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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-2700
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EL PASO NATURAL GAS COMPANY
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 74-0608280
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
EL PASO BUILDING
1001 LOUISIANA STREET
HOUSTON, TEXAS 77002
(Address of Principal Executive Offices) (Zip Code)
Telephone Number: (713) 420-2600
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Common stock, par value $1 per share. Shares outstanding on May 14, 2004:
1,000
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EL PASO NATURAL GAS COMPANY
TABLE OF CONTENTS
CAPTION PAGE
------- ----
PART I -- Financial Information
Item 1. Financial Statements........................................ 1
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 14
Risk Factors and Cautionary Statements Regarding
Forward-Looking Statements................................ 18
Item 3. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 19
Item 4. Controls and Procedures..................................... 19
PART II -- Other Information
Item 1. Legal Proceedings........................................... 21
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases
of Equity Securities...................................... 21
Item 3. Defaults Upon Senior Securities............................. 21
Item 4. Submission of Matters to a Vote of Security Holders......... 21
Item 5. Other Information........................................... 21
Item 6. Exhibits and Reports on Form 8-K............................ 21
Signatures.................................................. 22
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Below is a list of terms that are common to our industry and used
throughout this document:
/d = per day
BBtu = billion British thermal units
Bcf = billion cubic feet
MMcf = million cubic feet
Tcfe = trillion cubic feet equivalent
When we refer to cubic feet measurements, all measurements are at a pressure
of 14.73 pounds per square inch.
When we refer to "us", "we", "our" or "ours", we are describing El Paso
Natural Gas Company and/or our subsidiaries.
i
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EL PASO NATURAL GAS COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN MILLIONS)
(UNAUDITED)
QUARTER ENDED
MARCH 31,
--------------
2004 2003
---- ----
Operating revenues.......................................... $124 $132
---- ----
Operating expenses
Operation and maintenance................................. 39 34
Depreciation, depletion and amortization.................. 17 17
Taxes, other than income taxes............................ 8 8
---- ----
64 59
---- ----
Operating income............................................ 60 73
Other income, net........................................... 2 1
Interest and debt expense................................... (22) (20)
Affiliated interest income, net............................. 5 3
---- ----
Income before income taxes.................................. 45 57
Income taxes................................................ 11 22
---- ----
Net income.................................................. $ 34 $ 35
==== ====
See accompanying notes.
1
EL PASO NATURAL GAS COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
MARCH 31, DECEMBER 31,
2004 2003
--------- ------------
ASSETS
Current assets
Cash and cash equivalents................................. $ 25 $ 26
Accounts and notes receivable
Customer, net of allowance of $18 in 2004 and 2003...... 73 71
Affiliates.............................................. 2 4
Other................................................... 7 6
Materials and supplies.................................... 40 42
Deferred income taxes..................................... 152 206
Restricted cash........................................... 517 443
Other..................................................... 19 20
------ ------
Total current assets............................... 835 818
------ ------
Property, plant and equipment, at cost...................... 3,242 3,228
Less accumulated depreciation, depletion and
amortization............................................ 1,184 1,187
------ ------
Total property, plant and equipment, net........... 2,058 2,041
------ ------
Other assets
Notes receivable from affiliate........................... 776 779
Other..................................................... 90 86
------ ------
866 865
------ ------
Total assets....................................... $3,759 $3,724
====== ======
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Accounts payable
Trade................................................... $ 26 $ 35
Affiliates.............................................. 52 13
Other................................................... 6 5
Short-term borrowings, including current maturities of
long-term debt.......................................... 7 7
Accrued interest.......................................... 23 25
Taxes payable............................................. 76 122
Contractual deposits...................................... 10 29
Western Energy Settlement................................. 538 538
Other..................................................... 6 20
------ ------
Total current liabilities.......................... 744 794
------ ------
Long-term debt, less current maturities..................... 1,109 1,109
------ ------
Other liabilities
Deferred income taxes..................................... 360 386
Other..................................................... 117 113
------ ------
477 499
------ ------
Commitments and contingencies
Stockholder's equity
Common stock, par value $1 per share; 1,000 shares
authorized, issued and outstanding...................... -- --
Additional paid-in capital................................ 1,267 1,194
Retained earnings......................................... 162 128
------ ------
Total stockholder's equity......................... 1,429 1,322
------ ------
Total liabilities and stockholder's equity......... $3,759 $3,724
====== ======
See accompanying notes.
2
EL PASO NATURAL GAS COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)
QUARTER ENDED
MARCH 31,
--------------
2004 2003
---- ----
Cash flows from operating activities
Net income................................................ $ 34 $ 35
Adjustments to reconcile net income to net cash from
operating activities
Depreciation, depletion and amortization............... 17 17
Deferred income tax expense............................ 30 31
Risk-sharing revenue................................... -- (8)
Other non-cash income adjustments...................... -- 5
Asset and liability changes............................ (49) (32)
---- ----
Net cash provided by operating activities......... 32 48
---- ----
Cash flows from investing activities
Additions to property, plant and equipment................ (36) (38)
Proceeds from the sale of assets.......................... 1 30
Net change in affiliate advances.......................... 2 (43)
Additions to restricted cash.............................. (74) --
---- ----
Net cash used in investing activities............. (107) (51)
---- ----
Cash flows from financing activities
Capital contributions..................................... 74 --
---- ----
Net cash provided by financing activities......... 74 --
---- ----
Net change in cash and cash equivalents..................... (1) (3)
Cash and cash equivalents
Beginning of period....................................... 26 3
---- ----
End of period............................................. $ 25 $ --
==== ====
See accompanying notes.
3
EL PASO NATURAL GAS COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
We are an indirect wholly owned subsidiary of El Paso Corporation (El
Paso). We prepared this Quarterly Report on Form 10-Q under the rules and
regulations of the United States Securities and Exchange Commission. Because
this is an interim period filing presented using a condensed format, it does not
include all of the disclosures required by generally accepted accounting
principles. You should read it along with our 2003 Annual Report on Form 10-K,
which includes a summary of our significant accounting policies and other
disclosures. The financial statements as of March 31, 2004, and for the quarters
ended March 31, 2004 and 2003, are unaudited. We derived the balance sheet as of
December 31, 2003, from the audited balance sheet filed in our 2003 Form 10-K.
In our opinion, we have made all adjustments which are of a normal, recurring
nature to fairly present our interim period results. Due to the seasonal nature
of our business, information for interim periods may not be indicative of our
results of operations for the entire year.
Our accounting policies are consistent with those discussed in our 2003
Form 10-K.
2. LIQUIDITY
On May 3, 2004, El Paso announced that the results of its internal
investigation confirmed that its historical financial statements should be
restated to reflect its previously announced revisions to its natural gas and
oil reserve estimates. El Paso believes that a material restatement of its
financial statements would have constituted an event of default under its $3
billion revolving credit facility, under which we are eligible to borrow (see
Note 4), and various other financings; specifically under the provisions of
these arrangements related to representations and warranties on the accuracy of
its historical financial statements and on El Paso's debt to total
capitalization ratio. El Paso received waivers on its $3 billion revolving
credit facility and these other financing transactions to address these issues,
and these waivers continue to be effective. These waivers require that El Paso
issue its December 31, 2003 financial statements by June 15, 2004. Otherwise, El
Paso would need to obtain additional waivers to avoid an event of default. Based
upon a review of our financing transactions, we do not believe that a default on
El Paso's $3 billion revolving credit facility constitutes an event of default
on our debt agreements.
El Paso is a significant potential source of liquidity to us. We
participate in El Paso's cash management program. Under this program, depending
on whether we have short-term cash surpluses or requirements, we either provide
cash to El Paso or El Paso provides cash to us. We have historically provided
cash to El Paso under this program, and as of March 31, 2004, we had a cash
advance receivable from El Paso of $776 million, classified as a non-current
asset in our balance sheet. If El Paso were unable to meet its liquidity needs,
we would not have access to this source of liquidity and there is no assurance
that El Paso could repay the entire amounts owed to us. In that event, we could
be required to write-off some amount of these advances, which could have a
material impact on our stockholder's equity. Furthermore, we would still be
required to repay affiliated company payables. Write-downs that cause our debt
to EBITDA (as defined in our agreements) ratio to exceed 5 to 1 could prohibit
us from incurring additional debt. However, this non-cash equity reduction would
not result in an event of default under our existing debt securities. In
addition, based on our current estimates of cash flows, we do not believe we
will need to seek repayment of all or part of these advances in the next year.
El Paso's ownership in us and our ownership in Mojave Pipeline Company
(Mojave) serve as collateral under El Paso's revolving credit facility and other
of El Paso's financing transactions. If El Paso's lenders under this facility or
those financing transactions were to exercise their rights to this collateral,
our ownership could change and our ownership interests in Mojave could be
liquidated. However, this change of control and liquidation would not constitute
an event of default under our existing debt agreements.
If, as a result of the events described above, El Paso were subject to
voluntary or involuntary bankruptcy proceedings, El Paso and its other
subsidiaries and their creditors could attempt to make claims against us,
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including claims to substantively consolidate our assets and liabilities with
those of El Paso and its other subsidiaries. We believe that claims to
substantively consolidate us with El Paso and/or its other subsidiaries would be
without merit. However, there is no assurance that El Paso and/or its other
subsidiaries or their creditors would not advance such a claim in a bankruptcy
proceeding. If we were to be substantively consolidated in a bankruptcy
proceeding with El Paso and/or its other subsidiaries, there could be a material
adverse effect on our financial condition and our liquidity.
Finally, we have cross-acceleration provisions in our long-term debt that
state that should we incur an event of default under which borrowings in excess
of $25 million are accelerated, our long-term debt could also be accelerated.
The acceleration of our long-term debt would adversely affect our liquidity
position and, in turn, our financial condition.
3. WESTERN ENERGY SETTLEMENT
In the fourth quarter of 2002, we reached preliminary settlements to
resolve the principal litigation and claims relating to the sale or delivery of
natural gas and/or electricity to or in the Western United States. In the second
quarter of 2003, these preliminary settlements were finalized. See Note 5 for a
further discussion of the Western Energy Settlement. As of March 31, 2004, our
remaining Western Energy Settlement obligation was $538 million, which is
reflected as a current liability since we estimate the finalization of the
settlement in the next twelve months. As of March 31, 2004, $10 million of the
total obligation had been paid to certain settling parties. Upon final approval
of the settlement agreements, payments related to the Western Energy Settlement
will be reflected as a reduction of our cash flow from operating activities.
El Paso has established an escrow account for amounts funded by us and its
affiliates until final approval of the settlement agreements. As of March 31,
2004, total amounts funded by us in this account were $517 million. These funds
are reflected as restricted cash in our balance sheet. In January 2004, El Paso
issued 8.8 million shares of common stock for approximately $74 million, the net
proceeds of which were contributed to us by El Paso through our direct parent
and then placed in the escrow account. Payments from the escrow account related
to the Western Energy Settlement will be reflected as an increase in our cash
flows from investing activities.
4. CREDIT FACILITIES
Letters of Credit
As of December 31, 2003 we had $3 million of outstanding letters of credit
for an unconsolidated affiliate, $2 million of which will mature in April 2005.
In January 2004, we cancelled undrawn letters of credit in the amount of $1
million.
Other Financing Arrangements
El Paso maintains a $3 billion revolving credit facility, with a $1.5
billion letter of credit sublimit, which matures on June 30, 2005. The $3
billion revolving credit facility has a borrowing cost of LIBOR plus 350 basis
points, letter of credit fees of 350 basis points and a commitment fee of 75
basis points on the unused portion of the facility. We, along with El Paso and
our affiliates, ANR Pipeline Company, Tennessee Gas Pipeline Company and
Colorado Interstate Gas Company, are borrowers under El Paso's $3 billion
revolving credit facility. We are only liable for amounts we directly borrow
under the $3 billion revolving credit facility. As of March 31, 2004, $600
million was outstanding and $1.1 billion in letters of credit were issued under
the $3 billion revolving credit facility, none of which was borrowed by or
issued on behalf of us. During the fourth quarter of 2003 and the first quarter
of 2004, El Paso liquidated a portion of the collateral that supported the $3
billion revolving credit facility which, reduced the borrowing availability by
$42 million. See Note 2 for a discussion regarding El Paso's waivers on the
$3 billion revolving credit facility.
El Paso's equity in several of its subsidiaries, including its equity in us
and our equity in Mojave, collateralizes the $3 billion revolving credit
facility and other financing arrangements including leases, letters of credit
and other facilities.
5
Under the $3 billion revolving credit facility and other financing
arrangements, we are subject to a number of restrictions and covenants. The most
restrictive of these include (i) limitations on the incurrence of additional
debt, based on a ratio of debt to EBITDA (as defined in the agreements), the
most restrictive of which shall not exceed 5 to 1; (ii) limitations on the use
of proceeds from borrowings; (iii) limitations, in some cases, on transactions
with our affiliates; (iv) limitations on the incurrence of liens; (v) potential
limitations on our ability to declare and pay dividends; and (vi) potential
limitations on our ability to participate in El Paso's cash management program
discussed in Note 7.
5. COMMITMENTS AND CONTINGENCIES
Legal Proceedings
Western Energy Settlement. In June 2003, El Paso announced that it had
executed a Master Settlement Agreement, or MSA, to resolve the principal
litigation relating to the sale or delivery of natural gas and/or electricity to
or in the Western United States. The MSA settles California lawsuits in state
court, the California Public Utilities Commission (CPUC) proceeding at the
Federal Energy Regulatory Commission (FERC), and the California Attorney General
investigation discussed herein. Parties to the settlement agreements include
private class action litigants in California; the governor and lieutenant
governor of California; the attorney generals of California, Washington, Oregon
and Nevada; the CPUC; the California Electricity Oversight Board; the California
Department of Water Resources; Pacific Gas and Electric Company (PG&E), Southern
California Edison Company, five California municipalities and six non-class
private plaintiffs. We are a party to the MSA and, as such, will bear a portion
of the costs and obligations of the settlements, as discussed more fully below.
For a discussion of our liabilities in connection with the Western Energy
Settlement (WES), see Note 3.
In the MSA, we agreed to the following terms:
- We admitted to no wrongdoing;
- We would make cash payments totaling $93.5 million for the benefit of the
parties to the definitive settlement agreements subsequent to the signing
of these agreements. This amount represents the originally announced $100
million cash payment less credits for amounts that have been paid to
other settling parties;
- We agreed to pay amounts equal to the proceeds from the issuance of
approximately 26.4 million shares by El Paso of El Paso common stock on
behalf of the settling parties. In this transaction, El Paso sold its
common stock and provided the proceeds from the issuance to us through an
equity contribution to satisfy this obligation; and
- We would eliminate the originally announced 20-year obligation to pay $22
million per year in cash by depositing $250 million in escrow for the
benefit of the settling parties within 180 days of the signing of the
definitive settlement agreements. This prepayment eliminates any
collateral that might have been required on the $22 million per year
payment over the next 20 years.
The MSA is in addition to the Joint Settlement Agreement, or JSA, announced
earlier in June 2003 where we agreed to provide structural relief to the
settling parties. In the JSA, we agreed to do the following:
- Subject to the conditions in the settlement, (1) make 3.29 Bcf/d of
primary firm pipeline capacity on our system available to California
delivery points during a five year period from the date of settlement,
but only if shippers sign firm contracts for 3.29 Bcf/d of capacity with
California delivery points; (2) maintain facilities sufficient to
physically deliver 3.29 Bcf/d to the California delivery points; and (3)
not add any firm incremental load to our system that would prevent us
from satisfying our obligation to provide this capacity;
- Construct a new $173 million, 320 MMcf/d, Line 2000 Power-up expansion
project, and forgo recovery of the cost of service of this expansion
until our next rate case before the FERC;
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- Clarify the rights of Northern California shippers to recall some of our
system capacity (Block II capacity) to serve markets in PG&E's service
area; and
- With limited exceptions, bar any of our affiliated companies from
obtaining additional firm capacity on our pipeline system during a five
year period from the effective date of the settlement.
In connection with the JSA, a Stipulated Judgment was lodged with the
United States District Court for the Central District of California on April 30,
2004, for the court's consideration. The Stipulated Judgment must be signed
before the WES can become effective. It is uncertain when this may occur, but we
anticipate this condition will be satisfied this year. This Stipulated Judgment
provides for the enforcement of some of the obligations contained in the JSA.
El Paso Merchant Energy L.P. (EPME), our affiliate, was also a party to the
settlement agreements and, along with El Paso, is obligated to provide a total
of $1,027 million (on an undiscounted basis) under these agreements. Of this
amount, $2 million will be paid by El Paso upon final approval of the definitive
settlement agreements, $125 million represents a contractual price discount that
will be realized over the remaining 30-month life of an existing power contract
between EPME and one of the settling parties, and $900 million will be paid by
EPME or El Paso in installments over the next 20 years. The long-term payment
obligation is a direct obligation of El Paso and EPME and will be supported by
collateral posted by El Paso's affiliates in amounts specified by the settlement
agreements. We have guaranteed the payment of these obligations in the event El
Paso and EPME fail to pay these amounts.
In June 2003, in anticipation of the execution of the MSA, El Paso, the
CPUC, PG&E, Southern California Edison Company, and the City of Los Angeles
filed the JSA described above with the FERC in resolution of the CPUC complaint
proceeding discussed below under Rates and Regulatory Matters. In November 2003,
the FERC approved the JSA with minor modifications. Our east of California
shippers filed requests for rehearing which were denied by the FERC in March
2004.
We were named as a defendant in fifteen purported class action, municipal
or individual lawsuits filed in California state courts. These suits contend
that we acted improperly to limit the construction of new pipeline capacity to
California and/or to manipulate the price of natural gas sold into the
California marketplace. In December 2003, the California State Court in San
Diego dismissed us from seven of the fifteen class action suits and entered
judgment approving the MSA. The judgment was appealed but the appeal has now
been dismissed except as to attorney fees which do not impact us. Seven other
cases will be dismissed after the MSA becomes effective. Subject to several
conditions being satisfied, including the signing of the JSA, we anticipate the
Western Energy Settlement to become effective later this year. The fifteenth
lawsuit was settled in May 2003.
In November 2002, a lawsuit was filed in the Superior Court of California,
County of Los Angeles against us, as well as numerous other unrelated entities,
alleging the creation of artificially high natural gas index prices via the
reporting of false price and volume information. This purported class action on
behalf of California consumers alleges various unfair business practices and
seeks restitution, disgorgement of profits, compensatory and punitive damages,
and civil fines. This lawsuit will be resolved when the Western Energy
Settlement becomes effective.
In September 2001, we received a civil document subpoena from the
California Attorney General, seeking information said to be relevant to the
Attorney General's ongoing investigation into the high electricity prices in
California. This proceeding will be resolved when the Western Energy Settlement
becomes effective.
In February 2003, the state of Nevada and two individuals filed a class
action lawsuit in Nevada state court naming us and a number of our affiliates as
defendants. The allegations are similar to those in the California cases. The
suit seeks monetary damages and other relief under Nevada antitrust and consumer
protection laws. This proceeding will be resolved when the Western Energy
Settlement becomes effective.
Other Energy Market Lawsuits. In April 2003, Sierra Pacific Resources and
Nevada Power Company filed a suit against us. The allegations were similar to
those in the California cases. In January 2004, the Court dismissed the lawsuit.
In April 2004, the Court reaffirmed its previous order dismissing the
plaintiffs'
7
complaint with prejudice, but also granted the plaintiffs 45 days to amend their
complaint. Our costs and legal exposure related to this lawsuit are not
currently determinable.
In January 2003, a lawsuit titled IMC Chemicals v. EPME, et al. was filed
in California state court against us and our affiliates. The suit arose out of a
gas supply contract between IMC Chemicals (IMCC) and EPME and sought to void the
Gas Purchase Agreement between IMCC and EPME for gas purchases until December
2003. IMCC contended that EPME and its affiliates manipulated market prices for
natural gas and, as part of that manipulation, induced IMCC to enter into the
contract. In furtherance of its attempt to void the contract, IMCC repeated the
allegations and claims of the California lawsuits described above. EPME intends
to enforce the terms of the contract and has filed a counterclaim for contract
damages in excess of $5 million. IMCC's claim is undeterminable but appears to
be in excess of $20 million. Our costs and legal exposure related to this
lawsuit are not currently determinable.
State of Arizona v. El Paso et. al. In March 2003, the State of Arizona
sued us, our affiliates and other unrelated entities on behalf of Arizona
consumers. The suit alleges that the defendants conspired to artificially
inflate prices of natural gas and electricity during 2000 and 2001. Making
allegations similar to those alleged in the California cases, the suit seeks
relief similar to the California cases, but under Arizona antitrust and consumer
fraud statutes. We have filed motions to dismiss this matter which are scheduled
to be heard in State Court at the end of June 2004. Our costs and legal exposure
related to this lawsuit are not currently determinable.
Phelps Dodge vs. EPNG. On February 3, 2004, one of our customers, Phelps
Dodge, and a number of its affiliates filed a lawsuit against us in the State
Court of Arizona. Plaintiffs claim we violated Arizona anti-trust statutes and
allege that during 2000-2001, we unlawfully manipulated and inflated gas prices.
Our costs and legal exposure related to this lawsuit are not currently
determinable.
Shareholder Class Action Suit. In November 2002, we were named as a
defendant in a shareholder derivative suit titled Marilyn Clark v. Byron
Allumbaugh, David A. Arledge, John M. Bissell, Juan Carlos Braniff, James F.
Gibbons, Anthony W. Hall, Ronald L. Kuehn, J. Carleton MacNeil, Thomas McDade,
Malcolm Wallop, William Wise, Joe B. Wyatt, El Paso Natural Gas Company and El
Paso Merchant Energy Company filed in state court in Houston. This shareholder
derivative suit generally alleges that manipulation of California gas supply and
gas prices exposed our parent, El Paso, to claims of antitrust conspiracy, FERC
penalties and erosion of share value. The plaintiffs have not asked for any
relief with regard to us. Our costs and legal exposure related to this
proceeding are not currently determinable.
Carlsbad. In August 2000, a main transmission line owned and operated by
us ruptured at the crossing of the Pecos River near Carlsbad, New Mexico. Twelve
individuals at the site were fatally injured. As a result, the U.S. Department
of Transportation's Office of Pipeline Safety issued a Notice of Probable
Violation and Proposed Civil Penalty to us proposing a fine of $2.5 million. We
have fully accrued for these fines. In October 2001, we filed a response with
the Office of Pipeline Safety disputing each of the alleged violations. In
December 2003, the matter was referred to the Department of Justice.
In addition, after a public hearing conducted by the National
Transportation Safety Board (NTSB) on its investigation of the Carlsbad rupture,
the NTSB published its final report in April 2003. The NTSB stated that it had
determined that the probable cause of the August 19, 2000 rupture was a
significant reduction in pipe wall thickness due to severe internal corrosion,
which occurred because our corrosion control program "failed to prevent, detect,
or control internal corrosion" in the pipeline. The NTSB also determined that
ineffective federal preaccident inspections contributed to the accident by not
identifying deficiencies in our internal corrosion control program.
On November 1, 2002, we received a federal grand jury subpoena for
documents relating to the rupture and we cooperated fully in responding to the
subpoena. That subpoena has since expired. In December 2003 and January 2004,
eight current and former employees were served with testimonial subpoenas issued
by the grand jury. Six individuals testified in March 2004. On April 2, 2004, we
and El Paso received a new federal grand jury subpoena requesting additional
documents. We are cooperating fully in responding to this subpoena. We
anticipate two employees will testify before the grand jury in June 2004.
8
A number of personal injury and wrongful death lawsuits were filed against
us in connection with the rupture and have been settled. The settlement payments
were fully covered by insurance. In connection with the settlement of the cases,
we contributed $10 million to a charitable foundation as a memorial to the
families involved. The contribution was not covered by insurance.
Parties to four of the settled lawsuits have since filed an additional
lawsuit titled Diane Heady et al. v. EPEC and EPNG in Harris County, Texas, on
November 20, 2002, seeking additional sums based upon their interpretation of
earlier agreements. In addition, a lawsuit entitled Baldonado et al. vs. EPNG
was filed on June 30, 2003, in state court in Eddy County, New Mexico, on behalf
of firemen and EMS personnel who responded to the fire and who allegedly have
suffered psychological trauma. The Baldonado lawsuit was dismissed by the court.
It has been appealed. Our costs and legal exposure related to the Heady and
Baldonado lawsuits are currently not determinable, however, we believe these
matters will be fully covered by insurance.
Grynberg. In 1997, we and a number of our affiliates were named defendants
in actions brought by Jack Grynberg on behalf of the U.S. Government under the
False Claims Act. Generally, these complaints allege an industry-wide conspiracy
to underreport the heating value as well as the volumes of the natural gas
produced from federal and Native American lands, which deprived the U.S.
Government of royalties. The plaintiff in this case seeks royalties that he
contends the government should have received had the volume and heating value
been differently measured, analyzed, calculated and reported, together with
interest, treble damages, civil penalties, expenses and future injunctive relief
to require the defendants to adopt allegedly appropriate gas measurement
practices. No monetary relief has been specified in this case. These matters
have been consolidated for pretrial purposes (In re: Natural Gas Royalties Qui
Tam Litigation, U.S. District Court for the District of Wyoming, filed June
1997). Discovery is proceeding. Our costs and legal exposure related to these
lawsuits and claims are not currently determinable.
Will Price (formerly Quinque). We and a number of our affiliates are named
defendants in Will Price et al. v. Gas Pipelines and Their Predecessors, et al.,
filed in 1999 in the District Court of Stevens County, Kansas. Plaintiffs allege
that the defendants mismeasured natural gas volumes and heating content of
natural gas on non-federal and non-Native American lands and seek to recover
royalties that they contend they should have received had the volume and heating
value of natural gas produced from their properties been differently measured,
analyzed, calculated and reported, together with prejudgment and postjudgment
interest, punitive damages, treble damages, attorneys' fees, costs and expenses,
and future injunctive relief to require the defendants to adopt allegedly
appropriate gas measurement practices. No monetary relief has been specified in
this case. Plaintiffs' motion for class certification of a nationwide class of
natural gas working interest owners and natural gas royalty owners was denied on
April 10, 2003. Plaintiffs were granted leave to file a Fourth Amended Petition,
which narrows the proposed class to royalty owners in wells in Kansas, Wyoming
and Colorado, and removes claims as to heating content. A second class action
has since been filed as to the heating content claims. Our costs and legal
exposure related to these lawsuits and claims are not currently determinable.
Bank of America. We are a named defendant, with Burlington Resources,
Inc., in two class action lawsuits styled as Bank of America, et al. v. El Paso
Natural Gas Company, et al., and Deane W. Moore, et al. v. Burlington Northern,
Inc., et. al., each filed in 1997 in the District Court of Washita County, State
of Oklahoma and subsequently consolidated by the court. Plaintiffs contend that
defendants (i) underpaid royalties from 1983 to the present on natural gas
produced from specified wells in Oklahoma (ii) took improper deductions and
conducted improper transactions with affiliated companies and (iii) failed to
pay or delayed the payment of royalties on certain gas sold from these wells.
The plaintiffs seek an accounting and damages for alleged royalty underpayments,
plus interest from the time such amounts were allegedly due, as well as punitive
damages. The plaintiffs have filed expert reports alleging damages in excess of
$1 billion. While Burlington accepted our tender of defense in 1997, and had
been defending the matter since that time, it has recently asserted contractual
claims for indemnity against us. We believe we have substantial defenses to the
plaintiffs' claims as well as to the claims for indemnity. The court has
certified the plaintiff classes of royalty and overriding royalty interest
owners, and the parties are proceeding with discovery. In March 2004, the court
dismissed all claims brought on behalf of the class of overriding royalty
interest owners, but denied
9
defendant's other motions for summary judgment. It is anticipated that this
matter will be scheduled for trial during 2004. A third action, styled Bank of
America, et al v. El Paso Natural Gas and Burlington Resources Oil & Gas
Company, was filed in October 2003 in the District Court of Kiowa County,
Oklahoma asserting similar claims as to specified shallow wells in Oklahoma,
Texas and New Mexico. Defendants succeeded in transferring this action to
Washita County where it is pending before the same judge as the consolidated
1997 class action lawsuits. A class has not been certified. We believe we have
substantial defenses to the plaintiffs' claims as well as to the claims for
indemnity. Our costs and legal exposure related to these lawsuits and claims are
not currently determinable.
In addition to the above matters, we and our subsidiaries and affiliates
are named defendants in numerous lawsuits and governmental proceedings that
arise in the ordinary course of our business.
For each of our outstanding legal matters, we evaluate the merits of the
case, our exposure in the matter, possible legal or settlement strategies and
the likelihood of an unfavorable outcome. If we determine that an unfavorable
outcome is probable and can be estimated, we establish the necessary accruals.
As this information becomes available, or other relevant developments occur, we
will adjust our accrual amounts accordingly. While there are still uncertainties
related to the ultimate costs we may incur, based upon our evaluation and
experience to date, we believe our current reserves are adequate. As of March
31, 2004, we had accrued approximately $541 million for all outstanding legal
matters, including our accrual for the Western Energy Settlement.
Environmental Matters
We are subject to federal, state and local laws and regulations governing
environmental quality and pollution control. These laws and regulations require
us to remove or remedy the effect on the environment of the disposal or release
of specified substances at current and former operating sites. As of March 31,
2004, we had accrued approximately $28 million for expected remediation costs at
current and former sites and associated onsite, offsite and groundwater
technical studies and for related environmental legal costs. Our accrual at
March 31, 2004, was based on the probability of the most likely outcome that can
be reasonably estimated; however, our exposure could be as high as $57 million.
For the remainder of 2004, we estimate that our total remediation
expenditures will be approximately $3 million, which primarily will be expended
under government directed clean-up plans. In addition, we expect to make capital
expenditures for environmental matters of approximately $2 million in the
aggregate for the years 2004 through 2008. These expenditures primarily relate
to compliance with clean air regulations.
CERCLA Matters. We have received notice that we could be designated, or
have been asked for information to determine whether we could be designated, as
a Potentially Responsible Party (PRP) with respect to four active sites under
the Comprehensive Environmental Response, Compensation and Liability Act
(CERCLA) or state equivalents. We have sought to resolve our liability as a PRP
at these sites through indemnification by third parties and settlements which
provide for payment of our allocable share of remediation costs. As of March 31,
2004, we have estimated our share of the remediation costs at these sites to be
between $12 million and $19 million. Since the clean-up costs are estimates and
are subject to revision as more information becomes available about the extent
of remediation required, and because in some cases we have asserted a defense to
any liability, our estimates could change. Moreover, liability under the federal
CERCLA statute is joint and several, meaning that we could be required to pay in
excess of our pro rata share of remediation costs. Our understanding of the
financial strength of other PRPs has been considered, where appropriate, in
estimating our liabilities. Reserves for these matters are included in the
environmental reserve discussed above.
It is possible that new information or future developments could require us
to reassess our potential exposure related to environmental matters. We may
incur significant costs and liabilities in order to comply with existing
environmental laws and regulations. It is also possible that other developments,
such as increasingly strict environmental laws and regulations and claims for
damages to property, employees, other persons and the environment resulting from
our current or past operations, could result in substantial costs and
liabilities in the future. As this information becomes available, or other
relevant developments occur, we will
10
adjust our accrual amounts accordingly. While there are still uncertainties
relating to the ultimate costs we may incur, based upon our evaluation and
experience to date, we believe our reserves are adequate.
Rates and Regulatory Matters
CPUC Complaint Proceeding. In April 2000, the CPUC filed a complaint under
Section 5 of the Natural Gas Act (NGA) with the FERC alleging that our sale of
approximately 1.2 Bcf/d of capacity to our affiliate, EPME, raised issues of
market power and violation of the FERC's marketing affiliate regulations and
asked that the contracts be voided. In the spring and summer of 2001, two
hearings were held before an Administrative Law Judge (ALJ) to address the
market power issue and the affiliate issue. On November 19, 2003, in approving
the JSA, which is part of the Western Energy Settlement, the FERC also vacated
both of the ALJ's Initial Decisions. That decision was upheld by the FERC in an
order issued March 30, 2004. On April 9, 2004, our East of California shippers
appealed both FERC orders on this matter to the U.S. Court of Appeals for the
District of Columbia.
Systemwide Capacity Allocation Proceeding. In July 2001, several of our
customers filed complaints against us at the FERC claiming that we had failed to
provide appropriate service on our pipeline. As a result of the FERC's many
orders in these proceedings; (i) full requirements (FR) shippers under Rate
Schedule FT-1 were required to convert from full requirements to contract demand
service on September 1, 2003; (ii) firm customers were assigned specific receipt
point rights in lieu of systemwide receipt point rights; (iii) reservation
charges will be credited to all firm customers if we fail to schedule confirmed
volumes except in cases of force majeure; in such force majeure cases, the
reservation charge credits will be limited to the return and associated tax
portion of our reservation rate; (iv) no new firm contract can be executed
unless we can demonstrate there is adequate capacity on the system available to
provide the service; (v) capacity
turned-back to us from contracts that terminated or expired from May 31, 2002 to
May 1, 2003, could not be remarketed because it was included in the volumes
allocated to the FR shippers; and (vi) a backhaul service was established from
our California delivery points for existing and new shippers. We also received
certificate authority to add compression to our Line 2000 Power-up project to
increase our system capacity by 320 MMcf/d without receiving cost coverage for
the expansion until our next rate case (in January 2006).
On July 9, 2003, the FERC found that we had not violated our certificates,
our contractual obligations, including our obligations under the 1996 Rate
Settlement (discussed below), or our tariff provisions as a result of the
capacity allocations that have occurred on the system since the 1996 Rate
Settlement. In addition, the FERC found we had correctly stated the capacity
that is available on a firm basis for allocation among our shippers and that we
had properly allocated that capacity. On a prospective basis, the FERC ordered
us to set aside a pool of 110 MMcf/d of capacity for use by the converting FR
shippers until completion of the first phase of the Line 2000 Power-up expansion
which occurred on February 27, 2004. After that the pool of capacity set aside
was reduced to 50 MMcf/d until the second phase of the Power-up was placed into
service on April 30, 2004.
On July 18, 2003, the FR shippers filed an appeal of the July 9 order with
the D.C. Circuit (Arizona Corporation Comm'n, et al. v. FERC, No. 03-1206) and
subsequently sought a stay of the FERC's orders. The stay was denied by the
court. Other parties have filed appeals of the FERC's orders some of which have
been consolidated. Southwest Gas Corporation, another customer of ours, filed an
appeal of these FERC Orders on April 1, 2004 with the District of Columbia
Circuit. The final outcome of these appeals cannot be predicted with certainty.
Rate Settlement. Our current rate settlement establishes our base rates
through December 31, 2005. The settlement has certain requirements applicable to
the Post-Settlement Period. These requirements include a provision which limits
the rates to be charged to a portion of our contracted portfolio to a level
equal to the inflation-escalated rate from the 1996 rate settlement. We are
currently reviewing the definition and applicability of this future capped-rate
requirement given, among other things, the customer and contract changes
required by the capacity allocation proceeding discussed above. We have the
right to increase or decrease our base rates if changes in laws or regulations
result in increased or decreased costs in excess of
11
$10 million a year. Our settlement included both risk and revenue sharing
provisions which expired at the end of 2003. We refunded $12 million in the
first quarter of 2004 related to these expiring provisions.
Line 2000 Power-up Project. In October 2002, pursuant to the FERC's orders
in the systemwide capacity allocation proceeding, we filed with the FERC for a
certificate of public convenience and necessity to add compression to our Line
2000 project to increase the capacity of that line by an additional 320 MMcf/d
at an estimated capital cost of approximately $173 million. On June 4, 2003, the
FERC issued an order approving our certificate application. On November 14,
2003, the FERC denied pending requests for rehearing on its June 4 order
approving the Power-up. Phase I of the project was placed in service on February
27, 2004, adding 120 MMcf/d of compression to our system and Phase II was placed
in service on April 30, 2004, adding an additional 100 MMcf/d of capacity to our
system. Phase III is expected to be placed in service by mid-June 2004, adding
an additional 100 MMcf/d of capacity to our system.
There are other regulatory rules and orders in various stages of adoption,
review and/or implementation, none of which we believe will have a material
impact on us.
While the outcome of our outstanding rates and regulatory matters cannot be
predicted with certainty, based on current information, we do not expect the
ultimate resolution of these matters to have a material adverse effect on our
financial position, operating results or cash flows. However, it is possible
that new information or future developments could require us to reassess our
potential exposure related to these matters, which could have a material effect
on our results of operations, our financial position, and our cash flows.
Other Matters
Enron Bankruptcy. In December 2001, Enron Corp. (Enron) and a number of
its subsidiaries, including Enron North America Corp. and Enron Power Marketing,
Inc., filed for Chapter 11 bankruptcy protection in the United States Bankruptcy
Court for the Southern District of New York. Enron North America had
transportation contracts on our system. The transportation contracts have now
been rejected and we have filed a proof of claim in the amount of approximately
$128 million, which included $18 million for amounts due for services provided
through the date the contracts were rejected and $110 million for damage claims
arising from the rejection of its transportation contracts. We anticipate that
Enron will vigorously oppose these claims. Given the uncertainties of the
Bankruptcy Court, we have fully reserved for all amounts due from Enron through
the date the contracts were rejected, and we have not recognized any amounts
under these contracts since the rejection date.
CFTC Investigation. In April 2004, we elected to voluntarily cooperate
with the Commodity Futures Trading Commission (CFTC) in connection with the
CFTC's industry-wide investigation of activities affecting the price of natural
gas in the fall of 2003. Specifically, we provided information relating to
storage reports provided to the Energy Information Administration for the period
October 2003 through December 2003.
Copper Eagle Gas Storage. In August 2003, we purchased Copper Eagle Gas
Storage, L.L.C., which is developing a natural gas storage facility, for
approximately $12 million. We also purchased land for approximately $9 million
in order to further develop the project. The storage facility is located in
Arizona near an Air Force base. In April 2004, the Arizona state legislature
signed a bill into law that would prevent the development of natural gas storage
facilities in areas around an active military base. We are weighing whether to
challenge the statute on grounds it violates the U.S. Constitution and/or is
pre-empted under the Natural Gas Act. We do not believe our investment in this
project is impaired at this time. However, further developments could impact
this assessment.
While the outcome of these matters cannot be predicted with certainty,
based on current information, we do not expect the ultimate resolution of these
matters to have a material adverse effect on our financial position, operating
results or cash flows. However, it is possible that new information or future
developments could require us to reassess our potential exposure related to
these matters, which could have a material effect on our results of operations,
our financial position, and our cash flows.
12
6. RETIREMENT BENEFITS
The components of our postretirement benefit costs for the quarters ended
March 31 are as follows:
2004 2003
----- -----
(IN MILLIONS)
Interest costs.............................................. $ 2 $ 2
Expected return on plan assets.............................. (1) (1)
Amortization of transition obligation....................... 2 2
--- ----
Net postretirement benefit cost............................. $ 3 $ 3
=== ====
7. TRANSACTIONS WITH AFFILIATES
We participate in El Paso's cash management program which matches
short-term cash surpluses and needs of participating affiliates, thus minimizing
total borrowings from outside sources. As of March 31, 2004 and December 31,
2003, we had advanced to El Paso $776 million and $779 million. The market rate
of interest at March 31, 2004 was 2.5% and at December 31, 2003 was 2.8%. These
receivables are due upon demand; however, as of March 31, 2004 and December 31,
2003, we have classified these advances as non-current notes receivable from
affiliates because we do not anticipate settlement within the next twelve
months. See Note 2 for a discussion regarding our participation in and the
collectibility of these receivables.
At March 31, 2004 and December 31, 2003, we had other accounts receivable
from affiliates of $2 million and $4 million. Accounts payable to affiliates
were $52 million and $13 million at March 31, 2004 and December 31, 2003. These
balances arose in the normal course of business.
The following table shows revenues and charges from our affiliates for the
quarters ended March 31:
2004 2003
----- -----
(IN MILLIONS)
Revenues from affiliates.................................... $ 4 $ 4
Operations and maintenance expenses from affiliates......... 14 18
Reimbursement of operating expenses charged to affiliates... 4 3
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information contained in Item 2 updates, and should be read in
conjunction with, the information disclosed in our 2003 Form 10-K and the
financial statements and notes presented in Item 1 of this Form 10-Q.
RESULTS OF OPERATIONS
Our management, as well as El Paso's management, uses earnings before
interest expense and income taxes (EBIT) to assess the operating results and
effectiveness of our business. We define EBIT as net income adjusted for (i)
items that do not impact our income from continuing operations, such as the
impact of accounting changes, (ii) income taxes, (iii) interest and debt expense
and (iv) affiliated interest income. We exclude interest and debt expense from
this measure so that our management can evaluate our operating results without
regard to our financing methods. We believe the discussion of our results of
operations based on EBIT is useful to our investors because it allows them to
more effectively evaluate the operating performance of our business using the
same performance measure analyzed internally by our management. EBIT may not be
comparable to measurements used by other companies. Additionally, EBIT should be
considered in conjunction with net income and other performance measures such as
operating income or operating cash flow.
The following is a reconciliation of our operating income to our EBIT and
our EBIT to our net income for the quarters ended March 31:
2004 2003
------- -------
(IN MILLIONS, EXCEPT
VOLUME AMOUNTS)
Operating revenues.......................................... $ 124 $ 132
Operating expenses.......................................... (64) (59)
------ ------
Operating income.......................................... 60 73
Other income, net........................................... 2 1
------ ------
EBIT...................................................... 62 74
Interest and debt expense................................... (22) (20)
Affiliated interest income, net............................. 5 3
Income taxes................................................ (11) (22)
------ ------
Net income................................................ $ 34 $ 35
====== ======
Total throughput (BBtu/d)................................... 3,981 4,069
====== ======
OPERATING RESULTS (EBIT)
The following factors contributed to our overall EBIT reduction to $62
million for the three months ended March 31, 2004 from $74 million for the three
months ended March 31, 2003:
EBIT
IMPACT
------
(IN MILLIONS)
INCREASE/(DECREASE)
Operating revenue items:
Termination of customer risk sharing mechanism in December
2003................................................... $ (6)
Impact of capacity obligations to former full requirements
(FR) customers......................................... (3)
Operating expense and other items:
Impact of higher natural gas prices on natural gas
imbalances............................................. (3)
Impact of lower estimated power purchase costs in 2003.... (4)
Net fuel recoveries in excess of operating requirements... 4
----
Total decrease in EBIT............................... $(12)
====
14
The impact of the termination of our risk sharing mechanism in December
2003, reflected above, will continue to impact our comparative EBIT for the
remainder of 2004. The impact of the 110 MMcf/d capacity obligation for former
FR customers reflected above terminated with the completion of Phases I and II
of our Line 2000 Power-up project in February and April of 2004. We are now able
to re-market this capacity, however, we must demonstrate that such sales do not
adversely impact our service to our firm customers and we are at risk for
portions that were turned back to us on a permanently released basis.
INTEREST AND DEBT EXPENSE
Below is the analysis of our interest expense for the quarters ended March
31:
2004 2003
----- -----
(IN MILLIONS)
Long term debt, including current maturities................ $23 $20
Other interest.............................................. -- 1
Less: capitalized interest.................................. (1) (1)
--- ---
Total interest expense................................. $22 $20
=== ===
Interest and debt expense for the quarter ended March 31, 2004, was $2
million higher than the same period in 2003 primarily due to the issuance in
July 2003 of $355 million of 7.625% long-term notes offset by a decrease in
interest expense due to the retirement of $200 million of 6.75% notes in
November 2003.
AFFILIATED INTEREST INCOME, NET
Affiliated interest income, net for the quarter ended March 31, 2004, was
$2 million higher than the same period in 2003 due to higher interest rates on
average advances to El Paso under its cash management program offset by lower
average balances of these advances. The average short-term interest rate for the
first quarter increased from 1.4% in 2003 to 2.7% during the same period in
2004. The average advance balance for the first quarter of 2003 was $978 million
and decreased to $774 million during the same period in 2004.
INCOME TAXES
QUARTER ENDED
MARCH 31,
------------------
2004 2003
---- ----
(IN MILLIONS,
EXCEPT FOR RATES)
Income taxes................................................ $11 $22
Effective tax rate.......................................... 24% 39%
Our effective tax rate for the quarter ended March 31, 2003 was higher than
the statutory rate of 35 percent primarily due to the effect of state income
taxes. The effective tax rate for the quarter ended March 31, 2004 was lower
than the statutory rate of 35 percent due to a state income tax adjustment
related to the Western Energy Settlement. As of December 31, 2003, we maintained
a valuation allowance on deferred tax assets related to our estimate of our
ability to realize state tax benefits from the deduction of the charge we took
related to the Western Energy Settlement. During the first quarter of 2004, we
evaluated this allowance and now believe, based on our current estimates, that
these state tax benefits will be fully realized. Consequently, we reversed our
valuation allowance. Net of federal taxes, this benefit totaled approximately $6
million. Our total tax assets related to the Western Energy Settlement were $205
million as of March 31, 2004. Proposed tax legislation has been introduced in
the U.S. Senate which would disallow deductions for certain settlements made to
or on behalf of governmental entities. If enacted, this tax legislation could
impact the deductibility of the Western Energy Settlement and could result in a
write-off of some or all of the associated tax assets. In such event, our tax
expense would increase.
15
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
Our liquidity needs have historically been provided through cash flows from
operating activities and the use of El Paso's cash management program. Under El
Paso's cash management program, depending on whether we have short-term cash
surpluses or requirements, we either provide cash to El Paso or El Paso provides
cash to us. We have historically provided cash advances to El Paso, and we
reflect these net advances as investing activities in our statement of cash
flows. As of March 31, 2004, we had receivables from El Paso of $776 million as
a result of this program. These receivables are due upon demand; however, we do
not anticipate settlement within the next twelve months. As of March 31, 2004,
these receivables were classified as non-current notes receivable from
affiliates in our balance sheet. We believe that cash flows from operating
activities will be adequate to meet our short-term capital and debt service
requirements for our existing operations. However, as a result of announcements
by El Paso related to the restatement of its natural gas and oil reserves, our
ability to recover the amounts advanced under El Paso's cash management program
could be impacted.
If El Paso were unable to meet its liquidity needs, we would not have
access to this source of liquidity and there is no assurance that El Paso could
repay the entire amounts owed to us. In that event, we could be required to
write-off some amount of these advances, which could have a material impact on
our stockholder's equity. Furthermore, we would still be required to repay
affiliated company payables. Write-downs that cause our debt to EBITDA (as
defined in our agreements) ratio to exceed 5 to 1 could prohibit us from
incurring additional debt. However, this non-cash equity reduction would not
result in an event of default under our existing debt agreements. In addition,
based on our current estimates of cash flows, we do not believe we will need to
seek repayment of all or part of these advances in the next year.
El Paso's ownership in us and our ownership in Mojave serve as collateral
under El Paso's revolving credit facility and other of El Paso's financing
transactions. If El Paso's lenders under this facility or those financing
transactions were to exercise their rights to this collateral, our ownership
could change and our ownership interests in Mojave could be liquidated. However,
this change of control and liquidation would not constitute an event of default
under our existing debt agreements.
If, as a result of the events described above, El Paso were subject to
voluntary or involuntary bankruptcy proceedings, El Paso and its other
subsidiaries and their creditors could attempt to make claims against us,
including claims to substantively consolidate our assets and liabilities with
those of El Paso and its other subsidiaries. We believe that claims to
substantively consolidate us with El Paso and/or its other subsidiaries would be
without merit. However, there is no assurance that El Paso and/or its other
subsidiaries or their creditors would not advance such a claim in a bankruptcy
proceeding. If we were to be substantively consolidated in a bankruptcy
proceeding with El Paso and/or its other subsidiaries, there could be a material
adverse effect on our financial condition and our liquidity.
Finally, we have cross-acceleration provisions in our long-term debt that
state that should we incur an event of default under which borrowings in excess
of $25 million are accelerated, our long-term debt could also be accelerated.
The acceleration of our long-term debt would adversely affect our liquidity
position and, in turn, our financial condition.
Our cash flows for the quarters ended March 31 were as follows:
2004 2003
------ -----
(IN MILLIONS)
Cash flows from operating activities........................ $ 32 $ 48
Cash flows from investing activities........................ (107) (51)
Cash flows from financing activities........................ 74 --
16
Cash Flows from Operating Activities
Net cash provided by operating activities was $32 million for the first
three months of 2004 versus $48 million in the same period of 2003. This
decrease is primarily due to changes in assets and liabilities.
Cash Flows from Investing Activities
Net cash used in investing activities was $107 million for the first three
months of 2004. In March 2004, we deposited $74 million into an escrow account
for the benefit of Western Energy Settlement parties. Our investing activities
also consisted of $36 million in capital expenditures.
Cash Flows from Financing Activities
Net cash provided by financing activities consisted of an equity
contribution of $74 million from El Paso, through our direct parent, related to
the sale of El Paso's common stock for the benefit of Western Energy Settlement
parties.
CAPITAL EXPENDITURES
Our capital expenditures for the quarter ended March 31, 2004 were
approximately $36 million. Under our current plan, we expect to spend
approximately $210 million during 2004 for capital expenditures, consisting of
approximately $70 million to expand the capacity on our systems and $140 million
for maintenance capital. We expect to fund our maintenance and expansion capital
expenditures through a combination of internally generated funds and/or by
recovering amounts advanced to El Paso under its cash management program,
subject to the factors discussed above.
COMMITMENTS AND CONTINGENCIES
See Item 1, Financial Statements, Note 5, which is incorporated herein by
reference.
17
RISK FACTORS AND CAUTIONARY STATEMENTS FOR PURPOSES OF THE "SAFE HARBOR"
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This report contains or incorporates by reference forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Where any forward-looking statement includes a statement of the
assumptions or bases underlying the forward-looking statement, we caution that,
while we believe these assumptions or bases to be reasonable and to be made in
good faith, assumed facts or bases almost always vary from the actual results,
and the differences between assumed facts or bases and actual results can be
material, depending upon the circumstances. Where, in any forward-looking
statement, we or our management express an expectation or belief as to future
results, that expectation or belief is expressed in good faith and is believed
to have a reasonable basis. We cannot assure you, however, that the statement of
expectation or belief will result or be achieved or accomplished. The words
"believe," "expect," "estimate," "anticipate" and similar expressions will
generally identify forward-looking statements.
With this in mind, you should consider the risks discussed elsewhere in
this report and other documents we file with the Securities and Exchange
Commission, from time to time, and the following important factors that could
cause actual results to differ materially from those expressed in any
forward-looking statement made by us or on our behalf.
OUR RELATIONSHIP WITH EL PASO AND ITS FINANCIAL CONDITION SUBJECTS US TO
POTENTIAL RISKS THAT ARE BEYOND OUR CONTROL.
Due to our relationship with El Paso, adverse developments or announcements
concerning El Paso could adversely affect our financial condition, even if we
have not suffered any similar development. The senior unsecured indebtedness of
El Paso is currently rated Caa1 by Moody's (with a negative outlook and under
review for a possible downgrade) and CCC+ by Standard & Poor's (with a negative
outlook), which are below investment grade ratings. Our senior unsecured
indebtedness is currently rated B1 by Moody's (with a negative outlook and under
review for a possible downgrade) and B- by Standard & Poor's (with a negative
outlook). These debt ratings will increase our cost of capital and collateral
requirements, and could impede our access to capital markets. As a result of its
downgrades over the last two years, El Paso has realized substantial demands on
its liquidity. These downgrades are a result, at least in part, of the outlook
generally for the consolidated businesses of El Paso and its needs for
liquidity.
El Paso has a long-range plan that, among other things, defines, its future
businesses, targets significant debt reduction and establishes financial goals.
An inability to meet these objectives could adversely affect El Paso's liquidity
position, and in turn affect our financial condition.
Pursuant to El Paso's cash management program, surplus cash is made
available to El Paso in exchange for an affiliated receivable. In addition, we
conduct commercial transactions with some of our affiliates. As of March 31,
2004, we have net receivables of approximately $726 million from El Paso and its
affiliates. El Paso provides cash management and other corporate services to us.
If El Paso is unable to meet its liquidity needs, there can be no assurance that
we will be able to access cash under the cash management program, or that our
affiliates would pay their obligations to us. However, we would still be
required to satisfy affiliated company payables. Our inability to recover any
intercompany receivables owed to us could adversely affect our ability to repay
our outstanding indebtedness. For a further discussion of these matters, see
Item 1, Financial Statements, Note 7.
In May 2004, El Paso announced that the results of its internal review of
its natural gas and oil reserves confirmed its previous assessment that the
financial statements for El Paso and its subsidiaries, El Paso CGP Company
(EPCGP) and El Paso Production Holding Company (EPPH), should be restated. At
this time, these restated financial statements have not been filed. Also, as a
result of its reduction in reserve estimates, several class action lawsuits have
been filed against El Paso and several of its subsidiaries, but not against us.
The reduction in reserve estimates has also become the subject of an SEC
investigation and may become the subject of separate inquiries by other
governmental regulatory agencies. These investigations and lawsuits may further
negatively impact El Paso's credit ratings and place further demands on its
liquidity. See Item 1, Financial Statements, Note 2 for a further discussion of
these matters.
18
A DEFAULT UNDER EL PASO'S $3 BILLION REVOLVING CREDIT FACILITY BY ANY PARTY
COULD ACCELERATE OUR FUTURE BORROWINGS, IF ANY, UNDER THE FACILITY AND OUR
LONG-TERM DEBT, WHICH COULD ADVERSELY AFFECT OUR LIQUIDITY POSITION.
We are a party to El Paso's $3 billion revolving credit facility. We are
only liable, however, for our borrowings under the $3 billion revolving credit
facility, which were zero as of March 31, 2004. Under the $3 billion revolving
credit facility, a default by El Paso, or any other party, could result in the
acceleration of all outstanding borrowings under the facility, including the
borrowings of any non-defaulting party, and could preclude us from borrowing
under the facility in the future. We believe El Paso's announced restatement of
its prior period financial statements would have constituted an event of default
under the $3 billion credit facility; however, El Paso received waivers of the
potential defaults on its $3 billion credit facility, which continue to be
effective. See Item 1, Financial Statements, Note 2, for additional information
regarding these matters. The acceleration of our future borrowings, if any,
under the $3 billion revolving credit facility, or the inability to borrow under
the $3 billion revolving credit facility, could adversely affect our liquidity
position and, in turn, our financial condition.
Furthermore, the indentures governing our long-term debt include
cross-acceleration provisions. Therefore, if we borrow $25 million or more under
the credit facility and such borrowings are accelerated for any reason,
including the default of another party, our long-term debt could also be
accelerated. The acceleration of our long-term debt could also adversely affect
our liquidity position and, in turn, our financial condition.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
This information updates, and you should read it in conjunction with,
information disclosed in Part II, Item 7A in our Annual Report on Form 10-K for
the year ended December 31, 2003, in addition to the information presented in
Items 1 and 2 of this Quarterly Report on Form 10-Q.
There are no material changes in our quantitative and qualitative
disclosures about market risks from those reported in our Annual Report on Form
10-K for the year ended December 31, 2003.
ITEM 4. CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures and the internal controls over financial reporting as of
the end of the period covered by this Quarterly Report pursuant to Rules 13a-15
and 15d-15 under the Securities Exchange Act of 1934 (Exchange Act).
We strive to maintain disclosure controls and procedures and internal
controls over financial reporting that are designed to ensure that the
information required to be disclosed in our Exchange Act filings is recorded,
processed, summarized and reported within the required timeframes, and that this
information is accumulated and communicated to our management, including our
principal executive officer and principal financial officer, as appropriate, to
allow for timely decisions regarding required disclosure. In doing so, we
recognize that the effectiveness of our or any system of controls and procedures
is subject to limitations, including the exercise of judgment in the design,
implementation and evaluation of controls and procedures, the assumptions used
in identifying future events and the ability to completely eliminate misconduct.
As a result, there is no assurance that our or any controls and procedures will
prevent all errors and all fraud. By their nature, controls and procedures can
provide only reasonable assurance regarding our control objectives.
Based on the controls evaluation, our principal executive officer and
principal financial officer have concluded that the disclosure controls are
effective. We are currently documenting and reviewing our internal controls to
ensure compliance with Section 404 of the Sarbanes Oxley Act of 2002 by December
31, 2004. While we are not aware of any items at this time that constitute
material weaknesses, as that term is defined in Auditing Standards (AU) Section
325, we are identifying areas where our processes can be improved, and are
actively working to implement those improvements. Furthermore, as we continue
our compliance review, we
19
may identify additional matters which may need to be reported or which may
constitute material weaknesses in our internal controls over financial
reporting. Although we have identified deficiencies in our system of internal
controls over financial reporting, we do not believe these deficiencies have
had, or are reasonably likely to have, a material impact on our financial
statements. In addition, there have been no changes during the period in our
internal controls over financial reporting that would adversely affect our
ability to provide, with reasonable assurance, reliable information required in
our reports submitted under the Securities Exchange Act of 1934.
20
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Part I, Item 1, Financial Statements, Note 5, which is incorporated
herein by reference.
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
Each exhibit identified below is filed as a part of this report. Exhibits
not incorporated by reference to a prior filing are designated by an "*"; all
exhibits not so designated are incorporated herein by reference to a prior
filing as indicated.
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
*10.A.1 First Amendment to the $3,000,000,000 Revolving Credit
Agreement and Waiver dated as of March 15, 2004 among El
Paso Corporation, El Paso Natural Gas Company, Tennessee Gas
Pipeline Company, ANR Pipeline Company and Colorado
Interstate Gas Company, as Borrowers, the Lenders party
thereto and JPMorgan Chase Bank, as Administrative Agent,
ABN AMRO Bank N.V. and Citicorp North America, Inc., as
Co-Documentation Agents, Bank of America, N.A. and Credit
Suisse First Boston, as Co-Syndication Agents.
*31.A Certification of Chief Executive Officer pursuant to
sec. 302 of the Sarbanes-Oxley Act of 2002.
*31.B Certification of Chief Financial Officer pursuant to
sec. 302 of the Sarbanes-Oxley Act of 2002.
*32.A Certification of Chief Executive Officer pursuant to 18
U.S.C. sec. 1350 as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act of 2002.
*32.B Certification of Chief Financial Officer pursuant to 18
U.S.C. sec. 1350 as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act of 2002.
Undertaking
We hereby undertake, pursuant to Regulation S-K, Item 601(b),
paragraph (4)(iii), to furnish to the U.S. Securities and Exchange
Commission, upon request, all constituent instruments defining the rights
of holders of our long-term debt not filed herewith for the reason that the
total amount of securities authorized under any of such instruments does
not exceed 10 percent of our total consolidated assets.
b. Reports on Form 8-K
None.
21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EL PASO NATURAL GAS COMPANY
Date: May 14, 2004 /s/ JOHN W. SOMERHALDER II
------------------------------------
John W. Somerhalder II
Chairman of the Board
and Director
(Principal Executive Officer)
Date: May 14, 2004 /s/ GREG G. GRUBER
------------------------------------
Greg G. Gruber
Senior Vice President,
Chief Financial Officer, Treasurer
and Director
(Principal Financial and Accounting
Officer)
22
EL PASO NATURAL GAS COMPANY
EXHIBIT INDEX
Each exhibit identified below is filed as a part of this report. Exhibits
not incorporated by reference to a prior filing are designated by an "*"; all
exhibits not so designated are incorporated herein by reference to a prior
filing as indicated.
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
*10.A.1 First Amendment to the $3,000,000,000 Revolving Credit
Agreement and Waiver dated as of March 15, 2004 among El
Paso Corporation, El Paso Natural Gas Company, Tennessee Gas
Pipeline Company, ANR Pipeline Company and Colorado
Interstate Gas Company, as Borrowers, the Lenders party
thereto and JPMorgan Chase Bank, as Administrative Agent,
ABN AMRO Bank N.V. and Citicorp North America, Inc., as
Co-Documentation Agents, Bank of America, N.A. and Credit
Suisse First Boston, as Co-Syndication Agents.
*31.A Certification of Chief Executive Officer pursuant to
sec. 302 of the Sarbanes-Oxley Act of 2002.
*31.B Certification of Chief Financial Officer pursuant to
sec. 302 of the Sarbanes-Oxley Act of 2002.
*32.A Certification of Chief Executive Officer pursuant to 18
U.S.C. sec. 1350 as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act of 2002.
*32.B Certification of Chief Financial Officer pursuant to 18
U.S.C. sec. 1350 as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act of 2002.