SECURITIES AND EXCHANGE COMMISSION
                             Washington, D. C. 20549

                                    FORM 10-K

(Check One)
  [X]            ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934
                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 19971998
                                       OR
  [ ]            TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
                       OF THE SECURITIES EXCHANGE ACT OF 1934
         For the transition period from             ___________ to____________to
                                        -----------   ------------

                          Commission file number 0-994

                         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 Identification Number)
incorporation or organization)                          Identification Number)           

220 N.W. Second Avenue, Portland, Oregon                  97209
(Address of principal executive offices)               (Zip Code)

Registrant's telephone number, including area code:  (503) 226-4211

Securities registered pursuant to Section 12(b) of the Act:
Title of each class                   Name of each exchange on which registered
- -------------------                   -----------------------------------------
None                                               None

Securities registered pursuant to 
Section 12(g) of the Act:
Title of each class                     Shares outstanding on February 28, 199826, 1999
- -------------------                     ---------------------------------------
Common Stock, $3 1/6 par value,
and Common Share Purchase Rights                       22,922,54624,905,690
Preference Stock, without par value                       250,000
Preferred Stock, without par value                        124,285114,985

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ]      No [      ]
                             

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ X ].

     The aggregate market value of the shares of voting stock (common stock)
held by non-affiliates of the registrant at February 28, 199826, 1999 was: $640,982,000.$604,770,000.

                      DOCUMENTS INCORPORATED BY REFERENCE

List documents incorporated by reference and the Part of the Form 10-K into
which the document is incorporated.

Portions of the Proxy Statement of Company, dated April 17, 1998,16, 1999, are
incorporated by reference in Part III.


                          NORTHWEST NATURAL GAS COMPANY

               Annual Report to Securities and Exchange Commission
                                  on Form 10-K
                                for the year 19971998

                                TABLE OF CONTENTS



PART I                                                                     Page

- ------                                                               ----
Item 1.  Business
             General.............................................General......................................................... 3
             Gas Supply..........................................Supply...................................................... 4
             Regulation and Rates................................    7Rates.............................................7
             Competition and Marketing...........................Marketing....................................... 9
             Environment.........................................   11
               Employees...........................................   11Environment.....................................................11
             Employees.......................................................12

Item 2.  Properties...............................................   11Properties..........................................................12

Item 3.  Legal Proceedings........................................   12Proceedings...................................................13

Item 4.  Submission of Matters to a Vote of Security Holders......   12Holders.................13

Additional Item
         Executive Officers of the Registrant.....................   13Registrant................................14

PART II
- -------

Item 5. Market for the Registrant's Common Equity and Related 
        Stockholder Matters.............................   14Matters..................................................15

Item 6. Selected Financial Data..................................   16Data..............................................17

Item 7. Management's Discussion and Analysis of Results of Operations and
            Financial Condition...................   18Condition..............................................19

Item 7A.Quantitative and Qualitative Disclosures About Market Risk ..........33

Item 8. Financial Statements and Supplementary Data..............   31Data..........................37

Item 9. Changes in and Disagreements with Accountants on Accounting and
            Financial Disclosure.....................   63Disclosure.............................................66

PART III
- --------

Items 10. 
    - 13.   Incorporated by Reference to Proxy Statement.............   63Statement.....................66

PART IV
- -------

Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K............................................   63

SIGNATURES ........................................................   678-K.....66

SIGNATURES...................................................................71


                                       2





                          NORTHWEST NATURAL GAS COMPANY
                                     PART I


ITEM 1. BUSINESS

General
- -------

         Northwest Natural Gas Company (NW Natural or the Company) was
incorporated under the laws of Oregon in 1910. The Company and its predecessors
have supplied gas service to the public since 1859. Since September 1997, it has
been doing business as NW Natural.

         NW Natural is principally engaged in the distribution of natural gas.
The Oregon Public Utility Commission (OPUC) has allocated to NW Natural as its
exclusive service area a major portion of western Oregon, including the Portland
metropolitan area, most of the fertile Willamette Valley and the coastal area from
Astoria to Coos Bay. NW Natural also holds certificates from the Washington
Utilities and Transportation Commission (WUTC) granting it exclusive rights to
serve portions of three Washington counties bordering the Columbia River. Gas
service is provided in 95 cities, together with neighboring communities, in 16
Oregon counties, and in nine cities, together with neighboring communities, in
three Washington counties. Based on U.S. Census Bureau statistics for 1995, NW
Natural's service areas had a population of about 2,735,000, including about 78
percent of the population of the State of Oregon and 6 percent of the population
of the State of Washington. The Citycity of Portland Oregon is the principal retail and
manufacturing center in the Columbia River Basin. ItBasin, and is a major port and
growing nucleus for trade with Pacific Rim nations such as Japan, Taiwan and
Korea.

         At year-end 1997,1998, NW Natural had about 407,100425,600 residential customers,
50,30051,200 commercial customers and 600 industrial customers. Industries served
include pulp, paper and other forest products; the manufacture of electronic,
electrochemical and electrometallurgical products; the processing of farm and
food products; the production of various mineral products; metal fabrication and
casting; and the production of machine tools, machinery and textiles.

     The Company has two active wholly-owned subsidiaries. NNG Financial Corporation
(Financial Corporation), a wholly owned subsidiary, is incorporated in Oregon.
Canor Energy Ltd. (Canor), a 66 percent owned subsidiary, is incorporated in
Alberta, Canada.

         Financial Corporation arranges short-term financing for Canor and holds financial investments as a limited partner
in three solar electric generating plants, four windpower electric generation
projects and a hydroelectric project, all located in California, and in two
low-income housing projects in Portland. Financial Corporation also holds
interests in certain gas producing properties in the western United States (See
Item 2, Properties, below).

         Canor is engaged in natural gas and oil exploration, development and
production in Alberta and Saskatchewan, Canada. SinceBetween 1995 and early 1998,
Canor has managed a joint venture with Southlake Energy Inc. (Southlake), a wholly-ownedwholly
owned subsidiary of NIPSCO Industries, Inc. (NIPSCO), to develop gas and oil
properties in western Canada. Effective Mar. 31, 1998, Canor acquired Southlake
in exchange for shares in Canor. After the acquisition, Southlake was merged
with Canor. Canor now is 66 percent owned by NW Natural and 34 percent owned by
a NIPSCO plan to amalgamate their respective operations into a new company during 1998.subsidiary.

                                       3


Gas Supply - General
- --------------------

         NW Natural meets the needs of its core market (residential, commercial
and firm industrial) customers through natural gas purchases from a variety of
suppliers. NW Natural has a diverse portfolio of short-, medium- and long-term firm gas
supply contracts. During periods of peak demand, supplies under these contracts
are supplemented with gas from storage facilities either owned by or
contractually committed to NW Natural.

         Natural gas for NW Natural's core market is transported byover the
interstate pipeline system of Williams Northwest Pipeline (WNP), formerly
Northwest Pipeline Corporation, (NPC), primarily under three firm transportation
agreements. NPC's ratesand some supplies move over other pipelines
upstream of WNP's system in the U.S. and Canada. Rates for service under
thesetransportation agreements between NW Natural and the U. S. interstate pipelines
are established by the Federal Energy Regulatory Commission (FERC) under NPC's primary firm
transportation rate schedule, as amended, and by
Canadian federal or superseded from time to time.provincial authorities for the Canadian pipelines over which
NW Natural transports gas.

         The largest of the contractstransportation agreements with NPCWNP expires SeptemberSep. 30,
2013 and provides for firm transportation capacity of up to 2,160,440 therms(1)
per day. This agreement provides access to natural gas supplies in British
Columbia and the U.S. Rocky Mountains. 

         NW Natural also has a contractThe Company's second largest transportation agreement with NPC expiring SeptemberWNP expires
on Nov. 30, 2009 for
340,000 therms per day of firm transportation capacity for the Company's core
market. This agreement also accesses gas supplies in the U.S. Rocky Mountain
region.

         The third transportation contract with NPC, under which service
commenced on December 1, 1995 and expires November 30, 2011,2011. It provides 1,020,000 therms per day of firm transportation
capacity from the point of interconnection of the NPCWNP and PG&E Gas Transmission
Northwest (PG&E GT-NW, formerly Pacific Gas
Transmission)GT-NW) systems in eastern Oregon to NW Natural's service
territory. PG&E GT-NW's pipeline runs from the U.S./Canadian border through
northern Idaho, southeastern Washington and central Oregon to the
California/Oregon border. NW Natural's total capacity on PG&E GT-NW and two
other upstream pipelines (Alberta Natural Gas Company and NOVA Corporation of Alberta)
substantially matches this amount of NPCWNP capacity northward into Alberta,
Canada.

     NW Natural also has an agreement with WNP expiring Sep. 30, 2009, for
340,000 therms per day of firm transportation capacity for the Company's core
market. This agreement accesses gas supplies in the U.S. Rocky Mountain region.

         The cost to NW Natural of gas to supply its core market consists of the
purchase price paid to suppliers plus charges paid to pipelines to transport
such gas to NW Natural's distribution system. While the rates for pipeline
transportation and peaking services are subject to federal regulation, the
purchase price of gas is not. Although pipeline rates increased significantly in
1993 due to system expansion and rate design changes, the effect of such
increases on core market customers has been more than offset by lower gas commodity prices. In addition, NW Natural has been able to offset firm
transportation charges,prices
and by credits in part, by makingthe form of revenues from off-system sales of commodity and
releasingreleased transportation capacity in periods when core market customers do not
fully utilize firm pipeline capacity.

         NW Natural supplies many of its non-core customers (larger industrial
interruptible customers with full or partial dual fuel capabilities) through gas
transportation service, delivering gas purchased by these customers directly
from suppliers. (See "Transportation"."Transportation.")

- -------------------------
     (1)---------------------
1 One therm is equivalent to 100 cubic feet of natural gas at an assumed heat
content of 1,000 British Thermal Units (Btu's) per cubic foot.

                                       4



Gas Supply -- Core Market Basic Supply
- --------------------------------------

         NW Natural purchases gas for its core market from a variety of
suppliers located in the western United States and Canada. At JanuaryJan. 1, 1998,1999, NW
Natural had 2122 firm contracts with 2016 suppliers with original terms of from four
months to 15 years, which provided for a maximum of 2,757,0902,931,200 therms of firm gas
per day during the peak winter season and 1,418,3001,343,300 therms per day during the
remainder of the year. About 80 percent of the annual supply comes from Canada.Canada,
with most of the rest from the U.S. Rocky Mountain region.

         The terms of NW Natural's principal purchase agreements are summarized
as follows:

         An agreement expiring NovemberNov. 1, 2003, with CanWest Gas Supply, Inc.
(CanWest), an aggregator for gas producers in British Columbia, Canada, entitles
NW Natural to purchase up to 960,000 therms of firm gas per day. This agreement
contains a demand and commodity pricing structure and a provision for annual
renegotiations of the commodity price to reflect then-prevailing market prices.
The demand charges reflect the reservation of firm transportation space on the
Westcoast Energy, Inc. pipeline system in British Columbia. These demand charges
are subject to change as approved by the Canadian National Energy Board (NEB) in
rate proceedings similar to those conducted in the United States by the FERC.
This contract contains minimum purchase obligations.

         An agreement also expiring NovemberNov. 1, 2003, with Amoco Canada Petroleum
Company, Ltd., on terms similar to the CanWest agreement, entitles NW Natural to
purchase up to 83,300 therms of firm gas per day. This gas is aggregated from
production in the Canadian province of Alberta and the Yukon and Northwest
Territories. This contract contains minimum purchase obligations.

         An agreement with Poco Petroleums, Ltd., a Canadian producer, expiring
SeptemberSep. 30, 2003, entitles NW Natural to purchase up to 155,160 therms per day
during the winter and up to 110,000 therms per day during the summer of gas
produced in Alberta.

         Two agreements expiring SeptemberSep. 30, 2003 with Engage Energy (formerly
Westcoast Gas ServicesServices) entitle NW Natural to purchase up to 140,000 therms per
day year-round, plus up to 92,750 therms per day as winter season supply, of gas
produced in Alberta. Pricing for supplies under these agreements can be
renegotiated annually. The current pricing arrangement includes demand charges
for upstream capacity on the Canadian pipeline systems and a monthly reservation
charge. The commodity pricing consists of a portion of the daily contract
quantity at a fixed price and the remaining daily contract quantity tied to a
monthly Canadian index.

         An agreement expiring OctoberOct. 31, 2000, with Summit Resources Ltd.,
entitles NW Natural to purchase up to 77,580 therms per day during the winter
and up to 50,000 therms per day during the summer of gas produced in Alberta.
Pricing for supplies under this agreement can be renegotiated annually. The
current pricing arrangement includes demand charges for upstream capacity on
NOVA Corporation of Alberta's system and commodity charges that are fixed in
three volumetrically based tiers.

         During 1997,1998, new short-term (4 or 5 month) purchase agreements for firm
gas were entered into with 1411 suppliers, which provideprovided for a total of 1,181,1301,422,400

                                       5



therms per day during the 1997-981998-99 heating season. These contracts have a variety
of pricing structures and purchase obligations. NW Natural intends to enter into
new short-term purchase agreements in 19981999 for equivalent volumes of gas with
these or other similar suppliers to be available during the 1998-991999-2000 winter
season.

         NW Natural continues to purchase gas under agreements with two
producers (one of which is Financial Corporation), for gas produced from the
Mist gas field, located about 60 miles northwest of Portland, Oregon.Portland. The production
areas are situated near NW Natural's existing underground gas storage facility.
These agreements have primary terms of 10 years and prices that are tied to NW
Natural's weighted average cost of gas. Current production is approximately
25,00030,000 therms per day from about 17 wells, supplying about 1 percent of NW
Natural's total annual requirements. Production from these wells varies as
existing wells are depleted and new wells are drilled.

         During 1997, approximately 23 percent of NW Natural's purchases for its
core market was fromNatural also buys gas on the spot market (30 days or less), a significant increase
from the prior year. This reflects the increased as needed
to meet demand. Some flexibility is provided under the terms of NW Natural's
firm supply contracts, which permitpermitting the purchase of spot gas under certain conditionsin lieu of firm
contract volumes and allowedallowing NW Natural to take advantage of generally depressedfavorable pricing
on the spot market prices in the western United States and Canada.from time to time.

         NW Natural's goal in purchasing gas for its core market is to meet
customers' needs at reasonable prices. NW Natural believes that gas supplies
available from suppliers in the western United States and Canada are adequate to
serve its core market customers for the foreseeable future, and that the cost of
such gas generally will track market prices.

Gas Supply -- Core Market Peaking Supply
- ----------------------------------------

         NW Natural supplements its firm gas supplies with gas from
Company-owned or contracted peaking facilities in which gas is stored during
periods of low demand for use during periods of peak demand. In addition to
enabling NW Natural to meet its peak demand, these facilities make it possible
to lower the annual average cost of gas by allowing NW Natural both to reduce
its pipeline transportation contract demand and to purchase gas for storage
during the summer months when prices are generally at their lowest.

         NW Natural has contracts with NPCWNP which expire in 2004 for firm storage
services from the underground gas storage field at Jackson Prairie near
Centralia, Washington, and the liquefied natural gas (LNG) facility at Plymouth,
Washington. Together, these facilities provide NW Natural with daily firm
deliverability of 923,470 therms and total seasonal capacity of 13,082,647
therms. In addition, NW Natural has a contract with NPCWNP which continues from
year-to-year, at NW Natural's sole option, for additional daily deliverability
of 132,510 therms and additional seasonal capacity of 2,779,970 therms from the
Jackson Prairie storage field. Separate contracts with NPCWNP provide for the
transportation of these storage supplies to NW Natural's service territory.

         NW Natural owns and operates two LNG plants which liquefy gas during
the summer months for use duringstorage until the peak winter season. These two plants,
one located in Portland and the other near Newport, Oregon, provide a maximum
daily deliverability of 1.8 million therms and a total seasonal capacity of 17
million therms.

                                       6

NW Natural also owns and operates an underground gas storage facility
at Mist, Oregon. This facility has a maximum daily deliverability of 11.45
million therms and a total seasonal working gas capacity of 7085 million therms.
NW Natural is engaged in a multi-year, major expansion of the Mist storage
facility. New reservoir and surface facilities placed into service on Nov. 1,
1998, increased the Mist facility's maximum daily deliverability by 0.45 million
therms and its total seasonal working gas capacity by 15 million therms which
are included in the capacity figures shown above.

         NW Natural has a contract with Portland General Electric Company (PGE)
which expires in 2010 that provides NW Natural with additional winter peaking
supply. With certain limitations, NW Natural may interrupt gas deliveries to
PGE,PGE's Beaver gas-fired electricity generating plant, use that gas for its core
customers, and compensate PGE for its cost of replacement fuel oil. The daily
deliverability under this contract is 300,000 therms.

         NW Natural also has contracts with twothree industrial customers, onetwo gas
marketing companycompanies and another local gas distribution company on terms similar to
those under the contract with PGE whichthat provide a
total of 137,000 therms per day of year-round capacity, plus 150,000360,000 therms per
day of recallable capacity and supply. These contracts have originalremaining terms
ranging from fiveone to tennine years.

Gas Supply -- Transportation
- -------------------------------------------------------

         Between 1988 and early 1992, most of NW Natural's large industrial
interruptible customers switched from sales service to transportation service,
whereby they purchased gas directly from suppliers and shipped the gas on the
Company's system and those of its pipeline suppliers for a fee. Since 1992, many
of these customers have returned to sales service, primarily because NW
Natural's industrial sales rates were lower than those customers' costs of
purchasing and shipping their own gas. The ability of industrial customers to
switch between sales service and transportation service has made it possible for
NW Natural to retain most of these customers. Because transportation charges
typically have been the same as the margin on an equivalent sale of gas,
switching between sales service and transportation service by industrial
interruptible customers has not had a material effect on NW Natural's results of
operations. (See "Competition and Marketing".Marketing.")

Regulation and Rates
- --------------------

         NW Natural is subject to regulation with respect to, among other
matters, rates, systems of accounts and issuance of securities by the OPUC and
the WUTC. In 1997,1998, 94 percent of both NW Natural's gas deliveries and 93 percent of
its utility operating revenues were derived from Oregon customers and the
balance from Washington customers. The Company is exempt from the provisions of
the Natural Gas Act by order of the Federal Power Commission (now the FERC).

         NW Natural's most recent general rate caseincrease in Oregon, which was
effective in 1989, authorized rates designed to produce a return on common
shareholders' equity (ROE) of 13.25 percent. The most recent general rate
increase in Washington, which was effective in 1997, authorized rates designed
to produce a return on
common equityan ROE of 11.25 percent. Actual revenues resulting from the OPUC's
and WUTC's general rate orders are dependent on weather, economic conditions,
customer growth, competition and other factors affecting gas usage in NW
Natural's service area. NW Natural's returns on average common equity from
utility operations were 13.7 percent in 1996 and 12.0 percent in 1997.1997 and 9.9 percent in 1998. The

                                       7



Company's returns from consolidated operations, including subsidiary results,
were 13.0 percent in 1996 and 11.3 percent in 1997.1997 and 6.4 percent in 1998.

         In October 1998, NW Natural tentatively plans to file for afiled its first general rate increasecase in Oregon
since 1989. The filing proposes a revenue increase of $14.7 million per year
from Oregon operations through rate increases averaging 3.8 percent. The
proposed increase is designed to cover the costs of the additional gas storage
at Mist, NW Natural's new residential and small commercial customer information
system and its Year 2000 readiness project.

         In November 1998, the OPUC suspended the proposed rate increase for
investigation and hearings. On Mar. 17, 1999, the OPUC Staff filed testimony and
exhibits in the fourth quartergeneral rate case proceeding recommending a revenue reduction of
1998.$19.9 million per year from NW Natural's operations in Oregon. The Staff's
recommendation incorporated a proposed ROE of 8.5 percent, compared to the
Company's proposed ROE of 11.25 percent. The Staff's recommended reductions in
the Company's annual revenue requirements, besides the effect of the Staff's
proposed ROE ($18 million), included, among others, proposed disallowances of
expenses for wages and salaries ($3.4 million) and sales and marketing
activities ($8.9 million), and costs of NW Natural's new customer information
system ($2.0 million) due to a proposed disallowance of $13.8 million from NW
Natural's investment of $40.3 million in the system. The OPUC Staff is
considered to be an independent party in the case and its positions on issues
are not binding on the Commission. Hearings in the case are scheduled for May
1999 and a decision is expected by Sep. 1, 1999.

         In Oregon, NW Natural has a Purchased Gas Cost Adjustment (PGA) tariff
under which net income derived from Oregon operations is affected only within
defined limits by changes in purchased gas costs. The PGA tariff provides for
periodic revisions in rates due to changes in the Company's cost of purchased
gas. Costs included in the PGA adjustments are based on NW Natural's gas
requirements for the 12-month period ended each June 30. Any resulting rate
adjustments, derived from gas prices negotiated for the gas supply contract year
commencing on the following November 1, are made effective on the following
December 1.

         Effective JanuaryJan. 1, 1998, the PGA tariff provides that 67 percent of any
difference between actual purchased gas costs and estimated purchased gas costs
incorporated into rates will be deferred for amortization in subsequent periods.
If actual gas commodity costs exceed those incorporated in rates, NW Natural
subsequently will adjust its rates upward to recover 67 percent of the
deficiency from core market customers. Similarly, if actual gas commodity costs
are lower than those reflected in rates, rates will be adjusted downward to
distribute to core market customers 67 percent of such gas commodity cost
savings.

         In Washington, NW Natural is permitted to track increases and decreases
in gas commodity costs coincidental with their incurrence, with the result that
net income is not directly affected by changes in gas commodity costs.

         In both Oregon and Washington, the PGA permits NW Natural to recover
100 percent of FERC-approved pipeline transportation cost increases.

         In October 1997,1998, NW Natural filed under its Oregon PGA tariff to
increase rates for Oregon customers by an average of 11.45.9 percent. The OPUC
approved thea substitute filing increasing rates by an average of 3.4 percent
effective JanuaryDec. 1, 1998, along with a settlement between
NW Natural and the OPUC Staff. The settlement modified the incentive formula forbalance of gas cost deferrals to be recovered
in future deferrals of variations in gas costs, from 80 percent to 67 percent, and
provided for a revenue reduction not relating to gas costs amounting to $2.5
million per year, effective on a deferred basis as of January 1, 1998. In
February 1998, NW Natural filed a further rate increase averaging 6.1 percent
under the PGA tariff, proposing as of April 1, 1998, to remove a temporary rate
discount in effect since December 1996.filings.

                                      8




         In October 1997,1998, NW Natural filed under its Washington PGA tariff to
increase rates for Washington customers by 11.4an average of 5.8 percent. The WUTC
approved a
substitutethe filing increasing rates by 10.5 percent effective DecemberDec. 1, 1997.1998.

         The OPUC and WUTC have approved transportation tariffs under which NW
Natural may contract with customers to deliver customer-owned gas. Under these
tariffs, revenues from the transportation of customer-owned gas, except that of
large industrial customers having the capability of bypassing NW Natural's
system, generally are equivalent to the margins that would have been realized
from sales of Company-owned gas. (See "Gas Supply -- Transportation" and
"Competition and Marketing".Marketing.")

         The OPUC and WUTC have implemented "integrated resource planning"
processes under which utilities develop plans defining alternative growth
scenarios and resource acquisition strategies. In 1996 and 1997, respectively,
the OPUC and the WUTC acknowledged and accepted NW Natural's submission of its
third Integrated Resource Plan. The
WUTC acknowledged and accepted NW Natural's third plan in 1997. Elements of the Plan included an evaluation of
supply and demand resources; the consideration of uncertainties in the planning
process and the need for flexibility to respond to changes; a primary goal of
"least cost" service; and consistency with state energy policy. Although the
OPUC's order acknowledging the Integrated Resource Plan does not constitute
ratemaking approval of any specific resource acquisition or expenditure, the
OPUC indicated that it would give considerable weight in prudency reviews to
utility actions that are consistent with acknowledged plans. NW Natural will file itsNatural's fourth
Integrated Resource Plan filing, originally scheduled for acknowledgment by the OPUC and WUTC in 1998.1998, was deferred
until 1999.

Competition and Marketing
- -------------------------

         NW Natural has no direct competition in its service area from other
natural gas distributors. For residential customers' heating needs, however, NW
Natural competes with electricity, fuel oil, and, to a lesser extent, wood. It
also competes with electricity and fuel oil for commercial applications.
Competition among these forms of energy is based on price, reliability,
efficiency and performance. In 1997,1998, NW Natural maintained its competitive price
advantage over electricity and approximate price parity with fuel oil in both
the residential and commercial markets. Throughout 1997,1998, natural gas rates
continued to be substantially lower than rates for electricity provided by the
investor-owned utilities which serve approximately 75 percent of the homes in NW
Natural's Oregon service area. NW Natural believes that this rate advantage will
continue for the foreseeable future.

         The relatively low saturation of natural gas in residential
single-family and attached dwellings in NW Natural's service territory,
estimated at between 3335 and 40 percent, together with the price advantage of
natural gas compared with electricity and its operating convenience over fuel
oil, provides the potential for continuing growth in the residential conversion
market. In 1997, 21,8481998, 18,545 net residential customers (after subtracting
disconnected or terminated services) were added, including 8,7188,479 units of
existing residential housing which were reconnected to the system or were
converted from oil or electric appliances to natural gas. Of the new heating
conversions from other fuels, at leastabout 60 percent also converted to gas for water
heating. In addition, 3,006844 net commercial customers were connected in 1997.1998. The
net total of all new customers added in 1997,1998, including industrial sales and
transportation customers, was 24,852.19,386. This constituted a growth rate of 5.74.2
percent, more than three timestwice the national average for local distribution companies
as reported by the American Gas Association.

                                       9

Despite weather which was about 2 percent warmer weather,than 1997, natural gas
sales volumes to residential and commercial customers in 19971998 were up about the same as in 1996,3
percent over 1997, largely due to new customer acquisitions. For the year 1997,1998,
temperatures in NW Natural's service territory, based on heating degree days,
were 8 percent warmer than in 1996 and
45 percent warmer than the 20-year average.

         The Pacific Northwest has historically enjoyed some of the lowest
electric rates in the nation, primarily due to the proximity of federal
hydropower facilities. With further deregulation in the energy business, the
region is unlikely to experience the large drop in electric rates expected in
other, high-cost areas of the country.

         Electric deregulation holds the prospect of changing the competitive
landscape in the Northwest. Due to a number of environmental, economic and
political limitations on the future use of the hydroelectric infrastructure that
has dominated the Northwest energy supply for decades, several large gas-fired
generation projects are being planned to meet the region's future electricity
load growth. These projects could present opportunities for gas distributors to
serve the new loads as well as challenges from gas marketers. The developers of
generation projects often are affiliated with national multi-fuel marketers that
hold strong positions in a number of geographical areas in both gas and electric
markets. The availability of interstate pipeline capacity and gas storage
capacity will play significant roles in the future development of generation
projects.

         While the natural gas industry, including producers, interstate
pipelines and local distribution companies (LDCs), has undergone many changes in
its long history, perhaps no era has brought greater change than the past 10
years.decade.
These changes, brought about by the deregulation or restructuring of the energy
markets, are intended to promote competition where it is economically beneficial
to consumers. The changes are continuing, though at different rates among the
various regulatory jurisdictions aroundthroughout the country.

         Traditionally, LDCs have sold a "bundled" product which included the
natural gas itself as well as delivery to the meter. Since the late 1980s,
however, large customers have sought savings by procuring their own supplies of
natural gas from producers and contracting with pipelines and LDCs for
transportation. Since the cost of the gas commodity is passed through directly
to LDC customers without markup, the impact to net income when a customer
chooses transportation service has been negligible. While NW Natural's ability
to obtain competitively-priced gas commodity has enabled it to retain sales
customers, further deregulation of the industry may bring an unbundled product
offering to a greater number of customers, such that an increasing number of
suppliers will actively compete for customers' gas commodity business. However,
since the final delivery of customer-owned gas will continue to be through
regulated distribution systems, no material impact to NW Natural's profitability
is anticipated.

         BypassCompetition to serve the industrial and large commercial market in the
Pacific Northwest has been relatively steady since the early 1990s in terms of
NW Natural's facilities by other potential providersnumbers and types of delivery service is not considered a widespread, significant threat becausecompetitors. Competitors consist of the nature of NW Natural's customer basegas marketers,
oil/propane sellers and proximityelectric utilities. Wood-based fuels continue to interstate
pipelines.lose
market share primarily due to environmental concerns and restrictions.

         Total industrial throughput, including both sales and transportation of
firm and interruptible gas, was 585 million therms in 1998, up 1.0 percent from
579 million therms in 1997, up 2.7 percent from
564 million therms in 1996.1997. This continued growth in industrial throughput
despite a relatively soft regional economy in 1998 is an indicatorindication of the

                                      10

economic health and diversity of the region served by NW Natural. The basic industriesNatural serves. Industries
serving foreign markets such as forest products, agriculture, metals and metals continuehigh
technology suffered the most during the global economic slowdown that occurred
in 1998. However, industries with strong domestic sales fared very well and
continued to consolidategrow, and experience only
slow growth. ButNW Natural serves a new manufacturing base, notably high-technology, is emerging
and has expanded and diversified the region's economic base. This economic
growth has contributed to an increase inlarge group of medium-sized
industrial gas volumes averaging 2
percent per year over the past four years.customers with primarily national or regional market positions.

         Industrial firm gas sales and transportation deliveries during 19971998
totaled 194217 million therms, up 4112 percent from 1996.1997, reflecting the type of
growth described among medium-sized industrial customers. This increase reflects
mid-year transfersgrowth is
especially noteworthy in view of several largethe larger heating component of the load
profiles of these customers previously served under
interruptible rates (52 million therms) and the effectspermanent annual load loss in 1998 of a strong local
economy.5
million therms due to the bypass of one medium-sized industrial customer. In
1997, 91998, 10 percent of total utility operating revenues and 1719 percent of total
therms delivered were derived from sales and transportation deliveries to
industrial firm customers.

         Industrial interruptible gas sales and transportation deliveries during
19971998 totaled 385368 million therms, down 104 percent from 1996. While economic
expansion strengthened interruptible deliveries,1997. Interruptible
customers typically are larger volume customers with a number of largerheavy process load
profile, and generally were the customers migrated from tariff-based interruptible transportation or sales rates to
individually negotiated transportation agreements based upon bypass economics
(the customers' costs of a direct connection to an interstate pipeline).most affected by the recent downturn
in international markets. In 1997, 91998, 4 percent of total utility operating revenues
and 3532 percent of total therms delivered were derived from sales and transportation
deliveries to industrial interruptible customers.

         As described above,

         NW Natural and many of its largest industrial customers have entered
into negotiated transportation service agreements. These agreements are designed
to provide rates that are either: 1) competitive with either: (1) the costs of alternative
fuels, such as heavy oil,oil; or 2) competitive with(2) the customer's bypass alternatives. These
agreements generally prohibit bypass during their terms. During 1998, NW Natural
currently hasexperienced its first customer loss due to bypass in nearly 10 years. Due to the
cost pressures which confront a proposed contract beforenumber of the OPUCCompany's largest customers which
if not approved, may expose NW Natural to a bypasscompete globally, the risk of upbypass continues to 6
million therms of deliveries per year tobe a single customer. Other than this
possibility, NW Natural does not expect significant bypass to occur in the
foreseeable future.threat.

         Since 1994, NW Natural has been authorized by the OPUC to make off-systemupstream
commodity sales and to release portions of its firm interstate pipeline capacity
at discounted rates when seasonal demand is low. This authorization allows NW
Natural to compete effectively with independent gas marketers. EightySixty-seven
percent of all positive net revenues (gross revenues less the actual cost of gas
or pipeline capacity) generated from these sales and capacity releases ($3.54.6
million in 1997)1998) have been credited to Oregon core market customer gas costs. Effective March 2, 1998,costs,
with the crediting factor for off-system
commodity sales changed from 80 percent to 67 percent.balance benefiting shareholders.

         During 1997, NW Natural entered into a marketing alliance with
PacifiCorp, thePacifiCorp. The purpose of which isthe alliance was to provide electric and gas
commodity services and other energy-related services to industrial and
commercial customers in the states of Oregon and Washington.Washington that were eligible for PGE's
direct access pilot program. The alliance was successful in terms of the total
number of customers served and total electricity sold. The alliance's business
opportunities were significantly reduced at the end of 1998, however, with the
termination of PGE's pilot program. In addition,the absence of any further open access
opportunities, the alliance will provide other energy-related services
and products. NW Natural does not expect the alliance to have a material impact
on its earnings. The primary value of the alliance is to provide convenience and
extra value to end-use customers, creating a more loyal customer base for both
NW Natural and PacifiCorp. PacifiCorp provides wholesale power throughout the
U.S. and electricity and energy-related services to over 1.4 million retail
customersexpire in seven western states through its divisions, Pacific Power and Utah
Power.mid-1999.

Environment
- -----------

         NW Natural is subject to air, water, hazardous waste and other
environmental regulation by state and federal authorities and has complied in
all material respects with applicable regulations. Compliance with these

                                      11

regulations has not had a material effect on the Company's capital expenditures,
earnings or competitive position.

         NW Natural owns property in Linnton, Oregon, and previously owned
property in Salem and Eugene, Oregon that were sitesis the site of a
former gas manufacturing plants. The Linntonplant that was closed in 1956. In 1993, pursuant to
Oregon Department of Environmental Quality (ODEQ) procedures, NW Natural
submitted a notice of intent to participate in the ODEQ's Voluntary Cleanup
Program and, in 1994, the site is currently under investigation for potential
remediation. The Company receivedwas listed on ODEQ's Confirmed Release List and
Inventory. During 1995, initial tests revealed environmental contamination, but
the extent or the estimated cost of remediation cannot yet be determined. During
1998, the ODEQ and the U.S. Environmental Protection Agency (EPA) completed a
release from further liabilitystudy of sediments in a 5.5 mile segment of the Willamette River that includes
the area adjacent to the site. Remediation of the site may be affected by the
sediments management plan now being developed in response to the ODEQ/EPA
sediments study.

         Since 1993, NW Natural has recorded an expense of $2.0 million for the
Salemestimated costs of consultants' fees, ODEQ oversight cost reimbursements, and
the voluntary investigation, plus an estimate for costs of the continuing
investigation. NW Natural expects that its costs of investigation and any
remediation for which it may be responsible 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.

         In 1996, the Eugene Water and Electric Board (EWEB) asked NW Natural to
participate in an investigation and potential remediation of a 1.5 acre site of
a former manufactured gas plant in Eugene, Oregon. NW Natural purchased the
property in 1996. (See Part II, Item 7., "Environmental Matters.")1958, after the plant had been converted to a liquid propane gas
plant. It used the propane plant until 1960, when the distribution system was
converted to natural gas, and continued to use the plant as a service center
until its sale in 1976. Although NW Natural never operated the manufactured gas
plant, EWEB has contended that NW Natural's activities on the site may have
exacerbated prior contamination. To date, NW Natural has not agreed to
participate in an investigation of the site and has not obtained sufficient
information to determine the extent of its responsibility, if any, for
remediation of the site.

Employees 
- ---------

         At year-end 1997,1998, NW Natural had 1,3371,303 employees, of which 900937 were
members of the Office and Professional Employees International Union, Local No.
11. These union employees are working under a seven-year Joint Accord covering
wages, benefits and working conditions which will expire MarchMar. 31, 2004.

ITEM 2.  PROPERTIES

         NW Natural's natural gas distribution system consists of approximately
10,50011,100 miles of mains, as well as service pipes, meters and regulators, and gas
regulating and metering stations. The mains and feeder lines are located in
municipal streets or alleys pursuant to valid franchise or occupation
ordinances, in county roads or state highways pursuant to valid agreements or
permits granted pursuant to statute, or on lands of others pursuant to valid
easements obtained from the owners of such lands. NW Natural also holds all
necessary permits for the crossing of the Willamette River and a number of
smaller rivers by its mains.

                                      12

NW Natural owns service facilities in Portland, as well as various
satellite service centers, garages, warehouses, and other buildings necessary
and useful in the conduct of its business. It leases office space in Portland
for its corporate headquarters. District offices are maintained on owned or
leased premises at convenient points in the distribution system. NW Natural owns
LNG facilities in Portland and near Newport, Oregon, and also owns two
underground
natural gas reservoirs atlocated near Mist, Oregon.

         NW Natural considers all of its properties currently used in its
operations, both owned and leased, to be well maintained, in good operating
condition, and adequate for its present and foreseeable future needs.

         NW Natural 'sNatural's Mortgage and Deed of Trust constitutes a first mortgage
lien on substantially all of the real property constituting its utility plant.

         NW Natural holds interests in 8,9155,521 net acres of underground natural
gas storage and 1,824 net acres of oil and gas leases in Oregon. Financial
Corporation holds interests in United States oil and gas leases covering 8,5584,659
net acres located in Oregon, California, Wyoming, and Colorado. Canor holds interests in
Canadian gas and oil leases covering 149,211233,080 net acres in Alberta and
Saskatchewan. Most Canadian gas production is sold under long-term contracts to
markets in both Canada and the United States. NW Natural owns four depleted gas
reservoirs near Mist, Oregon, that will be developed as underground gas storage
facilities. It also holds an option to purchase future storage rights in certain
other areas of the Mist gas field. The Company also holds an equity investment
in a Boeing 737-300 aircraft.

ITEM 3.  LEGAL PROCEEDINGS

         In July 1995, a jury in an Oregon state court returned a verdict
against NW Natural in the case of Northwest Natural Gas Company v. Chase
--------------------------------------
Gardens, Inc. (Lane County Circuit Court Case No. 16-91-01370). The Oregon
- ------------- Court
of Appeals (Oregon Court of Appeals Case No. CA A90481) affirmed the trial court
decision in February 1997. TheNW Natural filed a petition for review of the Court
of Appeals' decision by the Oregon Supreme Court. In August 1997, the Oregon
Supreme Court agreed to hear the case on appeal and is expected to render a
final ruling during 1998.1999. NW Natural recorded a charge of $5.6 million in the
fourth quarter of 1996, equivalent to 15 cents a share, as a reserve against
payment of the judgment, related costs and post-judgment interest from the case.interest.

         The Company is party to certain other legal proceedingsactions in which claimants
seek material amounts. Although it is not possibleimpossible to predict the outcome with
certainty, based upon the opinions of legal counsel, management does not expect
disposition of these matters to have a materially adverse effect on the
Company's financial position, results of operations or cash flows.

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

         There were no matters submitted to a vote of security holders, through
the solicitation of proxies or otherwise, during the fourth quarter of the year
ended DecemberDec. 31, 1997.1998.

                                      13




ADDITIONAL ITEM.  EXECUTIVE OFFICERS OF THE REGISTRANT

                        Age at
    Name            December 31, 19971998    Positions held during last five years
    ----            -----------------    -------------------------------------

Richard G. Reiten          5859            President (1996 -(1996-  ); Chief Executive 
                                            Officer (1997-  ); Chief Operating 
                                            Officer (1996); President and Chief
                                            Operating Officer, Portland General
                                            Electric Company (1992-95); President,
                                             Portland General Corporation
                                             (1989-92).

Bruce R. DeBolt            5051            Senior Vice President, Finance, and 
                                            Chief Financial Officer (1990-  ).

Mark S. Dodson             5253            Senior Vice President, Public Affairs
                                             and General Counsel (1998 -1998-  );
                                             Senior Vice President (1997); 
                                             Partner, Ater Wynne Hewitt Dodson 
                                             & Skerritt LLP (1981 - 97)(1981-97).

Stephen P. Feltz           43            Treasurer and Controller (1999-  ); 
                                             Assistant Treasurer (1996-99); 
                                             Manager, General Accounting 
                                             (1996-99).

Dwayne L. Foley            5253            Senior Vice President (1999-  );
                                             Senior Vice President, Operations 
                                             Support, and Chief Engineer 
                                             (1997
                                          -   );(1997-99); Senior Vice President, 
                                             Operations and Information
                                             Services (1992-97);
                                             Senior Vice President, Gas
                                             Operations and Information Services
                                             (1990-92)Services(1992-97).

Michael S. McCoy           5455            Senior Vice President, Customer and 
                                             Utility Operations (1999- ); 
                                             Senior Vice President, Customer 
                                             Services (1992-   ).

Bruce B. Samson            62             Senior Vice President (1998);
(retired March 1, 1998)                      Senior Vice President, Public
                                             Affairs and General Counsel
                                             (1990-97)(1992-99).

W. Richard Harper, Jr.     4445            Vice President, Energy Marketing and 
                                             Supply 1997-(1997- ); Vice President, 
                                             Industrial and District Operations
                                             (1995-97); General Manager, 
                                             Industrial and Business 
                                             Development (1992-95).

Diana J. Johnston          5354            Vice President, Human Resources and 
                                             Administrative Services (1996- );
                                             Vice President, Human Resources 
                                             (1992-96).

Gregg S. Kantor            4041            Vice President, Public Affairs and 
                                             Communications (1998-  );Director,
                                             Public Affairs and Communications
                                             (1996-97); Principal, Kantor & 
                                             Associates (1994-96); Manager,
                                             Economic Development, Portland 
                                             General Electric Company 
                                             (1991-94).

C. J. Rue                  5253            Secretary (1982-  ); Assistant 
                                             Treasurer (1987-  ).

D. James Wilson            5859            Vice President (1999-  ); Treasurer 
                                             and Controller (1987-  ).(1987-99).


          Each executive officer serves successive annual terms; present terms
end May 28, 1998.27, 1999.

          There are no family relationships among the Company's executive 
officers.


                                       14


         
                                     PART II

ITEM 5.   MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER 
          MATTERS

         (A) NW Natural's common stock is traded on the Nasdaq National Market
tier of the Nasdaq Stock Market, which reports the daily high, low and closing
transaction prices, as well as volume data, under the symbol "NWNG"."NWNG."

         NW Natural's common stock is included on the Federal Reserve Board's
list of over-the-counter securities determined to be subject to margin
requirements under the Board's regulations.

         NW Natural's common stock was split three-for-two effective September 6,
1996, in the form of a 50% stock dividend, to shareholders of record August 23,
1996. Share prices and dividends paid on shares of NW Natural's common stock for
periods prior to the effective date of the stock split, have been adjusted for
the stock split.

         The quarterly high and low closing trades for NW Natural's common
stock, as quoted on the Nasdaq National Market and published in theThe Wall Street
Journal and on Nasdaq's World Wide Web site, were as follows:


                     1998                             1997        
              1996
                  ------------------            -----------------------------------------
Quarter Ended     High     Low                  High       Low    
- ------------------------------------------------------------------

March 31         ........$30.75  $25.75                $25.38  $23.25
$22.67      $20.83
June 30           .........28.25   26.38                 26.88   23.13
23.58       21.17
September 30      ....28.00   24.25                 27.75   24.25
24.25       22.54
December 31       .....30.25   25.75                 31.25   24.38      25.75       23.25

     The closing quotation for the common stock on DecemberDec. 31, 19971998 was $31.00.$25.875. On
DecemberDec. 31, 19961997 the closing quotation was $24.00.$31.00.

     (B) As of DecemberDec. 31, 19971998 there were 10,0979,340 holders of record of the Company's
common stock.

     (C) NW Natural has paid quarterly dividends on its common stock in     
each year since the stock first was issued to the public in 1951. Annual common
dividend payments have increased each year since 1956. Dividends per share paid
during the past two years were as follows:

          Payment Date:                     1998                         1997                     1996
          -------------                     ----                         ----

          February 15                       $0.30$0.305                       $0.30
          May 15                            $0.30$0.305                       $0.30
          August 15                         $0.30$0.305                       $0.30
          November 15                       $0.305                       $0.30$0.305
                                            ------                       -----------

          Total per share                   $1.22                        $1.205                   $1.20

         It is the intention of the Board of Directors to continue to pay cash
dividends on the Company's common stock on a quarterly basis. However, future
dividends will be dependent upon NW Natural's earnings, its financial condition
and other factors.


                                      15



         NW Natural's Dividend Reinvestment and Stock Purchase Plan permits
registered owners of common stock to reinvest all or a portion of their
quarterly dividends in additional shares of NW Natural's common stock at the
current market price. Shareholders also may invest cash on a monthly basis, up
to $50,000 per calendar year, in additional shares at the current market price.
During 1997,1998, dividend reinvestments and optional cash investments under the Plan
aggregated $5.2$5.3 million and resulted in the issuance of 211,532194,835 shares of common
stock. During the 2021 years the Plan has been available the Company has issued
and sold 3,400,1103,594,945 shares of common stock which produced $70.1$75.4 million in
additional capital.



                                      
16 ITEM 6. SELECTED FINANCIAL DATA The following table sets forth selected financial data concerning the Company's operations and financial condition. Operating revenues and cost of sales ($000): 1998 1997 1996 ---- ---- ---- Sales revenues: Residential $ 205,388 $ 177,835 $183,802 Commercial 117,889 100,677 104,582 Industrial - firm 34,303 27,025 30,672 Industrial - interruptible 15,337 13,944 17,097 Unbilled revenues 8,314 1,647 1,627 ----------- ---------- -------- Total gas sales revenues 381,231 321,128 337,780 Transportation 19,958 22,029 22,533 Other 2,617 7,884 9,824 ----------- ---------- -------- Total utility operating revenues 403,806 351,041 370,137 Cost of gas 173,242 130,381 141,789 ----------- ---------- -------- Net utility operating revenues 230,564 220,660 228,348 Non-utility net operating revenues 12,701 9,868 10,009 ----------- ---------- -------- Net operating revenues $ 243,265 $ 230,528 $238,357 =========== ========== ======== Net income $ 27,301 $ 43,059 $ 46,793 Preferred and preference stock dividend requirements 2,577 2,646 2,723 ----------- ---------- --------- Earnings applicable to common stock $ 24,724 $ 40,413 $ 44,070 =========== ========== ======== Average common shares outstanding (000)* 24,233 22,698 22,391 =========== ========== ======== Basic earnings per share of common stock* $1.02 $1.78 $1.97 =========== ========== ========= Diluted earnings per share of common stock* $1.02 $1.76 $1.94 =========== ========== ========= Dividends per share of common stock* $1.22 $1.205 $1.20 =========== ========== ========= Total assets - at end of period ($000) $1,191,736 $1,111,617 $988,869 ========== ========== ======== Ratio of Earnings to Fixed Charges** 2.12 2.99 3.53 ==== ==== ==== Operating revenues and cost of sales ($000): 1995 1994 ---- ---- Sales revenues: Residential $165,662 $176,510 Commercial 99,079 108,452 Industrial - firm 31,268 34,443 Industrial - interruptible 24,113 27,361 Unbilled revenues 1,173 (5,571) -------- -------- Total gas sales revenues 321,295 341,195 Transportation 16,650 14,702 Other 9,411 429 -------- -------- Total utility operating revenues 347,356 356,326 Cost of gas 142,025 162,437 -------- -------- Net utility operating revenues 205,331 193,889 Non-utility net operating revenues 8,271 11,773 -------- -------- Net operating revenues $213,602 $205,662 ======== ======== Net income $ 38,065 $ 35,461 Preferred and preference stock dividend requirements 2,806 2,983 -------- --------- Earnings applicable to common stock $ 35,259 $ 32,478 ========= ========= Average common shares outstanding (000)* 21,817 19,943 ========= ========= Basic earnings per share of common stock* $1.62 $1.63 ========= ========= Diluted earnings per share of common stock* $1.60 $1.61 ========= ========= Dividends per share of common stock* $1.18 $1.173 ========= ========= Total assets - at end of period ($000) $ 929,277 $ 889,304 ========= ========= Ratio of Earnings to Fixed Charges** 3.15 3.08 ==== ==== * Years prior to 1996 1995 1994 1993 ---- ---- ---- ---- ---- Sales revenues: Residential $ 177,835 $183,802 $165,662 $176,510 $168,217 Commercial 100,677 104,582 99,079 108,452 103,476 Industrial - firm 27,025 30,672 31,268 34,443 31,340 Industrial - interruptible 13,944 17,097 24,113 27,361 18,884 Unbilled revenues 1,647 1,627 1,173 (5,571) 5,153 ------------------------------------------------------- Total gas sales revenues 321,128 337,780 321,295 341,195 327,070 Transportation 22,029 22,533 16,650 14,702 17,892 Other 8,513 9,943 10,060 829 2,890 ------------------------------------------------------- Total utility operating revenues 351,670 370,256 348,005 356,726 347,852 Cost of gas 129,094 142,752 144,051 163,026 138,833 -------------------------------------------------------- Net utility operating revenues 222,576 227,504 203,954 193,700 209,019 Non-utility net operating revenues 9,868 10,009 8,271 11,773 10,865 -------------------------------------------------------- Net operating revenues $ 232,444 $237,513 $212,225 $205,473 $219,884 ======================================================== Net income $ 43,059 $ 46,793 $ 38,065 $ 35,461 $ 37,647 ======================================================== Preferred and preference stock dividend requirements 2,646 2,723 2,806 2,983 3,488 -------------------------------------------------------- Earnings applicable to common stock $ 40,413 $ 44,070 $ 35,259 $ 32,478 $ 34,159 ======================================================== Average common shares outstanding (000)* 22,698 22,391 21,817 19,943 19,612 ======================================================== Basic earnings per share of common stock* $1.78 $1.97 $1.62 $1.64 $1.74 ======================================================== Diluted earnings per share of common stock* $1.76 $1.94 $1.60 $1.61 $1.72 ======================================================== Dividends per share of common stock* $1.205 $1.20 $1.18 $1.173 $1.167 ======================================================== Total assets - at end of period ($000) $1,111,617 $988,869 $929,277 $889,304 $849,036 ======================================================== Ratio of Earnings to Fixed Charges** 2.99 3.53 3.15 3.08 3.22 ========================================================
* Prior years have been restated to give effect to three-for-twothe three-for- two stock split in September 1996. ** Computed using the Securities and Exchange Commission method. For this purpose, earnings consist of net income before taxes plus fixed charges, and fixed charges consist of interest on all indebtedness, the amortization of debt expense and discount or premium, and the estimated interest portion of rentals charged to income.
SELECTED FINANCIAL DATA (continued) 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Capitalization - at end of period ($000): Common stock equity $366,265 $346,778 $323,552 $274,408 $258,565 Redeemable preference stock 25,000 25,000 25,000 26,252 26,633 Redeemable preferred stock 12,429 13,749 14,840 15,950 17,041 Long-term debt 344,303 271,838 279,945 291,076 272,931 ------------------------------------------------------ Total capitalization $747,997 $657,365 $643,337 $607,686 $575,170 ====================================================== Gas sales and transportation deliveries (000 therms): Residential 306,356 306,310 256,462 260,218 267,818 Commercial 225,249 225,115 196,723 201,925 209,642 Industrial - firm 84,523 91,122 82,958 81,348 80,588 Industrial - interruptible 53,929 63,261 84,173 89,899 66,370 Unbilled therms 3,615 3,759 4,946 (7,519) 3,844 ------------------------------------------------------ Total gas sales 673,672 689,567 625,262 625,871 628,262 Transportation 440,452 410,062 379,116 364,461 415,367 ------------------------------------------------------ Total volumes delivered 1,114,124 1,099,629 1,004,378 990,332 1,043,629 ====================================================== Customers (average for period): Residential 394,415 374,558 355,427 338,053 320,186 Commercial 48,232 46,355 44,740 43,367 41,906 Industrial - firm 411 409 405 398 388 Industrial - interruptible 119 131 143 148 122 Transportation 120 106 79 66 100 ------------------------------------------------------ Total customers 443,297 421,559 400,794 382,032 362,702 ====================================================== Customer statistics: Heat requirements*** Actual degree days 4,092 4,427 3,779 4,020 4,452 20-year average degree days 4,264 4,273 4,306 4,324 4,313 Average annual use per customer in therms: Residential 777 823 726 776 844 Commercial 4,670 4,874 4,420 4,680 5,029 Gas purchased cost per therm - net (cents) 24.05 22.25 20.67 23.44 23.11 ======================================================
17 SELECTED FINANCIAL DATA (continued) 1998 1997 1996 ---- ---- ---- Capitalization - at end of period ($000): Common stock equity $412,404 $366,265 $346,778 Redeemable preference stock 25,000 25,000 25,000 Redeemable preferred stock 11,499 12,429 13,749 Long-term debt 366,738 344,303 271,838 -------- -------- -------- Total capitalization $815,641 $747,997 $657,365 ======== ======== ======== Gas sales and transportation deliveries (000 therms): Residential 315,686 306,356 306,310 Commercial 229,124 225,249 225,115 Industrial - firm 87,275 84,523 91,122 Industrial - interruptible 51,521 53,929 63,261 Unbilled therms 8,645 3,615 3,759 -------- -------- ---------- Total gas sales 692,251 673,672 689,567 Transportation 446,165 440,452 410,062 ---------- -------- ---------- Total volumes delivered 1,138,416 1,114,124 1,099,629 ========= ========= ========= Customers (average for period): Residential 413,714 394,415 374,558 Commercial 50,469 48,232 46,355 Industrial - firm 404 411 409 Industrial - interruptible 114 119 131 Transportation 122 120 106 ---------- ---------- ---------- Total customers 464,823 443,297 421,559 ======= ======= ======= Customer statistics: Heat requirements*** Actual degree days 4,011 4,092 4,427 20-year average degree days 4,234 4,264 4,273 Average annual use per customer in therms: Residential 749 777 823 Commercial 4,540 4,670 4,874 Gas purchased cost per therm - net (cents) 25.09 24.05 22.25 ===== ===== ===== 1995 1994 ---- ---- Capitalization - at end of period ($000): Common stock equity $323,552 $274,408 Redeemable preference stock 25,000 26,252 Redeemable preferred stock 14,840 15,950 Long-term debt 279,945 291,076 -------- -------- Total capitalization $643,337 $607,686 ======== ======== Gas sales and transportation deliveries (000 therms): Residential 256,462 260,218 Commercial 196,723 201,925 Industrial - firm 82,958 81,348 Industrial - interruptible 84,173 89,899 Unbilled therms 4,946 (7,519) -------- ------- Total gas sales 625,262 625,871 Transportation 379,116 364,461 -------- ------- Total volumes delivered 1,004,378 990,332 ========= ======= Customers (average for period): Residential 355,427 338,053 Commercial 44,740 43,367 Industrial - firm 405 398 Industrial - interruptible 143 148 Transportation 79 66 ---------- -------- Total customers 400,794 382,032 ======= ======= Customer statistics: Heat requirements*** Actual degree days 3,779 4,020 20-year average degree days 4,306 4,324 Average annual use per customer in therms: Residential 726 776 Commercial 4,420 4,680 Gas purchased cost per therm - net (cents) 20.67 23.44 ===== ===== *** A degree day is the measure of the coldness of the weather experienced based on the extent to which the average of the high and low temperatures for a day falls below 65 degrees Fahrenheit. 18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The consolidated financial statements include: Regulated utility: Northwest Natural Gas Company (NW Natural) Non-regulated wholly-owned subsidiaries:subsidiary businesses: NNG Financial Corporation (Financial Corporation), a wholly owned subsidiary Canor Energy, Ltd. (Canor), a majority-owned subsidiary Oregon Natural Gas Development Corporation (Oregon Natural)-merged- merged with and into NW Natural during the second quarter of 1996 Together these businesses are referred to herein as the "Company" (see "Subsidiary Operations" below and Note 2 to the Consolidated Financial Statements). The following is management's assessment of the Company's financial condition including the principal factors that affect results of operations. The discussion refers to the consolidated activities of the Company for the three years ended December 31, 1997. Earnings and Dividends - ---------------------- In 1997, the Company's earnings applicable to common stock were $40.4 million, the second highest in the Company's history. Earnings in 1996 were a record $44.1 million, up 25 percent from $35.3 million in 1995. The higher 1996 earnings reflect both colder weather and customer growth. Earnings for both 1997 and 1995 were lower due to warmer than normal weather, the effect of which was partially offset by additional sales from customer growth. The Company's basic earnings from consolidated operations were $1.78 a share in 1997, down from $1.97 a share in 1996 and up from $1.62 a share in 1995. NW Natural earned $1.70 a share from gas utility operations in 1997, compared to $1.87 in 1996 and $1.43 in 1995. Weather conditions in NW Natural's service territory in 1997 were 8 percent warmer than in 1996 and 4 percent warmer than the 20-year average. Weather in 1996 was 17 percent colder than 1995 and 4 percent colder than the 20-year average. The estimated weather-related decrease in net operating revenues (margin) during 1997 was equivalent to about 24 cents a share compared to actual conditions during 1996. The colder weather in 1996 resulted in increased gas deliveries to, and related margin from, weather-sensitive customers. The weather-related increase in 1996 was equivalent to about 55 cents a share compared to actual conditions in 1995. Customer growth of 5.7 percent during both 1997 and 1996 contributed an estimated $12.6 million to 1997 margin and $10.9 million to 1996 margin. Customer growth of 4.7 percent during 1995 contributed an estimated $9.7 million to margin. The estimated impact on margin of weather and customer growth are derived from NW Natural's internal planning model. The model calculates expected sales to, and revenues from, residential and commercial customers for "base usage," representing gas use for water heaters, ranges, and other appliances not sensitive to outside temperatures. The model also calculates expected sales to, and revenues from, these customers for "heat sensitive" usage, primarily furnaces, as a function of heating degree days (the difference between 65 degrees Fahrenheit and the average of a day's high and low temperatures). The model then estimates the earnings effect of the difference between expected sales and revenues under actual temperature conditions, and expected sales and revenues under average temperature conditions. Subsidiary earnings for 1997 were equivalent to 8 cents a share, compared to 10 cents in 1996 and 19 cents in 1995. The decrease in 1997 from 1996 was primarily due to a one-time $2.9 million gain in 1996 from Oregon Natural's sale of its underground storage assets to NW Natural which was offset in part by an impairment loss of $1.3 million on producing wells and a $1.0 million write-down of unproven properties. The decrease in 1996 from 1995 was primarily due to a one-time $3.8 million gain in 1995 from Oregon Natural's sale of production and related gathering system assets. 1997 was the 42nd consecutive year in which the Company's dividends paid have increased. Dividends paid on common stock were $1.205 a share in 1997 compared with $1.20 in 1996 and $1.18 in 1995. Results of Operations - --------------------- Regulatory Matters ------------------ NW Natural provides gas utility service in Oregon and Washington, with Oregon representing approximately 94 percent of its revenues. Future earnings and cash flows from utility operations will be determined for the most part by continued growth in the residential and commercial markets, and by NW Natural's ability to remain price competitive in the large industrial market, to control expenses, and to obtain timely regulatory approval for rate changes reflecting investments in new utility plant. NW Natural currently has no competition from other gas utility distributors in the territory it serves. However, it competes with Northwest Pipeline Corporation (NPC) to serve large industrial customers, with oil and electricity for industrial and commercial uses, and with oil, electricity, and wood for residential use. The Pacific Northwest has historically enjoyed some of the lowest electric rates in the nation, primarily due to the proximity of federal hydropower facilities. With further deregulation of the energy business, the market for energy will become more competitive, but the Pacific Northwest is unlikely to experience the large drop in electric rates that other, high-cost areas of the country are anticipating. In 1997, NW Natural maintained its competitive advantage over electricity and approximate price parity with fuel oil in the residential and commercial markets. In October 1997, the Washington Utilities and Transportation Commission (WUTC) approved a general rate increase averaging 3 percent for NW Natural's customers in Washington. Revenue from Washington operations will increase by approximately $0.6 million annually due to the combined effects of the general rate increase of about $0.5 million and a temporary surcharge to recover over five years the balance of deferred expense related to retiree health care and life insurance benefits attributable to Washington operations. The WUTC authorized a return on common equity of 11.25 percent. Effective December 1, 1997, the WUTC approved a rate increase averaging 10.5 percent to pass through to Washington customers increases in purchased gas costs and to remove temporary rate increments to amortize balances in deferred accounts. The WUTC approved rate decreases averaging 4.9 percent and 8.0 percent, respectively, effective December 1, 1996 and 1995. Effective January 1, 1998, the Oregon Public Utility Commission (OPUC) approved rate increases averaging 11.4 percent for NW Natural's customers in Oregon. The OPUC also approved a settlement modifying the incentive formula for deferrals of variations in gas costs, from 80 percent to 67 percent. The OPUC approved rate decreases averaging 3.6 percent and 6.7 percent effective December 1, 1996 and 1995, respectively. The rate increases in Oregon in 1998 and the rate decreases in 1996 and 1995 reflected changes in NW Natural's purchased gas costs, the application of temporary rate adjustments to amortize regulatory balancing accounts and the removal of temporary rate adjustments effective the previous year. None of the rate increases and decreases discussed above had a material effect on net income. Comparison of Gas Operations ----------------------------
The following table summarizes the composition of gas utility volumes and revenues for the three years ended December 31: Thousands (Except customers and degree days) 1997 1996 1995 - ------------------------------------------------------------------------------------------------- Gas Sales and Transportation Volumes (Therms): - ---------------------------- Residential and commercial sales 531,605 531,425 453,185 Unbilled volumes 3,615 3,759 4,946 --------- ---------- --------- Weather-sensitive volumes 535,220 48% 535,184 49% 458,131 46% Industrial firm sales 84,523 7% 91,122 8% 82,958 8% Industrial interruptible sales 53,929 5% 63,261 6% 84,173 8% --------- ---------- --------- Total gas sales 673,672 689,567 625,262 Transportation deliveries 440,452 40% 410,062 37% 379,116 38% --------- ---- --------- ---- --------- ---- Total volumes sold and delivered 1,114,124 100% 1,099,629 100% 1,004,378 100% ========= ==== ========= ==== ========= ==== Utility Operating Revenues: - --------------------------- Residential and commercial revenues $278,512 $288,384 $264,741 Unbilled revenues 1,647 1,627 1,173 -------- -------- -------- Weather-sensitive revenues 280,159 80% 290,011 78% 265,914 76% Industrial firm sales revenues 27,025 8% 30,672 8% 31,268 9% Industrial interruptible sales revenues 13,944 4% 17,097 5% 24,113 7% -------- -------- -------- Total gas sales revenues 321,128 337,780 321,295 Transportation revenues 22,029 6% 22,533 6% 16,650 5% Other revenues 8,513 2% 9,943 3% 10,060 3% -------- ---- -------- ---- -------- ---- Total utility operating revenues $351,670 100% $370,256 100% $348,005 100% ======== ==== ======== ==== ======== ==== Cost of gas sold $129,094 $142,752 $144,051 ======== ======== ======== Total number of customers (end of period) 458,021 433,169 409,949 ======= ======= ======= Actual degree days 4,092 4,427 3,779 ======== ======== ======== 20-year average degree days 4,264 4,273 4,306 ======== ======== ========
Residential and Commercial -------------------------- NW Natural continues to experience a rapid customer growth rate relative to others in the industry. The 24,852 customers added during 1997 represent a growth rate of 5.7 percent, repeating the record growth rate achieved in 1996. In the three years ended December 31, 1997, more than 66,000 customers were added to the system, representing an average annual growth rate of 5.4 percent. Weather conditions were 4 percent warmer than average in 1997, 4 percent colder than average in 1996, and 12 percent warmer than average in 1995. Average weather conditions are calculated from the most recent 20 years of temperature data measured by heating degree days. Weather in 1997 was 8 percent warmer than in 1996 while 1996 was 17 percent colder than 1995. Typically, 75 percent or more of NW Natural's annual operating revenues are derived from gas sales to weather-sensitive residential and commercial customers. Accordingly, variations in temperatures between periods will affect volumes of gas sold to, and revenues derived from, these customers. The volumes of gas sold to residential and commercial customers during 1997 were comparable to 1996, reflecting the combined effects of residential and commercial volumes added from customer growth, offset by reduced gas use due to warmer weather. Related revenues decreased 3 percent primarily due to rate decreases effective December 1, 1996. The addition of 23,220 customers and 17 percent colder weather in 1996 compared to 1995 resulted in a 9 percent increase in related revenues over 1995. In order to match revenues with related purchased gas costs, NW Natural records unbilled revenues for gas delivered but not yet billed to customers through the end of the period. Industrial Sales, Transportation and Other Revenues --------------------------------------------------- The combined margin from industrial sales and transportation decreased 5 percent in 1997, from $53.9 million in 1996 to $51.3 million in 1997, and increased 9 percent from $49.6 million in 1995 to $53.9 million in 1996. Total volumes delivered to industrial customers were 15.3 million therms, or 3 percent, higher in 1997 than in 1996. The decrease in margin despite increased volumes in 1997 reflects the migration by some customers to lower rates under special anti-bypass contracts. Total volumes delivered to industrial customers were 16.7 million therms, or 3 percent, higher in 1996 than in 1995. In addition to higher volumes, margin improved in 1996 due to higher prices under industrial incentive rate schedules which are designed to track changes in oil prices. NW Natural did not experience margin losses from new bypasses of its system in 1997, 1996 or 1995. Although NW Natural does not expect a significant number of its large customers to bypass its system in the foreseeable future, it may experience further deterioration of margin associated with customers' transfers to contracts with pricing designed to be competitive with the capital and operating costs of direct connections to NPC's system. Other revenues primarily relate to adjustments in regulatory accounts (see Note 1 to the Consolidated Financial Statements). Other revenues for 1997 included $6.1 million from the amortization of property tax savings and $1.2 million from the amortization of Oregon income tax savings. In 1996, other revenues included $4.0 million from the amortization of property tax savings, $1.6 million from regulatory amortizations, and two non-recurring gains. Specifically, NW Natural recorded a gain of $0.7 million for the recovery of costs and lost revenues related to energy conservation programs approved by the OPUC. NW Natural also recorded a gain of $0.9 million as the result of a settlement with the OPUC concerning amounts to be refunded to Oregon customers from prior-year savings in property taxes and Oregon income taxes. In 1995, other revenues included a one-time, $3.0 million payment under a contract with Portland General Electric Company (PGE), an electric utility based in Portland. This contract gave PGE the option to request gas transportation service for electric generation at one or more sites in NW Natural's service territory. Additionally, other revenues in 1995 included $2.3 million from amortization of the Interruptible Sales Adjustment account and $3.1 million from other regulatory amortizations. Cost of Gas ----------- The cost per therm of gas sold during 1997 was 7 percent lower than in 1996, while such cost in 1996 was 10 percent lower than in 1995. The cost per therm of gas sold includes current gas purchases, gas drawn from storage, demand cost equalization, regulatory deferrals, and company use. For the years 1997, 1996 and 1995, the cost of gas sold was reduced by non-regulated gas sales of $2.3 million, $1.2 million, and $0.3 million, respectively. Under an agreement with the OPUC, these sales are treated as a reduction of gas costs. The average cost per therm of gas purchased was 8 percent higher in 1997 than in 1996, due to fluctuations in prices NW Natural paid for the portion of its gas supplies tied to monthly market price indexes. NW Natural has a Purchased Gas Cost Adjustment (PGA) tariff under which its net income from Oregon operations is affected only within defined limits by changes in purchased gas costs. In 1997, NW Natural absorbed 20 percent of the higher cost of gas purchased, as compared to projections, under its Oregon PGA tariff. The remaining 80 percent of the higher gas costs was recorded as deferred debits (regulatory assets). Effective January 1, 1998, the incentive formula for deferred gas costs was modified so that NW Natural will absorb 33 percent of the difference between actual and projected gas costs and the remaining 67 percent will be deferred for recovery or refund to customers in future rates. Subsidiary Operations --------------------- Consolidated subsidiary earnings for 1997 were $1.8 million, equivalent to 8 cents a share, compared to $2.2 million, or 10 cents a share, in 1996, and $4.1 million, or 19 cents a share, in 1995 (see Note 2 to the Consolidated Financial Statements). In 1997, Financial Corporation earned $1.6 million, compared to $1.0 million in 1996 and $1.3 million in 1995. 1997 results included a $1.1 million gain from the sale of Financial Corporation's interest in a California solar electric generation partnership during the fourth quarter. The decreases in Financial Corporation's on-going operating results from 1996 to 1997 and from 1995 to 1996 were primarily due to weaker operating results attributable to its investments in windpower energy facilities in California. Canor earned $0.2 million in 1997, compared to $0.5 million in 1996. Canor's 1997 results included a $0.9 million write-down of unproven properties in the fourth quarter, while 1996 results include $0.9 million in impairment losses resulting from the application of Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." Oregon Natural was merged into NW Natural during 1996, thereby effecting the transfer of certain assets, including the stock of Canor, to NW Natural. As a result of this merger, Canor became a wholly-owned subsidiary of NW Natural. Earnings from Canor's operations in 1995, prior to the merger, are included in Oregon Natural's results of operations. Oregon Natural earned $0.7 million in 1996 compared to $1.8 million in 1995. Oregon Natural's earnings in 1996 and 1995 included one-time gains from asset sales, including a $2.9 million gain from the sale of underground storage assets to NW Natural in 1996, and a $3.8 million gain from the sale of its gathering system and gas producing properties in 1995. The 1996 gain was partially offset by a $1.3 million impairment loss on producing wells and a $1.0 million write-down of unproven properties. Operating Expenses ------------------ Operations and Maintenance -------------------------- Consolidated operations and maintenance expenses were $2.3 million, or 3 percent, lower in 1997 than in 1996. NW Natural's operations and maintenance expenses in 1997 decreased $2.1 million, or 3 percent, compared to 1996 primarily due to a one-time charge of $4.9 million in 1996 for 1995 litigation (see "Chase Gardens Litigation", below), offset by increases in customer service and market development expense ($2.9 million); electronic and network services ($0.6 million); and environmental investigation and remediation charges ($0.6 million). Included in 1997 operations and maintenance expense was a $4 million increase in payroll due to salary increases as well as wage increases resulting from NW Natural's new seven-year labor agreement effective April 1, 1997. Subsidiary expenses decreased $0.2 million, or 6 percent, in 1997 compared to 1996 primarily due to a decline in oil and gas production costs. NW Natural's operations and maintenance expenses in 1996 were $9.3 million higher than in 1995, while subsidiary expenses decreased $1.1 million. The increase in utility operations and maintenance expenses was primarily due to the $4.9 million judgment against NW Natural in the Chase Gardens litigation ------------- (see below); expenses related to cold weather and floods ($0.6 million); higher bonus accruals ($1.9 million); environmental investigation costs ($0.4 million); service costs tied to customer growth ($0.8 million); and market development costs ($0.7 million). Lower subsidiary operations and maintenance expenses were primarily due to a decline in oil and gas production expenses. Chase Gardens Litigation ------------------------ In July 1995, a jury in an Oregon state court returned a verdict against NW Natural in the case of Northwest Natural Gas Company v. Chase -------------------------------------- Gardens, Inc. (Lane County Circuit Court Case No. 16-91-01370). The Oregon - ------------- Court of Appeals (Oregon Court of Appeals Case No. CA A90481) affirmed the trial court decision in February 1997. The Oregon Supreme Court agreed to hear the case on appeal and is expected to render a final ruling during 1998. NW Natural recorded charges of $5.6 million in the fourth quarter of 1996, equivalent to 15 cents a share, as a reserve against payment of the $4.9 million judgment plus related costs and post-judgment interest. Taxes Other Than Income ----------------------- Taxes other than income, which are comprised of property, franchise, payroll and other taxes, declined $1.6 million, or 8 percent, in 1997. Property tax expense was $1.6 million, or 17 percent, lower than in 1996, due to settlements reached in 1996 relating to property valuations and regulatory treatment of reduced property taxes. NW Natural's franchise taxes, which are incurred as a percentage of revenue, decreased 4 percent, from $8.2 million in 1996 to $7.9 million in 1997, paralleling the percentage decrease in gas sales revenues from 1996 to 1997. The decrease in franchise taxes was offset by increased payroll taxes and regulatory fees. Depreciation, Depletion and Amortization ---------------------------------------- Depreciation, depletion and amortization expense increased $1.6 million, or 4 percent, in 1997 compared to 1996, and $2.5 million, or 6 percent, in 1996 compared to 1995. NW Natural's depreciation expense increased $3.1 million from 1996 to 1997 due to an additional $111.1 million of utility plant placed in service. The new Customer Information System (CIS), placed in service in the fourth quarter of 1997, increased depreciation expense by $0.2 million compared to 1996. NW Natural's depreciation expense decreased $0.7 million, or 2 percent, in 1996 compared to 1995 primarily due to lower depreciation rates approved by the OPUC and WUTC effective January 1, 1996. Depreciation, depletion and amortization expense for subsidiaries decreased $1.5 million in 1997. Depreciation expense for 1997 included expenses of $1.7 million recorded by Canor for the write-down of unproven properties and the abandonment of dry wells. Subsidiary depreciation, depletion and amortization expense increased $3.2 million, or 79 percent, in 1996 compared to 1995 primarily due to impairment and abandonment expenses totaling $2.3 million which were recorded by Oregon Natural pursuant to SFAS No. 121 and the write-down of unproven properties. Canor also recorded a $0.9 million expense during 1996 pursuant to SFAS No. 121. Other Income ------------ The variations in other income during the past three years resulted primarily from non-recurring items and a $1.4 million decline in interest income in 1997 from 1996. Oregon Natural recorded a gain in 1996 on the sale of its underground storage facilities, and recorded a gain in 1995 on the sale of its gathering system and interests in production assets in Oregon. NNG Energy Systems, Inc., a wholly-owned subsidiary of the Company that was dissolved in 1995, recorded a gain in 1995 resulting from the reorganization of its California cogeneration subsidiary. Interest Charges ---------------- NW Natural's interest charges increased $2.7 million, or 10 percent, in 1997 compared to 1996 due to the issuance of $90 million of Medium-Term Notes during 1997 and higher commercial paper balances outstanding. The average commercial paper balances increased from $14.0 million in 1996 to $45.8 million in 1997. The increases in NW Natural's long-term and short-term debt balances were primarily due to the financing of its $117 million utility construction program and $28.6 million in deferred gas costs. Interest charges in 1996 increased $1.2 million, or 5 percent, compared to 1995, also due to higher long-term and short-term debt balances outstanding related to the financing of NW Natural's utility construction expenditures, and to accrued interest charges of $0.7 million for post-judgment interest for the Chase Gardens litigation. Allowance for Funds Used During Construction (AFUDC) represents the cost of funds used during the construction of utility plant (see Note 1 to the Consolidated Financial Statements). In 1997, 1996 and 1995, AFUDC reduced interest expense by $1.7 million , $0.8 million and $0.6 million, respectively. The weighted average AFUDC rates were 5.8 percent in 1997, 8.9 percent in 1996 and 5.3 percent in 1995 (See "Financing Activities" below). Income Taxes ------------ The effective corporate income tax rate for the years ended December 31, was 33 percent for 1997 and 37 percent for both 1996 and 1995. The lower 1997 tax rate was primarily due to permanent tax savings from the change in book depreciation rates, an increase in tax credits, and a reversal of amounts previously recorded for a California solar energy investment that was sold by Financial Corporation (see Note 7 to the Consolidated Financial Statements). The significant increase in 1996 income tax expense was due to the $14 million, or 23 percent, increase in income before income taxes compared to 1995. In 1996, NW Natural recorded an adjustment reducing tax expense for the year by $1.9 million, or 8 cents a share, for reversal of deferred tax amounts provided in prior years. Redeemable Preferred and Preference Stock Dividend Requirements --------------------------------------------------------------- Redeemable preferred and preference stock dividend requirements for 1997 were lower by $0.1 million, or 3 percent, compared to 1996, due to sinking fund redemptions and the redemption of all the outstanding shares of the $4.68 series of preferred stock in June 1997. 1996 requirements were $0.1 million, or 3 percent, lower than 1995 due to sinking fund redemptions and the conversion or redemption of the remaining shares of the Convertible Preference Stock, $2.375 Series, in May 1995. Financial Condition - ------------------- Capital Structure ----------------- NW Natural's capital expenditures are incurred primarily for utility construction resulting from customer growth and system improvements. NW Natural finances these expenditures from cash provided by operations and from short-term borrowings which are periodically refinanced through the sale of long-term debt or equity securities. In addition to its capital expenditures, the weather-sensitive nature of gas usage by NW Natural's residential and commercial customers influences the Company's financing requirements. Short-term liquidity requirements are satisfied primarily through the sale of commercial paper, which is supported by commercial bank lines of credit (see Note 6 to the Consolidated Financial Statements). The Company's long-term goal is to maintain a capital structure comprised of 45 to 50 percent common stock equity, 5 to 10 percent preferred and preference stock and 45 to 50 percent short-term and long-term debt. When additional capital is required, the Company issues debt or equity securities depending upon both the target capital structure and market conditions. The Company also uses these sources to meet long-term debt and preferred and preference stock redemption requirements (see Notes 3 and 5 to the Consolidated Financial Statements). Cash Flows ---------- Operating Activities -------------------- Cash provided by operating activities in 1997 was $44.1 million, or 49 percent, lower than in 1996. The decrease was primarily due to an increase in deferred gas costs ($36.7 million) and a decrease in accounts payable ($6.0 million). In 1996, cash provided by operating activities was $6.1 million, or 7 percent, higher than in 1995, primarily due to increased gas deliveries and the related margin from weather-sensitive customers resulting from colder weather and customer growth. The increase in margin in 1996 was partially offset by the continuing effects of rate reductions effective in December 1994 and 1995 to amortize credit balances in regulatory accounts. The Company has lease and purchase commitments related to its operating activities which are financed with cash flows from operations (see Note 13 to the Consolidated Financial Statements). Investing Activities -------------------- Cash requirements for NW Natural's capital expenditures in 1997 totaled $115.9 million, up $32.5 million, or 39 percent, from 1996. The increase included expenditures for expansion of the Mist underground storage facility ($10.8 million); completion of the new customer information system (CIS) software development ($7.9 million); transportation equipment ($2.2 million); expansion and reinforcement of the gas distribution system to accommodate customer growth ($3.2 million); land purchases for a new service center ($1.6 million); and the upgrading of other computer system hardware and software ($1.5 million). The $16.2 million increase in capital expenditures in 1996 compared to 1995 resulted largely from higher amounts expended for the gas distribution system in order to serve significant customer growth ($8.8 million); the ongoing development of the new CIS which had been delayed in 1995 ($3.7 million); and the development of a remote data terminal system ($1.9 million). NW Natural's construction expenditures are estimated at $90 million for 1998. Over the five year period 1998 through 2002, these expenditures are estimated to be $500 million to $550 million. The higher projected level of capital expenditures over the next five years reflects continued high customer growth, a major system reinforcement project and the development of additional underground storage facilities. About half of the required funds are expected to be internally generated, with the remainder to be funded through a combination of long-term debt and equity securities with short-term debt providing liquidity and bridge financing. NW Natural invested $3.0 million in both 1996 and 1997 in Canor's exploration and production program to supplement Canor's internally-generated funds. Financing Activities -------------------- Cash provided by financing activities in 1997 totaled $76.8 million, compared to cash used for financing of $6.5 million in 1996 and $7.2 million in 1995. The primary financing activities which accounted for the change from 1996 were NW Natural's sale of $90 million of its Medium-Term Notes in 1997 and the net issuance of $39.3 million of commercial paper, partially offset by the redemption of $27 million of long-term debt. Significant financing activity in 1996 consisted of NW Natural's sale of $20 million of Medium-Term Notes, the net issuance of $21.2 million of commercial paper and the redemption of $22 million of long-term debt. In 1995, financing activity consisted primarily of NW Natural's sales of $33 million of common stock and $10 million of Medium-Term Notes, the redemption of the remaining shares of the $2.375 series of Convertible Preference Stock and a net decrease of $24.8 million of commercial paper. Ratios of Earnings to Fixed Charges ----------------------------------- For the years ended December 31, 1997, 1996 and 1995, the Company's ratios of earnings to fixed charges, computed using the Securities and Exchange Commission method, were 2.99, 3.53 and 3.15, respectively. For this purpose, earnings consist of net income before taxes plus fixed charges, and fixed charges consist of interest on all indebtedness, the amortization of debt expense and discount or premium, and the estimated interest portion of rentals charged to income. Contingent Liabilities - ---------------------- Like all companies with business application software programs, the Company is affected by the "Year 2000" issue. Much of this software, which includes NW Natural's customer service, operations, and financial systems, was written using two digits to define the year, rather than four. Any of the Company's software that is time-sensitive may recognize a date using "00" as the year 1900 rather than 2000. This could result in the computer shutting down or performing incorrect calculations. NW Natural has identified and is in the process of correcting the systems within its control that could be affected by the Year 2000 issue. In 1997, the consultant that performed an assessment of NW Natural's application software estimated that the cost of making its application source code for these systems Year 2000-compliant would be about $4.0 million. NW Natural believes that with the appropriate modifications, it will be able to operate its time-sensitive software programs beyond the turn of the century. NW Natural has identified major vendors for which it depends on products or services and is contacting such vendors to hear what plans they have to correct problems they may face with Year 2000 compliance. The Company can make no assurances regarding the Year 2000 compliance status of systems or parties outside its control, and cannot assess the effect on it of any non-compliance by such systems or parties. In December 1997, the OPUC authorized NW Natural to defer and amortize over five years, commencing January 1, 1998, its incremental costs for assessment, planning and renovation of systems for Year 2000 compliance. Environmental Matters - --------------------- NW Natural owns property in Linnton, Oregon, that is the site of a former gas manufacturing plant that was closed in 1956. In 1993, pursuant to Oregon Department of Environmental Quality (ODEQ) procedures, NW Natural submitted a notice of intent to participate in the ODEQ's Voluntary Cleanup Program and, in 1994, the site was listed on ODEQ's Confirmed Release List and Inventory. During 1995, initial tests revealed environmental contamination, but the extent or the estimated cost of remediation cannot yet be determined. NW Natural continues to monitor this site. NW Natural expects that its costs of investigation and any remediation at the Linnton site for which it may be responsible should be recoverable, in large part, from insurance or through future rates. During the period from 1993 through 1997, NW Natural recorded as expense a total of $1.6 million for the estimated costs of consultants' fees, ODEQ oversight and the voluntary investigation. In 1996, the Eugene Water and Electric Board (EWEB) asked NW Natural to participate in an investigation and the potential remediation of a 1.5 acre site of a former manufactured gas plant in Eugene, Oregon. NW Natural purchased the property in 1958, after the plant had been converted to a liquid propane gas plant. It used the propane plant until 1960 when the system was converted to natural gas, and continued to use the site as a service center until 1976 when it was sold. To date, NW Natural has not agreed to participate in an investigation of the site and has not obtained sufficient information to determine the extent of its responsibility, if any, for remediation of the site. Forward-Looking Statements - -------------------------- This report and other presentations made by the Company from time to time may contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance, and other statements which are other than statements of historical facts. The Company's expectations, beliefs and projections are expressed in good faith and are believed by the Company to have a reasonable basis. However, each such forward-looking statement involves uncertainties and is qualified in its entirety by reference to the following important factors that could cause the actual results of the Company to differ materially from those projected in such forward-looking statements: (i) prevailing governmental policies and regulatory actions, including those of the Oregon Public Utility Commission (OPUC) and the Washington Utilities and Transportation Commission (WUTC), with respect to allowed rates of return, industry and rate structure, purchased gas and investment recovery, acquisitions and dispositions of assets and facilities, operation and construction of plant facilities, present or prospective wholesale and retail competition, changes in tax laws and policies and changes in and compliance with environmental and safety laws and policies; (ii) 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) unanticipated changes in interest or foreign currency exchange rates or in rates of inflation; (vii) unanticipated changes in operating expenses and capital expenditures; (viii) capital market conditions; (ix) competition for new energy development opportunities; and (x) legal and administrative proceedings and settlements.settlements; and (xi) estimates of future costs or the effect on future operations as a result of events that could result from the Year 2000 issue described further herein. 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 19 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. Earnings and Dividends - ---------------------- The Company's earnings applicable to common stock in 1998 were $24.7 million, down from $40.4 million in 1997 and $44.1 million in 1996. Earnings for 1998 were reduced by write-downs of subsidiary assets. Earnings for 1996 and 1997 were the highest and second highest on record for the Company. Earnings for both 1998 and 1997 were reduced by warmer than normal weather, the effect of which was partially offset by additional sales from customer growth. 1996 earnings reflected both colder weather and customer growth. Diluted earnings per share from consolidated operations were $1.02 a share in 1998, down from $1.76 a share in 1997 and $1.94 a share in 1996. NW Natural earned $1.44 a share from gas utility operations in 1998, compared to $1.70 in 1997 and $1.87 in 1996. Weather conditions in its service territory in 1998 were 2 percent warmer than in 1997 and 5 percent warmer than the 20-year average. Weather in 1997 was 8 percent warmer than 1996 and 4 percent warmer than the 20-year average. The estimated weather-related decrease in net operating revenues (margin) during 1998 was equivalent to about 9 cents a share compared to actual conditions during 1997. The weather-related decrease in margin in 1997 was equivalent to about 24 cents a share as compared to actual conditions in 1996. Customer growth of 4.2 percent during 1998 contributed an estimated $11.6 million to 1998 margin. Customer growth of 5.7 percent during both 1997 and 1996 contributed an estimated $12.7 million to 1997 margin and $10.9 million to 1996 margin. Earnings in 1998 from NW Natural's non-utility operations other than the subsidiaries included 15 cents a share due to a transaction involving Canor (see "Subsidiary Operations" and "Other Income (Expense)," below). Subsidiary results for 1998 were equivalent to a loss of 56 cents a share, compared to earnings of 8 cents a share in 1997 and 10 cents in 1996. The loss in 1998 includes write-downs of subsidiary assets totaling $19.4 million, equivalent to 50 cents a share. 1997 results included a $1.1 million gain from the sale of an interest in a California solar electric partnership. The decrease in 1997 from 1996 was primarily due to a one-time gain in 1996 of $2.9 million from the sale of underground storage assets to NW Natural, offset by a $1.3 million impairment loss on producing wells and a $1.0 million write-down of unproven properties. 1998 was the 43rd consecutive year in which the Company's dividends paid have increased. Dividends paid on common stock were $1.22 a share in 1998 compared to $1.205 in 1997 and $1.20 in 1996. 20 Results of Operations - --------------------- Regulatory Matters ------------------ NW Natural provides gas utility service in Oregon and Washington, with Oregon representing approximately 93 percent of its revenues. Future earnings and cash flows from utility operations will be determined for the most part by the pace of continued growth in the residential and commercial markets, by NW Natural's ability to remain price competitive in the large industrial market, by its ability to control expenses, and by its ability to obtain timely regulatory ratemaking treatment for investments made in utility plant. NW Natural currently has no competition from other gas utility distributors in the territory it serves. However, it competes with Williams Northwest Pipeline (WNP), formerly Northwest Pipeline Corporation, to serve large industrial customers; with oil and electricity for industrial and commercial uses; and with oil, electricity, and wood for residential use. The Pacific Northwest has historically enjoyed some of the lowest electric rates in the nation, primarily due to the proximity of federal hydropower facilities. With further deregulation in the energy business, the market for energy will become more competitive, but the Northwest is unlikely to experience the large drop in electric rates that other, high cost areas of the country are anticipating. In 1998, NW Natural maintained its competitive advantage over electricity and approximate price parity with fuel oil in the residential and commercial markets. The OPUC approved rate increases averaging 3.4 percent, 6.1 percent and 11.4 percent effective, respectively, Dec. 1, Apr. 1 and Jan. 1, 1998, and rate decreases averaging 3.6 percent effective Dec. 1, 1996. These rate changes reflected changes in NW Natural's purchased gas costs, the application of temporary rate adjustments to amortize regulatory balancing accounts and the removal of temporary rate adjustments effective the previous year. The WUTC approved rate increases averaging 5.8 percent and 10.5 percent effective Dec. 1, 1998 and 1997, respectively, and rate decreases averaging 4.9 percent effective Dec. 1, 1996. These rate changes primarily reflected changes in NW Natural's purchased gas costs. In October 1997, the WUTC approved a general rate increase averaging 3 percent for NW Natural's customers in Washington and authorized a rate of return on common equity of 11.25 percent. None of the rate increases and decreases discussed above had a material effect on net income. In October 1998, NW Natural filed its first general rate case in Oregon since 1989. The filing proposes a revenue increase of $14.7 million per year from Oregon operations through rate increases averaging 3.8 percent. The proposed increase is designed to cover the costs of the additional gas storage at Mist, NW Natural's new customer information system (CIS), and the Year 2000 project. In November 1998, the OPUC suspended the proposed rate increase for investigation and hearings. 21 Comparison of Gas Operations ----------------------------- The following table summarizes the composition of gas utility volumes and revenues for the three years ended December 31: Thousands 1998 1997 (Except customers and degree days) - ---------------------------------------------------------------------------- Gas Sales and Transportation Volumes (Therms): - ---------------------------------------------- Residential and commercial sales 544,810 531,605 Unbilled volumes 8,645 3,615 --------- ------- Weather-sensitive volumes 553,455 49% 535,220 48% Industrial firm sales 87,275 8% 84,523 7% Industrial interruptible sales 51,521 4% 53,929 5% --------- --------- Total gas sales 692,251 673,672 Transportation deliveries 446,165 39% 440,452 40% --------- ---- ------- ---- Total volumes sold and delivered 1,138,416 100% 1,114,124 100% ========= ==== ========= ==== Utility Operating Revenues: - -------------------------- Residential and commercial revenues $323,277 $278,512 Unbilled revenues 8,314 1,647 ----------- ----------- Weather-sensitive revenues 331,591 82% 280,159 80% Industrial firm sales revenues 34,303 8% 27,025 8% Industrial interruptible sales revenues 15,337 4% 13,944 4% ---------- ---------- Total gas sales revenues 381,231 321,128 Transportation revenues 19,958 5% 22,029 6% Other revenues 2,617 1% 7,884 2% ---------- ----- ---------- ----- Total utility operating revenues $403,806 100% $351,041 100% ========== ==== ========== ==== Cost of gas sold $173,242 $130,381 ========== ========== Total number of customers (end of period) 477,407 458,021 ========== ========== Actual degree days 4,011 4,092 ========== ========== 20-year average degree days 4,234 4,264 ========== ========== Thousands 1996 (Except customers and degree days) - ------------------------------------------------------------ Gas Sales and Transportation Volumes (Therms): - ---------------------------------------------- Residential and commercial sales 531,425 Unbilled volumes 3,759 ------- Weather-sensitive volumes 535,184 49% Industrial firm sales 91,122 8% Industrial interruptible sales 63,261 6% -------- Total gas sales 689,567 Transportation deliveries 410,062 37% --------- ---- Total volumes sold and delivered 1,099,629 100% ========= ==== Utility Operating Revenues: - --------------------------- Residential and commercial revenues $288,384 Unbilled revenues 1,627 -------- Weather-sensitive revenues 290,011 78% Industrial firm sales revenues 30,672 8% Industrial interruptible sales revenues 17,097 5% -------- Total gas sales revenues 337,780 Transportation revenues 22,533 6% Other revenues 9,824 3% ---------- ------ Total utility operating revenues $370,137 100% ======== ==== Cost of gas sold $141,789 ======== Total number of customers (end of period) 433,169 ======== Actual degree days 4,427 ======== 20-year average degree days 4,273 ======== 22 Residential and Commercial -------------------------- Customer growth continues at a rapid rate relative to others in the industry. The 19,386 customers added since Dec. 31, 1997 represent a growth rate of 4.2 percent, compared to the record growth rate of 5.7 percent in both 1997 and 1996. In the three years ended Dec. 31, 1998, more than 67,000 customers were added to the system, representing an average annual growth rate of 5.2 percent. Typically, 75 percent or more of NW Natural's annual operating revenues are derived from gas sales to weather-sensitive residential and commercial customers. Accordingly, variations in temperatures between periods will affect volumes of gas sold to and revenues derived from these customers. Weather conditions were 5 percent warmer than average in 1998, 4 percent warmer than average in 1997, and 4 percent colder than average in 1996. Average weather conditions are calculated from the most recent 20 years of temperature data measured by heating degree days. Weather in 1998 was 2 percent warmer than in 1997 and 1997 was 8 percent warmer than 1996. The volumes of gas sold to residential and commercial customers during 1998 increased 3 percent as compared to 1997, reflecting continued customer growth offset by warmer weather. Related revenues increased 18 percent due to increased volumes and the rate increases effective in late 1997 and 1998. Revenue from residential and commercial customers was down 3 percent in 1997 as compared to 1996 primarily due to the rate decreases effective Dec. 1, 1996. In order to match revenues with related purchased gas costs, NW Natural records unbilled revenues for gas delivered but not yet billed to customers through the end of the period. Industrial Sales, Transportation and Other Revenues --------------------------------------------------- Total volumes of gas delivered to industrial customers were 1 percent higher in 1998 than in 1997 and 3 percent higher in 1997 than in 1996. However, the combined margin from industrial sales and transportation decreased by 7 percent in 1998 from 1997 and by 5 percent in 1997 from 1996. The decrease in industrial margin despite increased volumes in both 1998 and 1997 reflects the effect of low oil prices on an industrial schedule in which rates vary with oil prices, and transfers of some industrial customers to rate schedules or special contracts with lower margins. In addition, NW Natural lost one large industrial customer to a bypass of its system in 1998 after experiencing no losses due to bypass in either 1997 or 1996. Although NW Natural does not expect a significant number of its large customers to bypass its system in the foreseeable future, it may experience further deterioration of margin associated with customers' transfers to contracts with pricing designed to be competitive with the capital and operating costs of direct connections to WNP's system. Other revenues are primarily related to adjustments in regulatory accounts (see Note 1 to the Consolidated Financial Statements). In 1998, other revenues included the deferral of $2.0 million in revenue reductions required under a settlement approved by the OPUC as part of the Jan. 1, 1998 rate changes, offset by $3.1 million from the amortization of property tax savings and $1.4 million from amortizations of other regulatory accounts. 23 In 1997, other revenues included $6.1 million from the amortization of property tax savings and $1.2 million from the amortization of Oregon income tax savings. In 1996, other revenues included $4.0 million from the amortization of property tax savings, $1.6 million from regulatory amortizations, and non-recurring gains totaling $1.6 million from the resolution of two regulatory issues before the OPUC. Cost of Gas ----------- NW Natural's cost per therm of gas sold was 29 percent higher in 1998 than in 1997, primarily due to higher prevailing prices in the natural gas commodity market. Its cost of gas sold was 6 percent lower in 1997 than in 1996. The cost per therm of gas sold includes current gas purchases, gas drawn from storage, demand cost equalization, regulatory deferrals and company use. The cost of gas sold was reduced by off-system gas sales of $4.6 million in 1998 compared to $2.3 million in 1997 and $1.2 million in 1996. Under an agreement with the OPUC, revenues from these sales are treated as a reduction of gas costs. NW Natural has a Purchased Gas Cost Adjustment (PGA) tariff under which its net income from Oregon operations is affected only within defined limits by changes in purchased gas costs. Effective Jan. 1, 1998, the incentive formula for deferred gas costs under its PGA tariff in Oregon was modified so that NW Natural absorbs 33 percent of the higher cost of gas sold, or retains 33 percent of the lower cost, in either case as compared to projections. The remaining 67 percent of the higher or lower gas costs are recorded as deferred debits or credits (regulatory assets or liabilities) for recovery from or refund to customers in future rates. In 1997 and 1996, NW Natural absorbed 20 percent of its higher cost of gas sold, while the remaining 80 percent of higher gas costs was recorded as deferred debits. Subsidiary Operations --------------------- Consolidated results for the subsidiaries in 1998 were losses of $13.8 million, equivalent to 56 cents a share, compared to earnings of $1.8 million, or 8 cents a share, in 1997 and $2.2 million, or 10 cents a share, in 1996 (see Note 2 to the Consolidated Financial Statements). Subsidiary results in 1998 included asset write-downs totaling $19.4 million, equivalent to 50 cents a share for NW Natural. Operating results without the asset write-downs were a loss of $1.4 million, equivalent to 6 cents a share. Financial Corporation recorded asset impairment charges in 1998 totaling $16.6 million, equivalent to 43 cents a share. The charges resulted from the application of Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," to Financial Corporation's limited partnership investments in solar electric, wind-power electric and hydroelectric generation projects in California. The determinations of impairments for Financial Corporation's assets resulted from lower estimates of prices for future sales of electricity from the partnerships' power projects. Financial Corporation's operating results in 1998 were net income of $0.1 million, compared to $1.6 million in 1997 and $1.0 million in 1996. The declines in Financial Corporation's ongoing operations from 1997 to 24 1998 and from 1996 to 1997 were primarily due to weaker operating results from its investments in the limited partnerships. Its 1997 results included a $1.1 million gain from the sale of an interest in a solar electric partnership. NW Natural's share of Canor's results for 1998 was a loss of $3.2 million, compared to income of $0.2 million in 1997 and $0.5 million in 1996. Results for 1998 included asset write-downs totaling $2.8 million, equivalent to 7 cents a share for NW Natural. Approximately half of the write-downs were asset impairment charges due to the application of SFAS No. 121, resulting from the impact of low oil prices on Canor's oil properties in Alberta. The other write-downs were due to determinations that some oil and gas wells were no longer productive because of water encroachment. Canor's 1997 results included a $0.9 million write-down of unproven properties, while its 1996 results included $0.9 million in asset impairment charges under SFAS No. 121. In March 1998, Canor purchased the stock of Southlake Energy, Inc. (Southlake), an indirect subsidiary of NIPSCO Industries, Inc. (NI). Canor was then amalgamated with Southlake. The resulting company is owned 66 percent by NW Natural and 34 percent by NI Canada ULC, another indirect subsidiary of NI. For financial reporting purposes, Canor's operating revenues and expenses are included in full in the Company's Statement of Income. The 34 percent portion of Canor's results applicable to the minority interest is included in Other Income (Expense) as a reduction in the case of earnings, or as an increase in the case of losses. Oregon Natural earned $0.7 million in 1996, including a one-time gain of $2.9 million from the sale of underground storage assets to NW Natural. The gain was partially offset by charges totaling $2.3 million for asset impairments and write-downs of unproven properties. Oregon Natural was merged into NW Natural during 1996, thereby effecting the transfer of certain assets, including the stock of Canor, to NW Natural. The Company's investments in its subsidiaries at Dec. 31, 1998 were $31.9 million for Canor and $6.6 million for Financial Corporation, compared to $19.8 million for Canor and $17.3 million for Financial Corporation at Dec. 31, 1997. The increase in the Company's investment in Canor includes $11.8 million converted to equity from inter-company debt at the time of Canor's amalgamation with Southlake. Operating Expenses ------------------- Operations and Maintenance -------------------------- Consolidated operations and maintenance expenses were $8.0 million, or 10 percent, higher in 1998 than in 1997. NW Natural's operations and maintenance expenses increased $4.1 million, or 6 percent, compared to 1997 due to higher accruals for uncollectible accounts ($1.4 million); maintenance expenses for a new customer information system (CIS) ($1.1 million); amortizations of Year 2000 costs ($0.8 million); higher market development expenses ($0.4 million); and employee severance charges ($0.6 million). Subsidiary expenses increased $3.9 million, or 94 percent, in 1998 compared to 1997 due to the inclusion in this category of all of the expenses for Canor following the Canor/Southlake amalgamation. Operations and maintenance expenses in 1997 were $2.3 million lower than in 1996 primarily due to a one time charge of $4.9 million in 1996 for 1995 litigation (see "Chase Gardens Litigation," below), offset by increases in customer service and market development expense ($2.9 million); electronic 25 and network services ($0.6 million); and environmental investigation and remediation charges ($0.6 million). Subsidiary expenses decreased $0.2 million, or 6 percent, in 1997 compared to 1996 primarily due to a decline in Oregon Natural's production costs. Chase Gardens Litigation ------------------------ In July 1995, a jury in an Oregon state court returned a verdict against NW Natural in the case of Northwest Natural Gas Company v. Chase Gardens, Inc. (Lane County Circuit Court Case No. 16-91-01370). The Oregon Court of Appeals (Oregon Court of Appeals Case No. CA A90481) affirmed the trial court decision in February 1997. NW Natural filed a petition for review of the Court of Appeals' decision by the Oregon Supreme Court. In August 1997, the Oregon Supreme Court agreed to hear the case on appeal and is expected to render a final ruling during 1999. NW Natural recorded a charge of $5.6 million in 1996, equivalent to 15 cents a share, as a reserve against payment of the judgment, related costs and post-judgment interest. Taxes Other Than Income ----------------------- Taxes other than income, which are comprised of property, franchise, payroll and other taxes, increased $2.0 million, or 10 percent, in 1998. Property tax expense was $0.9 million, or 12 percent higher than in 1997, due to more plant in service. Franchise taxes, which are based on gross revenues, increased $1.1 million, reflecting higher revenues due to rate increases effective Jan. 1, Apr. 1 and Dec. 1, 1998. Taxes other than income declined $1.6 million, or 8 percent, in 1997. NW Natural's property taxes decreased $1.6 million, or 17 percent due to settlements reached in 1996 relating to property valuations and regulatory treatment of reduced property taxes. Franchise taxes decreased $0.3 million, or 4 percent, paralleling the percentage decrease in gas sales revenues from 1996 to 1997. The decrease in franchise taxes was offset by an increase in payroll taxes and regulatory fees. Depreciation, Depletion and Amortization ---------------------------------------- Depreciation, depletion and amortization expense increased $11.2 million, or 25 percent, in 1998 compared to 1997, and $1.6 million, or 4 percent, in 1997 compared to 1996. NW Natural's depreciation expense increased by $4.9 million from 1997 to 1998 due to an additional $92.4 million of utility plant placed in service. The new CIS, placed in service in the fourth quarter of 1997, increased depreciation expense by $2.2 million compared to 1997. NW Natural's depreciation expense increased by $3.1 million in 1997 compared to 1996, primarily due to an additional $111.1 million of utility plant placed in service in 1997. Depreciation, depletion, and amortization expense for the subsidiaries increased $6.3 million in 1998. Canor's depreciation expense increased $6.3 million due in part to an increase in total assets after the Canor/Southlake amalgamation. Depreciation expenses for Canor also included $4.2 million for asset write-downs (see "Subsidiary Operations," above). Depreciation, depletion and amortization expense for the subsidiaries decreased $1.5 million in 1997 compared to 1996. Depreciation expense for 1997 included charges of $1.7 million recorded by Canor for the write-down of unproven properties and abandonment of dry wells. 26 Other Income (Expense) ---------------------- The variations in other income (expense) during the past three years resulted primarily from non-recurring items. In 1998, NW Natural recorded as other income a $3.5 million gain, equivalent to 15 cents a share, from the amalgamation of Canor with Southlake. The resulting gain was not subject to U.S. income tax. Other income (expense) for 1998 also includes the $16.6 million in asset write-downs recorded by Financial Corporation under SFAS No. 121 (see "Subsidiary Operations," above). In 1996, Oregon Natural recorded a $2.9 million gain on the sale of its underground storage facilities to NW Natural. Other income now includes interest income on deferred regulatory accounts; other income for prior years has been reclassified to conform to this presentation. Prior to Jan. 1, 1998, interest accrued on deferred regulatory accounts was included in miscellaneous operating income or was treated as an adjustment to the cost of gas. Interest Charges ---------------- Interest charges increased $3.3 million, or 11 percent, in 1998 compared to 1997 due to a $16.4 million increase in long-term debt and an increase in NW Natural's average balance of commercial paper outstanding from $45.8 million in 1997 to $53.1 million in 1998. The increases in commercial paper and long-term debt balances were due to increased gas costs, construction spending to fund customer growth and other spending for general corporate purposes. Interest charges in 1997 increased $2.7 million, or 10 percent, compared to 1996. The 1997 increase also resulted from higher long-term and short-term debt balances due to the financing of NW Natural's $117 million utility construction program and $28.6 million in deferred gas costs. Allowance for Funds Used During Construction (AFUDC) represents the cost of funds used during the construction of utility plant (see Note 1 to the Consolidated Financial Statements). In 1998, AFUDC reduced interest expense by $1.4 million compared to $1.7 million in 1997 and $0.8 million in 1996. The weighted average AFUDC rates were 5.5 percent in 1998, 5.8 percent in 1997, and 8.9 percent in 1996 (See "Financing Activities," below). Income Taxes ------------ The effective corporate income tax rates for 1998, 1997 and 1996 were 31 percent, 33 percent and 37 percent, respectively. The lower rate in 1998 was due primarily to the non-taxable gain from Canor's amalgamation with Southlake (see "Subsidiary Operations," and "Other Income (Expense)," above), and in part to permanent tax savings resulting from a change in book depreciation rates and increased tax credits. The effective tax rate in 1997 was lower than the statutory rate due to permanent tax savings from the change in book depreciation rates, an increase in tax credits and a reversal of amounts previously recorded for the California solar energy investment sold (see Note 7 to the Consolidated Financial Statements). Redeemable Preferred and Preference Stock Dividend Requirements --------------------------------------------------------------- Redeemable preferred and preference stock dividend requirements for 1998 were lower by $0.1 million, or 3 percent, compared to 1997, due to sinking fund redemptions. The 1997 requirements were lower by $0.1 27 million, or 3 percent, due to sinking fund redemptions and the redemption of the $4.68 Series of redeemable preferred stock. Financial Condition - ------------------- Capital Structure ----------------- NW Natural's capital expenditures are primarily related to utility construction resulting from customer growth and system improvements. NW Natural finances these expenditures from cash provided by operations and from short-term borrowings which are periodically refinanced through the sale of long-term debt or equity securities. In addition to its capital expenditures, the weather-sensitive nature of gas usage by NW Natural's residential and commercial customers influences the Company's financing requirements. Short-term liquidity is satisfied primarily through the sale of commercial paper, which is supported by commercial bank lines of credit (see Note 6 to the Consolidated Financial Statements). The Company's long-term goal is to maintain a capital structure comprised of 45 to 50 percent common stock equity, 5 to 10 percent preferred and preference stock and 45 to 50 percent short-term and long-term debt. When additional capital is required, the Company issues debt or equity securities depending upon both the target capital structure and market conditions. The Company also uses these sources to meet long-term debt and preferred and preference stock redemption requirements (see Notes 3 and 5 to the Consolidated Financial Statements). Cash Flows ---------- Operating Activities -------------------- Operating activities provided net cash of $66.9 million in 1998 compared to $45.8 million in 1997. The 46 percent increase was due to increased cash from operations ($26.6 million), offset in part by higher working capital requirements ($5.5 million). The increase in cash from operations compared to 1997 was primarily due to lower deferred gas costs receivable ($37.5 million), an increase in depreciation, depletion and amortization expense ($11.2 million) and non-cash investment losses including the asset write-downs by Financial Corporation ($16.0 million). The increase in cash from operations was offset by lower net income ($15.8 million), a reduction in deferred taxes and investment tax credits ($17.0 million) and a gain on sale of assets ($2.9 million). The increase in working capital requirements was due to increases in accounts receivable ($9.5 million) and accrued unbilled revenue ($8.8 million) which were offset by a reduction in accounts payable ($3.3 million) and other current assets and liabilities ($9.5 million). Cash provided by operating activities in 1997 was $45.8 million, 49 percent lower than in 1996. The decrease was primarily due to an increase in deferred gas costs ($36.7 million) and a decrease in accounts payable ($6.0 million). The Company has lease and purchase commitments relating to its operating activities which are financed with cash flows from operations (see Note 12 to the Consolidated Financial Statements). 28 Investing Activities -------------------- Cash used in investing activities declined $25.5 million, from $124.1 million in 1997 to $98.6 million in 1998. NW Natural's capital expenditures totaled $80.0 million, down $35.9 million, or 31 percent, from 1997. The decrease in cash requirements for utility construction resulted from completion of the new CIS ($14.0 million), a gas storage expansion project (Mist Storage II) ($5.2 million) and several special projects ($5.9 million); lower replacement and reinforcement expenditures ($1.5 million); a land purchase for a new service center in 1997 ($1.6 million); reduced expenditures for computer hardware and software ($1.1 million); and lower construction overhead ($2.0 million). Cash requirements for NW Natural's capital program in 1997 totaled $115.9 million, up $32.5 million, or 39 percent, from 1996. The increase included expenditures for Mist Storage II ($10.8 million); completion of the new CIS ($7.9 million); transportation equipment ($2.2 million); expansion and reinforcement of the gas distribution system to accommodate customer growth ($3.2 million); land purchases for the new service center ($1.6 million); and the upgrading of other computer system hardware and software ($1.5 million). NW Natural's construction expenditures are estimated at $110 million for 1999. Over the five year period 1999 through 2003, these expenditures are estimated at between $500 million and $550 million. The high level of capital expenditures over the next five years reflects projected high customer growth plus a major system reinforcement project and the development of additional underground storage facilities. An estimated 50 percent of the required funds is expected to be internally generated, with the remainder to be funded through a combination of long-term debt and equity securities with short-term debt providing liquidity and bridge financing. In 1998, non-utility capital expenditures totaled $19.8 million. Canor invested $13.5 million in Canadian exploration and production properties. NW Natural's non-utility expenditures totaling $6.3 million included expenditures relating to a contract for the construction of a new headquarters building for the Port of Portland on land currently owned by NW Natural ($6.0 million) and additions to existing facilities ($0.3 million). NW Natural invested $3.0 million in both 1996 and 1997 in Canor's exploration and production program to supplement Canor's internally generated funds. During 1998, NW Natural converted to equity $11.8 million of intercompany loans to Canor. Financing Activities -------------------- Cash provided by financing activities in 1998 totaled $32.3 million, down from $76.8 million in 1997. Proceeds from the sales of $22 million, $10 million and $20 million of Medium-Term Notes, Series B, in March, June and November 1998, respectively, and $44.7 million from the negotiated public offering and sale of 1,725,000 shares of NW Natural's common stock in April 1998, were used in part to reduce long-term debt ($35.0 million) and short-term debt ($2.0 million). Cash provided by financing activities in 1997 totaled $76.8 million, compared to cash used for financing of $6.5 million in 1996. The primary financing activities in 1997 which accounted for the change from 1996 were NW Natural's sale of $90 million of its Medium-Term Notes and the net 29 issuance of $39.3 million of commercial paper, partially offset by the redemption of $27 million of Medium-Term Notes and First Mortgage Bonds. Ratios of Earnings to Fixed Charges ----------------------------------- For the years ended Dec. 31, 1998, 1997 and 1996, the Company's ratios of earnings to fixed charges, computed using the Securities and Exchange Commission method, were 2.12, 2.99 and 3.53, respectively. For this purpose, earnings consist of net income before taxes plus fixed charges. Fixed charges consist of interest on all indebtedness, the amortization of debt expense and discount or premium, and the estimated interest portion of rentals charged to income. Contingent Liabilities - ---------------------- Year 2000 Readiness ------------------- Overview --------- The Company has identified and is in the process of correcting the information technology (IT) and non-IT systems within its control that could be affected by the Year 2000 issue. In early 1997, NW Natural established a Year 2000 Project Office with technical specialists experienced in the Year 2000 issue, sponsored by two senior executives. The Company's objective in its Year 2000 project is to reduce the risk of business disruption or serious financial loss due to IT and non-IT systems failures relating to the Year 2000 issue. In November 1997, NW Natural replaced its largest application, its customer information system for residential and small commercial customers incorporating billing, customer order, credit and other programs, with a fully Year 2000-ready system. Additional project work includes maintaining and managing the inventory of its date-sensitive IT and non-IT systems; researching and managing the degree of Year 2000 readiness of IT and non-IT systems of the suppliers and vendors with whom it has material relationships; identifying and assessing the cost of renovating or replacing non-IT systems within its control that could be affected by the Year 2000 issue; assigning risk ratings to its IT and non-IT systems in order to prioritize renovation and replacement efforts; and developing contingency plans for high-risk systems or vendor products where products are known to be non-compliant or readiness levels cannot be independently verified. Readiness of Systems -------------------- The Year 2000 project office has achieved various stages of correction for impacted IT systems and non-IT equipment and, overall, NW Natural has maintained and expects to continue its planned schedule for correction. NW Natural plans to complete renovations of its internal applications with the highest risk ratings by Jun. 30, 1999, and to evaluate and develop appropriate plans to renovate or address risks of failure in its remaining lower-risk systems by the end of 1999. Among 48 applications originally identified for internal renovation, 22 percent had been completed through construction, testing and implementation as of Dec. 31, 1998. Eighty-eight percent of the high priority 30 applications either were complete or had been identified for replacement or retirement. NW Natural has been developing a new billing system for industrial and large commercial (I&C) customers to replace an existing system that is not Year 2000 compliant. The development project for the new I&C system is on schedule, but the Company has implemented a contingency plan by reviewing coding designs, staffing availability and cost estimates for the renovation of the existing system so that it could be ready by year-end. This effort may be terminated at any time if it appears that the I&C replacement project is reaching its key milestones on schedule for completion by October 1999. Suppliers and Vendors --------------------- NW Natural is evaluating the status of Year 2000 compliance efforts of critical suppliers and vendors. These contacts include written communication or face-to-face meetings with providers of interstate capacity and storage, natural gas suppliers, financial institutions and electric and telephone companies. In addition, the project office is currently investigating 570 vendor-supplied products. Of these products, 386 products either have been determined to be compliant, or have been represented by the vendors to be compliant if used in connection with other compliant systems. Another 119 products were deemed non-compliant and 65 products are under active investigation. If warranted, the Company will identify alternative vendor sources to the extent alternatives are available, and develop contingency plans for any critical vendor products considered at risk where alternatives are not available. Risks and Contingency Planning ------------------------------ The Company has not quantified its worst-case exposure from the Year 2000 issue, but the project office intends to make such estimates while prioritizing the highest-risk systems for correction. With respect to its internal operations, NW Natural believes its most significant risks are its ability to render timely bills to its industrial and large commercial customers, its ability to use electronic devices to control and operate its distribution system and its ability to maintain continuous operation of its computer systems. In the event that any Year 2000-related problems may occur, the Company intends to implement contingency plans to mitigate the impact of such failures to the extent possible. These plans will include options for manual control and operation of the gas distribution system. With respect to external factors, NW Natural relies on the suppliers of natural gas and interstate transportation to deliver natural gas to the Company's distribution system. External infrastructure such as electric and telephone service is necessary for the Company's basic operation as well as the operations of many of its customers. A failure by any of these critical vendors could challenge the Company's ability to meet the demands of its customers. As part of its normal business practice, however, NW Natural maintains plans to follow during emergency circumstances. These plans are incorporated into its contingency plan for potential Year 2000-related problems. 31 Financial Impact ---------------- NW Natural's total estimated cost for its Year 2000 readiness program is $6.9 million. This amount includes its costs of assessment, planning, vendor management, project management and other project costs as well as the costs of renovating and testing internal applications. NW Natural's costs in 1997 and 1998 for Year 2000 activities totaled $4.1 million. Neither the total estimated cost nor the costs to date include the costs incurred in replacing NW Natural's customer information system or costs for other IT systems that are being replaced rather than renovated. In accordance with an order of the OPUC, NW Natural's incremental operating costs for Year 2000 readiness are being deferred and amortized over a five-year period. Disclaimer ---------- As a result of its Year 2000 program and the replacement of the residential and small commercial customer information system, the Company does not believe that, in the aggregate, Year 2000 issues will be material to its business, operations or financial condition. However, despite the Company's efforts, there can be no assurance that all material Year 2000 risks relating to systems within its control will have been adequately identified and corrected before the end of 1999. In addition, while the Company is in the process of researching the Year 2000 readiness of its suppliers and vendors, the Company can make no assurances regarding the Year 2000 compliance status of systems or parties outside its control, and currently cannot assess the effect on it of any non-compliance by such systems or parties. The Year 2000 statements in this report are Year 2000 Readiness Disclosures under the Year 2000 Information and Readiness Disclosure Act and are made to the best knowledge and belief of the Company. Environmental Matters - --------------------- NW Natural owns property in Linnton, Oregon, that is the site of a former gas manufacturing plant that was closed in 1956. In 1993, pursuant to Oregon Department of Environmental Quality (ODEQ) procedures, NW Natural submitted a notice of intent to participate in the ODEQ's Voluntary Cleanup Program and, in 1994, the site was listed on ODEQ's Confirmed Release List and Inventory. During 1995, initial tests revealed environmental contamination, but the extent or the estimated cost of remediation cannot yet be determined. During 1998, the ODEQ and the U.S. Environmental Protection Agency (EPA) completed a study of sediments in a 5.5 mile segment of the Willamette River that includes the area adjacent to the site. Remediation of the site may be affected by the sediments management plan now being developed in response to the ODEQ/EPA sediments study. Since 1993, NW Natural has recorded expenses of $2.0 million for the estimated costs of consultants' fees, ODEQ oversight cost reimbursements and voluntary investigation, plus an estimate for costs of the continuing investigation. NW Natural expects that its costs of investigation and any remediation for which it may be responsible 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. NW Natural also is monitoring an environmental investigation of a site in Eugene, Oregon (see Note 12 to the Consolidated Financial Statements). 32 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's primary market risk exposures associated with activities involving derivative financial instruments and other financial instruments are natural gas commodity price risk, foreign currency risk and interest rate risk. NW Natural uses derivative financial instruments as tools to mitigate certain of these market risks. NW Natural enters into such instruments for hedging purposes, not for trading purposes. Market risks associated with the derivative financial instruments are monitored by management personnel who do not directly enter into these contracts and by a committee of the Board of Directors. Canor also enters into derivative financial instruments for the purpose of hedging price risks associated with contractual gas purchase and sales commitments and natural gas production. Unrealized changes in the market value of these derivatives are recognized upon settlement along with the underlying hedged transactions. Physical and financial commodity and foreign currency transactions - ------------------------------------------------------------------ NW Natural enters into short-term and long-term natural gas purchase contracts with demand and commodity fixed-price and variable-price components, along with associated short-term and long-term natural gas transportation contracts. Many of the purchases made under these contracts are in Canadian dollars and NW Natural uses foreign currency forward contracts to hedge against foreign exchange rate fluctuations. NW Natural historically has taken physical delivery of at least the minimum quantities specified in its natural gas purchase contracts. Many commodity purchase contracts provide for net settlement based on the difference between contract price and comparable market value should the contract minimum quantities not be delivered. Changes in the market value of these contracts are not recorded. Rather, actual costs are recorded when the contracted delivery is received. NW Natural's PGA mechanism in Oregon provides for the recovery from customers of actual commodity costs in comparison with established benchmark costs, except that NW Natural absorbs 33 percent of the higher cost of gas sold, or retains 33 percent of the lower cost, in either case as compared to projections. The physical delivery gas purchase contracts are subject to annual re-pricing, a process that is intended to reflect anticipated market price trends during the next year. NW Natural has generally been able to obtain competitive prices for these purchases and in turn has provided competitive prices for sales to its customers. Market risk is typically managed on a contract by contract basis, subject to parameters established by the Board of Directors. NW Natural has established risk management processes, policies and procedures to monitor and control these market risks, including an objective that there be a balance between contracted minimum purchase quantities and expected demand. Because NW Natural considers all of the derivative financial instruments it uses to be hedges, it does not measure market risk on a daily basis. The only determination of market position for these contracts is mark-to-market. Management does not believe market valuation of the physical contracts would be warranted because the Company intends to take physical delivery of the commodity and the contracts are subject to annual re-pricing. 33 At Dec. 31, 1998, differences between notional values and fair values with respect to NW Natural's open positions in derivative financial instruments were not material to the Company's financial position or results of operations. However, to the degree that market risks exist due to potential adverse changes in commodity prices and foreign exchange rates in relation to these financial and physical contracts, the Company considers the risks to be: Commodity Price Risk - -------------------- The prices of natural gas commodity are subject to fluctuations due to unpredictable factors including weather, pipeline transportation congestion and other factors that affect short-term supply and demand. The following table summarizes information with respect to transactions that are sensitive to commodity price risk. NW Natural uses natural gas commodity swap agreements to convert certain long-term gas purchase contracts from floating prices to fixed prices. As of Dec. 31, 1998, the Company had not entered into any natural gas commodity swaps or other derivative commodity instruments extending beyond the end of 1999. In the table, the notional quantity is the total volume of natural gas covered by these derivative commodity instruments, and the notional value of the gas is the sum of the notional quantities covered by each instrument times the respective strike (pay) price. The mark-to-market value is the sum of the notional quantities covered by each instrument times the market index (receive) prices applicable to such instrument as of Dec. 31, 1998. If all of the commodity swap agreements had been settled on that date, NW Natural would have realized a gain of $0.6 million. Estimated Mark-to-Market Value of Commodity Swaps ------------------------------------------------- - ------------------------------------------------------------------------------- Notional Notional Mark-to-market Quantity Value Value Maturity (MMMBtu) ($000) ($000) - ------------------------------------------------------------------------------- Natural gas 1999 26,626 $50,085 $50,737 commodity swaps - ------------------------------------------------------------------------------- 34 Foreign Currency Risk - --------------------- The following table summarizes information with respect to transactions that are sensitive to foreign currency exchange rate risk. The costs of natural gas commodity and certain pipeline services are subject to changes in the value of Canadian currency in relation to U. S. currency. NW Natural uses foreign currency forward contracts to hedge against fluctuations in currency values with respect to its purchases of at least 80 percent of its estimated daily requirements for natural gas purchased from suppliers in Canada. As of Dec. 31, 1998, the Company had not entered into any derivative financial instruments relating to foreign currency exchange rates extending beyond the end of 1999. The fair value of these contracts is defined as the sum of the contract amounts covered by each contract times the respective settlement price if the contracts had been settled at Dec. 31, 1998. If all of the contracts had been settled on that date, NW Natural would have realized a negligible gain. Estimated Fair Value of Forward Currency Exchange Contracts ----------------------------------------------------------- - ------------------------------------------------------------------------------- Maturity Date Total Fair Value 1999 ($000) ($000) --------------- -------- ----------- - ------------------------------------------------------------------------------- Forward Exchange $12,115 Contracts ($000 Canadian) Average Exchange 1.5305 Rate Forward Exchange $7,895 $7,895 $7,916 Contracts ($000 U.S.) - ------------------------------------------------------------------------------- Interest Rate Risk - ------------------ Interest rate risk relates to new debt financing needed to fund capital requirements, including maturing debt securities, and to the issuance of commercial paper. NW Natural manages interest rate risk through the issuance of fixed-rate debt with varying maturities and the refunding of debt through optional redemption when interest rates are favorable. NW Natural had no derivative financial instruments to hedge interest rates in place at Dec. 31, 1998. The following table summarizes information as of Dec. 31, 1998, with respect to financial instruments that are sensitive to changes in interest rates. Fair value for these instruments, all of which are fixed-rate long-term debt, is defined as the present value of the debt securities' future cash flows discounted at interest rates that reflect market conditions as of Dec. 31, 1998. 35 Estimated Fair Value of Long-Term Debt -------------------------------------- - ------------------------------------------------------------------------------ There- Fair 1999 2000 2001 2002 2003 after Total Value ---- ---- ---- ---- ---- ----- ----- ----- - ------------------------------------------------------------------------------ Principal $10.0 $10.0 $10.0 $30.0 $20.0 $287.0 $367.0 $425.0 amounts of First Mortgage Bonds and Medium Term Notes, by maturity date (Millions) Weighted 7.69% 5.97% 8.47% 6.38% 6.40% 7.55% 7.38% average interest rate - ------------------------------------------------------------------------------ Principal -- -- -- -- -- $9.7 $9.7 $11.2 amount of Convertible Debentures (Millions) Weighted 7.25% average interest rate - ------------------------------------------------------------------------------ Total $10.0 $10.0 $10.0 $30.0 $20.0 $296.7 $376.7 $436.2 (Millions) ----- ----- ----- ----- ----- ------ ------ ------ - ------------------------------------------------------------------------------ 36 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA TABLE OF CONTENTS ----------------- Page ---- 1. Management's Responsibility for Financial Statements............... 32Statements............. 38 2. Independent Auditors' Reports...................................... 33Accountant's Reports................................. 39 3. Consolidated Financial Statements: Consolidated Statements of Income for the Years Ended December 31, 1998, 1997 1996 and 1995................................... 351996........................... 41 Consolidated Statements of Earnings Invested in the Business for the Years Ended December 31, 1998, 1997 1996 and 1995.................. 361996............. 42 Consolidated Balance Sheets, December 31, 19971998 and 1996............ 371997.......... 43 Consolidated Statements of Cash Flows for the Years Ended December 31, 1998, 1997 1996 and 1995.................................. 391996................................. 45 Consolidated Statements of Capitalization, December 31, 19971998 and 1996.......................................................... 401997.................................................... 46 Notes to Consolidated Financial Statements......................... 41Statements....................... 47 4. Quarterly Financial Information (unaudited)........................ 62...................... 65 Supplemental Schedules Omitted ------------------------------ All other schedules are omitted because of the absence of the conditions under which they are required or because the required information is included elsewhere in the financial statements. 37 MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS ---------------------------------------------------- The financial statements in this report were prepared by management, which is responsible for their objectivity and integrity. The statements have been prepared in conformity with generally accepted accounting principles and, where appropriate, reflect informed estimates based on judgments of management. The responsibility of the Company's independent auditors is to render an independent report on the financial statements. The Company's system of internal accounting controls is designed to provide reasonable assurance that assets are safeguarded and transactions are executed in accordance with management's authorizations, that transactions are recorded to permit the preparation of financial statements in conformity with orders of regulatory authorities and generally accepted accounting principles and that accountability for assets is maintained. The Company's system of internal controls has provided such reasonable assurances during the periods reported herein. The system includes written policies, procedures and guidelines, an organization structure that segregates duties and an established program for monitoring the system by internal auditors. In addition, Northwest Natural Gas Company has prepared and annually distributes to its employees a Code of Ethics covering its policies for conducting business affairs in a lawful and ethical manner. Ongoing review programs are carried out to ensure compliance with these policies. The Board of Directors, through its Audit Committee, oversees management's financial reporting responsibilities. The committee meets regularly with management, the internal auditors, and representatives of the Company's independent auditors. Both internal and external auditors have free and independent access to the committee and the Board of Directors. No member of the committee is an employee of the Company. The committee reports the results of its activities to the full Board of Directors. Annually, the Audit Committee recommends the nomination of independent auditors to the Board of Directors for shareholder approval. /s/ Richard G. Reiten --------------------------------------------------- Richard G. Reiten President and Chief Executive Officer /s/ Bruce R. DeBolt -------------------------- Bruce R. DeBolt Senior Vice President, Finance, and Chief Financial Officer REPORT OF INDEPENDENT ACCOUNTANTS February 20, 199838 Independent Accountant's Report To the Board of Directors and StockholdersShareholders of NW Natural In our opinion, the accompanying consolidated balance sheets andfinancial statements of capitalization and the related consolidated statements of income, of cash flows and of changes in earnings investedlisted in the businessaccompanying index present fairly, in all material respects, the financial position of Northwest Natural Gas Company (doing business as NW Natural) and its subsidiaries (the "Company") at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the year thentwo years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audit.audits. We conducted our auditaudits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit providesaudits provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE/s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Portland, Oregon February 19, 1999 39 INDEPENDENT AUDITORS' REPORT To the Directors and Shareholders of Northwest Natural Gas Company We have audited the accompanying consolidated balance sheet and statement of capitalization of Northwest Natural Gas Company and subsidiaries, as of December 31, 1996, and the related consolidated statements of income, earnings invested in the business, and cash flows of Northwest Natural Gas Company and subsidiaries for each of the two years in the periodyear ended December 31, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.audit. We conducted our auditsaudit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provideaudit provides a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the consolidated financial positionresults of operations and cash flows of Northwest Natural Gas Company and subsidiaries at December 31, 1996, andfor the results of their operations and their cash flows for each of the two years in the periodyear ended December 31, 1996, in conformity with generally accepted accounting principles. /s/ Deloitte & Touche LLP DELOITTE & TOUCHE LLP Portland, Oregon February 12, 1997 NORTHWEST NATURAL GAS COMPANY CONSOLIDATED STATEMENTS OF INCOME (Thousands, Except Per Share Amounts)
Year Ended December 31 1997 1996 1995 - ------------------------------------------------------------------------------- NET OPERATING REVENUES: Operating revenues $361,756 $380,318 $356,276 Cost of sales 129,312 142,805 144,051 -------- -------- -------- Net operating revenues 232,444 237,513 212,225 OPERATING EXPENSES: Operations and maintenance 77,879 80,218 72,018 Taxes other than income taxes 19,952 21,597 24,181 Depreciation, depletion and amortization 44,619 43,047 40,594 -------- -------- -------- Total operating expenses 142,450 144,862 136,793 -------- -------- -------- INCOME FROM OPERATIONS 89,994 92,651 75,432 -------- -------- -------- OTHER INCOME 2,654 8,196 10,432 -------- -------- -------- INTEREST CHARGES: Interest on long-term debt 24,918 23,176 23,141 Other interest 4,500 3,448 2,252 Amortization of debt discount and expense 730 865 882 -------- -------- -------- Total interest charges 30,148 27,489 26,275 Allowance for funds used during construction (1,665) (782) (596) -------- -------- -------- Total interest charges-net 28,483 26,707 25,679 -------- -------- -------- INCOME BEFORE INCOME TAXES 64,165 74,140 60,185 INCOME TAXES 21,106 27,347 22,120 -------- ------- -------- NET INCOME 43,059 46,793 38,065 Redeemable preferred and preference stock dividend requirements 2,646 2,723 2,806 -------- -------- -------- EARNINGS APPLICABLE TO COMMON STOCK $ 40,413 $ 44,070 $ 35,259 ======== ======== ======== AVERAGE COMMON SHARES OUTSTANDING 22,698 22,391 21,817 ====== ====== ====== BASIC EARNINGS PER SHARE OF COMMON STOCK $1.78 $1.97 $1.62 ===== ===== ===== DILUTED EARNINGS PER SHARE OF COMMON STOCK $1.76 $1.94 $1.60 ===== ===== ===== DIVIDENDS PER SHARE OF COMMON STOCK $1.205 $1.20 $1.18 ====== ===== ===== -----------------------------------------------40 NORTHWEST NATURAL GAS COMPANY CONSOLIDATED STATEMENTS OF INCOME (Thousands, Except Per Share Amounts) Year Ended December 31 1998 1997 1996 - ------------------------------------------------------------------------------- OPERATING REVENUES: Gross operating revenues $416,689 $361,127 $380,199 Cost of sales 173,424 130,599 141,842 --------- --------- --------- Net operating revenues 243,265 230,528 238,357 OPERATING EXPENSES: Operations and maintenance 85,882 77,879 80,218 Taxes other than income taxes 21,939 19,952 21,597 Depreciation, depletion and amortization 55,822 44,619 43,047 --------- --------- --------- Total operating expenses 163,643 142,450 144,862 -------- -------- --------- INCOME FROM OPERATIONS 79,622 88,078 93,495 --------- --------- --------- OTHER INCOME (EXPENSE) (8,310) 4,570 7,352 ---------- --------- ---------- INTEREST CHARGES: Interest on long-term debt 27,567 24,918 23,176 Other interest 4,902 4,500 3,448 Amortization of debt discount and expense 714 730 865 ---------- --------- ----------- Total interest charges 33,183 30,148 27,489 Allowance for funds used during construction (1,426) (1,665) (782) ----------- --------- ----------- Total interest charges-net 31,757 28,483 26,707 --------- --------- --------- INCOME BEFORE INCOME TAXES 39,555 64,165 74,140 INCOME TAXES 12,254 21,106 27,347 ---------- --------- --------- NET INCOME 27,301 43,059 46,793 Redeemable preferred and preference stock dividend requirements 2,577 2,646 2,723 ---------- --------- ---------- EARNINGS APPLICABLE TO COMMON STOCK $ 24,724 $ 40,413 $ 44,070 ======== ======== ======== AVERAGE COMMON SHARES OUTSTANDING 24,233 22,698 22,391 ========= ========= ========= BASIC EARNINGS PER SHARE OF COMMON STOCK $1.02 $1.78 $1.97 ===== ===== ===== DILUTED EARNINGS PER SHARE OF COMMON STOCK $1.02 $1.76 $1.94 ===== ===== ===== DIVIDENDS PER SHARE OF COMMON STOCK $1.22 $1.205 $1.20 ===== ====== ===== ------------------------------------ See Notes to Consolidated Financial Statements.
NORTHWEST NATURAL GAS COMPANY CONSOLIDATED STATEMENTS OF EARNINGS INVESTED IN THE BUSINESS (Thousands) 1997 1996 1995 - -------------------------------------------------------------------------------- BALANCE AT BEGINNING OF YEAR $ 98,376 $105,651 $ 97,275 Net Income 43,059 46,793 38,065 Cash dividends: Redeemable preferred and preference stock (2,660) (2,735) (2,836) Common stock (27,321) (26,836) (25,517) Stock Dividend: Common stock -- (23,704) -- Foreign currency translation and capital stock expense (591) (793) (1,336) -------- ------- ------- BALANCE AT END OF YEAR $110,863 $ 98,376 $105,651 ======== ========41 NORTHWEST NATURAL GAS COMPANY CONSOLIDATED STATEMENTS OF EARNINGS INVESTED IN THE BUSINESS (Thousands) Year Ended December 31, 1998 1997 1996 ---------------- ----------------- ---------------- Earnings invested in the business: Balance at Beginning of Year $113,098 $100,026 $106,549 Net Income 27,301 $27,301 43,059 $43,059 46,793 $46,793 Cash Dividends Paid: Redeemable preferred and preference stock (2,587) (2,660) (2,735) Common stock (29,615) (27,321) (26,836) Common Stock Dividend - - (23,704) Common Stock Expense (1,684) (6) (41) --------- -------- --------- Balance at End of $106,513 $113,098 $100,026 Year ========= ========= ========= Accumulated Other Comprehensive Income (Loss): Balance at Beginning of Year $ (2,235) $ (1,650) $ (898) Other comprehensive income (loss)- Foreign currency translation adjustment (225) (225) (585) (585) (752) (752) -------- -------- --------- -------- --------- --------- Comprehensive Income $27,076 $42,474 $46,041 ======= ========
----------------------------------------------========= Balance at End of Year $ (2,460) $ (2,235) $(1,650) ========= ========= ========= ------------------------------------ See Notes to Consolidated Financial Statements. NORTHWEST NATURAL GAS COMPANY CONSOLIDATED BALANCE SHEETS (Thousands)
December 31 1997 1996 - ------------------------------------------------------------------------------- ASSETS: PLANT AND PROPERTY: Utility plant $1,164,499 $1,055,112 Less accumulated depreciation 366,607 336,141 ---------- ----------- Utility plant - net 797,892 718,971 Non-utility property 52,422 45,689 Less accumulated depreciation and depletion 22,843 19,38842 NORTHWEST NATURAL GAS COMPANY CONSOLIDATED BALANCE SHEETS (Thousands) December 31 1998 1997 - ------------------------------------------------------------------------------ ASSETS: PLANT AND PROPERTY: Utility plant $1,239,690 $1,164,499 Less accumulated depreciation 404,117 366,607 ---------- ---------- Utility plant - net 835,573 797,892 ---------- ---------- Non-utility property 89,050 52,422 Less accumulated depreciation and depletion 29,927 22,843 ---------- ---------- Non-utility property - net 59,123 29,579 ---------- ---------- Total plant and property 894,696 827,471 ---------- ---------- INVESTMENTS AND OTHER: Investments 15,898 34,148 Long-term notes receivable 816 978 ---------- ---------- Total investments and other 16,714 35,126 ---------- ---------- CURRENT ASSETS: Cash and cash equivalents 7,383 6,731 Accounts receivable - customers 49,023 40,673 Allowance for uncollectible accounts (1,547) (1,253) Accrued unbilled revenue 34,258 23,911 Inventories of gas, materials and supplies 21,258 17,385 Prepayments and other current assets 16,105 17,226 ---------- ---------- Total current assets 126,480 104,673 ---------- ---------- REGULATORY TAX ASSETS 56,860 56,860 ---------- ---------- Non-utility property - net 29,579 26,301 ---------- ---------- Total plant and property 827,471 745,272 ---------- --------- INVESTMENTS AND OTHER: Investments 34,148 33,008 Long-term notes receivable 978 1,715 ---------- --------- Total investments and other 35,126 34,723 ---------- --------- CURRENT ASSETS: Cash and cash equivalents 6,731 8,219 Accounts receivable - customers 40,673 41,890 Allowance for uncollectible accounts (1,253) (1,057) Accrued unbilled revenue 23,911 22,340 Inventories of gas, materials and supplies 17,385 14,439 Prepayments and other current assets 17,226 12,483 ---------- --------- Total current assets 104,673 98,314 ---------- --------- REGULATORY TAX ASSETS 56,860 57,940 ---------- --------- DEFERRED GAS COSTS RECEIVABLE 27,795 28,628 -- ---------- ---------- DEFERRED DEBITS AND OTHER 69,191 58,859 52,620 ---------- ---------- TOTAL ASSETS $1,191,736 $1,111,617 $ 988,869 ========== ==========
---------------------------------------------------------------------------------- See Notes to Consolidated Financial Statements. NORTHWEST NATURAL GAS COMPANY CONSOLIDATED BALANCE SHEETS (Thousands)
December 31 1997 1996 - -------------------------------------------------------------------------------- CAPITALIZATION AND LIABILITIES: CAPITALIZATION (See Consolidated Statements of Capitalization): Common stock $ 72,404 $ 71,425 Premium on common stock 182,998 176,977 Earnings invested in the business 110,863 98,376 ---------- -------- Total common stock equity 366,265 346,778 Redeemable preference stock 25,000 25,000 Redeemable preferred stock 12,429 13,749 Long-term debt 344,303 271,838 ---------- -------- Total capitalization 747,997 657,365 ---------- -------- CURRENT LIABILITIES: Notes payable 89,317 50,058 Accounts payable 58,775 64,795 Long-term debt due within one year 16,000 26,000 Taxes accrued 4,656 3,196 Interest accrued 6,058 5,396 Other current and accrued liabilities 21,390 19,418 ---------- -------- Total current liabilities 196,196 168,863 ---------- -------- DEFERRED INVESTMENT TAX CREDITS 11,949 11,668 ---------- -------- DEFERRED INCOME TAXES 139,953 123,625 ---------- -------- DEFERRED GAS COSTS LIABILITY -- 8,058 ---------- -------- REGULATORY ACCOUNTS AND OTHER 15,522 19,290 ---------- -------- COMMITMENTS AND CONTINGENCIES (Note 13) -- -- ---------- -------- TOTAL CAPITALIZATION AND LIABILITIES $1,111,617 $988,869 ========== ========
-----------------------------------------------43 NORTHWEST NATURAL GAS COMPANY CONSOLIDATED BALANCE SHEETS (Thousands) December 31 1998 1997 - ------------------------------------------------------------------------------ CAPITALIZATION AND LIABILITIES: CAPITALIZATION (See Consolidated Statements of Capitalization): Common stock $ 78,701 $ 72,404 Premium on common stock 229,650 182,998 Earnings invested in the business 106,513 113,098 Accumulated other comprehensive income (loss) (2,460) (2,235) ------------- -------------- Total common stock equity 412,404 366,265 Redeemable preference stock 25,000 25,000 Redeemable preferred stock 11,499 12,429 Long-term debt 366,738 344,303 ----------- ------------ Total capitalization 815,641 747,997 ----------- ------------ MINORITY INTEREST 16,322 - ------------ ------------ CURRENT LIABILITIES: Notes payable 87,264 89,317 Accounts payable 56,039 58,775 Long-term debt due within one year 10,000 16,000 Taxes accrued 7,486 4,656 Interest accrued 6,204 6,058 Other current and accrued liabilities 23,477 21,390 ------------ ------------- Total current liabilities 190,470 196,196 ----------- ------------ DEFERRED INVESTMENT TAX CREDITS 11,248 11,949 ------------ ------------- DEFERRED INCOME TAXES 140,310 139,953 ------------ ------------ REGULATORY LIABILITY AND OTHER 17,745 15,522 ------------- ------------- COMMITMENTS AND CONTINGENCIES (Note 12) - - -------------- ---------------- TOTAL CAPITALIZATION AND LIABILITIES $1,191,736 $1,111,617 ========== ========== ----------------------------------- See Notes to Consolidated Financial Statements. NORTHWEST NATURAL GAS COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (Thousands)
Year Ended December 31 1997 1996 1995 - ------------------------------------------------------------------------------------------------ OPERATING ACTIVITIES: Net income $ 43,059 $ 46,793 $ 38,065 Adjustments to reconcile net income to net cash provided by operations: Depreciation, depletion and amortization 44,619 43,047 40,594 Gain on sale of assets (849) (2,897) (4,636) Deferred income taxes and investment tax credits 16,609 4,108 5,222 Equity in (earnings) losses of investments (468) (773) (2,141) Allowance for funds used during construction (1,868) (1,593) (620) Deferred gas costs (36,686) (11,856) -- Regulatory accounts and other - net (5,159) (2,491) 3,974 --------- -------- -------- Cash from operations before working capital changes 59,257 74,338 80,458 Changes in operating assets and liabilities: Accounts receivable 1,413 (6,448) 7,767 Accrued unbilled revenue (1,571) (847) (1,173) Inventories of gas, materials and supplies (2,946) (185) 704 Accounts payable (6,020) 23,011 (6,733) Accrued interest and taxes 2,122 (6,306) 3,744 Other current assets and liabilities (6,439) 6,377 (908) ---------- -------- -------- CASH PROVIDED BY OPERATING ACTIVITIES 45,816 89,940 83,859 ---------- -------- -------- INVESTING ACTIVITIES: Acquisition and construction of utility plant assets (115,886) (83,400) (67,163) Investment in non-utility plant (9,229) (3,246) (18,964) Proceeds from sale of non-utility assets 1,014 -- 7,862 Investments and other (35) 3,682 1,356 --------- -------- -------- CASH USED IN INVESTING ACTIVITIES (124,136) (82,964) (76,909) --------- ------- -------- FINANCING ACTIVITIES: Common stock issued 6,465 5,690 39,569 Redeemable preference stock retired -- -- (174) Redeemable preferred stock retired (1,320) (1,091) (989) Long-term debt: Issued 90,000 20,000 10,000 Retired (27,000) (22,000) (1,131) Change in short-term debt 39,259 21,226 (24,822) Cash dividend payments: Redeemable preferred and preference stock (2,660) (2,735) (2,836) Common stock (27,321) (26,836) (25,517) Foreign currency translation and capital stock expense (591) (793) (1,336) --------- --------- --------- CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES 76,832 (6,539) (7,236) --------- --------- -------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (1,488) 437 (286) CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 8,219 7,782 8,068 --------- --------- --------- CASH AND CASH EQUIVALENTS - END OF YEAR $ 6,731 $ 8,219 $ 7,782 ========= ========= ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 28,756 $25,846 $ 25,346 Income taxes $ 7,288 $27,266 $ 15,819 SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING ACTIVITIES: Conversion to common stock: $2.375 Series of Convertible Preference Stock -- -- $ 1,078 7-1/4 percent Series of Convertible Debentures $ 535 $1,107 $ 121 -----------------------------------------------44 NORTHWEST NATURAL GAS COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (Thousands) Year Ended December 31 1998 1997 1996 - ------------------------------------------------------------------------------- OPERATING ACTIVITIES: Net income $ 27,301 $ 43,059 $ 46,793 Adjustments to reconcile net income to net cash provided by operations: Depreciation, depletion and amortization 55,822 44,619 43,047 Gain on sale of assets (3,782) (849) (2,897) Deferred income taxes and investment tax credits (344) 16,609 4,108 Equity in losses (earnings) of investments 15,572 (468) (773) Allowance for funds used during construction (1,426) (1,868) (1,593) Deferred gas costs receivable 833 (36,686) (11,856) Regulatory accounts and other - net (8,109) (5,159) (2,491) -------- -------- -------- Cash from operations before working capital changes 85,867 59,257 74,338 Changes in operating assets and liabilities: Accounts receivable - net (8,056) 1,413 (6,448) Accrued unbilled revenue (10,347) (1,571) (847) Inventories of gas, materials and supplies (3,873) (2,946) (185) Accounts payable (2,736) (6,020) 23,011 Accrued interest and taxes 2,976 2,122 (6,306) Other current assets and liabilities 3,108 (6,439) 6,377 -------- -------- -------- CASH PROVIDED BY OPERATING ACTIVITIES 66,939 45,816 89,940 -------- -------- -------- INVESTING ACTIVITIES: Acquisition and construction of utility plant assets (80,022) (115,886) (83,400) Investment in non-utility property (19,780) (9,229) (3,246) Proceeds from sale of non-utility assets - 1,014 - Investments and other 1,226 (35) 3,682 -------- -------- -------- CASH USED IN INVESTING (98,576) (124,136) (82,964) ACTIVITIES -------- -------- -------- FINANCING ACTIVITIES: Common stock issued 52,384 6,465 5,690 Redeemable preferred stock retired (930) (1,320) (1,091) Long-term debt: Issued 52,000 90,000 20,000 Retired (35,000) (27,000) (22,000) Change in short-term debt (2,054) 39,259 21,226 Cash dividend payments: Redeemable preferred and preference stock (2,587) (2,660) (2,735) Common stock (29,615) (27,321) (26,836) Foreign currency translation and capital stock expense (1,909) (591) (793) ------- -------- -------- CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES 32,289 76,832 (6,539) ------- -------- -------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 652 (1,488) 437 CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 6,731 8,219 7,782 ------- -------- ------- CASH AND CASH EQUIVALENTS - END OF YEAR $ 7,383 $ 6,731 $ 8,219 ========= ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 32,323 $ 28,756 $25,846 Income taxes $ 8,205 $ 7,288 $27,266 SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES: Conversion to common stock: 7-1/4 percent Series of Convertible Debentures $ 565 $ 535 $1,107 ---------------------------------- See Notes to Consolidated Financial Statements
NORTHWEST NATURAL GAS COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION (Thousands, Except Share Amounts)
December 31 1997 1996 - ---------------------------------------------------------------------------------------------------------------------- COMMON STOCK EQUITY: Common stock - par value $3-1/6 per share; authorized 60,000,000 shares: outstanding - 1997, 22,864,328 shares; 1996, 22,555,184 shares $ 72,404 $ 71,425 Premium on common stock 182,998 176,977 Earnings invested in the business 110,863 98,376 -------- -------- Total common stock equity 366,265 49% 346,778 53% -------- ---- -------- ---- REDEEMABLE PREFERENCE STOCK, authorized 2,000,000 shares; $6.95 Series, stated value $100 per share; outstanding - 1997, 250,000 shares; 1996, 250,000 shares 25,000 25,000 -------- -------- Total redeemable preference stock 25,000 3% 25,000 4% -------- ---- -------- ---- REDEEMABLE PREFERRED STOCK, authorized 1,500,000 shares; all outstanding series have a stated value of $100 per share: $4.68 Series, outstanding -1997, 0 shares; 1996, 3,905 shares -- 391 $4.75 Series, outstanding -1997, 4,285 shares; 1996, 6,085 shares 429 608 $7.125 Series, outstanding -1997, 120,000 shares; 1996, 127,500 shares 12,000 12,750 -------- --------- Total redeemable preferred stock 12,429 2% 13,749 2% -------- ---- --------- ---- LONG-TERM DEBT: First Mortgage Bonds -------------------- 9-3/4% Series due 2015 50,000 50,000 9-1/8% Series due 2019 20,000 22,000 Medium-Term Notes ----------------- First Mortgage Bonds: 7.38% Series A due 1997 -- 20,000 7.69% Series A due 1999 10,000 10,000 5.96% Series B due 2000 5,000 5,000 5.98% Series B due 2000 5,000 5,000 8.05% Series A due 2002 10,000 10,000 6.40% Series B due 2003 20,000 20,000 6.34% Series B due 2005 5,000 5,000 6.38% Series B due 2005 5,000 5,000 6.45% Series B due 2005 5,000 5,000 6.80% Series B due 2007 10,000 -- 6.50% Series B due 2008 5,000 5,000 8.26% Series B due 2014 10,000 10,000 7.00% Series B due 2017 40,000 -- 8.31% Series B due 2019 10,000 10,000 9.05% Series A due 2021 10,000 10,000 7.25% Series B due 2023 20,000 20,000 7.50% Series B due 2023 4,000 4,000 7.52% Series B due 2023 11,000 11,000 6.52% Series B due 2025 10,000 10,000 7.05% Series B due 2026 20,000 20,000 7.00% Series B due 2027 20,000 -- 6.65% Series B due 2027 20,000 -- Unsecured: 7.40% Series A due 1997 -- 5,000 8.93% Series A due 1998 5,000 5,000 8.95% Series A due 1998 10,000 10,000 8.47% Series A due 2001 10,000 10,000 Convertible Debentures ---------------------- 7-1/4% Series due 2012 10,303 10,838 -------- -------- 360,303 297,838 Less long-term debt due within one-year 16,000 26,000 -------- -------- Total long-term debt 344,303 46% 271,838 41% -------- ---- -------- ---- TOTAL CAPITALIZATION $747,997 100% $657,365 100% ======== ==== ========45 NORTHWEST NATURAL GAS COMPANY CONSOLIDATED STATEMENTS OF CAPITALIZATION (Thousands, Except Share Amounts) December 31 1998 1997 - ------------------------------------------------------------------------------- COMMON STOCK EQUITY: Common stock - par value $3-1/6 per share; authorized 60,000,000 shares: outstanding - 1998, 24,853,121 shares; 1997, 22,864,328 shares $ 78,701 $ 72,404 Premium on common stock 229,650 182,998 Earnings invested in the business 106,513 113,098 Accumulated other comprehensive income (loss) (2,460) (2,235) --------- --------- Total common stock 412,404 51% 366,265 49% equity --------- ---- --------- ---- REDEEMABLE PREFERENCE STOCK, authorized 2,000,000 shares; $6.95 Series, stated value $100 per share; outstanding - 1998, 250,000 shares; 1997, 250,000 shares 25,000 25,000 --------- --------- Total redeemable preference stock 25,000 3% 25,000 3% --------- ---- --------- --- REDEEMABLE PREFERRED STOCK, authorized 1,500,000 shares; all outstanding series have a stated value of $100 per share: $4.75 Series, outstanding - 1998, 2,485 shares; 1997, 4,285 shares 249 429 $7.125 Series, outstanding - 1998, 112,500 shares; 1997, 120,000 shares 11,250 12,000 -------- --------- Total redeemable preferred stock 11,499 1% 12,429 2% -------- -- -------- ---- LONG-TERM DEBT: First Mortgage Bonds -------------------- 9-3/4% Series due 2015 50,000 50,000 9-1/8% Series due 2019 - 20,000 Medium-Term Notes ----------------- First Mortgage Bonds: 7.69% Series A due 1999 10,000 10,000 5.96% Series B due 2000 5,000 5,000 5.98% Series B due 2000 5,000 5,000 8.05% Series A due 2002 10,000 10,000 5.55% Series B due 2002 20,000 - 6.40% Series B due 2003 20,000 20,000 6.34% Series B due 2005 5,000 5,000 6.38% Series B due 2005 5,000 5,000 6.45% Series B due 2005 5,000 5,000 6.80% Series B due 2007 10,000 10,000 6.50% Series B due 2008 5,000 5,000 8.26% Series B due 2014 10,000 10,000 7.00% Series B due 2017 40,000 40,000 6.60% Series B due 2018 22,000 - 8.31% Series B due 2019 10,000 10,000 9.05% Series A due 2021 10,000 10,000 7.25% Series B due 2023 20,000 20,000 7.50% Series B due 2023 4,000 4,000 7.52% Series B due 2023 11,000 11,000 6.52% Series B due 2025 10,000 10,000 7.05% Series B due 2026 20,000 20,000 7.00% Series B due 2027 20,000 20,000 6.65% Series B due 2027 20,000 20,000 6.65% Series B due 2028 10,000 - Unsecured: 8.93% Series A due 1998 - 5,000 8.95% Series A due 1998 - 10,000 8.47% Series A due 2001 10,000 10,000 Convertible Debentures ---------------------- 7-1/4% Series due 2012 9,738 10,303 --------- --------- 376,738 360,303 Less long-term debt due within within one-year 10,000 16,000 --------- --------- Total long-term debt 366,738 45% 344,303 46% --------- ---- --------- ---- TOTAL CAPITALIZATION $815,641 100% $747,997 100% ========= ====
-----------------------------------------------========= ==== ------------------------------------ See Notes to Consolidated Financial Statements. NORTHWEST NATURAL GAS COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS46 Northwest Natural Gas Company Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: - --------------------------------------------------------------------------------------------------------- Organization and Principles of Consolidation - -------------------------------------------- The consolidated financial statements include: Regulated utility: --Northwest-Northwest Natural Gas Company (doing business as NW Natural) Non-regulated wholly-ownedsubsidiary businesses: --NNG-NNG Financial Corporation (Financial Corporation) --Canor, a wholly owned subsidiary -Canor Energy, Ltd. (Canor) --Oregon, a majority-owned subsidiary -Oregon Natural Gas Development Corporation (Oregon Natural), a wholly owned subsidiary Oregon Natural was merged with and into NW Natural during the second quarter of 1996. Together these businesses are referred to herein as the "Company." Intercompany accounts and transactions have been eliminated. Investments in corporate joint ventures and partnerships in which the Company's ownership is 50 percent or less are accounted for by the equity method or the cost method (see Note 10)9). Certain amounts from prior years have been reclassified to conform with the 19971998 presentation. Use of Estimates - ---------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts in the consolidated financial statements and accompanying notes. Changes in such estimates may affect amounts reported in future periods. Industry Regulation - ------------------- The Company's principal business is the distribution of natural gas which is regulated by the Oregon Public Utility Commission (OPUC) and the Washington Utilities and Transportation Commission (WUTC). Accounting records and practices conform to the requirements and uniform system of accounts prescribed by these regulatory authorities in accordance with Statement of Financial Accounting Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation." Utility Plant - ------------- Utility plant for NW Natural's utility plantNatural is stated at original cost (see table in Note 10)9). When a depreciable unit of property is retired, the original cost is removed from both utility plant and the accumulated provision for depreciation together with the cost of removal, less any salvage. No gain or loss is recognized upon normal retirement. 47 Northwest Natural Gas Company Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- NW Natural's provision for depreciation of utility property, which is computed under the straight-line, age-life method in accordance with independent engineering studies and as approved by regulatory authorities, approximated 3.83.9 percent of average depreciable plant in 1998 and 3.8 percent in both 1997 and 1996 and 4.2 percent in 1995.1996. The rate of depreciation approximates the economic life of the utility property. Certain additions to utility plant include an allowance for funds used during construction (AFUDC), a non-cash item. AFUDC represents the cost of funds borrowed during construction and is calculated using actual commercial paper interest rates. If commercial paper borrowings are insufficient to finance the total work in progress, then a composite rate of interest on all debt, shown as a reduction to interest charges, and a return on equity funds, shown as other income, is used to compute AFUDC. While cash is not realized currently from AFUDC, it is realized in the ratemaking process over the service life of the related property through increased revenues resulting from higher rate base and higher depreciation expense. NW Natural's weighted average AFUDC rates were 5.5 percent for 1998, 5.8 percent for 1997, and 8.9 percent for 1996, and 5.3 percent for 1995.1996. Regulatory Accounts - ------------------- In applying SFAS No. 71, NW Natural has capitalized certain costs and benefits as regulatory assets and liabilities pursuant to orders of the state utility regulatory commissions, in general rate proceedings or expense deferral proceedings, in order to provide for recovery of revenues or expenses from, or refunds to, NW Natural's utility customers in future periods. At December 31, 19971998 and 1996,1997, regulatory tax assets were $56.9 million and $57.9 million, respectively,for both years, while other regulatory assets and liabilities (net) were $36.9$39.9 million and $8.2$36.9 million, respectively. If NW Natural should determine in the future NW Natural determines that all or a portion of these regulatory assets and liabilities no longer meetsmeet the criteria for ccontinuedcontinued application of SFAS No. 71, itthen NW Natural would be required to write off that portion which it could not recover or refund. Cash and Cash Equivalents - ------------------------- For purposes of reporting cash flows, cash and cash equivalents include cash on hand and highly liquid temporary investments with original maturity dates of three months or less. Unbilled Revenue - ---------------- NW Natural accrues for gas deliveries not billed to customers from the meter reading dates to month end. Inventories - ----------- NW Natural's inventories of gas in storage and materials and supplies are stated at the lower of average cost or net realizable value. 48 Northwest Natural Gas Company Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- Derivatives Policy - ------------------ NW Natural has aNatural's "Derivatives Policy" which allows up to a 100 percent hedge position in currency derivatives to match and lock-inlock in prices on individual Canadian natural gas purchase transactions; interest rate derivatives to match specific outstanding debt instruments maturing in less than five years; and natural gas commodity derivatives to lock-inlock in or cap prices on gas purchased for a future period under contracts with market-indexed pricing. The policy requires derivatives to be used within prescribed limitations and only in order to reduce price risk, so as to qualify for hedge accounting treatment. Changes in market values of foreign currency contracts, and gains or losses on commodity swapderivative contracts, are deferred and recognized as adjustments to gas purchase costs upon concurrent settlement of these contracts (see Note 12)11). In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This standard is effective for all fiscal years beginning after Jun. 15, 1999 (Jan. 1, 2000 for NW Natural). SFAS No. 133 requires that all derivative instruments be recorded each period either in current earnings or in other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if so designated, what type of hedge transaction it is. The Company has not determined the impact that adoption of SFAS No. 133 will have on results of operations or its financial position. The FASB's Emerging Issues Task Force (EITF) Issue 98-10, "Accounting for Energy Trading and Risk Management Activities," which is effective for fiscal years beginning after Dec. 15, 1998, addresses how to account for purchases and sales of energy trading contracts. NW Natural does not believe its purchase and sales activities meet the definition of trading activities, and therefore EITF Issue 98-10 is not applicable. Segment Reporting - ----------------- In June 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," which requires disclosures of segment data based on how management makes decisions about allocating resources to segments and measuring performance. The Company principally operates in a single line of business consisting of the distribution of natural gas. Other segments are primarily investments in alternative energy projects in California and oil and gas exploration properties in Canada. The following table presents information about reportable segments for 1998, 1997 and 1996. Inter-segment transactions are insignificant. (Thousands) Utility Other Total ----------- ------- ----- ----- 1998 Net operating revenues $ 230,564 $12,701 $ 243,265 Income (loss) from operations 86,981 (7,359) 79,622 Depreciation expense (includes Canor SFAS No.121 impairment charges) 43,767 12,055 55,822 SFAS No. 121 asset impairment charges - (20,804) (20,804) Net income (loss) 37,498 (10,197) 27,301 Assets 1,120,706 71,030 1,191,736 49 Northwest Natural Gas Company Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- (Thousands) Utility Other Total ----------- ------- ------ ------ 1997 Net operating revenues $ 220,660 $ 9,868 $ 230,528 Income (loss) from operations 88,127 (49) 88,078 Depreciation expense 38,833 5,786 44,619 Net income 41,226 1,833 43,059 Assets 1,049,289 62,328 1,111,617 1996 Net operating income $ 228,348 $10,009 $ 238,357 Income (loss) from operations 95,157 (1,662) 93,495 Depreciation expense 35,779 7,268 43,047 SFAS No. 121 asset impairment charges - (2,218) (2,218) Net income 44,516 2,277 46,793 Assets 927,182 61,687 988,869 Income Taxes - ------------ NW Natural uses the liabilitybalance sheet method of accounting for deferred income taxes. Deferred tax liabilities and assets reflect the expected future tax consequences, based on enacted tax law, of temporary differences between the tax basis of assets and liabilities and their financial reporting amounts.amounts (see Note 7). Consistent with rate and accounting instructions of regulatory authorities, deferred income taxes are not currently collected for those temporary income tax differences where the prescribed regulatory accounting methods do not provide for current recovery in rates. NW Natural has recorded a regulatory tax asset for such amounts pending recovery from customers in future rates. These amounts are primarily differences between the book and tax basis of net utility plant in service. This asset balance was $56.9 million at Decemberboth Dec. 31, 19971998 and $57.9 million at December 31, 1996 (see Note 7).1997. Investment tax credits on utility property additions and leveraged leases which reduce income taxes payable are deferred for financial statement purposes and are amortized over the life of the related property or lease. Investment and energy tax credits generated by non-regulated subsidiaries are amortized over a period of one to five years. Other Income (Expense) - ---------------------------------- Other income (expense) consists of interest income,income; gain on the sale of assets, including non-recurring gains from the amalgamation of Canor and Southlake in 1998 and the sale of Oregon Natural's underground gas storage assets, gathering system and gas producing propertiesfacilities to NW Natural in 1996 and 1995,1996; investment income (loss) of Financial Corporation, including Financial Corporation's write-downs due to asset impairments in 1998; and other miscellaneous income from merchandise sales, rent,rents, the aircraft lease and other items. 50 Northwest Natural Gas Company Notes to Consolidated Financial Statements - ------------------------------------------------------------------------------- Earnings Per Share - ------------------ The Company adopted SFAS No. 128, "Earnings Per Share",Share," effective for the year ended DecemberDec. 31, 1997. SFAS No. 128 requires disclosure of basic and diluted earnings per share. All prior years have been1996 was restated to reflect the adoption of SFAS No. 128. Basic earnings per share are computed based on the weighted average number of common shares outstanding each year. Diluted earnings per share reflect the potential effects of the conversion of any outstanding convertible debentures and the exercise of outstanding stock options. Diluted earnings are calculated as follows:
1997 1996 1995 ------------------------------------------------------------------------------- (Thousands, except per share amounts) Earnings applicable to common stock $40,413 $44,070 $35,259 Debenture interest less taxes 455 479 528 ------- ------- -------1998 1997 1996 ----- ---- ---- Earnings applicable to common stock $24,724 $40,413 $44,070 Debenture interest less taxes 431 455 479 ------- -------- ------ Net income available for diluted common stock $25,155 $40,868 $44,549 $35,787 ======= ======= ======= Average common shares outstanding 22,698 22,391 21,817 Stock options 32 27 11 Convertible debentures 518 545 600 ------- ------- ------ Diluted average common shares outstanding 23,248 22,963 22,428 ======= ======= ======= Average common shares outstanding 24,233 22,698 22,391 Stock options 41 32 27 Convertible debentures 489 518 545 ------- -------- ------- Diluted average common shares outstanding 24,763 23,248 22,963 ====== ====== ====== Diluted earnings per share of common stock $1.02 $1.76 $1.94 $1.60 ===== ===== =====
2. CONSOLIDATED SUBSIDIARY OPERATIONS: - --------------------------------------------------------------------------------------- At DecemberDec. 31, 1997,1998, the Company had two active wholly-owned subsidiaries, Financial Corporation, a wholly owned subsidiary, and Canor.Canor, a majority-owned subsidiary. Another wholly-ownedwholly owned subsidiary, Oregon Natural, was merged into NW Natural during 1996. NNG Financial Corporation - ------------------------- Financial Corporation providesprovided short-term financing for Canor and has several financial investments, including investments as a limited partner in solar electric generating systems, windpower electric generating projects, a hydroelectric facility and low-income housing projects. It also holds interests in certain gas producing properties in the western United States (see Note 10)9). During the fourth quarter of 1998, Financial Corporation recorded asset impairment charges resulting from the application of an impairment model based on SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," to limited partnership investments in solar electric, wind-power electric and hydroelectric generation projects in California. The pre-tax write-down of $16.0 million is included in Other Income (Expense) in the Consolidated Statements of Income. Canor Energy, Ltd. - ------------------ Canor, an Alberta, Canada corporation, is engaged in natural gas and oil exploration, development and production in Alberta and Saskatchewan, Canada. Canor recorded asset write-downs of $4.2 million 51 Northwest Natural Gas Company Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- in 1998 for its oil and gas production properties. Approximately half of the write-downs were due to impairment charges under SFAS No. 121 resulting from the impact of low oil prices on Canor's oil properties in Canada. The additional write-downs were due to determinations that some of Canor's oil and gas wells were no longer productive due to water encroachment. All asset write-downs for Canor are included in depreciation expense. Canor began operations in 1990 as a wholly-ownedwholly owned subsidiary of Oregon Natural. When Oregon Natural was merged into NW Natural during 1996, Canor became a wholly-ownedwholly owned subsidiary of NW Natural. Summarized financial information for the consolidated subsidiaries follows:
Thousands 1997 1996 1995 - ------------------------------------------------------------------------------- Statements of income for the year ended December 31: Net operating revenues $ 9,868 $10,009 $ 8,271 Operating expenses 9,917 11,671 9,727 ------- ------- ------- Income (loss) from operations (49) (1,662) (1,456) Income from financial investments 468 773 2,063 Other income and interest charges 962 4,197 5,991 ------- ------- ------- Income before income taxes 1,381 3,308 6,598 Income tax expense (benefit) (381) 1,076 2,497 ------- ------- ------- Net income $ 1,762 $ 2,232 $ 4,101 ======= ======= ======= Balance sheets as of December 31: Assets: Non-utility property - net $29,135 $25,704 $36,053 Investments and other 25,896 26,081 37,364 Current assets 19,012 20,898 20,750 ------- ------- ------- Total assets $74,043 $72,683 $94,167 ======= ======= ======= Capitalization and liabilities: Equity $34,883 $30,706 $30,392 Current liabilities 13,668 13,590 37,459 Other liabilities 25,492 28,387 26,316 ------- ------- ------- Total capitalization and liabilities $74,043 $72,683 $94,167 ======= ======= ======= - -------------------------------------------------------------------------------
In 1998, Canor acquired all of the capital stock of Southlake Energy, Inc. (Southlake), an indirect subsidiary of NIPSCO Industries, Inc. (NI), in exchange for shares of common stock representing a 34 percent interest in Canor. The minority interest in Canor is held by NI Canada ULC (NICULC). For financial reporting purposes, Canor's assets, liabilities and earnings are consolidated in the Company's financial statements, and NICULC's common stock interest is recorded as "Minority Interest" in the Balance Sheet. 3. CAPITAL STOCK: - ------------------------------------------ Common Stock - ------------ At DecemberDec. 31, 1997,1998, NW Natural had reserved 68,18150,544 shares of common stock for issuance under the Employee Stock Purchase Plan, 737,153542,318 shares under its Dividend Reinvestment and Stock Purchase Plan, 833,858807,157 shares under its 1985 Stock Option Plan (see Note 4), 578,033549,658 shares for future conversions of its 7-1/4 percent Convertible Debentures and 3,000,000 shares under the Shareholder Rights Plan. During 1996, the Board of Directors adopted a Shareholder Rights Plan and declared a dividend of one Right for each outstanding share of common stock. Each Right entitles the shareholder to purchase one tenth of a share of common stock for $6.67. In the event that any person acquired more than 15 percent of the outstanding common stock, or should the Company be acquired in a merger or other business combination transaction, subject to the terms of the Rights Plan, the Right would become exercisable, entitling each holder (other than the acquiring person or group), for a purchase price equal to 10 times the current purchase price of the Right, to purchase that number of shares of common stock having a market value equal to 20 times the purchase price of the Right. The Rights will expire on March 15, 2006. Effective September 6, 1996, additional shares of common stock were distributed to shareholders of record on August 23, 1996, in connection with a three-for-two stock split. All share disclosures and per share data related to the common stock included in these financial statements are presented on a post-split basis. Amounts associated with common stock for years prior to the effective date of the stock split have been adjusted to reflect the split. Redeemable Preference Stock - --------------------------- The $6.95 Series of Preference Stock is not redeemable prior to DecemberDec. 31, 2002, but is subject to mandatory redemption on that date. Redeemable Preferred Stock - -------------------------- The mandatory preferred stock redemption requirements aggregate $1.0 million in both 1998 and 1999 and $0.8 million in each of the years 2000, 2001, 2002 and 2002.2003. These requirements are noncumulative.non-cumulative. At any time NW Natural is in default on any of its obligations to make the prescribed sinking fund payments, it may not pay cash dividends on common stock or preference stock. Upon involuntary liquidation, all series of redeemable preferred stock are entitled to their stated value. The remaining shares of the $4.68 Series of redeemable preferred stock were redeemed on June 2, 1997. The redeemable preferred stock is callable at stipulated prices, plus accrued dividends. At DecemberDec. 31, 1997,1998, the redemption prices were $100 per shareprice for the $4.75 Series.Series was $100 per share. Shares of the $7.125 Series are redeemable on or after May 1, 19981999 at a price of $104.75$104.275 per share decreasing each year thereafter to $100 per share on or after May 1, 2008. The following table shows the changes in the number of shares of NW Natural's capital stock and the premium on common stock for the years 1997, 1996 and 1995:
Premium ------------Shares-------------- on Common Preference Preferred Stock Stock Stock Stock Thousands) - ------------------------------------------------------------------------------------- Balance, December 31, 1994 20,128,028 300,079 159,504 $134,641 Sales to the public 1,725,000 -- -- 30,571 Sales to employees 21,046 -- -- 346 Sales to stockholders 237,985 -- -- 4,376 Exercise of stock options - net 18,359 -- -- 45 Conversion of preference stock to common 106,755 (43,137) -- 853 Conversion of convertible debentures to common 6,078 -- -- 108 Sinking fund purchases -- -- (11,100) -- Redemptions -- (6,942) -- -- Other -- -- -- 3 ---------- ------- ------- -------- Balance, December 31, 1995 22,243,251 250,000 148,404 170,943 Sales to employees 15,043 -- -- 255 Sales to stockholders 235,878 -- -- 4,834 Exercise of stock options - net 5,400 -- -- (11) Conversion of convertible debentures to common 55,612 -- -- 956 Sinking fund purchases -- -- (10,914) -- ---------- ------- ------- -------- Balance, December 31, 1996 22,555,184 250,000 137,490 176,977 Sales to employees 27,525 -- -- 514 Sales to stockholders 211,532 -- -- 4,561 Exercise of stock options - net 43,216 -- -- 496 Conversion of convertible debentures to common 26,871 -- -- 450 Sinking fund purchases -- -- (9,300) -- Redemptions -- -- (3,905) -- ---------- ------- ------- -------- Balance, December 31, 1997 22,864,328 250,000 124,285 $182,998 ========== ======= ======= ========52 Northwest Natural Gas Company Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
The following table shows the changes in the number of shares of NW Natural's capital stock and the premium on common stock for the years 1998, 1997 and 1996: Premium ----------------- Shares ------------ on Redeemable Redeemable Common Common Preference Preferred Stock Stock Stock Stock (Thousands) Balance, December 31, 1995 22,243,251 250,000 148,404 $170,943 Sales to employees 15,043 - - 255 Sales to stockholders 235,878 - - 4,834 Exercise of stock options - net 5,400 - - (11) Conversion of convertible debentures to common 55,612 - - 956 Sinking fund purchases - - (10,914) - ---------- ---------- -------- -------- Balance, December 31, 1996 22,555,184 250,000 137,490 176,977 Sales to employees 27,525 - - 514 Sales to stockholders 211,532 - - 4,561 Exercise of stock options - net 43,216 - - 496 Conversion of convertible debentures to common 26,871 - - 450 Sinking fund purchases - - (13,205) - ---------- --------- -------- --------- Balance, December 31, 1997 22,864,328 250,000 124,285 182,998 Sales to the public 1,725,000 - - 40,789 Sales to employees 17,637 - - 366 Sales to stockholders 194,835 - - 4,644 Exercise of stock options - net 22,946 - - 377 Conversion of convertible debentures to common 28,375 - - 475 Sinking fund purchases - - (9,300) 1 ---------- --------- -------- ---------- Balance, December 31, 1998 24,853,121 250,000 114,985 $ 229,650 =========== ========= ======== ========== - ------------------------------------------------------------------------------ 4. STOCK OPTION AND PURCHASE PLANS: - ------------------------------------------------------------------------------ NW Natural's 1985 Stock Option Plan (Plan) authorizes an aggregate of 1,200,000 shares of common stock for issuance as incentive or non-statutory stock options. These options may be granted only to officers and key employees designated by a committee of NW Natural's Board of Directors. All options are granted at an option price not less than the market value at the date of grant and may be exercised for a period not exceeding 10 years from the date of grant. Option holders may exchange shares they have owned for at least one year, at the current market price, to purchase shares at the option price. Since the Plan's inception in 1985, options on 649,173769,173 shares of common stock have been granted at prices ranging from $11.75 to $24.00$27.875 per share, and options on 55,29656,296 shares have expired. NW Natural applies Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to 53 Northwest Natural Gas Company Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- Employees," and related interpretations in accounting for its stock-based compensation plans. Accordingly, no compensation cost has been recognized for either the Plan or the employee stock purchase plan. HadEmployee Stock Purchase Plan. If compensation cost for awards under NW Natural's two stock-based compensation plans had been determined based on the fair value at the grant dates for awards under those plans in a manner consistent withusing the method determined underprescribed by SFAS No. 123, "Accounting for Stock-Based Compensation," net income and earnings per share would have been reduced to the pro forma amounts shownindicated below:
1998 1997 1996 ---- ---- ---- Earnings applicable to common stock ($000): - ------------------------------------------- As reported $24,724 $40,413 $44,070 Pro forma 24,518 40,302 43,480 Basic earnings per share - ------------------------ As reported $1.02 $1.78 $1.97 Pro forma 1.01 1.78 1.94 Diluted earnings per share - -------------------------- As reported $1.02 $1.76 $1.94 Pro forma 1.01 1.75 1.89
For purposes of determining the pro forma expense, the fair value of each option is estimated on the grant date using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 19961998 and 1995,1996, respectively: a dividend yield of 54.7 and 5.45.0 percent; expected volatility of 2227 and 2122 percent; risk-free interest rates of 65 and 76 percent; and for both of such years, expected lives of seven years. Information regarding the Plan is summarized as follows:
Options ------------------------------- 1997 1996 1995 ---- ---- ---- Outstanding, beginning of year 308,663 167,846 208,506 $11.75 Options: Exchanged by holders -- -- (10,284) Exercised -- -- (14,310) $16.59 Options: Exchanged by holders (20,598) (12,933) (14,268) Exercised (10,432) (5,400) (4,048) $24.00 Options: Exchanged by holders (7,184) -- -- Exercised (12,243) (8,250) (9,000) Expired (4,773) -- -- $20.17 Options: Granted -- -- 11,250 Exercised (500) -- -- $20.92 Options: Granted -- 170,400 -- Exchanged by holders (5,159) -- -- Exercised (20,041) -- -- Expired -- (3,000) -- ------- ------- --------- Outstanding, end of year 227,733 308,663 167,846 ======= ======= ======= Available for grant, end of year 606,125 601,352 760,500Information regarding the Plan is summarized as follows: Options ----------------------------------- 1998 1997 1996 ---- ---- ---- Outstanding, beginning of year 227,733 308,663 167,846 $16.59 Options: Exchanged by holders (2,608) (20,598) (12,933) Exercised (2,264) (10,432) (5,400) $24.00 Options: Exchanged by holders - (7,184) - Exercised (8,082) (12,243) (8,250) Expired - (4,773) - $20.17 Options: Exercised (247) (500) - $20.92 Options: Granted - - 170,400 Exchanged by holders (1,147) (5,159) - Exercised (12,353) (20,041) - Expired - - (3,000) 54 Northwest Natural Gas Company Notes to Consolidated Financial Statements - --------------------------------------------------------------------------------
Options ----------------------------------- 1998 1997 1996 ---- ---- ---- $27.875 Options: Granted 116,000 - - Expired (1,000) - - $26.75 Options: Granted 4,000 - - ------- ------- ------- Outstanding, end of year 320,032 227,733 308,663 ======= ======= ======= Available for grant, end of year 487,125 606,125 601,352 ======= ======= ======= ---------------------------------------------------------------------- NW Natural has an employee stock purchase plan wherebyNatural's Employee Stock Purchase Plan allows employees mayto purchase common stock at 92 percent of the average bid and ask market price on the subscription date. The subscription date which is set annually, and eachannually. Each eligible employee may purchase up to 900 shares payable through payroll deduction over a six to 12 month period. 5. LONG-TERM DEBT: - ------------------ The issuance of first mortgage bonds, including secured medium-term notes, under the Mortgage and Deed of Trust (Mortgage) is limited by property, earnings and other provisions of the mortgage. NW Natural'sMortgage. The Mortgage and Deed of Trust constitutes a first mortgage lien on substantially all of itsNW Natural's utility property. The 7-1/4 percent Series of Convertible Debentures may be converted at any time into 50-1/4 shares of common stock for each $1,000 face value ($19.90 per share). The sinking fund requirements and maturities for the five years ending DecemberDec. 31, 2002,2003, on the long-term debt outstanding at DecemberDec. 31, 1997,1998 amount to: $16.0$10.0 million in 1998;1999, 2000 and $11.02001, $30.0 million in each of the years 1999, 2000, 20012002, and 2002.$20.0 million in 2003. 6. NOTES PAYABLE AND LINES OF CREDIT: - ------------------------------------------- NW Natural has available through SeptemberSep. 30, 1998,1999, committed lines of credit with five commercial banks totaling $100 million, consisting of a primary fixed amount of $50 million plus an excess amount of up to $50 million available as needed, at NW Natural's option, on a monthly basis.needed. Financial Corporation has available through SeptemberSep. 30, 1998,1999, committed lines of credit with two commercial banks totaling $20 million, consisting of a primary fixed amount of $15 million plus an excess amount of up to $5 million available as needed, at Financial Corporation's option, on a monthly basis.needed. Financial Corporation's lines are supported by the guaranty of NW Natural. Under the terms of these lines of credit, which are used as backup lines for commercial paper programs, 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 are based on current market rates as negotiated. There were no outstanding balances on either the NW Natural or the Financial Corporation linethese lines of credit as of DecemberDec. 31, 19971998 or 1996.1997. 55 Northwest Natural Gas Company Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- NW Natural entered into an additional $18 million line of credit with a commercial bank for the purpose of constructing a new headquarters building for the Port of Portland on property owned by NW Natural. This line of credit is available through Nov. 30, 1999 with interest rates based on London Interbank Offer Rate (LIBOR) or Interbank Offer Rate (IBOR). At Dec. 31, 1998, the outstanding balance was $6 million. Canor has a $30 million (Canadian) revolving credit facility available for its normal business operations through a Canadian commercial bank. The amount of the facility declines by $1.2 million per quarter, beginning Apr. 1, 1999 and is subject to a re-setting annually either upward or downward, based upon an analysis of Canor's gas and oil reserves as of March 31 each year. Canor had $5.8 million (U.S.) outstanding on this line of credit at Dec. 31, 1998. NW Natural and Financial Corporation issue domestic commercial paper, which is supported by the committed bank lines, under agency agreements with a commercial bank. Additionally, Financial Corporation's commercial paper is supported by the guaranty of NW Natural. The amounts and average interest rates of commercial paper outstanding were as follows at DecemberDec. 31:
1997 1996 -------------- -------------- Thousands Amount Rate Amount Rate ------------------------------------------------------------ NW Natural $82,634 5.5% $43,532 5.4% Financial Corporation 6,683 5.6% 6,526 5.4%1998 1997 -------------------- ------------------- Thousands Amount Rate Amount Rate ---------------------------------------------------------------------- NW Natural $75,400 5.2% $82,634 5.9% Financial Corporation - - 6,683 6.0% ------- ------- Total $75,400 $89,317 $50,058 ======= =======
7. INCOME TAXES: - ---------------------- A reconciliation between income taxes calculated at the statutory federal tax rate and the tax provision reflected in the financial statements is as follows:
Thousands 1997 1996 1995 - ---------------------------------------------------------------------------------------- Computed income taxes based on statutory federal income tax rate of 35% $22,457 $25,949 $21,065 Increase (reduction) in taxes resulting from: Differences between book and tax depreciation 221 1,313 1,575 Current state income tax, net of federal tax benefit 1,944 3,235 2,051 Federal income tax credits (360) (228) (384) Restoration of investment and energy tax credits (844) (849) (1,088) Removal costs (544) (538) (552) Reversal of amounts provided in prior years (1,455) (1,900) -- Unconsolidated foreign subsidiary income (loss) (13) 113 266 Gains on Company-Owned Life Insurance (470) (324) (260) Other - net 170 576 (552) ------- ------- ------- Total provision for income taxes $21,106 $27,347 $22,121 ======= ======= ======= - ------------------------------------------------------------------------------------------
The provision for income taxes consists of the following: Thousands 1997 1996 1995 - ----------------------------------------------------------------------------------------- Income taxes currently payable: Federal $ 5,852 $17,634 $16,104 State (1,644) 2,912 1,052 Foreign 62 126 284 ------- ------- ------- Total 4,270 20,672 17,440 ------- ------- ------- Deferred taxes - net: Federal 13,032 5,451 4,086 State 4,635 1,889 1,683 Foreign 13 184 -- ------- ------- ------ Total 17,680 7,524 5,769 ------- ------- ------ Investment and energy tax credits restored: From utility operations (800) (800) (800) From subsidiary operations (44) (49) (288) ------ ------ ------- Total (844) (849) (1,088) Total provision for income taxes $21,106 $27,347 $22,121 ======= ======= ======= Percentage of pretax income 32.9% 36.9% 36.8% ===== ===== ====== - -----------------------------------------------------------------------------------------
Deferred tax assets and liabilities are comprised of the following: Thousands 1997 1996 - ------------------------------------------------------------------------------- Deferred tax liabilities: Property, plant and equipment $113,121 $112,210 Regulatory asset 22,177 22,597 -------- -------- Total 135,298 134,807 -------- -------- Deferred tax assets: Regulatory liability (asset) $(13,971) $ 3,609 Other deferred assets 9,316 7,554 Alternative minimum tax credits -- 19Thousands 1998 1997 1996 - --------------------------------------------------------------------------- Computed income taxes based on statutory federal income tax rate of 35% $13,844 $22,457 $25,949 Increase (reduction) in taxes resulting from: Differences between book and tax depreciation 310 221 1,313 Current state income tax, net of federal tax benefit 1,976 1,944 3,235 Federal income tax credits (574) (360) (228) Restoration of investment and energy tax credits (700) (844) (849) Removal costs (424) (544) (538) Reversal of amounts provided in prior years (361) (1,455) (1,900) Unconsolidated foreign subsidiary income (loss) 96 (13) 113 Gains on Company-owned life insurance (504) (470) (324) Gain on Canor amalgamation not subject to tax (1,240) - - Other - net (169) 170 576 --------- -------- -------- Total provision for income taxes $12,254 $21,106 $27,347 ======= ======= ======= 56 Northwest Natural Gas Company Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- The provision for income taxes consists of the following: Thousands 1998 1997 1996 - -------------------------------------------------------------------------------- Income taxes currently payable: Federal $12,787 $5,852 $17,634 State 1,790 (1,644) 2,912 Foreign 324 62 126 -------- ------- ------- Total 14,901 4,270 20,672 -------- ------ ------- Deferred taxes - net: Federal (876) 13,032 5,451 State 1,386 4,635 1,889 Foreign (2,457) 13 184 -------- ------- -------- Total (1,947) 17,680 7,524 -------- ------ -------- Investment and energy tax credits restored: From utility operations (645) (800) (800) From subsidiary operations (55) (44) (49) -------- -------- --------- Total (700) (844) (849) -------- -------- --------- Total provision for income taxes $12,254 $21,106 $27,347 ------- ------- ------- Percentage of pretax income 31.0% 32.9% 36.9% ====== ====== ====== - -------------------------------------------------------------------------------- Deferred tax assets and liabilities are comprised of the following: Thousands 1998 1997 - -------------------------------------------------------------------------------- Deferred tax liabilities: Property, plant and equipment $112,495 $113,121 Regulatory asset 21,388 22,177 -------- -------- Total 133,883 135,298 -------- -------- Deferred tax assets: Regulatory liability $(14,684) $(13,971) Other deferred assets 8,257 9,316 Total (6,427) (4,655) 11,182 -------- -------- Net accumulated deferred income tax liability $140,310 $139,953 $123,625 ======== ========
Deferred Canadian tax asset (included in deferred debits) $ 2,247 $ - --------------------------------------------------------------------------------======= ======== - ------------------------------------------------------------------------ 8. EMPLOYEE RETIREMENT PLANS:PENSION AND OTHER POSTRETIREMENT BENEFITS: - -------------------------------------------------------------------------------------- The Company adopted disclosure rules required by SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," during 1998. SFAS No. 132 requires companies to provide comparative disclosures for earlier periods unless the information is 57 Northwest Natural Gas Company Notes to Consolidated Financial Statements - ------------------------------------------------------------------------------- not readily available. Amounts relating to the Company's pension and other postretirement benefit plans were available for 1997 but were not available for 1996. NW Natural has two qualified non-contributory defined benefit retirement plans covering all regular employees with more than one year of service.service, a non-qualified supplemental pension plan for eligible executive officers and other postretirement benefit plans for its employees. The benefits underfollowing tables provide a reconciliation of the plans are based upon years of service andchanges in the employee's average compensation during the final years of service. NW Natural's funding policy is to make the annual contribution required by applicable regulations and recommended by its actuary. Plan assets consist primarily of marketable foreign and domestic equity securities, corporate obligations, U.S. governmentplans' benefit obligations and cash equivalents. The following table sets forthfair value of assets over the amountstwo-year period ended Dec. 31, 1998 and a statement of the funded status as of Dec. 31, 1998 and 1997: Pension Benefits ---------------- Thousands 1998 1997 --------- -------- -------- Change in benefit obligation: Benefit obligation at January 1 $127,879 $112,281 Service cost 3,430 2,858 Interest cost 9,282 8,424 Expected benefits paid (6,762) (6,041) Plan amendments (2,948) 3,175 Net actuarial loss 11,738 7,182 -------- --------- Benefit obligation at December 31 142,619 127,879 ------- ------- Change in plan assets: Fair value of plan assets at January 1 158,118 134,375 Actual return on plan assets 23,532 29,298 Employer contributions 666 529 Benefits paid (6,762) (6,084) -------- --------- Fair value of plan assets at December 31 175,554 158,118 ------- ------- Funded status: Funded status at December 31 32,935 30,239 Unrecognized transition (asset) obligation 1,072 1,027 Unrecognized prior service cost 5,601 10,054 Unrecognized net actuarial (gain) or loss (40,936) (44,060) ------- ------- Net amount recognized $ (1,328) $ (2,740) ======= ======= Amounts recognized in the statement of financial statementsposition consist of: Prepaid benefit cost $ 5,900 $ 3,271 Accrued benefit liability (8,902) (9,987) Intangible asset 1,674 3,976 ------ ------- Net amount recognized $(1,328) $(2,740) ======= ======= Other Benefits --------------- Thousands 1998 1997 --------- -------- -------- Change in benefit obligation: Benefit obligation at January 1 $12,332 $10,863 Service cost 288 238 Interest cost 891 844 Expected benefits paid (578) (570) Plan amendments - - Net actuarial loss 2,784 957 --------- --------- Benefit obligation at December 31 15,717 12,332 --------- --------- Change in plan assets: Fair value of plan assets at January 1 - - Actual return on plan assets - - Employer contributions 578 570 Benefits paid (578) (570) --------- --------- Fair value of plan assets at December 31 - - --------- --------- Funded status: Funded status at December 31 (15,717) (12,332) Unrecognized transition (asset) obligation 7,896 8,460 Unrecognized prior service cost - - Unrecognized net actuarial (gain) or loss 1,553 (1,230) ---------- --------- Net amount recognized $(6,268) $(5,102) ========== ========= Amounts recognized in the statement of financial position consist of: Prepaid benefit cost $ - $ - Accrued benefit liability (6,268) (5,102) Intangible asset - - ---------- -------- Net amount recognized $(6,268) $(5,102) ========== ======== - ------------------------------------------------------------------- The Company's non-qualified supplemental pension plan was the only pension plan with an accumulated benefit obligation in excess of plan assets. The plan's accumulated benefit obligation was $11,090,000 at Dec. 31, 1998 and $13,511,000 at Dec. 31, 1997. There were no plan assets in the non-qualified plan due to the nature of the plan, but the Company funds its obligation with trust-owned life insurance. The amount of the life insurance coverage is designed to provide sufficient returns to recover all costs of the plan. The Company's plans for 58 Northwest Natural Gas Company Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- postretirement benefits other than pensions also have no plan assets. The aggregate benefit obligation for those plans is $15,717,000 at Dec. 31, 1998 and $12,332,000 at Dec. 31, 1997. The following tables provide the components of net periodic cost for the plans for the years ended Dec. 31, 1998 and 1997 and the combined funded statusassumptions used in the measurement of these costs and the Company's benefit obligations: Pension Benefits Other Benefits ---------------- -------------- Thousands 1998 1997 1998 1997 --------- ------- -------- ------ ------ Service cost $ 3,430 $ 2,858 $ 288 $ 238 Interest cost 9,282 8,424 890 845 Expected return on plan assets (13,926) (10,915) - - Amortization of transition (asset) obligation (45) (45) 564 564 Amortization of prior service cost 1,481 865 - - Recognized actuarial (gain) loss (969) (676) 2 (87) ----- ----- ------- ------- Net periodic benefit $ (747) $ 511 $ 1,744 $ 1,560 cost ===== ======= ===== ===== Weighted average assumptions as of December 31: Discount rate 6.75% 7.25% 6.75% 7.25% Expected return on plan assets 10.00% 9.00% n/a n/a Rate of compensation increase 4.50% 4.50% n/a n/a The assumed health care cost trend used in measuring the accumulated postretirement benefit obligation was 6.5 percent for the HMO plan and 9.0 percent for the indemnity plan during 1998. These rates were assumed to decrease gradually each year to a rate of 4.0 percent for 2004 and remain at that level thereafter. Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A 1 percent change in assumed health care cost trend rates would have the following effects: 1% Increase 1% Decrease ----------- ----------- Effect on the total service and interest cost components of net periodic postretirement health care benefit cost $ 211,000 $ (175,000) Effect on the health care component of the retirement plans:
Thousands 1997 1996 1995 ----------------------------------------------------------------------- Service cost $ 3,010 $ 3,082 $ 2,819 Interest cost 7,575 6,980 6,843 Return on assets (29,298) (14,935) (29,291) Net amortization and deferral 17,900 4,110 19,927 -------- -------- -------- Annual pension cost $ (813) $ (763) $ 298 ======== ======== ======== ----------------------------------------------------------------------- Vested benefit obligation $ 91,078 $ 84,502 $ 79,805 Total accumulated benefit obligation $ 96,364 $ 84,915 $ 80,079 -----------------------------------------------------------------------
Thousands 1997 1996 1995 ----------------------------------------------------------------------- Funded status as of December 31: Plan assets at fair value $158,118 $134,376 $124,748 Projected benefit obligation for service rendered to date 114,368 100,481 96,999 -------- -------- --------- Funded status 43,750 33,895 27,749 Unrecognized net gain (45,820) (35,326) (30,185) Unrecognized net asset at transition (727) (1,123) (1,518) Unrecognized prior service costs 6,068 5,012 5,650 -------- -------- -------- Prepaid pension cost $ 3,271 $ 2,458 $ 1,696 ======== ======== ======== Total cash contribution $ 0 $ 0 $ 0 ======== ======== ======== ----------------------------------------------------------------------- Discount rate: Funded status 7.25% 7.50% 7.50% ===== ===== ===== Pension cost 7.50% 7.50% 8.00% ===== ===== ===== Expected long-term rate of return on plan assets 9.00% 9.00% 9.00% ===== ===== ===== Rate for compensation increases 4.50% 5.00% 5.00% ===== ===== ===== -----------------------------------------------------------------------
Effective December 31, 1997,accumulated postretirement benefit obligation $1,906,000 $(1,581,000) NW Natural changed the assumed discount rate used in determining the funded status of the plans from 7.50 percent to 7.25 percent. The 7.25 percent discount rate was used in determining the funded status of the plans at year-end 1997 and 7.50 percent was used to determine annual pension cost in 1997 and 1996. The 7.25 percent discount rate will be used to determine funded status and pension cost in 1998. NW Naturalalso has a qualified "Retirement K Savings Plan"defined benefit contribution plan under Internal Revenue Code Section 401(k) and a non-qualified "Executive Deferred Compensation Plan,"deferred compensation plan for eligible employees. These plans are designed to enhance the existing retirement program of employees and to assist them in strengthening their financial security by providing an incentive to save and invest regularly. NW Natural's contributions to these plans in 1997, 1996 and 1995 were $1.1 million $1.0 million and $0.8 million, respectively. NW Natural has a non-qualified supplemental retirement plan for eligible executive officers which it is funding with trust-owned life insurance. The amount of coverage is designed to provide sufficient returns to recover all costs of the plan if assumptions made as to mortality experience, policy earnings, and other factors are realized. Expenses related to the plan were $1.3 million in both 19971998 and 19961997 and $1.0 million in 1995.1996. 59 Northwest Natural Gas Company Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- 9. POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFITS: - ---------------------------------------------------------------- The Company provides continued health care and life insurance coverage after retirement for exempt employees. These benefits and similar benefits for active employees are provided by insurance companies, and related premiums are based on the amount of benefits paid during the year. The accrued costs in excess of benefits paid relating to SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other than Pensions," are not included in NW Natural's rates in Oregon. The staff of the OPUC has recommended that NW Natural's portion of these costs allocated to Oregon be authorized for recovery in rates only pursuant to a general rate case filing, and has recommended against the use of deferred accounting treatment for their recovery. NW Natural is charging the Oregon portion of these costs to expense. In Washington, the WUTC's order in NW Natural's 1997 general rate case authorized NW Natural to begin amortizing the deferred SFAS No. 106 costs attributable to Washington operations that had accrued since adoption of SFAS No. 106 in 1993, to be collected from customers over a five year period. Additionally, the ongoing annual SFAS No. 106 cost relating to Washington operations was placed into rates and deferrals were discontinued. The following table sets forth the postretirement health care and life insurance plan's status at December 31:
Thousands 1997 1996 1995 ------------------------------------------------------------------------- Retirees $ 5,903 $ 5,753 $ 5,983 Fully eligible active plan participants 1,418 1,232 1,254 Other active plan participants 5,011 3,878 4,236 ------- ------- ------- Total accumulated postretirement benefit obligation 12,332 10,863 11,473 Fair value of plan assets -- -- -- ------- ------- ------- Accumulated postretirement benefit obligation in excess of plan assets 12,332 10,863 11,473 Unrecognized transition obligation (8,460) (9,024) (9,588) Unrecognized gain 1,230 2,273 1,262 ------- ------- ------- Accrued postretirement benefit cost $ 5,102 $ 4,112 $ 3,147 ======= ======= ======= Service cost - benefits earned during the period $ 238 $ 262 $ 239 Interest cost on accumulated postretirement benefit obligation 845 838 859 Amortization of transition obligation 477 556 503 ------- ------- ------- Net postretirement benefit cost $ 1,560 $ 1,656 $ 1,601 ======= ======= =======
The unrecognized transition obligation is being amortized over a period of 20 years beginning January 1, 1993. The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation for pre-Medicare eligibility is 8.5 percent for 1998; 8 percent for 1999; 7.5 percent for 2000; 7 percent for 2001; 6.5 percent for 2002; then decreasing over the next five years to 4 percent. The assumed rate for the HMO plan is 5 percent for 1998; 4.5 percent for 1999; and 4 percent for the next eight years. The assumed rate for post-Medicare eligibility is 8 percent for 1998; 7.5 percent for 1999; 7 percent for 2000; 6.5 percent for 2001; 6 percent for 2002; then decreasing over the next five years to 4 percent. A one-percentage-point change in the assumed health care cost trend rate for each year would adjust the accumulated postretirement benefit obligation and net postretirement health care cost as of December 31, 1997 by approximately 14.8 percent and 16.1 percent, respectively. The assumed discount rate used in determining the accumulated postretirement benefit obligation was 7.25 percent at December 31, 1997, 8.0 percent at December 31, 1996, and 7.5 percent at December 31, 1995. 10. PROPERTY AND INVESTMENTS: - ------------------------------- The following table sets forth the major classifications of NW Natural's utility plant and accumulated provision for depreciation at December 31:
1997 1996 --------------------- --------------------------------------------------------- The following table sets forth the major classifications of NW Natural's utility plant and accumulated provision for depreciation at Dec. 31: 1998 1997 ------------------------ ------------------------ Average Average Depreciation Depreciation Thousands Amount Rate Amount Rate - ------------------------------------------------------------------------------- Transmission and distribution $ 938,760 3.5% $ 873,862 3.6% Storage 66,827 2.6% 66,624 2.7% General 76,518 7.1% 66,483 6.8% Intangible and other 47,205 6.0% 11,287 12.5% ---------- ---------- Utility plant in service 1,129,310 3.8% 1,018,256 3.8% Gas stored long-term 11,190 10,708 Work in progress 23,999 26,148 ---------- ---------- Total utility plant 1,164,499 1,055,112 Less accumulated depreciation 366,607 336,141 ---------- --------- Utility plant-net $ 797,892 $ 718,971 ========== ========= - --------------------------------------------------------------------------------
The following table summarizes the Company's investments in affiliated entities accounted for under the equity and cost methods, and its investment in a leveraged lease at December 31:
Thousands 1997 1996 ----------------------------------------------------------------------- Electric generation $23,060 $22,035 Aircraft leveraged lease 8,932 8,265 Gas pipeline and other 2,156 2,708 ------- -------Transmission and distribution $ 995,214 3.5% $ 938,760 3.5% Storage 98,172 2.1% 66,827 2.6% General 78,729 7.4% 76,518 7.1% Intangible and other 49,628 8.6% 47,205 6.0% ----------- ----------- Utility plant in service 1,221,743 3.9% 1,129,310 3.8% Gas stored long-term 11,301 11,190 Work in progress 6,646 23,999 ------------ ----------- Total utility plant 1,239,690 1,164,499 Less accumulated depreciation 404,117 366,607 ----------- ---------- Utility plant-net $ 835,573 $ 797,892 ========== ========== The following table summarizes the Company's investments in non-utility plant at Dec. 31: Thousands 1998 1997 - -------------------------------------------------------------------------------- Canadian oil and gas properties and other $74,503 $44,037 Port of Portland building 6,016 - Dock, land and oil station 3,565 3,339 Other 4,966 5,046 --------- --------- Total non-utility plant 89,050 52,422 Less accumulated depreciation 29,927 22,843 -------- -------- Non-utility plant-net $ 59,123 $29,579 ======== ======= - -------------------------------------------------------------------------------- The following table summarizes the Company's investments in affiliated entities accounted for under the equity and cost methods, and its investment in a leveraged lease at Dec. 31: Thousands 1998 1997 - -------------------------------------------------------------------------------- Electric generation $5,509 $23,060 Aircraft leveraged lease 8,439 8,932 Gas pipeline and other 1,950 2,156 --------- -------- Total investments and other $15,898 $34,148 $33,008 ======= =======
- -------------------------------------------------------------------------------- 60 Northwest Natural Gas Company Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- Financial Corporation has investedownership interests ranging from 4.0 to 5.3 percent in solar electric generation plants located near Barstow, California. Power generated by these plants is sold to Southern California Edison Company under long-term contracts. Financial Corporation's ownership interests in these projects range from 4.0 percent to 5.3 percent. Financial Corporation also has investedownership interests ranging from 8.5 to 41 percent in U. S. Windpower Partners electric generatinggeneration projects with facilities located near Livermore and Palm Springs, California. The wind-generated power is sold to Pacific Gas and Electric Company and Southern California Edison Company under long-term contracts. Financial Corporation's ownership interests in these projects range from 8.5 percent to 41 percent. In 1987, Oregon Natural purchased a Boeing 737-300 aircraft which was leased to Continental Airlines for 20 years under a leveraged lease agreement. As part of Oregon Natural's merger with NW Natural in 1996, ownership of the aircraft was transferred to NW Natural. 11.10. FAIR VALUE OF FINANCIAL INSTRUMENTS: - -------------------------------------------------------------------------------------- The estimated fair values of NW Natural's financial instruments have been determined using available market information and appropriate valuation methodologies. The following is a list of financial instruments whose carrying values are sensitive to market conditions:
December 31, 1997 December 31, 1996 ----------------------- ---------------------- Carrying Estimated Carrying Estimated Thousands Amount Fair Value Amount Fair Value - ------------------------------------------------------------------------------------- Redeemable preference stock $ 25,000 $ 25,250 $ 25,000 $ 22,750 Redeemable preferred stock $ 12,429 $ 12,411 $ 13,749 $ 12,956 Long-term debt including amount due within one year $360,303 $389,536 $297,838 $316,205 - ------------------------------------------------------------------------------------
December 31, 1998 December 31, 1997 ------------------------ --------------------- Carrying Estimated Carrying Estimated Thousands Amount Fair Value Amount Fair Value - ------------------------------------------------------------------------------- Redeemable preference stock $ 25,000 $ 25,250 $ 25,000 $ 25,250 Redeemable preferred stock $ 11,499 $ 11,520 $ 12,429 $ 12,411 Long-term debt including amount due within one year $376,738 $436,224 $360,303 $389,536 - -------------------------------------------------------------------------------- Fair value of the redeemable preference stock and the redeemable preferred stock was estimated using quoted market prices. Interest rates that are currently available to the Company for issuance of debt with similar terms and remaining maturities were used to estimate fair value for debt issues. The carrying amount of long-term notes receivable was stated at estimated fair value at DecemberDec. 31, 19971998 and 1996. 12.1997. 11. USE OF FINANCIAL DERIVATIVES: - ------------------------------------------------------------------------- In connection with its Canadian gas purchase commitments, NW Natural uses foreign currency forward contracts to hedge against fluctuations in currency values. The forward contracts have terms ranging up to 12 months. Such contracts are purchased in an amount up to 100 percent but not less than 80 percent of estimated daily requirements for commodity gas purchased in Canadian currency from gas suppliers in Canada. The notional amount of these contracts at DecemberDec. 31, 1998 and 1997, totaled $7.9 million and $5.6 million, respectively, and, if settled on that date, NW Natural would have realized a negligible gain in 1998 and a negligible loss on these contracts.in 1997. 61 Northwest Natural Gas Company Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- As part of an overall strategy to maintain an acceptable level of exposure to the risk of gas price fluctuations,fluctuation, NW Natural has developed a targeted mix of fixed-rate and cap-protected natural gas commodity contracts versus variable rate contracts. To efficiently manage this mix, NW Natural usesutilizes natural gas commodity swap and cap agreements to effectively convert the gas purchase commitments into an acceptable fixed-rate and capped rate mix. NW Natural uses natural gas commodity swap agreements to convert certain long-term gas purchase contracts from floating prices to fixed prices. Under the commodity swap agreements, NW Natural receives or makes payments based on the differential between a specified price and the actual price of natural gas as measured by price indices relating to the market area where it purchases the gas. The swap agreements have terms ranging up to 12 months. At DecemberDec. 31, 1998 and 1997, and 1996, NW Naturalthe Company had cap and swap agreements with broker-dealers to cover notional quantities of 136,741 and 131,635 and 30,000 million British Thermal Units (MMBtu)MMBtu per day of gas, respectively. Under the swap agreements in effect at DecemberDec. 31, 1998 and 1997, NW Natural paysthe Company paid fixed prices averaging $1.898 and $1.687 per MMBtu.MMBtu, respectively. In return, it receivesreceived a price that variesvaried from month to month with market conditions. The notional amountamounts of the swap agreements at DecemberDec. 31, 1998 and 1997 was $23were $48.7 million and $23.0 million, respectively, and, if settled on that date,those dates, NW Natural would have realized a gain of $0.6 million and a loss on these swaps of $4.4 million.million, respectively. (See Note 1 "Derivatives Policy," for a summary of accounting for gains and losses.) 13.Canor also manages its commodity price risk through the use of gas and oil commodity swaps and collars. At Dec. 31, 1998, the notional amount of these contracts was $1.4 million and, if settled on that date, Canor would have realized a negligible gain. At Dec. 31, 1997, Canor had no outstanding commodity swap or collar contracts. 12. COMMITMENTS AND CONTINGENCIES: - -------------------------------------------------------------------------- Lease Commitments ----------------- Future lease commitments are: $5.3 million in 1998; $2.8$4.8 million in 1999; $2.5$5.1 million in 2000; $2.3$4.5 million in 2001; and $2.1$4.0 million in 2002.2002; and $2.6 million in 2003. Thereafter, total commitments amount to $6.2$7.7 million. These commitments principally relate to the lease of NW Natural'sthe Company's office headquarters, underground gas storage facilities, vehicles and computer systems. Total rental expense for 1998, 1997 1996 and 19951996 was $ 6.46.0 million, $5.4$6.4 million and $5.3$5.4 million, respectively. Purchase Commitments -------------------- NW Natural has signed agreements providing for the availability of firm pipeline capacity under which it must make fixed monthly payments for contracted capacity. The pricing component of the monthly payment is established, subject to change, by U.S. or Canadian regulatory bodies. In addition, NW Natural has entered into long-term agreements to release firm pipeline capacity. The aggregate amounts of these agreements were as follows at DecemberDec. 31, 1997:
Capacity Capacity Purchase Release Thousands Agreements Agreements ----------------------------------------------------------------------- 1998 $ 80,100 $ 4,296 1999 80,100 4,296 2000 80,100 4,296 2001 79,379 4,296 2002 77,297 4,296 2003 through 2023 523,459 33,651 -------- ------- Total 920,435 55,131 Less: Amount representing interest 284,800 16,334 -------- ------- Total at present value $635,635 $38,797 ======== ======= -----------------------------------------------------------------------
1998: 62 Northwest Natural Gas Company Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- Capacity Capacity Purchase Release Thousands Agreements Agreements - -------------------------------------------------------------------------------- 1999 $ 77,750 $ 3,779 2000 77,750 3,779 2001 77,088 3,779 2002 74,253 3,779 2003 70,231 3,779 2004 through 2023 409,270 25,827 --------- ------ Total 786,342 44,722 Less: Amount representing interest 201,528 10,376 -------- ------- Total at present value $584,814 $34,346 ======== ======= - -------------------------------------------------------------------------------- NW Natural's total payments of fixed charges under capacity purchase agreements in 1998, 1997 and 1996 and 1995 were $76.2 million, $76.7 million, $73.4 million and $62.2$73.4 million, respectively. Included in the amounts for 1998, 1997 1996 and 19951996 were reductions for capacity release sales totaling $4.2$3.9 million, $4.2 million and $4.8$4.2 million, respectively. In addition, NW Natural is required to pay per-unit charges based on the actual quantities shipped under the agreements. In certain of NW Natural's take-or-pay purchase commitments, annual deficiencies may be offset by prepayments subject to recovery over a longer term if future purchases exceed the minimum annual requirements. Environmental Matters --------------------- NW Natural owns property in Linnton, Oregon, that is the site of a former gas manufacturing plant that was closed in 1956. In 1993, pursuant to Oregon Department of Environmental Quality (ODEQ) procedures, NW Natural submitted a notice of intent to participate in the ODEQ's Voluntary Cleanup Program and, in 1994, the site was listed on ODEQ's Confirmed Release List and Inventory. During 1995, initial tests revealed environmental contamination, but the extent or the estimated cost of remediation cannot yet be determined. During 1998, the ODEQ and the U.S. Environmental Protection Agency (EPA) completed a study of sediments in a 5.5 mile segment of the Willamette River that includes the area adjacent to the site. Remediation of the site may be affected by the sediments management plan now being developed in response to the ODEQ/EPA sediments study. Since 1993, NW Natural continues to monitor this site.has recorded an expense of $2.0 million for the estimated costs of consultants' fees, ODEQ oversight cost reimbursements, and the voluntary investigation, plus an estimate for costs of the continuing investigation. NW Natural expects that its costs of investigation and any remediation at the Linnton site for which it may be responsible should be recoverable, in large part, from insurance. In the event these costs are not recovered from insurance, orNW Natural will seek recovery through future rates. During the period from 1993 through 1997, NW63 Northwest Natural recorded as expense a total of $1.6 million for the estimated costs of consultants' fees, ODEQ oversight and the voluntary investigation.Gas Company Notes to Consolidated Financial Statements - -------------------------------------------------------------------------------- In 1996, the Eugene Water and Electric Board (EWEB) asked NW Natural to participate in an investigation and the potential remediation of a 1.5 acre site of a former manufactured gas plant in Eugene, Oregon. NW Natural purchased the property in 1958, after the plant had been converted to a liquid propane gas plant. It used the propane plant until 1960 when the system was converted to natural gas, and continued to use the site as a service center until 1976 when it was sold. Although NW Natural never operated the manufactured gas plant, EWEB has contended that NW Natural's activities on the site may have exacerbated prior contamination. To date, NW Natural has not agreed to participate in an investigation of the site and has not obtained sufficient information to determine the extent of its responsibility, if any, for remediation of the site. Litigation ---------- In July 1995, a jury in an Oregon state court returned a verdict against NW Natural in the case of Northwest Natural Gas Company v. -------------------------------- Chase Gardens, Inc. (Lane County Circuit Court Case No. 16-91-01370). ------------------- The Oregon Court of Appeals (Oregon Court of Appeals Case No. CA A90481) affirmed the trial court decision in February 1997. TheNW Natural filed a petition for review of the Court of Appeals' decision by the Oregon Supreme Court. In August 1997, the Oregon Supreme Court agreed to hear the case on appeal and is expected to render a final ruling during 1998.1999. NW Natural recorded a charge of $5.6 million in the fourth quarter of 1996, equivalent to 15 cents aper share, as a reserve against payment of the judgment, related costs and post-judgment interest from the case.interest. The Company is party to certain other legal proceedingsactions in which claimants seek material amounts. Although it is not possibleimpossible to predict the outcome with certainty, based upon the opinions of legal counsel, management does not expect disposition of these matters to have a materially adverse effect on the Company's financial position, results of operations or cash flows. 64 NORTHWEST NATURAL GAS COMPANY QUARTERLY FINANCIAL INFORMATION (UNAUDITED) - --------------------------------------------------------------------------------
---------------------Quarter Ended ----------------------- Dollars (Thousands, Except Per Share Amounts) Mar. 31 June 30 Sept. 30 Dec. 31 Total - ------------------------------------------------------------------------------------------------------ 1997 Operating revenues 134,347 65,855 46,283 115,271 361,756 Net operating revenues 84,039 43,726 32,488 72,191 232,444 Net income 24,753 2,360 (2,448) 18,394 43,059 Basic Earnings (loss) per share 1.07 0.07 (0.14) 0.78 1.78* Diluted Earnings---------------------------------------------------------------------------- Quarter Ended Dollars -------------------------------------- (Thousands Except Per Share Amounts) Mar. 31 June 30 Sept. 30 Dec. 31 - ------------------------------------------------------------------------------- 1998 Operating revenues 135,697 83,654 53,810 143,528 Net operating revenues 78,307 50,003 34,460 80,495 Net income 23,186 4,093 (5,920) 5,942 Basic earnings (loss) per share 0.98 0.14 (0.26) 0.21** Diluted earnings(loss) per share 0.97 0.14 (0.26) 0.21** 1997 Operating revenues 134,237 65,688 46,068 115,134 Net operating revenues 83,806 43,299 31,897 71,526 Net income 24,753 2,360 (2,448) 18,394 Basic earnings (loss) per share 1.07 0.07 (0.14) 0.78 Diluted earnings(loss) per share 1.04 0.07 (0.14) 0.76 - ------------------------------------------------------------------------------- Dollars (Thousands Except Per Share Amounts) Total - ------------------------------------------------------------------- 1998 Operating revenues 416,689 Net operating revenues 243,265 Net income 27,301 Basic earnings (loss) per share 1.02* Diluted earnings (loss) per share 1.02* 1997 Operating revenues 361,127 Net operating revenues 230,528 Net income 43,059 Basic earnings (loss) per share 1.78* Diluted earnings (loss) per share 1.76* 1996 Operating revenues 137,561 71,884 50,585 120,288 380,318 Net operating revenues 83,504 46,183 34,578 73,248 237,513 Net income 23,356 5,508 255 17,674** 46,793 Basic Earnings (loss) per share 1.02 0.22 (0.02) 0.76** 1.97* Diluted Earnings (loss) per share 1.00 0.22 (0.02) 0.74** 1.94* - --------------------------------------------------------------------------------------------------------
* Quarterly earnings per share are based upon the average number of common shares outstanding during each quarter. Because the average number of shares outstanding has increased in each quarter shown, the sum of quarterly earnings maydoes not equal earnings per share for the year. Variations in earnings between quarterly periods are due primarily to the seasonal nature of the Company's business. ** Results for the fourth quarter of 19961998 include a charge equivalent to 1549 cents aper share resulting from a judgment against NW Natural in litigation dating from 1995, and an adjustment reducing tax expenseasset write-down charges by $1.9 million, or 8 cents a share, for reversal of deferred tax amounts provided in prior years.subsidiaries. 65 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III (Item 10. Directors and Executive Officers of the Registrant; Item 11. Executive Compensation; Item 12. Security Ownership of Certain Beneficial Owners and Management; and Item 13. Certain Relationships and Related Transactions.) Information called for by Part III (Items 10., 11., 12. and 13.) is incorporated herein by reference to portions of the Company's definitive proxy statement. See the Additional Item included in Part I for information concerning executive officers of the Company. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this report: 1. A list of all Financial Statements is incorporated by reference to Item 8. 2. List of Exhibits filed: *(3a.) Restated Articles of Incorporation, as filed and effective June 24, 1988 and amended December 8, 1992, December 1, 1993 and May 27, 1994 (incorporated herein by reference to Exhibit (3a.) to Form 10-K for 1994, File No. 0-994). (3b.*(3b.) Bylaws as amended December 18, 1997.May 28, 1998. *(4a.) Copy of Mortgage and Deed of Trust, dated as of July 1, 1946, to Bankers Trust and R. G. Page (to whom Stanley Burg is now successor), Trustees (incorporated herein by reference to Exhibit 7(j) in File No. 2-6494); and copies of Supplemental Indentures Nos. 1 through 14 to the Mortgage and Deed of Trust, dated respectively, as of June 1, 1949, March 1, 1954, April 1, 1956, February 1, 1959, July 1, 1961, January 1, 1964, March 1, 1966, December 1, 1969, April 1, 1971, January 1, 1975, December 1, 1975, July 1, 1981, June 1, 1985 and November 1, 1985 (incorporated herein by reference to Exhibit 4(d) in File No. 33-1929); Supplemental Indenture No. 15 to the Mortgage and Deed of Trust, dated as of July 1, 1986 (filed as Exhibit (4)(c) in File No. 33-24168); Supplemental Indentures Nos. 16, 17 and 18 to the Mortgage and Deed of Trust, dated, respectively, as of November 1, 1988, October 1, 1989 and July 1, 1990 (incorporated herein by reference to Exhibit (4)(c) in File No. 33-40482); Supplemental Indenture No. 19 to the Mortgage 66 and Deed of Trust, dated as of June 1, 1991 (incorporated herein by reference to Exhibit 4(c) in File No. 33-64014); and Supplemental Indenture No. 20 to the Mortgage and Deed of Trust, dated as of June 1, 1993 (incorporated herein by reference to Exhibit 4(c) in File No. 33-53795). *(4d.) Copy of Indenture, dated as of June 1, 1991, between the Company and Bankers Trust Company, Trustee, relating to the Company's Unsecured Medium-Term Notes (incorporated herein by reference to Exhibit 4(e) in File No. 33-64014). *(4e.) Officers' Certificate dated June 12, 1991 creating Series A of the Company's Unsecured Medium-Term Notes (incorporated herein by reference to Exhibit (4e.) to Form 10-K for 1993, File No. 0-994). *(4f.) Officers' Certificate dated June 18, 1993 creating Series B of the Company's Unsecured Medium-Term Notes (incorporated herein by reference to Exhibit (4f.) to Form 10-K for 1993, File No. 0-994). (4f.(1)) Officers' Certificate dated January 15, 1999 relating to Series B of the Company's Unsecured Medium-Term Notes and supplementing the Officers'Certificate dated June 18, 1993. *(4g.) Rights Agreement, dated as of February 27, 1996, between the Company and Boatmen's Trust Company (ChaseMellon Shareholder Services, successor), which includes as Exhibit A thereto the form of a Right Certificate and as Exhibit B thereto the Summary of Rights to Purchase Common Shares (incorporated herein by reference to Exhibit 1 to Form 8-A, dated February 27, 1996, File No. 0-994). *(10j.) Transportation Agreement, dated June 29, 1990, between the Company and Northwest Pipeline Corporation (incorporated herein by reference to Exhibit (10j.) to Form 10-K for 1993, File No. 0-994). *(10j.(1)) Replacement Firm Transportation Agreement, dated July 31, 1991, between the Company and Northwest Pipeline Corporation (incorporated herein by reference to Exhibit (10j.(2)) to Form 10-K for 1992, File No. 0-994). *(10j.(2)) Firm Transportation Service Agreement, dated November 10, 1993, between the Company and Pacific Gas Transmission Company incorporated(incorporated herein by reference to Exhibit (10j.(2)) to Form 10-K for 1993, File No. 0-994). *(10j.(3)) Service Agreement, dated June 17, 1993, between NorthwestNorth- west Pipeline Corporation and the Company (incorporated herein by reference to Exhibit (10j.(3)) to Form 10-K for 1994, File No. 0-994). 67 *(10j.(4)) Firm Transportation Service Agreement, dated October 22, 1993, between Pacific Gas Transmission Company and the Company (incorporated herein by reference to Exhibit (10j.(4))to Form 10-K for 1994, File No. 0-994). *(10j.(5)) Firm Transportation Service Agreement, dated June 22, 1994, between Pacific Gas Transmission Company and the Company (incorporated herein by reference to Exhibit (10j.(5)) to Form 10-K for 1995, File No. 0-994). (10j.*(10j.(6)) Firm Transportation and Supply Agreement, dated May 9, 1997, between PanEnergy Trading and Market Services, LLC, Inland Pacific Energy Services Corp., and the Company.Company (incorporated herein by reference to Exhibit (10j.(6)) to Form 10-K for 1997, File No. 0-994). (11) Statement re computation of per share earnings. (12) Statement re computation of ratios. (23a.) Consent of Deloitte & Touche LLP. (23b.) Consent of Price WaterhousePricewaterhouseCoopers LLP. (27) Financial Data Schedule. Executive Compensation Plans and Arrangements: ---------------------------------------------- *(10b.) Executive Supplemental Retirement Income Plan, 1995 Restatement (incorporated herein by reference to Exhibit (10b.) to Form 10-K for 1994, File No. 0-994). *(10b.-1) 1995 Amendment to Executive Supplemental Retirement Income Plan (1995 Restatement) (incorporated herein by reference to Exhibit (10b.-1) to Form 10-K for 1995, File No. 0-994). *(10c.)*(10b.-2) Amendment 1998-1 to the Executive Supplemental Retirement Income Plan (1995 Restatement) (incorporated herein by reference to Exhibit 10(a) to Form 10-Q for the quarter ended September 30, 1998, File No. 0-994). *(10b.-3) ESRIP Change in Control Amendment to the Executive Supplemental Retirement Income Plan (1995 Restatement) (incorporated herein by reference to Exhibit 10(b) to Form 10-Q for the quarter ended September 30, 1998, File No. 0-994). *(10c) 1985 Stock Option Plan, as amended effective May 25, 1995 (incorporated herein by reference to Exhibit (10c.) to Form 10-K for 1995, File No. 0-994). *(10e.) Executive Deferred Compensation Plan, 1990 Restatement, effective January 1, 1990 (incorporated herein by reference to Exhibit (10e.) to Form 10-K for 1990, File No. 0-994). 68 *(10e.-1) Amendment No. 1 to Executive Deferred Compensation Plan (incorporated herein by reference to Exhibit (10e.-1) to Form 10-K for 1991, File No. 0-994). *(10e.-2) Amendment No. 2 to Executive Deferred Compensation Plan (incorporated herein by reference to Exhibit (10e.-2) to Form 10-K for 1994, File No. 0-994). (10e.-3)*(10e.-3) Amendment No. 3 to Executive Deferred Compensation Plan. (10f.Plan (incorporated herein by reference to Exhibit (10e.-3) to Form 10-K for 1997, File No. 0-994). *(10e.-4) Amendment No. 4 to Executive Deferred Compensation Plan, effective September 24, 1998 (incorporated herein by reference to Exhibit 10(c) to Form 10-Q for the quarter ended September 30, 1998, File No. 0-994). *(10f.) Directors Deferred Compensation Plan, effective June 1, 1981, restated as of December 1, 1997.1997 (incorporated herein by reference to Exhibit (10f.) to Form 10-K for 1997, File No. 0-994). *(10f.-1) Amendment No. 1 to Directors Deferred Compensation Plan (December 1, 1997 Restatement) (incorporated herein by reference to Exhibit 10(d) to Form 10-Q for the quarter ended September 30, 1998, File No. 0-994). *(10g.) Form of Indemnity Agreement as entered into between the Company and each director and executive officer (incorporated herein by reference to Exhibit (10g.) to Form 10-K for 1988, File No. 0-994). (10i.*(10i.) Non-Employee Directors Stock Compensation Plan, as amended effective January 1, 1998.1998 (incorporated herein by reference to Exhibit (10i.) to Form 10-K for 1997, File No. 0-994). *(10k.) Executive Annual Incentive Plan, effective March 1, 1990, as amended effective January 1, 1992 and January 1, 1996 (incorporated herein by reference to Exhibit (10k.) to Form 10-K for 1995, File No. 0-994). *(10l.) Employment agreement dated November 27, 1989, between the Company and an executive officer (incorporated herein by reference to Exhibit (10l.) to Form 10-K for 1991, File No. 0-994). *(10m.) Agreement dated September 22, 1994, between the Company and an executive officer (incorporated herein by reference to Exhibit (10m.) to Form 10-K for 1994, File No. 0-994). *(10n.) Employment agreement dated November 2, 1995, as amended February 27, 1996, between the Company and an executive officer (incorporated herein by reference to Exhibit (10n.) to Form 10-K for 1995, File No. 0-994). (10n.-1)*(10n.-1) Amendment dated December 18, 1997 to employment agreement dated November 2, 1995, as previously amended February 27, 1996, between the Company and an executive officer.officer (incorporated herein by reference to Exhibit (10n.-1) to Form 10-K for 1997, File No. 0-994). 69 *(10n.-2) Amendment dated September 24, 1998 to employment agreement dated November 2, 1995, as previously amended, between the Company and an executive officer (incorporated herein by reference to Exhibit 10(e) to Form 10-Q for the quarter ended September 30, 1998, File No. 0-994). *(10o.) Form of Severance Agreementamended and restated executive change in control severance agreement as entered into between the Company and designatedeach executive officersofficer (incorporated herein by reference to Exhibit (10o.)10(f) to Form 10-K10-Q for 1995,the quarter ended September 30, 1998, File No. 0-994). *(10p.) Employment Agreement dated July 2, 1997, between the Company and an executive officer (incorporated herein by reference to Exhibit 10 (a) to10(a) for Form 10-Q for the quarter ended September 30, 1997, File No. 0-994). (10p.-1)*(10p.-1) Amendment dated December 18, 1997 to employment agreement dated July 2, 1997, between the Company and an executive officer (incorporated herein by reference to Exhibit (10p.-1) to Form 10-K for 1997, File No. 0-994). *(10p.-2) Amendment dated September 24, 1998 to employment agreement dated July 2, 1997, as previously amended, between the Company and an executive officer (incorporated by reference to Exhibit 10(g) to Form 10-Q for the quarter ended September 30, 1998, File No. 0-994). (10q.) Employment agreement dated October 19, 1998, between the Company and an executive officer. The Company agrees to furnish the Commission, upon request, a copy of certain instruments defining rights of holders of long-term debt of the Company or its consolidated subsidiaries which authorize securities thereunder in amounts which do not exceed 10% of the total assets of the Company. (b)b) Reports on Form 8-K. NoOn December 23, 1998, the Company filed a Current ReportsReport on Form 8-K were filed during the quarter ended December 31, 1997.relating to projected year-end impairment charges. - --------------------------------------------------------------------------------------- *Incorporated herein by reference as indicated 70 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NORTHWEST NATURAL GAS COMPANY Date: March 17, 199829, 1999 By: /s/ Richard G. Reiten ------------------------------------------------------- Richard G. Reiten, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
SIGNATURE TITLE DATE - ------------------------------ ---------------------------------------- -------------- Richard G. Reiten Principal Executive Officer and Director March 17, 1998 - ------------------------------ Richard G. Reiten, President and Chief Executive Officer /s/ Bruce R. DeBolt Principal Financial Officer March 17, 1998 - ------------------------------ Bruce R. DeBolt Senior Vice President, Finance, and Chief Financial Officer /s/ D. James Wilson Principal Accounting Officer March 17, 1998 - ------------------------------- D. James Wilson Treasurer and Controller /s/ Mary Arnstad Director ) - ------------------------------- ) Mary Arnstad ) ) /s/ Thomas E. Dewey, Jr. Director ) - ------------------------------- ) Thomas E. Dewey, Jr. ) ) /s/ Tod R. Hamachek Director ) - ------------------------------- ) Tod R. Hamachek ) ) /s/ Richard B. Keller Director ) - ------------------------------- ) Richard B. Keller ) ) /s/ Wayne D. Kuni Director ) - ------------------------------- ) Wayne D. Kuni ) ) March 17, 1998 Director ) - ------------------------------ ) Randall C. Pape ) ) /s/ Robert L. Ridgley Director ) - ------------------------------ ) Robert L. Ridgley ) ) /s/ Dwight A. Sangrey Director ) - ------------------------------ ) Dwight A. Sangrey ) ) /s/ Melody C. Teppola Director ) - ------------------------------ ) Melody C. Teppola ) ) /s/ Russell F. Tromley Director ) - ------------------------------SIGNATURE TITLE DATE - ------------------------------------------------------------------------------- /s/ Richard G. Reiten Principal Executive - ---------------------------------- Officer and Director March 29, 1999 Richard G. Reiten, President and Chief Executive Officer /s/ Bruce R. DeBolt Principal Financial - ---------------------------------- Officer March 29, 1999 Bruce R. DeBolt Senior Vice President, Finance, and Chief Financial Officer /s/ Stephen P. Feltz Principal Accounting - ---------------------------------- Officer March 29, 1999 Stephen P. Feltz Treasurer and Controller /s/ Mary Arnstad Director ) - ---------------------------------- ) Mary Arnstad ) ) /s/ Thomas E. Dewey, Jr. Director ) - ---------------------------------- ) Thomas E. Dewey, Jr. ) ) /s/ Tod R. Hamachek Director ) - ---------------------------------- ) Tod R. Hamachek ) ) /s/ Richard B. Keller Director ) - ---------------------------------- ) Richard B. Keller ) ) /s/ Wayne D. Kuni Director ) - ---------------------------------- ) Wayne D. Kuni ) ) March 29, 1999 /s/ Randall C. Pape Director ) - ---------------------------------- ) Randall C. Pape ) ) /s/ Robert L. Ridgley Director ) - ---------------------------------- ) Robert L. Ridgley ) ) /s/ Dwight A. Sangrey Director ) - ---------------------------------- ) Dwight A. Sangrey ) ) /s/ Melody C. Teppola Director ) - ---------------------------------- ) Melody C. Teppola ) ) /s/ Russell F. Tromley Director ) - ---------------------------------- ) Russell F. Tromley ) ) /s/ Benjamin R. Whiteley Director ) - ------------------------------ Benjamin R. Whiteley
Director ) - ---------------------------------- ) Benjamin R. Whiteley ) 71 NORTHWEST NATURAL GAS COMPANY ----------------------------- EXHIBIT INDEX ------------- To Annual Report on Form 10-K For Fiscal Year Ended December 31, 19971998 Exhibit Document Number -------- ------- * Restated Articles of Incorporation, as filed (3a.) June 24, 1988 and amended December 8, 1992, December 1, 1993 and May 27, 1994 (3a.)* Bylaws as amended December 18, 1997May 28, 1998 (3b.) * Mortgage and Deed of Trust, dated as of July 1, (4a.) 1946, as supplemented by Supplemental Indenture Nos. 1 through 20 (4a.) * Indenture, dated as of June 1, 1991, between (4d.) the Company and Bankers Trust Company (4d.) * Officers' Certificate, dated June 12, 1991, (4e.) creating Unsecured Medium-Term Notes Series A (4e.) * Officers' Certificate, dated June 18, 1993, (4f.) creating Unsecured Medium-Term Notes Series B Officers' Certificate, dated January 15, 1999, relating (4f.(1)) to Series B of the Company's Unsecured Medium-Term Notes and supplementing the Officers' Certificate dated June 18, 1993 * Rights Agreement, dated as of February 27, 1996, (4g.) between the Company and Boatmen's Trust Company (ChaseMellon Shareholder Services, successor) (4g.) * Transportation Agreement, dated June 29, 1990, (10j.) between the Company and Northwest Pipeline Corporation (10j.) * Replacement Firm Transportation Agreement, (10j.(1)) dated July 31, 1991, between the Company and Northwest Pipeline Corporation (10j.(1)) * Firm Transportation Service Agreement, dated (10j.(2)) November 10, 1993, between the Company and Pacific Gas Transmission Company (10j.(2)) * Service Agreement, dated June 17, 1993, between (10j.(3)) Northwest Pipeline Corporation and the Company (10j.(3)) * Firm Transportation Service Agreement, dated (10j.(4)) October 22, 1993, between Pacific Gas Transmission Company and the Company (10j.(4)) * Firm Transportation Service Agreement, dated (10j.(5)) June 22, 1994, between Pacific Gas Transmission Company and the Company (10j.(5))* Firm Transportation and Supply Agreement, (10j.(6)) dated May 9, 1997, between PanEnergy Trading and Market Services, Inland Pacific Energy Services Corp., and the Company (10j.(6)) Statement re computation of per share earnings (11) Statement re computation of ratios (12) Consent of Deloitte & Touche LLP (23a.) Consent of Price WaterhousePricewaterhouseCoopers LLP (23b.) Financial Data Schedule (27) Executive Compensation Plans and Arrangements ------------------------------------------------------------------------------------------- * Executive Supplemental Retirement Income (10b.) Plan, 1995 Restatement (10b.) * 1995 Amendment to Executive Supplemental (10b.-1) Retirement Income Plan (1995 Restatement) (10b.-1)* Amendment 1998-1 to the Executive (10b.-2) Supplemental Retirement Income Plan (1995 Restatement) * ESRIP Change in Control Amendment to the (10b.-3) Executive Supplemental Retirement Income Plan (1995 Restatement) * 1985 Stock Option Plan, as amended effective (10c.) May 25, 1995 (10c.) * Executive Deferred Compensation Plan, 1990 (10e.) Restatement, effective January 1, 1990 (10e.) * Amendment No. 1 to Executive Deferred (10e.-1) Compensation Plan (10e.-1) * Amendment No. 2 to Executive Deferred (10e.-2) Compensation Plan (10e.-2)* Amendment No. 3 to Executive Deferred (10e.-3) Compensation Plan (10e.-3)* Amendment No. 4 to Executive Deferred (10e.-4) Compensation Plan * Directors Deferred Compensation Plan, (10f.) effective June 1, 1981, restated as of December 1, 1997 (10f.)* Amendment No. 1 to Directors Deferred (10f.-1) Compensation Plan (December 1, 1997 Restatement) * Form of Indemnity Agreement entered into (10g.) between the Company and each director and executive officer (10g.)* Non-Employee Directors Stock Compensation (10i.) Plan, as amended effective January 1, 1998 (10i.) * Executive Annual Incentive Plan, effective (10k.) March 1, 1990, as amended effective January 1, 1992 and January 1, 1996 (10k.) * Employment agreement dated November 27, 1989 between the Company and an executive officer (10l.) * Agreement dated September 22, 1994 between the Company and an executive officer (10m.) * Employment agreement dated November 2, 1995, (10n.) as amended February 27, 1996, between the Company and an executive officer (10n.)* Amendment dated December 18, 1997 to (10n.-1) employment agreement dated November 2, 1995, (10n.-1)between the Company and an executive officer * Amendment dated September 24, 1998 to (10n.-2) employment agreement dated November 2, 1995, as previously amended, between the Company and an executive officer * Form of Severance Agreementamended and restated executive change (10o.) in control severance agreement as entered into between the Company and designatedeach executive officers (10o.)officer * Employment agreement dated July 2, 1997 (10p.) between the Company and an executive officer * Amendment dated December 18, 1997 to (10p.-1) employment agreement dated July 2, 1997, between the Company and an executive officer (10p.) * Amendment dated December 18, 1997September 24, 1998 to (10p.-2) employment agreement dated July 2, 1997, (10p.-1)as previously amended, between the Company and an executive officer Employment agreement dated October 19, 1998, (10q.) between the Company and an executive officer - ---------------------------------------------------------------------- * Incorporated by reference