-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, OIbHACg3Ml/Slh/1cmnlhngJtreLi5b3lUWjpGB60edOZM4VqCFTDPhSLXIjqLQ+ LSt+LXTzS2wvx+iz5ba78Q== 0000070145-98-000104.txt : 19981222 0000070145-98-000104.hdr.sgml : 19981222 ACCESSION NUMBER: 0000070145-98-000104 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 16 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981221 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NATIONAL FUEL GAS CO CENTRAL INDEX KEY: 0000070145 STANDARD INDUSTRIAL CLASSIFICATION: NATURAL GAS DISTRIBUTION [4924] IRS NUMBER: 131086010 STATE OF INCORPORATION: NJ FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-03880 FILM NUMBER: 98773063 BUSINESS ADDRESS: STREET 1: 10 LAFAYETTE SQ CITY: BUFFALO STATE: NY ZIP: 14203 BUSINESS PHONE: 7168576980 MAIL ADDRESS: STREET 1: 10 LAFAYETTE SQ STREET 2: 10 LAFAYETTE SQ CITY: BUFFALO STATE: NY ZIP: 14203 10-K 1 United States Securities and Exchange Commission Washington, D.C. 20549 Form 10-K Annual Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934 For the Fiscal Year Ended September 30, 1998 Commission File Number 1-3880 National Fuel Gas Company (Exact name of registrant as specified in its charter) New Jersey 13-1086010 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 10 Lafayette Square 14203 Buffalo, New York (Zip Code) (Address of principal executive offices) (716) 857-6980 Registrant's telephone number, including area code ----------------------------------------------------------- Securities registered pursuant to Section 12(b) of the Act: Name of each exchange Title of each class on which registered Common Stock, $1 Par Value, and New York Stock Exchange Common Stock Purchase Rights Securities registered pursuant to Section 12(g) of the Act: None 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 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 the 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 voting stock held by nonaffiliates of the registrant amounted to $1,686,072,000 as of November 30, 1998. Common Stock, $1 Par Value, outstanding as of November 30, 1998: 38,537,997 shares. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's Annual Report to Shareholders for 1998 are incorporated by reference into Part I of this report. Portions of the registrant's definitive Proxy Statement for the Annual Meeting of Shareholders to be held February 18, 1999 are incorporated by reference into Part III of this report. National Fuel Gas Company Form 10-K Annual Report For the Fiscal Year Ended September 30, 1998 Table of Contents Page ---- Part I - ------ Item 1. Business The Company and its Subsidiaries 19 Rates and Regulation 20 The Utility Segment 21 The Pipeline and Storage Segment 21 The Exploration and Production Segment 22 The International Segment 22 The Other Nonregulated Segment 22 Sources and Availability of Raw Materials 22 Competition 23 Seasonality 24 Capital Expenditures 24 Environmental Matters 25 Miscellaneous 25 Executive Officers of the Company 25 Item 2. Properties General Information on Facilities 26 Exploration and Production Activities 27 Item 3. Legal Proceedings 28 Item 4. Submission of Matters to a Vote of Security Holders 28 Part II - ------- Item 5. Market for the Registrant's Common Stock and Related Shareholder Matters 28 Item 6. Selected Financial Data 29 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 30 Item 7A. Quantitative and Qualitative Disclosures About Market Risk 55 Item 8. Financial Statements and Supplementary Data 55 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 86 Part III - -------- Item 10. Directors and Executive Officers of the Registrant 86 Item 11. Executive Compensation 86 Item 12. Security Ownership of Certain Beneficial Owners and Management 86 Item 13. Certain Relationships and Related Transactions 86 Part IV - ------- Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 87 Signatures 90 - ---------- This combined Annual Report to Shareholders/Form 10-K contains "forward-looking statements" as defined by the Private Securities Litigation Reform Act of 1995. Forward-looking statements should be read with the cautionary statements included in this combined Annual Report to Shareholders/Form 10-K at Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" (MD&A), under the heading "Safe Harbor for Forward-Looking Statements." Forward-looking statements are all statements other than statements of historical fact, including, without limitation, those statements that are designated with a "1" following the statement, as well as those statements that are identified by the use of the words "anticipates," "estimates," "expects," "intends," "plans," "predicts," "projects," and similar expressions. PART I ------ ITEM 1 Business The Company and its Subsidiaries National Fuel Gas Company (the Company or Registrant), a registered holding company under the Public Utility Holding Company Act of 1935, as amended (the Holding Company Act), was organized under the laws of the State of New Jersey in 1902. The Company is engaged in the business of owning and holding securities issued by its subsidiary companies. Except as otherwise indicated below, the Company owns all of the outstanding securities of its subsidiaries. Reference to "the Company" in this report means the Registrant or the Registrant and its subsidiaries collectively, as appropriate in the context of the disclosure. The Company is a diversified energy company consisting of five major business segments: 1. The Utility segment is carried out by National Fuel Gas Distribution Corporation (Distribution Corporation), a New York corporation. Distribution Corporation sells natural gas and provides natural gas transportation services through a local distribution system located in western New York and northwestern Pennsylvania (principal metropolitan areas: Buffalo, Niagara Falls and Jamestown, New York; Erie and Sharon, Pennsylvania). 2. The Pipeline and Storage segment is carried out by National Fuel Gas Supply Corporation (Supply Corporation), a Pennsylvania corporation, and by Seneca Independence Pipeline Company (SIP), a Delaware corporation. Supply Corporation provides interstate natural gas transportation and storage services for affiliated and nonaffiliated companies through (i) an integrated gas pipeline system extending from southwestern Pennsylvania to the New York-Canadian border at the Niagara River, and (ii) 29 underground natural gas storage fields owned and operated by Supply Corporation and four other underground natural gas storage fields operated jointly with various major interstate gas pipeline companies. SIP has a one-third general partnership interest in Independence Pipeline Company (Independence), a Delaware general partnership. Independence, after receipt of regulatory approvals and upon securing sufficient customer interest, plans to construct and operate the Independence Pipeline, a 370-mile interstate pipeline system which would transport about 900,000 dekatherms per day (Dth/day) of natural gas from Defiance, Ohio to Leidy, Pennsylvania. 3. The Exploration and Production segment is carried out by Seneca Resources Corporation (Seneca), a Pennsylvania corporation, and in California, by Seneca's wholly-owned subsidiary, HarCor Energy, Inc. (HarCor), a Delaware corporation. Seneca is engaged in the exploration for, and the development and purchase of, natural gas and oil reserves in the Gulf Coast of Texas, Louisiana, and Alabama, in California, in Wyoming, and in the Appalachian region of the United States. 4. The International segment is carried out by Horizon Energy Development, Inc. (Horizon), a New York corporation formed in 1995 to engage in foreign and domestic energy projects through investments as a sole or substantial owner in various business entities. These entities include Horizon Energy Holdings, Inc., a New York corporation, which owns 100% of Horizon Energy Development B.V. (Horizon B.V.) (formerly known as Beheer-en-Beleggingsmaatschappij Bruwabel B.V.). Horizon B.V. is a Dutch company whose principal assets are majority ownership of (i) Severoceske teplarny, a.s. (SCT), a company with district heating and power generation operations located in the northern part of the Czech Republic; (ii) Prvni severozapadni teplarenska, a.s. (PSZT), a wholesale power and district heating company that is located in close proximity to SCT; and (iii) Teplarna Kromeriz, a.s., a district heating company located in the southeast region of the Czech Republic. 5. The Other Nonregulated segment is carried out by the following subsidiaries: * National Fuel Resources, Inc. (NFR), a New York corporation engaged in the marketing and brokerage of natural gas and electricity, and the performance of energy management services for utilities and end-users located in the northeastern United States; * Upstate Energy, Inc. (Upstate) (formerly known as Niagara Energy Trading Inc.), a New York corporation formed in July 1997 to engage in wholesale natural gas marketing and other energy-related activities; * Niagara Independence Marketing Company (NIM), a Delaware corporation, owns a one-third general partnership interest in DirectLink Gas Marketing Company (DirectLink), a Delaware general partnership which will engage in natural gas marketing and related businesses, in part by subscribing for firm transportation capacity on the Independence Pipeline (see Pipeline and Storage segment discussion below); * Leidy Hub, Inc. (Leidy), a New York corporation formed to provide various natural gas hub services to customers in the eastern United States through a 50% ownership of Ellisburg-Leidy Northeast Hub Company (a Pennsylvania general partnership); * Seneca is also engaged in the marketing of timber from its Pennsylvania land holdings; * Highland Land & Minerals, Inc. (Highland), a Pennsylvania corporation which operates several sawmills and kilns in Pennsylvania; * Data-Track Account Services, Inc. (Data-Track), a New York corporation which provides collection services (principally issuing collection notices) for the Company's subsidiaries; and * Utility Constructors, Inc. (UCI), a Pennsylvania corporation which discontinued its operations (primarily pipeline construction) in 1995 and whose affairs are being wound down. Financial information about each of the Company's business segments can be found in Item 8 at Note I - Business Segment Information. No single customer, or group of customers under common control, accounted for more than 10% of the Company's consolidated revenues in 1998. All references to years in this report are to the Company's fiscal year ended September 30 unless otherwise noted. The discussion of the Company's business segments as contained in the Letter to Shareholders, which is included on pages 4 to 16 of the paper copy of the Company's combined Annual Report to Shareholders/Form 10-K, is included in this electronic filing as Exhibit 13 and is incorporated herein by reference. Rates and Regulation The Company is subject to regulation by the Securities and Exchange Commission (SEC) under the broad regulatory provisions of the Holding Company Act, including provisions relating to issuance of securities, sales and acquisitions of securities and utility assets, intra-Company transactions and limitations on diversification. The SEC and Congress have recommended legislation to repeal conditionally the Holding Company Act, in conjunction with legislation which would allow the various state regulatory commissions to have access to such books and records of companies in a holding company system as would be necessary for effective regulation, and allow for federal audit authority and oversight of affiliate transactions. However, the additional proposed access to Company books and records by state regulatory commissions would correspondingly increase the amount of regulatory burden at the state level. In addition, recent SEC rule changes have reduced the number of applications required to be filed under the Holding Company Act, exempted some routine financings and expanded diversification opportunities. The Company is unable to predict at this time what the ultimate outcome of legislative and/or regulatory changes will be, and therefore what the impact on the Company might be.1 The Utility segment's rates, services and other matters are regulated by the State of New York Public Service Commission (PSC) with respect to services provided within New York, and by the Pennsylvania Public Utility Commission (PaPUC) with respect to services provided within Pennsylvania. For additional discussion of the Utility segment's rates and regulation, see Item 7 under the heading "Rate Matters," and Item 8 at Note B-Regulatory Matters. The Pipeline and Storage segment's rates, services and other matters are regulated by the Federal Energy Regulatory Commission (FERC). SIP is not itself regulated by the FERC, but its sole business will be the ownership of an interest in Independence, whose rates, services and other matters will be regulated by the FERC. For additional discussion of the Pipeline and Storage segment's rates and regulation, see Item 7 under the heading "Rate Matters," and Item 8 at Note B-Regulatory Matters. The discussion under Item 8 at Note B-Regulatory Matters, includes a description of the regulatory assets and liabilities reflected on the Company's Consolidated Balance Sheets in accordance with applicable accounting standards. To the extent that the criteria set forth in such accounting standards are not met by the operations of the Utility segment or the Pipeline and Storage segment, as the case may be, the related regulatory assets and liabilities would be eliminated from the Company's Consolidated Balance Sheets and such accounting treatment would be discontinued. In the International segment, rates charged for the sale of thermal energy and electric energy at the retail level are subject to regulation and audit in the Czech Republic by the Czech Ministry of Finance. The regulation of electric energy rates at the retail level indirectly impacts the rates charged by the International segment for its electric energy sales at the wholesale level. In addition, the Company and its subsidiaries are subject to the same federal, state and local regulations on various subjects as other companies doing similar business in the same locations. The Utility Segment The Utility segment contributed approximately 115.3% of the Company's operating income before income taxes in 1998. Additional discussion of the Utility segment appears in the Letter to Shareholders contained in this combined Annual Report to Shareholders/Form 10-K, below under the headings "Sources and Availability of Raw Materials" and "Competition," in Item 7 "MD&A," and in Item 8 at Notes B-Regulatory Matters, H-Commitments and Contingencies and I-Business Segment Information. The Pipeline and Storage Segment The Pipeline and Storage segment contributed approximately 66.2% of the Company's operating income before income taxes in 1998. Supply Corporation currently has service agreements for substantially all of its firm transportation capacity, which totals approximately 1,943 million cubic feet (MMcf) per day. The Utility segment has contracted for approximately 1,126 MMcf per day or 58% of that capacity until 2003 and continuing year-to-year thereafter. An additional 25% of Supply Corporation's firm transportation capacity is subject to firm contracts with nonaffiliated customers until 2003 or later. Supply Corporation has available for sale to customers approximately 62.8 billion cubic feet (Bcf) of firm storage capacity. The Utility segment has contracted for 26.0 Bcf or 41% of that capacity, in service agreements with remaining initial terms of approximately 5 to 8 years and continuing year-to-year thereafter: 23.3 Bcf - 5 years; 2.0 Bcf - 8 years and 0.7 Bcf - 6 years. Nonaffiliated customers have contracted for the remaining 36.8 Bcf or 59% of firm storage capacity; 12.1 Bcf or 19% of total storage capacity is contracted by nonaffiliated customers until 2003 or later. Supply Corporation has been successful in marketing and obtaining executed contracts for storage service (at discounted rates) as it becomes available and expects to continue to do so.1 Independence has filed with the FERC signed precedent agreements providing for firm transportation service totaling about 629,000 Dth/day for ten years, out of total proposed transportation capacity of about 900,000 Dth/day. The customer for 500,000 Dth/day of that total is DirectLink, which is owned by the sponsors of the Independence Pipeline, including NIM. Additional discussion of the Pipeline and Storage segment appears in the Letter to Shareholders contained in this combined Annual Report to Shareholders/Form 10-K, below under the headings "Sources and Availability of Raw Materials" and "Competition," Item 7 "MD&A," and Item 8 at Notes B-Regulatory Matters and I-Business Segment Information. The Exploration and Production Segment The Exploration and Production segment incurred an operating loss before income taxes as a result of the oil and gas asset impairment it recorded in 1998. The impact of this segment's operating loss in relation to total operating income before income taxes in 1998 was negative 86.4%. Additional discussion of the Exploration and Production segment appears in the Letter to Shareholders contained in this combined Annual Report to Shareholders/Form 10-K, below under the heading "Competition," Item 7 "MD&A," and Item 8 at Notes A-Summary of Significant Accounting Policies, F-Financial Instruments, I-Business Segment Information, J-Stock Acquisitions and M-Supplementary Information for Oil and Gas Producing Activities. The International Segment The International segment contributed approximately 2.0% of the Company's operating income before income taxes in 1998. Additional discussion of the International segment appears in the Letter to Shareholders contained in this combined Annual Report to Shareholders/Form 10-K, below under the heading "Sources and Availability of Raw Materials" and "Competition," Item 7 "MD&A," and Item 8 at Notes F-Financial Instruments, I-Business Segment Information and J-Stock Acquisitions. The Other Nonregulated Segment The Other Nonregulated segment contributed approximately 5.0% of the Company's operating income before income taxes in 1998. The impact of the Corporate operation's operating loss in relation to total operating income before income taxes in 1998 was negative 2.1%. Additional discussion of the Other Nonregulated segment appears in the Letter to Shareholders contained in this combined Annual Report to Shareholders/Form 10-K, below under the headings "Sources and Availability of Raw Materials" and "Competition," Item 7 "MD&A," and Item 8 at Notes F-Financial Instruments and I-Business Segment Information. Sources and Availability of Raw Materials Natural gas is the principal raw material for the Utility segment and some of the subsidiaries in the Other Nonregulated segment, as discussed below. In 1998, the Utility segment purchased 117.2 Bcf of gas. Gas purchases from various producers and marketers in the southwestern United States under long-term (two years or longer) contracts accounted for 71% of these purchases. Purchases of gas in Canada and the United States on the spot market (contracts of less than a year) accounted for 24% of the Utility segment's 1998 gas purchases. Gas purchases from Southern Company Energy Marketing L.P. and Dynegy Marketing and Trade (both southwest gas under long-term contracts) represented 12% and 20%, respectively, of total 1998 gas purchases by the Utility segment. No other producer or marketer provided the Utility segment with 10% or more of its gas requirements in 1998. Supply Corporation transports and stores gas owned by its customers, whose gas originates in the southwestern and Appalachian regions of the United States as well as in Canada. SIP, through Independence, proposes to transport natural gas produced in Canada and in the midwestern United States. The Exploration and Production segment seeks to discover and produce raw materials (natural gas, oil and hydrocarbon liquids) as described in the Letter to Shareholders contained in this combined Annual Report to Shareholders/Form 10-K, Item 7 "MD&A" and Item 8 at Notes I-Business Segment Information and M - Supplementary Information for Oil and Gas Producing Activities. Coal is the principal raw material for the International segment, constituting 57% of the cost of materials needed to operate the boilers which produce steam or hot water. Natural gas, oil and limestone combined account for the remaining 43% of such materials. Coal is purchased and delivered directly from the Mostecka Uhelna Spolecnost, a.s. mine for Horizon's largest coal-fired plant under a contract where price and quantity are renegotiated each year. Based on the current extraction rate, this mine has proven reserves through 2030. Natural gas is imported by the Czech Republic government from Russia and the North Sea and is transported through the government-owned pipeline system and purchased by the International segment from two of the eight regional gas distribution companies. Oil is also imported. This segment purchases oil from domestic and foreign refineries. The Other Nonregulated segment needs natural gas for its marketing and Leidy's hub services, but is indifferent as to the source. Highland and Seneca's timber operations rely to a large degree upon timber located on Seneca's lands, so that source and availability are not issues. Competition Competition in the natural gas industry exists among providers of natural gas, as well as between natural gas and other sources of energy. The continuing deregulation of the natural gas industry should enhance the competitive position of natural gas relative to other energy sources by removing some of the regulatory impediments to adding customers and responding to market forces.1 In addition, the environmental advantages of natural gas compared with other fuels should increase the role of natural gas as an energy source.1 Moreover, natural gas is abundantly available in North America, which makes it a dependable alternative to imported oil. The electric industry is moving toward a more competitive environment as a result of the Federal Energy Policy Act of 1992 and initiatives undertaken by the FERC and various states. It is unclear at this point what impact this restructuring will have on the Company.1 The Company competes on the basis of price, service and reliability, product performance and other factors. Sources and providers of energy, other than those described under this "Competition" heading, do not compete with the Company to any significant extent. Competition: The Utility Segment The changes precipitated by the FERC's restructuring of the gas industry in Order No. 636 are redefining the roles of the gas utility industry and the state regulatory commissions. State restructuring initiatives are under way, with regulators in both New York and Pennsylvania promoting retail competition for natural gas supply purchases. However, the Utility segment's traditional distribution function remains largely unchanged. For further discussion of state restructuring initiatives refer to Item 7 under the heading "Rate Matters." Competition for large-volume customers continues with local producers or pipeline companies attempting to sell or transport gas directly to end-users located within the Utility segment's service territories (i.e., bypass). In addition, competition continues with fuel oil suppliers, and may increase with electric utilities making retail energy sales.1 The Utility segment is now better able to compete, through its unbundled flexible services, in its most vulnerable markets (the large commercial and industrial markets). The Utility segment continues to (i) develop or promote new sources and uses of natural gas and/or new services, rates and contracts and (ii) emphasize and provide high quality service to its customers. Competition: The Pipeline and Storage Segment Supply Corporation competes for market growth in the natural gas market with other pipeline companies transporting gas in the northeastern United States and with other companies providing gas storage services. Supply Corporation has some unique characteristics which enhance its competitive position. Its facilities are located adjacent to Canada and the northeastern United States, and provide part of the link between gas-consuming regions of the eastern United States and gas-producing regions of Canada and the southwestern, southern and midwestern regions of the United States. This location offers the opportunity for increased transportation and storage services in the future.1 SIP, through Independence, is competing for customers with other proposed pipeline projects which would bring natural gas from the Chicago area to the growing Northeast and Mid-Atlantic U.S. markets. In combination with expansion projects of Transcontinental Gas Pipe Line Corporation and ANR Pipeline Company, Independence intends to provide the least-cost path for this service and will access the storage and market hub at Leidy, Pennsylvania.1 It is likely that not all of the proposed pipelines will go forward, and that the first project built will have an advantage over other proposed projects.1 Independence is attempting to be the first of the proposed projects approved by the FERC and the first built.1 Independence will also create opportunities for increased transportation and storage services by Supply Corporation.1 Competition: The Exploration and Production Segment The Exploration and Production segment competes with other gas and oil producers and marketers with respect to its sales of oil and gas. The Exploration and Production segment also competes, by competitive bidding and otherwise, with other oil and gas exploration and production companies of various sizes for leases and drilling rights for exploration and development prospects. To compete in this environment, the Exploration and Production segment originates and acts as operator on most prospects, minimizes risk of exploratory efforts through partnership-type arrangements, applies the latest technology for both exploratory studies and drilling operations and focuses on market niches that suit its size, operating expertise and financial criteria. Competition: The International Segment Horizon competes with other entities seeking to develop foreign and domestic energy projects. Horizon, through SCT and PSZT, faces competition in the sales of thermal energy to large industrial customers. Currently, electric energy sales are made to local distribution companies. The Czech Ministry of Finance has announced plans to privatize the local distribution companies. While it is expected that these plans will increase competition at the retail level of the electric energy market, it is unclear at this point what impact this privatization will have on the wholesale electric energy market.1 Both SCT and PSZT sell electricity at the wholesale level. Competition: The Other Nonregulated Segment In the Other Nonregulated segment, NFR, Upstate and NIM, through DirectLink, compete with other marketers and energy management services providers. Leidy competes with other natural gas hub service providers. Highland competes with other sawmills in northwestern Pennsylvania. Seasonality Variations in weather conditions can materially affect the volume of gas delivered by the Utility segment, as virtually all of its residential and commercial customers use gas for space heating. The effect on the Utility segment in New York is mitigated by a weather normalization clause which is designed to adjust the rates of retail customers to reflect the impact of deviations from normal weather. Weather that is more than 2.2% warmer than normal results in a surcharge being added to customers' current bills, while weather that is more than 2.2% colder than normal results in a refund being credited to customers' current bills. In the International segment, district heating operations in the Czech Republic are also subject to the seasonality of weather. Volumes transported and stored by Supply Corporation may vary materially depending on weather, without materially affecting its earnings. Supply Corporation's rates are based on a straight fixed-variable rate design which allows recovery of all fixed costs in fixed monthly reservation charges. Variable charges based on volumes are designed only to reimburse the variable costs caused by actual transportation or storage of gas. Capital Expenditures A discussion of capital expenditures by business segment is included in Item 7 under the heading "Investing Cash Flow," subheading "Capital Expenditures and Other Investing Activities." Environmental Matters A discussion of material environmental matters involving the Company is included in Item 8, Note H-Commitments and Contingencies. Miscellaneous The Company had a total of 3,944 full-time employees at September 30, 1998, 2,554 employees in all of its U.S. operations and 1,390 employees in its International segment. This is an increase of 56% from the 2,524 total employed at September 30, 1997. Most of the increase (1,356 employees) occurred in the International segment. Agreements covering employees in collective bargaining units in New York were renegotiated in November 1997, effective December 1997, and are scheduled to expire in February 2001. Agreements covering most employees in collective bargaining units in Pennsylvania were renegotiated early, effective November 1998, and are scheduled to expire in April and May 2003. The Company has numerous municipal franchises under which it uses public roads and certain other rights-of-way and public property for the location of facilities. When necessary, the Company renews such franchises.
Executive Officers of the Company(1) Age as of Current Company Date Elected To Name 9/30/98 Positions Current Positions ---- --------- --------------- ----------------- Bernard J. Kennedy 67 Chairman of the Board of Directors. March 21, 1989 Chief Executive Officer. August 1, 1988 President. January 1, 1987 Director. March 29, 1978 Philip C. Ackerman 54 Director. March 16, 1994 Senior Vice President. June 1, 1989 President of Distribution Corporation. October 1, 1995 Executive Vice President of Supply Corporation. October 1, 1994 President of Horizon. September 13, 1995 President of certain other subsidiaries of the Company from prior to 1993.
Age as of Current Company Date Elected To Name 9/30/98 Positions Current Positions ---- --------- --------------- ----------------- Richard Hare 60 President of Supply Corporation. June 1, 1989 Senior Vice President of Penn-York Energy Corpor- ation until its merger into Supply Corporation on July 1, 1994. June 1, 1989 President of SIP. September 22, 1997 James A. Beck 51 President of Seneca. October 1, 1996(2) President of Upstate. July 18, 1997 President of NIM. September 22, 1997 President of Highland. March 11, 1998 Joseph P. Pawlowski 57 Treasurer. December 11, 1980 Senior Vice President of Distribution Corporation. February 20, 1992 Treasurer of Distribution Corporation. January 1, 1981 Treasurer of Supply Corporation. June 1, 1985 Secretary of Supply Corporation. October 1, 1995 Treasurer of SIP. September 22, 1997 Officer of certain other subsidiaries of the Company from prior to 1993. Gerald T. Wehrlin 60 Controller. December 11, 1980 Senior Vice President of Distribution Corporation. April 1, 1991 Controller of Seneca. September 1, 1981 Secretary and Treasurer of Leidy. September 1, 1993 Vice President of Horizon. February 21, 1997(3) Officer of certain other subsidiaries of the Company from prior to 1993. Walter E. DeForest 57 Senior Vice President of Distribution Corporation. August 1, 1993 President of Leidy. September 1, 1993 Bruce H. Hale 49 Senior Vice President of February 21, 1997, Supply Corporation. and from February 21, 1992 through December 31, 1992(4) Vice President of Horizon. September 13, 1995
Age as of Current Company Date Elected To Name 9/30/98 Positions Current Positions ---- --------- --------------- ----------------- Dennis J. Seeley 55 Senior Vice President of Distribution Corporation. February 21, 1997 and from April 1, 1991 through February 18, 1993(5) David F. Smith 45 Senior Vice President of Distribution Corporation. January 1, 1993 Secretary of Distribution Corporation. June 20, 1986 Officer of certain other subsidiaries of the Company from prior to 1993.
(1) The Company has been advised that there are no family relationships among any of the officers listed, and that there is no arrangement or understanding among any one of them and any other persons pursuant to which he was elected as an officer. (2) Vice President of Seneca from January 1, 1994 through April 30, 1995, Executive Vice President of Seneca from May 1, 1995 through September 30, 1996. (3) Secretary and Treasurer of Horizon from September 13, 1995 through February 21, 1997. (4) Senior Vice President of Distribution Corporation from April 1, 1991 through February 20, 1992, and again from January 1, 1993 through February 21, 1997. (5) Senior Vice President of Supply Corporation from January 1, 1993 through February 21, 1997. ITEM 2 PROPERTIES General Information on Facilities The investment of the Company in net property, plant and equipment was $2.2 billion at September 30, 1998. Approximately 61% of this investment is in the Utility and Pipeline and Storage segments, which are primarily located in western New York and western Pennsylvania. The remaining investment in property, plant and equipment is mainly in the Exploration and Production segment (28%), which is primarily located in the Gulf Coast, southwestern, western and Appalachian regions of the United States, and in the International segment (9%) which is located in the Czech Republic. During the past five years, the Company has made significant additions to plant in order to expand and improve transmission and distribution facilities for both retail and transportation customers, to augment the reserve base of oil and gas, and to purchase district heating and power generation facilities in the Czech Republic. Net plant has increased $767.3 million, or 52%, since 1993. The Utility segment has the largest net investment in property, plant and equipment, compared with the Company's other business segments. Its net investment in its gas distribution network (including 14,784 miles of distribution pipeline) and its services represent approximately 58% and 28%, respectively, of the Utility segment's net investment of $906.8 million. The Pipeline and Storage segment represents a net investment of $461.0 million in transmission and storage facilities at September 30, 1998. Transmission pipeline, with a net cost of $145.7 million, represents 32% of this segment's total net investment and includes 2,646 miles of pipeline required to move large volumes of gas throughout its service area. Storage facilities consist of 33 storage fields, 4 of which are jointly operated with certain pipeline suppliers, and 490 miles of pipeline. Net investment in storage facilities includes $88.6 million of gas stored underground-noncurrent, representing the cost of the gas required to maintain pressure levels for normal operating purposes as well as gas maintained for system balancing and other purposes, including that needed for no-notice transportation service. The Pipeline and Storage segment has 31 compressor stations with 70,550 installed compressor horsepower. The Exploration and Production segment had a net investment in properties amounting to $638.9 million at September 30, 1998. Of this amount, Seneca's net investment in oil and gas properties in the Gulf Coast/West Coast regions was $592.9 million, and Seneca's net investment in oil and gas properties in the Appalachian region aggregated $46.0 million. The International segment had a net investment in properties amounting to $202.6 million at September 30, 1998. PSZT's net investment in district heating and electric generation facilities was $145.7 million; SCT's net investment in district heating and electric generation facilities was $55.9 million; and Teplarna Kromeriz's net investment in district heating facilities was approximately $1.0 million. The Utility and Pipeline and Storage segments' facilities provided the capacity to meet its fiscal 1998 peak day sendout, including transportation service, of 1,727 MMcf, which occurred on December 31, 1997. Withdrawals from storage provided approximately 33% of the requirements on that day. Company maps, which are included on the inside front cover and on page 1 of the paper copy of this combined Annual Report to Shareholders/Form 10-K, are narratively described in the Appendix to this electronic filing and are incorporated herein by reference. Exploration and Production Activities The information that follows is disclosed in accordance with SEC regulations, and relates to the Company's oil and gas producing activities. A further discussion of oil and gas producing activities is included in Item 8, Note M-Supplementary Information for Oil and Gas Producing Activities. Note M sets forth proved developed and undeveloped reserve information for Seneca. Seneca's oil and gas reserves reported in Note M as of September 30, 1998, were estimated by Seneca's qualified geologists and engineers and were audited by independent petroleum engineers from Ralph E. Davis, Inc. Seneca reports its oil and gas reserve information, on an annual basis, to the Energy Information Administration (EIA). The basis of reporting Seneca's reserves to the EIA is identical to that reported in Note M. Supply Corporation holds reserves (not included in Note M) related to held for future use storage wells. Information on such reserves is included on Supply Corporation's Form 2 "Annual Report of Natural Gas Companies" filed with the FERC. The following is a summary of certain oil and gas information taken from Seneca's records: Production For the Year Ended September 30 1998 1997 1996 - ------------------------------- ---- ---- ---- Average Sales Price per Mcf of Gas* $ 2.45 $ 2.60 $ 2.35 Average Sales Price per Barrel of Oil* $12.15 $20.63 $19.50 Average Production (Lifting) Cost per Mcf Equivalent of Gas and Oil Produced $ 0.45 $ 0.35 $ 0.31 *Prices do not reflect gains or losses from hedging activities. Productive Wells At September 30, 1998 Gas Oil - --------------------- --- --- Productive Wells - gross 1,925 877 - net 1,821 833 Developed and Undeveloped Acreage At September 30, 1998 - --------------------- Developed Acreage - gross 639,768 - net 558,501 Undeveloped Acreage - gross 926,587 - net 701,241 Drilling Activity Productive Dry ----------------- ------------------ For the Year Ended September 30 1998 1997 1996 1998 1997 1996 - ------------------------------- ---- ---- ---- ---- ---- ---- Net Wells Completed - Exploratory 10.72 4.21 4.22 4.97 3.49 7.35 - Development 14.11 1.84 8.02 2.00 1.60 0 Present Activities At September 30, 1998 - --------------------- Wells in Process of Drilling - gross 18.00 - net 14.22 South Lost Hills Waterflood Program In Seneca's South Lost Hills Field (acquired in 1998 as part of the HarCor and Bakersfield Energy Resources, Inc. acquisitions) a waterflood project was initiated in 1996 on Ellis lease in the Diatomite reservior for pressure maintenance and recovery enhancement purposes. Currently there are 29 injectors and 86 producers in the program. The total injection and production from this waterflood project are 10,000 barrels of water per day and 400 barrels of oil per day, respectively. Expansion of the current project is being evaluated by a reservior simulation program. ITEM 3 Legal Proceedings None ITEM 4 Submission of Matters to a Vote of Security Holders No matter was submitted to a vote of security holders during the fourth quarter of 1998. PART II ------- ITEM 5 Market for the Registrant's Common Stock and Related Shareholder Matters Information regarding the market for the Registrant's common stock and related shareholder matters appears in Note D-Capitalization and Note L-Market for Common Stock and Related Shareholder Matters (unaudited), under Item 8 of this combined Annual Report to Shareholders/Form 10-K, and reference is made thereto. On July 1, 1998, the Company issued 700 unregistered shares of Company common stock to the seven non-employee directors of the Company, 100 shares to each such director. These shares were issued as partial consideration for the directors' service as directors during the quarter ended September 30, 1998, pursuant to the Company's Retainer Policy for Non-Employee Directors. These transactions were exempt from registration by Section 4(2) of the Securities Act of 1933, as amended, as transactions not involving any public offering. ITEM 6 Selected Financial Data
Year Ended September 30: 1998 1997 1996 1995 1994 - ----------------------- ---- ---- ---- ---- ---- Summary of Operations (Thousands) Operating Revenues $1,248,000 $1,265,812 $1,208,017 $975,496 $1,141,324 ---------- ---------- ---------- -------- ---------- Operating Expenses: Purchased Gas 441,746 528,610 477,357 351,094 497,687 Fuel Used in Heat and Electric Generation 37,592 1,489 - - - Operation and Maintenance 320,014 286,537 309,206 292,505 291,390 Property, Franchise and Other Taxes 92,817 100,549 99,456 91,837 103,788 Depreciation, Depletion and Amortization 118,880 111,650 98,231 71,782 74,764 Impairment of Oil and Gas Producing Properties 128,996 - - - - Income Taxes 24,024 68,674 66,321 43,879 47,792 ---------- ---------- ---------- -------- ---------- 1,164,069 1,097,509 1,050,571 851,097 1,015,421 ---------- ---------- ---------- -------- ---------- Operating Income 83,931 168,303 157,446 124,399 125,903 Other Income 35,870 3,196 3,869 5,378 3,656 ---------- ---------- ---------- -------- ---------- Income Before Interest Charges and Minority Interest in Foreign Subsidiaries 119,801 171,499 161,315 129,777 129,559 Interest Charges 85,284 56,811 56,644 53,883 47,124 ---------- ---------- ---------- -------- ---------- Minority Interest in Foreign Subsidiaries (2,213) - - - - ---------- ---------- ---------- -------- ---------- Income Before Cumulative Effect 32,304 114,688 104,671 75,894 82,435 Cumulative Effect of Changes in Accounting (9,116) - - - 3,237 ---------- ---------- ---------- -------- ---------- Net Income Available for Common Stock $ 23,188 $ 114,688 $ 104,671 $ 75,894 $ 85,672 ========== ========== ========== ======== ========== Per Common Share Data Basic Earnings Per Common Share $0.61** $3.01 $2.78 $2.03 $2.32* Diluted Earnings per Common Share $0.60** $2.98 $2.77 $2.03 $2.31* Dividends Declared $1.77 $1.71 $1.65 $1.60 $1.56 Dividends Paid $1.76 $1.70 $1.64 $1.59 $1.55 Dividend Rate at Year-End $1.80 $1.74 $1.68 $1.62 $1.58 At September 30: Number of Common Shareholders 23,743 20,267 21,640 21,429 22,465 ========== ========== ========== ======== ========== Net Property, Plant and Equipment (Thousands) Utility $ 906,754 $ 889,216 $ 855,161 $ 822,764 $ 787,794 Pipeline and Storage 460,952 450,865 452,305 463,647 443,622 Exploration and Production 638,886 443,164 375,958 339,950 295,418 International 202,590 942 1,274 70 - Other Nonregulated 38,946 35,168 24,893 22,620 18,579 Corporate 9 11 15 131 137 ---------- ---------- ---------- ---------- ---------- Total Net Plant $2,248,137 $1,819,366 $1,709,606 $1,649,182 $1,545,550 ========== ========== ========== ========== ========== Total Assets (Thousands) $2,684,459 $2,267,331 $2,149,772 $2,036,823 $1,980,806 ========== ========== ========== ========== ========== Capitalization (Thousands) Common Stock Equity $ 890,085 $ 913,704 $ 855,998 $ 800,588 $ 780,288 Long-Term Debt, Net of Current Portion 692,669 581,640 574,000 474,000 462,500 ---------- ---------- ---------- ---------- ---------- Total Capitalization $1,582,754 $1,495,344 $1,429,998 $1,274,588 $1,242,788 ========== ========== ========== ========== ==========
* 1994 includes Cumulative Effect of Changes in Accounting of $0.09 (basic and diluted), which resulted from the adoption of SFAS 109, "Accounting for Income Taxes" and SFAS 112, "Employers' Accounting for Postemployment Benefits." ** 1998 includes oil and gas asset impairment of ($2.06) basic, ($2.04) diluted and cumulative effect of a change in depletion methods of ($0.24) basic and diluted. Refer to further discussion of these items in Notes to Financial Statements, Note A - Summary of Significant Accounting Policies. ITEM 7 Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations 1998 Compared with 1997 National Fuel's earnings were $23.2 million, or $0.61 per common share ($0.60 per common share on a diluted basis), in 1998. These earnings include a non-cash impairment of Seneca's oil and gas assets in the amount of $79.1 million (after tax), as well as the cumulative effect through October 1, 1997, of a change in depletion methods for Seneca's oil and gas assets which reduced earnings by $9.1 million (after tax). Without these two non-cash items, earnings for the fiscal year ended September 30, 1998 would have been $111.4 million, or $2.91 per common share ($2.88 per common share on a diluted basis). This compares with earnings of $114.7 million, or $3.01 per common share ($2.98 per common share on a diluted basis), in 1997. The earnings for 1998 also reflect a net $5.0 million of after tax income from the settlement of the primary issues relating to IRS audits of years 1977-1994. The earnings decrease in 1998 was attributable to lower earnings of the Company's Utility and Exploration and Production segments, offset in part by higher earnings in the Pipeline and Storage, International (which incurred a loss in 1997) and Other Nonregulated segments. Utility earnings decreased as a result of the impact of warmer weather in 1998 compared with 1997, and the consequent overall lower usage per account. In addition, the Utility segment incurred interest expense, net of related rate recovery, in connection with the settlement of the primary issues relating to the previously referred to settlement of the IRS audits. Partly offsetting these negative impacts to earnings was the Utility segment's continued decrease in operation and maintenance (O&M) expense. In the Exploration and Production segment, earnings are down mainly because of low oil prices and decreased gas production. In addition, earnings were impacted as a result of higher interest costs related to Seneca's acquisition activities in 1998. (Refer to further discussion of acquisition activities under "Investing Cash Flow," subheading "Exploration and Production.") These circumstances more than offset the positive contribution to earnings that resulted from higher oil production, higher gas prices (after hedging) and Seneca's portion of interest income related to the previously mentioned settlement of IRS audits. In the Pipeline and Storage segment, earnings are up mainly due to Supply Corporation's portion of interest income from the previously mentioned settlement of IRS audits. Additional income tax expense related to certain unsettled issues were also recorded. Also contributing to Supply Corporation's earnings for the year was a buyout of a firm transportation agreement by a customer in the amount of $2.5 million. However, lower revenue from unbundled pipeline sales and open access transportation partly offset these positive earnings. The International segment realized increases from Horizon's share of earnings from its two main investments in district heating and power generation operations located in the Czech Republic. Horizon initially acquired 36.8% of SCT in 1997, and increased its ownership during 1998 to 82.7% by September 30, 1998. Horizon also invested in PSZT during 1998 and owned an 86.2% interest at September 30, 1998. The Other Nonregulated segment's earnings are up mainly because of higher earnings in the timber operations, offset in part by higher expenses in the natural gas marketing operations. Discussion of Asset Impairment and Cumulative Effect of a Change in Depletion Method Seneca follows the full-cost method of accounting for its oil and gas operations. Under this method, capitalized costs are limited by a present worth calculation of future revenues from oil and gas assets (full-cost ceiling). Due to significant declines in oil prices in 1998, Seneca's capitalized costs under the full-cost method of accounting exceeded the full-cost ceiling at March 31, 1998. Seneca was required to recognize an impairment of its oil and gas producing properties in the quarter ended March 31, 1998. This charge amounted to $129.0 million (pretax) and reduced net income for 1998 by $79.1 million ($2.06 per common share, basic; $2.04 per common share, diluted). Seneca changed its method of depletion for oil and gas properties from the gross revenue method to the units of production method. The new method was adopted because it provides a better matching of oil and gas revenues and depletion expense and is the preferable method used by oil and gas producing companies. Seneca's recent acquisition activities have increased its scope of operations in relation to National Fuel's operations. Consequently, the change in method was warranted. The units of production method was applied retroactively to prior years to determine the cumulative effect through October 1, 1997. This cumulative effect reduced earnings for 1998 by $9.1 million, net of income tax ($0.24 per common share, basic and diluted). Depletion of oil and gas properties for 1998 has been computed under the units of production method. The effect of the change from the gross revenue method to the units of production method increased net income for 1998 by $1.4 million ($0.04 per common share, basic and diluted). 1997 Compared with 1996 National Fuel's earnings were $114.7 million, or $3.01 per common share ($2.98 per common share on a diluted basis), in 1997. This compares with earnings of $104.7 million, or $2.78 per common share ($2.77 per common share on a diluted basis), in 1996. The earnings increase in 1997 was attributable to higher earnings of the Company's Utility and Pipeline and Storage segments, as well as a reduction in losses of its International segment, partly offset by lower earnings of the Exploration and Production segment and a loss in the Other Nonregulated segment compared with income in 1996. Utility earnings increased as a result of new rates effective in October 1996 and lower O&M expense. Partly offsetting these positive impacts to earnings was warmer weather in 1997 compared with 1996, as well as the inclusion in 1996 earnings of a downward revision of estimated purchased gas costs for 1995. The Pipeline and Storage segment earnings increase was attributable to higher revenue from unbundled pipeline sales and open access transportation, as well as lower O&M expense for the year. In the International segment, net losses in 1997 were significantly less than in 1996. The 1996 losses included expenses associated with the Company's withdrawal from participation in an international power project. Exploration and Production earnings decreased as a result of higher operation and depletion expense, which more than offset increased revenues resulting from increased prices and a slight increase in production. The Other Nonregulated segment's loss in 1997 resulted primarily from increased depletion expenses in this segment's timber operations related to cutting timber with a higher cost. Operating Revenues Year Ended September 30 (thousands) 1998 1997 1996 - ----------------------------------------------------------------------------- Utility Retail Revenues: Residential $ 612,647 $ 709,968 $ 678,395 Commercial 123,807 167,338 165,824 Industrial 18,068 22,412 25,648 - ----------------------------------------------------------------------------- 754,522 899,718 869,867 - ----------------------------------------------------------------------------- Off-System Sales 44,479 43,857 30,907 Transportation 62,844 49,285 49,180 Other 9,335 (1,494) 4,372 - ----------------------------------------------------------------------------- 871,180 991,366 954,326 - ----------------------------------------------------------------------------- Pipeline and Storage Storage Service 63,505 64,221 67,975 Transportation 94,347 92,858 92,401 Other 13,131 15,615 16,177 - ----------------------------------------------------------------------------- 170,983 172,694 176,553 - ----------------------------------------------------------------------------- Exploration and Production 124,272 119,260 114,462 - ----------------------------------------------------------------------------- International 76,259 1,910 286 - ----------------------------------------------------------------------------- Other Nonregulated 106,527 82,005 68,644 - ----------------------------------------------------------------------------- Less: Intersegment Revenues 101,221 101,423 106,254 - ----------------------------------------------------------------------------- Total Operating Revenues $1,248,000 $1,265,812 $1,208,017 ============================================================================= Operating Income (Loss) Before Income Taxes Year Ended September 30 (thousands) 1998 1997 1996 - ----------------------------------------------------------------------------- Utility $124,482 $123,856 $115,257 Pipeline and Storage 71,510 73,523 72,914 Exploration and Production (93,266) 42,694 46,408 International 2,136 (2,987) (14,281) Other Nonregulated 5,347 2,244 5,700 Corporate (2,254) (2,353) (2,231) - ----------------------------------------------------------------------------- Total Operating Income Before Income Taxes $107,955 $236,977 $223,767 ============================================================================= System Natural Gas Volumes Year Ended September 30 (billion cubic feet) 1998 1997 1996 - ------------------------------------------------------------------------- Utility Gas Sales Residential 71.7 85.7 90.7 Commercial 16.4 22.6 24.9 Industrial 4.3 5.1 6.0 Off-System 16.2 14.1 11.1 - ------------------------------------------------------------------------- 108.6 127.5 132.7 - ------------------------------------------------------------------------- Non-Utility Gas Sales Production (equivalent billion cubic feet) 52.2 50.0 49.2 - ------------------------------------------------------------------------- Total Gas Sales 160.8 177.5 181.9 - ------------------------------------------------------------------------- Transportation Utility 60.4 57.9 58.2 Pipeline and Storage 313.1 300.3 325.0 Nonregulated 0.8 0.5 0.6 - ------------------------------------------------------------------------- 374.3 358.7 383.8 - ------------------------------------------------------------------------- Marketing Volumes 26.4 21.0 20.2 - ------------------------------------------------------------------------- Less Intra and Intersegment Volumes: Transportation 140.8 151.9 157.7 Production 4.1 4.3 4.8 Gas Sales - - 0.8 Marketing - - 0.1 - ------------------------------------------------------------------------- 144.9 156.2 163.4 - ------------------------------------------------------------------------- Total System Natural Gas Volumes 416.6 401.0 422.5 ========================================================================= Utility Operating Revenues 1998 Compared with 1997 Operating revenues for the Utility segment decreased $120.2 million in 1998 compared with 1997. This decrease primarily reflects the recovery of lower gas costs which resulted from a decrease in gas sales (an 18.9 billion cubic feet (Bcf) decrease for 1998) and a decrease in the average cost of purchased gas (see discussion of purchased gas below under the heading "Purchased Gas"). While the decrease in gas sales also reflects, in part, the migration of certain retail customers to transportation service in both the New York and Pennsylvania jurisdictions as a result of new aggregator services, the major reason for the decrease stems from warmer weather which was on average 13.8% warmer than the prior year (see Degree Days table below). The switch to new aggregator services is discussed further in the "Rate Matters" section that follows. As of September 30, 1998, Distribution Corporation's 1996 rate settlement with the State of New York Public Service Commission (PSC) expired. As part of this rate settlement, Distribution Corporation had put into effect a $7.2 million annual base rate increase in its New York jurisdiction on October 1, 1997. However, this rate settlement also provided that earnings above a 12% return on equity (determined on a cumulative basis over the three years ended September 30, 1998) are to be shared equally between shareholders and customers. As a result of this sharing mechanism, Distribution Corporation has determined that the refund due customers is $10.7 million (of which $7.7 million was recorded in 1998 and $3.0 million was recorded in 1997). These amounts are included as a reduction of other operating revenues in 1998 and 1997, respectively. Also as part of the 1996 rate settlement, Distribution Corporation was allowed to utilize certain refunds from upstream pipeline companies and certain credits (referred to as the "refund pool") to offset certain specific expense items. In September 1998, Distribution Corporation recognized $7.9 million of the refund pool as other operating revenue and recorded an equal amount of O&M expense in accordance with the settlement agreement. In addition, 1998 other operating revenues include $6.0 million of revenue recorded in Distribution Corporation's New York jurisdiction related to the previously mentioned recent settlement of IRS audits. This $6.0 million represents the rate recovery (through the above noted refund pool) of interest expense as allowed by the 1996 rate settlement with the PSC. 1997 Compared with 1996 Operating revenues increased $37.0 million in 1997 compared with 1996. Despite lower gas sales (mainly due to weather that was, on average, 5.6% warmer than the prior year), revenues increased primarily because of the pass through of increased gas costs and a general base rate increase of $7.2 million in Distribution Corporation's New York jurisdiction effective October 1, 1996. Gas costs were up due to a 7% increase in the average costs of purchased gas (see discussion of purchased gas below under the heading "Purchased Gas"). Other operating revenues in 1997 were reduced by a $3.0 million refund provision to the Utility's customers for a 50% sharing of earnings over a 12% return on equity as discussed above. Operating Income 1998 Compared with 1997 Operating income before income taxes for the Utility segment increased $0.6 million in 1998 compared with 1997. Excluding the $6.0 million of rate recovery of interest expense related to the IRS audits, as noted above (this rate recovery is offset 100% by interest expense, included below the operating income line), the Utility segment's pretax operating income decreased $5.4 million for the year ended September 30, 1998. The decrease in operating income before income taxes resulted primarily from the negative impact of warmer weather and the related decrease in normalized gas usage per customer account. Partly offsetting this decrease in operating income before income taxes, the Utility segment experienced a decrease in O&M expense. This decrease is a result of management's continued emphasis on controlling costs. Also contributing to this decrease, 1997 O&M expense included $0.9 million of expenses associated with an early retirement offer to certain Pennsylvania operating union employees in 1997. In October 1998, the Company announced an early retirement offer to certain salaried, non-union hourly and union employees of Distribution Corporation. The estimated expense to be recorded by the Utility segment in 1999 related to this offer is $4.3 million to $4.7 million.1 The impact of weather on Distribution Corporation's New York rate jurisdiction is tempered by a weather normalization clause (WNC). The WNC in New York, which covers the eight-month period from October through May, has had a stabilizing effect on pretax operating income and earnings for the New York rate jurisdiction. In addition, in periods of colder than normal weather, the WNC benefits Distribution Corporation's New York customers. In 1998, the WNC in New York preserved pretax operating income of $12.1 million as weather, overall, was warmer than normal for the period of October 1997 through May 1998. Since the Pennsylvania rate jurisdiction does not have a WNC, uncontrollable weather variations directly impact pretax operating income and earnings. In the Pennsylvania service territory, weather was 15.7% warmer than 1997 and 13.4% warmer than normal. The Pennsylvania jurisdiction's warmer weather in 1998 compared with 1997 lowered pretax operating income by approximately $6.2 million. 1997 Compared with 1996 Operating income before income taxes increased $8.6 million in 1997 compared with 1996. The increase resulted primarily from the increases in 1997 revenue discussed above, combined with lower O&M expense. These items were partly offset by certain purchased gas costs adjustments, totaling $4.2 million, associated with lost and unaccounted-for gas in Distribution Corporation's New York jurisdiction that lowered purchased gas expense in 1996. O&M expense decreased primarily as a result of an early retirement offer to certain salaried, non-union hourly and union employees of Distribution Corporation that was effective October 1, 1996. The 1996 results included expenses for this retirement offer of $6.4 million. O&M expense in 1997 included $0.9 million of expense for the 1997 early retirement offer mentioned above. O&M expense also decreased as a result of management's continued emphasis on controlling costs. In 1997, the WNC in New York resulted in a benefit to customers of $0.2 million as weather, overall, was colder than normal for the period of October 1996 through May 1997. In the Pennsylvania service territory, weather in 1997 was 5.5% warmer than 1996 and 2.8% colder than normal. The Pennsylvania jurisdiction's warmer weather in 1997 compared with 1996 lowered pretax operating income by approximately $3.2 million. Degree Days Percent (Warmer) Colder ----------------------- Than ----------------------- Year Ended September 30 Normal Actual Normal Prior Year - ------------------------------------------------------------------------------- 1998: Buffalo 6,689 5,914 (11.6%) (12.9%) Erie 6,223 5,389 (13.4%) (15.7%) - ------------------------------------------------------------------------------- 1997: Buffalo 6,690 6,793 1.5% (5.7%) Erie 6,223 6,395 2.8% (5.5%) - ------------------------------------------------------------------------------- 1996: Buffalo 6,728 7,203 7.1% 16.5% Erie 6,258 6,764 8.1% 17.1% - ------------------------------------------------------------------------------ Purchased Gas The cost of purchased gas is by far the Company's single largest operating expense. Annual variations in purchased gas costs can be attributed directly to changes in gas sales volumes, the price of gas purchased and the operation of purchased gas adjustment clauses. Currently, Distribution Corporation has contracted for long-term firm transportation capacity with Supply Corporation and six other upstream pipeline companies, for long-term gas supplies with a combination of producers and marketers and for storage service with Supply Corporation and three nonaffiliated companies. In addition, Distribution Corporation can satisfy a portion of its gas requirements through spot market purchases. Changes in wellhead prices have a direct impact on the cost of purchased gas. Distribution Corporation's average cost of purchased gas, including the cost of transportation and storage, was $4.13 per thousand cubic feet (Mcf) in 1998, a decrease of 3% from the average cost of $4.26 per Mcf in 1997. The average cost of purchased gas in 1997 was 7% higher than the $3.98 per Mcf in 1996. Pipeline and Storage Operating Revenues 1998 Compared with 1997 Operating revenues decreased $1.7 million in 1998 compared with 1997. The decrease resulted primarily from lower revenues from unbundled pipeline sales and open access transportation (a decrease of $2.1 million), lower storage service revenues (a decrease of $0.7 million), and lower cashout revenue (a cash resolution of a gas imbalance whereby a customer pays Supply Corporation for gas it receives in excess of amounts delivered into Supply Corporation's system by the customer's shipper). Cashout revenues decreased by $1.1 million. However, there is no earnings impact as cashout revenue is offset by an equal amount of purchased gas expense. These decreases were partially offset by an increase in transportation demand charges (approximately $1.8 million) stemming from the 1998 Niagara Expansion Project (see further discussion under "Investing Cash Flow," subheading "Pipeline and Storage"). Transportation volumes in this segment increased 12.8 Bcf. Generally, volume fluctuations do not have a significant impact on earnings as a result of Supply Corporation's straight fixed-variable (SFV) rate design. However, as mentioned above, the increase in capacity stemming from the 1998 Niagara Expansion Project contributed to higher demand charge revenue. 1997 Compared with 1996 Operating revenues decreased $3.9 million in 1997 compared with 1996. The 1996 revenues reflected a rate increase which was retroactive to June 1, 1995. The retroactive rates added approximately $2.0 million to revenues in 1996 that related to 1995. The corresponding decrease in 1997 primarily impacted storage service revenues, which decreased by $3.8 million. In addition to the retroactive rate impact, storage service revenues decreased as a result of customers opting for more flexible services at discounted rates. A slight increase in transportation revenues primarily reflects an increase in surcharge adjustments. Other operating revenues decreased slightly as higher revenues from unbundled pipeline sales and open access transportation (an increase of $3.3 million) was more than offset by lower cashout revenue (a decrease of $3.7 million). Operating Income 1998 Compared with 1997 Operating income before income taxes for the Pipeline and Storage segment decreased $2.0 million in 1998 compared with 1997. As discussed above, the decrease is primarily attributable to lower revenue from unbundled pipeline sales and open access transportation and lower storage service revenues, offset in part by higher transportation demand charges. There also was an increase in O&M expense resulting primarily from the establishment of reserves for preliminary survey and investigation costs associated with the 1999 Niagara Expansion and Green Canyon projects. The 1999 Niagara Expansion project is discussed further under "Investing Cash Flow," subheading "Pipeline and Storage". The reserve related to the Green Canyon project (a natural gas gathering project offshore and onshore Louisiana) was established due to the lack of interest at this time by potential customers. Certain of these costs for which reserves have been established may be recovered at a future date.1 In addition, Supply Corporation recognized a base gas loss at its Zoar Storage Field. In total, these three items amounted to $3.7 million. Partially offsetting these increases in O&M expense was the reversal of a portion of a reserve set up in a prior period for the Laurel Fields Storage Project. The Pipeline and Storage segment was able to recapture approximately $1.0 million by selling preliminary engineering, survey, environmental and archeological information from the Laurel Fields Storage Project to the Independence Pipeline Company (the Independence Pipeline project is discussed further under "Investing Cash Flow," subheading "Pipeline and Storage"). Another decrease to O&M expense stems from the fact that 1997 O&M expense included $1.0 million of expenses associated with an early retirement offer to certain Pennsylvania operating union employees. In October 1998, the Company announced an early retirement offer to certain salaried, non-union hourly and union employees of Supply Corporation. The estimated expense to be recorded by the Pipeline and Storage segment in 1999 related to this offer is $0.7 million to $1.0 million. 1997 Compared with 1996 Operating income before income taxes increased $0.6 million in 1997 compared with 1996. This slight increase primarily reflects lower O&M expenses (including labor) combined with higher revenues related to unbundled pipeline sales and open access transportation. The cost of an early retirement offer to certain Pennsylvania operating union employees in 1997 resulted in $1.0 million of additional operating expenses. However, such expenses were $0.8 million less than the expenses associated with a 1996 early retirement offer. Partly offsetting these increases was the retroactive rate effect recorded in 1996 and lower storage service revenues, as discussed above. Exploration and Production Operating Revenues 1998 Compared with 1997 Operating revenues increased $5.0 million in 1998 compared with 1997. The main reason for the increase was the $4.9 million in revenues related to the gas processing plant that was acquired as part of the HarCor and Bakersfield Energy Resources (BER) acquisitions in 1998 (see further discussion of these acquisitions under "Investing Cash Flow," subheading "Exploration and Production"). While this gas processing plant contributed a large amount of revenue, this revenue was basically offset by an equal amount of expense. Gas production revenues, net of hedging activities, decreased $1.1 million as a result of decreased production, offset in part by higher gas prices (after hedging) (the weighted average gas price after hedging increased $0.09 per Mcf). Refer to the tables below for production and price information. The gas production declines were mainly due to the shut-in of production during the Gulf hurricane season and tropical storms, as well as the expected decline in production of West Cameron 552 and delays in drilling due to lack of rig availability in the first half of the year. Oil production revenues, net of hedging activities, were basically even with the prior year as increased production was offset by lower oil prices (after hedging). The weighted average oil price after hedging decreased $4.92 per barrel (bbl). The increase in oil production was mainly the result of West Coast production from the properties acquired in the Whittier, HarCor and BER acquisitions. 1997 Compared with 1996 Operating revenues increased $4.8 million in 1997 compared with 1996. Gas production revenues, net of hedging activities, increased $2.2 million as a result of higher prices (after hedging) (the weighted average gas price after hedging increased $0.07 per Mcf) slightly offset by decreased natural gas production. Oil production revenues, net of hedging activities, increased $2.8 million as a result of increases in oil production offset in part by lower oil prices (after hedging). The weighted average oil price after hedging decreased $0.06 per bbl. The increase in oil production was the result of a full year of production in 1997 at Vermilion 252 compared with only seven months in 1996. Refer to tables below for production and price information. Production Volumes Year Ended September 30 1998 1997 1996 - --------------------------------------------------------------- Gas Production (million cubic feet) Gulf Coast 29,461 32,377 32,355 West Coast 2,146 1,135 990 Appalachia 4,867 5,074 5,422 - --------------------------------------------------------------- 36,474 38,586 38,767 =============================================================== Oil Production (thousands of barrels) Gulf Coast 1,228 1,404 1,195 West Coast 1,376 490 533 Appalachia 10 8 14 - --------------------------------------------------------------- 2,614 1,902 1,742 =============================================================== Average Prices Year Ended September 30 1998 1997 1996 - --------------------------------------------------------------- Average Gas Price/Mcf Gulf Coast $2.40 $2.60 $2.33 West Coast $2.14 $1.79 $1.25 Appalachia $2.88 $2.79 $2.65 Weighted Average $2.45 $2.60 $2.35 Weighted Average After Hedging $2.27 $2.18 $2.11 - --------------------------------------------------------------- Average Oil Price/bbl Gulf Coast $14.69 $21.37 $20.45 West Coast* $ 9.85 $18.49 $17.41 Appalachia $16.80 $21.28 $18.43 Weighted Average $12.15 $20.63 $19.50 Weighted Average After Hedging $13.03 $17.95 $18.01 - -------------------------------------------------------------- *1998 includes high gravity oil which generally sells for a lower price. Seneca utilizes price swap agreements to manage a portion of the market risk associated with fluctuations in the price of natural gas and crude oil. Refer to further discussion of these hedging activities under "Market Risk Sensitive Instruments" and in Note F - Financial Instruments in Item 8 of this report. The following summarizes Seneca's settlements under price swap agreements during 1998, 1997 and 1996: Year Ended September 30 (thousands of dollars) 1998 1997 1996 - ------------------------------------------------------------------------------- Natural Gas Price Swap Agreements: Notional Quantities - Equivalent Bcf 26.4 24.9 23.0 Gain (Loss) ($6,375) ($16,387) ($9,231) Crude Oil Price Swap Agreements: Notional Quantities - Equivalent bbls 901,000 1,371,500 1,071,000 Gain (Loss) $2,299 ($5,090) ($2,606) - ------------------------------------------------------------------------------- Operating Income 1998 Compared with 1997 The Exploration and Production segment experienced an operating loss before taxes of $93.3 million compared with operating income before taxes of $42.7 million in 1997, a negative variation of $136.0 million. Excluding the $129.0 million non-cash impairment of this segment's oil and gas assets, as discussed previously, this segment had operating income before taxes of $35.7 million, a decrease of $7.0 million compared with the prior year. This decrease resulted from lower gas production revenues, net of hedging, as discussed above and higher lease operating expense. The increase in lease operating expenses stems from the additional operating costs of the Whittier, HarCor and BER properties. As previously discussed, Seneca changed its method of depletion for oil and gas producing properties from the gross revenue method to the units of production method. Depletion of oil and gas properties for 1998 has been computed under the units of production method which resulted in depletion expense that was $2.3 million less than it would have been under the gross revenue method. 1997 Compared with 1996 Operating income before income taxes decreased $3.7 million in 1997 compared with 1996. This decrease reflects higher depletion expense and higher operating expenses (lease operating expenses, salary expenses and production taxes) due to increased activities, which more than offset the increase in revenues, discussed above. International Operating Revenues 1998 Compared with 1997 Operating revenues increased $74.3 million in 1998 compared with 1997. The increase primarily reflects 100% of the revenues of SCT and PSZT for 1998. Horizon acquired a 34% equity interest in SCT in April 1997, subsequently increasing that interest to 36.8% by September 30, 1997 (and thus accounted for its investment in SCT under the equity method in 1997). During 1998, Horizon increased its ownership in SCT to 82.7% as of September 30, 1998. In February 1998, Horizon acquired a 75.3% equity interest in PSZT and subsequently increased its ownership interest to 86.2% as of September 30, 1998. The consolidation method was used to account for the investments in SCT and PSZT during 1998. Heating and Electric Sales of SCT and PSZT Year Ended September 30, 1998 (thousands of dollars) Volumes Revenues ----------------------------------------- -------- Heating Sales 6,870,921 Gigajoules*(6.5 Bcf Equivalent) $47,953 Electricity Sales 763,823 Megawatt hours $22,772 *Gigajoules = one billion joules. A joule is a unit of energy. 1997 Compared with 1996 Operating revenues increased $1.6 million in 1997 compared with 1996. This increase represents twelve months of operations in 1997 of Teplarna Kromeriz, a small district heating plant located in the Czech Republic. There were only three months of reported operations in 1996. Operating Income 1998 Compared with 1997 Operating income before income taxes for the International segment increased $5.1 million in 1998 compared with 1997. The current year reflects 100% of the revenues and pretax operating income of SCT as well as 100% of the revenues and pretax operating income of PSZT for February through September 1998. The minority interests in SCT and PSZT are shown separately on the Consolidated Statement of Income after operating results. In 1997, Horizon had a 36.8% equity interest in SCT and thus recorded its share of SCT's operating results below the operating income line in "Other Income." Because of the change in the nature of operations of the International segment during the past year, operating income comparisons between the current period and prior periods may not be meaningful. Future revenues from district heating operations are expected to fluctuate with changes in weather.1 The Company expects that rates charged for the sale of thermal energy and electric energy at the retail level will be subject to regulation and audit in the Czech Republic by the Czech Ministry of Finance.1 1997 Compared with 1996 Operating losses before income taxes for the International segment decreased from $14.3 million in 1996 to $3.0 million in 1997. This decrease in operating losses relates primarily to $9.0 million of nonrecurring expenses incurred in 1996 by Horizon, relating to its withdrawal from participation in an international power project in August 1996. In 1997, Horizon sold its right to this power project for approximately $2.8 million, including cash proceeds and the assumption of certain liabilities by the purchaser. Other Nonregulated Operating Revenues 1998 Compared with 1997 Operating revenues increased $24.5 million in 1998 compared with 1997. This increase reflects higher operating revenues from NFR, the Company's gas marketing subsidiary, and the Company's timber operations. NFR's operating revenues increased because of an increase in marketing volumes. Partially offsetting this, NFR recognized a pretax gain on exchange-traded futures and options of approximately $1.3 million in 1998 compared to a pretax gain of approximately $1.7 million in 1997. Refer to further discussion of the Company's hedging activities under "Market Risk Sensitive Instruments" and in Note F - Financial Instruments in Item 8 of this report. Operating revenues for the timber operations increased as a result of higher timber sales by Seneca and increased lumber sales resulting from Highland's purchase in 1998 of two new lumber mills. Highland also had a full year of production from the mill it purchased in January 1997. 1997 Compared with 1996 Operating revenues increased $13.4 million in 1997 compared with 1996. The increase primarily reflects higher operating revenues from NFR and Highland. NFR's operating revenues increased largely because of higher natural gas prices and an increase in marketing volumes. Also, NFR recognized a pretax gain on exchange-traded futures and options of approximately $1.7 million during 1997 compared to a pretax gain of approximately $1.0 million in 1996. Refer to further discussion of the Company's hedging activities under "Market Risk Sensitive Instruments" and in Note F - Financial Instruments in Item 8 of this report. Highland's operating revenues increased as a result of increased lumber sales resulting from the operation of a new lumber mill beginning in January 1997. Operating Income 1998 Compared with 1997 Operating income before income taxes increased $3.1 million in 1998 compared with 1997. This increase resulted from an increase in pretax operating income from the timber operations due to increased revenues discussed above offset in part by lower pretax operating income of NFR. NFR's increase in operating revenue noted above was substantially offset by increased gas costs. In addition, NFR had an increase in O&M expense, resulting from expansion of its customer base into new market areas. 1997 Compared with 1996 Operating income before income taxes decreased $3.5 million in 1997 compared with 1996. This decrease was principally due to a pretax loss in the timber operations as a result of increased depletion expense related to cutting timber with a higher cost. Income Taxes, Other Income and Interest Charges Income Taxes Income taxes decreased $44.7 million in 1998 primarily as a result of a decrease in pretax income. Income taxes increased $2.4 million in 1997 primarily as a result of an increase in pretax income. For further discussion of income taxes, refer to Note C Income Taxes in Item 8 of this report. Other Income Other income increased $32.7 million in 1998 and decreased $0.7 million in 1997. The 1998 increase in other income is primarily due to $18.5 million of interest income which resulted from the current year settlement of IRS audits. The 1998 increase is also due to a gain, net of hedging, of $5.1 million associated with U.S. dollar denominated debt carried on the balance sheet of PSZT (see further discussion regarding this PSZT debt in Note D - Capitalization and Note F - Financial Instruments in Item 8 of this report), as well as $1.3 million of interest income on temporary cash investments of SCT and PSZT. In addition, other income in 1998 increased from a buyout of a firm transportation agreement by a Pipeline and Storage segment customer in the amount of $2.5 million. The 1997 decrease resulted, in part, from certain nonrecurring items recorded in 1996 for Supply Corporation, including a gain on disposition of property, as well as interest income related to a retroactive rate settlement. In addition, the 1997 decrease reflects losses from Leidy Hub's equity investment in various gas hub partnerships and losses from Horizon's equity investment in SCT. The SCT losses relate to the period April 1997 (when Horizon made its initial equity investment in SCT) through September 30, 1997. Since SCT is a heating utility, it typically experiences losses during the summer months. Interest Charges Interest on long-term debt increased $11.0 million in 1998 and $1.3 million in 1997. The increase in 1998 and 1997 can be attributed to a higher average amount of long-term debt outstanding, offset slightly by a lower average interest rate. In 1998, long-term debt balances grew significantly as a result of the stock acquisitions of SCT, PSZT and HarCor combined with the Whittier and BER asset purchases. These acquisitions and asset purchases are discussed further under "Investing Cash Flow," subheadings "International" and "Exploration and Production." Other interest charges increased $17.5 million in 1998 and decreased $1.1 million in 1997. The increase in 1998 resulted primarily from interest expense related to the previously mentioned settlement of IRS audits (total interest expense related to the IRS audits amounted to $11.7 million). In addition, the increase in other interest for 1998 resulted from an increase in the average amount of short-term debt outstanding. Short-term debt was initially utilized to fund the acquisition activities in the International and Exploration and Production segments, as mentioned above, until a portion was replaced with long-term debt in May 1998. Furthermore, short-term debt was used to repay the long-term debt that matured in 1998. The decrease in 1997 resulted primarily from lower interest expense on Amounts Payable to Customers offset in part by higher interest on short-term borrowings because of higher average amounts outstanding. Capital Resources and Liquidity The primary sources and uses of cash during the last three years are summarized in the following condensed statement of cash flows: Sources (Uses) of Cash Year Ended September 30 (in millions) 1998 1997 1996 - ---------------------------------------------------------------------- Provided by Operating Activities $253.0 $294.7 $168.5 Capital Expenditures (393.2) (214.0) (171.6) Investment in Subsidiaries, Net of Cash Acquired (112.0) (21.1) - Other Investing Activities 2.1 1.4 (1.4) Short-Term Debt, Net Change 229.4 (107.3) 52.1 Long-Term Debt, Net Change 94.9 98.2 11.2 Issuance of Common Stock 7.9 7.1 9.0 Common Stock Dividends (67.0) (64.3) (61.2) Dividends Paid to Minority Interest (0.3) - - Effect of Exchange Rates on Cash 1.6 - - - ---------------------------------------------------------------------- Net Increase (Decrease) in Cash and Temporary Cash Investments $16.4 $(5.3) $6.6 ====================================================================== Operating Cash Flow Internally generated cash from operating activities consists of net income available for common stock, adjusted for noncash expenses, noncash income and changes in operating assets and liabilities. Noncash items include the cumulative effect of a change in accounting for depletion, the impairment of oil and gas producing properties, depreciation, depletion and amortization, deferred income taxes, minority interest in foreign subsidiaries and allowance for funds used during construction. Cash provided by operating activities in the Utility and Pipeline and Storage segments may vary substantially from year to year because of the impact of rate cases. In the Utility segment, supplier refunds, over- or under-recovered purchased gas costs and weather also significantly impact cash flow. The Company considers supplier refunds and over-recovered purchased gas costs as a substitute for short-term borrowings. The impact of weather on cash flow is tempered in the Utility segment's New York rate jurisdiction by its WNC and in the Pipeline and Storage segment by Supply Corporation's SFV rate design. Net cash provided by operating activities totaled $253.0 million in 1998, a decrease of $41.7 million compared with the $294.7 million provided by operating activities in 1997. The majority of this decrease occurred in the Utility segment. The Utility segment experienced a decrease in cash receipts from gas sales and transportation service (sales were down mainly due to warmer weather) and an increase in interest payments (primarily related to the recent settlement of IRS audits). Also, the Utility segment received a large refund from an upstream pipeline company in 1997 which did not recur in 1998. A portion of this refund was passed back to customers in 1998. These decreases to cash were partially offset by lower cash payments for gas purchases. The Exploration and Production segment experienced a decrease in cash provided by operating activities. Lower cash receipts from the sale of oil and gas combined with higher operating costs (primarily due to the Whittier, HarCor and BER acquisitions) were partially offset by interest income resulting from the aforementioned IRS settlement, a decrease in cash outlays for hedging transactions as well as a decrease in cash outlays for federal taxes. Partly offsetting the decreases discussed above, the International and Pipeline and Storage segments experienced increases in cash provided by operating activities. The International segment benefitted from the results of operations of SCT and PSZT while the Pipeline and Storage segment experienced an increase in cash provided by operating activities primarily because of interest income resulting from the aforementioned IRS settlement combined with cash received from a customer resulting from a buyout of a firm transportation agreement. Higher operating costs partially offset the increases to cash provided by operating activities in the Pipeline and Storage segment. Investing Cash Flow Capital Expenditures and Other Investing Activities Capital expenditures represent the Company's additions to property, plant and equipment and are exclusive of equity investments in corporations (stock acquisitions) and/or partnerships. Such investments are treated separately in the Statement of Cash Flows and discussed further in the segment discussion below. The Company's capital expenditures and other investments totaled $520.7 million in 1998. The table below presents these capital expenditures and other investments by business segment: Year Ended September 30, 1998 (in millions) - ------------------------------------------- Total Capital Expenditures Capital Other and Other Expenditures Investments Investments ------------ ----------- ----------- Utility $ 50.7 $ - $ 50.7 Pipeline and Storage 23.7 5.5 29.2 Exploration and Production 293.9 32.6(1) 326.5 International 14.7 89.4(2) 104.1 Other Nonregulated 10.2 - 10.2 ------ ------ ------ $393.2 $127.5 $520.7 ====== ====== ====== (1) Investment, net of cash acquired = $29.8 million. (2) Investments, net of cash acquired = $82.2 million. Utility The majority of the Utility capital expenditures were made for replacement of mains and main extensions, as well as for the replacement of service lines. Pipeline and Storage The majority of the Pipeline and Storage capital expenditures were made for additions, improvements and replacements to this segment's transmission and storage systems. Approximately $4.2 million was spent on the 1998 Niagara Expansion Project. As part of this expansion, Supply Corporation began transportation service for an additional 25,000 Dth per day in November 1997. In November 1998, Supply Corporation began transportation service for an additional 23,000 Dth per day of firm winter only capacity. As there has not been much interest in further expansion in this area at this time, the Company established a reserve in March 1998 for approximately $1.7 million (pretax) related to preliminary survey and investigation costs associated with the proposed 1999 Niagara Expansion Project. Seneca Independence Pipeline Company (SIP) made a $5.5 million investment in 1998 representing a one-third general partnership interest in Independence Pipeline Company, a Delaware general partnership. This investment was financed with short-term borrowings. Independence Pipeline Company intends to build a 370 mile natural gas pipeline from Defiance, Ohio to Leidy, Pennsylvania at an estimated cost of $675 million.1 If the Independence Pipeline Project is not constructed, SIP's share of the development costs (including SIP's investment in Independence Pipeline Company) is estimated not to exceed $6.0 million to $8.0 million.1 Exploration and Production In March 1998, Seneca acquired properties in the Midway-Sunset and North Lost Hills Field in the San Joaquin Basin of California from the Whittier Trust Company for approximately $141.0 million. This acquisition is included in the Exploration and Production capital expenditure amount in the table above. In May and June 1998, Seneca acquired the oil and gas properties located in the South Lost Hills Field in the San Joaquin Valley near Bakersfield, California, that were owned 75% by HarCor and 25% by BER. These properties produce gas and high gravity oil, include a gas processing plant and associated pipelines, and provide opportunities for additional drilling and development.1 The acquisition of HarCor's portion of these properties was completed in May 1998 through a tender offer (an offer of $2.00 per share) for the outstanding shares of HarCor. Approximately 95% of the outstanding shares of HarCor common stock were tendered in accordance with the tender offer. The common stock that was not purchased pursuant to the tender offer was converted into the right to receive $2.00 per share. The cost of the tender offer and subsequent conversion of the remaining shares of HarCor was approximately $32.6 million. The stock acquisition resulted in the assumption of approximately $64.7 million of long-term debt at the date of acquisition (refer to Note D - Capitalization in Item 8 of this report). The acquisition of BER's portion of these properties was completed in June 1998 through an asset purchase. The purchase price was approximately $30.0 million. This acquisition is included in the Exploration and Production capital expenditure amount in the table above. The acquisitions of Whittier, HarCor and BER were initially financed using short-term borrowings. Subsequently, approximately $120 million of short-term borrowings were replaced with long-term borrowings. These acquisitions complement the Exploration and Production segment's reserve mix, bringing its new reserve base to approximately 725 Bcf equivalent, of which 55% is oil and 45% is gas. Other Exploration and Production segment capital expenditures included approximately $98.6 million on the offshore program in the Gulf of Mexico, including offshore drilling expenditures, offshore construction and lease acquisition costs. Offshore exploratory drilling was concentrated on High Island 179, High Island A354, High Island A356, Vermilion 309, Eugene Island 47 and South Marsh Island 122. Offshore construction occurred primarily at West Cameron 540 and Vermilion 309. Lease acquisition costs resulted from successful bidding on fourteen state of Texas and three federal lease tracts in the Gulf of Mexico combined with the acquisition of a 50% interest in Vermilion 253. The remaining $24.3 million capital expenditures included onshore drilling and construction costs for wells located in Louisiana, Texas and California as well as onshore geological and geophysical costs, including the purchase of certain 3-D seismic data. International In fiscal 1998, Horizon acquired additional shares of SCT thereby increasing its equity interest in SCT to 82.7% as of September 30, 1998. The cost of acquiring these additional shares was approximately $24.9 million. This stock acquisition resulted in the assumption of approximately $5.1 million of long-term debt at the date of acquisition (refer to Note D - Capitalization in Item 8 of this report). In February 1998, Horizon acquired a 75.3% equity interest in PSZT and subsequently increased its ownership interest to 86.2% as of September 30, 1998. The cost of acquiring the shares of PSZT was approximately $64.5 million. This stock acquisition resulted in the assumption of approximately $59.2 million of long-term debt (refer to Note D - Capitalization in Item 8 of this report) and $4.3 million of short-term debt at the date of acquisition. Short-term borrowings were initially used to finance the acquisition costs of SCT and PSZT. Subsequently, approximately $80 million of short-term borrowings were replaced with long-term borrowings. The bulk of the International segment capital expenditures were made by PSZT for the reconstruction of boilers at its heating plant to comply with stricter clean air standards. Short-term borrowings and cash from operations were used to finance these capital expenditures. Other Nonregulated Other Nonregulated capital expenditures consisted primarily of timber purchases by the northeast division of Seneca as well as equipment purchases by Highland for its existing sawmill and kiln operations and the purchase of two new sawmills in Pennsylvania. The capital expenditures also included the purchase of furniture, equipment and computer hardware and software for NFR's gas marketing operations. Other Investing Activities Other cash provided by or used in investing activities primarily reflects cash received on the sale of various subsidiaries investments in property, plant and equipment, cash received on the sale of the Company's interest in Enerchange, L.L.C., a natural gas hub partnership, and cash used to make an initial investment in Independence Pipeline Company. Estimated Capital Expenditures and Other Investments The Company's estimated capital expenditures for the next three years are:1 Year Ended September 30 (in millions) 1999 2000 2001 - -------------------------------------------------------------------- Utility $48.9 $47.9 $46.9 Pipeline and Storage 27.0 20.5 20.5 Exploration and Production 92.0 126.1 128.8 International 35.6 5.8 5.5 Other Nonregulated 0.9 0.8 0.8 - -------------------------------------------------------------------- $204.4 $201.1 $202.5 ==================================================================== Estimated capital expenditures for the Utility segment during the next three years will be concentrated in the areas of main improvements, replacements and extensions, service line replacements and, to a minor extent, the installation of new services.1 Estimated capital expenditures for the Pipeline and Storage segment in 1998 will be concentrated in the reconditioning of storage wells and the replacement of storage and transmission lines.1 Estimated capital expenditures in 1999 for the Exploration and Production segment are significantly lower than capital spending in 1998 as the Company will be focusing on managing existing properties and reducing debt balances.1 The 1999 budget includes approximately $23.1 million for development drilling, facilities construction and recompletions related to the properties acquired in the HarCor, Whittier and BER acquisitions. Approximately $34.0 million has been budgeted for offshore exploratory drilling, development drilling and facilities construction. The budget also includes $5.8 million for lease acquisitions and $12.6 million for geological and geophysical expenditures. Estimated capital expenditures for the International segment will be concentrated in the process of reconstructing boilers at the heating plant of PSZT to comply with certain clean air standards mandated by the Czech Republic government. Approximately $33.0 million is budgeted for this reconstruction. The Company's other investments in 1999 will be concentrated in the Pipeline and Storage segment and the International segment. In the Pipeline and Storage segment, the Company plans to invest an additional $5.0 - $10.0 million in the Independence Pipeline Company.1 Additional spending in 1999 and beyond would depend on such factors as Federal Energy Regulatory Commission (FERC) approval and customer interest in the project.1 In the International segment, it is expected that SCT will spend approximately $6.0 million to increase its equity investment in one of its subsidiaries.1 The Company continuously evaluates capital expenditures and other investments. The amounts are subject to modification for opportunities such as the acquisition of attractive oil and gas properties, timber or storage facilities and the expansion of transmission line capacities. While the majority of capital expenditures in the Utility segment are necessitated by the continued need for replacement and upgrading of mains and service lines, the magnitude of future capital expenditures or other investments in the Company's other business segments depends, to a large degree, upon market conditions.1 Financing Cash Flow In order to meet the Company's capital requirements, cash from external sources must periodically be obtained through short-term bank loans and commercial paper, as well as through issuances of long-term debt and equity securities. The Company expects these traditional sources of cash to continue to supplement its internally generated cash during the next several years.1 In May 1998, the Company issued $200.0 million of 6.303% medium-term notes due in May 2008. After reflecting underwriting discounts and commissions, the net proceeds to the Company amounted to $198.8 million. Such proceeds were used to reduce short-term borrowings arising from acquisition activities in the International and Exploration and Production segments. The Company's embedded cost of long-term debt was 6.9% at September 30, 1998 and 1997. Consolidated short-term debt increased $233.9 million during 1998 ($229.4 million after reflecting $4.5 million of short-term borrowings assumed as part of the PSZT acquisition and subsequently repaid). The Company continues to consider short-term bank loans and commercial paper important sources of cash for temporarily financing capital expenditures and investments in corporations and/or partnerships, gas-in-storage inventory, unrecovered purchased gas costs, exploration and development expenditures and other working capital needs. In addition, the Company considers supplier refunds and over-recovered purchased gas costs as a substitute for short-term debt. Fluctuations in these items can have a significant impact on the amount and timing of short-term debt. At September 30, 1998, the Company had authorization from the SEC under a shelf registration filed pursuant to the Securities Act of 1933, to issue and sell up to $200.0 million of debentures and/or medium-term notes. In March 1998, the Company obtained authorization from the SEC, under the Public Utility Holding Company Act of 1935, to issue, in the aggregate, long-term debt securities and equity securities amounting to $2.0 billion during the order's authorization periods, which extends to December 31, 2002. The Company's indenture contains covenants which limit, among other things, the incurrence of funded debt. Funded debt basically is indebtedness maturing more than one year after the date of issuance. Because of the impairment of oil and gas producing properties recorded by the Company in March 1998, these covenants will restrict the Company's ability to issue additional funded debt, with certain exceptions, until at least the third quarter of fiscal 1999.1 This will not, however, limit the Company's issuance of funded debt to refund existing funded debt. The Company has adequate financing resources available to meet expected operating and capital requirements.1 At September 30, 1998, the Company had regulatory authorizations and unused short-term credit lines that would have permitted it to borrow an additional $423.7 million of short-term debt. The Company is involved in litigation arising in the normal course of its business. In addition to the regulatory matters discussed in Note B - Regulatory Matters, in Item 8 of this report, the Company is involved in other regulatory matters arising in the normal course of business that involve rate base, cost of service and purchased gas cost issues. While the resolution of such litigation or other regulatory matters could have a material effect on earnings and cash flows in the year of resolution, neither such litigation nor these other regulatory matters are expected to materially change the Company's present liquidity position nor have a material adverse effect on the financial condition of the Company at this time.1 Market Risk Sensitive Instruments Energy Commodity Price Risk Certain of the Company's nonregulated subsidiaries (primarily Seneca and NFR) utilize various derivative financial instruments (derivatives), including price swap agreements and exchange-traded futures and options, as part of the Company's overall energy commodity price risk management strategy. Under this strategy, the Company manages a portion of the market risk associated with fluctuations in the price of natural gas and crude oil, thereby providing more stability to operating results. The derivatives entered into by the Company's nonregulated subsidiaries are not held for trading purposes. These subsidiaries have operating procedures in place that are administered by experienced management to monitor compliance with their risk management policies. The following tables disclose natural gas and crude oil price swap information by expected maturity dates for agreements in which Seneca receives a fixed price in exchange for paying a variable price as quoted in "Inside FERC" or on the New York Mercantile Exchange. Notional amounts (quantities) are used to calculate the contractual payments to be exchanged under the contract. The tables do not reflect the earnings impact of the physical transactions that are expected to offset the financial gains and losses arising from the use of the price swap agreements. The weighted average variable prices represent the prices as of September 30, 1998. At September 30, 1998, Seneca had not entered into any natural gas price swap agreements extending beyond 2000 nor had it entered into any crude oil price swap agreements extending beyond 1999. Natural Gas Price Swap Agreements - --------------------------------- Expected Maturity Dates -------------- 1999 2000 Total ---- ---- ----- Notional Quantities (Equivalent Bcf) 18.7 3.1 21.8 Weighted Average Fixed Rate (per Mcf) $2.34 $2.37 $2.34 Weighted Average Variable Rate (per Mcf) $1.66 $1.66 $1.66 Crude Oil Price Swap Agreements - ------------------------------- Expected Maturity Dates -------------- 1999 ---- Notional Quantities (Equivalent bbls) 135,000 Weighted Average Fixed Rate (per bbl) $19.86 Weighted Average Variable Rate (per bbl) $14.97 At September 30, 1998, Seneca would have had to pay the respective counterparties to its natural gas price swap agreements an aggregate of approximately $1.4 million to terminate the natural gas price swap agreements outstanding at that date. Seneca would have received an aggregate of approximately $0.4 million from the counterparties to its crude oil price swap agreements to terminate the crude oil price swap agreements outstanding at September 30, 1998. The Company is exposed to credit risk on the price swap agreements that Seneca has entered into. Credit risk relates to the risk of loss that the Company would incur as a result of nonperformance by counterparties pursuant to the terms of their contractual obligations. To mitigate such credit risk, before entering into a price swap agreement with a new counterparty, management performs a credit check and prepares a report indicating the results of the credit investigation. This report must be approved by Seneca's board of directors after which a Master Swap Agreement is executed between Seneca and the counterparty. On an ongoing basis, periodic reports are prepared by management to monitor counterparty credit exposure. Considering the procedures in place, the Company does not anticipate any material impact to its financial position, results of operations, or cash flows as a result of nonperformance by counterparties.1 The following table discloses the net notional quantities, weighted average contract prices and weighted average settlement prices by expected maturity date for exchange-traded futures contracts utilized to manage natural gas price risk. These futures contracts have been entered into by NFR. The table does not reflect the earnings impact of the physical transactions that are expected to offset the financial gains and losses arising from the use of the futures contracts. At September 30, 1998, NFR held no futures contracts with maturity dates extending beyond 2000. Exchange-Traded Futures Contracts - --------------------------------- Expected Maturity Dates -------------- 1999 2000 Total ---- ---- ----- Contract Volumes Purchased (Equivalent Bcf) 11.1 3.2 14.3 Weighted Average Contract Price (per Mcf) $2.50 $2.58 $2.52 Weighted Average Settlement Price (per Mcf) $2.59 $2.55 $2.58 The following table discloses the net notional quantities and weighted average strike prices by expected maturity dates for exchange-traded options utilized to manage natural gas price risk. These options have been entered into by NFR. The table does not reflect the earnings impact of the physical transactions that would offset any financial gains or losses that might arise if an option were to be exercised. At September 30, 1998, NFR held no options with maturity dates extending beyond 1999. Exchange-Traded Options - ----------------------- Expected Maturity Dates -------------- 1999 ---- Option Volumes Purchased (Sold)(Equivalent Bcf) (2.3) Weighted Average Strike Price (per Mcf) $2.91 At September 30, 1998, NFR would have received approximately $0.4 million to settle the exchange-traded futures outstanding at that date. NFR had an unrealized gain of approximately $0.1 million related to its exchange-traded options outstanding at September 30, 1998. This unrealized gain consisted mostly of premiums received on the exchange-traded options it had sold. Exchange Rate Risk Horizon's investment in the Czech Republic is valued in Czech korunas, and as such, this investment is subject to currency exchange risk when the Czech korunas are translated into U.S. dollars. During 1998, the Czech koruna increased in value in relation to the U.S. dollar, resulting in a $9.4 million positive adjustment to the Cumulative Translation Adjustment. Further valuation changes to the Czech koruna would result in corresponding positive or negative adjustments to the Cumulative Translation Adjustment. Management cannot predict whether the Czech koruna will increase or decrease in value against the U.S. dollar.1 PSZT had U.S. dollar denominated debt in the amount of $50.6 million at September 30, 1998. Since the functional currency of PSZT is the Czech koruna and this debt had to be repaid in U.S. dollars, a change in exchange rates between the Czech koruna and the U.S. dollar would increase or decrease the amount of Czech koruna required to repay the debt, resulting in a corresponding gain or loss to be recognized in the income statement. From the acquisition of PSZT in February 1998 through September 30, 1998, PSZT recognized a pretax gain of approximately $7.2 million, which is included in Other Income in the Consolidated Statement of Income. To eliminate future exchange rate risk on the U.S. dollar denominated debt, PSZT bought a $50.6 million U.S. dollar forward contract at an exchange rate of 31.54 CZK per dollar on September 3, 1998. The purpose of the forward contract was to hedge against the exchange rate risk associated with the U.S. dollar denominated debt. At September 30, 1998, the fair value of this forward contract was $(2.1) million, representing the loss on the contract as of September 30, 1998. The loss was recorded as an accrued liability on the Consolidated Balance Sheets with the offset being Other Income in the Consolidated Statement of Income. Upon maturing on December 3, 1998, the final loss recognized on this forward contract was $2.0 million. With the maturity of this forward contract, PSZT simultaneously converted the $50.6 million of U.S. dollar denominated debt into a loan denominated in CZK, thus eliminating further exchange rate risk. Interest Rate Risk The Company's exposure to interest rate risk primarily consists of short-term debt instruments. At September 30, 1998, this included short-term bank loans and commercial paper totaling $326.3 million. The interest rate on the short-term bank loans and commercial paper approximated 5.6%. The following table presents the principal cash repayments and related weighted average interest rates by expected maturity date for the Company's long-term fixed rate debt as well as the other debt of certain of the Company's subsidiaries. The interest rates for the variable rate debt are based on those in effect at September 30, 1998:
Principal Amounts by Expected Maturity Dates ----------------------------------------------------- (millions of dollars) 1999 2000 2001 2002 2003 Thereafter Total ---- ---- ---- ---- ---- ---------- ----- National Fuel Gas Company Long-Term Fixed Rate Debt $150 $50 $- $- $- $574 $774 Weighted Average Interest Rate Paid 6.1% 6.6% -% -% -% 7.0% 6.8% Fair Value = $830.5 million HarCor Long-Term Fixed Rate Debt $62.6 $- $- $- $- $- $62.6 Weighted Average Interest Rate Paid 14.9% -% -% -% -% -% 14.9% Fair Value = $62.6 million PSZT Long-Term Fixed Rate Debt $- $9.9 $- $- $- $- $9.9 Weighted Average Interest Rate Paid -% 13.0% -% -% -% -% 13.0% Fair Value = $9.9 million Long-Term Variable Rate Debt $- $7.6 $10.1 $10.1 $10.1 $12.7 $50.6 Weighted Average Interest Rate Paid -% 8.0% 8.0% 8.0% 8.0% 8.0% 8.0% Fair Value = $50.6 million SCT Long-Term Variable Rate Debt $0.5 $0.5 $0.5 $0.6 $0.7 $1.7 $4.5 Weighted Average Interest Rate Paid 14.7% 14.7% 14.7% 14.7% 14.7% 14.7% 14.7% Fair Value = $4.5 million Other Notes Long-Term Debt* $3.8 $2.4 $1.8 $- $- $- $8.0 Weighted Average Interest Rate Paid 7.1% 7.4% 6.9% -% -% -% 7.1% Fair Value = $8.0 million
*$0.4 million is variable rate debt; $7.6 million is fixed rate debt. Rate Matters Utility New York Jurisdiction In November 1995, Distribution Corporation filed in its New York jurisdiction a request for an annual rate increase of $28.9 million with a requested return on equity of 11.5%. A two-year settlement (the 1996 settlement) with the parties in this rate proceeding was approved by the State of New York Public Service Commission (PSC). Effective October 1, 1996 and October 1, 1997, Distribution Corporation received annual base rate increases of $7.2 million. As part of the 1996 settlement, earnings above a 12% return on equity (excluding certain items and determined on a cumulative basis over the three years ending September 30, 1998) are to be shared equally between shareholders and customers. As a result of this sharing mechanism, Distribution Corporation has determined that the refund due customers as of September 30, 1998 is $10.7 million (of which $7.7 million was recorded in 1998 and $3.0 million was recorded in 1997). On October 21, 1998, the PSC approved a rate plan for Distribution Corporation for the period beginning October 1, 1998 and ending September 30, 2000. The plan is the result of a settlement agreement entered into by Distribution Corporation, Staff for the PSC (Staff), Multiple Intervenors (an advocate for large industrial customers) and the State Consumer Protection Board. Under the plan, Distribution Corporation's rates are reduced by $7.2 million, or 1.1%. In addition, customers will receive up to $6.0 million in bill credits, disbursed volumetrically over the two year term, reflecting a pre-determined share of excess earnings under the 1996 settlement described above. The remaining amount, if any, will be passed back to customers as determined by the PSC. An allowed return on equity of 12%, above which 50% of additional earnings are shared with the customers, is maintained from the 1996 settlement. Finally, the rate plan also provides that $7.2 million of 1999 revenues will be set aside in a special reserve to be applied against Distribution Corporation's incremental costs resulting from the PSC's gas restructuring effort further described below. On November 3, 1998, the PSC issued Policy Statement Concerning the ---------------------------------- Future of the Natural Gas Industry in New York State and Order Terminating - -------------------------------------------------------------------------------- Capacity Assignment (Policy Statement). The Policy Statement sets forth the - -------------------- PSC's "vision" on "how best to ensure a competitive market for natural gas in New York." That vision includes the following goals: (1) Effective competition in the gas supply market for retail customers; (2) Downward pressure on customer gas prices; (3) Increased customer choice of gas suppliers and service options; (4) A provider of last resort (not necessarily the utility) (5) Continuation of reliable service and maintenance of operations procedures that treat all participants fairly; (6) Sufficient and accurate information for customers to use in making informed decisions; (7) The availability of information that permits adequate oversight of the market to ensure fair competition; and (8) Coordination of Federal and State policies affecting gas supply and distribution in New York State. The Policy Statement provides that the most effective way to establish a competitive market in gas supply is "for local distribution companies to cease selling gas." The PSC hopes to accomplish that objective over a three-to-seven year transition period, taking into account "statutory requirements" and the individual needs of each local distribution company (LDC). The Policy Statement directs Staff to schedule "discussions" with each LDC on an "individualized plan that would effectuate our vision." In preparation for negotiations, LDCs will be required to address issues such as a strategy to hold new capacity contracts to a minimum, a long-term rate plan with a goal of reducing or freezing rates, and a plan for further unbundling. In addition, Staff will hold collaborative sessions with multiple parties to discuss generic issues including reliability and market power regulation. The PSC's Order Terminating Capacity Assignment, included with the ---------------------------------------- Policy Statement, directs the state's LDCs to file proposed tariffs, by no later than February 1, 1999, revising the current requirement that suppliers take assignment of an allocation of upstream capacity for each customer that elects to purchase gas from a supplier other than the LDC. Although the order states that the so-called "mandatory assignment" feature of aggregation service is terminated effective April 1, 1999, LDCs are permitted to show that their individual circumstances may warrant continuation of the requirement. The order also recognizes that LDCs with intermediate pipelines, like Distribution Corporation, could present "unique cost and reliability issues which require further consideration." The order provides that to the extent all or part of an LDC's mandatory assignment authority is indeed terminated, there will be a reasonable opportunity to recover stranded costs.1 Distribution Corporation plans to work cooperatively with the PSC to develop a plan which maximizes customer choice options while preserving reliability and the Distribution Corporation's financial objectives.1 Toward that end, Distribution Corporation believes that it must remain a merchant. At this time, current laws provide that LDCs are obligated to provide merchant service to qualified applicants. While the outcome of these PSC proceedings cannot be determined, the Company believes that changes, if any, will be implemented incrementally over a number of years.1 On April 3, 1998, Distribution Corporation filed comments in a PSC generic proceeding addressing gas transportation rates for electric generators. This case arose in response to concerns by the PSC regarding the effects of gas transportation costs on electric rates ultimately paid by the retail customers. Distribution Corporation argued, among other things, that the current rate setting policy, established in 1991, should remain unchanged for LDCs facing competitive bypass threats. On September 24, 1998, the PSC issued a proposal for a "basic gas-for-electric-generation-service tariff" developed by Staff based on its own analysis and input received from interested parties. The proposal sets a minimum rate based on presumed costs and allows additional charges for incremental costs and, to a minor extent, market factors. Numerous parties, including Distribution Corporation, filed comments on October 27, 1998 opposing the Staff proposal or recommending significant changes. Staff's proposal, if adopted, may diminish Distribution Corporation's ability to capture future gas-fired generation load opportunities.1 It would not, however, affect existing contracts with generation customers. The PSC issued a notice on April 7, 1998 that it is considering the revision of its regulations governing the operation of the Gas Adjustment Clause (GAC). As described by the PSC, the revised rules would allow the GAC to more accurately reflect gas prices. The revised rules would also allow LDCs to recover risk management costs through the GAC. On June 5, 1998, Distribution Corporation filed comments in the GAC docket raising several concerns with the PSC's proposed revisions. Pennsylvania Jurisdiction Distribution Corporation currently does not have a rate case on file with the Pennsylvania Public Utility Commission (PaPUC). Management will continue to monitor its financial position in the Pennsylvania jurisdiction to determine the necessity of filing a rate case in the future. Effective October 1, 1997, Distribution Corporation commenced a PaPUC approved customer choice pilot program called Energy Select. Energy Select, which will last until April 1, 1999, allows approximately 19,000 small commercial and residential customers of Distribution Corporation in the greater Sharon, Pennsylvania area to purchase gas supplies from qualified, participating non-utility suppliers (or marketers) of gas. Distribution Corporation is not a supplier of gas in this pilot. Under Energy Select, Distribution Corporation will continue to deliver the gas to the customer's home or business and will remain responsible for reading customer meters, the safety and maintenance of its pipeline system and responding to gas emergencies. NFR is a participating supplier in Energy Select. On October 30, 1998, Distribution Corporation filed a System Wide Energy Select proposal with the PaPUC, requesting an effective date of December 29, 1998. This program proposes to expand the Energy Select pilot program described above to apply across Distribution Corporation's entire Pennsylvania service territory. The plan borrows many features of the Energy Select pilot, but several important changes are proposed. Most significantly, the new program would include Distribution Corporation as a choice for retail consumers, in furtherance of Distribution Corporation's objective to remain a merchant. Also departing from the pilot scheme, Distribution Corporation proposes to undertake its role as supplier of last resort, and will maintain customer contact by providing a billing service on its own behalf and, as an option, for participating suppliers. Finally, the System Wide Energy Select filing proposes a comprehensive solution for the appropriate disposition of upstream capacity requirements. If approved, the program would assure traditional levels of supply and operational reliability while providing an economic means for reduction of long-term capacity obligations. At this juncture, the Company is not able to predict the PaPUC's determination on the System Wide Energy Select proposal. A gas restructuring bill (Senate Bill No. 943) was introduced in the Pennsylvania General Assembly in 1997 proposing to amend the Public Utility Code to allow all retail customers, including residential, the ability to choose their own gas supplier. Senate Bill No. 943 has not yet been enacted into law. However, in December 1997, the Chairman of the PaPUC convened a collaborative of gas industry interests to develop a consensus bill using Senate Bill No. 943 as the starting point. As a member of the utility interest group, Distribution Corporation is and will continue to be an active participant in the collaborative.1 The Company is not able to predict the outcome of the bill. Base rate adjustments in both the New York and Pennsylvania jurisdictions do not reflect the recovery of purchased gas costs. Such costs are recovered through operation of the purchased gas adjustment clauses of the regulatory authorities having jurisdiction. Pipeline and Storage Supply Corporation currently does not have a rate case on file with the FERC. Its last case was settled with the FERC in February 1996. As part of that settlement, Supply Corporation agreed not to seek recovery of revenues related to certain terminated service from storage customers until April 1, 2000, as long as the terminations were not greater than approximately 30% of the terminable service. Supply Corporation has been successful in marketing and obtaining executed contracts for such terminated storage service (at discounted rates) and expects to continue obtaining executed contracts for additional terminated storage service as it arises.1 Other Matters Environmental Matters It is the Company's policy to accrue estimated environmental clean-up costs (investigation and remediation) when such amounts can reasonably be estimated and it is probable that the Company will be required to incur such costs. Distribution Corporation has estimated its clean-up costs related to former manufactured gas plant sites and third party waste disposal sites will be in the range of $12.4 million to $13.4 million.1 At September 30, 1998, Distribution Corporation has recorded the minimum liability of $12.4 million. The Company is currently not aware of any material additional exposure to environmental liabilities. However, adverse changes in environmental regulations or other factors could impact the Company. In New York and Pennsylvania, Distribution Corporation is recovering site investigation and remediation costs in rates. Accordingly, the Consolidated Balance Sheet at September 30, 1998 includes related regulatory assets in the amount of approximately $12.4 million. The Company is subject to various federal, state and local laws and regulations relating to the protection of the environment. The Company has established procedures for the ongoing evaluation of its operations to identify potential environmental exposures and assure compliance with regulatory policies and procedures. For further discussion refer to Note H - Commitments and Contingencies under the heading "Environmental Matters" in Item 8 of this report. New Accounting Pronouncements In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). In June 1998, the FASB issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). For a discussion of SFAS 130 and SFAS 133 and their impact on the Company, see disclosure in Note A Summary of Significant Accounting Policies in Item 8 of this report. Year 2000 Numerous information technology computer systems, software programs and semiconductors are not capable of recognizing dates after the Year 2000 because such systems use only two digits to refer to a particular year. Such systems may read dates in the Year 2000 and thereafter as if those dates represent the year 1900 or thereafter and in certain instances, such systems may fail to function properly. State of Readiness The Company anticipates that the majority of its systems will be Year 2000 ready by March 31, 1999, and that the remaining systems (i.e. primarily those for which implementation is being deferred until after the 1998-1999 heating season) will be Year 2000 ready by April 30, 1999.1 Following the completion of an early-impact analysis study, a formal project manager at the Company was designated to spearhead the Year 2000 remediation effort. The methodology adopted by the Company to address the Year 2000 issue is a combination of methods recommended by respected industry consultants and efforts tailored to meet the Company's specific needs. The Company's Year 2000 plan addresses five primary areas. A. Mainframe Corporate Business Applications Developed and Maintained by the Company: A detailed plan and impact analysis was conducted in 1996-1997 to determine the extent of Year 2000 implications on the Company's mainframe-based computer systems. The remediation and testing in this area are 98 percent complete and are expected to be fully completed by December 31, 1998.1 B. Personal Computer Business Applications Software Developed and Supported by the Company: The Company has retained a consulting firm to perform a detailed impact analysis of the personal computer business application systems supported by the Company's Information Services Department. The firm is in the process of correcting Year 2000 problems identified by its analysis. Certain applications identified by the consulting firm as potentially problematic have been retired and replaced with Year 2000 compliant applications. The required changes and testing for these applications are 90 percent complete and are expected to be finished by March 31, 1999.1 C. Vendor-Supplied Software, Hardware, and Services for Corporate Business Applications Supported by the Company: This category includes all mainframe infrastructure products as well as all PC client / server software and hardware. The Company has sent letters to its vendors asking if their products and services will continue to perform as expected after January 1, 2000. These vendors are responsible for approximately 200 products and services associated with corporate computer applications. The Company has received responses from all vendors which the Company believes supply critical hardware, software, date-sensitive embedded chips and related computer services. The Company expects to complete testing and implementation of the vendor-supplied Year 2000 compliant products and services by April 30, 1999.1 D. Vendor-Supplied Products and Services Used on a Corporate Wide Basis: This category includes the critical products and services that are used by multiple departments within the Company including all products containing embedded chips which might be date sensitive. The Company has sent letters to the primary vendors who provide these products and services to the Company, requesting Year 2000 compliance plans. The Company is monitoring their responses and incorporating them into the Company's overall Year 2000 project and contingency plans. The Company expects to complete testing and implementation of the products and services of these vendors by March 31, 1999 (reference is made to the "Risks" section below).1 E. User-Department Maintained Business Applications: The Company uses certain business software applications that were either built in-house or vendor-supplied and subsequently maintained by individual departments of the Company. The scope of such applications includes, but is not limited to, spreadsheets, databases, vendor provided products and services and embedded process controls. A corporate wide Year 2000 task force is in place and has established a process to identify and resolve Year 2000 problems in this area. This task force meets on a monthly basis to coordinate ongoing activities and report on the project status. Providers of critical products and services have been identified and the Company has sent letters requesting their Year 2000 compliance plans. Responses are being monitored and incorporated into the Year 2000 planning of the various departments. All applications and services under this category are expected to be Year 2000 ready by April 30, 1999.1 Cost The cost of upgrading both vendor supplied and internally developed systems and services is being expensed as incurred. Management estimates that such cost will total approximately $2.2 million, of which approximately $1.3 million has been incurred to date and $0.9 million remains to be spent.1 Risks The Company's main concern is to ensure the safe and reliable production and delivery of natural gas and Company-provided services to its customers. Based on the efforts discussed above, the Company expects to be able to operate its own facilities without interruption and continue normal operation in Year 2000 and beyond.1 However, the Company has no control over the systems and services used by third parties with whom it interfaces. While the Company has placed its major third parties on notice that the Company expects their products and services to perform as expected after January 1, 2000, the Company cannot predict with accuracy the actual adverse consequences to the Company that could result if such third parties are not Year 2000 compliant.1 The widespread failure of electric, telecommunication, and upstream gas supply could potentially affect gas service to utility customers, and the Company is pursuing contingency plans to avoid such disruptions. The majority of the devices which control the Company's physical delivery system are not susceptible to Year 2000 problems because they do not contain micro-processors. The Company has conducted an extensive review of its existing micro processors (embedded technology) and is replacing non-Year 2000 compliant hardware. The Company expects to complete these replacements by April 30, 1999.1 Distribution Corporation is subject to regulatory review by both the PSC and the PaPUC. Both of these regulatory bodies have issued orders concerning the Year 2000 issue, and both have established dates in 1999 by which jurisdictional utilities must have taken the necessary steps to ensure that its critical systems are Year 2000 ready. In the event Distribution Corporation fails to meet the requirements of those orders, it may be subject to the imposition of fines or formal enforcement actions by the regulatory bodies. Contingency Planning The Company formed its Corporate Year 2000 task force in mid-1997. The primary function of this group is to: (1) raise awareness of the Year 2000 issue within the Company, (2) facilitate identification and remediation of Year 2000 potential problems within the Company, and (3) facilitate and develop corporate contingency plans. The group is comprised of middle to senior level managers and Company executives. The Company's main thrust at present in contingency planning is identification and prioritization of the potential risks posed by Year 2000 failures outside of the Company's control. All departments and subsidiaries have submitted lists of potential risks, which are now being prioritized, in relation to the overall corporation, in the order of human safety, reliability/delivery of Company services and administrative services. The Company has existing disaster/contingency plans to deal with operational gas supply or delivery problems, loss of the corporate data center, and loss of the corporate customer telephone centers. These plans are being reviewed to address failures resulting from Year 2000 problems created or occurring outside of the Company (i.e. loss of electricity, telephone service, etc.). The Company expects to have its Year 2000 contingency plans completed by mid-September 1999.1 The Company has selected this date as opposed to one in early 1999 so that the contingency plans are current and operational and that the Company will be able to use them immediately, if required.1 Effects of Inflation Although the rate of inflation has been relatively low over the past few years, and thus has benefited both the Company and its customers, the Company's operations remain sensitive to increases in the rate of inflation because of its capital spending and the regulated nature of a significant portion of its business. Safe Harbor for Forward-Looking Statements The Company is including the following cautionary statement in this combined Annual Report to Shareholders/Form 10-K to make applicable and take advantage of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 for any forward-looking statements made by, or on behalf of, the Company. Forward-looking statements include statements concerning plans, objectives, goals, strategies, future events or performance, and underlying assumptions and other statements which are other than statements of historical facts. From time to time, the Company may publish or otherwise make available forward-looking statements of this nature. All such subsequent forward-looking statements, whether written or oral and whether made by or on behalf of the Company, are also expressly qualified by these cautionary statements. Certain statements contained herein, including those which are designated with a "1", are forward-looking statements and accordingly involve risks and uncertainties which could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. The forward-looking statements contained herein are based on various assumptions, many of which are based, in turn, upon further assumptions. The Company's expectations, beliefs and projections are expressed in good faith and are believed by the Company to have a reasonable basis, including without limitation, management's examination of historical operating trends, data contained in the Company's records and other data available from third parties, but there can be no assurance that management's expectations, beliefs or projections will result or be achieved or accomplished. In addition to other factors and matters discussed elsewhere herein, the following are important factors that, in the view of the Company, could cause actual results to differ materially from those discussed in the forward-looking statement: 1. Changes in economic conditions, demographic patterns and weather conditions; 2. Changes in the availability and/or price of natural gas and oil; 3. Inability to obtain new customers or retain existing ones; 4. Significant changes in competitive factors affecting the Company; 5. Governmental/regulatory actions and initiatives, including those affecting financings, allowed rates of return, industry and rate structure, franchise renewal, and environmental/safety requirements; 6. Unanticipated impacts of restructuring initiatives in the natural gas and electric industries; 7. Significant changes from expectations in actual capital expenditures and operating expenses and unanticipated project delays; 8. Occurrences affecting the Company's ability to obtain funds from operations, debt or equity to finance needed capital expenditures and other investments; 9. Ability to successfully identify and finance oil and gas property acquisitions and ability to operate existing and any subsequently acquired properties; 10. Ability to successfully identify, drill for and produce economically viable natural gas and oil reserves; 11. Changes in the availability and/or price of derivative financial instruments; 12. Inability of the various counterparties to meet their obligations with respect to the Company's financial instruments; 13. Regarding foreign operations - changes in foreign trade and monetary policies, laws and regulations related to foreign operations, political and governmental changes, inflation and exchange rates, taxes and operating conditions; 14. Significant changes in tax rates or policies or in rates of inflation or interest; 15. Significant changes in the Company's relationship with its employees and the potential adverse effects if labor disputes or grievances were to occur; 16. Changes in accounting principles and/or the application of such principles to the Company; and/or 17. Unanticipated problems related to the Company's internal Year 2000 initiative as well as potential adverse consequences related to third party Year 2000 compliance. The Company disclaims any obligation to update any forward-looking statements to reflect events or circumstances after the date hereof. ITEM 7A Quantitative and Qualitative Disclosure About Market Risk Refer to the "Market Rate Sensitive Instruments" section in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations. ITEM 8 Financial Statements and Supplementary Data Index to Financial Statements - ----------------------------- Page ---- Financial Statements: Report of Independent Accountants 56 Consolidated Statements of Income and Earnings Reinvested in the Business, three years ended September 30, 1998 57 Consolidated Balance Sheets at September 30, 1998 and 1997 58-59 Consolidated Statement of Cash Flows, three years ended September 30, 1998 60 Notes to Consolidated Financial Statements 61 Financial Statement Schedules: For the three years ended September 30, 1998 II-Valuation and Qualifying Accounts 86 All other schedules are omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or Notes thereto. Supplementary Data - ------------------ Supplementary data that is included in Note K - Quarterly Financial Data (unaudited) and Note M - Supplementary Information for Oil and Gas Producing Activities, appears under this Item, and reference is made thereto. Report of Management - -------------------- Management is responsible for the preparation and integrity of the Company's financial statements. The financial statements have been prepared in accordance with generally accepted accounting principles and necessarily include some amounts that are based on management's best estimates and judgment. The Company maintains a system of internal accounting and administrative controls and an ongoing program of internal audits that management believes provide reasonable assurance that assets are safeguarded and that transactions are properly recorded and executed in accordance with management's authorization. The Company's financial statements have been examined by our independent accountants, PricewaterhouseCoopers LLP, which also conducts a review of internal controls to the extent required by generally accepted auditing standards. The Audit Committee of the Board of Directors, composed solely of outside directors, meets with management, internal auditors and PricewaterhouseCoopers LLP to review planned audit scope and results and to discuss other matters affecting internal accounting controls and financial reporting. The independent accountants have direct access to the Audit Committee and periodically meet with it without management representatives present. Report of Independent Accountants --------------------------------- To the Board of Directors and Shareholders of National Fuel Gas Company In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of National Fuel Gas Company and its subsidiaries at September 30, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 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 audits. We conducted our audits 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 audits provide a reasonable basis for the opinion expressed above. As discussed in Note A to the consolidated financial statements, the Company changed its method of depletion for oil and gas properties in 1998. PricewaterhouseCoopers LLP Buffalo, New York October 27, 1998 National Fuel Gas Company ------------------------- Consolidated Statements of Income and Earnings ---------------------------------------------- Reinvested in the Business -------------------------- Year Ended September 30 (Thousands of Dollars, Except Per Common Share Amounts) 1998 1997 1996 ---- ---- ---- Income Operating Revenues $1,248,000 $1,265,812 $1,208,017 ---------- ---------- ---------- Operating Expenses Purchased Gas 441,746 528,610 477,357 Fuel Used in Heat and Electric Generation 37,592 1,489 244 Operation 294,221 260,839 282,551 Maintenance 25,793 25,698 26,411 Property, Franchise and Other Taxes 92,817 100,549 99,456 Depreciation, Depletion and Amortization 118,880 111,650 98,231 Impairment of Oil and Gas Producing Properties 128,996 - - Income Taxes 24,024 68,674 66,321 ---------- ---------- ---------- 1,164,069 1,097,509 1,050,571 ---------- ---------- ---------- Operating Income 83,931 168,303 157,446 Other Income 35,870 3,196 3,869 ---------- ---------- ---------- Income Before Interest Charges and Minority Interest in Foreign Subsidiaries 119,801 171,499 161,315 ---------- ---------- ---------- Interest Charges Interest on Long-Term Debt 53,154 42,131 40,872 Other Interest 32,130 14,680 15,772 ---------- ---------- ---------- 85,284 56,811 56,644 ---------- ---------- ---------- Minority Interest in Foreign Subsidiaries (2,213) - - ---------- ---------- ---------- Income Before Cumulative Effect 32,304 114,688 104,671 Cumulative Effect of Change in Accounting for Depletion (9,116) - - ---------- ---------- ---------- Net Income Available for Common Stock 23,188 114,688 104,671 Earnings Reinvested in the Business Balance at Beginning of Year 472,595 422,874 380,123 ---------- ---------- ---------- 495,783 537,562 484,794 Dividends on Common Stock 67,671 64,967 61,920 ---------- ---------- ---------- Balance at End of Year $ 428,112 $ 472,595 $ 422,874 ========== ========== ========== Basic Earnings Per Common Share: Income Before Cumulative Effect $0.85 $3.01 $2.78 Cumulative Effect of Change in Accounting For Depletion (0.24) - - ----- ----- ----- Net Income Available for Common Stock $0.61 $3.01 $2.78 ===== ===== ===== Diluted Earnings Per Common Share: Income Before Cumulative Effect $0.84 $2.98 $2.77 Cumulative Effect of Change in Accounting For Depletion (0.24) - - ----- ----- ----- Net Income Available for Common Stock $0.60 $2.98 $2.77 ===== ===== ===== Weighted Average Common Shares Outstanding: Used in Basic Calculation 38,316,397 38,083,514 37,613,305 ========== ========== ========== Used in Diluted Calculation 38,703,526 38,440,018 37,825,453 ========== ========== ========== See Notes to Consolidated Financial Statements National Fuel Gas Company ------------------------- Consolidated Balance Sheets --------------------------- At September 30 (Thousands of Dollars) 1998 1997 ---- ---- Assets Property, Plant and Equipment $3,186,853 $2,668,478 Less - Accumulated Depreciation, Depletion and Amortization 938,716 849,112 ---------- ---------- 2,248,137 1,819,366 ---------- ---------- Current Assets Cash and Temporary Cash Investments 30,437 14,039 Receivables - Net 82,336 107,417 Unbilled Utility Revenue 15,403 20,433 Gas Stored Underground 31,661 29,856 Materials and Supplies - at average cost 24,609 19,115 Unrecovered Purchased Gas Costs 6,316 - Prepayments 19,755 17,807 ---------- ---------- 210,517 208,667 ---------- ---------- Other Assets Recoverable Future Taxes 88,303 91,011 Unamortized Debt Expense 22,295 23,394 Other Regulatory Assets 41,735 48,350 Investment in Unconsolidated Foreign Subsidiary - 18,887 Deferred Charges 8,619 12,025 Other 64,853 45,631 ---------- ---------- 225,805 239,298 ---------- ---------- $2,684,459 $2,267,331 ========== ========== See Notes to Consolidated Financial Statements National Fuel Gas Company ------------------------- Consolidated Balance Sheets --------------------------- At September 30 (Thousands of Dollars) 1998 1997 ---- ---- Capitalization and Liabilities Capitalization: Common Stock Equity Common Stock, $1 Par Value Authorized - 200,000,000 Shares; Issued and Outstanding - 38,468,795 Shares and 38,165,888 Shares, Respectively $ 38,469 $ 38,166 Paid In Capital 416,239 405,028 Earnings Reinvested in the Business 428,112 472,595 Cumulative Translation Adjustment 7,265 (2,085) ---------- ---------- Total Common Stock Equity 890,085 913,704 Long-Term Debt, Net of Current Portion 692,669 581,640 ---------- ---------- Total Capitalization 1,582,754 1,495,344 ---------- ---------- Minority Interest in Foreign Subsidiaries 25,479 - ---------- ---------- Current and Accrued Liabilities Notes Payable to Banks and Commercial Paper 326,300 92,400 Current Portion of Long-Term Debt 216,929 103,359 Accounts Payable 59,933 74,105 Amounts Payable to Customers 5,781 10,516 Other Accruals and Current Liabilities 80,480 83,793 ---------- ---------- 689,423 364,173 ---------- ---------- Deferred Credits Accumulated Deferred Income Taxes 258,222 288,555 Taxes Refundable to Customers 18,404 19,427 Unamortized Investment Tax Credit 11,372 12,041 Other Deferred Credits 98,805 87,791 ---------- ---------- 386,803 407,814 ---------- ---------- Commitments and Contingencies - - ---------- ---------- $2,684,459 $2,267,331 ========== ========== See Notes to Consolidated Financial Statements
National Fuel Gas Company ------------------------- Consolidated Statement of Cash Flows ------------------------------------ Year Ended September 30 (Thousands of Dollars) 1998 1997 1996 ---- ---- ---- Operating Activities Net Income Available for Common Stock $ 23,188 $114,688 $104,671 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities Cumulative Effect of a Change in Accounting for Depletion 9,116 - - Impairment of Oil and Gas Producing Properties 128,996 - - Depreciation, Depletion and Amortization 118,880 111,650 98,231 Deferred Income Taxes (26,237) 3,800 3,907 Minority Interest in Foreign Subsidiaries 2,213 - - Other (6,378) 8,030 4,540 Change in: Receivables and Unbilled Utility Revenue 45,200 (10,332) (20,747) Gas Stored Underground and Materials and Supplies (1,271) 7,300 (6,308) Unrecovered Purchased Gas Costs (6,316) - - Prepayments 829 10,065 1,881 Accounts Payable (24,975) 9,495 10,768 Amounts Payable to Customers (4,735) 5,898 (46,383) Other Accruals and Current Liabilities (15,481) 4,113 18,200 Other Assets 36 (2,856) (7,667) Other Liabilities 9,913 32,811 7,376 -------- -------- -------- Net Cash Provided by Operating Activities 252,978 294,662 168,469 -------- -------- -------- Investing Activities Capital Expenditures (393,233) (214,001) (171,567) Investment in Subsidiaries, Net of Cash Acquired (111,966) (21,075) - Other 2,130 1,429 (1,366) -------- --------- -------- Net Cash Used in Investing Activities (503,069) (233,647) (172,933) -------- --------- -------- Financing Activities Change in Notes Payable to Banks and Commercial Paper 229,387 (107,300) 52,100 Net Proceeds from Issuance of Long-Term Debt 198,750 99,500 99,650 Reduction of Long-Term Debt (103,867) (1,310) (88,500) Proceeds from Issuance of Common Stock 7,853 7,074 8,956 Dividends Paid on Common Stock (66,959) (64,260) (61,179) Dividends Paid to Minority Interest (253) - - -------- -------- -------- Net Cash Provided by (Used in) Financing Activities 264,911 (66,296) 11,027 -------- -------- -------- Effect of Exchange Rates on Cash 1,578 - - -------- -------- -------- Net Increase (Decrease) in Cash and Temporary Cash Investments 16,398 (5,281) 6,563 Cash and Temporary Cash Investments at Beginning of Year 14,039 19,320 12,757 -------- -------- -------- Cash and Temporary Cash Investments at End of Year $ 30,437 $ 14,039 $ 19,320 ======== ======== ======== See Notes to Consolidated Financial Statements National Fuel Gas Company Notes to Consolidated Financial Statements Note A - Summary of Significant Accounting Policies Principles of Consolidation The consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. The equity method is used to account for the Company's investment in minority owned entities. All significant intercompany balances and transactions have been eliminated where appropriate. The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassification Certain prior year amounts have been reclassified to conform with current year presentation. Regulation Two of the Company's principal subsidiaries, Distribution Corporation and Supply Corporation, are subject to regulation by state and federal authorities having jurisdiction. Distribution Corporation and Supply Corporation have accounting policies which conform to generally accepted accounting principles, as applied to regulated enterprises, and are in accordance with the accounting requirements and ratemaking practices of the regulatory authorities. Reference is made to Note B - Regulatory Matters for further discussion. In the International segment, rates charged for the sale of thermal energy and electric energy at the retail level are subject to regulation and audit in the Czech Republic by the Czech Ministry of Finance. The regulation of electric energy rates at the retail level indirectly impacts the rates charged by the International segment for its electric energy sales at the wholesale level. Revenues Revenues are recorded as bills are rendered, except that service supplied but not billed is reported as "Unbilled Utility Revenue" and is included in operating revenues for the year in which service is furnished. Unrecovered Purchased Gas Costs and Refunds Distribution Corporation's rate schedules contain clauses that permit adjustment of revenues to reflect price changes from the cost of purchased gas included in base rates. Differences between amounts currently recoverable and actual adjustment clause revenues, as well as other price changes and pipeline and storage company refunds not yet includable in adjustment clause rates, are deferred and accounted for as either unrecovered purchased gas costs or amounts payable to customers. Distribution Corporation's rate settlements with the State of New York Public Service Commission (PSC) include provisions for a sharing of earnings over a specified rate of return on equity. Estimated refund liabilities are recorded over the term of the settlements which reflect management's current estimate of such refunds. Reference is made to Note B - Regulatory Matters for further discussion. Property, Plant and Equipment The principal assets, consisting primarily of gas plant in service, are recorded at the historical cost when originally devoted to service in the regulated businesses, as required by regulatory authorities. Such cost includes an Allowance for Funds Used During Construction (AFUDC), which is defined in applicable regulatory systems of accounts as the net cost of borrowed funds used for construction purposes and a reasonable rate on other funds when so used. The rates used in the calculation of AFUDC are determined in accordance with guidelines established by regulatory authorities. Included in property, plant and equipment is the cost of gas stored underground - noncurrent, representing the volume of gas required to maintain pressure levels for normal operating purposes as well as gas volumes maintained for system balancing and other purposes, including those needed for no-notice transportation service. Maintenance and repairs of property and replacements of minor items of property are charged directly to maintenance expense. The original cost of the regulated subsidiaries' property, plant and equipment retired, and the cost of removal less salvage, are charged to accumulated depreciation. Oil and gas property acquisition, exploration and development costs are capitalized under the full-cost method of accounting as prescribed by the Securities and Exchange Commission (SEC). All costs directly associated with property acquisition, exploration and development activities are capitalized, with the principal limitation that such capitalized amounts not exceed the present value of estimated future net revenues (discounted at 10%) from production of proved gas and oil reserves plus the lower of cost or market of unevaluated properties, net of related income tax effect (the full-cost ceiling). Future net revenues are estimated based on end-of-period prices adjusted for contracted price changes. If capitalized costs exceed the full-cost ceiling at the end of any quarter, a permanent impairment is required to be charged to earnings in that quarter. Due to significant declines in oil prices in 1998, Seneca's capitalized costs under the full-cost method of accounting exceeded the full-cost ceiling at March 31, 1998. Seneca was required to recognize an impairment of its oil and gas producing properties in the quarter ended March 31, 1998. This charge amounted to $129.0 million (pretax) and reduced net income for 1998 by $79.1 million ($2.06 per common share, basic; $2.04 per common share, diluted). Depreciation, Depletion and Amortization Depreciation, depletion and amortization are computed by application of either the straight-line method or the units of production method, in amounts sufficient to recover costs over the estimated service lives of property in service, and for oil and gas properties, based on quantities produced in relation to proved reserves (see discussion of change in method of depletion for oil and gas properties below). The costs of unevaluated oil and gas properties are excluded from this computation. For timber properties, depletion, determined on a property by property basis, is charged to operations based on the annual amount of timber cut in relation to the total amount of recoverable timber. The provisions for depreciation, depletion and amortization, as a percentage of average depreciable property were 4.4% in 1998, 4.6% in 1997 and 4.4% in 1996. Cumulative Effect of Change in Accounting Effective October 1, 1997, Seneca changed its method of depletion for oil and gas properties from the gross revenue method to the units of production method. The new method was adopted because it provides a better matching of oil and gas revenues and depletion expense and is the preferable method used by oil and gas producing companies. Seneca's recent acquisition activities have increased its scope of operations in relation to those of the Company. Consequently, the change in method was warranted. The units of production method has been applied retroactively to prior years to determine the cumulative effect through October 1, 1997. This cumulative effect reduced earnings for 1998 by $9.1 million, net of income tax. Depletion of oil and gas properties for 1998 has been computed under the units of production method. The effect of the change from the gross revenue method to the units of production method increased net income for 1998 by $1.4 million ($0.04 per common share, basic and diluted). Pro forma amounts for 1998, 1997 and 1996 shown below, assume the retroactive application of the new depletion method. Year Ended September 30 ---------------------------------- 1998 1997 1996 ----- ---- ---- Net Income (Thousands): As reported $ 23,188 $114,688 $104,671 Pro forma $ 32,304 $113,022 $102,655 Earnings Per Common Share: Basic - As reported $0.61 $3.01 $2.78 Basic - Pro forma $0.85 $2.97 $2.73 Diluted - As reported $0.60 $2.98 $2.77 Diluted - Pro forma $0.84 $2.94 $2.71 Gas Stored Underground - Current Gas stored underground - current is carried at lower of cost or market, on a last-in, first-out (LIFO) method. Under present regulatory practice, the liquidation of a LIFO layer is reflected in future gas cost adjustment clauses. Based upon the average price of spot market gas purchased in September 1998, including transportation costs, the current cost of replacing the inventory of gas stored underground-current exceeded the amount stated on a LIFO basis by approximately $21.2 million at September 30, 1998. Unamortized Debt Expense Costs associated with the issuance of debt by the Company are deferred and amortized over the lives of the related issues. Costs associated with the reacquisition of debt related to rate-regulated subsidiaries are deferred and amortized over the remaining life of the issue or the life of the replacement debt in order to match regulatory treatment. Foreign Currency Translation The functional currency for the Company's foreign operations is the Czech koruna. The translation from the Czech koruna to U. S. dollars is performed for balance sheet accounts by using current exchange ratios in effect at the balance sheet date, and for revenue and expense accounts by using an average exchange rate during the period. The resultant translation adjustment is reported as a Cumulative Translation Adjustment, a separate component of Common Stock Equity. Income Taxes The Company and its domestic subsidiaries file a consolidated federal income tax return. Investment Tax Credit, prior to its repeal in 1986, was deferred and is being amortized over the estimated useful lives of the related property, as required by regulatory authorities having jurisdiction. Financial Instruments Seneca and NFR utilize price swap agreements as well as exchange-traded futures and options, respectively, to manage a portion of the market risk associated with fluctuations in the price of natural gas and crude oil. Gains or losses from the price swap agreements are accrued in operating revenues on the Consolidated Statement of Income at the contract settlement dates. Gains or losses from exchange-traded futures and options are recorded in Other Deferred Credits on the Consolidated Balance Sheet until the hedged commodity transaction occurs, at which point they are reflected in operating revenues on the Consolidated Statement of Income. Reference is made to Note F - Financial Instruments for further discussion. In the International segment, PSZT has purchased a forward contract to hedge against the exchange rate risk associated with U.S. dollar denominated debt. Exchange rate gains or losses related to the U.S. dollar denominated debt are recorded in Other Income on the Consolidated Statement of Income on a monthly basis. Gains or losses related to the forward contract are recorded in Other Income on the Consolidated Statement of Income as an offset to the gains or losses recognized on the U.S. dollar denominated debt. Reference is made to Note F - Financial Instruments for further discussion. Consolidated Statement of Cash Flows For purposes of the Consolidated Statement of Cash Flows, the Company considers all highly liquid debt instruments purchased with a maturity of generally three months or less to be cash equivalents. Interest paid in 1998, 1997 and 1996 was $46.2 million, $52.4 million and $54.8 million, respectively. Income taxes paid in 1998, 1997 and 1996 were $64.5 million, $69.2 million and $60.8 million, respectively. In 1998, the Company received a $22.4 million refund of taxes and interest from the Internal Revenue Service stemming from the settlement of the primary issues of audits of years 1977 - 1994. In addition, the Company received $2.2 million in tax refunds issued to SCT and PSZT by the Czech Ministry of Finance. Details of the SCT, PSZT and HarCor stock acquisitions during 1998 are as follows (dollars in millions): SCT PSZT HarCor Total --- ---- ------ ----- Assets acquired $66.1 $141.8 $105.6 $313.5 Liabilities assumed (22.3) (77.3) (73.0) (172.6) Existing investment at acquisition (18.9) - - (18.9) Cash acquired at acquisition (6.3) (0.9) (2.8) (10.0) ----- ----- ------ ------ Cash paid, net of cash acquired $18.6 $63.6 $ 29.8 $112.0 ===== ===== ====== ====== Further discussion of these acquisitions can be found at Note J - Stock Acquisitions. In 1997, Seneca entered into non-cash investing activities whereby it issued notes to third parties totaling $12.3 million in connection with the acquisition of timber properties. Earnings Per Common Share Basic earnings per common share is computed by dividing income available for common stock by the weighted average number of common shares outstanding for the period. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Such additional shares are added to the denominator of the basic earnings per common share calculation in order to calculate diluted earnings per common share. The only potentially dilutive securities the Company has outstanding are stock options. The diluted weighted average shares outstanding shown on the Consolidated Statement of Income reflects the potential dilution as a result of these stock options. Such dilution was determined using the Treasury Stock Method as required by Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share." New Accounting Pronouncements Accounting for Derivative Instruments and Hedging Activities In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. The intended use of the derivative and its designation as either (1) a hedge of the exposure to changes in the fair value of a recognized asset or liability or a firm commitment (a fair value hedge), (2) a hedge of the exposure to variable cash flows of a forecasted transaction (a cash flow hedge), or (3) a hedge of the foreign currency exposure of a net investment in a foreign operation (a foreign currency hedge), will determine when the gains or losses on the derivatives are to be reported in earnings and when they are to be reported as a component of other comprehensive income. Management has determined that the price swap agreements utilized by Seneca will qualify as cash flow hedges and that the exchange-traded futures and options utilized by NFR will qualify as fair value hedges upon implementation of SFAS 133. At adoption, these hedges will be recorded at fair value on the Consolidated Balance Sheets as either an asset or liability. In the case of the price swap agreements, the offset to the asset or liability will be other comprehensive income, as discussed below. As for the exchange-traded futures and options, the offset will be recorded as a cumulative effect of change in accounting item on the Consolidated Statement of Income. Since the exchange-traded futures and options will have been designated as hedges of firm commitments, the firm commitments will also be recorded at fair value on the Consolidated Balance Sheets as either an asset or liability. The offset to this asset or liability will be the aforementioned cumulative effect of change in accounting item on the Consolidated Statement of Income. Management is continuing to evaluate other financial instruments and contracts which may have embedded derivatives that could be impacted by the adoption of SFAS 133. The Company plans to adopt SFAS 133 in the first quarter of fiscal 2000. Comprehensive Income In June 1997, the FASB issued SFAS 130, "Reporting Comprehensive Income" (SFAS 130). SFAS 130 establishes standards for reporting and display of comprehensive income in a full set of general-purpose financial statements. Comprehensive income, as described in SFAS 130, includes Net Income Available for Common Stock as well as items under existing accounting standards that are reported as adjustments to stockholders' equity. Such adjustments to stockholders' equity currently include foreign currency translation adjustments, minimum pension liability adjustments and unrealized gains and losses on certain investments in debt and equity securities. Upon adoption of SFAS 133, certain unrealized gains or losses on derivative financial instruments will be included as a component of other comprehensive income in accordance with SFAS 130. The Company will adopt SFAS 130 in the first quarter of 1999. Note B - Regulatory Matters Regulatory Assets and Liabilities Distribution Corporation and Supply Corporation have incurred various costs and received various credits which have been reflected as regulatory assets and liabilities on the Company's Consolidated Balance Sheets. Accounting for such costs and credits as regulatory assets and liabilities is in accordance with SFAS 71, "Accounting for the Effect of Certain Types of Regulation" (SFAS 71). This statement sets forth the application of generally accepted accounting principles for those companies whose rates are established by or are subject to approval by an independent third-party regulator. Under SFAS 71, regulated companies defer costs and credits on the balance sheet as regulatory assets and liabilities when it is probable that those costs and credits will be allowed in the rate setting process in a period different from the period in which they would have been reflected in income by an unregulated company. These deferred regulatory assets and liabilities are then flowed through the income statement in the period in which the same amounts are reflected in rates. Distribution Corporation and Supply Corporation have recorded the following regulatory assets and liabilities: At September 30 (Thousands) 1998 1997 ---- ---- Regulatory Assets: Recoverable Future Taxes (Note C) $ 88,303 $ 91,011 Unamortized Debt Expense (Note A) 16,886 18,603 Pension and Post-Retirement Benefit Costs (Note G) 22,483 24,200 Gathering Plant 5,475 7,675 Environmental Clean-up (Note H) 12,394 8,697 Other 1,383 7,778 -------- -------- Total Regulatory Assets 146,924 157,964 -------- -------- Regulatory Liabilities: Amounts Payable to Customers (Note A) 5,781 10,516 New York Rate Settlement* 19,341 22,232 Taxes Refundable to Customers (Note C) 18,404 19,427 Pension and Post-Retirement Benefit Costs* (Note G) 20,222 10,446 Other* 1,741 1,538 -------- -------- Total Regulatory Liabilities 65,489 64,159 -------- -------- Net Regulatory Position $ 81,435 $ 93,805 ======== ======== * Included in Other Deferred Credits on the Consolidated Balance Sheets. If for any reason, including deregulation, a change in the method of regulation, or a change in competitive environment, Distribution Corporation and/or Supply Corporation ceases to meet the criteria for application of SFAS 71 for all or part of their operations, the regulatory assets and liabilities related to those portions ceasing to meet such criteria would be eliminated from the balance sheet and included in income of the period in which the discontinuance of SFAS 71 occurs. Such amounts would be classified as an extraordinary item. New York Rate Settlement As of September 30, 1998, Distribution Corporation's 1996 rate settlement with the PSC expired. As part of the 1996 rate settlement, earnings above a 12% return on equity (determined on a cumulative basis over the three years ended September 30, 1998) are to be shared equally between shareholders and customers. As a result of this sharing mechanism, Distribution Corporation has determined that the refund due customers as of September 30, 1998 is $10.7 million (of which $3.0 million will be passed back to customers in 1999 and thus is included as a current liability on the Consolidated Balance Sheet in Amounts Payable to Customers). An additional $3.0 million will be passed back to customers in 2000 with the remaining amount, if any, to be passed back to customers as determined by the PSC. In addition, as part of the 1996 rate settlement, Distribution Corporation was allowed to accumulate certain refunds from upstream pipeline companies and certain credits (referred to as the "refund pool") to offset certain specific expense items. This refund pool had a balance at September 30, 1998 of $6.0 million. Various other regulatory liabilities were also created through the rate settlement process and amounted to $5.6 million at September 30, 1998. Note C - Income Taxes The components of federal and state income taxes included in the Consolidated Statement of Income are as follows: Year Ended September 30 (Thousands) 1998 1997 1996 ---- ---- ---- Operating Expenses: Current Income Taxes - Federal $ 40,740 $ 57,807 $ 55,148 State 6,635 7,067 7,266 Deferred Income Taxes - Federal (21,687) 2,895 2,160 State (5,997) 905 1,747 Foreign Income Taxes 4,333 - - -------- -------- -------- 24,024 68,674 66,321 Other Income: Deferred Investment Tax Credit (665) (665) (665) Minority Interest in Foreign Subsidiaries (1,218) - - Cumulative Effect of Change in Accounting for Depletion (5,737) - - -------- -------- -------- Total Income Taxes $ 16,404 $ 68,009 $ 65,656 ======== ======== ======== The U.S. and foreign components of income (loss) before income taxes are as follows: Year Ended September 30 (Thousands) 1998 1997 1996 ---- ---- ---- U.S. $ 31,127 $184,257 $170,424 Foreign 8,465 (1,560) (97) -------- -------- -------- $ 39,592 $182,697 $170,327 ======== ======== ======== Total income taxes as reported differ from the amounts that were computed by applying the federal income tax rate to income before income taxes. The following is a reconciliation of this difference: Year Ended September 30 (Thousands) 1998 1997 1996 ---- ---- ---- Net Income Available for Common Stock $ 23,188 $114,688 $104,671 Income Tax Expense 16,404 68,009 65,656 -------- -------- -------- Income Before Income Taxes 39,592 182,697 170,327 -------- -------- -------- Income Tax Expense, Computed at Federal Statutory Rate of 35% 13,857 63,944 59,614 Increase (Reduction) in Taxes Resulting from: State Income Taxes 986 5,182 5,858 Depreciation 2,186 2,560 2,499 Property Retirements (1,609) (1,320) (1,083) Keyman Life Insurance (774) (695) (234) Prior Years Tax Adjustment 2,846 - - Miscellaneous (1,088) (1,662) (998) -------- -------- -------- Total Income Taxes $ 16,404 $ 68,009 $ 65,656 ======== ======== ======== Significant components of the Company's deferred tax liabilities and assets were as follows: At September 30 (Thousands) 1998 1997 ---- ---- Deferred Tax Liabilities: Abandonments $ 15,545 $ 14,241 Accelerated Tax Depreciation 132,138 190,913 Exploration and Intangible Well Drilling Costs 147,795 117,759 Other 42,109 47,948 -------- -------- Total Deferred Tax Liabilities 337,587 370,861 -------- -------- Deferred Tax Assets: Capitalized Overheads (22,484) (19,406) Other (56,881) (62,900) -------- -------- Total Deferred Tax Assets (79,365) (82,306) -------- -------- Total Net Deferred Income Taxes $258,222 $288,555 ======== ======== Regulatory liabilities representing the reduction of previously recorded deferred income taxes associated with rate-regulated activities that are expected to be refundable to customers amounted to $18.4 million and $19.4 million at September 30, 1998 and 1997, respectively. Also, regulatory assets, representing future amounts collectible from customers, corresponding to additional deferred income taxes not previously recorded because of prior ratemaking practices amounted to $88.3 million and $91.0 million at September 30, 1998 and 1997, respectively. The primary issues related to Internal Revenue Service audits of the Company for the years 1977-1994 were settled during the current year. Net income for the year ended September 30, 1998 was increased approximately $5.0 million as a result of interest, net of tax and other adjustments, related to this settlement. Note D - Capitalization Summary of Changes in Common Stock Equity Earnings Paid Reinvested Cumulative (Thousands, Except Common Stock In in the Translation --------------- Per Share Amounts) Shares Amount Capital Business Adjustment - ------------------ ------ ------ ------- -------- ---------- Balance at September 30, 1995 37,434 $37,434 $383,031 $380,123 $ - Net Income Available for Common Stock 104,671 Dividends Declared on Common Stock ($1.65 Per Share) (61,920) Common Stock Issued Under Stock and Benefit Plans 418 418 12,241 ------ ------- -------- -------- ------- Balance at September 30, 1996 37,852 37,852 395,272 422,874 - Net Income Available for Common Stock 114,688 Dividends Declared on Common Stock ($1.71 Per Share) (64,967) Cumulative Translation Adjustment (2,085) Common Stock Issued Under Stock and Benefit Plans 314 314 9,756 ------ ------- -------- -------- ------- Balance at September 30, 1997 38,166 38,166 405,028 472,595 (2,085) Net Income Available for Common Stock 23,188 Dividends Declared on Common Stock ($1.77 Per Share) (67,671) Cumulative Translation Adjustment 9,350 Common Stock Issued Under Stock and Benefit Plans 303 303 11,211 ------ ------- -------- -------- ------- Balance at September 30, 1998 38,469 $38,469 $416,239 $428,112* $ 7,265 ====== ======= ======== ======== ======= * The availability of consolidated earnings reinvested in the business for dividends payable in cash is limited under terms of the indentures covering long-term debt. At September 30, 1998, $353.7 million of accumulated earnings was free of such limitations. Common Stock The Company has various plans which allow shareholders, customers and employees to purchase shares of Company common stock. The Dividend Reinvestment and Stock Purchase Plan allows shareholders to reinvest cash dividends and/or make cash investments in the Company's common stock. The Customer Stock Purchase Plan provides residential customers the opportunity to acquire shares of Company common stock without the payment of any brokerage commissions or service charges in connection with such acquisitions. The 401(k) Plans allow employees the opportunity to invest in Company common stock, in addition to a variety of other investment alternatives. At the discretion of the Company, shares purchased under these plans are either original issue shares purchased directly from the Company or shares purchased on the open market by an agent. The Company also has a Director Stock Program under which it issues shares of Company common stock to its non-employee directors as partial consideration for their services as directors. Shareholder Rights Plan In 1996, the Company's Board of Directors adopted a shareholder rights plan and declared a dividend of one right (Right) for each share of common stock held by the shareholders of record on July 31, 1996. The Rights become exercisable ten days after actions that result or could result in the acquisition by a person or entity of 10% or more of the Company's voting stock. If the Rights become exercisable, each Company stockholder, except such an acquirer, will be able to exercise a Right and receive common stock (or, in certain cases, cash, property or other securities) of the Company, or common stock of the acquirer, having a market value equal to twice the Right's then current purchase price. If a Right were currently exercisable, it would entitle a Company stockholder, other than an acquirer, to purchase $130 worth of Company common stock (or the common stock of the acquirer) for $65. The Company is able to exchange the Rights at an exchange ratio of one share of common stock per Right. It is also able to redeem, in whole but not in part, the Rights at a price of $0.01 per Right anytime until ten days after an acquirer announces that it has acquired or has the right to acquire 10% or more of the Company's voting stock. In September 1998, the Directors voted to amend the shareholder rights plan to (i) remove provisions which would prevent newly elected directors from voting on certain questions including the redemption of Rights, (ii) allow such questions to be decided by a vote of three quarters of all the directors and (iii) extend the expiration date of the Rights by two years to July 31, 2008. Stock Option and Stock Award Plans The Company has various stock option and stock award plans which provide or provided for the issuance of one or more of the following to key employees: incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, performance units or performance shares. Stock options under all plans have exercise prices equal to the average market price of Company common stock on the date of grant, and generally no option is exercisable less than one year or more than ten years after the date of each grant. The Company follows the disclosure provision of SFAS 123, "Accounting for Stock-Based Compensation" (SFAS 123), but remains under the expense recognition provisions of Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," in accounting for its stock option and stock award plans. For the years ended September 30, 1998, 1997 and 1996, no compensation expense was recognized for options granted under these plans. Compensation expense related to stock appreciation rights and restricted stock under these stock plans was $4.1 million, $8.1 million and $6.7 million for the years ended September 30, 1998, 1997 and 1996, respectively. Had compensation expense for stock options granted under the Company's stock option and stock award plans been determined based on fair value at the grant dates consistent with the method of SFAS 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts below: Year Ended September 30 1998 1997 1996 - ------------------------------------------------------------------------------- Net Income (Thousands): As reported $23,188 $114,688 $104,671 Pro forma $18,859 $110,506 $104,322 Earnings per Common Share: Basic - As reported $0.61 $3.01 $2.78 Basic - Pro forma $0.49 $2.90 $2.77 Diluted - As reported $0.60 $2.98 $2.77 Diluted - Pro forma $0.49 $2.87 $2.76 The above 1996 pro forma amount relates only to options granted since the beginning of 1996. Had SFAS 123 been effective prior to 1996, the fair value of options granted in 1995 but vesting in 1996 would have further reduced 1996 pro forma net income and earnings per share by $1.0 million and $0.03, respectively. Transactions involving option shares for all plans are summarized as follows: Number of Shares Subject Weighted Average to Option Exercise Price - ------------------------------------------------------------------------------- Outstanding at September 30, 1995 1,500,290 $27.13 Granted in 1996 487,750 $34.44 Exercised in 1996* (195,321) $22.72 Forfeited in 1996 (19,468) $27.90 - ------------------------------------------------------------------------------- Outstanding at September 30, 1996 1,773,251 $29.62 Granted in 1997 678,750 $39.61 Exercised in 1997* (274,655) $25.80 Forfeited in 1997 (3,000) $36.81 - ------------------------------------------------------------------------------- Outstanding at September 30, 1997 2,174,346 $33.21 Granted in 1998 770,000 $44.44 Exercised in 1998* (205,200) $27.41 Forfeited in 1998 (3,250) $41.63 - ------------------------------------------------------------------------------- Outstanding at September 30, 1998 2,735,896 $36.80 - ------------------------------------------------------------------------------- Option shares exercisable at September 30, 1998 1,965,896 $33.80 Option shares available for future grant at September 30, 1998** 837,177 - ------------------------------------------------------------------------------- * In connection with exercising these options, 44,580; 117,326; and 77,679 shares were surrendered and canceled during 1998, 1997 and 1996, respectively. ** Including shares available for restricted stock grants. The weighted average fair value per share of options granted in 1998, 1997 and 1996 was $7.91, $7.66 and $5.58, respectively. These weighted average fair values were estimated on the date of grant using a binomial option pricing model which is a modification of the Black-Scholes option pricing model, with the following weighted average assumptions: Year Ended September 30 1998 1997 1996 ---- ---- ---- Quarterly Dividend Yield 0.98% 1.06% 1.22% Annual Standard Deviation (Volatility) 16.48% 16.76% 15.62% Risk Free Rate 5.77% 6.58% 6.28% Expected Term - in Years 5.5 5 5.5 The following table summarizes information about options outstanding at September 30, 1998:
Options Outstanding Options Exercisable - -------------------------------------------------------------- ----------------------------- Number Weighted Average Weighted Number Range of Outstanding Remaining Average Exercisable Weighted Average Exercise Prices at 9/30/98 Contractual Life Exercise Price at 9/30/98 Exercise Price - --------------- ---------- ---------------- -------------- ---------- -------------- $18.00 - $25.19 217,720 3.22 years $24.47 217,720 $24.47 $27.94 - $36.75 1,353,776 6.98 years $33.03 1,353,776 $33.03 $41.63 - $44.88 1,164,400 9.02 years $43.49 394,400 $41.63
Restricted stock is subject to restrictions on vesting and transferability. Restricted stock awards entitle the participants to full dividend and voting rights. The market value of restricted stock on the date of the award is being recorded as compensation expense over the periods during which the vesting restrictions exist. Certificates for shares of restricted stock awarded under the Company's stock options and stock award plans are held by the Company during the periods in which the restrictions on vesting are effective. The following table summarizes the awards of restricted stock over the past three years: Year Ended September 30 1998 1997 1996 - ------------------------------------------------------------------------------ Shares of Restricted Stock Awarded 7,609 6,300 8,000 Weighted Average Market Price of Stock on Award Date $44.875 $40.875 $36.81 - ------------------------------------------------------------------------------ As of September 30, 1998, 110,655 shares of non-vested restricted stock were outstanding. Vesting restrictions will lapse as follows: 1999 - 20,916 shares; 2000 - 28,216 shares; 2001 - 30,523 shares; 2002 - 8,000 shares; 2003 - 8,000 shares; 2004 - 7,000 shares; 2005 - 6,000 shares; and 2006 - 2,000 shares. Redeemable Preferred Stock As of September 30, 1998, there were 10,000,000 shares of $1 par value Cumulative Preferred Stock authorized but unissued. Long-Term Debt The outstanding long-term debt is as follows: At September 30 (Thousands) 1998 1997 ---- ---- National Fuel Gas Company: Debentures: 7-3/4% due February 2004 $125,000 $125,000 Medium-Term Notes: 6.42% due November 1997 - 50,000 6.08% due July 1998 - 50,000 5.58% due March 1999 100,000 100,000 7.25% due July 1999 50,000 50,000 6.60% due February 2000 50,000 50,000 7.395% due March 2023 49,000 49,000 8.48% due July 2024(1) 50,000 50,000 7.375% due June 2025 50,000 50,000 6.214% due August 2027(2) 100,000 100,000 6.303% due May 2008 200,000 - -------- -------- 774,000 674,000 -------- -------- HarCor: 14.875% Senior Secured Notes 62,571 - -------- -------- PSZT: 8.04% U.S. Dollar Denominated Debt due March 2000 - December 2004(3) 50,596 - 13% Debentures due December 1999 9,908 - -------- -------- 60,504 - -------- -------- SCT: 14.72% Term Loan payable quarterly through June 2006(4) 4,524 - -------- -------- Other Notes 7,999 10,999 -------- -------- Total Long-Term Debt 909,598 684,999 Less Current Portion 216,929 103,359 -------- -------- $692,669 $581,640 ======== ======== (1) Callable by the Company beginning July 1999 at a redemption price of 106.36%. This price would be effective through July 2000 and would decline in subsequent years. (2) Putable by debt holders only on August 12, 2002, at par. (3) Interest rate is six month LIBOR (London Interbank Offered Rates) plus 2.2%. (4) Interest rate is six month PRIBOR (Prague Interbank Offered Rate) plus 1%. In May 1998, the Company issued $200.0 million of 6.303% medium-term notes due to mature in May 2008. After deducting underwriting discounts and commissions, the net proceeds to the Company amounted to $198.8 million. The stock acquisitions of HarCor, PSZT and SCT and subsequent consolidation of these companies into the Company's consolidated financial statements accounts for the significant increase in long-term debt of Seneca and Horizon. These stock acquisitions are discussed further at Note J - Stock Acquisitions. The senior secured notes recorded by Seneca as a result of the HarCor acquisition have a book value of $53.6 million. In accordance with APB 16, "Business Combinations" (APB 16), the senior secured notes were adjusted to fair market value on the opening balance sheet to reflect an effective interest rate of 5.875% and the projected redemption of this debt in 1999. As such, the entire balance is included in Current Portion of Long-Term Debt on the Consolidated Balance Sheets at September 30, 1998. The aggregate principal amounts of long-term debt maturing for the next five years and thereafter are as follows: $216.9 million in 1999, $70.4 million in 2000, $12.4 million in 2001, $10.7 million in 2002, $10.8 million in 2003 and $588.4 million thereafter. The Company's indenture contains covenants which limit, among other things, the incurrence of funded debt. Funded debt basically is indebtedness maturing more than one year after the date of issuance. Because of the impairment of oil and gas properties recorded by the Company in March 1998, these covenants will restrict the Company's ability to issue additional funded debt, with certain exceptions, until at least the third quarter of fiscal 1999. This will not, however, limit the Company's issuance of funded debt to refund existing funded debt. Note E - Short-Term Borrowings The Company has SEC authorization under the Public Utility Holding Company Act of 1935, as amended, to borrow and have outstanding as much as $750.0 million of short-term debt at any time. The Company historically has borrowed short-term either through bank loans or the issuance of commercial paper. As for the former, the Company maintains uncommitted or discretionary lines of credit with certain financial institutions for general corporate purposes. These lines are utilized primarily as a means of financing, on an interim basis, various working capital requirements, acquisitions and capital expenditures of the Company, including the Company's oil and gas exploration and development program and the purchase and storage of gas. Borrowings under these lines of credit are made at competitive market rates. These credit lines are revocable at the option of the financial institutions and are reviewed on an annual basis. The Company could issue and have outstanding as much as $750.0 million of commercial paper at any time (or a lesser amount so that short-term borrowings from all sources do not exceed $750.0 million at any time), but is not likely to have more than $150.0 million in commercial paper outstanding because of the terms of the revolving credit arrangement discussed below. The Company has a 364-day committed revolving credit arrangement with five commercial banks, under which it may borrow as much as $150.0 million. This arrangement may be utilized for general corporate purposes, primarily to support the issuance of commercial paper. The Company pays a fee to maintain this arrangement, and may borrow through this arrangement under four interest rate options. If amounts are borrowed under this arrangement, the $750.0 million available for short-term borrowing by other means is correspondingly reduced. No borrowings were made under this arrangement during the fiscal year ended September 30, 1998. At September 30, 1998, the Company had outstanding notes payable to banks and commercial paper of $196.3 million and $130.0 million, respectively. At September 30, 1997, the Company had outstanding notes payable to banks and commercial paper of $32.4 million and $60.0 million, respectively. The weighted average interest rate on notes payable to banks was 5.67% and 6.12% at September 30, 1998 and 1997, respectively. The weighted average interest rate on commercial paper was 5.60% and 5.64% at September 30, 1998 and 1997, respectively. Note F - Financial Instruments Fair Values The fair market value of the Company's long-term debt is estimated based on quoted market prices of similar issues having the same remaining maturities, redemption terms and credit ratings. Based on these criteria, the fair market value of long-term debt, including current portion, was as follows: At September 30 (Thousands) 1998 1998 1997 1997 Carrying Fair Carrying Fair Amount Value Amount Value -------- ----- -------- ----- Long-Term Debt $909,598 $966,085 $684,999 $704,409 ======== ======== ======== ======== The fair value amounts are not intended to reflect principal amounts that the Company will ultimately be required to pay. Temporary cash investments, notes payable to banks and commercial paper are stated at amounts which approximate their fair value due to the short-term maturities of those financial instruments. Investments in life insurance are stated at their cash surrender values as discussed below. Investments Other assets include cash surrender values of insurance contracts. The cash surrender values of these insurance contracts amounted to $40.1 million and $35.7 million at September 30, 1998 and 1997, respectively. The insurance contracts were established as an informal funding mechanism for various benefit obligations the Company has to certain employees. Derivative Financial Instruments Seneca has entered into certain price swap agreements to manage a portion of the market risk associated with fluctuations in the price of natural gas and crude oil, thereby providing more stability to its operating results. These agreements are not held for trading purposes. The price swap agreements call for Seneca to receive monthly payments from (or make payment to) other parties based upon the difference between a fixed and a variable price as specified by the agreement. The variable price is either a crude oil price quoted on the New York Mercantile Exchange or a quoted natural gas price in "Inside FERC." These variable prices are highly correlated with the market prices received by Seneca for its natural gas and crude oil production. At September 30, 1998, Seneca had natural gas price swap agreements covering a notional amount of 21.8 Bcf extending through 2000 at a weighted average fixed rate of $2.34 per Mcf. Seneca also had crude oil price swap agreements covering a notional amount of 135,000 bbls extending through 1999 at a weighted average fixed rate of $19.86 per bbl. Seneca had unrecognized losses of approximately $1.0 million related to these price swap agreements which are offset by corresponding unrecognized gains from Seneca's anticipated natural gas and crude oil production over the terms of the price swap agreements. Seneca recognized net losses of $4.1 million, $21.5 million and $11.8 million related to price swap agreements during 1998, 1997 and 1996, respectively. As the price swap agreements have been designated as hedges, these losses were offset by corresponding gains from Seneca's natural gas and crude oil production. The Company is exposed to credit risk on the price swap agreements that Seneca has entered into. Credit risk relates to the risk of loss that the Company would incur as a result of nonperformance by counterparties pursuant to the terms of their contractual obligations. To mitigate such credit risk, before entering into a price swap agreement with a new counterparty, management performs a credit check and prepares a report indicating the results of the credit investigation. This report must be approved by Seneca's board of directors after which a Master Swap Agreement is executed between Seneca and the counterparty. On an ongoing basis, periodic reports are prepared by management to monitor counterparty credit exposure. Considering the procedures in place, the Company does not anticipate any material impact to its financial position, results of operations, or cash flows as a result of nonperformance by counterparties. NFR utilizes exchange-traded futures and options to manage a portion of the market risk associated with fluctuations in the price of natural gas. Such futures and options are not held for trading purposes. At September 30, 1998, NFR had natural gas futures contracts related to gas purchase and sale commitments covering 14.3 Bcf of gas on a net basis extending through 2000 at a weighted average contract price of $2.52 per Mcf. NFR also had sold natural gas options related to gas purchase and sale commitments covering 2.3 Bcf of gas on a net basis extending through 1999 at a weighted average strike price of $2.91 per Mcf. NFR had unrealized gains of approximately $0.5 million related to these futures contracts and options. Since these futures contracts and options qualify and have been designated as hedges, any gains or losses resulting from market price changes would be substantially offset by the related commodity transaction. NFR recognized net gains of $1.3 million, $1.7 million and $1.0 million related to futures contracts and options during 1998, 1997 and 1996, respectively. Since these futures contracts and options qualify and have been designated as hedges, these net gains were substantially offset by the related commodity transaction. PSZT purchased a $50.6 million U.S. dollar forward contract at an exchange rate of 31.54 Czech koruna per U.S. dollar in September 1998. The purpose of the forward contract is to hedge against the exchange rate risk associated with PSZT's U.S. dollar denominated debt (reference is made to Note D - - Capitalization). Since the functional currency of PSZT is the Czech koruna and this debt must be repaid in U.S. dollars, a change in exchange rates between the Czech koruna and the U.S. dollar may increase or decrease the amount of Czech koruna required to repay the debt, resulting in a corresponding gain or loss to be recognized in the Consolidated Statement of Income. At September 30, 1998, PSZT had a loss of $2.1 million related to this forward contract. This loss offset the gain on the U.S. dollar denominated debt from the date of purchase of the forward contract. The Company has SEC authority to enter into hedging transactions related to all or a portion of its existing or anticipated debt. The notional amounts of the hedging instruments may not exceed the amount of the Company's outstanding debt. No such hedging transactions were entered into during the year ended September 30, 1998 and none are currently outstanding. Note G - Retirement Plan and Other Post-Retirement Benefits Retirement Plan The Company has a tax-qualified, noncontributory, defined-benefit retirement plan (Plan) that covers substantially all domestic employees of the Company. The Plan uses years of service, age at retirement and earnings of employees to determine benefits. The Company's policy is to fund at least an amount necessary to satisfy the minimum funding requirements of applicable laws and regulations and not more than the maximum amount deductible for federal income tax purposes. Plan funding is subject to annual review by management and its consulting actuary. Plan assets primarily consist of equity and fixed income investments and units in commingled funds. For financial reporting purposes, the regulated subsidiaries record the difference between the amounts of pension cost recoverable in rates and the amounts of pension cost determined by the actuary under SFAS 87, "Employers' Accounting for Pensions," as deferred pension assets. The amounts deferred are expected to be recovered in rates as contributions are made to the Plan. Pension cost reflects the amount recovered from customers in rates during the year. Under the PSC's policies, Distribution Corporation segregates the amount of pension cost collected in rates, but not yet contributed to the pension plan, into a regulatory liability account. This liability accrues interest at the PSC mandated interest rate and this interest cost is included in pension cost. For purposes of disclosure, the liability also remains in the disclosed pension liability amount because it has not yet been contributed. Reconciliations of the Benefit Obligation, Plan Assets and Funded Status, as well as the components of Net Periodic Benefit Cost and the Weighted Average Assumptions are as follows: Year Ended September 30 (Thousands) 1998 1997 ---- ---- Change in Benefit Obligation Benefit Obligation at Beginning of Period $462,377 $432,753 Service Cost 10,655 9,988 Interest Cost 35,485 33,532 Amendments - 1,479 Actuarial Loss 52,446 10,336 Benefits Paid (28,713) (25,711) -------- -------- Benefit Obligation at End of Period $532,250 $462,377 -------- -------- Change in Plan Assets Fair Value of Assets at Beginning of Period $473,205 $431,828 Actual Return on Plan Assets 59,415 65,790 Employer Contribution 5,486 1,298 Benefits Paid (28,713) (25,711) -------- -------- Fair Value of Assets at End of Period $509,393 $473,205 -------- -------- Reconciliation of Funded Status Funded Status $(22,857) $ 10,828 Unrecognized Net Actuarial Gain (12,659) (38,687) Unrecognized Transition Asset (18,580) (22,296) Unrecognized Prior Service Cost 11,369 12,435 -------- -------- Accrued Benefit Cost $(42,727) $(37,720) -------- -------- Weighted Average Assumptions as of September 30 1998 1997 1996 ---- ---- ---- Discount Rate 7.00% 7.75% 8.00% Expected Return on Plan Assets 8.50% 8.50% 8.50% Rate of Compensation Increase 5.00% 5.00% 5.00% Year Ended September 30 (Thousands) Components of Net Periodic Benefit Cost 1998 1997 1996 ---- ---- ---- Service Cost $ 10,655 $ 9,988 $ 11,049 Interest Cost 35,485 33,532 31,422 Expected Return on Plan Assets (35,724) (34,011) (32,122) Amortization of Prior Service Cost 1,065 991 1,001 Amortization of Transition Asset (3,716) (3,754) (4,167) Amortization of Loss 981 - - Early Retirement Window - 1,904 6,986 Net Amortization and Deferral for Regulatory Purposes 4,829 (374) (2,320) -------- -------- -------- Net Periodic Benefit Cost $ 13,575 $ 8,276 $ 11,849 ======== ======== ======== The Benefit Obligation was determined using an assumed discount rate as noted in the data above. The effect of the discount rate change in 1998 was to increase the Benefit Obligation by $45.0 million as of the end of the period. The effect of the discount rate change in 1997 was to increase the Benefit Obligation as of the beginning of the period by $12.8 million. The mortality assumption for healthy lives was changed from the 1983 Group Annuity Mortality Tables to the 1994 Group Annuity Mortality Tables. This change had the effect of increasing the Benefit Obligation as of the beginning of the period by $9.8 million. As described in Note B - Regulatory Matters, subheading "New York Rate Settlement," Distribution Corporation was allowed a refund pool to offset certain specific expense items. Of the amount utilized in 1998, $6.6 million was recorded as pension cost and is included in Net Amortization and Deferral for Regulatory Purposes in the table above. In June 1997, the Company completed an early retirement offer for the Pennsylvania operating union employees of Distribution Corporation and Supply Corporation. As a result, the Company recorded expense of $1.9 million ($1.2 million after tax) related to special termination benefits, which is included in 1997 pension cost. In 1996, the Company had an early retirement offer for certain salaried, non-union hourly and New York union employees of Distribution Corporation and Supply Corporation. The Company recorded related expense in 1996 of $8.2 million ($5.2 million after tax), comprised of special termination benefits and severance pay. The special termination benefits portion of the expense of $7.0 million is included in 1996 pension cost. On October 26, 1998, the Company announced an early retirement offer to certain salaried, non-union hourly and union employees of Distribution Corporation and Supply Corporation who have completed at least five years of service and have attained at least 55 years of age on or before December 1, 1998. Approximately 280 employees are eligible for the early retirement offer. The offer must be accepted by an eligible employee by November 30, 1998 and will become effective December 1, 1998. The Company anticipates that approximately 40% of those eligible will accept the offer. Management's estimate of the pretax expense associated with this early retirement offer related to special termination benefits is approximately $5.0 million to $5.7 million. A charge to earnings will be reflected in the Company's first quarter of 1999 financial results after the number of employees accepting the offer is known. Other Post-Retirement Benefits In addition to providing retirement plan benefits, the Company provides health care and life insurance benefits for substantially all domestic retired employees under a post-retirement benefit plan (Post-Retirement Plan). The Company has established Voluntary Employees' Beneficiary Association (VEBA) trusts for collectively bargained employees and non-bargaining employees. The VEBA trusts are similar to the Company's Retirement Plan trust. Contributions to the VEBA trusts are tax deductible, subject to limitations contained in the Internal Revenue Code and regulations. Contributions to the VEBA trusts are made to fund employees' post-retirement health care and life insurance benefits, as well as benefits as they are paid to current retirees. Post-Retirement Plan assets primarily consist of equity and fixed income investments and money market funds. Distribution Corporation and Supply Corporation represent virtually all of the Company's total post-retirement benefit costs. Distribution Corporation and Supply Corporation are fully recovering their net periodic post-retirement benefit costs in accordance with the PSC and the Pennsylvania Public Utility Commission (PaPUC) and Federal Energy Regulatory Commission (FERC) authorization, respectively. In accordance with regulatory guidelines, the difference between the amounts of post-retirement benefit costs recoverable in rates and the amounts of post-retirement benefit costs determined by the actuary under SFAS 106, "Employers' Accounting for Post-Retirement Benefits Other Than Pensions," are deferred in each jurisdiction as either a regulatory asset or liability, as appropriate. The PSC policy regarding amounts collected in rates, but not contributed, described under the Retirement Plan section in this note, also applies to other post-retirement benefits. Reconciliations of the Benefit Obligation, Plan Assets and Funded Status, as well as the components of Net Periodic Benefit Cost and the Weighted Average Assumptions are as follows: Year Ended September 30 (Thousands) 1998 1997 ---- ---- Change in Benefit Obligation Benefit Obligation at Beginning of Period $ 218,370 $ 212,047 Service Cost 4,022 4,056 Interest Cost 17,122 16,594 Plan Participants' Contributions 867 417 Actuarial (Gain) Loss 27,014 (6,653) Benefits Paid (10,412) (8,091) --------- --------- Benefit Obligation at End of Period $ 256,983 $ 218,370 --------- --------- Change in Plan Assets Fair Value of Assets at Beginning of Period $ 98,639 $ 73,059 Actual Return on Plan Assets 14,602 13,618 Employer Contribution 19,174 19,636 Plan Participants' Contributions 867 417 Benefits Paid (10,412) (8,091) --------- --------- Fair Value of Assets at End of Period $ 122,870 $ 98,639 --------- --------- Reconciliation of Funded Status Funded Status $(134,113) $(119,731) Unrecognized Net Actuarial Loss 19,660 505 Unrecognized Transition Obligation 106,907 114,034 --------- --------- Accrued Benefit Cost $ (7,546) $ (5,192) --------- --------- Weighted Average Assumptions as of September 30 1998 1997 1996 ---- ---- ---- Discount Rate 7.00% 7.75% 8.00% Expected Return on Plan Assets 8.50% 8.50% 8.50% Rate of Compensation Increase 5.00% 5.00% 5.00% Year Ended September 30 (Thousands) Components of Net Periodic Benefit Cost 1998 1997 1996 ---- ---- ---- Service Cost $ 4,022 $ 4,056 $ 3,926 Interest Cost 17,122 16,594 14,391 Expected Return on Plan Assets (8,099) (6,014) (4,306) Amortization of Transition Obligation 7,127 7,768 7,862 Amortization of Loss 683 - - Net Amortization and Deferral for Regulatory Purposes 915 (1,257) (798) -------- -------- -------- Net Periodic Benefit Cost $ 21,770 $ 21,147 $ 21,075 ======== ======== ======== The Benefit Obligation was determined using an assumed discount rate as noted in the data above. The effect of the discount rate change in 1998 was to increase the Benefit Obligation by $25.3 million. The effect of the discount rate change in 1997 was to increase the Benefit Obligation as of the beginning of the period by $7.0 million. The mortality assumption for healthy lives was changed from the 1983 Group Annuity Mortality Tables to the 1994 Group Annuity Mortality Tables. This change had the effect of increasing the Benefit Obligation as of the beginning of the period by $7.4 million. The annual rate of increase in the per capita cost of covered medical care benefits was assumed to be 11% for 1996, 10% for 1997 and 9% for 1998; this rate was assumed to decrease gradually to 5.5% by the year 2003 and remain at that level thereafter. The annual rate of increase for medical care benefits provided by Healthcare Maintenance Organizations was assumed to be 7.5% in 1998 and gradually decline to 5.5% by the year 2002 and remain level thereafter. The annual rate of increase in the per capita cost of covered prescription drug benefits was assumed to be 10% for 1996, 8.5% for 1997 and 9% for 1998. This rate was assumed to decrease gradually to 5.5% by the year 2003 and remain level thereafter. The annual rate increase in the per capita Medicare Part B Reimbursement was assumed to be 12% for 1996, 3.1% for 1997 and 9% for 1998. This rate was assumed to decrease gradually to 5.5% by the year 2003 and remain level thereafter. The health care cost trend rate assumptions used to calculate the per capita cost of covered medical care benefits have a significant effect on the amounts reported. If the health care cost trend rates were increased by 1% in each year, the Benefit Obligation as of October 1, 1998, would be increased by $39.9 million. This 1% change would also have increased the aggregate of the service and interest cost components of net periodic post-retirement benefit cost for 1998 by $2.8 million. If the health care cost trend rates were decreased by 1% in each year, the Benefit Obligation as of October 1, 1998, would be decreased by $34.7 million. This 1% change would also have decreased the aggregate of the service and interest cost components of net periodic post-retirement benefit cost for 1998 by $3.1 million. Note H - Commitments and Contingencies Leases System companies have entered into lease agreements, principally for the use of office space, business machines, transportation equipment and meters. The Company's policy is to treat all leases as operating leases for both accounting and ratemaking purposes. While certain of these leases are capital leases, had they been capitalized, the effect on results of operations and financial position would not be material. Total lease expense approximated $14.0 million in 1998, $16.0 million in 1997 and $16.9 million in 1996. At September 30, 1998, the future minimum payments under the Company's lease agreements for the next five years are: $11.3 million in 1999, $9.3 million in 2000, $7.6 million in 2001, $5.7 million in 2002 and $4.5 million in 2003. The aggregate future minimum lease payments attributable to later years is $15.7 million. Environmental Matters It is the Company's policy to accrue estimated environmental clean-up costs (investigation and remediation) when such amounts can reasonably be estimated and it is probable that the Company will be required to incur such costs. Distribution Corporation has estimated its clean-up costs related to the sites described below in (i) and (ii) will be in the range of $12.4 million to $13.4 million. At September 30, 1998, Distribution Corporation has recorded the minimum liability of $12.4 million. The Company is currently not aware of any material additional exposure to environmental liabilities. However, adverse changes in environmental regulations or other factors could impact the Company. In New York and Pennsylvania, Distribution Corporation is recovering site investigation and remediation costs in rates. Accordingly, the Consolidated Balance Sheet at September 30, 1998 includes related regulatory assets in the amount of approximately $12.4 million. The Company is subject to various federal, state and local laws and regulations relating to the protection of the environment. The Company has established procedures for the ongoing evaluation of its operations to identify potential environmental exposures and assure compliance with regulatory policies and procedures. (i) Former Manufactured Gas Plant Sites Distribution Corporation has incurred and is incurring clean-up costs at five former manufactured gas plant sites in New York and Pennsylvania. Two of these sites are at the remediation stage, two at the investigation stage, and one has completed the investigation stage with remediation being designed. Distribution Corporation has been designated by the New York Department of Environmental Conservation (DEC) as a potentially responsible party (PRP) with respect to one of these sites in New York, and is also engaged in litigation with the DEC and the party who bought that site from Distribution Corporation's predecessor. Distribution Corporation also received in 1998 a notice that the DEC believes Distribution Corporation is responsible for contamination discovered at an additional former manufactured gas plant site in New York (without naming Distribution Corporation as a PRP). Distribution Corporation responded that other companies operated that site before Distribution Corporation's predecessor did, that liability could be imposed upon Distribution Corporation only if hazardous substances were disposed of at the site during a period when the site was operated by Distribution Corporation's predecessor, and that Distribution Corporation was unaware of any such disposal. Distribution Corporation has not incurred any clean-up costs at this site nor has it been able to reasonably estimate the probability or extent of potential liability. (ii) Third Party Waste Disposal Sites Distribution Corporation and Supply Corporation are each currently identified by the DEC or the federal Environmental Protection Agency as one of a number of companies considered to be PRPs with respect to certain waste disposal sites in New York which were operated by unrelated third parties. The PRPs are alleged to have contributed to the materials that may have been collected at such waste disposal sites by the site operators. The ultimate cost to Distribution Corporation or Supply Corporation with respect to the remediation of these sites will depend on such factors as the remediation plan selected, the extent of site contamination, the number of additional PRPs at each site and the portion, if any, attributed to Distribution Corporation or Supply Corporation. Distribution Corporation is a PRP at two waste disposal sites, one of which is in remediation and the other has completed the investigation stage with remediation being designed to begin in fiscal 1999. Supply Corporation is a PRP at one waste disposal site, which is at the investigation stage, and has estimated its exposure at less than $0.1 million for that site. Without being named a PRP, Distribution Corporation has also signed a consent decree (court approval pending) by which it would share the costs of remediating another waste disposal site in New York. Distribution Corporation also understands that PRPs at another site have obtained records from the operator (a waste oil collector) indicating that the site received used oil from Distribution Corporation (among others). A contribution claim will likely be asserted against Distribution Corporation, which has not incurred any clean-up costs at this site nor been able to reasonably estimate the probability or extent of potential liability. (iii) Clean Air Standards The Company, in its international operations in the Czech Republic, is in the process of reconstructing boilers at the heating plant of PSZT to comply with certain clean air standards mandated by the Czech Republic government. Capital expenditures related to this reconstruction incurred by PSZT in 1998 (since its acquisition by Horizon through September 30, 1998) were approximately $12 million. Approximately $33 million is budgeted for this reconstruction work in 1999. Other The Company has entered into contractual commitments in the ordinary course of business including commitments by Distribution Corporation to purchase capacity on nonaffiliated pipelines to meet customer gas supply needs. The majority of these contracts (representing 80% of current contracted demand capacity) expire within the next five years. Costs incurred under these contracts are purchased gas costs, subject to state commission review, and are being recovered in customer rates through inclusion in Distribution Corporation's rate schedules. The Company is involved in litigation arising in the normal course of its business. In addition to the regulatory matters discussed in Note B - Regulatory Matters, the Company is involved in other regulatory matters arising in the normal course of business that involve rate base, cost of service and purchased gas cost issues. While the resolution of such litigation or other regulatory matters could have a material effect on earnings and cash flows in the year of resolution, none of this litigation, and none of these other regulatory matters, are expected to have a material adverse effect on the financial condition of the Company at this time. Note I - Business Segment Information The Company's operations are comprised of five business segments: Utility, Pipeline and Storage, Exploration and Production, International and Other Nonregulated. The Utility segment is regulated by the PSC and the PaPUC and its operations are carried out by Distribution Corporation. Distribution Corporation sells and transports gas to retail customers located in western New York and northwestern Pennsylvania. It also provides off-system sales to customers located in regions through which the upstream pipelines serving Distribution Corporation pass (i.e., from the southwestern to northeastern regions of the United States). The Pipeline and Storage segment is regulated by the FERC and its operations are carried out by Supply Corporation and SIP. Supply Corporation transports and stores natural gas for utilities and pipeline companies in the northeastern United States markets. In 1998, 1997 and 1996, 51%, 52% and 51%, respectively, of Supply Corporation's revenue was from affiliated companies, mainly Distribution Corporation. SIP has a one-third general partnership interest in Independence Pipeline Company. The Exploration and Production segment's operations are carried out by Seneca. Seneca is engaged in exploration for, and development and purchase of, oil and natural gas reserves in the Gulf Coast areas of Texas, Louisiana, and Alabama, and in California, Wyoming, and the Appalachian region of the United States. Seneca's production is, for the most part, sold to purchasers located in the vicinity of its wells. The International segment's operations are carried out by Horizon. Horizon is engaged in the investigation and development of international energy projects. Horizon's primary focus currently is in the Czech Republic where it owns a majority interest in SCT and PSZT, which have district heating and power generation operations. The Other Nonregulated segment consists primarily of the Company's timber, sawmill and dry kiln operations (carried out by the northeast division of Seneca and by Highland) and energy marketing operations (carried out by NFR and Upstate). The data presented in the tables below reflect the Company's business segments for the three years ended September 30, 1998. Total operating revenues by segment include both revenues from nonaffiliated customers and intersegment revenues. Operating income is total operating revenues less operating expenses, not including income taxes. The elimination of significant intercompany balances and transactions, if appropriate, is made in order to reconcile segment information with consolidated amounts. Identifiable assets of a segment are those assets that are used in the operations of that segment. Corporate assets are principally cash and temporary cash investments, receivables, deferred charges and cash surrender values of insurance contracts. Year Ended September 30 (Thousands) 1998 1997 1996 ---- ---- ---- Operating Revenues Utility $ 871,180 $ 991,366 $ 954,326 Pipeline and Storage 170,983 172,694 176,553 Exploration and Production 124,272 119,260 114,462 International 76,259 1,910 286 Other Nonregulated 106,527 82,005 68,644 Intersegment Revenues(1) (101,221) (101,423) (106,254) ---------- ---------- ---------- $1,248,000 $1,265,812 $1,208,017 ========== ========== ========== Operating Income (Loss) Before Income Taxes Utility $124,482 $123,856 $115,257 Pipeline and Storage 71,510 73,523 72,914 Exploration and Production(2)(3) (93,266) 42,694 46,408 International 2,136 (2,987) (14,281) Other Nonregulated 5,347 2,244 5,700 Corporate (2,254) (2,353) (2,231) -------- -------- -------- $107,955 $236,977 $223,767 ======== ======== ======== Depreciation, Depletion and Amortization Utility $ 33,459 $ 32,972 $ 31,491 Pipeline and Storage 21,816 21,459 19,942 Exploration and Production(3) 50,937 51,117 46,042 International 7,309 107 - Other Nonregulated 5,357 5,992 752 Corporate 2 3 4 -------- ------- -------- $118,880 $111,650 $ 98,231 ======== ======== ======== Capital Expenditures Utility $ 50,680 $ 66,908 $ 63,730 Pipeline and Storage 23,692 22,562 22,260 Exploration and Production(4) 293,870 120,282 83,554 International(4) 14,778 292 133 Other Nonregulated(5) 10,213 16,266 3,056 Intersegment Elimination - - (1,166) -------- -------- -------- $393,233 $226,310 $171,567 ======== ======== ======== Identifiable Assets At September 30 (Thousands) Utility $1,161,046 $1,163,702 $1,154,364 Pipeline and Storage 513,346 510,109 515,569 Exploration and Production 661,742 466,208 396,077 International 239,763 23,987 3,370 Other Nonregulated 62,228 51,200 35,585 Corporate 46,334 52,125 44,807 ---------- ---------- ---------- $2,684,459 $2,267,331 $2,149,772 ========== ========== ========== (1) Represents primarily Pipeline and Storage revenue from the Utility segment. (2) 1998 includes impairment of oil and gas producing properties of $129.0 million. Refer to Note A - Summary of Significant Accounting Policies for further discussion. (3) In 1998, Seneca changed its method of depletion for oil and gas producing properties from the gross revenue method to the units of production method. The effect of this change was to reduce 1998 depletion expense and to reduce the operating loss before income taxes of the Exploration and Production segment by $2.3 million. See further discussion in Note A - Summary of Significant Accounting Policies. (4) 1998 amounts exclude stock acquisitions. Refer to Note J - Stock Acquisitions for further discussion. (5) 1997 amount includes noncash acquisition of $12.3 million in exchange for long-term debt obligations. Note J - Stock Acquisitions Exploration and Production In May 1998, Seneca West Corporation (Seneca West), a wholly-owned subsidiary of Seneca, completed a tender offer (an offer of $2.00 per share) for the outstanding shares of HarCor. The tender offer was commenced pursuant to the terms of an Agreement and Plan of Merger among HarCor, Seneca and Seneca West which provided for the merger of Seneca West with and into HarCor following the successful consummation of the tender offer. Approximately 95% of the outstanding shares of HarCor common stock were tendered in accordance with the tender offer. Accordingly, Seneca West was merged with and into HarCor and the common stock that was not purchased pursuant to the tender offer was converted in the merger into the right to receive $2.00 per share. The cost of the tender offer and subsequent conversion of the remaining shares of HarCor was approximately $32.6 million. The acquisition of HarCor was accounted for in accordance with the purchase method as specified by APB 16. HarCor's results of operations were incorporated into the Company's consolidated financial statements for the period subsequent to the completion of the tender offer in May 1998. See Note D - Capitalization for discussion of HarCor's senior secured debt. International During the year, Horizon, through a wholly-owned subsidiary, increased its ownership interest in SCT from 36.8% at September 30, 1997 to 82.7% at September 30, 1998. The cost of acquiring these additional shares was approximately $24.9 million. Also in 1998, Horizon invested in PSZT, and owned an 86.2% interest at September 30, 1998. The cost of acquiring the shares of PSZT was approximately $64.5 million. PSZT is a wholesale power and district heating company that adjoins the service territory of SCT in the northern Bohemia region of the Czech Republic. The acquisitions of SCT and PSZT have been accounted for in accordance with the purchase method as specified by APB 16. The acquisitions resulted in approximately $10.6 million of goodwill, which is being amortized over a twenty-year period. This goodwill ($10.1 million at September 30, 1998) is recorded in Other Assets in the Company's Consolidated Balance Sheet. See Note D Capitalization for discussion of the debt of SCT and PSZT. Note K - Quarterly Financial Data (unaudited) In the opinion of management, the following quarterly information includes all adjustments necessary for a fair statement of the results of operations for such periods. Per common share amounts are calculated using the weighted average number of shares outstanding during each quarter. The total of all quarters may differ from the per common share amounts shown on the Consolidated Statement of Income, which is based on the weighted average number of shares outstanding for the entire fiscal year. Because of the seasonal nature of the Company's heating business, there are substantial variations in operations reported on a quarterly basis. Financial data for the quarter ended December 31, 1997 reflects the accounting change in depletion methods for Seneca's oil and gas assets, which had a negative after tax $9.1 million, or $0.24 per share (basic and diluted) non-cash cumulative effect through October 1, 1997. See further discussion of this accounting change in Note A - Summary of Significant Accounting Policies. Financial data for the quarter ended March 31, 1998 reflects an impairment of Seneca's oil and gas producing properties. The after tax amount of this impairment charge was $79.1 million, or $2.07 per share (basic). See further discussion of this impairment in Note A - Summary of Significant Accounting Policies. Financial data for the quarter ended March 31, 1998 also reflects an after tax income amount of $5.0 million, or $0.13 per share (basic) from the settlement of the primary issues relating to IRS audits of years 1977 - 1994. Diluted per share amounts for the quarter ended March 31, 1998 are not applicable due to the antidilution effect on the loss for the quarter.
Net Income (Loss) Income Income Per Common (Loss) (Loss) Share Before Available Earnings Operating Before Cumulative for (Loss) Per Quarter Operating Income Cumulative Effect Common Common Share -------------- -------------- Ended Revenues (Loss) Effect Basic Diluted Stock Basic Diluted ----- -------- ------ ------ ----- ------- ----- ----- ------- 1998 (Thousands, except per common share amounts) - ------------------------------------------------------------------------------------ 12/31/97 $371,021 $ 52,280 $ 37,534 $ 0.98 $0.97 $ 28,418 $ 0.74 $0.73 3/31/98 $462,648 $(16,228) $(21,262) $(0.56) N/A $(21,262) $(0.56) N/A 6/30/98 $242,447 $ 33,726 $ 19,107 $ 0.50 $0.49 $ 19,107 $ 0.50 $0.49 9/30/98 $171,884 $ 14,153 $ (3,075) $(0.08) N/A $ (3,075) $(0.08) N/A 1997 (Thousands, except per common share amounts) - ------------------------------------------------------------------------------------ 12/31/96 $363,492 $ 52,153 $ 38,590 $ 1.02 $1.01 $ 38,590 $ 1.02 $1.01 3/31/97 $498,704 $ 70,812 $ 57,109 $ 1.50 $1.48 $ 57,109 $ 1.50 $1.48 6/30/97 $246,051 $ 31,283 $ 18,905 $ 0.50 $0.49 $ 18,905 $ 0.50 $0.49 9/30/97 $157,565 $ 14,055 $ 84 $ - $ - $ 84 $ - $ -
N/A - Not applicable due to antidilution. Note L - Market for Common Stock and Related Shareholder Matters (unaudited) At September 30, 1998, there were 23,743 holders of National Fuel Gas Company common stock. The common stock is listed and traded on the New York Stock Exchange. Information related to restrictions on the payment of dividends can be found in Note D Capitalization. The quarterly price ranges and quarterly dividends declared for the fiscal years ended September 30, 1998 and 1997, are shown below: Price Range Dividends Quarter Ended High Low Declared - ------------- ---- --- -------- 1998 12/31/97 $48-15/16 $42-11/16 $.435 3/31/98 $48-13/16 $45-3/8 $.435 6/30/98 $49-1/8 $39-5/8 $.450 9/30/98 $47 $39-13/16 $.450 1997 12/31/96 $44-1/8 $36-5/8 $.420 3/31/97 $44-7/8 $39-3/8 $.420 6/30/97 $44-1/8 $40-5/8 $.435 9/30/97 $45-7/16 $40-1/8 $.435 Note M - Supplementary Information for Oil and Gas Producing Activities The following supplementary information is presented in accordance with SFAS 69, "Disclosures about Oil and Gas Producing Activities," and related SEC accounting rules. Capitalized Costs Relating to Oil and Gas Producing Activities At September 30 (Thousands) 1998 1997 ---- ---- Proved Properties $739,684 $658,327 Unproved Properties 141,873 64,597 -------- -------- 881,557 722,924 Less - Accumulated Depreciation, Depletion and Amortization 261,236 284,429 -------- -------- $620,321 $438,495 ======== ======== Costs related to unproved properties are excluded from amortization as they represent unevaluated properties that require additional drilling to determine the existence of oil and gas reserves. Following is a summary of such costs excluded from amortization at September 30, 1998: Total Year Costs Incurred -------------------------------- (Thousands) at September 30, 1998 1998 1997 1996 Prior --------------------- ---- ---- ---- ----- Acquisition Costs $123,632 $ 92,864 $7,114 $12,930 $10,724 Exploration Costs 18,241 18,241 - - - -------- -------- ------ ------- ------- $141,873 $111,105 $7,114 $12,930 $10,724 ======== ======== ====== ======= ======= Costs Incurred in Oil and Gas Property Acquisition, Exploration and Development Activities Year Ended September 30 (Thousands) 1998 1997 1996 ---- ---- ---- Property Acquisition Costs:* Proved $189,201 $ 4,154 $ 4,632 Unproved 88,369 23,120 12,879 Exploration Costs 74,421 76,703 33,191 Development Costs 23,887 15,583 32,747 Other - - 230 -------- -------- ------- $375,878 $119,560 $83,679 ======== ======== ======= * Total proved and unproved property acquisition costs of $277.6 million include amounts related to the HarCor, Bakersfield Energy and Whittier Trust properties acquired in 1998 of $87.0 million, $25.3 million and $141.1 million, respectively. Results of Operations for Producing Activities Year Ended September 30 (Thousands) 1998 1997 1996 ---- ---- ---- Operating Revenues: Natural Gas (includes revenues from sales to affiliates of $11,065, $10,682 and $11,872, respectively) $ 89,284 $100,411 $ 91,018 Oil, Condensate and Other Liquids 31,770 39,237 33,978 -------- -------- -------- Total Operating Revenues* 121,054 139,648 124,996 Production/Lifting Costs 23,622 17,335 15,196 Depreciation, Depletion and Amortization ($0.96 per Mcfe of production, $0.36 and $0.36 per dollar of operating revenues, respectively)** 50,221 50,687 45,502 Impairment of Oil and Gas Producing Properties*** 128,996 - - Income Tax (Benefit) Expense (28,949) 24,699 22,069 -------- -------- -------- Results of Operations for Producing Activities (excluding corporate overheads and interest charges) $(52,836) $ 46,927 $ 42,229 ======== ======== ======== * Exclusive of hedging gains and losses. See further discussion in Note F - Financial Instruments. ** In 1998, Seneca changed its method of depletion for oil and gas producing properties from the gross revenue method to the units of production method. See further discussion in Note A - Summary of Significant Accounting Policies. *** See discussion of impairment in Note A - Summary of Significant Accounting Policies. Reserve Quantity Information (unaudited) The Company's proved oil and gas reserves are located in the United States. The estimated quantities of proved reserves disclosed in the table below are based upon estimates by qualified Company geologists and engineers and are audited by independent petroleum engineers. Such estimates are inherently imprecise and may be subject to substantial revisions as a result of numerous factors including, but not limited to, additional development activity, evolving production history, and continual reassessment of the viability of production under varying economic conditions. Gas Oil Year Ended MMcf Mbbl ---------------------- --------------------- September 30 1998 1997 1996 1998 1997 1996 ---- ---- ---- ---- ---- ---- Proved Developed and Undeveloped Reserves: Beginning of Year 232,449 207,082 221,459 17,981 25,749 22,865 Extensions and Discoveries 40,293 47,951 29,161 640 359 5,701 Revisions of Previous Estimates (18,623) 20,820 (3,442) (4,191) (6,224) (1,173) Production (36,474) (38,586) (38,767) (2,614) (1,902) (1,742) Sales of Minerals in Place - (5,464) (1,532) - (1) (27) Purchases of Minerals in Place and Other 107,420 646 203 54,775 - 125 ------- ------- ------- ------ ------ ------ End of Year 325,065 232,449 207,082 66,591 17,981 25,749 ======= ======= ======= ====== ====== ====== Proved Developed Reserves: Beginning of Year 194,454 163,537 162,504 11,354 14,043 14,937 ======= ======= ======= ====== ====== ====== End of Year 230,508 194,454 163,537 48,081 11,354 14,043 ======= ======= ======= ====== ====== ====== Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves (unaudited) The Company cautions that the following presentation of the standardized measure of discounted future net cash flows is intended to be neither a measure of the fair market value of the Company's oil and gas properties, nor an estimate of the present value of actual future cash flows to be obtained as a result of their development and production. It is based upon subjective estimates of proved reserves only and attributes no value to categories of reserves other than proved reserves, such as probable or possible reserves, or to unproved acreage. Furthermore, it is based on year-end prices and costs adjusted only for existing contractual changes, and it assumes an arbitrary discount rate of 10%. Thus, it gives no effect to future price and cost changes certain to occur under the widely fluctuating political and economic conditions of today's world. The standardized measure is intended instead to provide a somewhat better means for comparing the value of the Company's proved reserves at a given time with those of other oil- and gas-producing companies than is provided by a simple comparison of raw proved reserve quantities. Year Ended September 30 (Thousands) 1998 1997 1996 ---- ---- ---- Future Cash Inflows $1,547,216 $1,072,375 $1,003,280 Less: Future Production and Development Costs 574,637 252,205 294,778 Future Income Tax Expense at Applicable Statutory Rate 245,120 257,172 221,956 ---------- ---------- ---------- Future Net Cash Flows 727,459 562,998 486,546 Less: 10% Annual Discount for Estimated Timing of Cash Flows 260,688 179,798 157,302 ---------- ---------- ---------- Standardized Measure of Discounted Future Net Cash Flows $ 466,771 $ 383,200 $ 329,244 ========== ========== ========== The principal sources of change in the standardized measure of discounted future net cash flows were as follows: Year Ended September 30 (Thousands) 1998 1997 1996 ---- ---- ---- Standardized Measure of Discounted Future Net Cash Flows at Beginning of Year $383,200 $329,244 $245,268 Sales, Net of Production Costs (97,432) (122,313) (109,801) Net Changes in Prices, Net of Production Costs (180,853) 78,499 147,330 Purchases of Minerals in Place 364,102 1,138 770 Sales of Minerals in Place - (9,632) (1,141) Extensions and Discoveries 36,844 88,228 93,864 Changes in Estimated Future Development Costs (104,181) (20,785) (53,630) Previously Estimated Development Costs Incurred 28,514 43,731 42,780 Net Change in Income Taxes at Applicable Statutory Rate 57,190 (24,797) (52,613) Revisions of Previous Quantity Estimates (75,136) (27,317) (15,491) Accretion of Discount and Other 54,523 47,204 31,908 -------- -------- -------- Standardized Measure of Discounted Future Net Cash Flows at End of Year $466,771 $383,200 $329,244 ======== ======== ======== NATIONAL FUEL GAS COMPANY AND SUBSIDIARIES Schedule II - Valuation and Qualifying Accounts (Thousands) ----------- Additions ---------------------- Charged to Balance at Charged to Other Balance at Beginning Costs and Accounts Deductions End of Description of Period Expenses (Note 1) (Note 2) Period - ----------- ---------- ---------- ----------- ---------- --------- Year Ended September 30, 1998 - ----------------------------- Reserve for Doubtful Accounts $8,291 $15,861 $ 746 $18,666 $6,232 ====== ======= ====== ======= ====== Year Ended September 30, 1997 - ----------------------------- Reserve for Doubtful Accounts $7,672 $16,586 $ - $15,967 $8,291 ====== ======= ====== ======= ====== Year Ended September 30, 1996 - ----------------------------- Reserve for Doubtful Accounts $5,924 $15,191 $ - $13,443 $7,672 ====== ======= ====== ======= ====== Note 1 - Represents opening balance sheet reserve plus exchange rate impact of translating the Czech koruna to the U.S. dollar for Horizon. Note 2 - Amounts represent net accounts receivable written-off. 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 The information required by this item concerning the directors of the Company is omitted pursuant to Instruction G of Form 10-K since the Company's definitive Proxy Statement for its February 18, 1999 Annual Meeting of Shareholders will be filed with the SEC not later than 120 days after September 30, 1998. The information provided in such definitive Proxy Statement is incorporated herein by reference. Information concerning the Company's executive officers can be found in Part I, Item 1, of this report. ITEM 11 Executive Compensation The information required by this item is omitted pursuant to Instruction G of Form 10-K since the Company's definitive Proxy Statement for its February 18, 1999 Annual Meeting of Shareholders will be filed with the SEC not later than 120 days after September 30, 1998. The information provided in such definitive Proxy Statement is incorporated herein by reference. ITEM 12 Security Ownership of Certain Beneficial Owners and Management The information required by this item is omitted pursuant to Instruction G of Form 10-K since the Company's definitive Proxy Statement for its February 18, 1999 Annual Meeting of Shareholders will be filed with the SEC not later than 120 days after September 30, 1998. The information provided in such definitive Proxy Statement is incorporated herein by reference. ITEM 13 Certain Relationships and Related Transactions At September 30, 1998, the Company knows of no relationships or transactions required to be disclosed pursuant to Item 404 of Regulation S-K. PART IV ------- ITEM 14 Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) Financial Statement Schedules All financial statement schedules filed as part of this report are included in Item 8 of this Form 10-K and reference is made thereto. (b) Reports on Form 8-K None (c) Exhibits Exhibit Number Description of Exhibits ------ ----------------------- 3(i) Articles of Incorporation: 3.1 Restated Certificate of Incorporation of National Fuel Gas Company dated September 21, 1998 3(ii) By-Laws: 3.2 National Fuel Gas Company By-Laws as amended through September 17, 1998 (4) Instruments Defining the Rights of Security Holders, Including Indentures: * Indenture dated as of October 15, 1974, between the Company and The Bank of New York (formerly Irving Trust Company) (Exhibit 2(b) in File No. 2-51796) * Third Supplemental Indenture dated as of December 1, 1982, to Indenture dated as of October 15, 1974, between the Company and The Bank of New York (formerly Irving Trust Company) (Exhibit 4(a)(4) in File No. 33-49401) * Tenth Supplemental Indenture dated as of February 1, 1992, to Indenture dated as of October 15, 1974, between the Company and The Bank of New York (formerly Irving Trust Company) (Exhibit 4(a), Form 8-K dated February 14, 1992 in File No. 1-3880) * Eleventh Supplemental Indenture dated as of May 1, 1992, to Indenture dated as of October 15, 1974, between the Company and The Bank of New York (formerly Irving Trust Company) (Exhibit 4(b), Form 8-K dated February 14, 1992 in File No. 1-3880) * Twelfth Supplemental Indenture dated as of June 1, 1992, to Indenture dated as of October 15, 1974, between the Company and The Bank of New York (formerly Irving Trust Company) (Exhibit 4(c), Form 8-K dated June 18, 1992 in File No. 1-3880) * Thirteenth Supplemental Indenture dated as of March 1, 1993, to Indenture dated as of October 15, 1974, between the Company and The Bank of New York (formerly Irving Trust Company) (Exhibit 4(a)(14) in File No. 33-49401) * Fourteenth Supplemental Indenture dated as of July 1, 1993, to Indenture dated as of October 15, 1974, between the Company and The Bank of New York (formerly Irving Trust Company) (Exhibit 4.1, Form 10-K for fiscal year ended September 30, 1993 in File No. 1-3880) * Fifteenth Supplemental Indenture dated as of September 1, 1996 to Indenture dated as of October 15, 1974, between the Company and The Bank of New York (formerly Irving Trust Company) (Exhibit 4.1, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) * Rights Agreement between National Fuel Gas Company and Marine Midland Bank dated June 12, 1996 (Exhibit 99.1, Form 8-K dated June 13, 1996 in File No. 1-3880) (10) Material Contracts: (ii) (B) Contracts upon which Registrant's business is substantially dependent: * Service Agreement No. 830016 with Texas Eastern Transmission Corporation, under Rate Schedule FT-1, dated November 2, 1995 (Exhibit 10.1, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) * Service Agreement No. 830017 with Texas Eastern Transmission Corporation, under Rate Schedule FT-1, dated November 2, 1995 (Exhibit 10.2, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) * Service Agreement with Texas Eastern Transmission Corporation, under Rate Schedule CDS, dated November 2, 1995 (Exhibit 10.3, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) * Service Agreement between National Fuel Gas Distribution Corporation and National Fuel Gas Supply Corporation, under Rate Schedule FSS, dated April 3, 1996 [Portions of this agreement are subject to confidential treatment under Rule 24b-2] (Exhibit 10.4, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) * Service Agreement with St. Clair Pipelines Ltd., dated January 29, 1996 [Portions of this agreement are subject to confidential treatment under Rule 24b-2] (Exhibit 10.5, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) * Service Agreement with Empire State Pipeline under Rate Schedule FT, dated December 15, 1994 [Portions of this agreement are subject to confidential treatment under Rule 24b-2] (Exhibit 10.1, Form 10-K for fiscal year ended September 30, 1995, in File No. 1-3880) * Service Agreement between National Fuel Gas Distribution Corporation and National Fuel Gas Supply Corporation under Rate Schedule ESS dated August 1, 1993 (Exhibit 10.2, Form 10-K for fiscal year ended September 30, 1995, in File No. 1-3880) * Service Agreement between National Fuel Gas Distribution Corporation and National Fuel Gas Supply Corporation under Rate Schedule ESS dated September 19, 1995 (Exhibit 10.3, Form 10-K for fiscal year ended September 30, 1995, in File No. 1-3880) * Service Agreement between National Fuel Gas Distribution Corporation and National Fuel Gas Supply Corporation under Rate Schedule EFT dated August 1, 1993 (Exhibit 10.4, Form 10-K for fiscal year ended September 30, 1995, in File No. 1-3880) * Amendment dated as of May 1, 1995 to Service Agreement between National Fuel Gas Distribution Corporation and National Fuel Gas Supply Corporation under Rate Schedule EFT dated August 1, 1993 (Exhibit 10.5, Form 10-K for fiscal year ended September 30, 1995, in File No. 1-3880) * Service Agreement with Transcontinental Gas Pipe Line Corporation under Rate Schedule FT dated August 1, 1993 (Exhibit 10.6, Form 10-K for fiscal year ended September 30, 1995, in File No. 1-3880) * Service Agreement with Transcontinental Gas Pipe Line Corporation under Rate Schedule FT dated October 1, 1993 (Exhibit 10.7, Form 10-K for fiscal year ended September 30, 1995, in File No. 1-3880) * Service Agreement with Columbia Gas Transmission Corporation under Rate Schedule FTS, dated November 1, 1993 and executed February 13, 1994 (Exhibit 10.1, Form 10-K for fiscal year ended September 30, 1994 in File No. 1-3880) * Service Agreement with Columbia Gas Transmission Corporation under Rate Schedule FSS, dated November 1, 1993 and executed February 13, 1994 (Exhibit 10.2, Form 10-K for fiscal year ended September 30, 1994 in File No. 1-3880) * Service Agreement with Columbia Gas Transmission Corporation under Rate Schedule SST, dated November 1, 1993 and executed February 13, 1994 (Exhibit 10.3, Form 10-K for fiscal year ended September 30, 1994 in File No. 1-3880) * Gas Transportation Agreement with Tennessee Gas Pipeline Company under Rate Schedule FT-A (Zone 4), dated September 1, 1993 (Exhibit 10.1, Form 10-K for fiscal year ended September 30, 1993 in File No. 1-3880) * Gas Transportation Agreement with Tennessee Gas Pipeline Company under Rate Schedule FT-A (Zone 5), dated September 1, 1993 (Exhibit 10.2, Form 10-K for fiscal year ended September 30, 1993 in File No. 1-3880) * Service Agreement with CNG Transmission Corporation under Rate Schedule FT, dated October 1, 1993 (Exhibit 10.5, Form 10-K for fiscal year ended September 30, 1993 in File No. 1-3880) * Service Agreement with CNG Transmission Corporation under Rate Schedule GSS, dated October 1, 1993 (Exhibit 10.6, Form 10-K for fiscal year ended September 30, 1993 in File No. 1-3880) (iii) Compensatory plans for officers: * Employment Agreement, dated September 17, 1981, with Bernard J. Kennedy (Exhibit 10.4, Form 10-K for fiscal year ended September 30, 1994 in File No. 1-3880) * Ninth Extension to Employment Agreement with Bernard J. Kennedy, dated September 19, 1996 (Exhibit 10.6, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) * National Fuel Gas Company 1983 Incentive Stock Option Plan, as amended and restated through February 18, 1993 (Exhibit 10.2, Form 10-Q for the quarterly period ended March 31, 1993 in File No. 1-3880) * National Fuel Gas Company 1984 Stock Plan, as amended and restated through February 18, 1993 (Exhibit 10.3, Form 10-Q for the quarterly period ended March 31, 1993 in File No. 1-3880) * Amendment to the National Fuel Gas Company 1984 Stock Plan, dated December 11, 1996 (Exhibit 10.7, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) * National Fuel Gas Company 1993 Award and Option Plan, dated February 18, 1993 (Exhibit 10.1, Form 10-Q for the quarterly period ended March 31, 1993 in File No. 1-3880) * Amendment to National Fuel Gas Company 1993 Award and Option Plan, dated December 18, 1996 (Exhibit 10, Form 10-Q for the quarterly period ended December 31, 1996 in File No. 1-3880) * Amendment to National Fuel Gas Company 1993 Award and Option Plan, dated December 11, 1996 (Exhibit 10.8, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) * Amendment to National Fuel Gas Company 1993 Award and Option Plan, dated October 27, 1995 (Exhibit 10.8, Form 10-K for fiscal year ended September 30, 1995 in File No. 1-3880) * National Fuel Gas Company 1997 Award and Option Plan (Exhibit 10.9, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) * Change in Control Agreement, dated May 1, 1992, with Philip C. Ackerman (Exhibit EX-10.4, Form 10-K for fiscal year ended September 30, 1992 in File No. 1-3880) * Change in Control Agreement, dated May 1, 1992, with Richard Hare (Exhibit EX-10.5, Form 10-K for fiscal year ended September 30, 1992 in File No. 1-3880) * Agreement, dated August 1, 1989, with Richard Hare (Exhibit 10-Q, Form 10-K for fiscal year ended September 30, 1989 in File No. 1-3880) * Agreement dated August 1, 1986, with Joseph P. Pawlowski (Exhibit 10.1, Form 10-K for fiscal year ended September 30,1997 in File No. 1-3880) * Agreement dated August 1, 1986, with Gerald T. Wehrlin (Exhibit 10.2, Form 10-K for fiscal year ended September 30, 1997, in File No. 1-3880) * National Fuel Gas Company Deferred Compensation Plan, as amended and restated through May 1, 1994 (Exhibit 10.7, Form 10-K for fiscal year ended September 30, 1994 in File No. 1-3880) * Amendment to the National Fuel Gas Company Deferred Compensation Plan, dated September 19, 1996 (Exhibit 10.10, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) * Amendment to National Fuel Gas Company Deferred Compensation Plan, dated September 27, 1995 (Exhibit 10.9, Form 10-K for fiscal year ended September 30, 1995 in File No. 1-3880) * National Fuel Gas Company Deferred Compensation Plan, as amended and restated through March 20, 1997 (Exhibit 10.3, Form 10-K for fiscal year ended September 30, 1997 in File No. 1-3880) * Amendment to National Fuel Gas Company Deferred Compensation Plan dated June 16, 1997 (Exhibit 10.4, Form 10-K for fiscal year ended September 30, 1997 in File No. 1-3880) 10.1 Amendment No. 2 to the National Fuel Gas Company Deferred Compensation Plan, dated March 13, 1998 * National Fuel Gas Company Tophat Plan, effective March 20, 1997 (Exhibit 10, Form 10-Q for the quarterly period ended June 30, 1997 in File No. 1-3880) 10.2 Amendment No. 1 to the National Fuel Gas Company Tophat Plan, dated April 6, 1998 * Death Benefits Agreement, dated August 28, 1991, with Bernard J. Kennedy (Exhibit 10-TT, Form 10-K for fiscal year ended September 30, 1991 in File No. 1-3880) * Amendment to Death Benefit Agreement of August 28, 1991, with Bernard J. Kennedy, dated March 15, 1994 (Exhibit 10.11, Form 10-K for fiscal year ended September 30, 1995 in File No. 1-3880) * Amended and Restated Split Dollar Insurance and Death Benefit Agreement dated September 17, 1997 with Philip C. Ackerman (Exhibit 10.5, Form 10-K for fiscal year ended September 30, 1997 in File No. 1-3880) * Amended and Restated Split Dollar Insurance and Death Benefit Agreement dated September 15, 1997 with Richard Hare (Exhibit 10.6, Form 10-K for fiscal year ended September 30, 1997 in File No. 1-3880) * Amended and Restated Split Dollar Insurance and Death Benefit Agreement dated September 15, 1997 with Joseph P. Pawlowski (Exhibit 10.7, Form 10-K for fiscal year ended September 30, 1997 in File No. 1-3880) * Amended and Restated Split Dollar Insurance and Death Benefit Agreement dated September 15, 1997 with Gerald T. Wehrlin (Exhibit 10.8, Form 10-K for fiscal year ended September 30, 1997 in File No. 1-3880) * National Fuel Gas Company and Participating Subsidiaries Executive Retirement Plan as amended and restated through November 1, 1995 (Exhibit 10.10, Form 10-K for fiscal year ended September 30, 1995 in File No. 1-3880) * National Fuel Gas Company and Participating Subsidiaries 1996 Executive Retirement Plan Trust Agreement (II) dated May 10, 1996 (Exhibit 10.13, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) * Amendments to National Fuel Gas Company and Participating Subsidiaries Executive Retirement Plan dated September 18, 1997 (Exhibit 10.9, Form 10-K for fiscal year ended September 30, 1997 in File No. 1-3880) * Summary of Annual at Risk Compensation Incentive Program (Exhibit 10.10, Form 10-K for fiscal year ended September 30, 1993 in File No. 1-3880) * Administrative Rules with Respect to at Risk Awards under the 1993 Award and Option Plan (Exhibit 10.14, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) * Administrative Rules of the Compensation Committee of the Board of Directors of National Fuel Gas Company as amended through December 11, 1996 (Exhibit 10.15, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) * Excerpts of Minutes from the National Fuel Gas Company Board of Directors Meeting of December 5, 1991 regarding change in control agreements, non-employee director retirement plan, and restrictions on restricted stock (Exhibit 10-UU, Form 10-K for fiscal year ended September 30, 1991 in File No. 1-3880) * Excerpts from Minutes from the National Fuel Gas Company Board of Directors Meeting of September 19, 1996 regarding compensation of non-employee directors and related amendments of By-Laws (Exhibit 3.1, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) * Excerpts of Minutes from the National Fuel Gas Company Board of Directors Meeting of February 20, 1997 regarding the Retirement Benefits for Bernard J. Kennedy (Exhibit 10.10, Form 10-K for fiscal year ended September 30, 1997 in File No. 1-3880) * Excerpts of Minutes from the National Fuel Gas Company Board of Directors Meeting of March 20, 1997 regarding the Retainer Policy for Non-Employee Directors (Exhibit 10.11, Form 10-K for fiscal year ended September 30, 1997 in File No. 1-3880) * Form of Change in Control Agreement, dated May 1, 1992, with Walter E. DeForest, Bruce H. Hale, Joseph P. Pawlowski, Dennis J. Seeley, David F. Smith and Gerald T. Wehrlin, and dated March 16, 1995, with James A. Beck (Exhibit 10.16, Form 10-K for fiscal year ended September 30, 1996 in File No. 1-3880) (12) Computation of Ratio of Earnings to Fixed Charges (13) Letter to Shareholders as contained in the 1998 Annual Report and incorporated by reference into this Form 10-K (21) Subsidiaries of the Registrant: See Item 1 of Part I of this Annual Report on Form 10-K (23) Consents of Experts and Counsel: 23.1 Consent of Ralph E. Davis Associates, Inc. 23.2 Consent of Independent Accountants (27) Financial Data Schedules (99) Additional Exhibits: 99.1 Report of Ralph E. Davis Associates, Inc. All other exhibits are omitted because they are not applicable or the required information is shown elsewhere in this Annual Report on Form 10-K. * Incorporated herein by reference as indicated. 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. National Fuel Gas Company (Registrant) ------------------------- By /s/ B. J. Kennedy ---------------------------- B. J. Kennedy Chairman of the Board, President Date: December 10, 1998 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 dates indicated. Signature Title --------- ----- /s/ B. J. Kennedy ------------------------ Chairman of the Board, B. J. Kennedy President, Chief Executive Officer and Director Date: December 10, 1998 ----------------- /s/ P. C. Ackerman ------------------------ Senior Vice President, Principal P. C. Ackerman Financial Officer and Director Date: December 10, 1998 ----------------- /s/ R. T. Brady ------------------------ Director R. T. Brady Date: December 10, 1998 ----------------- /s/ J. V. Glynn ------------------------ Director J. V. Glynn Date: December 10, 1998 ----------------- /s/ W. J. Hill ------------------------ Director W. J. Hill Date: December 10, 1998 ----------------- /s/ B. S. Lee ------------------------ Director B. S. Lee Date: December 10, 1998 ----------------- /s/ E. T. Mann ------------------------ Director E. T. Mann Date: December 10, 1998 ----------------- /s/ G. L. Mazanec ------------------------ Director G. L. Mazanec Date: December 10, 1998 ----------------- /s/ G. H. Schofield ------------------------ Director G. H. Schofield Date: December 10, 1998 ----------------- /s/ J. P. Pawlowski ------------------------ Treasurer and Principal J. P. Pawlowski Accounting Officer Date: December 10, 1998 ----------------- /s/ A. M. Cellino ------------------------ Secretary A. M. Cellino Date: December 10, 1998 ----------------- /s/ G. T. Wehrlin ------------------------ Controller G. T. Wehrlin Date: December 10, 1998 ----------------- APPENDIX TO ITEM 2 - PROPERTIES Five maps outlining the Company's operating areas at September 30, 1998 are included on the inside front cover and on page 1 of the paper format version of the Company's combined Annual Report to Shareholders/Form 10-K. The first map identifies the Company's Pipeline and Storage operating area (i.e., Supply Corporation's storage areas and pipelines). The second map identifies the Company's Exploration and Production operating area (i.e., Seneca's operating area). The third map identifies the Company's International operating area (i.e., Horizon's Czech Republic operations). The fourth map identifies the geographic location of the Company's Other Nonregulated operating areas (i.e., NFR's marketing offices and Highland's sawmill operations). The fifth map identifies the Company's Utility Operating area (i.e., Distribution Corporation's service area). APPENDIX TO ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION - GRAPHS A. The Revenue Dollar - 1998 Two pie graphs detailing the revenue dollar in 1998: where it came from and where it went to, broken down as follows: Where it came from: $ .483 Residential Gas Sales .147 Commercial, Industrial and Off-System Gas Sales .083 Oil and Gas Production Revenues .077 Gas Transportation Revenues .070 Energy Marketing Revenues .039 District Heating Revenues .028 Gas Storage Service Revenues .018 Electric Generation Revenues .014 Timber and Sawmill Revenues .041 Other Revenues $1.000 Total Where it went to: $ .348 Gas Purchased .150 Wages, Including Benefits .105 Depreciation .102 Impairment of Oil and Gas Producing Properties .096 Other Materials and Services .087 Taxes .062 Interest .030 Fuel Used in Heat and Electric Generation .018 Earnings .002 Minority Interest in Foreign Subsidiaries $1.000 Total Exhibit Index ------------- 3.1 Restated Certificate of Incorporation of National Fuel Gas Company dated September 21, 1998 3.2 National Fuel Gas Company By-Laws as amended through September 17, 1998 10.1 Amendment No. 2 to the National Fuel Gas Company Deferred Compensation Plan, dated March 13, 1998 10.2 Amendment No. 1 to the National Fuel Gas Company Tophat Plan, dated April 6, 1998 (12) Computation of Ratio of Earnings to Fixed Charges (13) Letter to Shareholders as contained in the 1998 Annual Report and incorporated by reference into this Form 10-K 23.1 Consent of Ralph E. Davis Associates, Inc. 23.2 Consent of Independent Accountants 27.1 Financial Data Schedule for 12 months ended September 30, 1998 27.2 Financial Data Schedule Restated for 12 months ended September 30, 1997 27.3 Financial Data Schedule Restated for 12 months ended September 30, 1996 27.4 Financial Data Schedule Restated for 3 months ended December 31, 1996 27.5 Financial Data Schedule Restated for 3 months ended March 31, 1997 27.6 Financial Data Schedule Restated for 3 months ended June 30, 1997 99.1 Report of Ralph E. Davis Associates, Inc. EX-3 2 RESTATED CERTIFICATE OF INCORPORATION OF NATIONAL FUEL GAS COMPANY Dated: September 21, 1998 The undersigned corporation, National Fuel Gas Company, certifies that it has adopted, pursuant to Section 14A:9-5 of the New Jersey Business Corporation Act, the following restated certificate of incorporation which restates and integrates its certificate of incorporation, as heretofore restated and amended: ARTICLE FIRST Corporate Name The name of the corporation is NATIONAL FUEL GAS COMPANY. ARTICLE SECOND Registered Office and Agent The location of this corporation's current registered office in the State of New Jersey is 830 Bear Tavern Road, West Trenton, New Jersey 08628. The name of the corporation's current registered agent at that address is Corporation Service Company. ARTICLE THIRD Purpose and Objects The objects for which this corporation is formed are: to do all kinds of mining, manufacturing and trading business authorized by the laws of New Jersey; to transport goods and merchandise by land and water; to buy, sell, lease and improve lands; to build houses, structures, docks and piers; to lay and operate pipelines; to erect and operate telegraph and telephone lines and lines for conducting electricity; to enter into and carry out contracts of every kind pertaining to its business; to loan and borrow money; to purchase or otherwise acquire, hold, sell, assign and transfer shares of capital stock and bonds or other evidences of indebtedness of corporations, and to exercise all the privileges of ownership, including voting upon the stock so held; to carry on its business and have offices and agencies therefor in all parts of the world; and to hold, purchase, mortgage and convey real estate and personal property outside of the State of New Jersey. ARTICLE FOURTH Capital Stock The total authorized capital stock of this corporation shall consist of Ten Million (10,000,000) shares of Preferred Stock having the par value of One Dollar ($1.00) per share and Two Hundred Million (200,000,000) shares of Common Stock having the par value of One Dollar ($1.00) per share. The designations and relative rights, powers, preferences and limitations of the different classes of capital stock of this corporation are as follows: 1. Characteristics of Common Stock and Preferred Stock. The Board of Directors shall have the authority to amend this Certificate of Incorporation from time to time to divide the shares of the Preferred Stock into one or more series and to determine the designation, the number, and the special and relative rights, powers, preferences and limitations of the shares of each series so created. For illustrative purposes only, the forgoing power of the Board of Directors shall include, but shall not be limited to, the determination of the following terms: (a) the maximum number of shares to constitute each such series, which may subsequently be increased or decreased (but not below the number of shares of such series then outstanding) by resolution of the Board of Directors, the distinctive designation thereof and the stated value thereof if different from the par value thereof; (b) whether the shares of each such series shall have voting rights and, if such shares are given voting rights, the terms of such voting rights, subject to the provisions of paragraph 7 hereof; (c) the dividend rate or rates, if any, on the shares of each such series or the manner in which such rate or rates shall be determined, the conditions and dates upon which such dividends shall be payable, the preference or relation that such dividends shall bear to the dividends payable on any other class or classes or any other series of capital stock (including whether such dividends shall be participating or non-participating with respect to any other class or classes or any other series of capital stock), whether such dividends shall be cumulative or noncumulative, and if cumulative, the date or dates from which any such dividends shall be cumulative; (d) whether the shares of each such series shall be subject to redemption, and, if made subject to redemption, the time or times, price or prices and other terms, limitations, restrictions or conditions of such redemption, including whether such redemption shall be made at the election of the corporation or the holders of such shares; (e) the relative amounts, and the relative rights or preferences, if any, of payment in respect of shares of each such series which the holders of shares of each such series shall be entitled to receive upon the voluntary or involuntary liquidation, dissolution or winding-up of the corporation, including whether such rights shall be limited or participating with respect to shares of any other class or classes or any other series of capital stock upon the voluntary or involuntary liquidation, dissolution or winding up of the corporation; (f) whether or not the shares of each such series shall be subject to the operation of a retirement or sinking fund and, if so, the terms and provisions relative to the operation of such retirement or sinking fund; (g) whether or not the shares of each such series shall be convertible into, or exchangeable for, shares of any other class or classes or any other series of capital stock, or other securities, whether or not issued by the corporation, and if so convertible or exchangeable, the price or prices or the rate or rates of conversion or exchange, the method, if any, of adjusting any such price or prices or rate or rates and whether such shares shall be convertible or exchangeable at the election of the corporation or the holders of such shares; (h) the limitations and restrictions, if any, to be effective while any shares of each such series are outstanding, upon the payment of dividends or the making of other distributions on, and upon the purchase, redemption or other acquisition by the corporation of, the Common Stock or any other class or classes or any other series of capital stock of the corporation ranking junior to the shares of such series either as to dividends or upon liquidation, dissolution or winding-up of the corporation; (i) the conditions or restrictions, if any, to be effective while any shares of each such series are outstanding, upon the creation of indebtedness of the corporation or upon the issuance of any additional stock (including additional shares of such series or of any other class) ranking on a parity with or prior to the shares of such series as to dividends or distribution of assets upon liquidation, dissolution or winding-up of the corporation; and (j) any other preference, relative, participating, optional or other special rights, and the qualifications, limitations or restrictions thereof, as shall not be inconsistent with law, this Article FOURTH or any amendment creating such series. Each share of Common Stock shall be equal in all respects to every other share of the Common Stock. The Common Stock shall be subject to the express terms of the Preferred Stock and any series thereof. 2. Dividends on Preferred Stock. No holder of outstanding shares of any series of the Preferred Stock shall be entitled to receive any dividends thereon other than the dividends provided therefor pursuant to paragraph 1 hereof. 3. Redemption and Repurchase of Preferred Stock. If, on or before the redemption date with respect to any shares of any series of Preferred Stock that are subject to redemption, as fixed or determined pursuant to paragraph 1 hereof, this corporation shall deposit with a bank, trust company or other financial institution monies necessary for the redemption of such shares, then, notwithstanding that any certificate for such shares so redeemed shall not have been surrendered for cancellation, from and after such redemption date, all rights and preferences with respect to such shares so redeemed shall forthwith on such redemption date cease and terminate, except only the right of the holders thereof to receive, out of the monies so deposited, the amount payable upon redemption of such shares, without interest. Any such monies so deposited by this corporation and unclaimed at the end of six (6) years from such redemption date shall be repaid to this corporation upon its request, after which repayment the holders of the shares so called for redemption shall look only to this corporation for the payment thereof. Nothing herein contained shall limit any legal right of this corporation to purchase or otherwise acquire any shares of the Preferred Stock to the extent permitted by law. All or any shares of Preferred Stock at any time redeemed, purchased or otherwise acquired by this corporation may thereafter, in the discretion of the Board of Directors, be reissued or otherwise disposed of at any time or from time to time, to the extent and in the manner now or hereafter permitted by law. 4. Dividends on Common Stock. Subject to the rights and preferences of each series of Preferred Stock, as determined pursuant to paragraph 1 hereof, such dividends (payable in cash, stock or otherwise) as may be determined by the Board of Directors may be declared and paid on the Common Stock, but only out of funds legally available for the payment of such dividends. 5. Distributions on Common Stock. In the event of any liquidation, dissolution or winding up of this corporation, and subject to the rights and preferences of each series of Preferred Stock, as determined pursuant to paragraph 1 hereof, all assets and funds of this corporation remaining after paying or providing for the payment of all creditors of this corporation shall be divided among and paid to the holders of the Common Stock according to their respective shares. 6. Preemptive Rights. No holder of shares of any stock of this corporation of any class now or hereafter authorized shall have any right as such holder to purchase, subscribe for or otherwise acquire any shares of stock of this corporation of any class now or hereafter authorized, or any securities convertible into or exchangeable for any such shares, or any warrants or other instruments evidencing rights or options to subscribe for, purchase or otherwise acquire any such shares, whether such shares, certificates, securities, warrants or other instruments be unissued or issued and thereafter acquired by this corporation and whether such shares and other instruments be issued for cash, property, services, or by way of dividends or otherwise. 7. Voting Rights. At all meetings of the stockholders of this corporation, the holders of shares of Common Stock shall be entitled to one vote for each share of Common Stock held by them respectively except as otherwise expressly provided herein. The holders of shares of Preferred Stock shall have no right to vote and shall not be entitled to notice of any meeting of stockholders of this corporation nor to participate in any such meeting except as otherwise expressly provided herein or in any amendment creating a series of Preferred Stock and except for those purposes, if any, for which said rights cannot be denied or waived under mandatory provisions of law that shall be controlling. If, and to the extent that, the shares of any series of Preferred Stock are provided voting rights in accordance with the provisions hereof, including the provision of such voting rights in any amendment creating such series, each holder of shares of such series of Preferred Stock shall be entitled to one vote for each outstanding share of such shares of Preferred Stock held by such holder. 8. Reclassification, etc. From time to time, and without limitation of other rights and powers of this corporation as provided by law, this corporation may reclassify its capital stock and may create or authorize one or more classes of stock ranking prior to or on a parity with or subordinate to the Preferred Stock or may increase the authorized amount of the Preferred Stock or of the Common Stock or of any other class of stock of this corporation or may amend, alter, change or repeal any of the rights, privileges, terms and conditions of shares of the Preferred Stock or of any series thereof then outstanding or of shares of the Common Stock or of any other class of stock of this corporation, upon such vote, given at a meeting called for that purpose, of its stockholders then entitled to vote thereon as may be provided by law; provided that the consent of the holders of shares of the Preferred Stock (or of any series thereof) required by the provisions of any amendment creating any series of Preferred Stock or by applicable law, if any such consent be so required, shall have been obtained; and provided further that the rights, privileges, terms and conditions of shares of Common Stock shall not be subject to amendment, alteration, change or repeal without such vote (given by written consent, or by vote at a meeting called for that purpose) of the holders of Common Stock as may be provided by law. 9. Consideration for Shares. To the extent permitted by law, this corporation may, at any time and from time to time, issue and dispose of any of the authorized and unissued shares of the Preferred Stock and Common Stock for such consideration as may be fixed by the Board of Directors, or as may be determined in accordance with a general formula established by the Board of Directors, or at not less than such minimum consideration as the Board of Directors may authorize. ARTICLE FIFTH Business Combinations 1. In addition to any approval required by law or by this Certificate of Incorporation, and any other provision of this Certificate of Incorporation notwithstanding, any Business Combination and any Substantial Stockholder effecting, proposing to effect or attempting to effect a Business Combination, shall meet and be subject to all of the following conditions: (a) The aggregate amount of cash and the Fair Market Value as of the date of the consummation of the Business Combination of other consideration to be received per share by the holders of shares of Common Stock in such Business Combination shall be not less than the highest per share price (including brokerage commissions, transfer taxes and soliciting dealers' fees) that a Substantial Stockholder paid for any shares of Common Stock acquired by the Substantial Stockholder after it acquired a 5% Interest. (b) The consideration to be received by the holders of shares of Common Stock in such Business Combination shall be either cash or the same form as the consideration paid by the Substantial Stockholder for shares of Common Stock acquired by the Substantial Stockholder after it acquired a 5% Interest. If the Substantial Stockholder has acquired shares of Common Stock after the Substantial Stockholder has acquired a 5% Interest, using more than one form of consideration, the form of consideration to be received by the holders of shares of Common Stock shall be either cash or the form used to acquire the largest number of shares of Common Stock after the Substantial Stockholder has acquired a 5% Interest. (c) A proxy statement responsive to the requirements of the Securities Exchange Act of 1934 shall have been mailed to all holders of shares of Common Stock for the purpose of soliciting stockholder approval of such Business Combination. Such proxy statement shall contain at the front thereof, in a prominent place, any recommendations as to the advisability (or inadvisability) of the Business Combination that the Continuing Directors, or any of them, may have furnished in writing and, if deemed advisable by two-thirds of the Continuing Directors, an opinion of a reputable investment banking firm as to the fairness (or lack of fairness) of the terms of such Business Combination, from the point of view of the holders of shares of Common Stock other than the Substantial Stockholder. Such investment banking firm shall be selected by two-thirds of the Continuing Directors, shall be furnished with all information it reasonably requests and shall be paid by this corporation a reasonable fee for its services upon receipt by this corporation of such opinion. 2. For purposes of this Article FIFTH, two-thirds of the Continuing Directors shall have the power to determine in good faith, on the basis of information known to them, (a) the number of shares of Common Stock beneficially owned by any Person, the time at which any Person acquired a 5% Interest, the highest per share price paid by a Substantial Stockholder for any shares of Common Stock acquired by the Substantial Stockholder after it acquired a 5% Interest, and, subject to subparagraph 4(f) of this Article FIFTH, the Fair Market Value of the securities or other property exchanged in connection with the transactions described in subparagraphs 4(d)(ii) and (d)(iii), respectively, of this Article FIFTH, (b) whether a Person is an affiliate or associate of another, (c) whether a Person has an agreement, arrangement or understanding with another as to the matters referred to in subparagraph 4(c) of this Article FIFTH, and (d) whether the transactions described in subparagraphs (d)(ii) and (iii), respectively, of paragraph 4 of this Article FIFTH constitute Business Combinations. 3. Nothing contained in this Article FIFTH shall be construed to relieve any Substantial Stockholder from any fiduciary obligation imposed by law. 4. For the purposes of this Article FIFTH: (a) An "Affiliate" of, or a Person "affiliated" with, a specified Person, is a Person that directly, or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with, the Person specified. (b) The term "Associate", when used to indicate a relationship with any Person, means (1) any corporation or other organization (other than this corporation or a Subsidiary) of which such Person is a director, officer or partner or is, directly or indirectly, the beneficial owner of 10% or more of any class of equity securities thereof, (2) any trust or other estate in which such Person has a substantial beneficial interest or as to which such Person serves as a trustee or in a similar fiduciary capacity, and (3) any relative or spouse of such Person, or any relative of such spouse, who has the same home as such Person, or who is a director, officer or partner of a corporation or other organization of which such Person is a director, officer or partner or is, directly or indirectly, the beneficial owner of 10% or more of any class of equity securities thereof. (c) A Person shall be the "beneficial owner" of any shares of Common Stock: (i) with respect to which such Person or any of its Affiliates or Associates directly or indirectly has or shares (a) voting power, including the power to vote or to direct the voting of such shares of Common Stock and/or (b) investment power, including the power to dispose of or to direct the disposition of such shares of Common Stock, or (ii) that such Person or any of its Affiliates or Associates has (a) the right to acquire (whether such right is exercisable immediately or only after the passage of time), pursuant to any agreement, arrangement or understanding or upon the exercise of conversion rights, exchange rights, warrants, or options, or otherwise, or (b) the right to vote pursuant to any agreement, arrangement or understanding, or (iii) that are beneficially owned, directly or indirectly, by any other Person with which such first-mentioned Person or any of its Affiliates or Associates has any agreement, arrangement or understanding for the purpose of acquiring, holding, voting or disposing of any shares of Common Stock. Notwithstanding the foregoing, a member of a national securities exchange shall not be deemed to be a beneficial owner of shares of Common Stock held directly or indirectly by it on behalf of another Person solely because such member is the record holder of such shares of Common Stock, and pursuant to the rules of such exchange, may direct the vote of such shares of Common Stock, without instruction, on other than contested matters or matters that may affect substantially the rights or privileges of the holders of the shares of Common Stock to be voted, but is otherwise precluded by the rules of such exchange from voting without instruction. (d) "Business Combination" shall mean: (i) any merger, consolidation or share exchange of this corporation or any Subsidiary with or into (a) any Substantial Stockholder or (b) any other corporation (whether or not itself a Substantial Stockholder) which, after such merger or consolidation, would be an Affiliate of a Substantial Stockholder, or (ii) any sale, lease, exchange, mortgage, pledge, transfer or other disposition (in one transaction or a series of related transactions) to or with any Substantial Stockholder or an Affiliate of a Substantial Stockholder of any assets of this corporation or any Subsidiary, in exchange for cash, securities or other property (or a combination thereof) having a Fair Market Value in excess of $10 million that shall be determined to be a Business Combination by two-thirds of the Continuing Directors as provided in clause (d) of paragraph 2 of this Article FIFTH, or (iii) the issuance or transfer by this corporation or any Subsidiary (in one transaction or a series of related transactions) of any securities of this corporation or any Subsidiary to (a) any Substantial Stockholder or (b) any other corporation (whether or not itself a Substantial Stockholder) that, after such issuance or transfer, would be an Affiliate of a Substantial Stockholder, in exchange for cash, securities or other property (or a combination thereof) having a Fair Market Value in excess of $10 million that shall be determined to be a Business Combination by two-thirds of the Continuing Directors as provided in clause (d) of paragraph 2 of this Article FIFTH, or (iv) the adoption of any plan or proposal for the liquidation or dissolution of this corporation proposed by or on behalf of a Substantial Stockholder or an Affiliate of a Substantial Stockholder, or (v) any reclassification of securities (including any reverse stock split), recapitalization, reorganization, merger or consolidation of this corporation with any of its Subsidiaries or any similar transaction (whether or not with or into or otherwise involving a Substantial Stockholder or an Affiliate of a Substantial Stockholder) that has the effect, directly or indirectly, of increasing the proportionate share of the outstanding shares of any class of equity or convertible securities of this corporation or any Subsidiary that is directly or indirectly owned by any Substantial Stockholder or by an Affiliate of a Substantial Stockholder. (e) "Continuing Director" shall mean a person who was a director on or prior to February 21, 1985, or who was elected to and became a member of the Board of Directors of this corporation by vote of the Public Holders prior to the date as of which a Person becoming a Substantial Stockholder acquired a 5% Interest, or a person designated as a Continuing Director by two-thirds of the then Continuing Directors. (f) "Fair Market Value" shall mean: (i) in the case of stock, the closing sale price on the day immediately preceding the date in question of a share of such stock (or, if no trade was made on such day, the closing sale price on the closest day prior thereto on which a trade with respect to such stock was made), which price was quoted on the Composite Tape for New York Stock Exchange-Listed Stocks, or, if such stock is not quoted on the Composite Tape, on the New York Stock Exchange, or, if such stock is not listed on such Exchange, on the principal United States securities exchange registered under the Securities Exchange Act of 1934 on which such stock is listed, or, if such stock is not listed on any such exchange, the closing bid quotation with respect to a share of such stock on the day immediately preceding the date in question (or, if no closing bid quotation was available for such day, the closing bid quotation on the closest day prior thereto on which a closing bid quotation is available) on the National Association of Securities Dealers, Inc. Automated Quotations System or any system then in use, or if no such quotations are available, the fair market value on the date in question of a share of such stock as determined by two-thirds of the Continuing Directors in good faith; and (ii) in the case of property other than cash or stock, the fair market value of such property on the date in question as determined in good faith by two-thirds of the Continuing Directors. (g) A "5% Interest" shall mean beneficial ownership, directly or indirectly, of not less than 5% of the then outstanding Common Stock. (h) "Other consideration to be received" shall mean anything other than cash, including, without limitation, shares of Common Stock retained by Public Holders in the event of a Business Combination in which this corporation is the surviving corporation. (i) "Person" shall mean any individual, firm, corporation or other entity. (j) "Public Holders" shall mean Persons other than the relevant Substantial Stockholder. (k) "Subsidiary" shall mean any corporation a majority of the voting shares of which are at the time owned by this corporation or by other subsidiaries of this corporation or by this corporation and other subsidiaries of this corporation. (l) A "Substantial Stockholder" shall mean any Person (other than this corporation or any Subsidiary of this corporation or any trustee holding shares of Common Stock of this corporation for the benefit of the employees of this corporation or any Subsidiary of this corporation, or any of them, pursuant to one or more employee benefit plans or arrangements) who or that, as of the record date for the determination of stockholders entitled to notice of and to vote on such Business Combination, or as of the time of the vote on such Business Combination, or immediately prior to the consummation of any such transaction, is the beneficial owner, directly or indirectly, of not less than 5% of the then outstanding Common Stock of this corporation. ARTICLE SIXTH Board of Directors The business and affairs of this corporation shall be managed by a Board of Directors. The number of directors (exclusive of directors, if any, to be elected by the holders of shares of Preferred Stock, voting separately from the Common Stock as provided in any amendment creating any series of Preferred Stock) shall be not less than 7 nor more than 11, the exact number of directors to be determined from time to time by a resolution adopted by the affirmative vote of a majority of the entire Board of Directors. The directors of this corporation shall be divided into three classes, designated Class I, Class II and Class III, respectively. Each class shall be as nearly equal in number as may be possible. At the 1985 annual meeting of stockholders, Class I directors shall be elected for a one-year term, Class II directors for a two-year term and Class III directors for a three-year term. At each succeeding annual meeting of stockholders beginning in 1986, the successors to the class of directors whose term expires at that annual meeting shall be elected for a three-year term, and successors to directors of any other class, including directors elected in any such class by the Board of Directors to fill one or more vacancies or newly-created directorships, shall be elected for the remaining term of that class. If the number of directors is changed by resolution of the Board of Directors pursuant to this Article SIXTH, any increase or decrease shall be apportioned by the Board among the classes so as to maintain the number of directors in each class as nearly equal as possible, but in no case shall a decrease in the number of directors shorten the term of any incumbent director. Any newly-created directorship resulting from an increase in the number of directors by resolution of the Board pursuant to this Article SIXTH may be filled by a majority of the directors then in office. Any vacancy on the Board of Directors occurring for any reason, other than an increase in the number of directors as aforesaid, may be filled by a majority of the directors then in office, although less than a quorum, or by a sole remaining director. Directors of any class shall hold office until the annual meeting of the year in which the term of such class expires or, in the case of directors elected by the Board of Directors to fill vacancies or newly-created directorships, until the next annual meeting following their election, and until their respective successors shall be elected and shall qualify, subject to prior death, resignation, retirement, disqualification or removal from office. Notwithstanding the foregoing and except as otherwise provided by law, whenever the holders of shares of Preferred Stock shall have the right, voting separately from the Common Stock, to elect directors of this corporation, the number, election, term of office, filling of vacancies and other features of such directorships shall be governed by the terms and provisions of any amendment creating any series of Preferred Stock; and such directors so elected shall not be divided into classes pursuant to this Article SIXTH. During the prescribed term of office of any such directors, the Board of Directors shall consist of such directors in addition to the number of directors determined as provided in the first paragraph of this Article SIXTH. ARTICLE SEVENTH Current Directors The current Board of Directors of this corporation consists of nine (9) persons whose names and business addresses are as follows: Name Business Address Philip C. Ackerman National Fuel Gas Company 10 Lafayette Square Buffalo, New York 14203 Robert T. Brady MOOG Inc. Plant 24/Seneca at Jamison Road East Aurora, New York 14052 James V. Glynn Maid of the Mist Corporation 151 Buffalo Avenue Niagara Falls, New York 14303 William J. Hill 3515 Zimmerly Road Erie, Pennsylvania 16506 Bernard J. Kennedy National Fuel Gas Company 10 Lafayette Square Buffalo, New York 14203 Bernard S. Lee, Ph.D. Institute of Gas Technology 1700 South Mt. Prospect Road Des Plaines, Illinois 60018 Eugene T. Mann 272 Porterville Road Box 635 East Aurora, New York 14052 George L. Mazanec Duke Energy Corporation P.O. Box 1642 Houston, Texas 77251 George H. Schofield 224 Ocean Avenue Marblehead, Massachusetts 01945 ARTICLE EIGHTH Required Vote On Certain Actions The following actions approved by the Board of Directors shall be adopted upon receiving the affirmative vote of a majority of votes cast by the holders of shares of the corporation entitled to vote thereon and, in addition, if any class or series of shares is entitled to vote thereon as a class, a majority of the votes cast in each such class vote: (1) amendments to the Certificate of Incorporation, including restatements, where shareholder approval is required or requested; (2) a plan of merger or consolidation; (3) a sale, lease, exchange or other disposition of all, or substantially all, the assets of the corporation otherwise than in the usual and regular course of business; and (4) dissolution. Notwithstanding any other provision hereof or the By-Laws of this corporation (and notwithstanding the fact that a lesser percentage may be specified by law, this Certificate of Incorporation or the By-Laws of this corporation), the approval of at least three-fourths of the entire Board of Directors or, in the event that the Board of Directors consists of directors elected by the holders of shares of Preferred Stock, the approval of a majority of the entire Board of Directors shall be required before any proposal to amend, alter, change, repeal or adopt any provision inconsistent with Article FIFTH, Article SIXTH or this paragraph of Article EIGHTH of this Certificate of Incorporation, may be submitted to a vote at a meeting of stockholders. ARTICLE NINTH Director and Officer Exculpation No director or officer of this corporation shall be personally liable to the corporation or any of its shareholders for monetary damages for breach of any duty owed to the corporation or any of its shareholders, except to the extent that such exemption from liability is not permitted under the New Jersey Business Corporation Act, as the same exists or may hereafter be amended, or under any revision thereof or successor statute thereto. IN WITNESS WHEREOF, National Fuel Gas Company has caused this Restated Certificate of Incorporation to be duly executed as of the date first above written. NATIONAL FUEL GAS COMPANY By: /s/ B. J. Kennedy ---------------------------- Name: B. J. Kennedy Title: Chairman of the Board President and Chief Executive Officer CERTIFICATE OF ADOPTION OF RESTATED CERTIFICATE OF INCORPORATION OF NATIONAL FUEL GAS COMPANY Dated: September 21, 1998 The undersigned corporation, National Fuel Gas Company, having adopted a restated certificate of incorporation pursuant to Section 14A:9-5 of the New Jersey Business Corporation Act, hereby certifies that: 1. Name. The name of the corporation is NATIONAL FUEL GAS COMPANY (the ---- "Corporation"). 2. Date of Adoption. The date the restated certificate of ------------------- incorporation was adopted was September 17, 1998. 3. Board Adoption. The restated certificate of incorporation was --------------- approved and adopted by the Board of Directors of the Corporation. It restates and integrates, but does not substantively amend, the certificate of incorporation of the Corporation, as heretofore restated and amended. IN WITNESS WHREOF, the undersigned corporation has caused this Certificate to be executed on its behalf by its duly authorized officer as of the date first above written. NATIONAL FUEL GAS COMPANY By: /s/ B. J. Kennedy ------------------------------------- B. J. Kennedy Chairman of the Board, President and Chief Executive Officer EX-3 3 Amended 2/21/85 6/19/86 7/07/88 6/14/90 6/18/92 12/8/93 6/09/94 9/19/96 1/01/97 3/20/97 6/19/97 9/18/97 9/17/98 NATIONAL FUEL GAS COMPANY ------------------------- BY-LAWS ------- ARTICLE I --------- Meeting of Stockholders ----------------------- 1. Meetings of stockholders may be held at such place, within or without the State of New Jersey, as may be fixed by the Board of Directors and stated in the notice of the meeting. 2. In 1999 and thereafter, the annual meeting of stockholders shall be held on the third Thursday in February in each year beginning at ten o'clock in the forenoon, local time, unless such day shall be on a holiday, in which event such meeting shall be held at the same hour on the next succeeding business day. In 1998, the Annual Meeting of Stockholders shall be held on Thursday, February 26, 1998 at ten o'clock in the forenoon, local time. 3. Except as otherwise provided by New Jersey law, written notice of the time, place and purpose or purposes of every meeting of stockholders shall be given not less than 10 nor more than 60 days before the date of the meeting, either personally or by mail, to each stockholder of record entitled to vote at the meeting. 4. Unless otherwise provided by statute, all Special Meetings shall be called upon the written request of three or more directors or of stockholders owning one-fourth of the capital stock issued and outstanding. 5. Unless otherwise provided in the Company's Certificate of Incorporation or in New Jersey law, (i) the holders of shares entitled to cast a majority of the votes at any meeting of stockholders shall constitute a quorum at such meeting except that the votes that holders of any class or series of shares are entitled to cast shall not be counted in the determination of a quorum for action to be taken at a meeting with respect to which such class or series has no vote, and (ii) the holders of shares of any class or series entitled to cast a majority of the votes of such class or series entitled to vote separately on a specified item of business shall constitute a quorum of such class or series for the transaction of such specified item of business. If a quorum shall not be so represented, the stockholders present at any meeting of stockholders shall have power to adjourn the meeting to another time at the same or at another place. If the time and place to which the meeting is adjourned are announced at the meeting at which the adjournment is taken and at the adjourned meeting only such business is transacted as might have been transacted at the original meeting, it shall not be necessary to give notice of the adjourned meeting unless after the adjournment the Board of Directors fixes a new record date for the adjourned meeting. In the event the Board of Directors fixes such a new record date, a notice of the adjourned meeting shall be given to each stockholder of record at the new record date entitled to notice under Article I paragraph 3 of these By-Laws. 6. At each election of Directors, the proxies and ballots shall be received and all questions respecting the qualification of voters shall be decided by two inspectors, who shall be appointed by the presiding officer of the meeting; provided however, that no candidate for election as Director shall act as inspector. Such inspectors shall be sworn faithfully to perform their duties and shall report in writing the results of the ballot. ARTICLE II ---------- Board of Directors ------------------ 1. The Board of Directors shall consist of (i) such number of directors, not less than seven nor more than eleven, as may be determined from time to time by resolution adopted by the affirmative vote of a majority of the entire Board of Directors, and (ii) such directors as may be elected by vote of the holders of shares of preferred stock, when and as provided in the Certificate of Incorporation of the Company. In order to qualify for election as a director, a nominee must be a shareholder of the Company. 2. Subject to the provisions of the Statutes of the State of New Jersey, the Certificate of Incorporation, and the By-Laws of the Corporation, the Board of Directors shall have full and complete management and control of the business and affairs of the Corporation. 3. The Board of Directors may hold its meetings or any adjournment thereof either in the State of New Jersey or elsewhere and keep the books of the Corporation at such places within or without the State of New Jersey as the Board of Directors may from time to time determine. 4. Meetings of the Board of Directors may be called at the direction of the Chairman of the Board, the President, or any three of the Directors for the time being in office. 5. Notice of any meetings of the Board of Directors shall be given to each Director by mailing the same to him at his last known address, as the same appears upon the records of the Corporation at least five days before the meeting or by telegraphing, telephoning or delivering the same to him personally at least one day before the meeting. 6. At any meeting of the Board of Directors, there may be transacted without special notice, any business within the powers of the Directors to transact, except that of which the Statutes of the State of New Jersey expressly require special notice shall be given. 7. A. A majority of the Directors in office shall constitute a quorum for the transaction of any business which may properly come before them. If a majority of said Directors shall not be present at any meeting, the Directors present shall have power to adjourn to a day certain, and notice of the adjourned meeting shall be given by mailing the same addressed to each Director at his address as the same appears upon the records of the Corporation, at least two days prior to the adjourned meeting, or by telegraphing, telephoning or delivering the same to him personally at least one day before said adjourned meeting. But, if a majority of the Board of Directors are present, the said meeting, or any adjourned meeting thereof, may be adjourned to a subsequent day; such adjournment may be without notice of such adjournment if such notice is not required by New Jersey Law (as of June 1997, N.J.S.A. 14A:6-10(2)). -------- B. Unless a greater vote is required by applicable law or by the Certificate of Incorporation of the Company or these By-laws (including, but not limited to, subparagraph C of this paragraph 7), any action approved by a majority of the votes of directors present at a meeting at which a quorum is present shall be the act of the Board of Directors. C. Anything in these By-laws to the contrary notwithstanding, any action taken by the Board of Directors pursuant to the terms of any Rights Plan (as hereinafter defined) of the Company shall, unless otherwise provided by the terms of the Rights Plan, be approved by the affirmative vote of three-fourths (3/4ths) of the entire Board of Directors. For purposes of these By-laws, the term "Rights Plan" shall mean any plan pursuant to which shareholders of the Company are, upon the occurrence of certain specified events (including, but not limited to, the acquisition by any person of a specified number of shares of capital stock of the corporation), entitled to purchase shares of capital stock or other securities of either the Company or the acquiring person at a discounted price. 8. A. The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any pending, threatened or completed civil, criminal, administrative or arbitrative action, suit or proceeding, and any appeal therein and any inquiry or investigation which could lead to such action, suit or proceeding ("Proceeding") by reason of the fact that such person is or was a director or officer of the Corporation, or, while a director or officer of the Corporation, is or was serving at the request of the Corporation as a director, officer, trustee, employee or agent of another foreign or domestic corporation, or of any partnership, joint venture, sole proprietorship, employee benefit plan, trust or other enterprise, whether or not for profit, to the fullest extent permitted and in the manner provided by the laws of the State of New Jersey. B. Nothing in this paragraph 8 shall restrict or limit the power of the Corporation to indemnify its employees, agents and other persons, to advance expenses (including attorneys' fees) on their behalf and to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the Corporation in connection with any Proceeding. C. The indemnification provided by this paragraph 8 shall not exclude any other rights to which a person seeking indemnification may be entitled under the Certificate of Incorporation, By-Laws, agreement, vote of shareholders or otherwise. The indemnification provided by this paragraph 8 shall continue as to a person who has ceased to be a director or officer, and shall extend to the estate or personal representative of any deceased director or officer." 9. A. Except with respect to directors whose service as such ceases on or before February 20, 1997, who will continue to receive the previously-effective Director compensation until such time, each Director who is not a regular full-time employee of the Corporation or one or more of its subsidiaries, shall be paid an annual fee of $12,000 in cash and 400 shares of the common stock of the Corporation, payable in equal quarterly increments, in advance (i.e., as of the first business day of the quarter). There will be proration of payments during quarters in which such Director has only partial service. Each such share of stock of the Corporation will be nontransferable until the later of two years from its issuance or six months after such Director's cessation of service. B. Each Director of the Corporation who is not a regular full-time employee of the Corporation or one or more of its subsidiaries shall also receive a fee of $1,000 for attendance at any meeting of the Board of Directors and a fee of $800 for attendance at any meeting of any committee of the Board of Directors, except that if a Director participates in a committee meeting by telephone, the fee shall be $500. Each Director shall be reimbursed for the travel expenses incurred by him or her in attending any meeting of the Board of Directors or any committee of the Board of Directors. 10. Any contract or other transaction between the Corporation or a subsidiary of the Corporation and any other entity shall not be void or voidable because a Director of the Corporation is interested therein if the Corporation has complied with the provisions of any then-applicable New Jersey statute(s) necessary or sufficient to make the transaction not void or voidable, including, as of June 1997, N.J.S.A. 14A:6-8(1). -------- ARTICLE III ----------- Officers -------- 1. At the first meeting after the annual election, the Board of Directors shall choose a Chairman of the Board and a President, both of whom shall be members of the Board of Directors, and one or more Vice Presidents, a Secretary, a Treasurer and a Controller, who need not be members of the Board of Directors, and who shall hold their respective offices until others are chosen and qualify in their stead. The offices of Secretary and Treasurer may be filled by the same person. 2. In its discretion, the Board of Directors may leave unfilled for such period as it may determine, any office except the offices of the President, Treasurer and Secretary. 3. The Chairman of the Board shall be the Chief Executive Officer of the Corporation. He shall preside at all meetings of the Board of Directors and shall, during the recess of the Board of Directors, have general control and management of the affairs and business of the Corporation. In the absence of the President, he shall preside at stockholders' meetings. 4. In addition to the duties and responsibilities specified in the laws of the State of New Jersey and these By-Laws, the President shall preside at all stockholders' meetings and shall perform such other duties as from time to time may be assigned to him by the Board of Directors. In the absence of the Chairman of the Board, or in the event that there is a vacancy in the office of the Chairman of the Board, the President shall be the Chief Executive Officer of the Corporation and shall perform all the duties of the Chairman of the Board as well as those of President. 5. Each Vice President shall perform such duties as shall from time to time be assigned to him by the Board of Directors, the Chairman of the Board, or the President. 6. The Secretary, in addition to his statutory duties, shall give proper notice of all meetings of the stockholders and of the Board of Directors. He shall act as Secretary of all meetings of the stockholders and shall perform such other duties as shall from time to time be assigned to him by the Board of Directors or President. 7. The Treasurer, in addition to his statutory duties, shall keep full and accurate accounts of receipts and disbursements of the funds belonging to the Corporation, and shall cause to be deposited all moneys and other valuable effects in the name and to the credit of the Corporation in such depositories as may from time to time be designated by the Board of Directors. He shall disburse the funds of the Corporation as may be ordered by the Board, taking proper vouchers for such disbursements, and shall render to the President and Directors whenever they may require it, account of all his transactions as Treasurer, and of the financial condition of the Corporation. He shall perform such other duties as shall be assigned to him by the Board or President, and shall give a bond for the faithful discharge of his duties in such sum and with such surety or sureties as the Board of Directors may from time to time require. 8. The Controller shall see that adequate records of all assets, liabilities and transactions of the Corporation are maintained; that adequate audits thereof, are currently and regularly made, and in conjunction with other officers, initiate and enforce measures and procedures whereby the business of the Corporation shall be conducted with maximum efficiency, safety and economy. He shall also perform all such other duties as usually pertain to the office of Controller. He shall be in all matters subject to the control of and responsible to the Board of Directors alone. 9. The Board of Directors may from time to time appoint such other officers and agents as they may deem necessary or advisable for the transaction of the business of the Corporation, who shall hold their offices during the pleasure of the Board of Directors and perform such duties as may from time to time be designated or assigned to them by said Board of Directors. 10. If the office of the Chairman of the Board, the President, Vice President, Secretary, Treasurer, or Controller or one or more of them becomes vacant for any reason whatsoever, the Board of Directors at any duly convened meeting may, by a majority vote of those present, fill such vacancy and the person elected shall hold office for the unexpired term of such office and until his successor shall be chosen. 11. All officers and agents chosen or appointed by the Board of Directors shall be subject to removal by the Board of Directors at any time with or without cause, and in the case of the absence of any officer or agent of the Corporation, or for any other reason that may seem sufficient to the Board of Directors, the said Board of Directors subject to the limitations herein contained and the statutes in such case made and provided, may, without removal, delegate his powers and duties to any other officer or suitable person for such period as it shall deem proper. 12. All duly authorized bonds and debentures of the Corporation shall be signed on behalf of the Corporation by its Chairman of the Board or its President, or one of its Vice Presidents or, if so provided by resolution of the Board of Directors, by one or more of such officers and such other officer or officers designated by the Board of Directors; any or all such signatures may be manual or facsimile signatures, the signature on interest coupons attached to any said bonds or debentures shall be a facsimile signature; and the corporate seal or a facsimile of such seal may be impressed, affixed, imprinted or otherwise reproduced on said bonds and debentures and, if attested, shall be attested by the Corporation's Secretary or Assistant Secretary by manual or facsimile signature. In case any person whose signature (manual or facsimile) appears upon any said bond or debenture or coupons attached thereto shall cease to be an officer of the Corporation, or shall cease to be the officer specified thereon, before the bonds or debentures so signed shall have been authenticated by the trustee under the indenture or other instrument pursuant to which the bonds or debentures are delivered or sold, such bonds or debentures or coupons may nevertheless be adopted by the Corporation, without further action by the Board of Directors, and authenticated and delivered and sold as though the person or persons who so signed or attested such bonds or debentures or coupons had not ceased to be an officer of the Corporation or the officer specified thereof; and any bonds or debentures may be signed as aforesaid; and the seal of the Corporation impressed, affixed, imprinted or otherwise reproduced thereon may be attested on behalf of the Corporation as aforesaid, and coupons attached may be signed as aforesaid by such persons as at the actual date of the execution of the bonds or debentures or coupons shall be the proper officers of the Corporations, although at the time of the date of the bonds or debentures, such persons may not have been officers of the Corporation. ARTICLE IV ---------- Executive Committee ------------------- 1. The Directors may appoint an executive committee and one or more other committees of not less than three members to be chosen from among the members of the Board of Directors. Such committees may meet at such times and places as the committee shall, by resolution, determine and it shall make its own rules of procedure. A majority of the members of any such committee shall constitute a quorum. 2. Except as otherwise provided by Board resolution or statute (as of June 1997, N.J.S.A. 14A:6-9(1)), each such committee shall have and may exercise -------- the power of the Board of Directors in the management of the business and affairs of the Corporation at any time when the Board of Directors are not in session. Each such committee shall, however, be subject to the specific directions of the Board of Directors. 3. Each such committee shall keep regular minutes of their transactions and shall cause them to be recorded in books to be kept for that purpose in the office of the Corporation, and shall report the same to the Board of Directors at their regular meetings. ARTICLE V --------- Transfer of Shares ------------------ 1. Except as otherwise provided by statute, shares shall be transferred on the books of the Corporation only by the holder thereof in person or by his attorney upon the surrender and cancellation of the certificate or certificates of a like number of shares, except in case of lost or destroyed certificates, and in that case only after the receipt of a satisfactory bond if required by the Board of Directors. 2. The Board of Directors may appoint a transfer agent and a registrar of transfers, and may require all stock certificates to bear the signatures of either or both. ARTICLE VI ---------- Fiscal Year ----------- 1. The fiscal year of the corporation shall begin on the 1st day of October in each calendar year and end on the 30th day of September of the next succeeding year. ARTICLE VII ----------- Dividends and Working Capital ----------------------------- 1. Before declaring any dividends or making any distribution of profits, the Directors may set apart out of the net profits or out of the surplus of the Corporation as a reserve fund to be used as working capital or for any other proper purpose, such sum or sums as the Directors shall in their discretion deem just and proper and most for the benefit of the Corporation. 2. Dividends upon the capital stock of the Corporation when declared shall be payable on dates to be determined by the Board of Directors. ARTICLE VIII ------------ Closing of Transfer Books and Fixing A Record Book -------------------- The Board of Directors may close the stock transfer books of the Corporation for a period not exceeding sixty days preceding the date of any meeting of stockholders or the date for payment of any dividend, or the date for the allotment of rights, or the date when any change or conversion or exchange of capital stock shall go into effect. In lieu of so closing the stock transfer books, the Board of Directors may fix, in advance, a date, not exceeding sixty days preceding the date of any meeting of stockholders, or the date for the payment of any dividend, or the date for the allotment of rights, or the date when any change or conversion or exchange of capital stock shall go into effect, as a record date for the determination of the stockholders entitled to notice of, and to vote at, any such meeting, or entitled to receive payment of any such dividend, or any such allotment of rights, or to exercise the rights in respect to any such change, conversion or exchange of capital stock, and in such case only stockholders of record on the date so fixed shall be entitled to such notice of, and to vote at, such meeting, or to receive payment of such dividend, or allotment of rights or exercise of such rights, as the case may be, and notwithstanding any transfer of any stock on the books of the Corporation after any such record date fixed as aforesaid. ARTICLE IX ---------- Waiver of Notice ---------------- 1. Any notice required to be given by these By-Laws may be waived by the person entitled thereto. ARTICLE X --------- Seal ---- 1. The common corporate seal is and until otherwise ordered by the Board of Directors shall be an impression upon paper or wax bearing the words - "NATIONAL FUEL GAS COMPANY, NEW JERSEY, INCORPORATED 1902". ARTICLE XI ---------- Amendment of By-Laws -------------------- 1. Except as otherwise provided by statute, the Board of Directors shall have power to make, alter or repeal the By-Laws of the Corporation by a vote of a majority of all the Directors at any duly convened meeting of the Board, but any By-Laws so made or otherwise promulgated may be altered or repealed and new By-Laws made by the stockholders at any duly conveyed meeting thereof. EX-10 4 AMENDMENT NO. 2 TO NATIONAL FUEL GAS COMPANY DEFERRED COMPENSATION PLAN I, B. J. Kennedy, am duly authorized by Article 10, Paragraph 10.3 of the National Fuel Gas Company Deferred Compensation Plan ("Plan") to amend the Plan under certain circumstances or as necessary or appropriate. Accordingly, I do hereby amend the Plan as follows, effective January 1, 1997: 1. Paragraph 6.4(a) shall be deleted in its entirety and shall be replaced with the following: (a) Respecting Plan balances attributable to the Deferral Periods for Cycles I, II, II-A and III, the annuities shall be determined by using an interest rate equal to the sum of (i) the average of the Moody's Index in effect for the 60-month period that ends with the month preceding the month in which the Participant's Retirement Benefit Date occurs; and (ii) thirty-five percent (35%) of the average referred to in (i) above. 2. In all other respects the Plan shall remain unchanged. Dated: 3/13/98 /s/ B. J. Kennedy --------- ------------------------------------- B. J. Kennedy President, Chief Executive Officer and Chairman of the Board of Directors EX-10 5 AMENDMENT NO. 1 TO NATIONAL FUEL GAS COMPANY TOPHAT PLAN I, B. J. Kennedy, am duly authorized by Article 5, Paragraph 5.2 of the National Fuel Gas Company Tophat Plan ("Plan") to amend the Plan under certain circumstances and as necessary or appropriate. Accordingly, I do hereby amend the Plan as follows: 1. Paragraph 1.1 shall be deleted in its entirety and replaced with the following, effective August 1, 1997: 1.1 "Base Salary" shall mean gross cash compensation per ------------- regular payroll period, including salary continuation payments made by an Employer on account of sickness or accident, which are paid to a Participant for employment services rendered to an Employer, before reduction for compensation deferred pursuant to the National Fuel Gas Company Deferred Compensation Plan or pursuant to the National Fuel Gas Company Tax-Deferred Savings Plan for Non-Union Employees, and shall also include (i) payments made to a Participant pursuant to the Company's Annual At Risk Compensation Incentive Program or a successor plan thereto, and (ii) any performance-related lump sum compensation (i.e., lump sum payments other than ----------- expense or tuition reimbursements, moving expense reimbursements, lump sum payments for eligible unused vacation, worker's compensation payments, award payments for suggestions, severance payments or any other non-performance related payments) made on or after July 1, 1996, but shall exclude all other fees, commissions, special, extra or nonperiodic compensation in any form. Notwithstanding the above, amounts described in clause (ii) shall be included in Base Salary only for officers of any Employer other than Seneca Resources Corporation. 2. Before August 1, 1997, Base Salary shall have the same meaning as it had in Section 1.2 of the DCP Plan, as it existed on March 19, 1997. 3. In all other respects, the Plan shall remain unchanged. Dated: 4/6/98 /s/ B. J. Kennedy -------- ------------------------------------- B. J. Kennedy President, Chief Executive Officer and Chairman of the Board of Directors EX-12 6 EXHIBIT 12
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES UNAUDITED Fiscal Year Ended September 30 --------------------------------------------- 1998 1997 1996 1995 1994 --------------------------------------------- EARNINGS: Income Before Interest Charges and Minority Interest in Foreign Subsidiaries (2) $118,085 $169,783 $159,599 $128,061 $127,885 Allowance for Borrowed Funds Used in Construction 110 346 205 195 209 Federal Income Tax 43,626 57,807 55,148 30,522 36,630 State Income Tax 6,635 7,067 7,266 4,905 6,309 Deferred Inc. Taxes - Net (3) (26,237) 3,800 3,907 8,452 4,853 Investment Tax Credit - Net (663) (665) (665) (672) (682) Rentals (1) 4,672 5,328 5,640 5,422 5,730 --------------------------------------------- $146,228 $243,466 $231,100 $176,885 $180,934 ============================================= FIXED CHARGES: Interest & Amortization of Premium and Discount of Funded Debt $53,154 $42,131 $40,872 $40,896 $36,699 Interest on Commercial Paper and Short-Term Notes Payable 13,605 8,808 7,872 6,745 5,599 Other Interest (2) 16,919 4,502 6,389 4,721 3,361 Rentals (1) 4,672 5,328 5,640 5,422 5,730 --------------------------------------------- $88,350 $60,769 $60,773 $57,784 $51,389 ============================================= RATIO OF EARNINGS TO FIXED CHARGES 1.66 4.01 3.80 3.06 3.52
Notes: (1) Rentals shown above represent the portion of all rentals (other than delay rentals) deemed representative of the interest factor. (2) The twelve months ended September 30, 1998 and, fiscal 1997, 1996, 1995 and 1994 reflect the reclassification of $1,716, $1,716, $1,716, $1,716 and $1,674, representing the loss on reacquired debt amortized during each period, from Other Interest Charges to Operation Expense. (3) Deferred Income Taxes - Net for fiscal 1998 and 1994 exclude the cumulative effect of changes in accounting. EX-13 7 LETTER TO SHAREHOLDERS 1998* was a year in which we, and many companies in our industry, faced serious challenges. The weather was, on average, 12% warmer than normal in our Utility service areas. Our Exploration and Production segment experienced the unpredictable fury of this year's tropical storms, which, although not resulting in any physical damage for us, caused our gas production in the Gulf of Mexico to be shut-in for 13 days. Also, the steady decline of oil and gas prices was a significant factor in the year's earnings. In the second quarter of 1998, we could not avoid the "ceiling test" used under the rule prescribing the full cost method of accounting for oil and gas exploration and production operations. As a result of falling prices, we recorded a non-cash impairment to our oil and gas assets of $79.1 million after tax, or $2.06 per share.** The rule requiring this write-down is, unfortunately, a one way street, making it both arbitrary and misleading. While there is no denying that declining prices had a negative impact on the value of our oil and gas assets, we believe this snapshot approach to valuation overstates the magnitude of the decline as of fiscal year-end, and ignores the routine seasonal variability of energy prices. The rule provides only for write-downs and doesn't allow for write-ups that may occur due to subsequent price increases. While the requirement arguably provides a reasonable representation of our experience in the second quarter, it does not fully reflect our experience for the year. Our method of accounting for depletion of oil and gas properties was changed, effective October 1, 1997, to the more widely used units of production method. This resulted in a non-cash, non-recurring reduction of earnings per share of 24 cents. Without these two non-cash reductions, earnings per share were strong at $2.91 - only 3% lower than last year's record earnings. However, with the two non-cash special items, earnings per share for 1998 were $0.61 versus $3.01 for 1997. The total market value of Company stock rose approximately $128.7 million, to $1.8 billion, despite the volatility in the stock market this year. The market price per share closed at $47 on September 30, 1998, 6.8% higher than the market price per share on September 30, 1997. Once again, your Company fulfilled its commitment to annual dividend increases. In June, the Board of Directors raised the dividend by $0.06 (3.4%), to $1.80 per share on an annual basis, bringing you 28 years of consecutive increases and 96 years of uninterrupted dividend payments. As we look forward to the future growth of your Company, we expect the Company to continue this long history of uninterrupted dividend increases.1 - ----------------------- * All references to years in this Annual Report are to the Company's fiscal year, which ends September 30. ** All references to earnings per share are for basic earnings per common share. Several exciting projects and acquisitions were completed in 1998 which added value to your Company and, in turn, gave rise to new opportunities.1 Our goal of increasing domestic onshore activities of the Exploration and Production segment was achieved when we closed three acquisitions in the San Joaquin Basin in California. Our Pipeline and Storage segment became an equal partner with affiliates of Transcontinental Gas Pipe Line Corporation, one of the Williams Companies, and ANR Pipeline Company, a subsidiary of The Coastal Corporation, in the Independence Pipeline project. The International segment achieved an identity of its own through our considerable investments in Severoceske teplarny, a.s. and Prvni severozapadni teplarenska, a.s. which are both located in the northern region of the Czech Republic. We reached a settlement on the primary issues of a long-standing IRS audit, which provided a net $5.0 million benefit to the Company. Finally, but certainly important among this year's successes, we are pleased to report that the excellent efforts made by our employees to contain costs lead to another two-year rate settlement in New York, resulting in a rate reduction for our customers. We are all very aware that current events impact your Company. The worldwide surplus of crude oil and the warmer than normal temperatures have kept oil and gas prices at near record low levels. The strength of your Company will be tested in 1999 by many outside elements such as the predicted slowdown in the world economy, continued low commodity prices, and energy industry deregulation resulting in consumer choice of energy providers. Given the opportunities we enjoyed in 1998 to further your Company's historic strengths and to enhance our strong foundation, we are confident your Company will meet these challenges, grow from them and present an even stronger Company that will see us into the new millennium.1 EXPLORATION AND PRODUCTION The Exploration and Production segment experienced a pre-tax operating loss this year of $93.3 million, down $136 million from the prior year due to the non-cash impairment. Excluding this impairment, the segment had pre-tax operating income of $35.7 million, down $7 million from the previous year. At the beginning of the year when oil and gas prices were up, it was nearly impossible to obtain offshore drilling rigs at reasonable prices. Thus, we chose to defer drilling many of our planned wells. We took advantage of this lull in our drilling program to arrange three acquisitions of properties in the San Joaquin Basin in Southern California. We believe these properties will significantly enhance this segment's long-term growth potential.1 These acquisitions cost approximately $268 million, including assumed debt of $64.7 million, and contributed substantially - approximately 436 Bcf equivalent - to our total reserve base, which now stands at 725 Bcf equivalent. The mix of our reserves also changed, where nearly 55% is now oil and 45% is natural gas compared to 32% oil and 68% gas at September 30, 1997. In March, we acquired from The Whittier Trust Company and others properties in the Midway-Sunset and Lost Hills Fields, which added approximately 40 million barrels of proved oil reserves. In May, we completed a tender offer for HarCor Energy, Inc., an oil and gas company with properties located primarily on the west side of the San Joaquin Basin, which produce natural gas and higher gravity oil. Finally, in June, we acquired from Bakersfield Energy Resources, Inc. the remaining interests in those oil and gas assets located in the Lost Hills Field. In addition to the properties, we also acquired a gas processing plant and associated pipelines. As part of our West Coast reorganization plan, Barry L. McMahan was elected Vice President of Seneca Resources Corporation and is responsible for all West Coast operations. As oil and gas prices declined during the year we had some good news in the form of dramatically reduced prices for drilling rigs and other services associated with well completion. During the fourth quarter, we initiated development drilling on the California properties and resumed an active exploration program. To date, 35 development wells were successfully drilled on the California properties, with additional wells underway.1 Total production volumes increased to 52.2 Bcf equivalent this year from 50.0 Bcf equivalent last year. Oil production increased to 2.6 million barrels from 1.9 million barrels the year before, primarily due to increased oil production late in the year from the newly-acquired California properties. However, natural gas production levels went down from 38.6 Bcf to 36.5 Bcf because of decreased rig availability and tropical storms, as noted above. Should oil and gas prices improve, and if rig rates remain affordable, we expect to increase total production next year by approximately 46% to 76 Bcf equivalent and maintain a production ratio of 65% gas and 35% oil.1 In this regard, 82 exploration and development wells are planned for 1999.1 We anticipate most of the gas production increase for next year will be in the offshore area.1 In fact, late in the fourth quarter we successfully completed two additional development wells in the Gulf at Vermilion Block 309, raising the number of successful wells in that Block to six. All wells in this Block should be on line by the end of January 1999, and production from these wells is expected to be near 60 MMcf per day.1 In addition, we look for California production to increase approximately 15% for next year.1 Lower commodity prices do present other opportunities for us. A number of quality properties are for sale at competitive prices and many companies are looking for merger opportunities. We have further emphasized our business development efforts and will evaluate these opportunities as they arise.1 As part of this effort, Emmett Wassell was named to the newly created position of Vice President of Business Development of Seneca Resources Corporation, responsible for acquisitions and divestitures. PIPELINE AND STORAGE The Pipeline and Storage segment's 1998 pre-tax operating income decreased by $2 million to $71.5 million. Lower revenue from unbundled pipeline sales and open access transportation was the major cause of this decrease. As the natural gas industry evolves, we are proceeding with two fundamental strategies: o Capitalize on the opportunities which naturally result from our excellent location between Canada and the energy-hungry East Coast markets.1 o Expand our presence into new geographic areas through acquisitions and joint ventures.1 In 1998, we continued to develop, with our partners, the Independence Pipeline project, an interstate natural gas pipeline from Defiance, Ohio to our hub in Leidy, Pennsylvania.1 The pipeline will provide a critical path for about 900,000 Dth/day of gas from the Chicago area to the energy-demanding East Coast markets.1 Although this gas will primarily serve electric generation loads, it is enough to serve 900,000 residential customers on an average heating day.1 This project is currently planned to be in service by late 2000.1 The Independence Pipeline should also help us capitalize on opportunities for new or alternative uses of natural gas in the power generation market through its use of gas-fired turbines.1 This market is expected to generate areas of significant growth for our industry.1 As a result of deregulation and unbundling in the electric industry, many electric companies shied away from putting new units on line in recent years to avoid overcapacity and stranded costs. However, these companies now seek to reverse that trend and will look to increase the demand for and use of gas-fired turbines, thereby creating an additional market for natural gas.1 Growth in demand for natural gas is also expected to result from the shutdown of uneconomic nuclear power plants.1 If these plants are replaced by gas-fired combined cycle units, industry reports predict an additional demand of 1.5 Tcf/year, with approximately 1.2 Tcf /year in the New England, New York, Pennsylvania and New Jersey areas.1 The Independence Pipeline will be well-situated, both geographically and from a competitive cost standpoint, to meet this increased demand.1 We also anticipate increased demand for natural gas to result from the shutdown of coal-fired plants due to more stringent emission controls and costs. If these plants are also replaced by gas-fired combined cycle units, industry reports predict additional increased demand will range from 2.2 Tcf/year to 7.6 Tcf/year.1 As gas-fired units replace coal plants, emission of nitrogen oxide (which contributes to ozone depletion), sulfur dioxide (which causes acid rain) and carbon dioxide (which contributes to global warming) should be reduced significantly.1 Underground gas storage has long been a critical and integral part of meeting seasonal demands for natural gas. As the demand continues to increase, we stand ready to develop a number of depleted gas fields, which we control, to provide additional storage capacity to meet these needs.1 Moreover, given the success with our first horizontal storage well, from which we experienced a dramatic increase in deliverability, we are testing our other storage fields, in both New York and Pennsylvania, to determine if they are suitable for this new technology. Increasing the quantity of gas which can be withdrawn from storage in a day should provide new sources of revenue by enabling us to meet multiple markets' peak gas demand requirements.1 Also, applying our successful horizontal storage well technology to our other storage fields should enable us to build on our strategic location between Canadian supply sources and the East Coast market area.1 The Pipeline and Storage segment is a major contributor to your Company's net operating income, consistently providing a sound foundation for growth. As the pipeline industry evolves, we have the necessary components to satisfy the needs of both existing and emerging energy markets.1 UTILITY The Utility segment's 1998 pre-tax operating income increased by $0.6 million to $124.5 million. However, $6.0 million of revenues related to the IRS audits was entirely offset by interest expense also related to the IRS audits; thus, excluding this $6.0 million of revenue, pre-tax operating income decreased $5.4 million to $118.5 million. New York: At the expiration of the Utility's two-year rate settlement, we entered into a new two-year rate plan, commencing October 1, 1998. This plan provides for a $7.2 million rate reduction for our New York customers while preserving the 12% return on equity threshold for the 50/50 sharing of excess earnings with customers. Further, the new plan establishes a fund where $7.2 million of 1999 revenues will be set aside to help pay for future transition-related expenses incurred as the Company moves toward a competitive restructuring of its rates and services.1 We were able to negotiate this favorable rate plan primarily because of the Utility's ongoing cost control efforts. The New York Public Service Commission (PSC) recently issued a "vision statement" contemplating that local distribution companies would exit the merchant function over a three-to-seven year period. The PSC's proposal for the future of the gas industry in New York envisions that the Utility, as system operator, will retain the assets necessary to perform that function. These and other restructuring matters will be addressed in global settlement proceedings with each utility in New York. We will continue to work with the PSC and its Staff to more fully develop the PSC's restructuring objectives. However, we believe existing laws require gas utilities to maintain a certain, although possibly reduced, level of their traditional merchant service, including the requirement to serve as the retail customers' supplier of last resort.1 Pennsylvania: The Utility continues to avoid the need for a general rate increase through cost reductions and productivity advances and does not currently plan to file for any general rate increase in 1999.1 In 1998, we participated in an industry collaborative whose goal was to draft restructuring legislation that would ultimately bring energy provider choice to all of Pennsylvania's retail gas customers. While we gained valuable experience and insight into potential legislative reform, we determined that the legislation being considered by the collaborative was not in the best interests of our customers or our shareholders. It was too complex and required far more changes in laws and regulations than was truly needed. However, we capitalized on that collaborative experience, as well as our experience garnered through the Company's Energy Select program. That pilot program allowed our customers in the greater Sharon area the opportunity to buy natural gas from a merchant other than the Utility. In late October 1998, we filed a proposal with the Pennsylvania Public Utility Commission to offer direct access to competitive markets for all customers on our system. This customer choice program requires no new legislation.1 Recently, restructuring legislation was proposed in a significantly scaled-down version from the original gas restructuring bill. This draft proposal supports our view that sweeping changes to the current law are unnecessary. While we are evaluating this bill and its impact on our operations, we continue to pursue approval of our customer choice filing.1 To recognize his increased level of responsibility in Pennsylvania, Carl M. Carlotti was named Vice President of National Fuel Gas Distribution Corporation, responsible for the Pennsylvania division. As part of the industry's evolution, customer choice of gas suppliers is building momentum and should expand as customer awareness increases and as marketers pursue customers.1 No matter who the consumers buy their gas from, we will continue to deliver that gas in a cost efficient manner and profit from providing that service.1 To that end, we recently announced an early retirement offer to our employees. This will have a cost of approximately $5.5 million to be recorded in the first quarter of fiscal 1999; however, we expect to see some benefit to earnings in 1999, with the full value realized in fiscal 2000.1 INTERNATIONAL For the year, the International segment had pre-tax operating income of $2.1 million - up $5.1 million over the loss recognized last year. We continue our focus on eastern Central Europe - and the Czech Republic in particular - for further international expansion.1 Given the region's abundance of central steam plants and the prospects of increased electric energy usage, we expect more opportunities to use our expertise in both retail heating service as well as electric power generation.1 Our total investment in the Czech Republic now stands at $125 million, with $240 million in total assets. We increased our total ownership interest in Severoceske teplarny, a.s. (SCT) to 82.7%. We also acquired an 86.2% ownership interest in Prvni severozapadni teplarenska, a.s. (PSZT), a wholesale power and district heating company located in the northern Bohemia region of the Czech Republic. PSZT derives its revenues from the sale of both electric energy and thermal energy produced from its generation facilities located in Komorany. PSZT also purchases thermal energy for resale to residential, commercial and industrial customers. In 1999, we propose to merge SCT and PSZT in order to achieve operating and management efficiencies.1 This proposed merger of SCT and PSZT would create the third largest heating company in the Czech Republic and the third largest private producer of electricity for sale to the grid.1 Our investments in the International segment are an important part of our strategy to further increase your Company's earnings and shareholder value and provide a solid base to expand in eastern Central Europe.1 Over the next few years, we intend to exploit the co-generation prospects associated with our steam plants in the Czech Republic and use our facilities and personnel there to explore further opportunities, both within the Czech Republic and beyond its borders in Poland, Hungary and eastern Germany.1 OTHER NONREGULATED ACTIVITIES Our Other Nonregulated activities continue to grow and improve.1 As a group, they showed pre-tax operating income of $5.3 million, up $3.1 million from last year. Most of the increase came from our timber holdings and related sawmills. These holdings continue to increase in value due to biological growth and the steady demand for quality hardwoods.1 National Fuel Resources, Inc. (NFR) continues its dramatic growth in energy marketing, increasing its customer base, broadening its services and building a foundation for capturing more and more customers who will choose their energy supplier in a competitive marketplace.1 As a result of its marketing initiatives and the continued expansion of its sales team, NFR serves approximately 5,400 residential and commercial customers under long-term gas supply agreements. We are particularly proud of the efforts made during the year to secure two significant agreements, which provide geographic diversity to our customer base and demonstrate our competitiveness outside National Fuel's historic franchise area. In February, NFR secured a gas supply contract with the State of New Jersey to service various state owned and operated facilities, making NFR one of that state's largest retail suppliers of natural gas. In July, NFR began supplying energy to the University of Rochester for its central heating plant, eighteen campus buildings and Highland Hospital. Under this two-year agreement, NFR will supply approximately 3 Bcf of natural gas for heating and other process needs.1 NFR also participates in various natural gas and electric energy pilot programs, selling natural gas to residential customers in Pennsylvania as part of the Utility's Energy Select program and in Massachusetts as part of the Pioneer Valley Customer Choice program. Other electric projects for NFR include the state-wide pilot for food processors and farmers, and New York State Electric & Gas Corporation's Customer Advantage program for its electric customers in Lockport, New York. NFR successfully pursued this market, securing a contract to serve all of the Niagara County facilities in the pilot area. We are excited about the challenges and changes offered by the ever-changing gas and electric industry. As other companies have exited the market, or encountered heavy losses, NFR has remained a stable and profitable player, positioned to capitalize on regulatory changes that will occur in the future.1 INVESTING PLANS Because of our continued emphasis on expanding your Company's value as a diversified energy company, and in particular, capitalizing on the successes of the Exploration and Production segment, about one-half of our $204.4 million capital budget for 1999 is aimed at exploiting that segment's growth potential.1 There is $92 million targeted for our Exploration and Production segment, but this number is expected to fluctuate, depending on oil and gas prices and on drilling costs.1 We have allocated $35.6 million of the 1999 capital budget to our International segment, to be used primarily for retrofitting our facilities in the Czech Republic to comply with their environmental regulations.1 The $27 million allocated to our Pipeline and Storage segment largely covers the reconditioning of storage wells and the replacement of storage and transmission lines.1 Utility capital expenditures are projected at $48.9 million and will be used mostly to maintain our system and to replace main and service lines.1 This is a marked decrease from recent levels of Utility expenditures, and it also reflects the cumulative effect of replacing our steel pipe with plastic. The remaining amount is planned for the Other Nonregulated segment.1 As always, these numbers do not include any amounts for acquisitions or investments. Finally, we would like to thank all of our employees, including those who retired this year, for their years of commitment and contribution to your Company. We gratefully express our appreciation for their dedication in helping us continue to grow the value of your Company. Their efforts have provided your Company with a solid foundation, upon which to plan our future growth and take advantage of the exciting opportunities which that future will inevitably bring. /s/ Bernard J. Kennedy Chairman of the Board, President and Chief Executive Officer /s/ Philip C. Ackerman Senior Vice President December 10, 1998 1 This document contains "forward looking statements" as defined by the Private Securities Litigation Reform Act of 1995. Forward looking statements, including those designated by a "1," should be read with the cautionary statements included in this Annual Report on Form 10-K at Item 7, under the heading "Safe Harbor for Forward-Looking Statements." APPENDIX TO EXHIBIT 13 - This appendix contains a narrative description of image and graphic information as contained in the Letter to Shareholders included in the paper copy of the Company's combined Annual Report to Shareholders/Form 10-K. 1.) Image - Picture of Bernard J. Kennedy, Chairman of the Board, President and Chief Executive Officer, with Philip C. Ackerman, Senior Vice President. 2.) Graph - Annual Dividend Rate at Year End Bar graph showing the annual dividend rate per share at year-end (in dollars per common share) for 1988 through 1998, as follows: 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- $1.26 $1.34 $1.42 $1.46 $1.50 $1.54 $1.58 $1.62 $1.68 $1.74 $1.80 3.) Graph - Return on Average Common Equity Bar graph showing return on average common equity for 1994 through 1998, as follows (1994 and 1998 show actual return and return excluding special items): 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- 11.3% 9.6% 12.6% 13.0% 11.9%* 10.8%* 2.6% *Excludes special items for impairment of oil and gas producing assets in 1998 and for cumulative effect of changes in accounting in 1998 and 1994. 4.) Graph Bar graph showing oil and gas proved developed and undeveloped reserves (in billion cubic feet (Bcf) equivalent), at September 30, 1994 through 1998, as follows: 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- Oil 105.0 137.2 154.5 107.9 399.5 Gas 247.4 221.5 207.1 232.4 325.1 ----- ----- ----- ----- ----- 352.4 358.7 361.6 340.3 724.6 5.) Graph Bar graph showing oil and gas production (in billion cubic feet (Bcf) equivalent), for the years 1994 through 1998, as follows: 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- Oil 6.2 4.5 10.4 11.4 15.7 Gas 23.3 20.9 38.8 38.6 36.5 ---- ---- ---- ---- ---- 29.5 25.4 49.2 50.0 52.2 6.) Graphs - Oil and Gas Prices Two bar graphs showing weighted average oil and gas prices after hedging (in dollars) for the years 1994 through 1998, as follows: 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- Oil (per bbl) $14.86 $15.86 $18.01 $17.95 $13.03 Gas (per Mcf) $2.26 $2.01 $2.11 $2.18 $2.27 Images 7 - 11 are contained on a page devoted to the Exploration & Production segment as follows: 7.) Image - Picture of an offshore drilling rig located offshore Louisiana, with the following caption: Vermilion Block #309, located offshore Louisiana, is Seneca Resources' largest production endeavor. Production from its six wells is expected to be at a rate of 60 MMcf per day.1 8.) Image - Drilling rig with the following caption: Drilling rigs like the one pictured are used in Seneca Resources' San Joaquin exploration program. 9.) Graph - 1998 Exploration and Production Capital and Acquisition Expenditures Pie graph showing the following pie slices for the total $391.2 million (which includes $64.7 million of assumed debt) of 1998 Exploration and Production Capital and Acquisition Expenditures: Whittier 36%; HarCor 25%; BER 8%; Offshore 25%; Onshore and Other 6%. 10.) Image - Picture of gas processing plant with the following caption: In addition to oil and gas assets located in the San Joaquin Basin, California, Seneca Resources acquired the Belridge gas processing plant in June 1998. This plant has the capacity to remove and separate natural gas liquids from 22 MMcf of gas per day. 11.) Image - Pumping unit with the following caption: This pumping unit typifies the preferred method of lifting crude oil to the surface in Seneca's California operations. Images 12 - 13 are contained on a page devoted to the Pipeline & Storage segment as follows: 12.) Image - Picture of Concord Station Compressor engine with the following caption: The Concord Station Compressor engines have been altered to accommodate a wider range of operating conditions and handle additional throughput from the Niagara Expansion. Pictured: (center) Concord employee Michael P. Yasurek surveys the installation of a master rod and crossbar. 13.) Image - Map of Northeastern to Midwestern United States with outline of proposed Independence Pipeline Project, with the following caption: The proposed Independence Pipeline will transport natural gas to distribution companies, electric power producers and large-volume industrial and commercial customers, offering access to every major natural gas supply basin in North America, from the Gulf of Mexico, to western Canada. A second image of a circle containing the following sentence appears above the image of the map: The Independence Pipeline will provide a critical path for about 900,000 Dth/day of natural gas ... enough to serve 900,000 residential customers. 14.) Graph - Pipeline and Storage Throughput Bar graph showing Pipeline & Storage throughput with percentage of total transportation throughput to affiliated and nonaffiliated customers, for 1994 through 1998, as follows: 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- Affiliated 45% 42% 41% 41% 32% Nonaffiliated 55% 58% 59% 59% 68% Total Sales (Bcf) 296.6 290.7 325.0 300.3 313.0 15.) Graph - Utility Operation and Maintenance Expense Bar graph showing the Utility segment's operation and maintenance expense (in millions of dollars) for 1994 through 1998, as follows: 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- $193 $194 $201 $187 $184 16.) Graph - Fiscal 1998 Weather Bar graph showing fiscal 1998 percent warmer than last year and warmer than normal for Buffalo, New York and Erie, Pennsylvania, as follows: Percent warmer Than Than Last Year Normal --------- ------ Buffalo, New York 12.9% 11.6% Erie, Pennsylvania 15.7% 13.4% Images 17 - 18 are contained on a page devoted to the Utility segment as follows: 17.) Image - Picture of dispatch operations at Mineral Spring Works. Additional images above and to the right of dispatch operations picture are a National Fuel service van with dotted lines to an image of a satellite and a diagram of a dispatch service area map. The following caption is included: The dispatching of all New York customer service orders has been centralized at Mineral Spring Works. This facility operates 24 hours a day, 365 days a year. Pictured: (l-r): Teresa Ortiz, Aileen Kozakiewicz, Patricia A. White and Cheryl A. Henault. 18.) Image -Picture of National Fuel employees working on computerized mapping and work order management system with the following caption: National Fuel recently implemented an integrated, state-of-the-art computerized mapping and work order management system. This system will enhance mapping productivity, as well as provide "real time" gas facilities status. Pictured: Foreground: Erie Engineering employees Michael J. Bolla, Linda J. Wardzinski and Mark E. Thornton. Images 19 - 21 are contained on a page devoted to the International and the Other Nonregulated segments as follows: 19.) Image - Picture of PSZT facility with the following caption: Horizon Energy Development, Inc. acquired a majority interest in PSZT, a wholesale power and district heating company located in the northern Bohemia region of the Czech Republic. At this facility, steam turbines produce 240 megawatts of electric generation. Additional image of a street and buildings in Prague, Czech Republic and a map of the Czech Republic with the general location of SCT and PSZT identified. 20.) Image - Picture of Erie Barge Canal Locks with the following caption: National Fuel Resources is diversifying its energy selection by offering electric generation for sale to commercial, industrial and residential prospects in the Lockport, New York area. Symbolic of Lockport are the Erie Barge Canal Locks. 21.) Image - Picture of building at the University of Rochester with the following caption: National Fuel Resources has entered into a two-year agreement with the University of Rochester to supply approximately 3 Bcf of natural gas that will be used for heating and other process needs. 22.) Graph - NFR Number of Customers Bar graph showing number of customers of National Fuel Resources (NFR) for the years 1994 to 1998, as follows: 1994 1995 1996 1997 1998 ---- ---- ---- ---- ---- Commercial/ Industrial 180 246 672 937 1,499 Residential Gas - - - 370 3,872 Electric - - - - 105 ----- ----- ----- ----- ----- Total 180 246 672 1,307 5,476 EX-23 8 RALPH E. DAVIS ASSOCIATES, INC. Consultants-Petroleum and Natural Gas 3555 Timmons Lane - Suite 1105 Houston, Texas 77027 (713) 622-8955 CONSENT OF ENGINEER We hereby consent to the reproduction of our audit report dated October 19, 1998, and to the reference to our estimate dated October 1, 1998, appearing in this National Fuel Gas Company Annual Report on Form 10-K. We also consent to the incorporation by reference in (i) the Registration Statement (Form S-8, No. 2-95439), as amended, relating to the National Fuel Gas Company 1983 Incentive Stock Option Plan and the National Fuel Gas Company 1984 Stock Plan, and in the related Prospectuses, (ii) the Registration Statements (Form S-8, No. 33-28037, No. 333-3055, and Nos. 2-97641, 33-17341 and 333-3057), as amended, relating to the National Fuel Gas Company Tax-Deferred Savings Plan and the National Fuel Gas Company Tax-Deferred Savings Plan for Non-Union Employees, respectively, and in the related Prospectuses, (iii) the Registration Statement (Form S-3, No. 333-3803), as amended, relating to $500,000,000 of National Fuel Gas Company debentures and/or medium term notes and, in the related Prospectus, (iv) the Registration Statements (Form S-3, No. 33-51881 and Form S-3D, No. 333-51769), as amended, relating to the National Fuel Gas Company Dividend Reinvestment and Stock Purchase Plan, and in the related Prospectuses, (v) the Registration Statement (Form S-3, No. 33-36868), as amended, relating to the National Fuel Gas Company Customer Stock Purchase Plan, and in the related Prospectus, (vi) the Registration Statement (Form S-8, No. 33-49693), as amended, relating to the National Fuel Gas Company 1993 Award and Option Plan, and in the related Prospectus, and (vii) the Registration Statement (Form S-8, No. 333-51595) relating to the National Fuel Gas Company 1997 Award and Option Plan, and in the related Prospectus, of the reproduction of our report dated October 19, 1998, appearing in this National Fuel Gas Company Annual Report on Form 10-K. RALPH E. DAVIS ASSOCIATES, INC. /s/ Allen C. Barron ------------------------------- Allen C. Barron, P.E. Vice President Houston, Texas October 19, 1998 EX-23 9 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Prospectuses constituting part of the Registration Statements on Form S-3 (No. 33-51881), Form S-3 (No. 33-36868), Form S-3 (No. 333-03803), Form S-3 (No. 333-51769), Form S-8 (No. 2-94539), Form S-8 (No. 33-49693), Form S-8 (No. 333-03057), Form S-8 (No. 333-03055), and Form S-8 (No. 333-51595) of National Fuel Gas Company of our report dated October 27, 1998, appearing on page 56 of this Form 10-K. Buffalo, New York December 21, 1998 EX-27 10
UT THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM NATIONAL FUEL GAS COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS SEP-30-1998 OCT-01-1997 SEP-30-1998 PER-BOOK 2,248,137 0 210,517 8,619 217,186 2,684,459 38,469 416,239 428,112 890,085 0 0 692,669 196,300 0 130,000 0 0 0 0 775,405 2,684,459 1,248,000 24,024 1,140,045 1,164,069 83,931 35,870 119,801 85,284 23,188 0 23,188 67,671 47,767 252,978 0.61 0.60
EX-27 11
UT THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM NATIONAL FUEL GAS COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS SEP-30-1997 OCT-01-1996 SEP-30-1997 PER-BOOK 1,819,366 0 208,667 12,025 227,273 2,267,331 38,166 405,028 472,595 913,704 0 0 581,640 32,400 0 60,000 0 0 0 0 679,587 2,267,331 1,265,812 68,674 1,028,835 1,097,509 168,303 3,196 171,499 56,811 114,688 0 114,688 64,967 41,576 294,662 3.01 2.98
EX-27 12
UT THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM NATIONAL FUEL GAS COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS SEP-30-1996 OCT-01-1995 SEP-30-1996 PER-BOOK 1,709,606 0 220,981 7,377 211,808 2,149,772 37,852 395,272 422,874 855,998 0 0 574,000 109,700 0 90,000 0 0 0 0 520,074 2,149,772 1,208,017 66,321 984,250 1,050,571 157,446 3,869 161,315 56,644 104,671 0 104,671 61,920 40,872 168,469 2.78 2.77
EX-27 13 WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
UT THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM NATIONAL FUEL GAS COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 03-MOS SEP-30-1997 OCT-01-1996 DEC-31-1996 PER-BOOK 1,716,588 0 356,011 13,254 211,446 2,297,299 38,023 400,807 445,554 884,384 0 0 524,000 147,300 0 105,000 50,000 0 0 0 586,615 2,297,299 363,492 22,209 289,130 311,339 52,153 737 52,890 14,300 38,590 0 38,590 15,910 0 8,609 1.02 1.01
EX-27 14 WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
UT THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM NATIONAL FUEL GAS COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 06-MOS SEP-30-1997 OCT-01-1996 MAR-31-1997 PER-BOOK 1,746,452 0 353,119 9,464 204,686 2,313,721 38,138 404,889 486,696 929,723 0 0 531,739 153,200 0 20,000 52,628 0 0 0 626,431 2,313,721 862,196 56,411 682,821 739,232 122,964 1,322 124,286 28,587 95,699 0 95,699 31,877 0 145,739 2.52 2.49
EX-27 15 WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
UT THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM NATIONAL FUEL GAS COMPANY'S CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 09-MOS SEP-30-1997 OCT-01-1996 JUN-30-1997 PER-BOOK 1,771,144 0 249,272 11,400 217,131 2,248,947 38,148 404,873 489,060 929,836 0 0 532,214 27,100 0 105,000 53,309 0 0 0 601,488 2,248,947 1,108,247 69,719 884,281 954,000 154,247 2,598 156,845 42,240 114,605 0 114,605 48,419 0 270,874 3.01 2.98
EX-99 16 RALPH E. DAVIS ASSOCIATES, INC. CONSULTANTS-PETROLEUM AND NATURAL GAS 3555 TIMMONS LANE-SUITE 1105 HOUSTON, TEXAS 77027 (713) 622-8955 October 19, 1998 Seneca Resources Corporation 1201 Louisiana, Suite 400 Houston, Texas 77002 Attention: Mr. Don A. Brown Vice President Re: Oil, Condensate and Natural Gas Reserves, Seneca Resources Corporation As of October 1, 1998 Gentlemen: At your request, the firm of Ralph E. Davis Associates, Inc. has audited an evaluation of the proved oil, condensate and natural gas reserves on leaseholds in which Seneca Resources Corporation has certain interests. This report presents a summary of the Proved Developed (producing and non-producing) and Proved Undeveloped reserves anticipated to be produced from Seneca Resources' interest. Liquid volumes are expressed in thousands of barrels (MBbls) of stock tank oil. Gas volumes are expressed in millions of standard cubic feet (MMSCF) at the official temperature and pressure bases of the areas wherein the gas reserves are located. The summarized results of the reserve audit are as follows: RALPH E. DAVIS ASSOCIATES, INC. Seneca Resources Corp. Mr. Don A. Brown October 19, 1998 Page 2 Estimated Proved Reserves Net to Seneca Resources Corporation As of October 1, 1998 Proved Reserves -------------------------------------------- Developed ----------------------- Remaining Reserves Producing Non-Producing Undeveloped Total - ------------------ --------- ------------- ----------- ----- East Coast Division: - -------------------- Oil/Condensate, MBbls 80 0 0 80 Gas, MMSCF 80,062 414 0 80,476 Gulf Coast Division: - -------------------- Oil/Condensate, MBbls 2,855 883 342 4,080 Gas, MMSCF 63,116 53,345 4,788 121,249 West Coast Division: - -------------------- Oil/Condensate, MBbls 41,177 3,084 18,169 62,430 Gas, MMSCF 27,304 6,266 89,769 123,339 TOTAL: Oil/Condensate, MBbls 44,112 3,967 18,511 66,590 Gas, MMSCF 170,482 60,025 94,557 325,064 DISCUSSION: The scope of this study was to audit the proved reserves attributable to the interests of Seneca Resources Corporation. Reserve estimates were prepared by Seneca using acceptable evaluation principals for each source. The quantities presented herein are estimated reserves of oil, condensate and natural gas that geologic and engineering data demonstrate can be recovered from known reservoirs under existing economic conditions with reasonable certainty. Ralph E. Davis Associates, Inc. has audited the reserve estimates, the data incorporated into preparing the estimates and the methodology used to evaluate the reserves. In each of Seneca's producing divisions all 1998 additions and those properties of significant value were reviewed by Ralph E. Davis. Reserve estimates of current producing zones, productive zones RALPH E. DAVIS ASSOCIATES, INC. Seneca Resources Corp. Mr. Don A. Brown October 19, 1998 Page 3 behind pipe and undrilled well locations were reviewed in detail. Certain changes to either individual reserve estimates or the categorization of reserves were suggested by Ralph E. Davis Associates, Inc. and accepted by Seneca Resources. It is our opinion that the reserves presented herein meet all the criteria of Proved Reserves. Neither Ralph E. Davis Associates, Inc. nor any of its employees have any interest in Seneca Resources Corporation or the properties reported herein. The employment and compensation to make this study are not contingent on our estimate of reserves. We appreciate the opportunity to be of service to you in this matter, and will be glad to address any questions or inquiries you may have. Very truly yours, RALPH E. DAVIS ASSOCIATES, INC. /s/ Allen C. Barron Allen C. Barron, P. E. Vice President -----END PRIVACY-ENHANCED MESSAGE-----