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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-2700
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EL PASO NATURAL GAS COMPANY
(Exact Name of Registrant as Specified in its Charter)
<Table>
DELAWARE 74-0608280
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
EL PASO BUILDING
1001 LOUISIANA STREET
HOUSTON, TEXAS 77002
(Address of Principal Executive Offices) (Zip Code)
</Table>
Telephone Number: (713) 420-2600
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Common Stock, par value $1 per share. Shares outstanding on May 14, 2003:
1,000
EL PASO NATURAL GAS COMPANY MEETS THE CONDITIONS OF GENERAL INSTRUCTION
H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS REPORT WITH A REDUCED
DISCLOSURE FORMAT AS PERMITTED BY SUCH INSTRUCTION.
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PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EL PASO NATURAL GAS COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN MILLIONS)
(UNAUDITED)
<Table>
<Caption>
QUARTER ENDED
MARCH 31,
-------------
2003 2002
----- -----
Operating revenues.......................................... $132 $152
---- ----
Operating expenses
Operation and maintenance................................. 34 50
Depreciation, depletion and amortization.................. 17 13
Gain on long-lived assets................................. -- (1)
Taxes, other than income taxes............................ 8 8
---- ----
59 70
---- ----
Operating income............................................ 73 82
Other income................................................ 1 --
Interest and debt expense................................... (20) (16)
Affiliated interest income, net............................. 3 6
---- ----
Income before income taxes.................................. 57 72
Income taxes................................................ 22 28
---- ----
Net income.................................................. $ 35 $ 44
==== ====
</Table>
See accompanying notes.
1
EL PASO NATURAL GAS COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
<Table>
<Caption>
MARCH 31, DECEMBER 31,
2003 2002
--------- ------------
ASSETS
Current assets
Cash and cash equivalents................................. $ -- $ 3
Accounts and notes receivable
Customer, net of allowance of $18 in 2003 and 2002..... 77 79
Affiliates............................................. 431 432
Other.................................................. 7 13
Materials and supplies.................................... 43 43
Deferred income taxes..................................... 36 36
Other..................................................... 26 27
------ ------
Total current assets.............................. 620 633
------ ------
Property, plant and equipment, at cost...................... 3,042 3,060
Less accumulated depreciation, depletion and
amortization........................................... 1,151 1,152
------ ------
Total property, plant and equipment, net.......... 1,891 1,908
------ ------
Notes receivable from affiliate............................. 608 565
Other....................................................... 84 83
------ ------
Total assets...................................... $3,203 $3,189
====== ======
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Accounts payable
Trade.................................................. $ 34 $ 43
Affiliates............................................. 7 33
Other.................................................. 2 11
Short-term borrowings (including current maturities of
long-term debt)........................................ 200 200
Accrued interest.......................................... 23 15
Taxes payable............................................. 127 133
Contractual deposits...................................... 33 35
Western Energy Settlement................................. 100 100
Other..................................................... 50 53
------ ------
Total current liabilities......................... 576 623
------ ------
Long-term debt, less current maturities..................... 758 758
------ ------
Other liabilities
Deferred income taxes..................................... 252 221
Western Energy Settlement................................. 316 312
Other..................................................... 119 122
------ ------
687 655
------ ------
Commitments and contingencies
Stockholder's equity
Preferred stock, 8%, par value $0.01 per share; authorized
1,000,000 shares; issued and outstanding 500,000
shares; stated at liquidation value.................... 350 350
Common stock, par value $1 per share; authorized and
issued 1,000 shares.................................... -- --
Additional paid-in capital................................ 715 715
Retained earnings......................................... 117 88
------ ------
Total stockholder's equity........................ 1,182 1,153
------ ------
Total liabilities and stockholder's equity........ $3,203 $3,189
====== ======
</Table>
See accompanying notes.
2
EL PASO NATURAL GAS COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)
<Table>
<Caption>
QUARTER ENDED
MARCH 31,
---------------
2003 2002
---- -----
Cash flows from operating activities
Net income................................................ $ 35 $ 44
Adjustments to reconcile net income to net cash from
operating activities
Depreciation, depletion and amortization............... 17 13
Deferred income tax expense............................ 31 9
Net gain on long-lived assets.......................... -- (1)
Risk-sharing revenue................................... (8) (8)
Bad debt expense....................................... -- 8
Other non-cash income items............................ 5 --
Working capital changes................................... (44) (2)
Non-working capital changes............................... 12 9
---- -----
Net cash provided by operating activities......... 48 72
---- -----
Cash flows from investing activities
Additions to property, plant and equipment................ (38) (37)
Net proceeds from the sale of assets...................... 30 1
Net change in affiliate advances receivable............... (43) 58
---- -----
Net cash provided by (used in) investing
activities....................................... (51) 22
---- -----
Cash flows from financing activities
Net short-term borrowings................................. -- 121
Payments to retire long-term debt......................... -- (215)
---- -----
Net cash used in financing activities............. -- (94)
---- -----
Net change in cash and cash equivalents..................... (3) --
Cash and cash equivalents
Beginning of period....................................... 3 --
---- -----
End of period............................................. $ -- $ --
==== =====
</Table>
See accompanying notes.
3
EL PASO NATURAL GAS COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
We are an indirect wholly owned subsidiary of El Paso Corporation (El
Paso). We prepared this Quarterly Report on Form 10-Q under the rules and
regulations of the United States Securities and Exchange Commission (SEC).
Because this is an interim period filing presented using a condensed format, it
does not include all of the disclosures required by generally accepted
accounting principles. You should read it along with our 2002 Form 10-K, which
includes a summary of our significant accounting policies and other disclosures.
The financial statements as of March 31, 2003, and for the quarters ended March
31, 2003 and 2002, are unaudited. We derived the balance sheet as of December
31, 2002, from the audited balance sheet filed in our 2002 Form 10-K. In our
opinion, we have made all adjustments, all of which are of a normal, recurring
nature, to fairly present our interim period results. Due to the seasonal nature
of our business, information for interim periods may not necessarily indicate
the results of operations for the entire year. In addition, prior period
information presented in these financial statements includes reclassifications
which were made to conform to the current period presentation. These
reclassifications have no effect on our previously reported net income or
stockholder's equity.
Our accounting policies are consistent with those discussed in our Form
10-K, except as discussed below:
Accounting for Costs Associated with Exit or Disposal Activities. As of
January 1, 2003, we adopted Statement of Financial Accounting Standards (SFAS)
No. 146, Accounting for Costs Associated with Exit or Disposal Activities. SFAS
No. 146 requires that we recognize costs associated with exit or disposal
activities when they are incurred rather than when we commit to an exit or
disposal plan. There was no initial financial statement impact of adopting this
standard.
Accounting for Guarantees. On January 1, 2003, we adopted Financial
Accounting Standards Board Interpretation (FIN) No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. FIN No. 45 requires that we record a liability for all
guarantees, including financial performance and fair value guarantees, issued
after December 31, 2002, at fair value when they are issued. There was no
initial financial statement impact of adopting this standard.
Accounting for Regulated Operations. We continue to evaluate the
application of SFAS No. 71, Accounting for the Effects of Certain Types of
Regulation, for changes in the competitive environment and our operating cost
structures. See a further discussion of our accounting for regulated operations
in our 10-K.
2. WESTERN ENERGY SETTLEMENT
On March 20, 2003, we and our affiliates entered into an agreement in
principle with a number of public and private claimants, including the states of
California, Washington, Oregon and Nevada, to resolve the principal litigation,
claims and regulatory proceedings against us and our affiliates relating to the
sale or delivery of natural gas and electricity from September 1996 to the date
of the Western Energy Settlement (referred to as the Western Energy Settlement).
The settlement, as discussed in our 2002 Form 10-K and Note 4, will include
payments of cash, delivery of El Paso's common stock and availability of
capacity for five years at our California delivery points.
The portion of the Western Energy Settlement allocated to us by El Paso
Corporation was initially $412 million. This amount represented the settlement
amount of $665 million, less a discount (based on a discount rate of 10 percent)
of $253 million. During the quarter ended March 31, 2003, we recorded $4 million
of amortization expense on the discount associated with the settlement
obligation which increased our overall obligation to $416 million as of March
31, 2003. This amortization was reflected as an operation and maintenance
expense in our income statement.
4
This calculation of our portion of the settlement obligation required us to
use estimates and assumptions based on currently available information. These
estimates included the discount rate, the timing of final settlement and the
timing of payments made to satisfy obligations. As a result, our estimates and
assumptions used may change.
3. DEBT AND OTHER CREDIT FACILITIES
In April 2003, El Paso entered into a new $3 billion revolving credit
facility, with a $1.5 billion letter of credit sublimit, which matures in June
2005. This facility replaces the previous $3 billion, 364-day revolving credit
facility. El Paso's existing $1 billion revolving credit facility, which matures
in August 2003, and approximately $1 billion of other financing arrangements
(including leases, letters of credit and other facilities) were also amended to
conform El Paso's obligations to the new $3 billion revolving credit facility.
We, along with our affiliates, ANR Pipeline Company, Tennessee Gas Pipeline
Company (TGP) and El Paso, are borrowers under the $3 billion revolving credit
facility, and we, TGP and El Paso are borrowers under the $1 billion revolving
credit facility.
El Paso's equity in several of its subsidiaries, including us and our
equity in Mojave Pipeline Company, collateralizes the revolving credit facility
and the other financing arrangements. We will remain jointly and severally
liable under the $3 billion revolving credit facility through August 19, 2003.
After that date, we will only be liable for the amounts we borrow under the
facility. We are also jointly and severally liable for any amounts outstanding
under the $1 billion revolving credit facility until it matures in August 2003.
The revolving credit facilities have a borrowing cost of LIBOR plus 350
basis points and letter of credit fees of 350 basis points. A key financial
covenant of the facilities is the requirement for El Paso to maintain debt to
total capitalization, as defined in the revolving credit facilities, not to
exceed 75 percent. In addition, we and the other pipeline company borrowers
cannot incur incremental debt if the incurrence of debt would cause our debt to
EBITDA ratio, as defined in the revolving credit facilities, to exceed 5 to 1.
The proceeds from the issuance of debt by the pipeline company borrowers can be
used only for maintenance and expansion capital expenditures or investments in
other FERC-regulated assets, and to refinance existing debt. As of March 31,
2003, $1.5 billion was outstanding under the $3 billion facility, none of which
was borrowed by us, and $500 million was outstanding and $456 million in letters
of credit were issued under the $1 billion facility, none of which was borrowed
by us.
On January 8, 2003, Mojave paid approximately $3 million to the preferred
interest members of Trinity River. See our 2002 Form 10-K for a discussion of
Mojave's obligations under the Trinity River financing arrangement. In March
2003, El Paso entered into a $1.2 billion 2-year term loan and the proceeds were
used to retire the outstanding balance under the Trinity River financing
agreement.
5
4. COMMITMENTS AND CONTINGENCIES
Legal Proceedings
Western Energy Settlement. On March 20, 2003, we and our affiliates
entered into an agreement in principle (the Western Energy Settlement) with
various public and private claimants, including the states of California,
Washington, Oregon, and Nevada, to resolve the principal litigation, claims, and
regulatory proceedings, which are more fully described below, against us and our
affiliates relating to the sale or delivery of natural gas and electricity from
September 1996 to the date of the Western Energy Settlement. Among other things,
the components of the settlement include:
- a cash payment of $100 million;
- a $2 million cash payment from El Paso's officer bonus pool;
- the issuance of approximately 26.4 million shares of El Paso common
stock;
- delivery to the California border by our affiliate of $45 million worth
of natural gas annually for 20 years beginning in 2004;
- a reduction of the pricing of our affiliate's long-term power supply
contracts with the California Department of Water Resources of $125
million over the remaining term of those contracts, which run through the
end of 2005;
- payments of $22 million per year for 20 years;
- for a period of five years, EPNG will make available at its California
delivery points 3,290 MMcf per day of capacity on a primary delivery
point basis;
- for a period of five years, our affiliates will be subject to
restrictions in subscribing for new capacity on the EPNG system; and
- no admission of wrongdoing.
The Western Energy Settlement resulted in an after-tax charge to us of
approximately $262 million in the fourth quarter of 2002 for the component of
the settlement allocated to us.
The agreement in principle is subject to the negotiation of a formal
settlement agreement, portions of which will then be filed with the courts and
the FERC for approval. Upon approval, the parties will release us from covered
claims that they may have against us and our affiliates for the period covered
by the Western Energy Settlement, and the litigation, claims, and regulatory
proceedings against us and our affiliates will be dismissed with prejudice.
California Lawsuits. We have been named as a defendant in fifteen
purported class action, municipal or individual lawsuits, filed in California
state courts. These suits contend that we acted improperly to limit the
construction of new pipeline capacity to California and/or to manipulate the
price of natural gas sold into the California marketplace. Specifically, the
plaintiffs argue that our conduct violates California's antitrust statute
(Cartwright Act), constitutes unfair and unlawful business practices prohibited
by California statutes, and amounts to a violation of California's common law
restrictions against monopolization. In general, the plaintiffs are seeking (i)
declaratory and injunctive relief regarding allegedly anticompetitive actions,
(ii) restitution, including treble damages, (iii) disgorgement of profits, (iv)
prejudgment and postjudgment interest, (v) costs of prosecuting the actions and
(vi) attorney's fees. All fifteen cases have been consolidated before a single
judge, under two omnibus complaints, one of which has been set for trial in
September 2003. All of the class action lawsuits and all but one of the
individual lawsuits will be resolved upon finalization and approval of the
Western Energy Settlement. As to the remaining individual lawsuit, on May 8,
2003, a settlement agreement between the plaintiffs and defendants in that case
became effective and resolved all disputes between the parties in return for a
single payment by El Paso. Pursuant to the settlement, the plaintiffs action
will be dismissed with prejudice.
6
The California cases discussed above are five filed in the Superior Court
of Los Angeles County (Continental Forge Company, et al v. Southern California
Gas Company, et al, filed September 25, 2000*; Berg v. Southern California Gas
Company, et al, filed December 18, 2000*; County of Los Angeles v. Southern
California Gas Company, et al, filed January 8, 2002*; The City of Los Angeles,
et al v. Southern California Gas Company, et al and The City of Long Beach, et
al v. Southern California Gas Company, et al, both filed March 20, 2001*); two
filed in the Superior Court of San Diego County (John W.H.K. Phillip v. El Paso
Merchant Energy; and John Phillip v. El Paso Merchant Energy, both filed
December 13, 2000*); and two filed in the Superior Court of San Francisco County
(Sweetie's et al v. El Paso Corporation, et al, filed March 22, 2001*; and
California Dairies, Inc., et al v. El Paso Corporation, et al, filed May 21,
2001); and one filed in the Superior Court of the State of California, County of
Alameda (Dry Creek Corporation v. El Paso Natural Gas Company, et al filed
December 10, 2001*); and five filed in the Superior Court of Los Angeles County
(The City of San Bernardino v. Southern California Gas Company, et al; The City
of Vernon v. Southern California Gas Company; The City of Upland v. Southern
California Gas Company, et al; Edgington Oil Company v. Southern California Gas
Company, et al; World Oil Corp. v. Southern California Gas Company, et al, filed
December 27, 2002*).
In November 2002, a lawsuit titled Gus M. Bustamante v. The McGraw-Hill
Companies was filed in the Superior Court of California, County of Los Angeles
by several individuals, including Lt. Governor Bustamante acting as a private
citizen, against numerous defendants, including us, alleging the creation of
artificially high natural gas index prices via the reporting of false price and
volume information. This purported class action on behalf of California
consumers alleges various unfair business practices and seeks restitution,
disgorgement of profits, compensatory and punitive damages, and civil fines.
This lawsuit will be resolved upon finalization and approval of the Western
Energy Settlement.
In January 2003, a lawsuit titled IMC Chemicals v. EPME, et al. was filed
in California state court against us, El Paso and EPME. The suit arises out of a
gas supply contract between IMC Chemicals (IMCC) and EPME and seeks to void the
Gas Purchase Agreement between IMCC and EPME for gas purchases until December
2003. IMCC contends that EPME and its affiliates manipulated market prices for
natural gas and, as part of that manipulation, induced IMCC to enter into the
contract. In furtherance of its attempt to void the contract, IMCC repeats the
allegations and claims of the California lawsuits described above. EPME intends
to enforce the terms of the contract and counterclaim for contract damages. This
case was removed to Federal Court. A hearing was held on April 21, 2003 on the
respective motions of the El Paso defendants to dismiss, as well as IMCC's
motions to remand. Our costs and legal exposure related to these lawsuits and
claims are not currently determinable.
In September 2001, we received a civil document subpoena from the
California Attorney General, seeking information said to be relevant to the
Department's ongoing investigation into the high electricity prices in
California. We are continuing to cooperate in responding to their discovery
requests. This proceeding will be resolved upon finalization and approval of the
Western Energy Settlement.
Other Energy Market Lawsuits. The state of Nevada and two individuals
filed a class action lawsuit in Nevada state court naming us and a number of our
affiliates as defendants. The allegations are similar to those in the California
cases. The suit seeks monetary damages and other relief under Nevada antitrust
and consumer protection laws. This proceeding will be resolved upon finalization
and approval of the Western Energy Settlement.
A purported class action suit titled Henry W. Perlman et. al. v. Southern
California Gas Company, San Diego Gas & Electric; Sempra Energy, El Paso
Corporation, El Paso Natural Gas Company and El Paso Merchant Energy, L.P. was
filed in federal court in New York City in December 2002 alleging that the
defendants manipulated California's natural gas market by manipulating the spot
market of gas traded on the NYMEX. Our costs and legal exposure related to this
lawsuit are not currently determinable.
- ---------------
* Cases to be dismissed upon finalization and approval of the Western Energy
Settlement.
7
In March 2003, the State of Arizona sued us, our affiliates and other
unrelated entities on behalf of Arizona consumers. The suit alleges that the
defendants conspired to artificially inflate prices of natural gas and
electricity during 2000 and 2001. Making factual allegations similar to those
alleged in the California cases, the suit seeks relief similar to the California
cases as well, but under Arizona antitrust and consumer fraud statutes. Our
costs and legal exposure related to these lawsuits and claims are not currently
determinable.
On April 21, 2003, Sierra Pacific Resources and its, subsidiary, Nevada
Power Company filed a lawsuit titled Sierra Pacific Resources et al. v. El Paso
Corporation et al., in the U.S. District Court for the District of Nevada
against El Paso Corporation, EPNG, El Paso Tennessee Pipeline, EPME and four
other non-El Paso defendants. The lawsuit alleges that the defendants conspired
to manipulate supplies and prices of natural gas in the California-Arizona
border market from 1996 through 2001. The allegations are similar to those
raised in the several cases that are the subject of the Western Energy
Settlement described above. The plaintiffs allege that they entered into
contracts at inappropriately high prices and hedging transactions because of the
alleged manipulated prices. They allege that the defendants' activities
constituted (1) a violation of the Nevada Unfair Trade Practices Act; (2) fraud;
(3) both a conspiracy to violate and a violation of Nevada's RICO act; and (4) a
civil conspiracy. The complaint seeks $150 million in actual damages from all
the defendants, plus an additional $450 million in trebled damages. The El Paso
defendants were served with the complaint on May 5, 2003.
Shareholder Class Action Suit. In November 2002, we were named as a
defendant in a shareholder derivative suit titled Marilyn Clark v. Byron
Allumbaugh, David A. Arledge, John M. Bissell, Juan Carlos Braniff, James F.
Gibbons, Anthony W. Hall, Ronald L. Kuehn, J. Carleton MacNeil, Thomas McDade,
Malcolm Wallop, William Wise, Joe B. Wyatt, El Paso Natural Gas Company and El
Paso Merchant Energy Company filed in state court in Houston. This shareholder
derivative suit generally alleges that manipulation of California gas supply and
gas prices exposed our parent, El Paso, to claims of antitrust conspiracy, FERC
penalties and erosion of share value. The plaintiffs have not asked for any
relief with regards to us. Our costs and legal exposure related to this
proceeding are not currently determinable.
Carlsbad. In August 2000, a main transmission line owned and operated by
us ruptured at the crossing of the Pecos River near Carlsbad, New Mexico. Twelve
individuals at the site were fatally injured. On June 20, 2001, the U.S.
Department of Transportation's Office of Pipeline Safety issued a Notice of
Probable Violation and Proposed Civil Penalty to us. The Notice alleged five
violations of DOT regulations, proposed fines totaling $2.5 million and proposed
corrective actions. We have fully accrued for these fines. The alleged five
probable violations of the regulations of the Department of Transportation's
Office of Pipeline Safety are: (1) failure to develop an adequate internal
corrosion control program, with an associated proposed fine of $500,000; (2)
failure to investigate and minimize internal corrosion, with an associated
proposed fine of $1,000,000; (3) failure to conduct continuing surveillance on
our pipeline and consider, and respond appropriately to, unusual operating and
maintenance conditions, with an associated proposed fine of $500,000; (4)
failure to follow company procedures relating to investigating pipeline failures
and thereby to minimize the chance of recurrence, with an associated proposed
fine of $500,000; and (5) failure to maintain elevation profile drawings, with
an associated proposed fine of $25,000. On October 2001, we filed a response
with the Office of Pipeline Safety disputing each of the alleged violations. If
we are required to pay the proposed fines, it will not have a material adverse
effect on our financial position, operations results or cash flows.
On February 11, 2003, the National Transportation Safety Board (NTSB)
conducted a public hearing on its investigation of the Carlsbad rupture at which
the NTSB adopted Findings, Conclusions and Recommendation based upon its
investigation. In April 2003, the NTSB published its final report. The NTSB
stated that it had determined that the probable cause of the August 19, 2000
rupture was a significant reduction in pipe wall thickness due to severe
internal corrosion, which occurred because our corrosion control program "failed
to prevent, detect, or control internal corrosion" in the pipeline. The NTSB
also determined that ineffective federal preaccident inspections contributed to
the accident by not identifying deficiencies in our internal corrosion control
program.
8
On November 1, 2002, we received a federal grand jury subpoena for
documents relating to the rupture and we are cooperating fully with the grand
jury.
A number of personal injury and wrongful death lawsuits were filed against
us in connection with the rupture. All but one of these suits have been settled,
with settlement payments fully covered by insurance. The remaining case is
Geneva Smith, et al. vs. EPEC and EPNG filed October 23, 2000 in Harris County,
Texas. Trial is set to begin on August 11, 2003. In connection with the
settlement of the cases, we contributed $10 million to a charitable foundation
as a memorial to the families involved. The contribution was not covered by
insurance.
Parties to four settled lawsuits have since filed an additional lawsuit
titled Diane Heady et al. v. EPEC and EPNG in Harris County, Texas on November
20, 2002 seeking an additional $85 million based upon their interpretation of
earlier agreements. Parties to another of the settled lawsuits have filed a
lawsuit titled In the Matter of Jennifer Smith, in Eddy County, New Mexico, on
May 7, 2003, seeking an additional $86 million based upon their interpretation
of earlier agreements. In addition, plaintiffs' counsel for the settled New
Mexico state court cases have notified us that they intend to file suit on
behalf of about twenty-three firemen and EMS personnel who responded to the fire
and who allegedly have suffered psychological trauma. We have not been served
with such a lawsuit. Our costs and legal exposure related to these lawsuits and
claims are currently not determinable. However, we believe these matters will be
fully covered by insurance.
Grynberg. In 1997, we and a number of our affiliates were named defendants
in actions brought by Jack Grynberg on behalf of the U.S. Government under the
False Claims Act. Generally, these complaints allege an industry-wide conspiracy
to underreport the heating value as well as the volumes of the natural gas
produced from federal and Native American lands, which deprived the U.S.
Government of royalties. The plaintiff in this case seeks royalties that he
contends the government should have received had the volume and heating value of
natural gas produced from royalty properties been differently measured,
analyzed, calculated and reported, together with interest, treble damages, civil
penalties, expenses and future injunctive relief to require the defendants to
adopt allegedly appropriate gas measurement practices. No monetary relief has
been specified in this case. These matters have been consolidated for pretrial
purposes (In re: Natural Gas Royalties Qui Tam Litigation, U.S. District Court
for the District of Wyoming, filed June 1997). In May 2001, the court denied the
defendants' motions to dismiss. Discovery is proceeding. Our costs and legal
exposure related to these lawsuits and claims are currently not determinable.
Will Price (formerly Quinque). We and a number of our affiliates were
named defendants in Quinque Operating Company et al v. Gas Pipelines and Their
Predecessors, et al, filed in 1999 in the District Court of Stevens County,
Kansas. Quinque has been dropped as a plaintiff and Will Price has been added.
This class action complaint alleges that the defendants mismeasured natural gas
volumes and heating content of natural gas on non-federal and non-Native
American lands. The plaintiff in this case seeks certification of a nationwide
class of natural gas working interest owners and natural gas royalty owners to
recover royalties that the plaintiff contends these owners should have received
had the volume and heating value of natural gas produced from their properties
been differently measured, analyzed, calculated and reported, together with
prejudgment and postjudgment interest, punitive damages, treble damages,
attorney's fees, costs and expenses, and future injunctive relief to require the
defendants to adopt allegedly appropriate gas measurement practices. No monetary
relief has been specified in this case. Plaintiff's motion for class
certification was denied on April 10, 2003. Our costs and legal exposure related
to these lawsuits and claims are currently not determinable.
In addition to the above matters, we and our subsidiaries and affiliates
are named defendants in numerous lawsuits and governmental proceedings that
arise in the ordinary course of our business.
For each of our outstanding legal matters, we evaluate the merits of the
case, our exposure in the matter, possible legal or settlement strategies and
the likelihood of an unfavorable outcome. If we determine that an unfavorable
outcome is probable and can be estimated, we establish the necessary accruals.
As of March 31, 2003, we had accrued approximately $419 million for all
outstanding legal matters.
9
Environmental Matters
We are subject to federal, state and local laws and regulations governing
environmental quality and pollution control. These laws and regulations require
us to remove or remedy the effect on the environment of the disposal or release
of specified substances at current and former operating sites. As of March 31,
2003, we had accrued approximately $28 million for expected remediation costs at
current and former sites and associated onsite, offsite and groundwater
technical studies and for related environmental legal costs, which we anticipate
incurring through 2027. Our reserve estimates range from a low estimate of
approximately $27 million to a high estimate of approximately $54 million. Our
accrual at March 31, 2003 was based on the probability of the range of
reasonably possible outcomes. Below is a reconciliation of our accrued liability
as of March 31, 2003 (in millions).
<Table>
Balance as of January 1..................................... $29
Additions/adjustments for remediation activities............ (1)
---
Balance as of March 31...................................... $28
===
</Table>
In addition, we expect to make capital expenditures for environmental
matters of approximately $3 million in the aggregate for the years 2003 through
2008. These expenditures primarily relate to compliance with clean air
regulations. For 2003, we estimate that our total remediation expenditures will
be approximately $1 million, which primarily will be expended under government
directed clean-up plans.
CERCLA Matters. We have received notice that we could be designated, or
have been asked for information to determine whether we could be designated, as
a Potentially Responsible Party (PRP) with respect to four active sites under
the Comprehensive Environmental Response, Compensation and Liability Act
(CERCLA) or state equivalents. We have sought to resolve our liability as a PRP
at these sites through indemnification by third parties and settlements which
provide for payment of our allocable share of remediation costs. As of March 31,
2003, we have estimated our share of the remediation costs at these sites to be
between $14 million and $18 million. Since the clean-up costs are estimates and
are subject to revision as more information becomes available about the extent
of remediation required, and because in some cases we have asserted a defense to
any liability, our estimates could change. Moreover, liability under the federal
CERCLA statute is joint and several, meaning that we could be required to pay in
excess of our pro rata share of remediation costs. Our understanding of the
financial strength of other PRPs has been considered, where appropriate, in
determining our estimated liabilities.
It is possible that new information or future developments could require us
to reassess our potential exposure related to environmental matters. We may
incur significant costs and liabilities in order to comply with existing
environmental laws and regulations. It is also possible that other developments,
such as increasingly strict environmental laws and regulations and claims for
damages to property, employees, other persons and the environment resulting from
our current or past operations, could result in substantial costs and
liabilities in the future. As this information becomes available, or other
relevant developments occur, we will adjust our accrual amounts accordingly.
While there are still uncertainties relating to the ultimate costs we may incur,
based upon our evaluation and experience to date, we believe the reserves are
adequate.
Rates and Regulatory Matters
CPUC Complaint Proceeding. In April 2000, the CPUC filed a complaint under
Section 5 of the Natural Gas Act (NGA) with the FERC alleging that our sale of
approximately 1.2 billion cubic feet per day of capacity to our affiliate, El
Paso Merchant Energy Company (EPME), raised issues of market power and violation
of FERC's marketing affiliate regulations and asked that the contracts be
voided. Although the FERC held that we did not violate its marketing affiliate
requirements, it established a hearing before an ALJ to address the market power
issue. In the spring and summer of 2001, two hearings were held before the ALJ
to address the market power issue and, at the request of the ALJ, the affiliate
issue. In October 2001, the ALJ issued an initial decision on the two issues,
finding that the record did not support a finding that either we or EPME had
exercised market power and that accordingly the market power claims against us
should be
10
dismissed. The ALJ found, however, that we had violated FERC's marketing
affiliate rule. We and other parties filed briefs on exceptions and briefs
opposing exceptions to the October initial decision.
Also, in October 2001, the FERC's Office of Market Oversight and
Enforcement filed comments stating that the record at the hearings was
inadequate to conclude that we had complied with FERC regulations in the
transportation of gas to California. In December 2001, the FERC remanded the
proceeding to the ALJ for a supplemental hearing on the availability of capacity
at our California delivery points. On September 23, 2002, the ALJ issued his
initial decision, again finding that there was no evidence that EPME had
exercised market power during the period at issue to drive up California gas
prices and therefore recommending that the complaint against EPME be dismissed.
However, the ALJ found that we had withheld at least 345 MMcf/d of capacity (and
perhaps as much as 696 MMcf/d) from the California market during the period from
November 1, 2000 through March 31, 2001. The ALJ found that this alleged
withholding violated our certificate obligations and was an exercise of market
power that increased the gas price to California markets. He therefore
recommended that the FERC initiate penalty procedures against us. We and others
filed briefs on exceptions to the initial decision on October 23, 2002; briefs
opposing exceptions were filed on November 12, 2002. This proceeding will be
resolved upon finalization and approval of the Western Energy Settlement.
Systemwide Capacity Allocation Proceeding. In July 2001, several of our
contract demand or CD customers filed a complaint against us at the FERC
claiming, among other things, that our full requirements contracts or FR
contracts (contracts with no volumetric limitations) should be converted to CD
contracts, and that we should be required to expand our system and give demand
charge credits to CD customers when we are unable to meet their full contract
demands. In July 2001, several of our FR customers filed a complaint alleging
that we had violated the Natural Gas Act and our contractual obligations to them
by not expanding our system, at our cost, to meet their increased requirements.
On May 31, 2002, the FERC issued an order on the complaints in which it
required that (i) FR service, for all FR customers except small volume
customers, be converted to CD service; (ii) firm customers be assigned specific
receipt point rights in lieu of their existing systemwide receipt point rights;
(iii) reservation charge credits be given to all firm customers for failure to
schedule confirmed volumes except in cases of force majeure; (iv) no new firm
contracts be executed until we have demonstrated there is adequate capacity on
the system; and (v) a process be implemented to allow existing CD customers to
turn back capacity for acquisition by FR customers in which process we would
remain revenue neutral. These changes were to be made effective November 1,
2002. The order also stated that the FERC expected us to file for certificate
authority to add compression to Line 2000 to increase our system capacity by 320
MMcf/d without cost coverage until our next rate case (i.e. January 1, 2006). We
had previously informed the FERC that we were willing to add compression to Line
2000 provided we were assured of rate coverage in the next rate case. On July 1,
2002, we and other parties filed for clarification and/or rehearing of the May
31 order.
On September 20, 2002, at the urging of the FR shippers, the FERC issued an
order postponing until May 1, 2003 the effective date of the FR conversions.
That order also required us to allocate among our FR customers (i) the 320
MMcf/d of capacity that will be available from the addition of compression to
Line 2000, and (ii) any firm capacity that expires under existing contracts
between May 31, 2002, and May 1, 2003, thereby precluding us from reselling that
capacity. In total, the September 20 order requires that our FR customers pay
only their current aggregate reservation charges for existing unsubscribed
capacity, for the 230 MMcf/d of capacity made available in November 2002 by our
Line 2000 project, for the 320 MMcf/d of capacity from the addition of
compression to Line 2000, and for all capacity subject to contracts expiring
before May 1, 2003.
On April 14, 2003, the FERC issued an order granting a motion by the FR
shippers for deferral of the May 1 implementation date pending FERC review of
the Western Energy Settlement. The order reset the implementation date to
September 1, 2003. Beginning on that date and subject to the substantive
requirements of the September 20, 2002 order, we will be required to pay
reservation charge credits when we are unable to schedule confirmed volumes
except in cases of force majeure. Until September 1, 2003, we are required to
pay partial reservation charge credits to CD customers when we are unable to
schedule 95 percent
11
of their monthly confirmed volumes except for reasons of force majeure and
provided that there is no capacity available from other supply basins on our
system.
Several pleadings have been filed in response to the September 20 order,
including rehearing requests and requests by several customers to modify the
order based on the ALJ's decision in the CPUC Complaint Proceeding discussed
above. All such pleadings remain pending before the FERC.
On October 7, 2002, we filed tariff sheets in compliance with the September
20 order to implement a partial demand charge credit for the period November 1,
2002 to May 6, 2003, and to allow California delivery points to be used as
secondary receipt points to the extent of our backhaul displacement
capabilities. We proposed both a reservation and a usage charge for this
service. On December 26, 2002, the FERC issued an order (i) denying our request
to charge existing CD customers a reservation rate for California receipt
service for the remaining term of the settlement, i.e., through December 31,
2005; (ii) allowing us to charge our maximum IT rate for the service; (iii)
approving our proposed usage rate for the service until our next rate case; and
(iv) requiring us to make a showing that capacity is available for any new
shippers utilizing this service. We made a revised tariff filing on January 10,
2003, in compliance with the December 26 order. On January 27, 2003, we filed a
request for rehearing on certain aspects of the December 26 order. That request
is pending.
Rate Settlement. Our current rate settlement establishes our base rates
through December 31, 2005. Under the settlement, our base rates began escalating
annually in 1998 for inflation. We have the right to increase or decrease our
base rates if changes in laws or regulations result in increased or decreased
costs in excess of $10 million a year. In addition, all of our settling
customers participate in risk sharing provisions. Under these provisions, we
will receive cash payments in total of $295 million for a portion of the risk we
assumed from capacity relinquishments by our customers (primarily capacity
turned back to us by Southern California Gas Company and Pacific Gas & Electric
Company which represented approximately one-third of the capacity of our system)
during 1996 and 1997. The cash we received was deferred, and we recognize this
amount in revenues ratably over the risk sharing period. As of March 31, 2003,
we had unearned risk sharing revenues of approximately $24 million and had $10
million remaining to be collected from customers under this provision. Amounts
received for relinquished capacity sold to customers, above certain dollar
levels specified in our rate settlement, obligate us to refund a portion of the
excess to customers. Under this provision, we refunded a total of $46 million of
2002 revenues to customers during 2002 and the first quarter of 2003. During
2003, we established an additional refund obligation of $10 million. Both the
risk and revenue sharing provisions of the rate settlement extend through 2003.
Line 2000 Project. On July 31, 2000, we applied with the FERC for a
certificate of public convenience and necessity for our Line 2000 project, which
was designed to replace old compression on the system with a converted oil
pipeline, resulting in no increase in system capacity. In response to demand
conditions on our system, however, we filed in March 2001 to amend our
application to convert the project to an expansion project of 230 MMcf/d. On May
7, 2001, the FERC authorized the amended Line 2000 project. We placed the line
in service in November 2002 at an approximate capital cost of $185 million. The
cost of the Line 2000 conversion will not be included in our rates until our
next rate case, which will be effective on January 1, 2006.
On October 3, 2002, pursuant to the FERC's May 31 and September 20 orders
in the systemwide capacity allocation proceeding, we filed with the FERC for a
certificate of public convenience and necessity to add compression to our Line
2000 project to increase the capacity of that line by an additional 320 MMcf/d
at an estimated capital cost of approximately $173 million for all phases. That
application has been protested, and remains pending. In our request for
clarification of the September 20 order, we have asked for assurances from the
FERC that we will be able to begin cost recovery for this project at the time
our next rate case becomes effective. That request remains pending.
Marketing Affiliate NOPR. In September 2001, the FERC issued a Notice of
Proposed Rulemaking (NOPR). The NOPR proposes to apply the standards of conduct
governing the relationship between interstate pipelines and marketing affiliates
to all energy affiliates. The proposed regulations, if adopted by the FERC,
would dictate how we conduct business and interact with our energy affiliates.
In December 2001, we filed comments with the FERC addressing our concerns with
the proposed rules. A public hearing was held on
12
May 21, 2002, providing an opportunity to comment further on the NOPR. Following
the conference, additional comments were filed by El Paso's pipelines and
others. At this time, we cannot predict the outcome of the NOPR, but adoption of
the regulations in their proposed form would, at a minimum, place additional
administrative and operational burdens on us.
Negotiated Rate NOI. In July 2002, the FERC issued a Notice of Inquiry
(NOI) that seeks comments regarding its 1996 policy of permitting pipelines to
enter into negotiated rate transactions. We have entered into these transactions
over the years, and the FERC is now reviewing whether negotiated rates should be
capped, whether or not the "recourse rate" (a cost-of-service based rate)
continues to safeguard against a pipeline exercising market power and other
issues related to negotiated rate programs. On September 25, 2002, El Paso's
pipelines and others filed comments. Reply comments were filed on October 25,
2002. At this time, we cannot predict the outcome of this NOI.
Cash Management NOPR. On August 1, 2002, the FERC issued a NOPR requiring
that all cash management or money pool arrangements between a FERC regulated
subsidiary (like us) and a non-FERC regulated parent must be in writing, and set
forth the duties and responsibilities of cash management participants and
administrators; the methods of calculating interest and for allocating interest
income and expenses; and the restrictions on deposits or borrowings by money
pool members. The NOPR also requires specified documentation for all deposits
into, borrowings from, interest income from, and interest expenses related to,
these arrangements. Finally, the NOPR proposed that as a condition of
participating in a cash management or money pool arrangement, the FERC regulated
entity maintain a minimum proprietary capital balance of 30 percent, and the
FERC regulated entity and its parent maintain investment grade credit ratings.
On August 28, 2002, comments were filed. The FERC held a public conference on
September 25, 2002, to discuss the issues raised in the comments.
Representatives of companies from the gas and electric industries participated
on a panel and uniformly agreed that the proposed regulations should be revised
substantially and that the proposed capital balance and investment grade credit
rating requirements would be excessive. At this time, we cannot predict the
outcome of this NOPR.
Also on August 1, 2002, the FERC's Chief Accountant issued an Accounting
Release, which was effective immediately. The Accounting Release provides
guidance on how companies should account for money pool arrangements and the
types of documentation that should be maintained for these arrangements.
However, it did not address the proposed requirements that the FERC regulated
entity maintain a minimum proprietary capital balance of 30 percent and that the
entity and its parent have investment grade credit ratings. Requests for
rehearing were filed on August 30, 2002. The FERC has not yet acted on the
rehearing requests.
Emergency Reconstruction of Interstate Natural Gas Facilities NOPR. On
January 17, 2003, FERC issued a NOPR proposing, in emergency situations, to (1)
expand the scope of construction activities authorized under a pipeline's
blanket certificate to allow replacement of mainline facilities; (2) authorize a
pipeline to commence reconstruction of the affected system without a waiting
period; and (3) authorize automatic approval of construction that would be above
the normal cost ceiling. Comments on the NOPR were filed on February 27, 2003.
At this time, we cannot predict the outcome of this rulemaking.
Pipeline Safety Notice of Proposed Rulemaking. On January 28, 2003, the
U.S. Department of Transportation issued a NOPR proposing to establish a rule
requiring pipeline operators to develop integrity management programs to
comprehensively evaluate their pipelines, and take measures to protect pipeline
segments located in what the notice refers to as "high consequence areas." The
proposed rule resulted from the enactment of the Pipeline Safety Improvement Act
of 2002, a new bill signed into law in December 2002. Comments on the NOPR were
filed on April 30, 2003. At this time, we cannot predict the outcome of this
rulemaking.
Other Matters
Enron Bankruptcy. In December 2001, Enron Corp. and a number of its
subsidiaries, including Enron North America Corp. and Enron Power Marketing,
Inc., filed for Chapter 11 bankruptcy protection in the United States Bankruptcy
Court for the Southern District of New York. Enron North America had
13
transportation contracts on our system. The transportation contracts have now
been rejected and we have filed a proof of claim in the amount of approximately
$128 million, which included $18 million for amounts due for services provided
through the date the contracts were rejected and $110 million for damage claims
arising from the rejection of its transportation contracts. The September 20
order capacity allocation proceeding discussed in Rates and Regulatory Matters
above currently prohibits us from remarketing Enron capacity that was not
remarketed prior to May 31, 2002. We have sought rehearing of the September 20
order. We have fully reserved for all amounts due from Enron through the date
the contracts were rejected, and we have not recognized any amounts under these
contracts since the rejection date.
While the outcome of our outstanding legal matters, environmental matters,
and rates and regulatory matters cannot be predicted with certainty, based on
current information and our existing accruals, we do not expect the ultimate
resolution of these matters to have a material adverse effect on our financial
position, operating results or cash flows. However, it is possible that new
information or future developments could require us to reassess our potential
exposure related to these matters. It is also possible that these matters could
impact our debt rating and the credit rating of our parent. Further, for
environmental matters, it is also possible that other developments, such as
increasingly strict environmental laws and regulations and claims for damages to
property, employees, other persons and the environment resulting from our
current or past operations, could result in substantial costs and liabilities in
the future. As new information for our outstanding legal matters, environmental
matters and rates and regulatory matters becomes available, or relevant
developments occur, we will review our accruals and make any appropriate
adjustments. The impact of these changes may have a material effect on our
results of operations, our financial position, and on our cash flows in the
period the event occurs.
5. RELATED PARTY TRANSACTIONS
We participate in El Paso's cash management program which matches
short-term cash surpluses and need requirements of participating affiliates,
thus minimizing total borrowings from outside sources. Our continued
participation in the program may be dependent on any final rule issued by the
FERC in connection with its cash management notice of proposed rulemaking
discussed in Note 4. As of March 31, 2003 and December 31, 2002, we had advanced
to El Paso $1,033 million and $990 million. The market rate of interest at March
31, 2003 and December 31, 2002, was 1.3% and 1.5%. As of March 31, 2003 and
December 31, 2002, we have classified $608 million and $565 million of these
advances as non-current notes receivable from affiliates. These receivables were
due upon demand; however, we do not anticipate settlement within the next twelve
months.
At March 31, 2003 and December 31, 2002, we had other accounts receivable
from related parties of $6 million and $7 million. Accounts payable to
affiliates was $7 million at March 31, 2003, versus $33 million at December 31,
2002. These balances arose in the normal course of business.
As of March 31, 2003, we had accrued $7 million in dividends associated
with our preferred stock. On April 3, 2003, El Paso contributed its 500,000
shares of our 8% preferred stock to us, including the accrued dividends.
The following table shows revenues and charges from our affiliates for the
quarters ended March 31:
<Table>
<Caption>
2003 2002
----- -----
(IN MILLIONS)
Revenues from affiliates.................................... $ 4 $13
Operations and maintenance from affiliates.................. 18 17
Reimbursement for operating expenses from affiliates........ 4 1
</Table>
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information contained in Item 2 updates, and should be read in
conjunction with, the information disclosed in our 2002 Form 10-K in addition to
the financial statements and notes presented in Item 1, Financial Statements, of
this Form 10-Q.
RESULTS OF OPERATIONS
We use earnings before interest and income taxes (EBIT) to assess the
operating results and effectiveness of our business. EBIT is operating income
adjusted to include miscellaneous non-operating income. Items that are not
included in this measure are financing costs, including interest and debt
expense and income taxes. We believe this measurement is useful to our investors
because it allows them to evaluate the effectiveness of our businesses and
operations and our investments from an operational perspective, exclusive of the
costs to finance those activities and exclusive of income taxes. This
measurement may not be comparable to measurements used by other companies and
should not be used as a substitute for net income or other performance measures
such as operating income or operating cash flow. Presented below is a
reconciliation of our operating income to EBIT and EBIT to net income, and a
discussion of our results of operations were as follows for the quarters ended
March 31:
<Table>
<Caption>
2003 2002
-------- --------
(IN MILLIONS, EXCEPT
VOLUME AMOUNTS)
Operating revenues.......................................... $ 132 $ 152
Operating expenses.......................................... (59) (70)
------ ------
Operating income.......................................... 73 82
Other income................................................ 1 --
------ ------
EBIT...................................................... 74 82
Interest and debt expense................................... (20) (16)
Affiliated interest income, net............................. 3 6
Income taxes................................................ (22) (28)
------ ------
Net income................................................ $ 35 $ 44
====== ======
Throughput volumes (BBtu/d)(1).............................. 4,069 4,203
====== ======
</Table>
- ---------------
(1) BBtu/d means billion British thermal units per day.
First Quarter 2003 Compared to First Quarter 2002
Operating revenues for the quarter ended March 31, 2003, were $20 million
lower than the same period in 2002. A decrease of $15 million was due to
capacity contracts that have expired which we are prohibited from remarketing
due to our September 20, 2002 FERC order. For further discussion of this order,
see Item 1, Note 4. Also contributing to the decrease was a $6 million fuel
settlement related to our Mojave Pipeline rate case settled in the first quarter
of 2002. These decreases were partially offset by $2 million of higher
throughput-based revenues from transportation to interconnecting pipelines
serving markets in the midwest and east due to colder weather in 2003.
Operating expenses for the quarter ended March 31, 2003, were $11 million
lower than the same period in 2002. A decrease of $9 million was due to bad debt
expense recorded in 2002 related to the bankruptcy of Enron Corp. Also
contributing to the decrease was a $4 million decrease in our estimated purchase
power costs in 2003, $2 million due to the periodic revaluation of natural gas
imbalances due to higher natural gas prices in 2003 and $1 million related to an
insurance settlement for environmental claims received in 2003. These decreases
were partially offset by a $4 million expense related to the amortization of the
discount associated with the Western Energy Settlement obligation and a $2
million unfavorable fuel variance due to lower pipeline fuel recoveries.
15
INTEREST AND DEBT EXPENSE
Below is the analysis of our interest expense for the quarter ended March
31 (in millions):
<Table>
<Caption>
2003 2002
---- ----
Long term debt, including current maturities................ $20 $14
Commercial paper............................................ -- 4
Other interest.............................................. 1 --
Less: capitalized interest.................................. (1) (2)
--- ---
Total interest expense................................. $20 $16
=== ===
</Table>
Interest and debt expense for the quarter ended March 31, 2003, was $4
million higher than the same period in 2002. The increase was primarily due to a
$6 million increase in interest related to the issuance of $300 million of
long-term debt in June 2002, which was partially offset by lower interest
expense of $4 million due to the discontinuation of commercial paper activities
in the fourth quarter of 2002.
AFFILIATED INTEREST INCOME
Affiliated interest income for the quarter ended March 31, 2003, was $3
million lower than the same period in 2002 due to lower short-term interest
rates in 2003 and lower average balances advanced to El Paso under our cash
management program. The average short-term interest rates for the first quarter
decreased from 1.9% in 2002 to 1.4% in 2003. The average advance balance
decreased in the first quarter from $1.3 billion in 2002 to $1.0 billion in
2003.
INCOME TAXES
The income tax expense for the quarters ended March 31, 2003 and 2002, was
$22 million and $28 million, resulting in effective tax rates of 39 percent for
both periods. Our effective tax rates were different from the statutory rate of
35 percent primarily due to state income taxes.
COMMITMENTS AND CONTINGENCIES
See Item 1, Financial Statements, Note 4, which is incorporated herein by
reference.
16
CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE
SECURITIES LITIGATION REFORM ACT OF 1995
This report contains or incorporates by reference forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. Where any forward-looking statement includes a statement of the
assumptions or bases underlying the forward-looking statement, we caution that,
while we believe these assumptions or bases to be reasonable and to be made in
good faith, assumed facts or bases almost always vary from the actual results,
and the differences between assumed facts or bases and actual results can be
material, depending upon the circumstances. Where, in any forward-looking
statement, we or our management express an expectation or belief as to future
results, that expectation or belief is expressed in good faith and is believed
to have a reasonable basis. We cannot assure you, however, that the statement of
expectation or belief will result or be achieved or accomplished. The words
"believe," "expect," "estimate," "anticipate" and similar expressions will
generally identify forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
This information updates, and you should read it in conjunction with,
information disclosed in Part II, Item 7A in our Annual Report on Form 10-K for
the year ended December 31, 2002, in addition to the information presented in
Items 1 and 2 of this Quarterly Report on Form 10-Q.
There are no material changes in our quantitative and qualitative
disclosures about market risks from those reported in our Annual Report on Form
10-K for the year ended December 31, 2002.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Controls and Procedures. Under the supervision and with the
participation of management, including our principal executive officers and
principal financial officer, we have evaluated the effectiveness of the design
and operation of our disclosure controls and procedures (Disclosure Controls)
and internal controls (Internal Controls) within 90 days of the filing date of
this Quarterly Report pursuant to Rules 13a-15 and 15d-15 under the Securities
Exchange Act of 1934 (Exchange Act).
Definition of Disclosure Controls and Internal Controls. Disclosure
Controls are our controls and other procedures that are designed to ensure that
information required to be disclosed by us in the reports that we file or submit
under the Exchange Act is recorded, processed, summarized and reported, within
the time periods specified under the Exchange Act. Disclosure Controls include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by us in the reports that we file under the Exchange
Act is accumulated and communicated to our management, including our principal
executive officer and principal financial officer, as appropriate to allow
timely decisions regarding required disclosure. Internal Controls are procedures
which are designed with the objective of providing reasonable assurance that (1)
our transactions are properly authorized; (2) our assets are safeguarded against
unauthorized or improper use; and (3) our transactions are properly recorded and
reported, all to permit the preparation of our financial statements in
conformity with generally accepted accounting principles.
Limitations on the Effectiveness of Controls. El Paso Natural Gas
Company's management, including the principal executive officer and principal
financial officer, does not expect that our Disclosure Controls and Internal
Controls will prevent all errors and all fraud. A control system, no matter how
well conceived and operated, can provide only reasonable, not absolute,
assurance that the objectives of the control system are met. Further, the design
of a control system must reflect the fact that there are resource constraints,
and the benefits of controls must be considered relative to their costs. Because
of the inherent limitations in all control systems, no evaluation of controls
can provide absolute assurance that all control issues and instances of fraud,
if any, within the company have been detected. These inherent limitations
include the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple errors or mistakes. Additionally,
controls can be circumvented by the individual acts of some persons, by
collusion of two or more people, or by management override of the controls. The
design of any system of controls also is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future
conditions. Over time, controls may become
17
inadequate because of changes in conditions, or the degree of compliance with
the policies or procedures may deteriorate. Because of the inherent limitations
in a cost-effective control system, misstatements due to error or fraud may
occur and not be detected.
No Significant Changes in Internal Controls. We have sought to determine
whether there were any "significant deficiencies" or "material weaknesses" in El
Paso Natural Gas Company's Internal Controls, or whether the company had
identified any acts of fraud involving personnel who have a significant role in
El Paso Natural Gas Company's Internal Controls. This information was important
both for the controls evaluation generally and because the principal executive
officer and principal financial officer are required to disclose that
information to our Board and our independent auditors and to report on related
matters in this section of the Quarterly Report. The principal executive officer
and principal financial officer note that, from the date of the controls
evaluation to the date of this Quarterly Report, there have been no significant
changes in Internal Controls or in other factors that could significantly affect
Internal Controls, including any corrective actions with regard to significant
deficiencies and material weaknesses.
Effectiveness of Disclosure Controls. Based on the controls evaluation,
our principal executive officer and principal financial officer have concluded
that, subject to the limitations discussed above, the Disclosure Controls are
effective to ensure that material information related to El Paso Natural Gas
Company and its consolidated subsidiaries is made known to management, including
the principal executive officer and principal financial officer, particularly
during the period when our periodic reports are being prepared.
Officer Certifications. The certifications from the principal executive
officer and principal financial officer required under Sections 302 and 906 of
the Sarbanes-Oxley Act of 2002 have been included herein, or as Exhibits to this
Quarterly Report, as appropriate.
18
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See Part I, Item 1, Financial Statements, Note 4, which is incorporated
herein by reference.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits
Each exhibit identified below is filed as a part of this report. Exhibits
not incorporated by reference to a prior filing are designated by an "*"; all
exhibits not so designated are incorporated herein by reference to a prior
filing as indicated.
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
10.A $3,000,000,000 Revolving Credit Agreement dated as of April
16, 2003 among El Paso Corporation, El Paso Natural Gas
Company, Tennessee Gas Pipeline Company and ANR Pipeline
Company, as Borrowers, the Lenders Party thereto, and
JPMorgan Chase Bank, as Administrative Agent, ABN Amro Bank
N.V. and Citicorp North America, Inc., as Co-Document
Agents, Bank of America, N.A. and Credit Suisse First
Boston, as Co-Syndication Agents, J.P. Morgan Securities
Inc. and Citigroup Global Markets Inc., as Joint Bookrunners
and Co-Lead Arrangers. (Exhibit 99.1 to El Paso
Corporation's Form 8-K filed April 18, 2003, Commission File
No. 1-2700).
10.B $1,000,000,000 Amended and Restated 3-Year Revolving Credit
Agreement dated as of April 16, 2003 among El Paso
Corporation, El Paso Natural Gas Company and Tennessee Gas
Pipeline Company, as Borrowers, The Lenders Party thereto,
and JPMorgan Chase Bank, as Administrative Agent, ABN Amro
Bank N.V. and Citicorp North America, Inc., as Co-Document
Agents, Bank of America, N.A., as Syndication Agent, J.P.
Morgan Securities Inc. and Citigroup Global Markets Inc., as
Joint Bookrunners and Co-Lead Arrangers. (Exhibit 99.2 to El
Paso Corporation's Form 8-K filed April 18, 2003, Commission
File No. 1-2700).
10.C Security and Intercreditor Agreement dated as of April 16,
2003 among El Paso Corporation, the persons referred to
therein as Pipeline Company Borrowers, the persons referred
to therein as Grantors, each of the Representative Agents,
JPMorgan Chase Bank, as Credit Agreement Administrative
Agent and JPMorgan Chase Bank, as Collateral Agent,
Intercreditor Agent, and Depository Bank. (Exhibit 99.3 to
El Paso Corporation's Form 8-K filed April 18, 2003,
Commission File No. 1-2700).
*99.A Certification of Chief Executive Officer pursuant to 18
U.S.C. sec. 1350 as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act of 2002.
*99.B Certification of Chief Financial Officer pursuant to 18
U.S.C. sec. 1350 as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act of 2002.
</Table>
Undertaking
We hereby undertake, pursuant to Regulation S-K, Item 601(b),
paragraph (4)(iii), to furnish to the U.S. Securities and Exchange
Commission, upon request, all constituent instruments defining the rights
of holders of our long-term debt not filed herewith for the reason that the
total amount of securities authorized under any of such instruments does
not exceed 10 percent of our total consolidated assets.
b. Reports on Form 8-K
We filed a Current Report on Form 8-K dated March 21, 2003 announcing
information regarding the Western Energy Settlement.
We filed a Current Report on Form 8-K dated April 18, 2003 announcing
amendments to our financing facilities.
We filed a Current Report on Form 8-K dated April 24, 2003 of our
Computation of Ratio of Earnings to Fixed Charges for the five years ended
December 31, 2002.
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
EL PASO NATURAL GAS COMPANY
Date: May 14, 2003 /s/ JOHN W. SOMERHALDER II
------------------------------------
John W. Somerhalder II
Chairman of the Board,
Chief Executive Officer and Director
(Principal Executive Officer)
Date: May 14, 2003 /s/ GREG G. GRUBER
------------------------------------
Greg G. Gruber
Senior Vice President,
Chief Financial Officer and
Treasurer
(Principal Financial and Accounting
Officer)
21
CERTIFICATION
I, John W. Somerhalder II, certify that:
1. I have reviewed this quarterly report on Form 10-Q of El Paso Natural
Gas Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003 /s/ JOHN W. SOMERHALDER II
------------------------------------
John W. Somerhalder II
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)
El Paso Natural Gas Company
22
CERTIFICATION
I, Greg G. Gruber, certify that:
1. I have reviewed this quarterly report on Form 10-Q of El Paso Natural
Gas Company;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrants and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003
/s/ GREG G. GRUBER
--------------------------------------
Greg G. Gruber
Senior Vice President,
Chief Financial Officer and Treasurer
(Principal Financial Officer)
El Paso Natural Gas Company
23
EXHIBIT INDEX
Each exhibit identified below is filed as a part of this report. Exhibits
not incorporated by reference to a prior filing are designated by an "*"; all
exhibits not so designated are incorporated herein by reference to a prior
filing as indicated.
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
10.A $3,000,000,000 Revolving Credit Agreement dated as of April
16, 2003 among El Paso Corporation, El Paso Natural Gas
Company, Tennessee Gas Pipeline Company and ANR Pipeline
Company, as Borrowers, the Lenders Party thereto, and
JPMorgan Chase Bank, as Administrative Agent, ABN Amro Bank
N.V. and Citicorp North America, Inc., as Co-Document
Agents, Bank of America, N.A. and Credit Suisse First
Boston, as Co-Syndication Agents, J.P. Morgan Securities
Inc. and Citigroup Global Markets Inc., as Joint Bookrunners
and Co-Lead Arrangers. (Exhibit 99.1 to El Paso
Corporation's Form 8-K filed April 18, 2003, Commission File
No. 1-2700).
10.B $1,000,000,000 Amended and Restated 3-Year Revolving Credit
Agreement dated as of April 16, 2003 among El Paso
Corporation, El Paso Natural Gas Company and Tennessee Gas
Pipeline Company, as Borrowers, The Lenders Party thereto,
and JPMorgan Chase Bank, as Administrative Agent, ABN Amro
Bank N.V. and Citicorp North America, Inc., as Co-Document
Agents, Bank of America, N.A., as Syndication Agent, J.P.
Morgan Securities Inc. and Citigroup Global Markets Inc., as
Joint Bookrunners and Co-Lead Arrangers. (Exhibit 99.2 to El
Paso Corporation's Form 8-K filed April 18, 2003, Commission
File No. 1-2700).
10.C Security and Intercreditor Agreement dated as of April 16,
2003 among El Paso Corporation, the persons referred to
therein as Pipeline Company Borrowers, the persons referred
to therein as Grantors, each of the Representative Agents,
JPMorgan Chase Bank, as Credit Agreement Administrative
Agent and JPMorgan Chase Bank, as Collateral Agent,
Intercreditor Agent, and Depository Bank. (Exhibit 99.3 to
El Paso Corporation's Form 8-K filed April 18, 2003,
Commission File No. 1-2700).
*99.A Certification of Chief Executive Officer pursuant to 18
U.S.C. sec. 1350 as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act of 2002.
*99.B Certification of Chief Financial Officer pursuant to 18
U.S.C. sec. 1350 as adopted pursuant to sec. 906 of the
Sarbanes-Oxley Act of 2002.
</Table>