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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NO. 1-2921
PANHANDLE EASTERN PIPE LINE COMPANY, LLC
(Exact name of registrant as specified in its charter)
DELAWARE 44-0382470
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5444 WESTHEIMER ROAD 77056-5306
HOUSTON, TEXAS (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (713) 989-7000
Securities Registered Pursuant to Section 12(b) of the Act:
Title of each Class Name of each exchange in which registered
- ------------------- -----------------------------------------
PEPL 08 New York Stock Exchange
PEPL 13 New York Stock Exchange
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No[ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.[ ]
Indicate by check mark whether the registrant is an Accelerated Filer (as
defined in Exchange Act Rule 12D-2). Yes [ ] No [X]
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PART I
ITEM 1. BUSINESS
OUR BUSINESS
INTRODUCTION
Panhandle Eastern Pipe Line Company, LLC (formerly Panhandle Eastern Pipe Line
Company), a Delaware limited liability company, including all of its
subsidiaries (collectively, Panhandle), is an indirect wholly-owned subsidiary
of Southern Union Company (Southern Union Company and together with its
subsidiaries, Southern Union) since Southern Union's June 11, 2003 acquisition
of Panhandle (Panhandle Acquisition) from CMS Gas Transmission Company (CMS Gas
Transmission), a subsidiary of CMS Energy Corporation (together, CMS). (See ITEM
8. Financial Statements and Supplementary Data, Note I -- Corporate Structure).
Panhandle is primarily engaged in the interstate transportation and storage of
natural gas and also provides liquefied natural gas (LNG) terminalling and
regasification services and is subject to the rules and regulations of the
Federal Energy Regulatory Commission (FERC). The Panhandle entities include
Panhandle Eastern Pipe Line Company, LLC (Panhandle Eastern Pipe Line),
Trunkline Gas Company, LLC (Trunkline) a wholly-owned subsidiary of Panhandle
Eastern Pipe Line, Sea Robin Pipeline Company (Sea Robin), a Louisiana
unincorporated joint venture and an indirect wholly-owned subsidiary of
Panhandle Eastern Pipe Line, Trunkline LNG Company, LLC (Trunkline LNG) which is
a wholly-owned subsidiary of Trunkline LNG Holdings, LLC (LNG Holdings), an
indirect wholly-owned subsidiary of Panhandle Eastern Pipe Line and Pan Gas
Storage, LLC (d.b.a. Southwest Gas Storage), a wholly-owned subsidiary of
Panhandle Eastern Pipe Line. Collectively, the pipeline assets include more than
10,000 miles of interstate pipelines that transport natural gas from the Gulf of
Mexico, South Texas and the Panhandle regions of Texas and Oklahoma to major
U.S. markets in the Midwest and Great Lakes region. The pipelines have a
combined peak day delivery capacity of 5.4 billion cubic feet (bcf) per day and
72 bcf of owned underground storage capacity. Trunkline LNG, located on
Louisiana's Gulf Coast, operates one of the largest LNG import terminals in
North America and has 6.3 bcf of above ground LNG storage capacity.
ACQUISITION OF PANHANDLE - On June 11, 2003, Southern Union acquired Panhandle
from CMS for approximately $581,729,000 in cash and 3,000,000 shares of Southern
Union common stock (before adjustment for subsequent 5% stock dividend
distribution) valued at approximately $48,900,000 based on market prices at
closing of the Panhandle Acquisition and in connection therewith incurred
transaction costs of approximately $30,448,000. Southern Union also incurred
additional deferred state income tax liabilities estimated at $18,388,000 as a
result of the transaction. At the time of the acquisition, Panhandle had
approximately $1,157,228,000 of debt principal outstanding that it retained.
Southern Union funded the cash portion of the acquisition with approximately
$437,000,000 in cash proceeds it received for the January 1, 2003 sale of its
Texas operations, approximately $121,250,000 of the net proceeds it received
from concurrent common stock and equity units offerings and with working capital
available to Southern Union. Southern Union structured the Panhandle Acquisition
and the sale of its Texas operations in a manner intended to qualify as a
like-kind exchange of property under Section 1031 of the Internal Revenue Code
of 1986 (Internal Revenue Code), as amended. The Panhandle assets acquired and
liabilities assumed have been recorded at their estimated fair value as of the
acquisition date based on the results of outside appraisals. Panhandle Eastern
Pipe Line and five of its subsidiaries as well as the Southern Union subsidiary
that became Panhandle's direct parent upon the acquisition converted from
Delaware corporations to Delaware limited liability companies in June 2003.
Under the terms of the Panhandle sale agreement, CMS retained Panhandle's
ownership interests in and obligations associated with the Centennial Pipeline,
LLC (Centennial) and Guardian Pipeline, LLC (Guardian) pipeline projects, as
well as certain of Panhandle's net deferred tax assets, all tax liabilities, and
pension and certain other postretirement assets and liabilities. In accordance
with the sale agreement, Panhandle disposed of its interest in Centennial and
Guardian and certain cash collateral related to Guardian was transferred to CMS.
Such dispositions to CMS were recorded at Panhandle's net book value with no
gain or loss recognized. The Note Receivable from CMS Capital was eliminated in
the sale as the purchase by Southern Union from CMS included the offsetting Note
Payable of CMS Capital Corp., a subsidiary of CMS Enterprise Company (CMS
Capital) and thus the note was eliminated in pushdown accounting. For further
information, see Note V -- Related Party Transactions. On March 1, 2003, certain
assets previously held by CMS with a net book value of $15,149,000 were
contributed to Panhandle by CMS and were included in the Southern Union
purchase.
The Panhandle Acquisition was accounted for using the purchase method of
accounting in accordance with accounting principles generally accepted within
the United States of America with the purchase price paid by
2
Southern Union allocated to Panhandle's net assets as of the acquisition date
and as a tax free exchange pursuant to Section 1031 of the Internal Revenue
Code. Accordingly, the post-acquisition financial statements reflect a new basis
of accounting and pre-acquisition period and post-acquisition period financial
results (separated by a heavy black line) are presented but are not comparable.
A majority of Panhandle's total operating revenue comes from long-term service
agreements with local distribution company customers and their affiliates.
Panhandle also provides firm transportation services under contract to gas
marketers, producers, other pipelines, electric power generators, and a variety
of end-users. In addition, Panhandle's pipelines offer both firm and
interruptible transportation to customers on a short-term or seasonal basis.
Demand for gas transmission on Panhandle's pipeline systems is seasonal, with
the highest throughput and a higher portion of annual total operating revenues
and net earnings occurring in the traditional winter heating season in the first
and fourth calendar quarters. For the years 1999 to 2003, Panhandle's combined
throughput was 1,139 trillion British thermal units (TBtu), 1,374 TBtu, 1,335
TBtu, 1,259 TBtu and 1,380 TBtu, respectively. Beginning in March 2000, the
combined throughput includes Sea Robin's throughput.
In 2003, total combined twelve months operating revenue (combined pre- and
post-acquisition) was $503,361,000. Of Panhandle's total combined operating
revenue, approximately 77 percent was generated from transportation services,
approximately 12 percent from LNG terminalling services, approximately 8 percent
from storage services and approximately 3 percent from other services. Sales to
Proliance Energy, LLC, a nonaffiliated local distribution company and gas
marketer, accounted for approximately 16 percent of total operating revenue
during 2003; approximately 16 percent during 2002; and approximately 15 percent
during 2001. Sales to BG LNG Services, a nonaffiliated gas marketer, accounted
for approximately 15 percent of total operating revenue during 2003 and
approximately 13 percent during 2002. Sales to subsidiaries of CMS, primarily
Consumers Energy Company, accounted for approximately 12 percent of total
operating revenue during 2003; approximately 12 percent during 2002; and
approximately 15 percent during 2001. No other customer accounted for 10 percent
or more of total operating revenue during 2003, 2002 or 2001. Aggregate sales to
Panhandle's top ten customers accounted for approximately 69 percent, 67 percent
and 60 percent of total operating revenue during 2003, 2002 and 2001,
respectively.
For additional information, see ITEM 7. Management's Discussion and Analysis of
Results of Operations and Financial Condition -- Results of Operations.
REGULATION
Panhandle is subject to regulation by various federal, state, local and foreign
governmental agencies, including those specifically described below. See ITEM 1.
Business - Environmental.
FERC has comprehensive jurisdiction over Panhandle Eastern Pipe Line, Southwest
Gas Storage, Trunkline, Trunkline LNG and Sea Robin as natural gas companies
within the meaning of the Natural Gas Act of 1938. FERC jurisdiction relates,
among other things, to the acquisition, operation and disposal of assets and
facilities and to the service provided and rates charged.
FERC has authority to regulate rates and charges for transportation or storage
of natural gas in interstate commerce. FERC also has authority over the
construction and operation of pipeline and related facilities utilized in the
transportation and sale of natural gas in interstate commerce, including the
extension, enlargement or abandonment of service using such facilities.
Panhandle Eastern Pipe Line, Trunkline, Sea Robin, Trunkline LNG and Southwest
Gas Storage hold certificates of public convenience and necessity issued by the
FERC, authorizing them to construct and operate the pipelines, facilities and
properties now in operation for which such certificates are required, and to
transport and store natural gas in interstate commerce.
The Secretary of Energy regulates the importation and exportation of natural gas
and has delegated various aspects of this jurisdiction to FERC and the
Department of Energy's Office of Fossil Fuels.
Panhandle is also subject to the Natural Gas Pipeline Safety Act of 1968 and the
Pipeline Safety Improvement Act of 2002, which regulate the safety of gas
pipelines. Panhandle is also subject to the Hazardous Liquid Pipeline Safety Act
of 1979, which regulates oil and petroleum pipelines.
For a discussion of the effect of certain FERC orders on Panhandle, see ITEM 7.
Panhandle's Management's Discussion and Analysis -- Other Matters and Note III
- -- Regulatory Matters.
3
PROPERTY
Panhandle's interstate transmission and storage operations have more than 10,000
miles of pipeline in the United States. With approximately 6,500 miles of
pipeline, Panhandle Eastern Pipe Line's natural gas transmission system consists
of four large diameter pipelines extending approximately 1,300 miles from
producing areas in the Anadarko Basin of Texas, Oklahoma and Kansas through the
states of Missouri, Illinois, Indiana, Ohio and into Michigan. Trunkline's
transmission system consists of two large diameter pipelines of approximately
3,500 miles of pipeline which extend approximately 1,400 miles from the Gulf
Coast areas of Texas and Louisiana through the states of Arkansas, Mississippi,
Tennessee, Kentucky, Illinois and Indiana to a point on the Indiana-Michigan
border. Sea Robin's transmission system consists of two offshore Louisiana
natural gas supply systems and is comprised of approximately 400 miles of
pipeline extending approximately 81 miles into the Gulf of Mexico.
In connection with its gas transmission systems, Panhandle owns and operates 47
compressor stations and has five gas storage fields located in Illinois, Kansas,
Louisiana, Michigan and Oklahoma with an aggregate storage capacity of 72 bcf.
Panhandle also has contracts with third parties for approximately 18 bcf of
storage for a total of approximately 90 bcf of total storage capacity.
Through its subsidiary, Trunkline LNG, Panhandle owns a liquefied natural gas
(LNG) terminal in Lake Charles, Louisiana. The LNG terminal has a sustainable
send out capacity of approximately .63 bcf per day and is one of the largest
operating LNG terminals in North America. Trunkline LNG is currently in the
process of an approximately $137 million expansion (Phase I) of the LNG
terminal, which would increase sustainable send out capacity to 1.2 bcf per day
by the end of 2005. In February 2004, Trunkline LNG filed a further incremental
LNG expansion project (Phase II) with the FERC and is awaiting commission
approval. Phase II is estimated to cost approximately $77 million and would
increase the LNG terminal sustainable send out capacity to 1.8 bcf per day by
mid-2006. In February 2004, Trunkline filed an application with the FERC to
request approval of a 30-inch diameter, 23-mile natural gas pipeline loop from
the LNG terminal. The estimated cost of this pipeline expansion is approximately
$40 million. The pipeline creates additional transport capacity in association
with the Trunkline LNG expansion and also includes new and expanded delivery
points with major interstate pipelines.
ENVIRONMENTAL
Panhandle is subject to federal, state and local laws and regulations relating
to the protection of the environment. These evolving laws and regulations may
require expenditures over a long period of time to control environmental
impacts. Panhandle has established procedures for the on-going evaluation of its
operations to identify potential environmental exposures and assure compliance
with regulatory policies and procedures.
Panhandle's gas transmission operations are subject to federal, state and local
regulations regarding water quality, hazardous and solid waste disposal and
other environmental matters. Panhandle has previously identified environmental
contamination at certain sites on its gas transmission systems and has
undertaken cleanup programs at these sites. The contamination resulted from the
past use of lubricants containing polychlorinated bi-phenyls (PCBs) in
compressed air systems; the past use of paints containing PCBs; and the prior
use of wastewater collection facilities and other on-site disposal areas.
Panhandle has developed and is implementing a program to remediate such
contamination in accordance with federal, state and local regulations. Some
remediation is being performed by former Panhandle affiliates in accordance with
indemnity agreements that also indemnify against certain future environmental
litigation and claims. Panhandle is also subject to various federal, state and
local laws and regulations relating to air quality control. These regulations
include rules relating to regional ozone control and hazardous air pollutants.
The regional ozone control rules are known as State Implementation Plans (SIP)
and are designed to control the release of nitrogen oxide (NOx) compounds. The
rules related to hazardous air pollutants are known as Maximum Achievable
Control Technology (MACT) rules and are the result of the 1990 Clean Air Act
Amendments that regulate the emission of hazardous air pollutants from internal
combustion engines and turbines.
See ITEM 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition - Cautionary Statement Regarding Forward-Looking Information
and Note XII -- Commitments and Contingencies in the Notes to the Consolidated
Financial Statements.
4
COMPETITION
Panhandle's interstate pipelines compete with other interstate and intrastate
pipeline companies in the transportation and storage of natural gas. The
principal elements of competition among pipelines are rates, terms of service
and flexibility and reliability of service. Panhandle's direct competitors
include Alliance Pipeline LP, ANR Pipeline Company, Natural Gas Pipeline Company
of America, Northern Border Pipeline Company, Texas Gas Transmission
Corporation, Northern Natural Gas Company and Vector Pipeline.
Natural gas competes with other forms of energy available to Panhandle's
customers and end-users, including electricity, coal and fuel oils. The primary
competitive factor is price. Changes in the availability or price of natural gas
and other forms of energy, the level of business activity, conservation,
legislation and governmental regulations, the capability to convert to
alternative fuels, and other factors, including weather and natural gas storage
levels, affect the demand for natural gas in the areas served by Panhandle.
INSURANCE
Panhandle maintains insurance coverage provided under its policies or policies
of Southern Union similar to other comparable companies in the same lines of
business. The insurance policies are subject to terms, conditions, limitations
and exclusions that do not fully compensate Panhandle for all losses.
Furthermore, as Panhandle renews its policies, it is possible that full
insurance coverage may not be obtainable on commercially reasonable terms due to
the recent more restrictive insurance markets.
EMPLOYEES
At December 31, 2003, Panhandle had 1,049 full-time equivalent employees. Of
these employees, 230 were represented by the Paper, Allied-Industrial Chemical
and Energy Workers International Union, AFL-CIO, CLC. In June 2003, Panhandle
entered into a new agreement with this union that expires in May 2006. The new
agreement caps wage increases at three percent annually.
In conjunction with its acquisition by Southern Union, Panhandle initiated a
workforce reduction designed to reduce the workforce by approximately five
percent. The workforce reduction initiative was an involuntary plan with a
voluntary component, and was fully implemented by the end of the third quarter
of 2003. Total workforce reduction initiative costs of approximately $9,000,000
are included in the $30,448,000 of transaction costs incurred (see Item 1,
Business - Acquisition of Panhandle).
AVAILABLE INFORMATION
Panhandle files annual, quarterly and special reports and other information with
the Securities and Exchange Commission (SEC). Any document Panhandle files with
the SEC may be read or copied at the SEC's public reference room at 450 Fifth
Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for
information on the public reference room. Panhandle's SEC filings are also
available at the SEC's website at http://www.sec.gov.
ITEM 2. PROPERTIES
A description of Panhandle properties is contained in ITEM 1. Business --
Property.
ITEM 3. LEGAL PROCEEDINGS
Panhandle and certain of its affiliates are parties to routine lawsuits and
administrative proceedings incidental to their businesses involving, for
example, claims for personal injury and property damage, contractual matters,
various tax matters, and rates and licensing. Reference is made to ITEM 1.
Business -- Regulation, as well as to ITEM 7. Management's Discussion and
Analysis of Results of Operations and Financial Condition and ITEM 8. Financial
Statements and Supplementary Data -- Notes to Consolidated Financial Statements
included herein for additional information regarding various pending
administrative and judicial proceedings involving regulatory, environmental and
other legal matters.
ENVIRONMENTAL MATTERS - Panhandle and its affiliates are subject to various
federal, state and local laws and regulations relating to the environment.
Several of these companies have been named parties to various actions involving
environmental issues. Based on our present knowledge and subject to future legal
and factual
5
developments, Panhandle's management believes that it is unlikely that these
actions, individually or in the aggregate, will have a material adverse effect
on its financial condition. See ITEM 7. Management's Discussion and Analysis of
Results of Operations and Financial Condition and ITEM 8. Financial Statements
and Supplementary Data -- Notes to Consolidated Financial Statements.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
N/A
PART II
ITEM 5. MARKET FOR PANHANDLE'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Panhandle's membership interests are privately held by its indirect parent,
Southern Union. In February and May 2002, prior to its conversion to a limited
liability company, Panhandle paid $16,624,000 and $11,500,000 in cash dividends,
respectively, on its common stock to CMS, its former parent. Panhandle has paid
no dividends since May 2002.
ITEM 6. SELECTED FINANCIAL DATA
Year Ended
June 12 - January 1 - December 31, March 29- January 1 -
December 31, June 11, ---------------------------------- December 31, March 28,
Selected Financial Data 2003 (1) 2003 (1) 2002 2001 2000 1999 (2) 1999 (2)
- ----------------------- --------- --------- --------- --------- --------- --------- ---------
(dollars in thousands)
Selected consolidated statements
of operations data:
Operating revenues $ 269,091 $ 234,270 $ 483,673 $ 514,105 $ 482,734 $ 342,679 $ 128,543
Operating income 103,348 107,882 209,401 168,194 184,084 125,256 66,994
Net income (loss) 51,452 50,014 (299,611) 53,957 64,155 41,497 32,565
Selected consolidated balance
sheet data as of end of period:
Total assets 2,281,543 2,232,460 2,906,615 2,801,437 2,560,218
Owner's equity 646,818 752,584 1,124,326 1,122,515 1,127,799
Short-term debt 209,671 11,641 8,790 - -
Long-term debt, excluding
current portion 995,773 1,150,285 1,287,714 1,192,835 1,093,761
(1) The heavy black line separating January 1 through June 11, 2003 from June 12
through December 31, 2003 relates to the Southern Union acquisition of Panhandle
from CMS, effective June 11, 2003. During June 2003, Panhandle converted from a
Delaware corporation to a Delaware limited liability company in a restructuring
in connection with the acquisition.
(2) The heavy black line separating January 1 through March 28, 1999 from March
29 through December 31, 1999 relates to the acquisition of Panhandle by CMS from
Duke Energy, effective March 29, 1999.
6
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
Management's Discussion and Analysis of Results of Operations and Financial
Condition is provided as a supplement to the accompanying consolidated financial
statements and footnotes to help provide an understanding of Panhandle's
financial condition, changes in financial condition and results of operations.
The following section includes an overview of Panhandle's business as well as
recent developments that Panhandle believes are important in understanding its
results of operations, and to anticipate future trends in those operations.
Subsequent sections include an analysis of Panhandle's results of operations on
a consolidated basis and information relating to Panhandle's liquidity and
capital resources, quantitative and qualitative disclosures about market risk,
an outlook perspective for Panhandle, and other matters.
OVERVIEW
Panhandle is primarily engaged in the interstate transportation and storage of
natural gas and also provides LNG terminalling and regasification services. The
Panhandle entities include Panhandle Eastern Pipe Line, Trunkline, Sea Robin,
Trunkline LNG and Southwest Gas Storage. Collectively, the pipeline assets
include more than 10,000 miles of interstate pipelines that transport natural
gas from the Gulf of Mexico, South Texas and the Panhandle regions of Texas and
Oklahoma to major U.S. markets in the Midwest and Great Lakes region. The
pipelines have a combined peak day delivery capacity of 5.4 bcf per day, 72 bcf
of owned underground storage capacity and 6.3 bcf of above ground LNG storage
capacity. Trunkline LNG, located on Louisiana's Gulf Coast, operates one of the
largest LNG import terminals in North America.
On June 11, 2003, Southern Union acquired Panhandle from CMS for approximately
$581,729,000 in cash and 3,000,000 shares of Southern Union common stock (before
adjustment for a subsequent 5% stock dividend) valued at approximately
$48,900,000 based on market prices at closing and in connection therewith
incurred transaction costs of approximately $30,448,000. Southern Union also
incurred additional deferred state income tax liabilities estimated at
$18,388,000 as a result of the transaction. At the time of the acquisition,
Panhandle had $1,157,228,000 principal amount of debt outstanding that it
retained. Southern Union funded the cash portion of the acquisition with
approximately $437,000,000 in cash proceeds it received for the January 1, 2003
sale of its Texas operations, approximately $121,250,000 of the net proceeds it
received from concurrent common stock and equity units offerings and with
working capital available to Southern Union. Southern Union structured the
Panhandle Acquisition and the sale of its Texas operations to qualify as a
like-kind exchange of property under Section 1031 of the Internal Revenue Code
of 1986, as amended.
Under the terms of the Panhandle sale agreement, CMS retained Panhandle's
ownership interests in and obligations associated with the Centennial and
Guardian pipeline projects, as well as certain of Panhandle's net deferred tax
assets, all tax liabilities, and pension and certain other postretirement assets
and liabilities. In accordance with the sale agreement, Panhandle disposed of
its interest in Centennial and Guardian and certain cash collateral related to
Guardian was transferred to CMS. The Note Receivable from CMS Capital was
included in the sale to Southern Union but was eliminated under pushdown
accounting. For further information, see Note V -- Related Party Transactions.
On March 1, 2003, certain assets previously held by CMS with a net book value of
$15,149,000 were contributed to Panhandle by CMS and were included in the
Southern Union purchase.
The Acquisition was accounted for in accordance with accounting principles
generally accepted within the United States by allocating the purchase price and
acquisition costs incurred by Southern Union to Panhandle's net assets as of the
acquisition date. The Panhandle assets acquired and liabilities assumed have
been recorded at their estimated fair value as of the acquisition date based on
the results of outside appraisals. Accordingly, the post-acquisition financial
statements reflect a new basis of accounting and pre-acquisition period and
post-acquisition period financial results (separated by a heavy black line) are
presented but are not comparable. However, since results for the matching prior
year stub periods are not available, the results of operations below are being
presented on a combined pre-acquisition and post-acquisition basis. Panhandle
views this presentation as meaningful in discussing its operating results due to
the continuity of its continuing operations. The most significant impacts of the
new basis of accounting going forward are expected to be higher depreciation
expense due to the step-up of depreciable assets, assignment of purchase price
to certain amortizable intangible assets, and lower interest costs (though not
cash payments) for the remaining life of debt due to its revaluation and related
debt premium amortization.
7
RESULTS OF OPERATIONS
Following is a comparison of net income (loss) for the twelve-month period ended
December 31, 2003 (combined pre- and post-acquisition) and the twelve-month
period ended December 31, 2002.
TWELVE MONTHS ENDED
DECEMBER 31, 2003 VS. 2002 IN THOUSANDS
- -------------------------- ------------
Twelve months presentation
January 1 - June 11, 2003 (Pre-acquisition) $ 50,014
June 12 - December 31, 2003 (Post-acquisition) 51,452
---------
Combined twelve months ended December 31, 2003 101,466
Twelve months ended December 31, 2002 (Pre-acquisition) (299,611)
---------
Change $ 401,077
=========
POST- PRE- COMBINED PRE-ACQUISITION
ACQUISITION ACQUISITION TWELVE MONTHS TWELVE MONTHS
JUNE 12 - JANUARY 1 - ENDED ENDED TWELVE
DECEMBER 31, JUNE 11, DECEMBER 31, DECEMBER 31, MONTHS
REASONS FOR THE CHANGE: 2003 2003 2003 2002 CHANGE
- ----------------------- ------------ ----------- ------------- --------------- ------
IN THOUSANDS
Reservation revenue $ 193,385 $160,030 $ 353,415 $ 349,153 $ 4,262
LNG terminalling revenue 33,389 26,750 60,139 57,879 2,260
Commodity revenue 37,207 36,378 73,585 64,162 9,423
Equity earnings and other revenue 5,110 11,112 16,222 12,479 3,743
Operation, maintenance and general (117,930) (90,800) (208,730) (201,181) (7,549)
Depreciation and amortization (33,129) (23,110) (56,239) (51,184) (5,055)
General taxes (14,684) (12,478) (27,162) (21,907) (5,255)
Other income (expense), net 6,962 6,077 13,039 (13,436) 26,475
Interest expenses, net (25,537) (35,416) (60,953) (76,529) 15,576
Minority interest - - - (3,527) 3,527
Income taxes (33,321) (30,532) (63,853) (46,401) (17,452)
Cumulative effect of change in
accounting principles, net of tax - 2,003 2,003 (369,119) 371,122
--------- -------- --------- --------- --------
Total $ 51,452 $ 50,014 $ 101,466 $(299,611) $401,077
========= ======== ========= ========= ========
For the combined twelve months ended December 31, 2003, Panhandle's recorded net
income was $101,466,000, an increase of $401,077,000 from the corresponding
period in 2002 due primarily to a goodwill impairment charge of $601,108,000
($369,119,000 after-tax) which was recorded during 2002 in compliance with SFAS
No. 142. SFAS No. 142 requires that goodwill is not amortized over an estimated
useful life, but rather subject to a fair-value based impairment assessment.
RESERVATION REVENUE. For the combined twelve months ended December 31, 2003,
reservation revenue increased $4,262,000 versus the same time period during
2002, due to higher average reservation rates realized resulting from increased
transportation demand caused by low customer storage levels at the end of first
quarter 2003.
LNG TERMINALLING REVENUE. For the combined twelve months ended December 31,
2003, LNG terminalling revenue increased $2,260,000 versus the same time period
during 2002, due to the higher LNG volumes on the
8
BG LNG Services contract relating to 102 cargoes delivered during 2003 compared
to 47 cargoes delivered for the same time period during 2002. As the majority of
the LNG revenue comes in the form of fixed capacity reservation charges,
incremental ships do not increase or decrease LNG terminalling revenues
proportionately.
COMMODITY REVENUE. For the combined twelve months ended December 31, 2003,
commodity revenue increased $9,423,000 versus the same time period during 2002,
primarily due to an increase in firm and interruptible commodity volumes
transported during 2003. Volumes increased 10 percent in the twelve months of
2003 versus 2002 due to a colder winter in the midwest market area during the
first quarter of 2003 and higher volumes transported to fill storage in the
second and third quarters of 2003. Commodity revenues are dependent upon various
commodity factors, including weather, customer storage levels, and natural gas
demand.
EQUITY EARNINGS AND OTHER REVENUE. Equity earnings and other revenue for the
combined twelve months ended December 31, 2003 increased $3,743,000 versus the
same time period during 2002. The sale of Panhandle's one-third equity interest
in Centennial in February 2003, which had been written down to the estimated
selling price in the fourth quarter of 2002, resulted in no income recognition
for the Centennial equity investment during the first quarter of 2003, while
start-up related losses of $7,924,000 occurred during 2002. In addition, gas
imbalance cash-out gains in the first quarter of 2003, recouping prior losses,
were comparable to a gain of $3,841,000 for the settlement of Order 637 matters
related to imbalance penalties and capacity release during the first quarter of
2002 (see Note III -- Regulatory Matters).
OPERATION, MAINTENANCE AND GENERAL. Operation, maintenance and general expenses
increased $7,549,000 for the combined twelve months ended December 31, 2003,
versus the same time period during 2002, primarily due to higher employee
benefit and insurance costs, under recovered Panhandle fuel costs of
approximately $3,504,000 and higher LNG related electric power which is
associated with LNG throughput levels and will vary with such going forward and
fuel costs of approximately $3,569,000 offset partially by lower corporate
charges, which were approximately $15,497,000 for the combined twelve months
ended December 31, 2003 versus $29,346,000 for 2002, as well as lower
transportation expense. Certain corporate charges are expected to be higher in
2004 due to receiving only a partial year of such charges in 2003.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
$5,055,000 for the combined twelve months ended December 31, 2003 versus 2002,
primarily due to the step-up of depreciable assets and assignment of purchase
price to certain shorter-lived amortizable intangible assets related to the
Panhandle Acquisition. This step-up impact is expected to continue to result in
higher depreciation in 2004 versus pre-acquisition periods.
GENERAL TAXES. General taxes increased by $5,255,000 for the combined twelve
months ended December 31, 2003 versus 2002, primarily due to higher ad valorem
taxes relating to non-recurring 2002 prior period adjustments and higher
compressor fuel tax in 2003.
OTHER INCOME (EXPENSE), NET. Other income (expense), net, for the combined
twelve months ended December 31, 2003 increased $26,475,000 versus 2002,
primarily due to a $6,123,000 gain on debt extinguishment in 2003 and a
$26,281,000 pre-tax write-down of the Centennial investment in December 2002.
These increases were partially offset by lower intercompany interest income, net
during 2003, which was $6,432,000 for the combined twelve months ended December
31, 2003 versus $8,743,000 for 2002 and a $920,000 gain on debt extinguishment
in 2002.
INTEREST EXPENSES, NET. Interest expenses, net, for the combined twelve months
ended December 31, 2003, versus the same time period during 2002, were reduced
by $15,576,000 primarily due to elimination of interest on $128,685,000 of
long-term debt principal retired in April 2002 and May 2002, amortization of
debt premiums of $8,473,000 for the twelve months ended December 31, 2003 which
was recorded in purchase accounting related to the Panhandle acquisition by
Southern Union and reduced interest charges associated with Panhandle's
conditional tender offers. For further discussion of Panhandle's long-term debt
and guarantees, see Note XII -- Commitments and Contingencies - Other
Commitments and Contingencies.
MINORITY INTEREST. Minority interest for 2003 decreased $3,527,000 due to
Panhandle's purchase of Dekatherm Investor Trust's interest in LNG Holdings, an
indirectly wholly-owned subsidiary of Panhandle Holdings, LLC, during November
2002 for approximately $40,800,000. As a result, Panhandle owns 100 percent of
LNG Holdings and therefore no minority interest exists subsequent to that
purchase.
INCOME TAXES. Income taxes during the combined twelve months ended December 31,
2003, versus the same time period during 2002, increased $17,452,000 due to
increases in pretax income, which reflects an effective tax rate of
approximately 39.3, 38.9 and 40.0 percent for the 2003 post-acquisition period
ended December 31, 2003, and the pre-acquisition periods ended June 11, 2003 and
December 31, 2002, respectively.
9
Following is a comparison of the twelve-month period ended December 31, 2002 and
the twelve-month period ended December 31, 2001.
YEARS ENDED DECEMBER 31 2002 2001 CHANGE
- ----------------------- ---------- -------- ----------
IN THOUSANDS
Net Income (Loss) $ (299,611) $ 53,957 $ (353,568)
========== ======== ==========
IN THOUSANDS
REASONS FOR THE CHANGE: 2002 VS. 2001
- ----------------------- -------------
Reservation revenue $ (2,952)
LNG terminalling revenue (16,865)
Commodity revenue (7,083)
Equity earnings and other revenue (3,532)
Operation, maintenance and general 48,460
Depreciation and amortization 17,910
General taxes 5,269
Other income (expense), net (19,149)
Interest expenses, net 6,328
Minority interest (3,549)
Income taxes (9,286)
Cumulative effect of change in
accounting principle, net of tax (369,119)
----------
Total Change $ (353,568)
==========
For 2002, Panhandle incurred a net loss of $299,611,000, a decrease of
$353,568,000 from the corresponding period in 2001 due primarily to a goodwill
impairment charge during 2002 of $601,108,000 ($369,119,000 after-tax) which was
recorded in compliance with SFAS No. 142, as previously discussed.
RESERVATION REVENUE. For 2002, reservation revenue decreased $2,952,000 compared
to 2001, due to the impact of Trunkline's rate settlement effective May 2001 and
less capacity sold, primarily due to the conversion of Trunkline's 26-inch
pipeline to liquids service after the first quarter of 2001.
LNG TERMINALLING REVENUE. For 2002, LNG terminalling revenue decreased
$16,865,000 compared to 2001. In May 2001, Trunkline LNG signed an agreement
with BG LNG Services that provided for a 22-year contract for the existing
uncommitted long-term capacity at the LNG terminal. The 22-year firm contract
resulted in reduced revenues from 2001 levels but more stability going forward
is expected. That contract, in conjunction with new rates which became effective
in January 2002 (see Note III -- Regulatory Matters), and higher natural gas
prices in the first nine months of 2001, resulted in reduced revenues for
Trunkline LNG from 2001 levels.
COMMODITY REVENUE. For 2002, commodity revenue decreased $7,083,000 compared to
2001, primarily due to decreased natural gas transportation volumes. Volumes
decreased 6 percent in the twelve months of 2002 versus 2001 due to higher
storage levels entering the summer months of 2002, which reduced transportation
volumes to fill storage in the second and third quarters of 2002, and an
unseasonably mild winter in the Midwest market area in early 2002.
EQUITY EARNINGS AND OTHER REVENUE. Equity earnings and other revenue for 2002
decreased $3,532,000 compared to 2001. The decreases were primarily due to
start-up related losses of $7,924,000 related to the Centennial Pipeline equity
investment. Other revenue for the twelve months ended December 31, 2002 includes
a non-recurring gain of $3,841,000 for the settlement of Order 637 matters
related to capacity release and imbalance penalties (see Note III -- Regulatory
Matters), equaling a non-recurring gain related to the settlement of
10
a gas purchase contract in the first quarter of 2001.
OPERATION, MAINTENANCE AND GENERAL. Operation, maintenance and general expenses
were reduced by $48,460,000 for 2002, compared to 2001. Panhandle operating
expenses were lower due to $23,579,000 of lower of cost or market adjustments to
Panhandle's system balancing gas recorded in 2001. Expenses also decreased
approximately $25,000,000 compared to the same time period during 2001 due to
reduced corporate charges, employee benefit costs and property and liability
insurance costs and related losses. Employee benefit costs were lower due to
reduced incentive plan payouts for 2001 approved in 2002, as well as no
incentive plan payouts being approved by the CMS Board of Directors for 2002.
DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased
$17,910,000 for 2002 compared with 2001, primarily due to adoption of SFAS No.
142. SFAS No. 142 provides that goodwill is no longer subject to amortization.
Instead, goodwill amounts are subject to a fair-value based impairment
assessment. Upon adoption of SFAS 142, Panhandle completed the goodwill
impairment testing which resulted in a $601,108,000 pretax write-down
($369,119,000 after-tax) under the new standard, restated to the first quarter
of 2002, and has reflected such change as a cumulative effect of change in
accounting for goodwill. For further information, see Note III -- Summary of
Significant Accounting Policies and Other Matters and Note IV -- Goodwill.
GENERAL TAXES. General taxes decreased by $5,269,000 for 2002 compared with
2001, primarily due to lower ad valorem taxes relating to non-recurring 2001
prior period adjustments and lower property taxes in 2002.
OTHER INCOME (EXPENSE), NET. Other income (expense), net, for 2002 decreased
$19,149,000 compared with 2001, primarily due to a $26,281,000 pre-tax
write-down of the Centennial investment in December 2002. Interest income from
CMS Capital was $8,843,000 and $9,190,000 during 2002 and 2001, respectively.
INTEREST EXPENSES, NET. Interest expenses, net, for 2002 were reduced by
$6,328,000 from 2001 primarily due to $318,430,000 in reductions to long-term
debt principal in December 2001, April 2002 and May 2002, partially offset by
$290,000,000 of LNG Holdings debt issued in December 2001. In March 2002,
Panhandle executed a fixed-to-floating interest rate swap with notional amounts
totaling $175,000,000 related to existing notes to take advantage of lower
short-term interest rates, which reduced interest expense on the Consolidated
Income Statement compared to the prior year. In June 2002, the swaps were
unwound to monetize an increase in the market value of the fixed to floating
rate position. The resulting cash gain of approximately $2,562,000 was
originally scheduled to be amortized to income through the second and third
quarters of 2004, which are the maturity dates of the original debt instruments
that were hedged. However, these deferred gains were eliminated in purchase
accounting upon the Panhandle Acquisition date. Interest cost decreases due to
reductions in debt principal and amortization of the gain on the swaps were
partially offset by credit fees and other interest charges of $3,263,000 during
2002 related to Centennial, Guardian and LNG Holdings. For further discussion of
Panhandle's long-term debt and guarantees, see Note XII -- Commitment and
Contingencies - Other Commitments and Contingencies.
MINORITY INTEREST. Minority interest in 2002 increased $3,549,000 due to an
interest in LNG Holdings being held by a third party from December 2001 until
November 2002.
INCOME TAXES. Income taxes for 2002, versus 2001, increased $9,286,000 due to
corresponding changes in pretax income.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. Based on Panhandle's current level of operations,
management believes that cash flow from operations, available existing cash, and
other sources, including liquid working capital and new borrowings, will be
adequate to meet other liquidity needs for a few years, although no assurances
can be given as to the sufficiency of cash flows or the ability to refinance
existing obligations.
Cash flows from operating activities for the combined twelve months ended
December 2003 increased by approximately $49 million versus the same time period
in 2002 primarily due to higher revenues and deferred taxes, partially offset by
higher expenses.
INVESTING ACTIVITIES. Historically, Panhandle's capital requirements have
generally been satisfied through operating cash flow, except that Panhandle may
utilize access to capital markets for extraordinary capital expenditures.
Panhandle estimates expenditures associated with Phase I and Phase II LNG
terminal expansion
11
and the Trunkline 30-inch diameter, 23-mile natural gas pipeline loop from the
LNG terminal to be $93 million in 2004, $106 million in 2005 and $13 million in
2006. These estimates were developed for budget planning purposes and are
subject to revision.
Cash flows used in investing activity for the combined twelve months ended
December 2003 decreased by approximately $70 million versus the same time period
in 2002 primarily due to investments in Guardian made during 2002 and proceeds
from the sale of the Centennial investment in February, 2002.
FINANCING ACTIVITIES. In June and July of 2002, the major debt ratings services
lowered their ratings on Panhandle's senior unsecured debt from BBB to BB based
on concerns surrounding the liquidity and debt levels of CMS, Panhandle's former
indirect parent. Following Panhandle's acquisition by Southern Union, Fitch
Ratings, Inc. and Standard & Poor's restored Panhandle's ratings to BBB and
Moody's raised its rating on Panhandle to Baa3. Panhandle's note provisions are
not directly impacted by debt rating changes, but are subject to other
requirements such as the maintenance of a fixed charge coverage ratio and a
leverage ratio which restrict certain payments if not maintained, and
limitations on liens. At December 31, 2003, Panhandle was subject to a
$194,493,000 limitation on additional restricted payments, including dividends
and loans to affiliates and a limitation of $206,700,000 of additional secured
indebtedness based on a limitations on liens covenant. At December 31, 2003,
Panhandle was in compliance with all covenants.
At December 31, 2003, Panhandle had scheduled debt principal payments of
$209,671,000, $12,548,000, $13,970,000, $231,916,000, $300,000,000 and
$417,428,000 for the years 2004 through 2008 and thereafter, respectively.
Panhandle plans to refinance the $146,080,000 principal amount of its debt that
matures March 15, 2004 and $52,455,000 principal amount of its debt that matures
August 15, 2004. Panhandle is currently in the process of securing financing of
$200 million to cover these obligations prior to the March 15, 2004 maturity
date of the $146 million of notes. Panhandle's parent, Southern Union, is
restricted from making additional equity investments in, or loans to Panhandle,
and from providing guarantees of Panhandle obligations, pursuant to an agreement
requiring approval by a state regulatory commission where a division of Southern
Union currently conducts business. In the event the expected financing
transaction is not successful, Panhandle intends to draw upon existing sources
of liquidity, including Notes and Tax sharing receivables from affiliates and
other sources, or secure a bridge loan to refinance or extinguish the
indebtedness due in 2004. Panhandle's management believes it will be able to
refinance or retire this indebtedness based on the available sources of credit
and existing liquidity. Panhandle's ability to arrange financing, including
refinancing, will be subject to future economic conditions and financial,
business and other factors beyond Panhandle's control.
In July 2003, Panhandle initiated conditional tender offers for certain
outstanding indebtedness (Panhandle Tender Offer) for any and all of the
$747,370,000 outstanding principal amount of five of its series of senior notes
outstanding at that point in time and also conditionally called certain
redeemable debentures (Panhandle Calls) of all of the outstanding $134,500,000
principal amount of its two series of debentures that were outstanding.
Panhandle repurchased $378,257,000 of the principal amount of its outstanding
notes through the Panhandle Tender Offer for total consideration of $396,445,000
plus accrued interest through the purchase date. Panhandle also redeemed its
$134,500,000 of debentures for total consideration of $139,411,000 including the
specified call premium, plus accrued interest through the redemption dates. As a
result of these transactions, Panhandle recorded a pre-tax gain on the
extinguishment of debt of approximately $6,123,000 ($3,674,000, net of tax) in
the third quarter of 2003 due to increases in interest rates subsequent to the
acquisition date, which has been classified as Other Expense (Income), Net,
pursuant to the requirements of SFAS No. 145. In August 2003, Panhandle issued
$550,000,000 of new five and ten year senior notes principally to refinance the
repurchased notes and redeemed debentures.
On September 10, 2003, Panhandle provided a guarantee to CB&I Constructors, Inc.
for the full performance by Trunkline LNG, its subsidiary, of the engineering,
procurement and construction contract (the "Contract") between Trunkline LNG and
CB&I Constructors, Inc. (See Note XII -- Commitments and Contingencies).
Cash flows used in financing activities for the combined twelve months ended
December 2003 increased by approximately $260 million versus the same time
period in 2002 primarily due to an increase in notes receivable with affiliated
companies in 2003, in addition to net debt retirements in 2003.
12
OUTLOOK
Panhandle is a leading United States interstate natural gas pipeline system and
also owns one of the largest operating LNG regasification terminals in North
America and intends to optimize results through expansion and better utilization
of its existing facilities and construction of new facilities. This involves
providing additional transportation, storage and other value-added services to
customers such as gas-fueled power plants, local distribution companies,
industrial end-users, marketers and others. Panhandle conducts operations
primarily in the central, gulf coast, midwest, great lakes, and southwest
regions of the United States. Pipeline revenues are generally higher in the
first and fourth quarters of each year primarily due to higher contract rates
and the increase in customer demand levels for gas due to the colder weather
during these periods.
Trunkline LNG entered into a 22-year contract with BG LNG Services beginning
January 2002, for all the uncommitted capacity at the Lake Charles, Louisiana
facility. Trunkline LNG announced the planned expansion of the Lake Charles
facility to approximately 1.2 bcf per day of send out capacity, up from its
current send out capacity of .63 bcf per day and in December 2002, FERC approved
the expansion of the LNG regasification terminal. The expanded facility is
currently expected to be in operation by the end of 2005. In February 2004,
Trunkline LNG filed a further incremental LNG expansion project with the FERC
and is awaiting commission approval. This expansion will increase the LNG
terminal's sustainable send out capacity to 1.8 bcf per day by mid-2006. BG LNG
Services has contracted for all the proposed additional capacity subject to
Trunkline LNG achieving certain construction milestones at this facility.
As of December 31, 2002, Panhandle owned a one-third interest in Guardian, which
constructed a 141-mile, 36-inch pipeline from Illinois to southeastern Wisconsin
for the transportation of natural gas and began operations in December 2002. On
March 10, 2003, Panhandle's ownership interest in Guardian was transferred to
CMS Gas Transmission (see Note IX -- Investment in Affiliates). Trunkline
currently operates the Guardian pipeline, but will not be the operator after
June 30, 2004 when the current agreement with Guardian expires. This is not
expected to have a material impact on Panhandle. In 2002, Panhandle also held a
one-third interest in the Centennial Pipeline Company, which has converted an
existing 720-mile 26-inch pipeline extending from the U.S. gulf coast to
Illinois for the transportation of interstate refined petroleum products. The
pipeline began full commercial service in April 2002. On February 10, 2003,
Panhandle sold its one-third equity interest in Centennial to Centennial's two
other partners, MAPL and TEPPCO for $40,000,000. In December 2002, Panhandle
recorded a $26,281,000 pre-tax ($16,071,000 after-tax) write-down of its
investment in Centennial to $40,000,000, as a result of indicated values upon
announcement of the definitive agreement to sell Panhandle and the associated
efforts to sell Centennial in December 2002. For further information see Note IX
- -- Investment in Affiliates.
OTHER MATTERS
CRITICAL ACCOUNTING POLICIES. Panhandle's consolidated financial statements have
been prepared in accordance with generally accepted accounting principles. The
preparation of these financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
related disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Estimates and assumptions about future events and their
effects cannot be perceived with certainty. On an on-going basis, Panhandle
evaluates its estimates based on historical experience, current market
conditions and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying value of assets and liabilities that are not
readily apparent from other sources. Nevertheless, actual results may differ
from these estimates under different assumptions or conditions. The following is
a summary of Panhandle's most critical accounting policies, which are defined as
those policies whereby judgments or uncertainties could affect the application
of those policies and materially different amounts could be reported under
different conditions or using different assumptions. For a summary of all of the
Panhandle's significant accounting policies, see Note II -- Summary of
Significant Accounting Policies and Other Matters.
System Gas and Operating Supplies -- System gas and operating supplies consist
of gas held for operations and materials and supplies, carried at the lower of
weighted average cost or market. The gas held for operations that is not
expected to be consumed in operations in the next twelve months has been
reflected in non-current assets. All system gas and materials and supplies
purchased are recorded at the lower of cost or market, while net gas received
from and owed back to customers is valued at market.
Gas Imbalances -- Gas imbalances occur as a result of differences in volumes of
gas received and delivered. Gas imbalance in-kind receivables and payables are
valued at cost or market, based on whether net imbalances have
13
reduced or increased system gas balances, respectively. Net imbalances which
have reduced system gas are valued at the cost basis of the system gas, while
net imbalances which have increased system gas and are owed back to customers
are priced, along with the corresponding system gas, at market.
Goodwill and Other Intangibles -- SFAS No. 142 "Goodwill and Other Intangible
Assets," provides that goodwill and other intangible assets that have indefinite
useful lives not be amortized, but instead must be tested at least annually for
impairment, and intangible assets that have finite useful lives should continue
to be amortized over their useful lives. SFAS No. 142 also provides specific
guidance for testing goodwill and other nonamortized intangible assets for
impairment. Goodwill of a reporting unit shall be tested for impairment between
annual tests if an event occurs or circumstances change that would more likely
than not reduce the fair value of a reporting unit below its carrying amount.
Examples of such events or circumstances may include a significant change in
business climate or a loss of key personnel, among others. SFAS No. 142 requires
that management make certain estimates and assumptions in order to allocate
goodwill to reporting units and to determine the fair value of reporting unit
net assets and liabilities, including, among other things, an assessment of
market conditions, projected cash flows, cost of capital and growth rates, which
could significantly impact the reported value of goodwill and other intangible
assets, as compared to Panhandle's accounting policy for the assessment of
goodwill impairment in 2002, which was based on an undiscounted cash flow model.
Estimating future cash flows requires significant judgment and management
projections may vary from cash flows eventually realized. Panhandle adopted the
provisions of SFAS No. 142 as of January 1, 2002. Panhandle did not have a
goodwill balance on the balance sheet as of December 31, 2003, therefore, there
was no need to perform an impairment test.
Long-Lived Assets -- Long-lived assets, including property, plant and equipment,
intangibles and equity investments, comprise a significant amount of Panhandle's
total assets. Management reviews long-lived assets for impairment whenever
events or changes in circumstances indicate that the carrying amount may not be
realizable. If an evaluation is required, the estimated future undiscounted cash
flows associated with the asset are compared to the asset's carrying amount to
determine if an impairment of such asset is necessary. The effect of any
impairment would be to expense the difference between the fair value of such
asset and its carrying value. The assets acquired and liabilities assumed in the
Panhandle Acquisition have been recorded at their estimated fair value as of the
adjustment date based on the results of outside appraisals. Accordingly, the
post-acquisition financial statements reflect a new basis of accounting. For
further discussion of Panhandle's long-lived assets, see Note VII -- Property,
Plant and Equipment.
Other Postretirement Benefits -- Panhandle accounts for other postretirement
benefit costs in accordance with SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions," and SFAS No. 132R, "Employers'
Disclosures about Pensions and Other Postretirement Benefits." The Statements
require liabilities to be recorded on the balance sheet at the present value of
the future obligations to employees net of any plan assets. The calculation of
these liabilities and associated expenses require the expertise of actuaries and
are subject to many assumptions including life expectancies, present value
discount rates, expected long-term rate of return on plan assets, rate of
compensation increase and anticipated health care costs. Any change in these
assumptions can significantly change the liability and associated expenses
recognized in any given year. For further discussion of Panhandle's other
postretirement benefits, see Note XIII -- Retirement Benefits.
Derivatives and Hedging Activities -- Panhandle utilizes derivative instruments
on a limited basis to manage certain business risks. Interest rate swaps are
used to reduce interest rate risks and to manage interest expense. Panhandle
accounts for its derivatives in accordance with SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended. Under this
Statement, all derivatives are recognized on the balance sheet at their fair
value. On the date the derivative contract is entered into, management
designates the derivative as either: (i) a hedge of the fair value of a
recognized asset or liability or of an unrecognized firm commitment (a fair
value hedge); (ii) a hedge of a forecasted transaction or of the variability of
cash flows to be received or paid in connection with a recognized asset or
liability (a cash flow hedge), or (iii) an instrument that is held for trading
or non-hedging purposes (a trading or non-hedging instrument). Changes in the
fair value of a derivative that qualifies as a fair-value hedge, along with the
gain or loss on the hedged asset or liability that is attributable to the hedged
risk, are recorded in earnings. Changes in the fair value of a derivative that
qualifies as a cash-flow hedge, to the extent that the hedge is effective, are
recorded in other comprehensive income, until earnings are affected by the
variability of cash flows of the hedged transaction (e.g., until periodic
settlements of a variable-rate asset or liability are recorded in earnings).
Hedge ineffectiveness is recorded through earnings immediately. Lastly, changes
in the fair value of derivative trading and non-hedging instruments are reported
in current-period earnings. Fair value is determined based upon mathematical
models using current and historical data.
14
Panhandle formally assesses, both at the hedge's inception and on an ongoing
basis, whether the derivatives that are used in hedging transactions have been
highly effective in offsetting changes in the fair value or cash flows of hedged
items and whether those derivatives may be expected to remain highly effective
in future periods. Panhandle discontinues hedge accounting when: (i) it
determines that the derivative is no longer effective in offsetting changes in
the fair value or cash flows of a hedged item; (ii) the derivative expires or is
sold, terminated, or exercised; (iii) it is no longer probable that the
forecasted transaction will occur; or (iv) management determines that
designating the derivative as a hedging instrument is no longer appropriate. In
all situations in which hedge accounting is discontinued and the derivative
remains outstanding, Panhandle will carry the derivative at its fair value on
the balance sheet, recognizing changes in the fair value in current-period
earnings. See Note II -- Summary of Significant Accounting Policies and Other
Matters.
Commitments and Contingencies -- Panhandle is subject to proceedings, lawsuits
and other claims related to environmental and other matters. Accounting for
contingencies requires significant judgments by management regarding the
estimated probabilities and ranges of exposure to potential liability. For
further discussion of Panhandle's commitments and contingencies, see Note XII --
Commitments and Contingencies.
ACCOUNTING PRONOUNCEMENTS
SFAS NO. 132R, "EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT
BENEFITS" (SFAS NO. 132R): Issued by the FASB in December 2003, the Statement is
effective for fiscal years ending after December 15, 2003. SFAS No. 132R amends
SFAS No. 87, 88 and 106 and enhances disclosures about pension plans and other
postretirement benefit plans. Companies are required to provide more details
about their plan assets, benefit obligations, cash flows, benefit costs and
other relevant information. Additionally, companies are required to provide a
breakdown of plan assets by category, a description of investment policies and
strategies and target allocation percentages, or target ranges for these
categories. Panhandle adopted SFAS No. 132R during the fourth quarter of 2003
and has determined that the application of SFAS No. 132R has no additional
impact on its consolidated financial position or results of operations.
SFAS NO. 143, "ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS" (SFAS NO. 143): In
June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations ("ARO"), which is effective for fiscal years beginning after June
15, 2002. The standard requires legal obligations associated with the retirement
of long-lived assets to be recognized at their fair value at the time that the
obligations are incurred. Upon initial recognition of a liability, cost should
be capitalized as part of the related long-lived asset and allocated to expense
over the useful life of the asset. Panhandle adopted the new rules on asset
retirement obligations on January 1, 2003. Adoption of the new rule resulted in
an increase in net property, plant and equipment of $10,082,000, recognition of
an asset retirement obligation of $6,024,000, and a cumulative effect of
adoption that increased net income and stockholder's equity by $2,003,000, net
of tax. Accretion expense during 2003 through June 11, 2003 was approximately
$282,000, and approximately $364,000 for the period June 12 through December 31,
2003. There were no settlements or cash flow revisions during the 2003 periods
presented. Accretion expense for 2002 would have been approximately $532,000 on
a pro forma basis as if the accounting pronouncement had been applied during
such period.
The fair value of ARO liabilities has been calculated using an expected present
value technique. This technique reflects assumptions, such as costs, inflation,
and profit margin that third parties would consider in order to take on the
settlement of the obligation. Fair value, to the extent possible, should include
a market risk premium for unforeseeable circumstances. No market risk premium
was included in Panhandle's ARO fair value estimate since a reasonable estimate
could not be made. If a reasonable estimate of fair value cannot be made in the
period the asset retirement obligation is incurred, such as assets with an
indeterminate life, the liability will be recognized when a reasonable estimate
of fair value can be made. Generally, property such as onshore transmission
assets has an indeterminate life, retirement cash flows cannot be determined and
there is a low probability of a retirement date. Therefore, no liability has
been recorded for these assets. The initial measurement of the ARO liability for
some of Panhandle's offshore lateral lines is based largely on cost estimates
from third parties.
The following table is a general description of the ARO and its associated
long-lived assets.
DECEMBER 31, 2003 IN THOUSANDS
- ---------------------------------------------------------------------------------------------
IN SERVICE
ARO DESCRIPTION DATE LONG LIVED-ASSETS AMOUNT
- ---------------------------------------------------------------------------------------------
Retire offshore lateral lines Various Offshore lateral lines $ 10,082
15
The following table is a reconciliation of the carrying amount of the ARO.
DECEMBER 31, 2003 IN THOUSANDS
- -------------------------------------------------------------------------------------------------------------------------
ARO LIABILITY
---------------------------------
PRE-ACQUISITION POST-ACQUISITION
---------------------------------
JAN 1-JUN 11 JUN 12-DEC 31
PRO FORMA 2003 2003 CASH FLOW
ARO DESCRIPTION 1/1/02 1/1/03 INCURRED SETTLED ACCRETION REVISIONS 12/31/03
- ------------------------------------------------------------------------------ -----------------------------------------
Offshore laterals $ 5,492 $ 6,024 $809 - $282 $364 - $ 7,479
During the second quarter of 2003 Panhandle reclassified $27,286,000 of negative
salvage previously included in accumulated depreciation to other non-current
liabilities for amounts collected for asset retirement obligations on certain
assets which are not recordable as SFAS No. 143 liabilities but represent other
legal obligations.
SFAS NO. 145: Issued by the FASB on April 30, 2002, this Standard rescinds SFAS
No. 4, "Reporting Gains and Losses from Extinguishment of Debt" (SFAS No. 4),
and SFAS No. 64, "Extinguishment of Debt Made to Satisfy Sinking-Fund
Requirements" (SFAS No. 64). As a result, any gain or loss on extinguishment of
debt should be classified as an extraordinary item only if it meets the criteria
set forth in Accounting Principles Board Opinion (APB) No. 30, "Reporting
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions". This provision is effective for fiscal years beginning after May
15, 2002. SFAS No. 145 amends SFAS No. 13, "Accounting for Leases" (SFAS No.
13), to require sale-leaseback accounting for certain lease modifications that
have similar economic impacts to sale-leaseback transactions. This provision is
effective for transactions occurring and financial statements issued after May
15, 2002. Panhandle has adopted SFAS No. 145 and the implementation resulted in
a reclassification of a $920,000 gain ($565,000, net of tax) and a $3,233,000
loss ($1,986,000, net of tax) related to debt retirements which were previously
reflected as Extraordinary Item to Other Expense (Income), Net for the twelve
months ended December 31, 2002 and December 31, 2001, respectively. During the
third quarter of 2003 Panhandle recognized a $6,123,000 ($3,674,000, net of tax)
gain on debt extinguishment and is classified as Other Expense (Income), Net,
pursuant to the requirements of SFAS No. 145.
SFAS NO. 148, "ACCOUNTING FOR STOCK-BASED COMPENSATION - TRANSITION AND
DISCLOSURE, AN AMENDMENT OF FASB STATEMENT NO. 123" (SFAS NO. 148): Issued by
the FASB in December 2002, this standard provides for alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, the statement amends the
disclosure requirements of SFAS No. 123, "Accounting for Stock-Based
Compensation" (SFAS No. 123), to require more prominent and more frequent
disclosures in financial statements about the effects of stock-based
compensation. The transition guidance and annual disclosure provisions of the
statement are effective as of December 31, 2002 and interim disclosure
provisions are effective for interim financial reports starting in 2003.
Panhandle adopted the fair value based method of accounting for stock-based
employee compensation effective December 31, 2002, the amounts of which were
immaterial during the fourth quarter of 2002, applying the prospective method of
adoption which requires recognition of all employee awards granted, modified, or
settled after the beginning of the year in which the recognition provisions are
first applied. Panhandle applied SFAS No. 148 for new awards granted during the
period January 1, 2002 through June 11, 2003, which resulted in no expense
recorded during the 2003 periods presented due to no stock options issued during
2003. CMS retained financial responsibility for all stock options issued prior
to June 12, 2003. No options have been subsequently granted.
SFAS NO. 149, "AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES" (SFAS NO. 149): In April 2003, the FASB issued SFAS No. 149, which
is effective for contracts entered into or modified after June 30, 2003, with
certain exceptions. The standard (i) clarifies under what circumstances a
contract with an initial net investment meets the characteristic of a
derivative, (ii) clarifies when a derivative contains a financing component,
(iii) amends the definition of an underlying to conform it to language used in
FASB Interpretation No. 45, and (iv) amends certain other existing
pronouncements. Panhandle adopted SFAS No. 149 during the third quarter of 2003
and has determined that the application of SFAS No. 149 had no material impact
on its consolidated financial position or results of operations.
FASB INTERPRETATION NO. 45, "GUARANTOR'S ACCOUNTING AND DISCLOSURE REQUIREMENT
FOR GUARANTEES, INCLUDING INDIRECT GUARANTEES OF INDEBTEDNESS OF OTHERS": Issued
by the FASB in November 2002, the interpretation expands on existing disclosure
requirements for most guarantees, and clarifies that at the time a company
issues a guarantee, the company must recognize an initial liability for the fair
value, or market value, of the obligations it assumes under that guarantee and
must disclose that information in its interim and annual
16
financial statements. The interpretation is effective for guarantees issued or
modified on and after January 1, 2003. For contracts that are within the initial
recognition and measurement provision of this interpretation, the provisions are
to be applied to guarantees issued or modified after December 31, 2002.
Implementation of the standard had no material impact on Panhandle's
consolidated financial position or results of operations during the 2003 periods
presented.
FASB INTERPRETATION NO. 46R, "CONSOLIDATION OF VARIABLE INTEREST ENTITIES" (FIN
NO. 46R): Issued by the FASB in December 2003, the interpretation defines a
variable interest entity as a legal entity whose equity owners do not have
sufficient equity at risk and/or a controlling financial interest in the entity.
The interpretation is effective for special-purpose entities for periods ending
after December 15, 2003 and for all other types of variable interest entities
for periods ending after March 15, 2004. This standard requires a company to
consolidate a variable interest entity if it is allocated a majority of the
entity's losses and/or returns, including fees paid by the entity. The adoption
of FIN No. 46R had no material impact on Panhandle's consolidated financial
position or results of operations as of December 31, 2003. Panhandle is still
assessing the interpretation for any potential impact for future periods.
CUSTOMER CONCENTRATION. During 2003, sales to Proliance Energy, LLC, a
nonaffiliated local distribution company and gas marketer, accounted for
approximately 16 percent of Panhandle's total combined twelve months operating
revenues, sales to BG LNG Services, a nonaffiliated gas marketer, accounted for
approximately 15 percent of Panhandle's total combined twelve months operating
revenues and sales to subsidiaries of CMS, primarily Consumers Energy Company,
accounted for approximately 12 percent of Panhandle's total combined twelve
months operating revenues. No other customer accounted for 10 percent or more of
total combined twelve months operating revenues during the same period.
Aggregate sales to Panhandle's top 10 customers accounted for approximately 69
percent of total combined twelve months operating revenues during 2003.
REGULATION. Panhandle is subject to regulation by various federal, state and
local governmental agencies, including those specifically described below.
FERC has comprehensive jurisdiction over Panhandle Eastern Pipe Line, Trunkline,
Sea Robin, Trunkline LNG, and Southwest Gas Storage as natural gas companies
within the meaning of the Natural Gas Act of 1938. FERC jurisdiction relates,
among other things, to the acquisition, operation and disposal of assets and
facilities and to the service provided and rates charged.
FERC has authority to regulate rates and charges for both transportation and
storage of natural gas in interstate commerce. FERC also has authority over the
construction and operation of pipeline and related facilities utilized in the
transportation and sale of natural gas in interstate commerce, including the
extension, enlargement or abandonment of service using such facilities.
Panhandle, Trunkline, Sea Robin, Trunkline LNG, and Southwest Gas Storage hold
certificates of public convenience and necessity issued by the FERC, authorizing
them to construct and operate the pipelines, facilities and properties now in
operation for which such certificates are required, and to transport and store
natural gas in interstate commerce.
The Secretary of Energy regulates the importation and exportation of natural gas
and has delegated various aspects of this jurisdiction to FERC and the
Department of Energy's Office of Fossil Fuels.
Panhandle is also subject to the Natural Gas Pipeline Safety Act of 1968 and the
Pipeline Safety Improvement Act of 2002, which regulate the safety of gas
pipelines. Panhandle is also subject to the Hazardous Liquid Pipeline Safety Act
of 1979, which regulates oil and petroleum pipelines.
In 1993, the U.S. Department of the Interior announced its intention to seek,
through its Mineral Management Service (MMS), additional royalties from gas
producers as a result of payments received by such producers in connection with
past take-or-pay settlements and buyouts and buydowns of gas sales contracts
with natural gas pipelines. Panhandle Eastern Pipe Line and Trunkline, with
respect to certain producer contract settlements, may be contractually required
to reimburse or, in some instances, to indemnify producers against such royalty
claims. The potential liability of the producers to the government and of the
pipelines to the producers involves complex issues of law and fact, which are
likely to take substantial time to resolve. If required to reimburse or
indemnify the producers, Panhandle Eastern Pipe Line and Trunkline may file with
FERC to recover these costs from pipeline customers. Management believes these
commitments and contingencies will not have a material adverse effect on
Panhandle's business, financial condition or results of operations.
17
COMPETITION. Panhandle's interstate pipelines compete with other interstate and
intrastate pipeline companies in the transportation and storage of natural gas.
The principal elements of competition among pipelines are rates, term of service
and flexibility and reliability of service. Panhandle's primary competitors
include Alliance Pipeline LP, ANR Pipeline Company, Natural Gas Pipeline Company
of America, Northern Border Pipeline Company, Texas Gas Transmission
Corporation, Northern Natural Gas Company and Vector Pipeline.
Natural gas competes with other forms of energy available to Panhandle's
customers and end-users, including electricity, coal and fuel oils. The primary
competitive factor is price. Changes in the availability or price of natural gas
and other forms of energy, the level of business activity, conservation,
legislation and governmental regulations, the capability to convert to alternate
fuels, and other factors, including weather and natural gas storage levels,
affect the demand for transportation services in the areas served by Panhandle.
ENVIRONMENTAL MATTERS. Panhandle's interstate natural gas transportation
operations are subject to federal, state and local regulations regarding water
quality, hazardous and solid waste disposal and other environmental matters.
Panhandle has identified environmental contamination at certain sites on its gas
transmission systems and has undertaken cleanup programs at these sites. The
contamination resulted from the past use of lubricants containing PCBs in
compressed air systems; the past use of paints containing PCBs; and the prior
use of wastewater collection facilities and other on-site disposal areas.
Panhandle has developed and is implementing a program to remediate such
contamination in accordance with federal, state and local regulations. Some
remediation is being performed by former Panhandle affiliates in accordance with
indemnity agreements that also indemnify against certain future environmental
litigation and claims. Panhandle is also subject to various federal, state and
local laws and regulations relating to air quality control. These regulations
include rules relating to regional ozone control and hazardous air pollutants.
The regional ozone control rules are known as SIP and are designed to control
the release of NOx compounds. The rules related to hazardous air pollutants are
known as MACT rules and are the result of the 1990 Clean Air Act Amendments that
regulate the emission of hazardous air pollutants from internal combustion
engines and turbines.
PCB Assessment and Clean-up Programs -- Panhandle previously identified
environmental contamination at certain sites on its systems and undertook
clean-up programs at these sites. The contamination resulted from the past use
of lubricants containing PCBs in compressed air systems and the prior use of
wastewater collection facilities and other on-site disposal areas. Panhandle is
also taking actions regarding PCBs in paints at various locations. For further
information, see Note XII -- Commitments and Contingencies - Environmental
Matters.
Air Quality Control -- In 1998, the EPA issued a final rule on regional ozone
control that requires revised SIPS for 22 states, including five states in which
Panhandle operates. Panhandle has completed installation of NOx controls on four
engines and anticipates placing NOx controls on engines at a total of six
compressor station locations. This program is expected to be completed by May
2007.
In 2004, Panhandle expects final rules from the EPA regarding control of
hazardous air pollutants, and Panhandle expects that some of its engines and
turbines will be affected. In 2002, the Texas Commission on Environmental
Quality enacted the Houston/Galveston SIP regulations requiring reductions in
NOx emissions in an eight-county area surrounding Houston. Trunkline's Cypress
compressor station is affected and may require the installation of emission
controls. New regulations also require certain grandfathered facilities to enter
into the new source permit program which may require the installation of
emission controls at five additional facilities. The rule affects six company
facilities in Texas. Panhandle expects controls to be installed by December
2007. For further information, see Note XII -- Commitments and Contingencies -
Environmental Matters.
OFF-BALANCE SHEET ARRANGEMENTS AND AGGREGATE CONTRACTUAL OBLIGATIONS. As of
December 31, 2003, Panhandle was not responsible for any firm commitment
guarantees with related or unrelated parties. As of December 31, 2002, Panhandle
had guarantees related to the Centennial and Guardian pipeline projects of
$50,000,000 and $60,000,000, respectively, and a letter of credit for
$62,500,000 supporting the Guardian guarantee. Panhandle has since been released
from these guarantees and the letter of credit obligation was transferred to CMS
Gas Transmission (see Note IX -- Investment in Affiliates).
18
CONTRACTUAL COMMITMENTS. Panhandle has contractual obligations with regard to
future payments of operating leases and natural gas storage service. The
following table summarizes Panhandle's expected contractual obligations and
commitments at December 31, 2003.
IN THOUSANDS 2004 2005 2006 2007 2008 THEREAFTER
-------- -------- -------- --------- --------- ----------
Operating Leases (1) $ 12,152 $ 11,590 $ 10,768 $ 9,195 $ 5,882 $ 6,250
Total long term debt (2) 209,671 12,548 13,970 231,916 300,000 417,428
Firm capacity payments (3) 12,811 8,391 6,891 6,891 6,891 37,799
-------- -------- -------- --------- --------- ----------
Total $234,634 $ 32,529 $ 31,629 $ 248,002 $ 312,773 $ 461,477
======== ======== ======== ========= ========= =========
(1) Lease of various assets utilized for operations
(2) Debt principal obligations
(3) Lease of third party storage capacity
CAPITAL EXPENDITURES. Panhandle estimates expenditures associated with Phase I
and Phase II LNG terminal expansion and the Trunkline 30-inch diameter, 23-mile
natural gas pipeline loop from the LNG terminal are estimated to be
approximately $93 million in 2004, approximately $107 million in 2005 and
approximately $12 million in 2006. These estimates were developed for budget
planning purposes and are subject to revision.
CASH MANAGEMENT. On October 25, 2003, FERC issued the final rule in Order No.
634-A on the regulation of cash management practices. Order No. 634-A requires
all FERC-regulated entities that participate in cash management programs (i) to
establish and file with FERC for public review written cash management
procedures including specification of duties and responsibilities of cash
management program participants and administrators, specification of the methods
for calculating interest and allocation of interest income and expenses, and
specification of any restrictions on deposits or borrowings by participants, and
(ii) to document monthly cash management activity. In compliance with FERC Order
No. 634-A, Panhandle filed its cash management plan with FERC on December 11,
2003.
NEW FERC REPORTING REQUIREMENTS. On February 11, 2004, in Order No. 646, the
FERC adopted new quarterly financial reporting requirements for regulated
entities. The new requirements are effective for the first quarterly results for
the period ending March 31, 2004 and requires major public utilities and
licensees and major natural gas companies to submit the first report on or
before July 9, 2003. All subsequent quarterly reports for major public utilities
and licensees, and major natural gas companies are required to be submitted 60
days after the end of each quarter. Panhandle is currently studying the
implications and costs of the new regulation to Panhandle Eastern Pipe Line,
Trunkline, Trunkline LNG, Sea Robin and Southwest Gas Storage.
MARKETING AFFILIATE RULEMAKING. In response to changes in the structure of the
energy industry, the FERC adopted Order No. 2004 on November 25, 2003 that will
establish standards of conduct for their energy affiliates. The final rule
revises and conforms the current gas and electric standards by broadening the
definition of an energy affiliate covered by the standards of conduct to
include, in addition to current marketers or merchant affiliates, gathering,
processing, intrastate pipelines and certain local distribution companies. On
February 9, 2004, Panhandle Eastern Pipe Line, Trunkline, Trunkline LNG, Sea
Robin and LNG Holdings submitted an informational filing describing the measures
it will take to bring itself into compliance with the standards of conduct by
June 1, 2004.
PIPELINE SAFETY NOTICE OF PROPOSED RULEMAKING. On December 12, 2003, the U.S.
Department of Transportation issued a final rule requiring pipeline operators to
develop integrity management programs to comprehensively evaluate their
pipelines, and take measures to protect pipeline segments located in "high
consequence areas." The final rule took effect on January 14, 2004 and
incorporates requirements of the Pipeline Safety Improvement Act of 2002 enacted
in December 2002. Although Panhandle cannot predict the actual costs of
compliance with this rule, it does not expect the order to have a material
effect on Panhandle's business, financial condition or results of operations.
CONTROLLED GROUP PENSION LIABILITIES. Southern Union (including certain of its
divisions) sponsors a number of
19
defined benefit pension plans arising from its (including any of its present or
former divisions) or its predecessor's businesses when Southern Union acquired
Panhandle. Under applicable pension and tax laws, upon being acquired by
Southern Union, Panhandle became a member of Southern Union's "controlled group"
with respect to those plans, and, along with Southern Union and any other
members of that group, is jointly and severally liable for any failure by
Southern Union (along with any other persons that may be or become a sponsor of
any such plan) to fund any of these pension plans or to pay any unfunded
liabilities that these plans may have if they are ever terminated. In addition,
if any of the obligations of any of these pension plans is not paid when due, a
lien in favor of that plan or the Pension Benefit Guaranty Corporation may be
created against the assets of each member of Southern Union's controlled group,
including Panhandle and each of its subsidiaries. As of June 30, 2003, the
aggregate amount of the projected benefit obligations of these pension plans was
approximately $336,651,000 and the estimated fair value of all of the assets of
these plans was approximately $237,376,000.
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION. The Management's
Discussion and Analysis of Results of Operations and Financial Condition and
other sections of this Form 10-K may contain forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. These
statements constitute forward-looking statements that are based on current
expectations, estimates and projections about the industry in which Panhandle
operates and management's beliefs and assumptions. These forward-looking
statements are not historical facts, but rather reflect current expectations
concerning future results and events. Words such as "expects," "anticipates,"
"intends," "plans," "believes," "seeks," "estimates," variations of such words
and similar expressions are intended to identify such forward-looking
statements. Similarly, statements that describe objectives, plans or goals are
or may be forward-looking statements.
These statements are not guarantees of future performance and involve various
risks, uncertainties and assumptions, which are difficult to predict and many of
which are outside Panhandle's control. Therefore, actual results, performance
and achievements may differ materially from what is expressed or forecasted in
such forward-looking statements. Prospective investors may review Panhandle's
reports filed in the future with the Commission for more current descriptions of
developments that could cause actual results to differ materially from such
forward-looking statements. However, prospective investors should not place
undue reliance on forward-looking statements, which speak only as of the date of
this Form 10-K, or, in the case of documents incorporated by reference, the date
of those documents.
Factors that could cause actual results to differ materially from those
expressed in the forward-looking statements include, but are not limited to, the
following: customer growth; gas throughput volumes and available sources of
natural gas; discounting of transportation rates due to competition, abnormal
weather conditions in Panhandle's service territories; new legislation and
government regulations affecting or involving Panhandle; Panhandle's ability to
comply with or to challenge successfully existing or new environmental
regulations; the outcome of pending and future litigation; the impact of
relations with labor unions of bargaining-unit union employees; the impact of
future rate cases or regulatory rulings; Panhandle's ability to control costs
successfully and achieve operating efficiencies, including the purchase and
implementation of new technologies for achieving such efficiencies; the nature
and impact of any extraordinary transactions, such as any acquisition or
divestiture of a business unit or any assets; the economic climate and growth in
Panhandle's industry and service territories and competitive conditions of
energy markets in general; inflationary trends; changes in gas or other energy
market commodity prices and interest rates; the current market conditions
causing more customer contracts to be of shorter duration, which may increase
revenue volatility; exposure to customer concentration with a significant
portion of revenues realized from a relatively small number of customers and any
credit risks associated with the financial position of those customers;
Panhandle or its parent's debt securities ratings; factors affecting operations
such as maintenance or repairs, environmental incidents or gas pipeline system
constraints; the possibility of war or terrorist attacks; and other risks and
unforeseen events.
In light of these risks, uncertainties and assumptions, the results reflected in
the forward-looking statements contained or incorporated by reference in this
Form 10-K might not occur. In addition, Panhandle could be affected by general
industry and market conditions, and general economic conditions, including
interest rate fluctuations, federal, state and local laws and regulations
affecting the retail gas industry or the energy industry generally.
Panhandle does not undertake any obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise. All subsequent written and oral forward-looking statements
attributable to us or persons acting on Panhandle's behalf are expressly
qualified in their entirety by the cautionary statements contained throughout
this Form 10-K.
20
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Panhandle has long-term debt which subjects Panhandle to the risk of loss
associated with movements in market interest rates.
At December 31, 2003, Panhandle had issued fixed-rate long-term debt of
$915,963,000 in principal amount (excluding net premiums on debt of $19,911,000)
and having a fair value of $968,735,000. These debt instruments are fixed-rate
and, therefore, do not expose Panhandle to the risk of earnings loss due to
changes in market interest rates. However, the fair value of these instruments
would increase by approximately $26,019,000 if interest rates were to decline by
10% from their levels at December 31, 2003. In general, such an increase in fair
value would impact earnings and cash flows only if Panhandle were to reacquire
all or a portion of these instruments in the open market prior to its maturity
(See Note XI -- Debt).
Panhandle's floating-rate obligations which relate to the Trunkline LNG facility
aggregated $269,570,000 at December 31, 2003. The floating rate notes, to the
extent not hedged, expose Panhandle to the risk of increased interest expense in
the event of increases in short-term interest rates. If the floating rates were
to increase by 10% from December 31, 2003 levels, Panhandle's consolidated
interest expense would increase by approximately $60,000 each month in which
such increase were sustained.
Panhandle is party to interest rate swap agreements with an aggregate notional
amount of $202,179,000 as of December 31, 2003 that fix the interest rate
applicable to floating rate long-term debt and which qualify for hedge
accounting. For the twelve-month period ending December 31, 2003, the swap
ineffectiveness was not significant. As of December 31, 2003, floating rate
London InterBank Offered Rate (LIBOR) based interest payments are exchanged for
weighted fixed rate interest payments of 5.08%. Interest rate swaps are carried
on the Consolidated Balance Sheet at fair value with the unrealized gain or loss
adjusted through accumulated other comprehensive income. As such, payments or
receipts on interest rate swap agreements, in excess of the liability recorded,
are recognized as adjustments to interest expense. As of December 31, 2003, June
11, 2003 (the acquisition date) and December 31, 2002, the fair value liability
position of the swaps was $19,806,000, $26,850,000 and $22,424,000,
respectively. As of December 31, 2003 and since the acquisition date, an
unrealized gain of $2,293,000 ($1,372,000, net of tax) was included in
accumulated other comprehensive income related to these swaps, of which
approximately $289,000, net of tax, is expected to be reclassified to interest
expense during the next twelve months as the hedged interest payments occur (see
Note X -- Financial Instruments).
21
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements:
PANHANDLE EASTERN PIPE LINE COMPANY, LLC
Consolidated Statements of Operations.............................................. 23
Consolidated Balance Sheets........................................................ 24-25
Consolidated Statements of Cash Flows.............................................. 26
Consolidated Statements of Owner's Equity and
Comprehensive Income........................................................ 27
Notes to Consolidated Financial Statements......................................... 28
Quarterly Financial Information (Unaudited)........................................ 52
Reports of Independent Auditors.................................................... 53-55
Exhibits, Financial Statements Schedules and Reports on Form 8-K................... 62
22
PANHANDLE EASTERN PIPE LINE COMPANY, LLC
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
Post-acquisition Pre-acquisition
---------------- -------------------------------------------
June 12 - January 1 - Year Ended Year Ended
December 31, June 11, December 31, December 31,
2003 2003 2002 2001
----------- ----------- ------------ ------------
OPERATING REVENUE
Transportation and storage of natural gas $ 230,592 $196,408 $ 413,315 $ 423,350
LNG terminalling revenue 33,389 26,750 57,879 74,744
Equity income (losses) from unconsolidated subsidiaries 971 (424) (7,038) (786)
Other 4,139 11,536 19,517 16,797
---------- --------- --------- ---------
Total operating revenue 269,091 234,270 483,673 514,105
---------- --------- --------- ---------
OPERATING EXPENSES
Operation, maintenance and general 117,930 90,800 201,181 249,641
Depreciation and amortization 33,129 23,110 51,184 69,094
General taxes 14,684 12,478 21,907 27,176
---------- --------- --------- ---------
Total operating expenses 165,743 126,388 274,272 345,911
---------- --------- --------- ---------
OPERATING INCOME 103,348 107,882 209,401 168,194
OTHER INCOME (EXPENSE), NET 6,962 6,077 (13,436) 5,713
INTEREST EXPENSES, NET 25,537 35,416 76,529 82,857
MINORITY INTEREST - - 3,527 (22)
---------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 84,773 78,543 115,909 91,072
INCOME TAXES 33,321 30,532 46,401 37,115
---------- --------- --------- ---------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLES 51,452 48,011 69,508 53,957
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLES,
NET OF TAX:
Goodwill, SFAS 142 - - (369,119) -
Asset Retirement Obligations, SFAS 143 - 2,003 - -
---------- --------- --------- ---------
NET INCOME (LOSS) $ 51,452 $ 50,014 $(299,611) $ 53,957
========== ========= ========= =========
See accompanying notes.
23
PANHANDLE EASTERN PIPE LINE COMPANY, LLC
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
Post-acquisition Pre-acquisition
---------------- ---------------
December 31, December 31,
2003 2002
------------ -------------
ASSETS
PROPERTY, PLANT AND EQUIPMENT
Cost $ 1,893,960 1,764,613
Construction work-in-progress 90,556 44,530
----------- -----------
1,984,516 1,809,143
Less accumulated depreciation and amortization 32,114 188,374
----------- -----------
Net property, plant and equipment 1,952,402 1,620,769
----------- -----------
INVESTMENTS IN AFFILIATES 1,394 67,746
----------- -----------
CURRENT ASSETS
Cash and temporary cash investments at cost, which approximates market 16,810 80,545
Restricted cash - 64,263
Accounts receivable, less allowances of $1,464 and $8,444, respectively 56,315 50,074
Accounts receivable - related parties 816 8,745
Gas imbalances - receivable 26,974 17,764
System gas and operating supplies 60,937 40,515
Deferred income taxes, net 7,731 12,818
Note receivable - related party 87,350 59,567
Other 8,271 7,327
----------- -----------
Total current assets 265,204 341,618
----------- -----------
Goodwill, net - 112,582
Other intangibles, net 30,698 -
Restricted cash 1,500 -
Debt issuance cost 4,699 17,704
Deferred income taxes, net - 40,856
Non-current system gas 23,938 14,774
Other 1,708 16,411
----------- -----------
TOTAL ASSETS $ 2,281,543 $ 2,232,460
=========== ===========
See accompanying notes.
24
PANHANDLE EASTERN PIPE LINE COMPANY, LLC
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
Post-acquisition Pre-acquisition
---------------- ---------------
December 31, December 31,
2003 2002
----------- -----------
OWNER'S EQUITY
Common stock, no par, 1,000 shares authorized,
issued and outstanding $ - $ 1,000
Accumulated other comprehensive income (loss) 1,372 (39,179)
Members' capital 679,465 -
Other paid-in capital - 1,280,794
Retained earnings (deficit) 51,452 (340,031)
Note receivable - CMS Capital - (150,000)
Tax sharing receivable - Southern Union (85,471) -
----------- -----------
Total owner's equity 646,818 752,584
Long-term debt 995,773 1,150,285
----------- -----------
Total capitalization 1,642,591 1,902,869
----------- -----------
CURRENT LIABILITIES
Accounts payable 1,452 1,932
Accounts payable - overdrafts 6,607 7,389
Accounts payable - related parties 9,039 8,455
Current portion of long-term debt 209,671 11,641
Note payable - 30,000
Gas imbalances - payable 66,049 40,977
Accrued taxes 9,979 10,712
Accrued interest 21,017 24,881
Other 65,230 59,374
----------- -----------
Total current liabilities 389,044 195,361
----------- -----------
Deferred income taxes, net 131,991 -
Post-retirement benefits 33,473 53,511
Other 84,444 80,719
----------- -----------
Commitments and Contingencies
TOTAL OWNER'S EQUITY AND LIABILITIES $ 2,281,543 $ 2,232,460
=========== ===========
See accompanying notes.
25
PANHANDLE EASTERN PIPE LINE COMPANY, LLC
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Post-acquisition Pre-acquisition
---------------- --------------------------------------------
June 12- Year Ended Year Ended
December 31, January 1 - December 31, December 31,
2003 June 11, 2003 2002 2001
---------------- ------------- ------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 51,452 $ 50,014 $ (299,611) $ 53,957
Adjustments to reconcile net income (loss) to net
cash from operating activities:
Depreciation and amortization 33,129 23,110 51,184 69,094
Cumulative effect of change in accounting principle - (2,003) 369,119 -
Retirement of debt (gain) loss (6,123) - (920) 3,233
Centennial write-down - - 26,281 -
Deferred income taxes, net 33,321 30,532 29,762 52,272
Changes in current assets and liabilities 7,712 9,160 (2,756) (15,994)
Other, net (8,473) - - 2,915
---------- ---------- ---------- ----------
Net cash flows from operating activities 111,018 110,813 173,059 165,477
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CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Capital and investment expenditures (64,270) (29,339) (113,354) (87,7