The
accompanying unaudited interim consolidated financial statements of Panhandle
Eastern Pipe Line Company, LP, a Delaware limited partnership, including all of
its subsidiaries (collectively, Panhandle) have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission (SEC) for
quarterly reports on Form 10-Q. These statements do not include all of the
information and note disclosures required by generally accepted accounting
principles, and should be read in conjunction with Panhandle’s financial
statements and notes thereto for the twelve months ended December 31, 2004,
included in Panhandle’s Form
10-K filed with the SEC. The accompanying unaudited interim consolidated
financial statements have been prepared in accordance with accounting principles
generally accepted in the United States of America and reflect adjustments
(including both normal recurring as well as any non-recurring) which are, in the
opinion of management, necessary for a fair presentation of results for the
interim period. Because of the seasonal nature of Panhandle’s operations, the
results of operations and cash flows for any interim period are not necessarily
indicative of the results that may be expected for the full year. All dollar
amounts in the tables herein are stated in thousands unless otherwise indicated.
Certain prior period amounts have been reclassified to conform with the current
period presentation.
I
Corporate Structure
Panhandle Eastern
Pipe Line Company,
LP (Panhandle
Eastern Pipe Line) is an
indirect wholly-owned subsidiary of Southern Union Company (Southern
Union Company and,
together with its subsidiaries, Southern
Union).
Panhandle is primarily engaged in the interstate transportation and storage of
natural gas and also provides liquefied natural gas (LNG)
terminalling and regasification services. Panhandle is subject to the rules and
regulations of the Federal Energy Regulatory Commission (FERC). The
Panhandle entities include Panhandle Eastern Pipe Line, Trunkline Gas Company,
LLC (Trunkline), a
wholly-owned subsidiary of Panhandle Eastern Pipe Line, Sea Robin Pipeline
Company, LLC (Sea
Robin), an
indirect wholly-owned subsidiary of Panhandle Eastern Pipe Line, Trunkline LNG
Company, LLC (Trunkline
LNG), which
is a wholly-owned subsidiary of Trunkline LNG Holdings, LLC (LNG
Holdings), an
indirect wholly-owned subsidiary of Panhandle Eastern Pipe Line and Pan Gas
Storage, LLC (d.b.a. Southwest
Gas Storage), a
wholly-owned subsidiary of Panhandle Eastern Pipe Line. Collectively, the
pipeline assets include more than 10,000 miles of interstate pipelines that
transport natural gas from the Gulf of Mexico, South Texas and the panhandle
regions of Texas and Oklahoma to major U.S. markets in the Midwest and Great
Lakes region. The pipelines have a combined peak day delivery capacity of 5.4
billion cubic feet (bcf) per day
and 72 bcf of owned underground storage capacity. Trunkline LNG, located on
Louisiana's Gulf Coast, operates one of the largest LNG import terminals in
North America, based on current send out capacity, and has 6.3 bcf of above
ground LNG storage capacity.
Southern
Union Panhandle, LLC serves as the general partner of Panhandle Eastern Pipe
Line and owns a one percent general partner interest in Panhandle Eastern Pipe
Line. Southern Union Company owns a ninety-nine percent limited partner interest
in Panhandle Eastern Pipe Line.
II
Summary of Significant Accounting Policies and Other
Matters
Principles
of Consolidation. The
unaudited interim consolidated financial statements include the accounts of all
majority-owned subsidiaries, after eliminating significant intercompany
transactions and balances. Investments in businesses not controlled by Panhandle
Eastern Pipe Line, but over which it may have significant influence, are
accounted for using the equity method. Investments that are variable interest
entities are consolidated if Panhandle is allocated a majority of the entity’s
gains and/or losses, including fees paid by the entity. All significant
intercompany accounts and transactions are eliminated in
consolidation.
Asset
Impairment.
Panhandle applies the provisions of Statement of Financial Accounting Standards
(SFAS) No.
144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” to
account for impairments on long-lived assets. Impairment losses are recognized
for long-lived assets used in operations when indicators of impairment are
present and the undiscounted cash flows are not sufficient to recover the
assets’ carrying value. The amount of impairment is measured by comparing the
fair value of the asset to its carrying amount.
PANHANDLE
EASTERN PIPE LINE COMPANY, LP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Revenues.
Panhandle’s
revenues from transportation and storage of natural gas and LNG terminalling are
based on capacity reservation charges and commodity usage charges. Reservation
revenues are based on contracted rates and capacity reserved by the customers
and are recognized monthly. Revenues from commodity usage charges are also
recognized monthly, based on the volumes received from or delivered to the
customer, depending on the tariff of that particular Panhandle entity, with
any differences in received and delivered volumes resulting in an imbalance.
Volume imbalances are generally settled in-kind with no impact on revenues, with
the exception of Trunkline, which cashes out imbalances pursuant to its tariff,
and records gains and losses on such cashout sales as a component of revenue, to
the extent not owed back to customers.
Significant
Customers and Credit Risk.
Panhandle manages trade credit risks to minimize exposure to uncollectible trade
receivables. Prospective and existing customers are reviewed for
creditworthiness based upon pre-established standards. Customers that do not
meet minimum standards are required to provide additional credit support.
Panhandle utilizes the allowance method for recording its allowance for
uncollectible accounts which is primarily based on the application of historical
bad debt percentages applied against Panhandle’s aged accounts receivable.
Increases in the allowance are recorded as a component of operation expenses.
Reductions in the allowance are recorded when receivables are written off.
Panhandle has an allowance for doubtful accounts totaling $1,289,000 and
$1,289,000 at March 31, 2005 and December 31, 2004, respectively, relating to
its trade receivables.
Accounting
for Retirement Benefits. To
account for other postretirement benefit costs, Panhandle follows SFAS No. 106,
“Employers’ Accounting for Postretirement Benefits Other Than Pensions”, and
SFAS No. 132R, “Employers’ Disclosures about Pensions and Other Postretirement
Benefits,” as amended. For defined benefit plans, under certain circumstances,
these statements require liabilities to be recorded on the balance sheet at the
present value of these future obligations to employees net of any plan assets.
The calculation of these liabilities and associated expenses requires the
expertise of actuaries and is subject to many assumptions, including life
expectancies, present value discount rates, expected long-term rate of return on
plan assets, rate of compensation increase and anticipated health care costs.
Any change in these assumptions can significantly change the liability and
associated expenses recognized in any given year.
Panhandle
does not maintain or participate in a defined benefit retirement plan for its
employees, but instead provides benefits to substantially all employees under a
defined contribution 401(k) plan. Under the 401(k) plan, Panhandle provides a
matching contribution of 50 percent of the employee’s contribution to the 401(k)
plan that does not exceed 4 percent of the employee’s eligible pay. In addition,
Panhandle makes additional contributions to the 401(k) plan ranging from 4 to 6
percent of the employee’s eligible pay, depending on the employee’s age and
years of service under a Retirement Power Account benefit.
Panhandle
provides certain postretirement health and life benefits to eligible, active
employees. The accumulated postretirement benefit obligation with respect to
such postretirement health and life benefits as of March 31, 2005 and December
31, 2004 was approximately $39,404,000 and $38,260,000, respectively. See
Note
VIII - Benefits.
Accounting
for Derivatives and Hedging Activities.
Panhandle follows SFAS No. 133, “Accounting for Derivative Instruments and
Hedging Activities”,
as
amended, to accrue for derivative and hedging activities. See Note
V - Accounting for Derivatives and Hedging Activities.
Accounting
for Taxes. For
federal and certain state income tax purposes, Panhandle’s subsidiaries are not
treated as separate taxpayers. Instead, their income is directly taxable to
Southern Union. Since its conversion to a limited partnership, Panhandle has
been treated as a disregarded entity for federal income tax purposes. Pursuant
to a tax sharing agreement with Southern Union, Panhandle will pay its share of
taxes based on its taxable income, which will generally equal the liability
which Panhandle would have incurred as a separate taxpayer. Panhandle will
receive credit under an intercompany note from Southern Union for differences in
tax depreciation resulting from the like-kind exchange over the taxable life of
the related assets.
PANHANDLE
EASTERN PIPE LINE COMPANY, LP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred
tax assets and liabilities are recorded based on the difference between the
financial statement and tax basis of assets and liabilities using enacted tax
rates in effect for the year in which the differences are expected to reverse.
Deferred tax assets, such as net operating loss carryforwards, may be reduced by
a valuation allowance if, based on the weight of available evidence, it is more
likely than not that some portion or all of the deferred tax assets will not be
realized.
Commitments
and Contingencies.
Panhandle is subject to proceedings, lawsuits and other claims related to
environmental and other matters. Accounting for contingencies requires
significant judgments by management regarding the estimated probabilities and
ranges of exposure to potential liability. See Note
IX - Commitments and Contingencies.
New
Accounting Standards
FSP
No. FAS 106-2, “Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003”
(the
Medicare Prescription Drug Act): Issued
by the Financial Accounting Standards Board (FASB) in May 2004, FASB
Financial Staff Position (FSP) No. FAS 106-2 (FSP FAS 106-2)
requires entities to record the impact of the Medicare Drug Prescription Act as
an actuarial gain in the postretirement benefit obligation for postretirement
benefit plans that provide drug benefits covered by that legislation. Panhandle
adopted this FSP as of March 31, 2005, the effect of which was not material to
its consolidated financial statements. The effect of this FSP may vary as a
result of any future changes to Panhandle’s benefit plans.
FASB
Statement No.123R, "Share-Based Payment (revised 2004)":
Issued by
the FASB in December 2004, the statement revises FASB Statement No. 123,
“Accounting for Stock-Based Compensation,” supersedes the Accounting Principal
Board Opinion No. 25, “Accounting for Stock Issued to Employees” and amends the
FASB Statement No. 95, “Statement of Cash Flows.” The statement will be
effective for Southern Union, Panhandle’s parent company, in the first annual
reporting period beginning after June 15, 2005 and will require Southern Union
to measure all employee stock-based compensation awards using a fair value
method and record such expense in its consolidated financial statements.
Panhandle will be charged for its proportionate share of the expense recorded by
Southern Union. In addition, the adoption of the statement will require
additional accounting and disclosure related to the income tax and cash flow
effects resulting from share-based payment arrangements. Panhandle is currently
evaluating the impact of this statement on its consolidated financial position,
results of operations and cash flows.
FSP
No. 109-1, “Application of FASB Statement No. 109, ‘Accounting for Income
Taxes,’ to the Tax Deduction on Qualified Production Activities Provided by the
American Jobs Creation Act of 2004”: On
October 22, 2004, the American Jobs Creation Act of 2004 (the
Act) was
signed. The Act raises a number of issues with respect to accounting for income
taxes. On December 21, 2004, the FASB issued a Staff Position regarding the
accounting implications of the Act related to the deduction for qualified
domestic production activities (FSP FAS 109-1) which is effective for
periods subsequent to December 31, 2004. The guidance in the FSP otherwise
applies to financial statements for periods ending after the date the Act was
enacted. In FSP FAS 109-1, “Application of FASB Statement No. 109, ‘Accounting
for Income Taxes,’ to the Tax Deduction on Qualified Production Activities
Provided by the American Jobs Creation Act of 2004,” the FASB decided that the
deduction for qualified domestic production activities should be accounted for
as a special deduction under Statement of Financial Accounting Standards No.
109, “Accounting for Income Taxes,” and rejected an alternative view to treat it
as a rate reduction. Accordingly, any benefit from the deduction should be
reported in the period in which the deduction is claimed on the tax return. In
most cases, a company’s existing deferred tax balances will not be impacted at
the date of enactment. For some companies, the deduction could have an impact on
their effective tax rate and, therefore, should be considered when determining
the estimated annual rate used for interim financial reporting. Panhandle is
currently evaluating the impact of this FSP but does not believe it will have a
significant impact on its consolidated financial position, results of operations
or cash flows.
PANHANDLE
EASTERN PIPE LINE COMPANY, LP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
FSP
No. FIN 46R-5, “Implicit Variable Interests under FASB Interpretation No. 46
(revised December 2003), Consolidation of Variable Interest Entities” (FSP FIN
No. 46R-5): Issued
by the FASB in March 2005, this staff position addresses whether a reporting
enterprise should consider whether it holds an implicit variable interest in a
variable interest entity (VIE) or
potential VIE when specific conditions exist. An implicit variable interest is
an implied pecuniary interest in an entity that indirectly changes with changes
in the fair value of the entity’s net assets exclusive of variable interests.
Implicit variable interests may arise from transactions with related parties, as
well as from transactions with unrelated parties. This FSP is effective, for
entities to which the interpretations of FIN 46(R) have been applied, in the
first reporting period beginning after March 31, 2005. Panhandle adopted this
FSP as of March 31, 2005, the effect of which had no impact on Panhandle’s
consolidated
financial position, results of operations or cash flows.
FIN
No. 47, “Accounting for Conditional Asset Retirement
Obligations.” Issued
by the FASB in March 2005, this interpretation clarifies that the term
“conditional asset retirement obligation” as used in SFAS No. 143, “Accounting
for Asset Retirement Obligations,” refers to a legal obligation to perform an
asset retirement activity in which the timing and/or method of settlement are
conditioned on a future event that may or may not be within the control of the
entity. The obligation to perform the asset retirement activity is unconditional
even though uncertainty exists about the timing and/or method of settlement. The
entity is required to recognize a liability for the fair value of a conditional
asset retirement obligation if the fair value can be reasonably estimated. This
statement is effective for the fiscal year ending after December 31, 2005.
Panhandle is currently evaluating the impact, if any, of this interpretation on
its consolidated financial position, results of operations or cash flows.
FERC
Proposed Accounting Release: In
November 2004, the FERC issued an industry-wide Proposed Accounting Release
that, if enacted as written, would require pipeline companies to expense rather
than capitalize certain costs related to mandated pipeline integrity programs
(under the Pipeline Safety Improvement Act of 2002). The accounting release was
proposed to be effective January 1, 2005, following a period of public comment
on the release. Comments were filed on January 19, 2005, including pipeline
association comments suggesting that such costs be capitalized. Panhandle is
awaiting a final release and cannot, at this time, predict the final outcome.
Panhandle
has currently budgeted in 2005 approximately $22 million of pipeline integrity
related costs, of which approximately $3 million of currently capitalized costs
would be required to be expensed pursuant to the release.
III
Regulatory Matters
In
conjunction with a FERC Order issued in September 1997, certain natural gas
producers were required to refund to interstate natural gas pipelines, including
Panhandle Eastern Pipe Line, monies previously paid to producers as
reimbursement of the producers Kansas Ad Valorem tax obligations. The FERC order
required the affected pipelines to refund these amounts to their customers. In
June 2001, Panhandle Eastern Pipe Line filed a proposed settlement of these
proceedings which all the customers and most of the producers supported. The
settlement provided for the producers to refund and the customers to accept a
reduction from the amounts originally billed to the producers. In September
2001, the FERC approved the settlement without modification and the settlement
became effective on October 15, 2001. Settlements were reached with all of the
non-settling producers in November 2003, except for Pioneer Natural Resources,
Inc. (Pioneer) and
Burlington Resources Oil & Gas Company, LP (Burlington). On
January 29, 2004 and February 13, 2004, the Commission approved settlements with
these remaining non-settling producers. A FERC hearing to resolve the
outstanding issues with Pioneer was conducted on October 16, 2003. FERC orders
which established Pioneer’s refund amount were issued on June 2, 2004 and
October 12, 2004. As of December 31, 2004, all tax collections due from
producers had been received and distributed to Panhandle’s customers. One
producer, Burlington, is contesting the applicability of the FERC refund
requirement due to a prior gas purchase contract settlement with Panhandle
Eastern Pipe Line. On January 21, 2005, the United States Court of Appeals for
the District of Columbia Circuit remanded this case back to the FERC for further
explanation as to why Burlington should be required to make a refund to
Panhandle Eastern Pipe Line. Management believes that this matter will not have
a material adverse effect on Panhandle’s consolidated results of operations or
financial position. At December 31, 2004, other current liabilities included
$206,000 for tax collections due to customers.
PANHANDLE
EASTERN PIPE LINE COMPANY, LP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
In
December 2002, FERC approved a Trunkline LNG certificate application to expand
the Lake Charles facility to approximately 1.2 bcf per day of sustainable send
out capacity versus the current sustainable send out capacity of .63 bcf per day
and increase terminal storage capacity to 9 bcf from the current 6.3 bcf. BG LNG
Services has contract rights for the .57 bcf per day of additional capacity.
Construction on the Trunkline LNG expansion project (Phase
I)
commenced in September 2003 and is expected to be completed at an estimated cost
of $137 million, plus capitalized interest, by the end of 2005. On September 17,
2004, as modified on September 23, 2004, FERC approved Trunkline LNG’s further
incremental expansion project (Phase
II). Phase
II is estimated to cost approximately $77 million, plus capitalized interest,
and would increase the LNG terminal sustainable send out capacity to 1.8 bcf per
day. Phase II has an expected in-service date of mid-2006. BG LNG Services has
contracted for all the proposed additional capacity, subject to Trunkline LNG
achieving certain construction milestones at this facility. Approximately $150
million and $127 million of costs are included in the line item Construction
work-in-progress for the expansion projects at March 31, 2005 and December 31,
2004, respectively.
In
February 2004, Trunkline filed an application with the FERC to request approval
of a 30-inch diameter, 23-mile natural gas pipeline loop from the LNG terminal.
Trunkline’s filing was approved on September 17, 2004, as modified on September
23, 2004. The pipeline creates additional transport capacity in association with
the Trunkline LNG expansion and also includes new and expanded delivery points
with major interstate pipelines. On November 5, 2004, Trunkline filed an amended
application with the FERC to change the size of the pipeline from 30-inch
diameter to 36-inch diameter to better position Trunkline to provide
transportation service for expected future LNG volumes and increase operational
flexibility. The amendment was approved by FERC on February 11, 2005. The
Trunkline natural gas pipeline loop project associated with the LNG terminal is
estimated to cost $50 million, plus capitalized interest. Approximately $23
million and $21 million of costs are included in the line item Construction
work-in-progress for this project at March 31, 2005 and December 31, 2004.
IV
Related Party Transactions
Panhandle
Eastern Pipe Line receives transportation revenues from Missouri Gas Energy, a
Southern Union division, which account for less than one percent of annual
consolidated revenues. These deliveries are at contracted rates that pre-date
the acquisition
of Panhandle by Southern Union (Panhandle Acquisition).
| |
|
Three
Months |
|
Three
Months |
|
| |
|
Ended
March 31, |
|
Ended
March 31, |
|
|
Related
Party Transactions |
|
2005 |
|
2004 |
|
| |
|
|
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
Transportation
and storage of natural gas |
|
$ |
895 |
|
$ |
977 |
|
|
Operation
and maintenance: |
|
|
|
|
|
|
|
|
Management
& royalty fees |
|
|
3,386
|
|
|
3,222
|
|
|
Other
expenses |
|
|
3,704
|
|
|
4,472
|
|
|
Interest
income, net |
|
|
563
|
|
|
279
|
|
Pursuant
to a demand note with Southern Union under a cash management program, Panhandle
has loaned excess cash, net of repayments, totaling $93,745,000 to Southern
Union since the Panhandle Acquisition. Net loans of $3,000,000 were
recorded during the three month period ended March 31, 2005. Panhandle is
credited with interest on the note at a one month LIBOR rate. Interest income
associated with the Note receivable - Southern Union was $510,000 and $269,000
for the periods ended March 31, 2005 and March 31, 2004, respectively, and is
included in Other, net in the accompanying Consolidated Statements of
Operations. Panhandle expects to draw down on the note over the next twelve
months to fund capital expenditures in excess of operating cash flows and has
thus reflected the note receivable from Southern Union as a current asset.
PANHANDLE
EASTERN PIPE LINE COMPANY, LP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
A summary
of certain balances due from or (due to) related parties included in the
Consolidated Balance Sheets for the periods presented is as
follows:
| |
|
March
31, |
|
December
31, |
|
|
Related
Party Transactions |
|
2005 |
|
2004 |
|
| |
|
|
|
|
|
| |
|
|
|
|
|
|
|
|
Note
receivable - Southern Union |
|
$ |
93,745 |
|
$ |
90,745 |
|
|
Accounts
receivable |
|
|
7,801
|
|
|
7,287
|
|
|
Accounts
payable |
|
|
(5,468 |
) |
|
(3,478 |
) |
|
Owners'
equity - Tax sharing note receivable - Southern Union |
|
|
57,679
|
|
|
70,971
|
|
Southern
Union structured the Panhandle Acquisition in a manner intended to qualify as a
like-kind exchange of property under Section 1031 of the Internal Revenue Code
of 1986, as amended. For tax purposes, the Panhandle assets that were part of
the exchange were recorded at the tax basis of the Southern Union assets for
which they were exchanged. The resulting transaction generated an estimated
deferred tax liability of approximately $91 million at the acquisition date and
a corresponding receivable from Southern Union reflected as a reduction to
owners’ equity on Panhandle’s Consolidated Balance Sheet. Repayment of the
receivable from Southern Union is limited to actual tax liabilities otherwise
payable by Panhandle pursuant to the tax sharing agreement with Southern Union.
In March
2005 and December 2004, Panhandle recorded a $13,292,000 and a $7,720,000 income
tax liability settlement against the Tax sharing note receivable,
respectively. In the
fourth quarter of 2004, Panhandle recorded a $12,247,000 reduction in its
deferred tax liability and the corresponding Tax sharing note receivable from
Southern Union due to revised calculations in the amount of Panhandle’s tax
basis utilized by Southern Union in the like-kind exchange associated with the
Panhandle Acquisition.
On
November 17, 2004, CCE Holdings, LLC (CCE), a
joint venture in which Southern Union owns a 50 percent interest, acquired 100
percent of the equity interests of CrossCountry Energy, LLC (CrossCountry) from
Enron Corp. and certain of its subsidiaries for approximately $2,450,000,000 in
cash, including the assumption of certain consolidated debt. On November 5,
2004, CCE entered into an Administrative Services Agreement (the
Management Agreement) with
Panhandle and SU Pipeline Management LP (Manager), a
Delaware limited partnership and a wholly owned subsidiary of Southern Union.
Under the terms of the Management Agreement, Panhandle covenants, to the extent
permitted by applicable law, to cause Manager to perform the duties and
obligations of Manager. Manager has assembled an integrated pipeline management
team, which includes employees of Panhandle and CrossCountry. Pursuant to the
Management Agreement, Manager is responsible for the operations and
administrative functions of the enterprise. CCE and Manager will share certain
operations of Manager and its affiliates, and CCE will be obligated to bear its
share of costs of the Manager and its affiliates, as well as certain transition
costs and, under certain conditions, pay annual management fees to Manager.
Transition costs are non-recurring costs of establishing the shared services,
including but not limited to severance costs, professional fees, certain
transaction costs, and the costs of relocating offices and personnel, pursuant
to the Management Agreement. At December 31, 2004, Panhandle recognized a
liability of approximately $6 million for severance related costs which is
reimbursable from CCE for which an offsetting amount is reflected in Accounts
receivable - related parties at March 31, 2005.
V
Accounting for Derivatives and Hedging Activities
Panhandle
follows SFAS No. 133, “Accounting for Derivative Instruments and Hedging
Activities”,
as
amended, to account for derivative and hedging activities. Panhandle utilizes
interest-rate related derivative instruments to manage its exposure on its debt
instruments and does not enter into derivative instruments for any purpose other
than hedging purposes. All derivatives are recognized on the balance sheet at
their fair value. On the date the derivative contract is entered into, Panhandle
designates the derivative as either: (i) a hedge of the fair value of a
recognized asset or liability or of an unrecognized firm commitment
(fair
value hedge) or (ii)
a hedge of a forecasted transaction or the variability of cash flows to be
received or paid in conjunction with a recognized asset or liability
(cash
flow hedge).
PANHANDLE
EASTERN PIPE LINE COMPANY, LP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Interest
rate swaps are used to reduce interest rate risks and to manage interest
expense. By entering into these agreements, Panhandle converts floating-rate
debt into fixed-rate debt or converts fixed-rate debt to floating. Interest
differentials paid or received under the swap agreements are reflected as an
adjustment to interest expense. These interest rate swaps are financial
derivative instruments that qualify for hedge treatment. For derivatives treated
as hedges of future cash flows, the effective portion of changes in fair value
is recorded in other comprehensive income until the related hedge items impact
earnings. Any ineffective portion of a hedge is reported in earnings
immediately. Upon termination of a cash flow hedge of the variability of cash
flows to be paid, the resulting gain or loss is amortized to income through the
maturity date of the original designated hedging relationship, unless it is
probable that the forecasted transaction will not occur during a specified time
period. For derivatives treated as a hedge of the fair value of a debt
instrument, the effective portion of changes in fair value are recorded as an
adjustment to the hedged debt. The ineffective portion of a fair value hedge is
recognized in earnings if the short cut method of assessing effectiveness is not
used. Upon termination of a fair value hedge of a debt instrument, the resulting
gain or loss is amortized to income through the maturity date of the debt
instrument.
Panhandle’s
subsidiary LNG Holdings is party to interest rate swap agreements with an
aggregate notional amount of $191,722,000 as of March 31, 2005 that fix the
interest rate applicable to floating rate long-term debt and which qualify for
hedge accounting. For the three month period ended March 31, 2005, there was no
swap ineffectiveness. For the three month period ended March 31, 2004, the
amount of swap ineffectiveness was not significant. As of March 31, 2005,
floating rate LIBOR based interest payments were exchanged for weighted average
fixed rate interest payments of 6.09 percent. As such, payments, in excess of
the liability recorded, or receipts on interest rate swap agreements are
recognized as adjustments to interest expense. As of March 31, 2005 and December
31, 2004, the fair value liability position of the swaps was $7,486,000 and
$11,053,000, respectively. For the three month periods ended March 31, 2005 and
March 31, 2004, an unrealized gain of $1,556,000 ($930,000, net of tax) and an
unrealized loss of $3,765,000 ($2,252,000, net of tax), respectively, was
included in accumulated other comprehensive income related to these swaps.
Current market pricing models were used to estimate fair values of interest rate
swap agreements.
On April
29, 2005, existing LNG Holdings bank loans due in 2007 were repaid in full using
the proceeds from a Credit Agreement entered into on April 26, 2005
(the
Credit Agreement).
Interest rate swaps previously designated as cash flow hedges of the LNG
Holdings bank loans were terminated upon repayment of the loans (see
Note
VI - Debt). As a
result, a gain of $3,465,000 ($2,072,000, net of tax), will be
reflected in Accumulated other comprehensive income in the Consolidated Balance
Sheet and will
be amortized to interest expense through the maturity date of the original bank
loans in 2007.
In March
2004, Panhandle entered into interest rate swaps to hedge the risk associated
with the fair value of its $200 million 2.75 percent Senior Notes. See
Note
VI - Debt. These
swaps are designated as fair value hedges and qualify for the short cut method
under SFAS No. 133. As of March 31, 2005 and December 31, 2004 the fair value
position of the swaps was a liability of $6,067,000 and $3,936,000,
respectively, recorded as a reduction to long-term debt. Under the swap
agreements, Panhandle will receive fixed interest payments at a rate of 2.75
percent and will make floating interest payments based on the six-month LIBOR.
No ineffectiveness is assumed in the hedging relationship between the debt
instrument and the interest rate swap. As of March 31, 2005, these swaps have an
average interest rate of 3.12 percent.
PANHANDLE
EASTERN PIPE LINE COMPANY, LP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
VI Debt
| |
|
|
|
March
31, |
|
December
31, |
|
|
Long-term
Debt |
|
Year
Due |
|
2005 |
|
2004 |
|
| |
|
|
|
|
|
|
|
|
|
|
|
6.50%
Senior Notes |
|
|
2009 |
|
$ |
60,623 |
|
$ |
60,623 |
|
|
8.25%
Senior Notes |
|
|
2010 |
|
|
40,500
|
|
|
40,500
|
|
|
7.00%
Senior Notes |
|
|
2029 |
|
|
66,305
|
|
|
66,305
|
|
|
4.80%
Senior Notes |
|
|
2008 |
|
|
300,000
|
|
|
300,000
|
|
|
6.05%
Senior Notes |
|
|
2013 |
|
|
250,000
|
|
|
250,000
|
|
|
2.75%
Senior Notes |
|
|
2007 |
|
|
200,000
|
|
|
200,000
|
|
|
LNG
Holdings bank loans (floating rate) |
|
|
2007 |
|
|
255,626
|
|
|
258,433
|
|
|
Total
debt outstanding |
|
|
|
|
|
1,173,054
|
|
|
1,175,861
|
|
|
Current
portion of long-term debt |
|
|
|
|
|
-
|
|
|
(12,548 |
) |
|
Interest
rate swaps (2.75% Senior Notes) |
|
|
|
|
|
(6,067 |
) |
|
(3,936 |
) |
|
Unamortized
debt premium, net |
|
|
|
|
|
14,077
|
|
|
14,688
|
|
|
Total
long-term debt |
|
|
|
|
$ |
1,181,064 |
|
$ |
1,174,065 |
|
Panhandle
has $1,181,064,000 of debt recorded at March 31, 2005. Debt of $925,438,000,
including net premiums of $14,077,000 and interest rate swaps of $6,067,000, is
at fixed rates ranging from 2.75 percent to 8.25 percent, with an average annual
interest rate of 5.12 percent excluding debt premium, discount and issuance cost
amortization. The $255,626,000 of variable rate bank loans had an average rate
of 4.15 percent for the three month period ended March 31, 2005. The assets of
Trunkline LNG are pledged as collateral for the variable rate loans. See
Note
V - Accounting for Derivatives and Hedging Activities for
discussion of interest rate swap agreements associated with outstanding debt.
Panhandle’s
notes are subject to certain requirements such as the maintenance of a fixed
charge coverage ratio and a leverage ratio which restrict certain payments if
not maintained, and limitations on liens. At March 31, 2005, Panhandle, based on
the currently most restrictive debt covenant requirements, was subject to a
$391,424,000 limitation on additional restricted payments including dividends
and loans to affiliates, and a limitation of $334,533,000 of additional secured
indebtedness or other defined liens based on a limitation on liens covenant. At
March 31, 2005, Panhandle was in compliance with all covenants.
At March
31, 2005, Panhandle had no scheduled debt payments for the remainder of 2005 and
2006 and scheduled payments of $455,626,000, $300,000,000, $60,623,000 and
$356,805,000 for the years 2007 through 2009 and in total thereafter,
respectively.
LNG
Holdings, as borrower, and Panhandle Eastern Pipe Line and Trunkline LNG, as
guarantors, entered into a Credit Agreement dated as of April 26, 2005, with a
consortium of banks for a senior term loan financing in the aggregate principal
amount of $255,626,000 which matures on March 15, 2007. The senior term loan
carries a floating interest rate tied to LIBOR or prime interest rates at
Panhandle’s option, in addition to a margin which is tied to the rating of
Panhandle’s unsecured senior funded debt. On April 29, 2005, the proceeds from
the Credit Agreement were used to repay all outstanding indebtedness under
existing LNG Holdings floating rate bank loans that were due in 2007. The senior
term loan requires maintenance of a fixed charge coverage ratio and a leverage
ratio which restrict certain payments if not maintained, and a limitation on
liens. If the senior term loan had been in effect at March 31, 2005, Panhandle
Eastern Pipe Line would have been subject to a more restrictive limitation of
$223,443,000 of additional secured or subsidiary level indebtedness.
If
the senior term loan had been in effect at March 31, 2005, Panhandle would also
have been subject to a limitation of $264,458,000 of total additional
indebtedness.
PANHANDLE
EASTERN PIPE LINE COMPANY, LP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
On March
12, 2004, Panhandle issued $200,000,000 of 2.75 percent Senior Notes due 2007,
Series A, in reliance on an exemption from the registration requirements of the
Securities Act of 1933 for offers and sales of securities not involving a public
offering or sale, in order to refinance Panhandle’s maturing debt. Panhandle
used a portion of the net proceeds to retire $146,080,000 of 6.125 percent
Senior Notes which matured on March 15, 2004, as well as for other general
corporate purposes. A portion of the remaining net proceeds was also used to pay
off the $52,455,000 of 7.875 percent Senior Notes which matured on August 15,
2004. Panhandle filed a registration statement on May 12, 2004 to initiate an
exchange of the unregistered 2.75 percent Senior Notes due 2007, Series A, for
substantially identical securities registered under the Securities Act of 1933.
Such exchange was completed June 25, 2004.
VII
Comprehensive Income
The table
below provides an overview of comprehensive income for the periods
indicated.
| |
|
Three
Months |
|
Three
Months |
|
| |
|
Ended
March 31, |
|
Ended
March 31, |
|
| |
|
2005 |
|
2004 |
|
| |
|
|
|
|
|
|
|
|
Net
earnings |
|
$ |
31,470 |
|
$ |
33,057 |
|
| |
|
|
|
|
|
|
|
|
Unrealized
gain (loss) related to interest rate swaps, |
|
|
|
|
|
|
|
|
net
of taxes of $1,412 and $(593), respectively |
|
|
2,160
|
|
|
(822 |
) |
|
Realized
(gains) losses in net income, |
|
|
|
|
|
|
|
|
net
of taxes of $(786) and $(920), respectively |
|
|
(1,230 |
) |
|
(1,430 |
) |
| |
|
|
|
|
|
|
|
|
Total
comprehensive income |
|
$ |
32,400 |
|
$ |
30,805 |
|
| |
|
|
|
|
|
|
|
Accumulated
other comprehensive income reflected in the Consolidated Balance Sheet at March
31, 2005 and December 31, 2004 includes unrealized gains related to interest
rate swaps.
PANHANDLE
EASTERN PIPE LINE COMPANY, LP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
VIII
Benefits
Components
of Net Periodic Benefit Cost
Net
periodic benefit costs for the three months ended March 31, 2005 and 2004 for
postretirement benefit plans other than pensions (OPEB) includes the following
components:
| |
|
Three
Months |
|
Three
Months |
|
| |
|
Ended
March 31, |
|
Ended
March 31, |
|
|
OPEB |
|
2005 |
|
2004 |
|
| |
|
|
|
|
|
|
|
|
Service
cost |
|
$ |
740 |
|
$ |
645 |
|
|
Interest
cost |
|
|
900
|
|
|
735
|
|
|
Expected
return on plan assets |
|
|
(230 |
) |
|
(48 |
) |
|
Amortization
of prior service cost |
|
|
(55 |
) |
|
-
|
|
|
Amortization
of transition obligation |
|
|
-
|
|
|
-
|
|
|
Recognized
actuarial gain |
|
|
160
|
|
|
-
|
|
|
Settlement
recognition |
|
|
-
|
|
|
-
|
|
| |
|
|
|
|
|
|
|
|
Net
periodic benefit cost |
|
$ |
1,515 |
|
$ |
1,332 |
|
For the
three months ended March 31, 2005, approximately $0.4 million in contributions
have been made to the OPEB plan. Panhandle expects to contribute an additional
$7.4 million to fund the OPEB plan in fiscal 2005 for a total of $7.8
million.
Panhandle
does not have a pension plan but does make employer contributions to a qualified
defined contribution plan, which contributions range from four to six percent of
the participating employee’s salary based on the participating employee’s age
and years of service. During the quarters ended March 31, 2005 and 2004,
approximately $1 million and $1 million, respectively, was recorded as expense
associated with Panhandle contributions to the qualified defined contribution
plan.
Stock
Based Compensation. Following
its acquisition by Southern Union on June 11, 2003 and in accordance with
Southern Union’s policy, Panhandle reports stock option grants using the
intrinsic-value method in accordance with APB Opinion No. 25, “Accounting for
Stock Issued to Employees,” and related authoritative interpretations. Under the
intrinsic-value method, because the exercise price of the Southern Union
employee stock options is greater than or equal to the market price of the
underlying stock on the date of grant, no compensation expense is
recognized.
PANHANDLE
EASTERN PIPE LINE COMPANY, LP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
The
following table illustrates the effect on net earnings and net earnings
available for equity holders if Panhandle had applied the fair value recognition
provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as
amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and
Disclosure,” to stock-based employee compensation:
| |
|
Three
Months |
|
Three
Months |
|
| |
|
Ended
March 31, |
|
Ended
March 31, |
|
| |
|
2005 |
|
2004 |
|
| |
|
|
|
|
|
|
|
|
Net
earnings, as reported |
|
$ |
31,470 |
|
$ |
33,057 |
|
|
Deduct
total stock-based employee compensation |
|
|
|
|
|
|
|
|
expense
determined under fair value based method |
|
|
|
|
|
|
|
|
for
all awards, net of related taxes |
|
|
51
|
|
|
207
|
|
|
Pro
forma net earnings |
|
$ |
31,419 |
|
$ |
32,850 |
|
Recently
Enacted Legislation. The
Medicare Prescription Drug Act was signed into law December 8, 2003. The Act
introduces a prescription drug benefit under Medicare (Medicare Part D)
as well as a federal subsidy to sponsors of retiree healthcare benefit plans
that provide a prescription drug benefit that is at least actuarially equivalent
to Medicare Part D. Issued by the FASB in May 2004, FASB Financial Staff
Position (FSP) No. FAS
106-2 (FSP
FAS 106-2)
requires entities to record the impact of the Medicare Prescription Drug Act as
an actuarial gain in the postretirement benefit obligation for postretirement
benefit plans that provide drug benefits covered by that legislation. Panhandle
adopted this FSP as of March 31, 2005, the effect of which was not material to
its consolidated financial statements. The effect of this FSP may vary as a
result of any future changes to Panhandle's benefit plans.
IX
Commitments and Contingencies
Litigation. Panhandle
is involved in legal, tax and regulatory proceedings before various courts,
regulatory bodies and governmental agencies regarding matters arising in the
ordinary course of business, some of which involve substantial amounts. Where
appropriate, Panhandle has made accruals in accordance with SFAS No. 5 in
order to provide for such matters. Management believes the final disposition of
these proceedings will not have a material adverse effect on Panhandle’s
consolidated results of operations or financial position.
Hope Land
Mineral Corporation (Hope
Land)
contends that it owns the storage rights to property that contains a portion of
Panhandle’s Howell storage field. During June 2003, the Michigan Court of
Appeals reversed the trial court’s previous order, which had granted summary
judgment in favor of Panhandle and dismissed the case. Panhandle filed an appeal
of the Court of Appeals order with the Michigan Supreme Court which was denied
in December of 2003. In April 2005, Hope Land filed trespass and unjust
enrichment complaints against Panhandle to prevent running of the statute of
limitations. Panhandle intends to file an action for condemnation to obtain the
storage rights from Hope Land. Panhandle does not believe the outcome of this
case will have a material adverse effect on Panhandle’s consolidated results of
operations or financial position.
Jack
Grynberg, an individual, has filed actions against a number of companies,
including Panhandle, now transferred to the U.S. District Court for the District
of Wyoming, for damages for mis-measurement of gas volumes and Btu content,
resulting in lower royalties to mineral interest owners. A similar action has
also been filed against a number of companies, including Panhandle, in Kansas
District Court. Panhandle believes that its measurement practices conformed to
the terms of its FERC Gas Tariff, which was filed with and approved by FERC. As
a result, Panhandle believes that it has meritorious defenses to the complaint
(including FERC-related affirmative defenses, such as the filed rate/tariff
doctrine, the primary/exclusive jurisdiction of FERC, and the defense that
Panhandle complied with the terms of its tariff) and is defending the suit
vigorously.
PANHANDLE
EASTERN PIPE LINE COMPANY, LP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Environmental
Matters. Panhandle’s
gas transmission operations are subject to federal, state and local regulations
regarding water quality, hazardous and solid waste management, air quality
control and other environmental matters. Panhandle has previously identified
environmental contamination at certain sites on its gas transmission systems and
has undertaken cleanup programs at these sites. The contamination resulted from
the past use of lubricants containing polychlorinated bi-phenyls (PCBs) in
compressed air systems; the past use of paints containing PCBs; and the prior
use of wastewater collection facilities and other on-site disposal areas.
Panhandle has developed and is implementing a program to remediate such
contamination in accordance with federal, state and local regulations.
As part
of the cleanup program resulting from contamination due to the use of lubricants
containing PCBs in compressed air systems, Panhandle Eastern Pipe Line and
Trunkline have identified PCB levels above acceptable levels inside the
auxiliary buildings that house the air compressor equipment at thirty-three
compressor station sites. Panhandle has developed and is implementing a United
States Environmental Protection Agency (EPA)
approved process to remediate this PCB contamination in accordance with federal,
state and local regulations. Sixteen sites have been decontaminated per the EPA
approved process as prescribed in the EPA regulations.
At some
locations, PCBs have been identified in paint that was applied many years ago.
In accordance with EPA regulations, Panhandle has implemented a program to
remediate sites where such issues are identified during painting activities. If
PCBs are identified above acceptable levels, the paint is removed and disposed
of in an EPA approved manner.
The
Illinois Environmental Protection Agency (Illinois
EPA)
notified Panhandle Eastern Pipe Line and Trunkline, together with other
non-affiliated parties, of contamination at three former waste oil disposal
sites in Illinois. Panhandle Eastern Pipe Line’s and Trunkline’s estimated share
for the costs of assessment and remediation of the sites, based on the volume of
waste sent to the facilities, is approximately seventeen percent. Panhandle and
twenty-one other non-affiliated parties conducted an initial voluntary
investigation of the Pierce Oil Springfield site, one of the three sites. In
addition, Illinois EPA has informally indicated that it has referred the Pierce
Oil Springfield site, to the EPA so that environmental contamination present at
the site can be addressed through the federal Superfund program. No formal
notice has yet been received from either agency concerning the referral.
However, the EPA is expected to issue special notice letters and has begun the
process of listing the site on the National Priority List. Panhandle and three
of the other non-affiliated parties associated with the Pierce Oil Springfield
site met with the EPA and Illinois EPA regarding this issue. Panhandle was given
no indication as to when the listing process was to be completed. Panhandle has
also submitted a Comprehensive
Environmental Response, Compensation, and Liability Act 104e
data request from the EPA Region V regarding the second Pierce Waste Oil site
known as the Dunavan site, located in Oakwood, Illinois. Panhandle’s response
showed that waste oil generated at Panhandle facilities was shipped to the
Dunavan Oil site in Oakwood, Illinois, resulting in Panhandle becoming a
potentially responsible party at such site.
Panhandle
expects the cleanup programs for all of the above matters to continue for
several years and has estimated its share of remaining cleanup costs to range
from approximately $7 million to $16 million. At March 31, 2005, Panhandle has
related accruals totaling approximately $12,741,000, of which $2,858,000 is
included in Other current liabilities for the estimated current amounts and
$9,883,000 is included in Other non-current liabilities on the Consolidated
Balance Sheet. At December 31, 2004, Panhandle had related accruals totaling
approximately $12,912,000, of which $3,046,000 is included in Other current
liabilities for the estimated current amounts and $9,866,000 is included in
Other non-current liabilities on the Consolidated Balance Sheet. During the
first quarter of 2005, Panhandle spent $171,000 related to these cleanup
programs.
PANHANDLE
EASTERN PIPE LINE COMPANY, LP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
Air
Quality Control. In 1998,
the EPA issued a final rule on regional ozone control that requires Panhandle to
place controls on engines in five midwestern states. The part of the rule that
affects Panhandle was challenged in court by various states, industry and other
interests, including the Interstate Natural Gas Association of America
(INGAA), an
industry group to which Panhandle belongs. In March 2000, the court upheld most
aspects of the EPA’s rule, but agreed with INGAA’s position and remanded to the
EPA the sections of the rule that affected Panhandle. The final rule was
promulgated by the EPA in April 2004. The five midwestern states have not
promulgated state regulations to address the requirements of this rule. Based on
an EPA guidance document negotiated with gas industry representatives in 2002,
it is believed that Panhandle will be required under state rules to reduce
nitrogen oxide (NOx)
emissions by eighty-two percent on the identified large internal combustion
engines and will be able to trade off engines within the company and within each
of the five Midwestern states affected by the rule in an effort to create a cost
effective NOx reduction solution. The final implementation date is May 2007. The
rule impacts twenty large internal combustion engines on the Panhandle system in
Illinois and Indiana at an approximate cost of $23 million for capital
improvements through 2007, based on current projections.
In 2002,
the Texas Commission on Environmental Quality enacted the Houston/Galveston SIP
regulations requiring reductions in NOx emissions in an eight-county area
surrounding Houston. Trunkline’s Cypress compressor station is affected and
requires the installation of emission controls. New regulations also require
certain grandfathered facilities in Texas to enter into the new source permit
program which may require the installation of emission controls at one
additional facility owned and operated by Panhandle. These two rules affect two
company facilities in Texas at an estimated cost of approximately $14 million
for capital improvements through March 2007, based on current projections.
The EPA
promulgated various Maximum Achievable Control Technology (MACT) rules
in February 2004. The rules require that Panhandle Eastern Pipe Line and
Trunkline control Hazardous Air Pollutants (HAPs) emitted
from certain internal combustion engines at major HAPs sources. Most of
Panhandle Eastern Pipe Line and Trunkline compressor stations are major HAPs
sources. The HAPs pollutant of concern for Panhandle Eastern Pipe Line and
Trunkline is formaldehyde. As promulgated, the rule seeks to reduce formaldehyde
emissions by seventy-six percent from these engines. Catalytic controls will be
required to reduce emissions under these rules with a final implementation date
of June 2007. Panhandle Eastern Pipe Line and Trunkline have over twenty
internal combustion engines subject to the rules. It is expected that compliance
with these regulations will cost an estimated $1 million for capital
improvements, based on current projections.
Other
Commitments and Contingencies. In 1993,
the U.S. Department of the Interior announced its intention to seek, through its
Mineral Management Service (MMS),
additional royalties from gas producers as a result of payments received by such
producers in connection with past take-or-pay settlements and buyouts and
buydowns of gas sales contracts with natural gas pipelines. Panhandle Eastern
Pipe Line and Trunkline, with respect to certain producer contract settlements,
may be contractually required to reimburse or, in some instances, to indemnify
producers against such royalty claims. The potential liability of the producers
to the government and of the pipelines to the producers involves complex issues
of law and fact, which are likely to take substantial time to resolve. If
required to reimburse or indemnify the producers, Panhandle Eastern Pipe Line
and Trunkline may file with FERC to recover these costs from pipeline customers.
Management believes these commitments and contingencies will not have a material
adverse effect on Panhandle’s business, financial condition or results of
operations.
In
conjunction with Southern Union’s investment in CCE and CCE’s acquisition of
CrossCountry from Enron Corp. and certain subsidiaries of Enron, Panhandle
initiated an additional workforce reduction plan designed to reduce the
workforce by approximately an additional six percent. Approximately $6 million
of the approximately $7.7 million of the resulting severance and related costs
are reimbursable by CCE pursuant to agreements between the parties involved.
PANHANDLE
EASTERN PIPE LINE COMPANY, LP
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS