004 $ 16,600 $ 750 $ 35,000 $ 185 $ 2,982 $ 60,692 $ 116,209
2005 - 750 - 105 2,701 51,450 55,006
2006 - 750 23,000 97 2,193 49,511 75,551
2007 - 750 29,500 43 199 46,637 77,129
2008 - 750 - - 175 44,767 45,692
---------------------------------------------------------------------------------------------------
Total 2004 - 2008 16,600 3,750 87,500 430 8,250 253,057 369,587
Thereafter - 3,750 363,358 - 3,373 218,186 588,667
Less: imputed
interest - - - (38) - (120,599) (120,637)
---------------------------------------------------------------------------------------------------
Total $ 16,600 $ 7,500 $ 450,858 $ 392 $ 11,623 $ 350,644 $ 837,617
===================================================================================================
Commercial Paper
The Company's primary source of short-term funds is commercial paper
notes payable. Both NW Natural and Financial Corporation issue commercial paper
under agency agreements with a commercial bank. NW Natural's commercial paper is
supported by its committed bank lines of credit (see "Lines of Credit," below),
while Financial Corporation's commercial paper is supported by committed bank
lines of credit and the guaranty of NW Natural (see Part II, Item 8., Note 6, in
the 2002 Form 10-K). NW Natural had $16.6 million in commercial paper notes
outstanding at June 30, 2003, compared to none outstanding at June 30, 2002 and
$69.8 million outstanding at Dec. 31, 2002. Financial Corporation had no
commercial paper notes outstanding at June 30, 2003 or 2002, or at Dec. 31,
2002.
26
Lines of Credit
NW Natural has lines of credit with four commercial banks totaling $150
million. Half of the credit facility with each bank, totaling $75 million, is
committed and available through Sept. 30, 2003, and the other $75 million is
committed and available through Sept. 30, 2004. In addition, Financial
Corporation has available through Sept. 30, 2003, committed lines of credit with
two commercial banks totaling $20 million. Financial Corporation's lines are
supported by the guaranty of NW Natural.
Under the terms of these lines of credit, NW Natural and Financial
Corporation pay commitment fees but are not required to maintain compensating
bank balances. The interest rates on borrowings under these lines of credit, if
any, are based on current market rates. There were no outstanding balances on
either the NW Natural or Financial Corporation lines of credit at June 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
loans outstanding under NW Natural's bank lines are tied to credit ratings,
which would increase or decrease the cost of bank debt, if any, when ratings are
changed.
The lines of credit require the Company to maintain an indebtedness to
total capitalization ratio of 65 percent or less and to maintain a consolidated
net worth at least equal to 80 percent of its net worth at Sept. 30, 2002, plus
50 percent of the Company's net income for each subsequent fiscal quarter.
Failure to comply with either of these covenants would entitle the banks to
terminate their lending commitments and to accelerate the maturity of all
amounts outstanding. At June 30, 2003 and at Dec. 31, 2002, the Company was in
compliance with both of these covenants. The banks have waived through Sept. 30,
2003, a requirement that NW Natural represent that the assets dedicated to its
qualified pension plans exceed the unfunded liabilities of the plans before it
may draw upon the lines of credit.
NW Natural may be unable to draw upon the two-year portions of the
credit lines, totaling $75 million, until its notes relating to the two-year
commitments are approved by the OPUC or the Washington Utilities and
Transportation Commission (WUTC), or both. NW Natural expects that it will be
able to secure such approvals, if required.
Optional Redemptions of Long-Term Debt
NW Natural has exercised optional redemption provisions applicable to
certain of its long-term debt, including all $4 million of the 7.50% Series B
Medium-Term Notes (MTN) 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 are
redeemable 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 the
7.50% and 7.52% Series on July 1 and will redeem the 7.25% Series on Aug. 18, in
each case with the proceeds from sales of commercial paper. NW Natural intends
to refinance this debt through the sale of new long-term debt in the third or
fourth quarter of 2003.
Cash Flows
Operating Activities
Operations provided net cash of $120.5 million in the six months ended
June 30, 2003, compared to $134.8 million in the first six months of 2002. The
$14.3 million, or 11 percent, decrease was due to a decrease in cash from
operations before working capital changes ($16.0 million), partially offset by
an increase in working capital ($1.6 million). The decrease in cash from
operations before working capital changes compared to the first six 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), plus a smaller increase in
deferred income taxes and investment tax credits ($4.5 million), partially
offset by a larger increase in deferred gas costs ($2.6 million). The increase
in working capital for the six months ended June 30, 2003 over the same period
27
last year was due to smaller decreases in accounts receivable ($21.0 million)
and accrued unbilled revenue ($15.1 million) caused primarily by lower customer
rates and last year's $29.9 million gas cost refund, partially offset by an
increase in accrued interest and taxes in 2003 compared to a decrease in 2002
($25.4 million), an increase in cash provided from changes in other current
assets and liabilities ($5.2 million), a larger decrease in inventories of gas,
materials and supplies ($4.1 million) and a smaller decrease in accounts payable
($3.0 million).
NW Natural's refunds to customers of approximately $29.9 million of
deferred gas cost savings in June 2002 (see "Results of Operations - Comparison
of Gas Operations," above) reduced cash flows from operations in the first six
months of 2002 by that amount, but the reduction was more than offset by other
factors affecting cash flows in that period.
Investing Activities
Cash requirements for investing activities in the first six months of
2003 totaled $56.8 million, up from $37.7 million in the same period of 2002.
Cash requirements for utility construction totaled $56.1 million, up $23.7
million from the first six months of 2002. The increase in cash requirements for
utility construction in the first six months of 2003 was primarily the result of
capital expenditures relating to NW Natural's extension of the pipeline from its
Mist gas storage field ($13.0 million) and other special projects to serve new
customer load or new service areas ($5.7 million).
Investments in non-utility property during the first six months of 2003
totaled $0.8 million, down from $2.6 million during the first six months of
2002.
NW Natural's utility construction expenditures in 2003 currently are
estimated to total $139 million, up from $85 million in 2002. Projected utility
construction in 2003 includes $31 million for customer growth, up from $29
million in 2002; $41 million for system improvement and support, up from $25
million in 2002; $41 million for this year's portion of the SMPE project (see
Note 7 to the accompanying Consolidated Financial Statements) 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. NW Natural is proceeding with construction
of an initial segment of the SMPE project pending resolution of appeals from the
order approving its site certificate for the project.
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 six months of 2003
totaled $46.9 million, down from $73.0 million in the same period of 2002.
Factors contributing to the $26.1 million difference were a smaller reduction in
short-term debt in the first six months of 2003 ($53.2 million), compared to a
larger reduction in the first six months of 2002 ($108.3 million), partially
offset by a $20 million decrease in long-term debt issued and a $9.5 million
increase in long-term debt retired.
In February 2003, NW Natural sold $40 million of its secured 5.66%
Series B 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.
28
In March 2002, NW Natural sold $60 million of its secured Series B
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 six 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.
Ratios of Earnings to Fixed Charges
For the six months and 12 months ended June 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 3.48, 2.74 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
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 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, as
of June 30, 2003, for its estimated costs of investigation and remediation
related to the Gasco site. See "Application of Critical Accounting Policies -
Critical Estimates," above.
NW Natural has accrued all material loss contingencies relating to
environmental matters that it believes to be probable of assertion and
reasonably estimable. See Part II, Item 8., Note 12, in the 2002 Form 10-K. Due
to the preliminary nature of these environmental investigations, the range of
any additional possible loss contingency cannot be currently estimated.
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 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. As of June 30,
2003, NW Natural has recorded $0.6 million of these costs in a deferred
regulatory account. Additionally, on a cumulative basis through June 30, 2003,
the Company has accrued environmental costs totaling $7.9 million relating to
the five sites, including $5.5 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 expects that the costs of further investigation and
remediation for which it may be responsible with respect to the Gasco site, the
Wacker site, the Portland Harbor site and the Portland Gas site, if any, should
be recoverable, in large part, from insurance. In the event these costs are not
recovered from insurance, NW Natural will seek recovery through future rates.
29
Forward-Looking Statements
This report and other presentations made by the Company from time to
time may contain forward-looking statements within the meaning of Section 21E of
the Securities Exchange Act of 1934, as amended. Forward-looking statements
include statements concerning plans, objectives, goals, strategies, future
events or performance, and other statements that are other than statements of
historical facts. The Company's expectations, beliefs and projections are
expressed in good faith and are believed to have a reasonable basis. However,
each such forward-looking statement involves uncertainties and is qualified in
its entirety by reference to the following important factors, among others, that
could cause the actual results of the Company to differ materially from those
projected in such forward-looking statements: (i) prevailing state and federal
governmental policies and regulatory actions, including those of the OPUC and
the WUTC, with respect to allowed rates of return, industry and rate structure,
purchased gas and investment recovery, acquisitions and dispositions of assets
and facilities, operation and construction of plant facilities, the maintenance
of pipeline integrity, present or prospective wholesale and retail competition,
changes in tax laws and policies and changes in and compliance with
environmental and safety laws, regulations and policies; (ii) weather conditions
and other natural phenomena; (iii) unanticipated population growth or decline,
and changes in market demand and demographic patterns; (iv) competition for
retail and wholesale customers; (v) pricing of natural gas relative to other
energy sources; (vi) risks resulting from uninsured property damage to Company
property, intentional or otherwise; (vii) unanticipated changes in interest or
foreign currency exchange rates or in rates of inflation; (viii) economic
factors that could cause a severe downturn in certain key industries, thus
affecting demand for natural gas; (ix) unanticipated changes in operating
expenses and capital expenditures; (x) unanticipated changes in future
liabilities relating to employee benefit plans; (xi) capital market conditions,
including their effect on pension costs; (xii) competition for new energy
development opportunities; (xiii) potential inability to obtain permits, rights
of way, easements or other necessary authority to construct pipelines or other
system expansions; and (xiv) legal and administrative proceedings and
settlements. All subsequent forward-looking statements, whether written or oral
and whether made by or on behalf of the Company, also are expressly qualified by
these cautionary statements.
Any forward-looking statement speaks only as of the date on which such
statement is made, and the Company undertakes no obligation to update any
forward-looking statement to reflect events or circumstances after the date on
which such statement is made or to reflect the occurrence of unanticipated
events. New factors emerge from time to time and it is not possible for the
Company to predict all such factors, nor can it assess the impact of each such
factor or the extent to which any factor, or combination of factors, may cause
results to differ materially from those contained in any forward-looking
statement.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes to the information provided in Part
II, Item 7A., "Quantitative and Qualitative Disclosures About Market Risk," in
the 2002 Form 10-K.
Item 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
As of June 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 or submitted with the Securities
and Exchange Commission under the Exchange Act.
30
(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 quarter ended March 31, 2003. In the settlement, Cascade
transferred all of its records, rights and interests in certain leases,
including gas storage leases, in Columbia County, Oregon to NW Natural and
agreed to refrain from certain competitive activities in the area. The
counterclaims against NW Natural described in the 2002 Form 10-K have been
dismissed and Enerfin Resources Northwest Limited Partnership (Enerfin) is the
remaining defendant in the Action. NW Natural paid Cascade $0.5 million and
agreed to defend and indemnify Cascade against claims by Enerfin relating to the
validity and enforceability of the transferred leases. However, NW Natural will
have no obligation to defend or indemnify Cascade from any claims for recovery
of punitive or other exemplary damages. In June 2003, the court denied Enerfin's
motion 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 expects to oppose the motion.
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 and a final decision is pending. On July 30, 2003, the Supreme Court denied
a motion filed by one of the appellants to stay construction of the SMPE.
From time to time the Company is subject to other claims and litigation
arising in the ordinary course of business. Although the final outcome of any
such legal proceeding cannot be predicted with certainty, the Company does not
expect disposition of these matters to have a materially adverse effect on the
Company's financial position, results of operation or cash flows.
31
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NW Natural's Annual Meeting of Shareholders was held in Portland,
Oregon on May 22, 2003. At the meeting, seven director-nominees were elected, as
follows:
Term
Director Class Expiring Votes For Votes Withheld
-------- ----- -------- --------- --------------
Timothy P. Boyle I 2006 20,898,490 304,943
Mark S. Dodson I 2006 20,923,609 279,824
Randall C. Pape I 2006 20,916,638 286,795
Richard L. Woolworth I 2006 20,921,849 281,584
Robert L. Ridgley II 2004 20,903,246 300,187
John D. Carter III 2005 20,797,560 405,873
C. Scott Gibson III 2005 20,142,469 1,060,964
The other four directors whose terms of office as directors continued
after the Annual Meeting are: Tod R. Hamachek, Melody C. Teppola, Russell F.
Tromley and Richard G. Reiten. In accordance with the Company's Bylaws, Thomas
E. Dewey, Jr., and Wayne D. Kuni, retired as directors at the conclusion of the
meeting. Dwight A. Sangrey did not stand for election to another term. There
were no broker non-votes on the election of directors.
No other matters were voted upon at the meeting.
Item 5. OTHER INFORMATION
Regulatory Matters
On Aug. 5, 2003, Oregon Governor Ted Kulongoski appointed two new
Commissioners to serve on the three-member Oregon Public Utility Commission
(OPUC). The appointments of Ray Baum, 47, a former Oregon legislator and
attorney from La Grande, Oregon, and John Savage, 51, who most recently served
as OPUC Utility Program Director and formerly was with the Oregon Department of
Energy, are subject to confirmation by the Oregon Senate. Baum fills the vacancy
created by the retirement on May 1, 2003 of Joan Smith, and Savage replaces OPUC
Chairman Roy Hemmingway, who will retire Sept. 1, 2003. Lee Beyer continues to
serve as a Commissioner. If Senate confirmation of the new commissioners is not
obtained prior to Chairman Hemmingway's retirement, the OPUC will not have
members constituting a quorum to conduct its business until such confirmations
are obtained.
32
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit (3) - Bylaws of the Company, as amended July 24, 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 April 2, 2003, May 1, 2003 and July 29, 2003, the Company filed or
furnished its Current Reports on Form 8-K relating, respectively, to: (a) the
lowering of its earnings guidance for the quarter ended March 31, 2003; (b)
earnings for the quarter ended March 31, 2003 (unaudited) and the status of the
Company's Oregon general rate case; and (c) earnings for the quarter ended June
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: August 12, 2003 /s/ Stephen P. Feltz
--------------------------------
Stephen P. Feltz
Principal Accounting Officer
Treasurer and Controller
33
NORTHWEST NATURAL GAS COMPANY
EXHIBIT INDEX
To
Quarterly Report on Form 10-Q
For Quarter Ended
June 30, 2003
Exhibit
Document Number
Bylaws of the Company, as amended July 24, 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 (31.1)
Rule 13a-14(a)/15d-14(a), Section 302 of the
Sarbanes-Oxley Act of 2002
Certification of Principal Financial Officer Pursuant to (31.2)
Rule 13a-14(a)/15d-14(a), Section 302 of the
Sarbanes-Oxley Act of 2002
Certification of Principal Executive Officer and Principal (32.1)
Financial Officer Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002