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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 SEPTEMBER 30, 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 1-7320
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ANR PIPELINE COMPANY
(Exact Name of Registrant as Specified in its Charter)
DELAWARE 38-1281775
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
EL PASO BUILDING
1001 LOUISIANA STREET 77002
HOUSTON, TEXAS (Zip Code)
(Address of Principal Executive Offices)
Telephone Number: (713) 420-2600
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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 November 12,
2004: 1,000
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ANR PIPELINE 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................................. 10
Cautionary Statements for purposes of the "Safe Harbor"
provisions of the Private Securities Litigation Reform Act
of 1995................................................... 15
Item 3. Quantitative and Qualitative Disclosures About Market
Risk...................................................... 15
Item 4. Controls and Procedures..................................... 15
PART II -- Other Information
Item 1. Legal Proceedings........................................... 16
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds.................................................. 16
Item 3. Defaults Upon Senior Securities............................. 16
Item 4. Submission of Matters to a Vote of Security Holders......... 16
Item 5. Other Information........................................... 16
Item 6. Exhibits.................................................... 16
Signatures.................................................. 17
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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
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 ANR
Pipeline Company and/or our subsidiaries.
i
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ANR PIPELINE COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN MILLIONS)
(UNAUDITED)
NINE MONTHS
QUARTER ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- --------------
2004 2003 2004 2003
---- ---- ---- ----
Operating revenues...................................... $101 $117 $342 $428
---- ---- ---- ----
Operating expenses
Operation and maintenance............................. 58 69 173 217
Depreciation, depletion and amortization.............. 10 9 28 27
Taxes, other than income taxes........................ 7 6 20 19
---- ---- ---- ----
75 84 221 263
---- ---- ---- ----
Operating income........................................ 26 33 121 165
Earnings from unconsolidated affiliate.................. 14 11 50 42
Other income, net....................................... 4 -- 4 --
Interest and debt expense............................... (17) (18) (52) (48)
Affiliated interest income, net......................... 6 1 10 1
---- ---- ---- ----
Income before income taxes.............................. 33 27 133 160
Income taxes............................................ 12 9 49 59
---- ---- ---- ----
Net income.............................................. $ 21 $ 18 $ 84 $101
==== ==== ==== ====
See accompanying notes.
1
ANR PIPELINE COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
2004 2003
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ASSETS
Current assets
Cash and cash equivalents................................. $ 42 $ 25
Accounts and notes receivable
Customer, net of allowance of $3 in 2004 and 2003...... 47 67
Affiliates............................................. 7 5
Other.................................................. 1 3
Materials and supplies.................................... 20 22
Other..................................................... 13 13
------ ------
Total current assets.............................. 130 135
------ ------
Property, plant and equipment, at cost...................... 3,660 3,660
Less accumulated depreciation, depletion and
amortization........................................... 2,158 2,200
------ ------
Total property, plant and equipment, net.......... 1,502 1,460
------ ------
Other assets
Investment in unconsolidated affiliate.................... 319 325
Notes receivable from affiliates.......................... 477 367
Other..................................................... 10 20
------ ------
806 712
------ ------
Total assets...................................... $2,438 $2,307
====== ======
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Accounts payable
Trade.................................................. $ 28 $ 32
Affiliates............................................. 23 18
Other.................................................. 17 13
Short-term borrowings, including current maturities of
long-term debt......................................... 75 --
Accrued interest.......................................... 17 17
Taxes payable............................................. 84 59
Contractual deposits...................................... 18 13
Other payable to affiliate................................ 8 8
Other..................................................... 19 21
------ ------
Total current liabilities......................... 289 181
------ ------
Long-term debt, less current maturities..................... 733 807
------ ------
Other liabilities
Deferred income taxes..................................... 331 307
Payable to affiliates..................................... 184 188
Other..................................................... 34 41
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549 536
------ ------
Commitments and contingencies
Stockholder's equity
Common stock, par value $1 per share; 1,000 shares
authorized, issued and outstanding..................... -- --
Additional paid-in capital................................ 597 597
Retained earnings......................................... 270 186
------ ------
Total stockholder's equity........................ 867 783
------ ------
Total liabilities and stockholder's equity........ $2,438 $2,307
====== ======
See accompanying notes.
2
ANR PIPELINE COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
2004 2003
------ ------
Cash flows from operating activities
Net income................................................ $ 84 $ 101
Adjustments to reconcile net income to net cash from
operating activities
Depreciation, depletion and amortization............... 28 27
Deferred income tax expense............................ 24 32
Earnings from unconsolidated affiliate, adjusted for
cash distributions.................................... 7 (13)
Other non-cash income items............................ 1 2
Asset and liability changes............................ 35 11
----- -----
Net cash provided by operating activities............ 179 160
----- -----
Cash flows from investing activities
Additions to property, plant and equipment................ (81) (61)
Net proceeds from sale of assets.......................... 42 7
Net change in affiliate advances.......................... (110) (369)
Other..................................................... (13) --
----- -----
Net cash used in investing activities................ (162) (423)
----- -----
Cash flows from financing activities
Net proceeds from the issuance of long-term debt.......... -- 288
----- -----
Net cash provided by financing activities............ -- 288
----- -----
Net change in cash and cash equivalents..................... 17 25
Cash and cash equivalents
Beginning of period....................................... 25 --
----- -----
End of period............................................. $ 42 $ 25
===== =====
See accompanying notes.
3
ANR PIPELINE 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 September 30, 2004, and for the
quarters and nine months ended September 30, 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.
In addition, prior period information presented in these financial statements
includes reclassifications which were made to conform to current period
presentation. These reclassifications had no effect on our previously reported
net income or stockholder's equity.
Our accounting policies are consistent with those discussed in our 2003
Form 10-K.
2. LIQUIDITY
El Paso is a significant potential source of liquidity to us. We
participate in El Paso's cash management program whereby, 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 as of September 30, 2004, we had a cash advance receivable from
El Paso of $477 million, classified as a non-current asset in our balance sheet.
We believe that our cash flows from operating activities will be adequate to
meet our short term capital and debt service requirements for our existing
operations, therefore we do not believe we will need to seek repayment of these
advances in the next twelve months.
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 amounts owed to us. In that event, we could be required to write-off
some or all of these advances, which could have a material impact on our
stockholder's equity and we would still be required to repay affiliated company
payables, if demanded. Although increases in our debt to EBITDA (as defined in
our agreements) ratio that cause the ratio to exceed 5 to 1 could prohibit us
from incurring additional debt, the equity reduction that would result if we
wrote off these receivables would not result in an event of default under our
existing debt agreements.
During 2004, El Paso restated its historical financial statements to
reflect the accounting impact of revisions to its natural gas and oil reserve
estimates and changes in the manner in which it accounted for certain derivative
contracts, primarily those related to the hedging of its natural gas production.
El Paso believes the restatement of its historical financial statements would
have constituted events of default under its revolving credit facility, under
which we are eligible to borrow, and various other financings; specifically
under the provisions of those agreements related to representations and
warranties on the accuracy of its historical financial statements and on El
Paso's debt to total capitalization ratio. During 2004, El Paso received a
series of waivers on its revolving credit facility and these other financing
transactions to address these issues. These waivers continue to be in effect. El
Paso also received an extension of time from various lenders until November 30,
2004 to file its second quarter 2004 Form 10-Q which it expects to meet. If El
Paso is unable to file its second quarter 2004 Form 10-Q by that date and is not
able to negotiate an additional extension of the filing deadline, its revolving
credit facility and various other financings could be accelerated. As part of
obtaining the waivers, El Paso amended various provisions of the revolving
credit facility, including provisions related to events of default and
limitations on the ability of El Paso, as well as its subsidiaries, to prepay
debt that matures after June 30, 2005. Although we are a party to El Paso's
revolving credit facility, we do not have
4
any borrowings or letters of credit outstanding under that facility. See Note 3
below for a further discussion of the revolving credit facility and the
potential refinancing of this facility.
Based upon a review of the covenants contained in our long-term debt
agreements, we believe that a default on El Paso's revolving credit facility
would not result in an event of default under our debt agreements.
El Paso's ownership interest in us serves as collateral under El Paso's
revolving credit facility and other of El Paso's financing transactions. If El
Paso's lenders under these facilities were to exercise their rights to this
collateral, our ownership could change. However, this change of control 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.
3. DEBT AND CREDIT FACILITIES
Our short-term borrowings, including current maturities of long-term debt,
consist of $75 million, 7.00% debentures due 2025. They are classified as
current maturities because the holders may require us to redeem their debentures
at par value on June 1, 2005.
Credit Facilities
El Paso maintains a revolving credit facility, with a $1.5 billion letter
of credit sublimit, which matures on June 30, 2005. The 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, Tennessee
Gas Pipeline Company, Colorado Interstate Gas Company and El Paso Natural Gas
Company, are borrowers under the revolving credit facility. El Paso liquidated a
portion of the collateral that supported the revolving credit facility, which
reduced the overall borrowing availability from $3 billion to $2.5 billion in
October 2004. We are only liable for amounts we directly borrow under the
revolving credit facility. As of September 30, 2004, there were no borrowings
and $1.1 billion in letters of credit were issued under the revolving credit
facility, none of which were issued on our behalf. See Note 2 for a discussion
regarding El Paso's waivers on the revolving credit facility.
El Paso's equity in several of its subsidiaries, including its equity in
us, collateralizes the revolving credit facility and other financing
arrangements including leases, letters of credit and other credit facilities.
El Paso is in the process of negotiating the refinancing of this facility
as the combination of a three year revolving credit facility and a five year
term loan and currently expects to be successful in this refinancing by December
31, 2004.
Under the revolving credit facility and other financing agreements, 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 our 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 5.
5
4. COMMITMENTS AND CONTINGENCIES
Legal Proceedings
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 in
April 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 claim. 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 to 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
September 30, 2004, we had less than $1 million accrued for our outstanding
legal matters.
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 September
30, 2004, we had accrued approximately $28 million for expected remediation
costs and associated onsite, offsite and groundwater technical studies and for
related environmental legal costs. Our accrual was based on the most likely
outcome that can be reasonably estimated. Below is a reconciliation of our
accrued liability as of September 30, 2004 (in millions):
Balance as of January 1, 2004............................... $29
Additions/adjustments for remediation activities............ 2
Payments for remediation activities......................... (3)
---
Balance as of September 30, 2004............................ $28
===
6
In addition, we expect to make capital expenditures for environmental
matters of approximately $19 million in the aggregate for the years 2004 through
2008. These expenditures primarily relate to compliance with clean air
regulations. For the remainder of 2004, we estimate that our total remediation
expenditures will be approximately $1 million, which primarily will be expended
under government directed clean-up plans.
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 three 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 September
30, 2004 we have estimated our share of the remediation costs at these sites to
be approximately $1 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 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
Cashout Proceeding. In May 2002, we made our annual filing to reconcile
the costs and revenues associated with operating our cashout program, a program
that involves the sale and purchase of natural gas to satisfy shipper
imbalances. In October 2002, the Federal Energy Regulatory Commission (FERC)
accepted the filing, and allowed our proposed cashout surcharge to go into
effect. However, the FERC also found that the existing cashout mechanism was no
longer "just and reasonable" and set the case for hearing to establish a
replacement mechanism.
After a hearing in January 2004, the Administrative Law Judge (ALJ) issued
an initial decision in April 2004. The ALJ concluded that five changes should be
made to our cashout mechanism: (1) eliminate the cashout surcharge; (2)
institute an in-kind balancing option for all shippers; (3) shippers remaining
under a mechanism that remedies negative imbalances by cash payments, use a
high/low pricing mechanism to determine the amount of the cash payment; (4)
balance the system at the end of each month, to the extent it is operationally
feasible to do so; and (5) keep Plant Thermal Reduction shippers apprised of the
status of imbalances. In addition, the ALJ found that we should be made whole
for past amounts owed to us under the prior cashout mechanism and rejected
certain proposals of a group of shippers for establishment of an imbalance
account to be credited with revenues from the sale of excess fuel and lost and
unaccounted for gas and storage overrun service revenues. In November 2004, the
FERC issued an Order on the initial decision. The FERC reversed the ALJ's
requirement that we offer our shippers an in-kind balancing option. The FERC
affirmed the ALJ's determination to allow us to utilize high-low pricing as part
of our cashout mechanism to develop the amount of cash payment that must be made
to resolve imbalances. Under this mechanism, we will cashout shortages by
selling gas to imbalance shippers at the highest weekly index price during the
month, and will purchase overages at the lowest weekly index price during the
month. The FERC also reversed the ALJ's decision with respect to imbalances of
Plant Thermal Reduction shippers, finding that such shippers, not us, should
retain primary responsibility for obtaining plant data needed to monitor and
control these imbalances.
7
Finally, the FERC affirmed the ALJ's rejection of various refund and crediting
proposals made by a group of shippers. This decision is subject to further
review by the FERC on rehearing.
Accounting for Pipeline Assessment Costs. In November 2004, the FERC
issued an industry-wide Proposed Accounting Release that, if enacted as written,
will disallow the capitalization of certain costs that are part of our pipeline
integrity program. The accounting release is proposed to be effective January
2005 following a period of public comment on the release. We are currently
reviewing the release and have not determined what impact this release will have
on our consolidated financial statements.
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.
Other
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
of October 2003 though December 2003. In August 2004, the CFTC announced they
had completed the investigation and found no evidence of wrongdoing.
5. INVESTMENT IN UNCONSOLIDATED AFFILIATE AND TRANSACTIONS WITH AFFILIATES
Investment in Unconsolidated Affiliate
Our investment in unconsolidated affiliate consists of our equity ownership
interest in Great Lakes Gas Transmission Limited Partnership (Great Lakes L.P.).
Summarized income statement information of our proportionate share of our
unconsolidated affiliate for the periods ended September 30, is as follows:
NINE MONTHS
QUARTERS ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- ---------------
2004 2003 2004 2003
---- ---- ---- ----
(IN MILLIONS)
Operating results data:
Operating revenues................................ $31 $31 $99 $96
Operating expenses................................ 15 15 41 43
Net income(1)..................................... 9 7 33 27
- ---------------
(1)Our proportionate share of net income includes our share of taxes payable by
partners recorded by Great Lakes L.P.
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 September 30, 2004 and December 31,
2003, we had advanced to El Paso $477 million and $367 million. The interest
rate at September 30, 2004 was 2.7% and at December 31, 2003 was 2.8%. These
receivables are due upon demand; however, as of September 30, 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.
8
At September 30, 2004 and December 31, 2003, we had accounts receivable
from affiliates of $7 million and $5 million. In addition, we had accounts
payable to affiliates of $23 million and $18 million at September 30, 2004, and
December 31, 2003. These balances arose in the normal course of business. We
also received $2 million in deposits related to our transportation contracts
with TGP which is included in our balance sheet as current liabilities as of
September 30, 2004 and December 31, 2003.
At September 30, 2004 and December 31, 2003, we had payables to an
affiliate of $192 million and $196 million, for obligations related to a
non-cancelable lease on our former headquarters. Of these amounts, $8 million
was classified as current at September 30, 2004 and December 31, 2003. This
payable resulted from the relocation of our headquarters from Detroit, Michigan
to Houston, Texas and the transfer of this lease to our affiliate from a third
party. The lease payments are due semi-annually.
During the third quarter of 2004, we sold a storage field and its related
base gas to Mid Michigan Gas Storage Company, our affiliate, at its net book
value of $42 million. We did not recognize a gain or loss on this sale. We also
acquired assets from our affiliates with a net book value of $13 million.
The following table shows revenues and charges from our affiliates for the
periods ended September 30:
NINE MONTHS
QUARTERS ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- ---------------
2004 2003 2004 2003
---- ---- ---- ----
(IN MILLIONS)
Revenues from affiliates............................ $ 2 $ 4 $ 8 $15
Operations and maintenance expenses from
affiliates........................................ 30 34 85 100
Reimbursements of operating expenses charged to
affiliates........................................ 1 -- 3 1
9
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 Annual Report on Form
10-K and the financial statements and notes presented in Item 1 of this
Quarterly Report on 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. Our business consists of consolidated
operations as well as an investment in an unconsolidated affiliate. 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
both our consolidated business and our unconsolidated investments 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 or other performance measures such as
operating income or operating cash flow.
The following is a reconciliation of EBIT to net income.
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------- ------------------
2004 2003 2004 2003
------ ------ ------- -------
(IN MILLIONS, EXCEPT VOLUME AMOUNTS)
Operating revenues....................................... $ 101 $ 117 $ 342 $ 428
Operating expenses....................................... (75) (84) (221) (263)
------ ------ ------ ------
Operating income.................................... 26 33 121 165
------ ------ ------ ------
Earnings from unconsolidated affiliate................... 14 11 50 42
Other income, net........................................ 4 -- 4 --
------ ------ ------ ------
Other............................................... 18 11 54 42
------ ------ ------ ------
EBIT................................................ 44 44 175 207
Interest and debt expense................................ (17) (18) (52) (48)
Affiliated interest income, net.......................... 6 1 10 1
Income taxes............................................. (12) (9) (49) (59)
------ ------ ------ ------
Net income.......................................... $ 21 $ 18 $ 84 $ 101
====== ====== ====== ======
Throughput volumes (BBtu/d)(1)........................... 4,656 4,695 5,220 5,495
====== ====== ====== ======
- ----------
(1) Throughput volumes include billable transportation throughput volumes for
storage withdrawal and volumes associated with our proportionate share of
our 50 percent equity investment in Great Lakes L.P.
10
OPERATING RESULTS (EBIT)
Third Quarter 2004 Compared to Third Quarter 2003
The following factors contributed to our overall EBIT for the three months
ended September 30, 2004 as compared to the same period in 2003:
REVENUE EXPENSE OTHER EBIT
IMPACT IMPACT IMPACT IMPACT
------- ------- ------ ------
FAVORABLE/(UNFAVORABLE)
(IN MILLIONS)
Dakota gasification facility........................ $ (4) $ 4 $ -- $ --
Impact of contract changes with We Energies......... (2) -- -- (2)
Impact of contract remarketing/restructuring........ (3) -- -- (3)
Lower sales of operational natural gas recoveries
relative to operating needs....................... (2) -- -- (2)
Impact of FERC approved contract buyout of Dakota
gasification facility............................. -- 6 -- 6
Earnings from our equity investment in Great Lakes
L.P. primarily due to favorable marketing of
short-term services and lower operating expense... -- -- 3 3
Deferred gain on sale of Deepwater assets
recognized........................................ -- -- 4 4
Other items......................................... (5) (1) -- (6)
---- ---- ---- ----
Total............................................. $(16) $ 9 $ 7 $ --
==== ==== ==== ====
Nine Months Ended 2004 compared to Nine Months Ended 2003
The following factors contributed to our overall EBIT decrease of $32
million for the nine months ended September 30, 2004 as compared to the same
period in 2003:
REVENUE EXPENSE OTHER EBIT
IMPACT IMPACT IMPACT IMPACT
------- ------- ------ ------
FAVORABLE/(UNFAVORABLE)
(IN MILLIONS)
Dakota gasification facility........................ $(32) $ 31 $ -- $ (1)
Impact of contract changes with We Energies......... (14) -- -- (14)
Impact of contract remarketing/restructuring........ (18) -- -- (18)
Lower sales of operational natural gas recoveries
relative to operating needs....................... (17) -- -- (17)
Impact of FERC approved contract buyout of Dakota
gasification facility............................. -- 6 -- 6
Earnings from our equity investment in Great Lakes
L.P. primarily due in favorable marketing of
short-term services and lower operating expense... -- -- 8 8
Deferred gain on sale of Deepwater assets
recognized........................................ -- -- 4 4
Other items......................................... (5) 5 -- --
---- ---- ---- ----
Total............................................. $(86) $ 42 $ 12 $(32)
==== ==== ==== ====
During the third quarter of 2003, our natural gas purchase and sale
contract associated with the Dakota gasification facility was bought out. As a
result of this buyout, we will have lower operating revenues and lower operating
expenses for the remainder of 2004 with an insignificant overall impact on our
operating income and EBIT. In addition, Guardian Pipeline, which is owned in
part by We Energies, is currently providing a portion
11
of its firm transportation requirements and directly competes with us for a
portion of the markets in Wisconsin. During 2003, we renegotiated the terms of
several contracts with We Energies, in particular, our rates, volumes and
receipt and delivery points on our pipeline system. This renegotiation will
continue to impact our operating revenues and EBIT for the remainder of 2004.
In the second quarter of 2004, we received $3 million as a result of a
shipper restructuring its transportation contract on our Southwest Leg. This
deferred revenue, which is reflected in our other current liabilities as of
September 30, 2004, will be recognized in March 2005 when our obligations under
the contract are fulfilled. We have also entered into an agreement with that
same shipper to restructure another of its transportation contracts on our
Southeast Leg as well as a related gathering contract. We expect to complete the
second restructuring in March 2005 upon which we will receive $26 million.
In November 2004, the FERC issued an industry-wide Proposed Accounting
Release that, if enacted as written, will disallow the capitalization of certain
costs that are part of our pipeline integrity program. The accounting release is
proposed to be effective January 2005 following a period of public comment on
the release. We are currently reviewing the release and have not determined what
impact this release will have on our consolidated financial statements.
INTEREST AND DEBT EXPENSE
Interest and debt expense for the three and nine months ended September 30,
2004, was $1 million lower and $4 million higher than the same period in 2003
primarily due to the issuance in March 2003 of $300 million senior unsecured
notes with an annual interest rate of 8.875%.
AFFILIATED INTEREST INCOME, NET
Third Quarter 2004 Compared to Third Quarter 2003
Affiliated interest income, net for the quarter ended September 30, 2004,
was $5 million higher than the same period in 2003 due to higher interest rates
and higher average advances to El Paso under its cash management program. The
average advance balance for the third quarter of 2003 of $378 million increased
to $476 million for the same period in 2004. The average short-term interest
rate for the third quarter increased from 1.9% in 2003 to 2.5% during the same
period in 2004.
Nine Months Ended 2004 Compared to Nine Months Ended 2003
Affiliated interest income, net for the nine months ended September 30,
2004, was $9 million higher than the same period in 2003 due primarily to higher
interest rates and higher average advances to El Paso under its cash management
program. The average advance balance for the nine months of 2004 increased to
$421 million from $323 million in 2003. The average short-term interest rates
for the nine month period increased from 1.6% in 2003 to 2.5% during the same
period in 2004.
INCOME TAXES
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------- ------------------
2004 2003 2004 2003
---- ---- ----- -----
(IN MILLIONS, EXCEPT FOR RATES)
Income taxes..................................... $12 $ 9 $49 $59
Effective tax rate............................... 36% 33% 37% 37%
Our effective tax rates were different than the statutory rate of 35
percent in all periods, primarily due to the effect of state income taxes.
EXPANSION/CERTIFICATED PROJECTS
WestLeg. In June 2003, the FERC granted certificate authorization for our
proposed WestLeg expansion project. The WestLeg project will expand the capacity
of our system by approximately 218 MMcf/d by looping our Madison Lateral line,
located in Wisconsin's Walworth and Rock Counties and in
12
Illinois' McHenry County, and modifying our existing Beloit Lateral line in Rock
County, Wisconsin. The project was placed into service in November 2004 at a
total cost of $48 million.
EastLeg. In July 2004, the FERC granted certificate authorization for our
proposed EastLeg project. The EastLeg project will add 142 MMcf/d of capacity
along our lateral system in Wisconsin. The project consists of replacing 4.7
miles of existing 14-inch pipe with a 30-inch line in Washington County, adding
3.5 miles of 8-inch looping on the Denmark Lateral in Brown County and modifying
our existing Mountain Compressor Station in Oconto County, Wisconsin. The
estimated cost of the project is $19 million and the anticipated in-service date
of the project is November 2005.
NorthLeg. In June 2004, the FERC granted certificate authorization for our
proposed NorthLeg project. The NorthLeg project will add 110 MMcf/d of capacity
and 6,000 horse power of electric powered compression at its Weyauwega
Compressor station in Waupaca County, Wisconsin. The estimated cost of the
project is $14 million and the anticipated in-service date of the project is
November 2005.
Storage Realignment. The Storage Realignment Project involves four natural
gas storage fields in Michigan. We converted a total of 4.1 Bcf of base gas to
working gas at three storage fields and abandoned by sale the Capac Storage
Field to Mid Michigan Gas Storage Company, an affiliated non-jurisdictional
company. We also propose to construct injection/withdrawal wells and install
separation equipment at one field and appurtenant equipment at two other fields
to enhance late season deliverability. The estimated cost of the project is
approximately $10 million. The FERC issued an order in August 2004 granting
certificate authorization for the project. We anticipate completing the
realignment by the third quarter of 2006.
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 as of
September 30, 2004, we had a cash advance receivable from El Paso of $477
classified as a non-current asset 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, therefore we do not
believe we will need to seek repayment of these advances within the next twelve
months.
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 amounts owed to us. In that event, we could be required to write-off
some or all of these advances, which could have a material impact on our
stockholder's equity and we would still be required to repay affiliated company
payables, if demanded. Although increases in our debt to EBITDA (as defined in
our agreements) ratio that cause the ratio to exceed 5 to 1 could prohibit us
from incurring additional debt, the equity reduction that would result if we
wrote off these receivables would not result in an event of default under our
existing debt agreements.
During 2004, El Paso restated its historical financial statements to
reflect the accounting impact of revisions to its natural gas and oil reserve
estimates and changes in the manner in which it accounted for certain derivative
contracts, primarily those related to the hedging of its natural gas production.
El Paso believes the restatement of its historical financial statements would
have constituted events of default under its revolving credit facility, under
which we are eligible to borrow, and various other financings; specifically
under the provisions of those agreements related to representations and
warranties on the accuracy of its historical financial statements and on El
Paso's debt to total capitalization ratio. During 2004, El Paso received a
series of waivers on its revolving credit facility and these other financing
transactions to address these issues. These waivers continue to be in effect. El
Paso also received an extension of time from various lenders until November 30,
2004 to file its second quarter 2004 Form 10-Q which it expects to meet. If El
Paso is unable to file its second quarter 2004 Form 10-Q by that date and is not
able to negotiate an additional extension of the filing deadline, its revolving
credit facility and various other financings could be accelerated. As part of
13
obtaining the waivers, El Paso amended various provisions of the revolving
credit facility, including provisions related to events of default and
limitations on the ability of El Paso, as well as its subsidiaries, to prepay
debt that matures after June 30, 2005. Although we are a party to El Paso's
revolving credit facility, we do not have any borrowings or letters of credit
outstanding under that facility. See Item 1, Financial Statements, Note 3, for a
further discussion of the revolving credit facility and the potential
refinancing of this facility.
Based upon a review of the covenants contained in our long-term debt
agreements, we believe that a default on El Paso's revolving credit facility
would not result in an event of default under our debt agreements.
El Paso's ownership interest in us serves as collateral under El Paso's
revolving credit facility and other of El Paso's financing transactions. If El
Paso's lenders under these facilities were to exercise their rights to this
collateral, our ownership could change. However, this change of control 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.
Our cash flows for the nine months ended September 30 were as follows:
2004 2003
----- -----
(IN MILLIONS)
Cash flows from operating activities........................ $ 179 $ 160
Cash flows from investing activities........................ (162) (423)
Cash flows from financing activities........................ -- 288(1)
- ---------------
(1) Represents net proceeds from the issuance of $300 million of long-term debt
in March 2003.
Cash Flows from Operating Activities
Net cash provided by operating activities was $179 million for the first
nine months of 2004 versus $160 million in the same period of 2003. This
increase was primarily due to higher distributed earnings from an affiliated
investment as well as various changes in assets and liabilities in 2004 offset
by higher interest payments in 2004.
Cash Flows from Investing Activities
Net cash used in investing activities consisted of an increase of $110
million in advances to our affiliate and $81 million in capital expenditures.
These uses of cash were offset by $42 million in proceeds from the sale of
assets to an affiliate as discussed in Note 5.
CAPITAL EXPENDITURES
Our capital expenditures for the nine months ended September 30, 2004 were
approximately $81 million. We expect to spend $65 million for the remainder of
2004 consisting of $21 million to expand the capacity on our system and $44
million for maintenance capital. We expect to fund capital expenditures through
a combination of internally generated funds and/or by recovering amounts
advanced to El Paso under its cash management program.
COMMITMENTS AND CONTINGENCIES
See Item 1, Financial Statements, Note 4, which is incorporated herein by
reference.
14
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.
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
During 2003, we initiated a project to ensure compliance with Section 404
of the Sarbanes-Oxley Act of 2002 (SOX), which will apply to us at December 31,
2005. This project entailed a detailed review and documentation of the processes
that impact the preparation of our financial statements, an assessment of the
risks that could adversely affect the accurate and timely preparation of those
financial statements, and the identification of the controls in place to
mitigate the risks of untimely or inaccurate preparation of those financial
statements. Following the documentation of these processes, we initiated an
internal review or "walk-through" of these financial processes by the financial
management responsible for those processes to evaluate the design effectiveness
of the controls identified to mitigate the risk of material misstatements
occurring in our financial statements. We also initiated a detailed process to
evaluate the operating effectiveness of our controls over financial reporting.
This process involves testing the controls for effectiveness, including a review
and inspection of the documentary evidence supporting the operation of the
controls on which we are placing reliance. While we have identified areas where
our processes and internal controls can be improved, we have not identified any
deficiencies we believe, individually or in the aggregate, would constitute a
material weakness in our internal controls over financial reporting. As we
continue our SOX 404 compliance efforts, we may identify matters which may need
to be reported or which may constitute material weaknesses in our internal
controls over financial reporting.
We did not make any changes to our internal controls over financial
reporting during the quarter ended September 30, 2004, that have had a material
adverse effect or are reasonably likely to have a material adverse effect on our
internal controls over financial reporting. However, we have made changes to
improve our internal controls during the quarter ended September 30, 2004.
We also undertook a review of our overall disclosure controls and
procedures. Disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that information required to be
disclosed by us in the reports that we file or submit under the Exchange Act is
accumulated and communicated to our management, including our principal
executive and financial officers, or persons performing similar functions, as
appropriate to allow timely decisions regarding required disclosure. Based on
our evaluation, we have concluded that our disclosure controls and procedures
were effective at September 30, 2004.
15
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Part I, Item 1, Financial Statements, Note 4, which is incorporated
herein by reference.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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
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
- ------- -----------
*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.
16
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.
ANR PIPELINE COMPANY
Date: November 12, 2004 /s/ JOHN W. SOMERHALDER II
----------------------------------
John W. Somerhalder II
Chairman of the Board and Director
(Principal Executive Officer)
Date: November 12, 2004 /s/ GREG G. GRUBER
----------------------------------
Greg G. Gruber
Senior Vice President,
Chief Financial Officer, Treasurer
and Director
(Principal Financial and
Accounting Officer)
17
ANR PIPELINE 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
- ------- -----------
*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.