AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 24, 2003
REGISTRATION NOS. 333-106586-01
333-106586-02
333-106586-03
333-106586-04
333-106586-05
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------------------
AMENDMENT NO. 2
TO
FORM S-4
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
------------------------------------
EL PASO PRODUCTION HOLDING COMPANY
(Exact name of registrant as specified in its charter)
<Table>
DELAWARE 1311 76-0659544
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification Number)
</Table>
Additional Subsidiary Guarantor Registrants Listed on Following Page
------------------------------------
<Table>
EL PASO BUILDING ROBERT W. BAKER, ESQ.
1001 LOUISIANA STREET EL PASO BUILDING
HOUSTON, TEXAS 77002 1001 LOUISIANA STREET
(713) 420-2600 HOUSTON, TEXAS 77002
(Address, including zip code, and telephone (713) 420-2600
number, including area code, of registrant's (Name, address, including zip code, and telephone
principal executive offices) number, including area code, of agent for service)
</Table>
------------------------------------
<Table>
COPIES TO:
G. MICHAEL O'LEARY KELLY J. JAMESON, ESQ.
ANDREWS KURTH LLP EL PASO BUILDING
600 TRAVIS STREET 1001 LOUISIANA STREET
SUITE 4200 HOUSTON, TEXAS 77002
HOUSTON, TEXAS 77002 (713) 420-2600
(713) 220-4200
</Table>
------------------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE OF THE SECURITIES TO THE
PUBLIC: As soon as practicable after this registration statement becomes
effective.
If the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective Amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
------------------------------------
CALCULATION OF REGISTRATION FEE
<Table>
<Caption>
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
AMOUNT PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF TO BE OFFERING PRICE AGGREGATE OFFERING AMOUNT OF
SECURITIES TO BE REGISTERED REGISTERED PER UNIT(1) PRICE(1) REGISTRATION FEE
- ------------------------------------------------------------------------------------------------------------------------
7 3/4% Senior Notes due 2013........ $1,200,000,000 100% $1,200,000,000 $97,080(1)
Guarantees of 7 3/4% Senior Notes
due 2013(2)....................... -- -- -- (3)
- ------------------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------------
</Table>
(1) Calculated in accordance with Rule 457(f)(2). For purposes of this
calculation, the Offering Price per Note was assumed to be the stated
principal amount of each original note that may be received by the
Registrant in the exchange transaction in which the Notes will be offered.
(2) Each of the subsidiaries of El Paso Production Holding Company listed in the
Table of Additional Subsidiary Guarantor Registrants on the following page
has guaranteed the Notes being registered pursuant hereto.
(3) No separate consideration will be received for the Guarantees and,
therefore, no additional registration fee is required.
------------------------------------
EACH REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL SUCH REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
ADDITIONAL SUBSIDIARY GUARANTOR REGISTRANTS
<Table>
<Caption>
STATE OR OTHER JURISDICTION
EXACT NAME OF SUBSIDIARY OF INCORPORATION OR I.R.S. EMPLOYER
GUARANTOR REGISTRANT ORGANIZATION IDENTIFICATION NUMBER
------------------------ --------------------------- ---------------------
El Paso Production Company(1)............................... Delaware 63-0593810
El Paso Production GOM Inc.(1).............................. Delaware 34-1281693
Vermejo Minerals Corporation(1)............................. Delaware 76-0263646
El Paso Energy Raton, L.L.C.(1)............................. Delaware 76-0659544
</Table>
- ---------------
(1) The address for such Subsidiary Guarantor is El Paso Building, 1001
Louisiana Street, Houston, Texas, 77002.
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES, AND WE ARE NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES, IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED NOVEMBER 24, 2003
PROSPECTUS
EL PASO PRODUCTION HOLDING COMPANY
OFFER TO EXCHANGE
REGISTERED 7 3/4% SENIOR NOTES DUE 2013
FOR
ALL OUTSTANDING 7 3/4% SENIOR NOTES DUE 2013
($1,200,000,000 IN PRINCIPAL AMOUNT OUTSTANDING)
We are offering to exchange our registered 7 3/4% Senior Notes due 2013 for
all of our outstanding 7 3/4% Senior Notes due 2013. In this prospectus, we will
call the original notes the "Old Notes" and the registered notes the "New
Notes." The Old Notes and New Notes are collectively referred to in this
prospectus as the "notes."
THE EXCHANGE OFFER
- Expires 5:00 p.m., New York City time, , 2003, unless
extended.
- Subject to certain customary conditions, which we may waive, the exchange
offer is not conditioned upon a minimum aggregate principal amount of Old
Notes being tendered.
- All outstanding Old Notes validly tendered and not withdrawn will be
exchanged.
- The exchange offer is not subject to any condition other than that the
exchange offer not violate applicable law or any applicable
interpretation of the staff of the Securities and Exchange Commission.
THE NEW NOTES
- The terms of the New Notes to be issued in the exchange offer are
substantially identical to the Old Notes, except that we have registered
the New Notes with the Securities and Exchange Commission. In addition,
the New Notes will not be subject to certain transfer restrictions.
- Interest on the New Notes will accrue from May 23, 2003 at the rate of
7 3/4% per annum, payable semi-annually in arrears on each June 1 and
December 1, beginning December 1, 2003.
- The New Notes will be eligible for trading in The Portal(SM) Market, a
subsidiary of the Nasdaq Stock Market, Inc.
---------------------
YOU SHOULD CAREFULLY CONSIDER THE RISK FACTORS BEGINNING ON PAGE 14 OF THIS
PROSPECTUS BEFORE PARTICIPATING IN THE EXCHANGE OFFER.
---------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
---------------------
Each broker-dealer that receives New Notes for its own account pursuant to
the exchange offer must acknowledge that it will deliver a prospectus in
connection with any resale of such New Notes. The letter of transmittal states
that by so acknowledging and by delivering a prospectus, a broker-dealer will
not be deemed to admit that it is an "underwriter" within the meaning of the
Securities Act. This prospectus, as it may be amended or supplemented from time
to time, may be used by a broker-dealer in connection with resales of New Notes
received in exchange for Old Notes where such Old Notes were acquired by such
broker-dealer as a result of market-making activities or other trading
activities. See "Plan of Distribution."
The date of this prospectus is , 2003.
------------------------
TABLE OF CONTENTS
<Table>
<Caption>
PAGE
----
Prospectus Summary.......................................... 1
Risk Factors................................................ 14
Forward-Looking Statements.................................. 25
Use of Proceeds............................................. 26
Capitalization.............................................. 26
Ratio of Earnings to Fixed Charges.......................... 27
Selected Consolidated Historical Financial Data............. 28
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 29
Business and Properties..................................... 42
Security Ownership of Certain Beneficial Owners and
Management................................................ 59
Management.................................................. 60
Certain Relationships and Related Transactions.............. 68
The Exchange Offer.......................................... 72
Description of Notes........................................ 80
Material United States Federal Income Tax Considerations.... 130
Plan of Distribution........................................ 132
Legal Matters............................................... 133
Experts..................................................... 133
Available Information....................................... 133
Glossary of Terms........................................... A-1
Index to Financial Statements............................... F-1
</Table>
------------------------
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS DOCUMENT OR TO
WHICH WE HAVE REFERRED YOU. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH
INFORMATION THAT IS DIFFERENT. THIS DOCUMENT MAY ONLY BE USED WHERE IT IS LEGAL
TO SELL THESE SECURITIES. THE INFORMATION IN THIS DOCUMENT MAY ONLY BE ACCURATE
ON THE DATE OF THIS DOCUMENT.
------------------------
Until , all dealers that effect transactions in these securities,
whether or not participating in this offering, may be required to deliver a
prospectus. This is in addition to the dealers' obligation to deliver a
prospectus when acting as underwriter and with respect to their unused
allotments.
i
PROSPECTUS SUMMARY
This summary contains a brief discussion of information contained elsewhere
in this prospectus. As a summary, it does not contain all of the information
that you should consider before making a decision to exchange your Old Notes for
New Notes. You should read the entire prospectus carefully, including the
historical financial statements and notes to those financial statements included
in this prospectus. Please read "Risk Factors" beginning on page 14 of this
prospectus for more information about important risks that you should consider
before exchanging your Old Notes for New Notes.
In this prospectus, unless the context otherwise indicates, the terms "El
Paso Production" and "we," "us," "our" and similar terms mean El Paso Production
Holding Company and its subsidiaries. The term "Parent EPC" means, depending on
context, El Paso Corporation, one or more of its consolidated subsidiaries, or
all of them taken as a whole.
Unless otherwise indicated, our reserve information as of December 31, 2002
and our production data for the year ended December 31, 2002 contained in this
prospectus give pro forma effect to our asset sale during the first quarter of
2003. Please read "Recent Events" for a description of this asset sale.
We have provided definitions for some of the oil and natural gas industry
terms used in this prospectus in the "Glossary of Terms" beginning on page A-1.
OUR COMPANY
We are a large independent natural gas and oil company engaged in the
exploration for and the acquisition, development and production of natural gas,
oil and natural gas liquids in selected major producing regions of the United
States, including Alabama, Colorado, Louisiana, New Mexico, Oklahoma, South
Texas and the Gulf of Mexico. As of December 31, 2002, pro forma for our asset
sale during the first quarter of 2003, our estimated proved reserves were
approximately 2.4 Tcfe, 91% of which were natural gas and 63% were proved
developed. We believe our focus on natural gas reserves will allow us to realize
the benefits of favorable natural gas industry fundamentals in North America.
We are a wholly-owned subsidiary of El Paso Corporation, or "Parent EPC", a
diversified energy company with core businesses in natural gas pipelines,
natural gas and oil production and midstream services. Parent EPC is one of the
ten largest independent oil and natural gas companies in the United States based
on estimated proved reserves. Parent EPC owns other exploration and production
assets in addition to those owned by us. Our proved reserves represent
approximately 50% of Parent EPC's total proved reserves. The majority of our
assets were acquired through Parent EPC's merger with Sonat Inc. in October
1999.
We have a balanced portfolio of development, exploitation and exploration
projects, including long-lived and shorter-lived properties. We own significant
coalbed methane operations in the Raton Basin of Colorado and New Mexico, the
Black Warrior Basin of Alabama and the Arkoma Basin of eastern Oklahoma.
Approximately 52% of our proved reserves are coalbed methane, which are
generally characterized by lower development expenditures, higher drilling
success rates and longer reserve lives. In the Gulf of Mexico we have interests
in 218 offshore blocks and approximately 100 active platforms. In South Texas,
our operations are focused on the prolific Vicksburg trend. Approximately 20%
and 11% of our proved reserves are located in the Gulf of Mexico and South
Texas, respectively, which are generally characterized by higher development
expenditures, higher returns on invested capital and shorter reserve lives. Our
remaining 17% of proved reserves are located in North Louisiana and are
generally characterized by lower development costs, higher drilling success
rates and longer reserve lives. Based on 2002 production and proved reserves at
December 31, 2002, we had an overall reserve-to-production ratio of 10 years.
1
OBJECTIVES AND STRATEGY
Our primary objective is to be the most profitable production company on
the basis of profit per unit of production and return on capital. In order to
achieve this goal, we employ a strategy based on the following principles:
Focus Operations on Core Regions. Our concentration of reserves and our
significant acreage positions in our core areas enable us to realize economies
of scale and synergies in drilling and production operations. Our operations are
primarily focused on (i) coalbed methane formations in the Raton Basin of
Colorado and New Mexico, the Black Warrior Basin of Alabama and the Arkoma Basin
of eastern Oklahoma, (ii) the Vicksburg trend in South Texas, (iii) the deep
(greater than 12,000 feet) gas reserves in the relatively shallow waters of the
Continental Shelf of the Gulf of Mexico and (iv) North Louisiana. Our long
operating histories in each of these areas and our understanding of their unique
geological characteristics have given us exploratory and operational expertise.
We exploit this expertise to find and develop reserves economically.
Maintain a Balanced Portfolio of Quality Assets. We attempt to maintain a
geologically and geographically balanced reserve base. In addition, we
continuously seek to upgrade the quality of our assets by rigorously exploiting
our properties that have the potential for value enhancement and growth, while
disposing of marginal or non-strategic properties. Our balanced portfolio
provides reserve and production diversification that helps to stabilize our cash
flow and returns.
Control Operations and Costs. Our operational control and in-house
expertise allow us to lower both our finding and development costs and
production expenses. Our integrated approach allows us to manage capital
allocation and expenses and to act quickly to exploit opportunities as they
arise. For example, we utilize real-time data monitoring to direct our drilling,
completion and production operations. This high level of operational control
reduces the time from discovery to production, improves drilling success rates,
lowers production costs and increases productivity of our employees, our most
valuable asset. The substantial scale of our operations in our core areas has
allowed us to develop relationships with key vendors onshore and offshore which
has enabled us to reduce the costs of our operations.
Sustain Technological Expertise. We have developed in-house geophysical
and seismic data interpretation, deep drilling, and high-rate completion
expertise. We plan our drilling and development programs to incorporate the best
technologies of our vendors and proactively work with them to design more
efficient and effective technologies. We continually analyze our inventory of 2D
and 3D seismic data to identify locations to explore for and develop reserves in
our core areas of operation.
Grow Primarily Through the Drillbit. Our drilling program is balanced
between exploratory and lower risk development and exploitation projects. Our
exploratory strategy utilizes our technological expertise to drill technically
advanced wells in regions that have large reserve potential. Although these
particular regions can be difficult to identify, and wells drilled there are not
always successful, we have employed this strategy effectively in South Texas and
the deep gas reserves in the relatively shallow waters of the Continental Shelf
of the Gulf of Mexico, and we are expanding it to North Louisiana. Over the past
three years, we have achieved a drilling success rate in excess of 90%; however,
a successful well may not necessarily produce sufficient hydrocarbons to pay for
its initial capital costs.
Pursue a Focused Acquisition Strategy. We supplement our growth through a
focused acquisition program by purchasing properties that meet acceptable
investment return criteria. Acquisitions in 2002 included an estimated 314 Bcfe
of proved reserves in properties located in South Texas and an estimated 448 Bcf
of coal seam natural gas proved reserves attributable to properties in Colorado
and New Mexico. We also seek to acquire undeveloped acreage in areas that expand
the footprint of our current regions and in regions where we believe that our
in-house knowledge of deep (greater than 12,000 feet) geology can be applied to
exploit reserves that have not been developed.
Please read "Business and Properties" beginning on page 42 of this
prospectus for a more complete discussion of our operations.
2
RECENT EVENTS
TRINITY RIVER RESTRUCTURING
During 1999, El Paso Corporation formed a series of companies referred to
as Trinity River. The Trinity River companies were formed to raise money that
would be used to provide financing to invest in various capital projects and
other assets. To secure the financing made to the Trinity River companies,
Parent EPC pledged assets including all of our equity interests in certain of
our subsidiaries.
In March 2003, Parent EPC entered into a $1.2 billion term loan secured by
substantially all of the natural gas and oil reserves of our subsidiaries. The
purpose of this loan was to repay in full the Trinity River financing. To
accomplish this, Parent EPC loaned the proceeds of this term loan to our
subsidiaries, which in turn used the funds to repay the outstanding $913 million
net balance on the Trinity River financing. We provided a guarantee for this
loan. As a result of these transactions, (i) the Trinity River financing was
paid in full; (ii) our wholly owned subsidiaries owe $1.2 billion to Parent EPC;
(iii) we are a guarantor of these subsidiaries' loans; and (iv) substantially
all of the natural gas and oil reserves of our subsidiaries are pledged to
secure the Parent EPC term loan. We repaid our subsidiaries' loans with the net
proceeds of the offering of the Old Notes.
REDUCTION OF DEBT RATING OUTLOOK
On November 11, 2003, Moody's Investors Service reduced our rating outlook
to negative from stable until production trends, proven developed reserve
levels, reserve replacement cost trends, or other business or organizational
developments demonstrate the compatibility of our debt and B2 rating.
RESIGNATION OF PRESIDENT RODNEY D. ERSKINE
On November 14, 2003, it was announced that the president of El Paso
Production Holding Company, Rodney D. Erskine, had resigned. Randy L. Bartley,
our chief operating officer, will serve as interim president until a replacement
is found. We have initiated a search process that will consider internal and
external candidates.
DRILLING VENTURES
In October 2003 we entered into agreements with a wholly owned subsidiary
of Lehman Brothers (Lehman), an investment bank, and a wholly owned subsidiary
of Nabors Industries Ltd. (Nabors) that could collectively result in an
additional $190 million of drilling activity over the next nine to 12 months.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity" for a discussion of these agreements.
ASSET SALE
In March 2003, we sold natural gas and oil properties including 0.4 Tcfe of
proved reserves located in Oklahoma and Texas to Chesapeake Energy Corporation
for approximately $440 million. The proceeds from this sale were loaned to
Parent EPC through our cash management program.
SALE OF EQUITY INVESTMENT
On April 16, 2003, in connection with the restructuring of Parent EPC's
revolving credit facilities, we sold our 58% interest in Noric Holdings I, LLC
to an indirect subsidiary of Parent EPC for $0.1 million.
3
This sale was required by the terms of our subsidiaries' $1.2 billion loan
agreement with Parent EPC discussed under "Trinity River Restructuring" above.
At the time of such sale, the book value of our combined interest in Noric
Holdings I was approximately $159.7 million. The difference between the cash
consideration price and the book value of the investment was recorded as a
dividend to Parent EPC.
PURCHASE OF GULF OF MEXICO OFFSHORE LEASES
We were the successful bidder on 22 blocks in the Gulf of Mexico at
Minerals Management Service lease sales held on March 19, 2003 and August 20,
2003. As of September 30, 2003, the MMS completed its review of our bids and has
awarded us 20 blocks and rejected our bid on the other two blocks. We paid total
bonus consideration of $7.5 million for the 20 blocks awarded representing
86,776 gross and net acres.
------------------------
Our principal offices are in the El Paso Building, located at 1001
Louisiana Street, Houston, Texas 77002, and our telephone number at that address
is (713) 420-2600.
------------------------
4
OWNERSHIP STRUCTURE
The following chart shows our organization and ownership structure as of
the date of this prospectus.
(ORGANIZATIONAL CHART)
5
SUMMARY OF THE TERMS OF THE EXCHANGE OFFER
The Exchange Offer............ We are offering to exchange up to $1.2 billion
of the New Notes for up to $1.2 billion of the
Old Notes. Old Notes may be exchanged only in
$1,000 increments.
The terms of the New Notes are identical in all
material respects to the Old Notes except that
the New Notes will not contain terms with
respect to transfer restrictions, registration
rights and payment of liquidated damages that
relate to the Old Notes. The New Notes and the
Old Notes will be governed by the same
indenture.
Registration Rights
Agreement..................... Pursuant to a registration rights agreement
relating to the Old Notes among us and Credit
Suisse First Boston LLC, Citigroup Global
Markets Inc., Banc of America Securities LLC,
Deutsche Bank Securities Inc., Lehman Brothers
Inc. and Scotia Capital (USA) Inc.
(collectively, the "initial purchasers"), we
agreed to file, on or prior to 90 days after
the closing of the offering of the Old Notes,
this exchange offer registration statement with
the SEC with respect to a registered offer to
exchange the Old Notes for the New Notes. We
also agreed to use our reasonable best efforts
to have this exchange offer registration
statement declared effective by the SEC within
210 days after the original issue date of the
Old Notes and to complete the exchange offer
within 30 business days thereafter. If we fail
to fulfill our obligations under the
registration rights agreement, additional
interest will accrue on the Old Notes at an
annual rate of 0.25% for each subsequent 90-day
period up to a maximum annual rate of 1.00%.
See "Description of Notes -- Exchange Offer and
Registration Rights."
Resale........................ We believe that you will be able to freely
transfer the New Notes without registration or
any prospectus delivery requirement; however,
certain broker-dealers and certain of our
affiliates may be required to deliver copies of
this prospectus if they resell any New Notes.
Expiration Date............... 5:00 p.m., New York City time, on ,
2003, unless the exchange offer is extended.
You may withdraw Old Notes you tender pursuant
to the exchange offer at any time prior to
, 2003. See "The Exchange
Offer -- Expiration Date; Extensions;
Termination; Amendments."
Conditions to the Exchange
Offer......................... The exchange offer is not subject to any
conditions other than that it does not violate
applicable law or any applicable interpretation
of the staff of the SEC.
Procedures for Tendering Old
Notes......................... If you wish to accept the exchange offer, sign
and date the letter of transmittal that was
delivered with this prospectus in accordance
with the instructions, and deliver the letter
of transmittal, along with the Old Notes and
any other required documentation, to the
exchange agent. Alternatively, you can tender
your outstanding Old Notes by following the
procedures for book-entry transfer, as
described in this prospectus. By executing the
letter of transmittal or by transmitting an
agent's message in lieu thereof, you will
represent to us that, among other things:
6
- the New Notes you receive will be acquired in
the ordinary course of your business;
- you are not participating, and you have no
arrangement with any person or entity to
participate, in the distribution of the New
Notes;
- you are not our "affiliate," as defined in
Rule 405 under the Securities Act, or a
broker-dealer tendering Old Notes acquired
directly from us for resale pursuant to Rule
144A or any other available exemption under
the Securities Act; and
- if you are not a broker-dealer, that you are
not engaged in and do not intend to engage in
the distribution of the New Notes.
Effect of Not Tendering....... Old Notes that are not tendered or that are
tendered but not accepted will, following the
completion of the exchange offer, continue to
be subject to the existing restrictions upon
transfer thereof.
U.S. Federal Income Tax
Consequences.................. The exchange of New Notes for Old Notes in the
exchange offer will not be a taxable event for
U.S. federal income tax purposes. See "Material
United States Federal Income Tax
Considerations."
Special Procedures for
Beneficial Owners............. If you are a beneficial owner whose Old Notes
are registered in the name of a broker, dealer,
commercial bank, trust company or other nominee
and wish to tender such Old Notes in the
exchange offer, please contact the registered
holder as soon as possible and instruct them to
tender on your behalf and comply with our
instructions set forth elsewhere in this
prospectus.
Guaranteed Delivery
Procedures.................... If you wish to tender your Old Notes, you may,
in certain instances, do so according to the
guaranteed delivery procedures set forth
elsewhere in this prospectus under "The
Exchange Offer -- Procedures for Tendering Old
Notes -- Guaranteed Delivery."
Withdrawal Rights............. You may withdraw Old Notes that you tender
pursuant to the exchange offer by furnishing a
written or facsimile transmission notice of
withdrawal to the exchange agent containing the
information set forth in "The Exchange
Offer -- Withdrawal of Tenders" at any time
prior to the expiration date.
Acceptance of Old Notes and
Delivery of New Notes......... We will accept for exchange any and all Old
Notes that are properly tendered in the
exchange offer prior to the expiration date.
See "The Exchange Offer -- Procedures for
Tendering Old Notes." The New Notes issued
pursuant to the exchange offer will be
delivered promptly following the expiration
date.
7
Broker-Dealers................ Each broker-dealer that receives New Notes for
its own account pursuant to the Exchange Offer
must acknowledge that it will deliver a
prospectus in connection with any resale of
such New Notes. The letter of transmittal
states that by so acknowledging and by
delivering a prospectus, a broker-dealer will
not be deemed to admit that it is an
"underwriter" within the meaning of the
Securities Act. This prospectus, as it may be
amended or supplemented from time to time, may
be used by a broker-dealer in connection with
resales of New Notes received in exchange for
Old Notes where such Old Notes were acquired by
such broker-dealer as a result of market-making
activities or other trading activities. See
"Plan of Distribution."
SUMMARY OF TERMS OF NEW NOTES
Issuer........................ El Paso Production Holding Company
Securities Offered............ $1.2 billion principal amount of 7 3/4% senior
notes due 2013.
Maturity Date................. June 1, 2013
Interest Rate................. 7 3/4% per annum, accruing from the issue date
of the notes.
Interest Payment Dates........ June 1 and December 1 of each year, beginning
on December 1, 2003.
Ranking....................... The notes will be senior unsecured and
unsubordinated obligations of El Paso
Production Holding Company ranking equally with
its other outstanding unsubordinated
indebtedness. The guarantees of the notes by
certain of our subsidiaries will be senior
unsecured and unsubordinated obligations of
such subsidiaries ranking equally in right of
payment with all other unsubordinated
indebtedness of such subsidiaries. As of
September 30, 2003, our only outstanding
indebtedness was the $1.2 billion principal
amount of Old Notes.
Certain Restrictive
Covenants..................... The indenture governing the notes limits the
ability of El Paso Production Holding Company
and its restricted subsidiaries, among other
things, to:
- incur additional indebtedness;
- make advances under El Paso's cash management
program;
- make certain restricted payments;
- create limitations on the ability of
restricted subsidiaries to pay dividends,
make loans or transfer property to El Paso
Production Holding Company;
- sell assets, including capital stock of
subsidiaries;
- engage in transactions with affiliates;
- engage in other lines of business;
- incur liens securing indebtedness;
- enter into sale-leaseback transactions; and
- consolidate, merge or transfer assets.
From and after the time the notes are first
rated at least Baa3 or higher by Moody's and
BBB- or higher by Standard & Poor's, the
covenants will be of no force or effect with
the exception of
8
covenants that contain limitations on liens and
sale-leaseback transactions and certain of the
provisions applicable to consolidations,
mergers and transfers of assets.
These restrictions are subject to a number of
important qualifications and exceptions.
See "Description of Notes -- Certain
Covenants."
See "Risk Factors -- Risks Related to the
Notes."
Use of Proceeds............... We will not receive any proceeds from the
exchange of the New Notes for the outstanding
Old Notes.
Optional Redemption........... Except as set forth below, we cannot redeem the
notes before June 1, 2008. On or after June 1,
2008, we can redeem some or all of the notes
for cash at the redemption prices described in
this offering memorandum, plus accrued and
unpaid interest to the date of redemption.
In addition, at any time and from time to time
on or before June 1, 2006, we may redeem up to
35% of the notes with the proceeds of certain
equity offerings or of a capital contribution
to our common equity.
Guarantees.................... The payment of the principal, interest,
liquidated damages and premium on the notes
will be fully and unconditionally guaranteed
jointly and severally on a senior unsecured
basis by our existing wholly-owned
subsidiaries. See "Description of Notes --
Guarantees."
Change of Control............. If El Paso Production Holding Company
experiences a change of control followed by any
downgrade of the ratings of the notes by either
Standard & Poor's or Moody's, subject to
certain conditions, El Paso Production Holding
Company must give holders of the notes the
opportunity to sell their notes back to El Paso
Production Holding Company at 101% of their
principal amount, plus accrued and unpaid
interest and liquidated damages, if any. See
"Description of Notes -- Change of Control."
The change of control covenant will be of no
force or effect from and after the time the
notes are first rated Baa3 or higher by Moody's
and BBB- or higher by Standard & Poor's.
A change of control in El Paso Corporation does
not constitute a change of control under the
indenture.
Ratings....................... Standard & Poor's has assigned a rating of B+
with negative outlook to the notes, and Moody's
has assigned a rating of B2 to the notes. On
November 11, 2003, Moody's reduced our rating
outlook to negative from stable.
RISK FACTORS
Participating in the exchange offer involves risks. You should carefully
consider the information under the caption "Risk Factors" and all other
information in this prospectus before exchanging your Old Notes for New Notes.
9
SUMMARY CONSOLIDATED HISTORICAL AND PRO FORMA FINANCIAL DATA
You should read the following summary historical and pro forma financial
information in connection with the financial statements and related notes
included in this prospectus. The historical consolidated financial data for each
of the three fiscal years ended December 31, 2002 were derived from our audited
annual financial statements included in this prospectus. The data for the nine
months ended September 30, 2002 and 2003 were derived from our unaudited interim
financial statements also included in this prospectus. The summary pro forma
financial information is derived from our unaudited pro forma financial
statements included in this prospectus. The summary pro forma financial
information has been prepared to show the pro forma effect of: (i) our asset
sale in March 2003, (ii) the sale in April 2003 of our equity interest in Noric
Holdings I to an affiliate of El Paso Corporation, (iii) the borrowing of $1.2
billion from El Paso Corporation to retire the Trinity River financing, and (iv)
the offering of the Old Notes (using the interest rate on the notes of 7 3/4%)
and our use of the proceeds from that offering to repay the loan from El Paso
Corporation, as if these transactions occurred on January 1, 2002 for operating
results. The summary pro forma financial information is for informational
purposes only and should not be considered indicative of actual results that
would have been achieved had these transactions actually been consummated on the
dates indicated. Our summary historical and pro forma results are not
necessarily indicative of results to be expected in future periods.
<Table>
<Caption>
PRO FORMA
PRO FORMA NINE MONTHS NINE MONTHS
YEAR ENDED ENDED ENDED
YEAR ENDED DECEMBER 31, DECEMBER 31, SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------ --------------- -------------
2000 2001 2002 2002 2002 2003 2003
------ ------ ------ ------------ ------ ------ -------------
(IN MILLIONS, EXCEPT RATIOS)
OPERATING RESULTS DATA:
Operating revenues............................... $ 537 $ 604 $ 841 $ 774 $ 630 $ 736 $710
------ ------ ------ ------ ------ ------ ----
Operating expenses............................... 144 185 215 203 157 199 192
Depreciation, depletion and amortization......... 206 234 317 291 242 228 221
------ ------ ------ ------ ------ ------ ----
Operating income................................. 187 185 309 280 231 309 297
------ ------ ------ ------ ------ ------ ----
Interest income from affiliate................... 8 9 8 8 5 7 7
Interest expense to affiliate(1)................. -- -- -- -- -- (23) --
Interest expense(2).............................. -- -- -- (90) -- (31) (67)
Earnings from unconsolidated
affiliates..................................... 11 29 6 -- 5 8 --
Other income (expense)........................... 4 1 5 5 (3) 2 2
Minority interest in consolidated subsidiaries... -- (4) (3) -- (2) (3) --
------ ------ ------ ------ ------ ------ ----
Income before income taxes....................... 210 220 325 203 236 269 239
Provision for income taxes....................... (70) (71) (112) (71) (79) (105) (97)
------ ------ ------ ------ ------ ------ ----
Income before cumulative effect of accounting
changes........................................ 140 149 213 $ 132 $ 157 $ 164 $142
====== ====
Cumulative effect of accounting changes, net of
income taxes................................... -- -- -- -- (2)
------ ------ ------ ------ ------
Net income....................................... $ 140 $ 149 $ 213 $ 157 $ 162
====== ====== ====== ====== ======
CASH FLOW DATA:
Net cash provided by operating activities........ $ 197 $ 352 $ 849 $ 658 $ 471
Net cash used in investing activities............ (522) (655) (891) (680) (75)
Net cash provided by (used in) financing
activities..................................... 323 303 198 22 (434)
FINANCIAL POSITION DATA:
Total assets..................................... $2,358 $3,236 $4,218 $3,695 $3,872
Total debt....................................... -- -- -- -- 1,170
Total stockholder's equity....................... 2,147 2,798 3,309 2,979 1,894
OTHER FINANCIAL DATA:
Ratio of earnings to fixed charges(3)............ -- -- -- -- 6
</Table>
- ---------------
(1) Actual interest expense to affiliate for the nine months ended September 30,
2003 reflects interest recorded from March 13 through May 23 related to the
Trinity River financing.
(2) Actual interest expense for the nine months ended September 30, 2003 is
shown net of capitalized interest of $3 million. Pro forma interest expense
for the year ended December 31, 2002 and the nine months ended September 30,
2003 is shown net of capitalized interest of $3 million and $3 million,
respectively.
10
(3) There were no fixed charges for the years ended December 31, 2000, 2001 and
2002 and for the nine months ended September 30, 2002, since we were funded
through equity contributions from El Paso Corporation. In the nine months
ended September 30, 2003, we incurred interest costs related to the Trinity
River refinancing and the issuance of the Old Notes.
For the purposes of computing these ratios, earnings means pre-tax income
(loss) from continuing operations before:
- adjustments for minority interest in consolidated subsidiaries;
- income from equity investees, adjusted to reflect actual distributions
from equity investments; and
- fixed charges;
less:
- capitalized interest.
Fixed charges means the sum of the following:
- interest costs;
- amortization of debt costs;
- that portion of rental expense which we believe represents an interest
factor; and
- preferred returns on consolidated subsidiaries.
11
SUMMARY HISTORICAL AND PRO FORMA RESERVE INFORMATION
The following table summarizes our historical estimates of net proved oil
and natural gas reserves as of the dates indicated and the present value
attributable to the reserves at such dates (using realized prices based on
year-end oil and natural gas spot prices), discounted at 10% per annum. The
historical estimates of our net proved oil and natural gas reserves as of
December 31, 2000, 2001 and 2002 were prepared internally by us. For each of the
periods, Huddleston & Co., Inc., an independent petroleum engineering firm,
prepared an independent reserve estimate for our properties. For each of the
periods presented, Huddleston & Co., Inc. prepared an independent reserve
estimate for 100% of our properties. The total estimate of proved reserves
prepared independently by Huddleston & Co., Inc. is within 5% of our internally
prepared estimates for each of the periods presented in the table.
All proved reserve estimates were prepared using constant prices and costs
in accordance with the guidelines of the SEC based on the prices received on a
field-by-field basis as of December 31 of each year. Proved reserve estimates do
not include any value for probable or possible reserves which may exist, nor do
they include any value for undeveloped acreage. The proved reserve estimates
represent our net revenue interest in our properties.
<Table>
<Caption>
PRO FORMA
YEAR ENDED
AS OF DECEMBER 31,(1) DECEMBER 31,
------------------------------------ ------------
2000 2001 2002 2002
---------- ---------- ---------- ------------
Liquids (MBbl).............................. 30,217 55,786 49,723 34,432
Natural Gas (MMcf).......................... 1,585,444 2,121,299 2,525,813 2,187,103
Natural Gas Equivalent (MMcfe).............. 1,766,744 2,456,015 2,824,147 2,393,697
Proved Developed Reserves Percentage........ 63% 58% 63% 63%
PV-10 Value (in thousands).................. $8,982,084 $2,427,933 $5,282,146 $4,445,543
Ratio of Reserves to Production(2).......... 8.3x 11.1x 10.4x 9.6x
</Table>
- ---------------
(1) The information in the table above excludes reserves attributable to Noric
Holdings I, which we sold to an affiliate of El Paso Corporation in April
2003. We owned a 58% equity interest in Noric Holdings I, and proved
reserves attributable to the oil and natural gas properties interests of
Noric Holdings I are not included in our historical or pro forma reserve
estimates.
(2) Calculated by dividing net proved reserves by net production volumes for the
year indicated.
12
SUMMARY HISTORICAL AND PRO FORMA PRODUCTION AND SALES DATA
The following table sets forth certain information regarding our historical
net production volumes, revenues, average prices realized, transportation costs
and production costs associated with sales of natural gas and oil for the
periods indicated, and our pro forma net production volumes, revenues, average
prices realized, transportation costs and production costs after giving effect
to our asset sale in March 2003 as if this transaction occurred on January 1,
2002.
<Table>
<Caption>
PRO FORMA
PRO FORMA NINE MONTHS NINE MONTHS
YEAR ENDED YEAR ENDED ENDED ENDED
DECEMBER 31,(1) DECEMBER 31,(1) SEPTEMBER 30,(1) SEPTEMBER 30,(1)
------------------------ --------------- ------------------------ ----------------
2000 2001 2002 2002 2002 2003 2003
------ ------ ------ --------------- ------ --------------- ----------------
NET PRODUCTION VOLUMES
Natural Gas (Bcf)............ 182 187 215 195 159 152 147
Oil, Condensate and Liquids
(MMBbls)................... 5 6 10 9 8 5 5
------ ------ ------ ------ ------ ------ ------
Total (Bcfe)............... 212 221 272 249 205 180 174
NATURAL GAS AND OIL SALES (IN
MILLIONS)
Natural Gas.................. $ 441 $ 483 $ 640 $ 582 $ 474 $ 604 $ 581
Oil, Condensate and
Liquids.................... 91 120 211 202 165 126 123
------ ------ ------ ------ ------ ------ ------
Total...................... $ 532 $ 603 $ 851 $ 784 $ 639 $ 730 $ 704
NATURAL GAS AVERAGE SALES PRICE
(PER MCF)(2)
Price excluding hedges....... $ 3.98 $ 4.33 $ 3.25 $ 3.24 $ 2.99 $ 5.79 $ 5.76
Price including hedges....... $ 2.42 $ 2.57 $ 2.99 $ 2.98 $ 2.98 $ 3.96 $ 3.94
OIL, CONDENSATE AND LIQUIDS
AVERAGE SALES PRICE (PER
BBL)(2)
Price excluding hedges....... $28.58 $23.19 $22.06 $22.69 $21.48 $28.74 $28.66
Price including hedges....... $18.22 $21.50 $21.87 $22.49 $21.51 $27.33 $27.24
AVERAGE TRANSPORTATION COST
Natural gas (per Mcf)........ $ 0.17 $ 0.21 $ 0.19 $ 0.17 $ 0.19 $ 0.19 $ 0.18
Oil, Condensate and Liquids
(per Bbl).................. $ 0.20 $ 0.49 $ 1.23 $ 1.32 $ 1.17 $ 1.20 $ 1.23
AVERAGE PRODUCTION COST AND
PRODUCTION TAXES (PER MCFE)
Average Production Cost(3)... $ 0.34 $ 0.45 $ 0.40 $ 0.42 $ 0.39 $ 0.45 $ 0.44
Average Production Taxes..... $ 0.10 $ 0.11 $ 0.07 $ 0.07 $ 0.06 $ 0.12 $ 0.11
</Table>
- ---------------
(1) The information in this table does not include data with respect to our 58%
equity interest in Noric Holdings I, which we sold for $0.1 million to an
affiliate of El Paso Corporation in April 2003.
(2) Prices are stated before transportation costs.
(3) Our production costs include direct lifting costs (labor, repairs and
maintenance, materials and supplies), the administrative costs of field
offices, insurance and property and severance taxes.
13
RISK FACTORS
Before you participate in the exchange offer, you should read carefully the
following risk factors, in addition to the other information in this prospectus.
RISKS RELATED TO OUR BUSINESS
OIL AND NATURAL GAS PRICES ARE VOLATILE. A SUBSTANTIAL DECREASE IN OIL AND
NATURAL GAS PRICES COULD ADVERSELY AFFECT OUR FINANCIAL RESULTS.
Our future financial condition, revenues, results of operations, future
rate of growth and the carrying value of our oil and natural gas properties
depend primarily upon the prices we receive for our oil and natural gas
production. Oil and natural gas prices historically have been volatile and are
likely to continue to be volatile in the future, especially given current world
geopolitical conditions. The prices for oil and natural gas are subject to a
variety of additional factors that are beyond our control. These factors
include:
- the level of consumer demand for, and the supply of, oil and natural gas;
- commodity processing, gathering and transportation availability;
- the level of imports of, and the price of, foreign oil and natural gas;
- the ability of the members of the Organization of Petroleum Exporting
Countries to agree to and maintain oil price and production controls;
- domestic governmental regulations and taxes;
- the price and availability of alternative fuel sources;
- weather conditions;
- market uncertainty;
- political conditions or hostilities in oil and natural gas producing
regions, including the Middle East and South America; and
- worldwide economic conditions.
Further, because approximately 91% of our proved reserves at December 31,
2002 were natural gas reserves, we are substantially more sensitive to changes
in natural gas prices than we are to changes in oil prices. Declines in oil and
natural gas prices would not only reduce revenue, but could reduce the amount of
oil and natural gas that we can produce economically and, as a result, could
affect our ability to borrow money or raise capital. In addition, significant
price declines may cause us to be unable to meet our financial obligations,
including payments on the notes, or make planned expenditures.
WE COULD INCUR A WRITE-DOWN OF THE CARRYING VALUES OF OUR PROPERTIES IN THE
FUTURE DEPENDING ON OIL AND NATURAL GAS PRICES, WHICH COULD NEGATIVELY IMPACT
OUR NET INCOME AND STOCKHOLDER'S EQUITY.
Under the full cost method of accounting, SEC accounting rules require us
to review the carrying value of our oil and gas properties on a quarterly basis
for possible write-down or impairment. Under these rules, capitalized costs of
proved reserves may not exceed a ceiling calculated as the present value of
estimated future net revenues from those proved reserves, determined using a 10%
per year discount factor and unescalated prices in effect as of the end of each
fiscal quarter (PV-10 value), plus the lower of cost or fair market value of
unproved reserves, net of related income tax effects. Capital costs in excess of
the ceiling must be permanently written down. The changes in oil and natural gas
prices have a significant impact on our PV-10 value, and thus a decline in
prices could cause a write-down (which could be substantial) that would
negatively affect our net income and stockholder's equity.
14
ESTIMATING OUR RESERVES, PRODUCTION AND FUTURE NET CASH FLOW IS DIFFICULT.
Estimating quantities of proved oil and natural gas reserves is a complex
process. It requires interpretations of available technical data and various
estimates, including estimates based upon assumptions relating to economic
factors, such as future commodity prices, production costs, severance and excise
taxes, capital expenditures and workover and remedial costs, and the assumed
effect of governmental regulation. Reserve estimates are based on
interpretations and assumptions, and therefore actual results may vary from our
estimates. Also, the use of a 10% discount factor for reporting purposes, as
prescribed by the SEC, may not necessarily represent the most appropriate
discount factor, given actual interest rates and risks to which our business or
the oil and natural gas industry in general are subject. Any significant
variations from the interpretations or assumptions used in our estimates or
changes of conditions could cause the estimated quantities and net present value
of our reserves to differ materially.
The reserve data included in this prospectus represent only estimates. You
should not assume that the present values referred to in this prospectus
represent the current market value of our estimated oil and natural gas
reserves. The timing of the production and the expenses from the development and
production of oil and gas properties will affect both the timing of actual
future net cash flows from our proved reserves and their present value.
As of December 31, 2002, approximately 37% of our estimated pro forma
proved reserves were undeveloped. Recovery of undeveloped reserves requires
significant capital expenditures and successful drilling operations. The reserve
data assumes that we can and will make these expenditures and conduct these
operations successfully, but these assumptions may not be accurate.
THE SUCCESS OF OUR BUSINESS DEPENDS UPON OUR ABILITY TO REPLACE RESERVES THAT WE
PRODUCE.
Unless we successfully replace the reserves that we produce, our reserves
will decline, resulting eventually in a decrease in oil and natural gas
production and lower revenues and cash flows from operations. We historically
have replaced reserves through both drilling and acquisitions. The business of
exploring for, developing or acquiring reserves requires substantial capital
expenditures. Historically, we have funded our capital expenditures in part
through contributions from El Paso Corporation, our parent. El Paso Corporation
has no commitment to fund our future capital needs and in the future may elect
not to or may be unable to do so. In response to the current liquidity concerns
of our parent, we have reduced our 2003 capital expenditure budget
significantly. If El Paso Corporation's liquidity crisis does not abate or
becomes more severe, we could be forced to further reduce our 2003 or future
capital expenditures. If we do not continue to make significant capital
expenditures, or if our outside capital resources become limited, we may not be
able to continue to replace the reserves that we produce, which would negatively
affect our future revenues and results of operations.
OUR OIL AND NATURAL GAS DRILLING AND PRODUCING OPERATIONS INVOLVE MANY RISKS AND
MAY NOT BE PROFITABLE.
Our operations are subject to all the risks normally incident to the
operation and development of oil and natural gas properties and the drilling of
oil and natural gas wells, including well blowouts, cratering and explosions,
pipe failure, fires, formations with abnormal pressures, uncontrollable flows of
oil, natural gas, brine or well fluids, release of contaminants into the
environment and other environmental hazards and risks. The nature of the risks
is such that some liabilities could exceed our insurance policy limits, or, as
in the case of environmental fines and penalties, cannot be insured. As a
result, we could incur substantial costs that could significantly adversely
affect our future results of operations or financial condition.
In addition, in our drilling operations we are subject to the risk that we
will not encounter commercially productive reservoirs. New wells drilled by us
may be unproductive, or we may not recover all or any portion of our investment
in those wells. Drilling for oil and natural gas often is unprofitable, not only
because of dry wells but also due to wells that are productive but do not
produce sufficient net reserves to return a profit at then realized prices after
deducting drilling, operating and other costs.
15
OUR DRILLING OPERATIONS MAY BE DELAYED OR CANCELED AS A RESULT OF FACTORS BEYOND
OUR CONTROL, RESULTING IN SIGNIFICANT COSTS TO US.
Our drilling operations may be curtailed, delayed or canceled as a result
of numerous factors that are beyond our control, including:
- unexpected drilling conditions;
- title problems;
- pressure or irregularities in formations;
- equipment failures or accidents;
- adverse weather conditions;
- compliance with environmental and other governmental requirements; and
- costs of, or shortages or delays in the availability of, drilling rigs,
equipment and services.
A delay or curtailment of our drilling operations due to these or other
factors can result in significant costs or significant reductions in revenue to
us. For example, in the Gulf of Mexico in 2002, we lost four days of drilling
time and deferred 39 MMcf/d of production due to Hurricane Isidore, as well as
four days of lost drilling time and 55 MMcf/d of deferred production due to
Hurricane Lili. Our expenses relating to the two storms totaled $10 million.
SHORTAGES OF OIL FIELD EQUIPMENT, SERVICES AND QUALIFIED PERSONNEL COULD REDUCE
OUR CASH FLOW AND ADVERSELY AFFECT RESULTS OF OPERATIONS.
The demand for qualified and experienced field personnel to drill wells and
conduct field operations, geologists, geophysicists, engineers and other
professionals in the oil and natural gas industry can fluctuate significantly,
often in correlation with oil and natural gas prices, causing periodic
shortages. From time to time, there have also been shortages of drilling rigs
and other equipment, as demand for rigs and equipment has increased along with
the number of wells being drilled. These factors also cause significant
increases in costs for equipment, services and personnel. Higher oil and natural
gas prices generally stimulate increased demand and result in increased prices
for drilling rigs, crews and associated supplies, equipment and services. It is
beyond our control and ability to predict whether these conditions will exist in
the future and, if so, what their timing and duration will be. These types of
shortages or price increases could significantly decrease our profit margin,
cash flow and operating results or restrict our ability to drill the wells and
conduct the operations which we currently have planned and budgeted.
WE ARE SUBJECT TO COMPLEX LAWS AND REGULATIONS, INCLUDING ENVIRONMENTAL AND
SAFETY REGULATIONS, THAT CAN NEGATIVELY AFFECT THE COST, MANNER OR FEASIBILITY
OF DOING BUSINESS.
Our operations and facilities are subject to certain federal, state, and
local laws and regulations relating to the exploration for, and development,
production and transportation of, oil and natural gas, as well as environmental
and safety matters.
Under these laws and regulations, we could be liable for:
- personal injuries;
- property and natural resource damages;
- oil spills and releases or discharges of hazardous materials;
- well reclamation costs;
- remediation and clean-up costs and other governmental sanctions, such as
fines and penalties; and
- other environmental damages.
16
Existing laws or regulations, as currently interpreted or reinterpreted in
the future, or future laws or regulations could harm our business, results of
operations and financial condition. We may be required to make large and
unanticipated capital expenditures to comply with environmental and other
governmental regulations. In addition, our operations could be significantly
delayed or curtailed and our costs of operations could significantly increase as
a result of regulatory requirements or restrictions. We are unable to predict
the ultimate cost of compliance with these requirements or their effect on our
operations.
OUR USE OF HEDGING ARRANGEMENTS HAS RESULTED IN FINANCIAL LOSSES AND MAY
ADVERSELY AFFECT OUR FUTURE RESULTS OF OPERATIONS OR LIQUIDITY.
To reduce our exposure to fluctuations in the prices of oil and natural
gas, we use futures, swaps and option contracts traded on the New York
Mercantile Exchange (NYMEX), over-the-counter options and price and basis swaps
with other natural gas merchants and financial institutions. Under our current
hedging policy, we may hedge up to 50% of our anticipated production for a
rolling 12-month forward period. As of September 30, 2003, we had hedged
approximately 33 million MMBtus of our anticipated remaining natural gas
production for 2003 at a NYMEX Henry Hub price of $3.19 per MMBtu before
regional price differentials and transportation costs. In addition, we have
hedged approximately 75 million MMBtus at $3.12 per MMBtu of our 2004
anticipated natural gas production, 79 million MMBtus at $3.16 per MMBtu of our
2005 anticipated natural gas production and 84 million MMBtus at $3.28 per MMBtu
of our 2006 anticipated natural gas production. We have also hedged additional
volumes at various prices through 2012. At September 30, 2003 the mark-to-market
value of these hedges was a loss of $423 million. Hedging arrangements expose us
to risk of financial loss in some circumstances, including when:
- production is less than expected;
- the counter-party to the hedging contract defaults on its contract
obligations; or
- there is a change in the expected differential between the underlying
price in the hedging agreement and actual prices received.
For the years ended December 31, 2001 and 2002 and the nine months ended
September 30, 2003, we recognized losses of $338 million, $58 million, and $286
million, respectively, as a result of our hedging arrangements.
In addition, these hedging arrangements may limit the benefit we would
receive from increases in the prices for oil and natural gas. The use of
derivatives also may require the posting of cash collateral with counterparties
which can impact working capital when commodity prices change. El Paso
Corporation has announced that it plans to exit the commodities trading business
within the next 18 to 24 months. Recently, however, El Paso has indicated that
it may continue to provide us with certain gas marketing and hedging services.
Depending on our financial condition, if we assume responsibility for our
hedging activities, we may be required to begin posting cash collateral if
prevailing prices exceed the prices in those hedging arrangements. As we have
not previously conducted these activities on our own behalf, our results of
operations could be adversely affected if we assume control over our hedging
activities. In addition, the obligation to post cash or other collateral could,
if imposed, adversely affect our liquidity.
WE MAY ASSUME RESPONSIBILITY TO MARKET OUR NATURAL GAS PRODUCTION WHICH COULD
ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
We currently sell the majority of our natural gas production to affiliates
of El Paso Corporation at monthly index prices for natural gas. As part of El
Paso Corporation's plan to increase liquidity, it has announced that it will
exit the energy trading business within the next 18 to 24 months. At such time,
we may assume the marketing of our own natural gas production or enter into
marketing agreements with third parties that will market our production. As we
have not previously conducted these activities on our own behalf, our results of
operations could be adversely affected if we assume control over the marketing
of our production.
17
OUR GROWTH MAY BE DEPENDENT UPON SUCCESSFUL ACQUISITIONS WHICH ARE SUBJECT TO
MANY UNCERTAINTIES.
Acquisitions of exploration and production companies and producing
properties and undeveloped properties have been an important part of our
historical growth. We expect acquisitions will also contribute to our future
growth. Successful acquisitions require an assessment of a number of factors,
many of which are beyond our control. These factors include recoverable
reserves, exploration or development potential, future oil and gas prices,
operating costs and potential environmental and other liabilities. Our
assessments are inexact and their accuracy is inherently uncertain. If we are
unable to continue making successful acquisitions, the growth of our company may
be negatively impacted.
OUR ACQUISITIONS COULD SUBJECT US TO SIGNIFICANT UNKNOWN LIABILITIES.
In connection with our acquisitions we are often not entitled to
contractual indemnification for preclosing liabilities, including environmental
liabilities associated with acquired properties. Normally, we acquire interests
in properties on an "as is" basis with limited remedies for breaches of
representations and warranties. We may not be able to become sufficiently
familiar with the properties to fully assess their deficiencies and
capabilities. We do not inspect every well. Even when we inspect a well, we do
not always discover structural, subsurface and environmental problems that may
exist or arise. Our review prior to signing a definitive purchase agreement may
be even more limited. We could incur significant unknown liabilities, including
environmental liabilities, or experience losses due to title defects, in our
acquisitions for which we have limited or no contractual remedies or insurance
coverage.
LOSS OF KEY PERSONNEL COULD HARM OUR BUSINESS.
We believe our continued success depends on the collective abilities and
efforts of our senior management, including our Chief Financial Officer, Gene T.
Waguespack and our Chief Operations Officer, Randy L. Bartley. The loss of one
or more of these officers could have a material adverse effect on our business.
Our President, Rodney D. Erskine, resigned in November 2003 and we are
undertaking a search for a replacement. We have no employment agreements with
any of our key personnel and we do not maintain any key man life insurance
policies.
COSTS OF ENVIRONMENTAL LIABILITIES COULD EXCEED OUR ESTIMATES.
Our operations are subject to numerous environmental laws and regulations,
which obligate us to install and maintain pollution controls and to clean up
various sites at which regulated materials may have been disposed of or
released. It is not possible for us to estimate reliably the amount and timing
of all future expenditures related to environmental matters because of:
- the uncertainties in estimating clean up costs;
- the discovery of additional contamination or contamination more
widespread than previously thought;
- the uncertainty in quantifying liability under environmental laws that
impose joint and several liability on all potentially responsible
parties; and
- future changes to environmental laws and regulations.
Although we believe we have established appropriate reserves for
liabilities, including clean up costs, we could be required to set aside
additional reserves in the future due to these uncertainties.
TERRORIST ATTACKS AIMED AT OUR ENERGY OPERATIONS COULD ADVERSELY AFFECT OUR
BUSINESS.
On September 11, 2001, the United States was the target of terrorist
attacks of unprecedented scale and the United States and others instituted
military action in response. Since the September 11th attacks, the U.S.
government has issued warnings that energy assets may be a future target of
terrorist organizations. These developments have subjected our oil and natural
gas operations to increased risks. Any future terrorist attack on our
facilities, those of our customers and, in some cases, those of other
18
energy companies, including El Paso, could have a material adverse effect on our
business. The continued threat of terrorism and the impact of military and other
action will lead to increased volatility in prices for oil and natural gas and
could affect markets for our operations. These conditions have caused
instability in world financial markets and could generate additional global
economic instability.
WE ARE SUBJECT TO FINANCING AND INTEREST RATE EXPOSURE RISKS.
Our future success depends on our ability to access capital markets and
obtain financing at cost-effective rates. Our ability to access financial
markets and obtain cost-effective rates in the future are dependent on a number
of factors, many of which we cannot control, including changes in:
- our credit ratings;
- interest rates;
- the structured and commercial financial markets;
- market perceptions of us or the natural gas and energy industry;
- tax rates due to new tax laws; and
- the stock price, credit ratings and financial condition of our parent, El
Paso Corporation.
WE FACE COMPETITION FROM THIRD PARTIES TO ACQUIRE RESERVES.
The natural gas and oil business is highly competitive in the search for
and acquisition of reserves. Competition for reserves and producing oil and gas
properties is intense and many of our competitors have financial and other
resources that are substantially greater than those available to us. Our
competitors include the major oil companies, independent oil and gas concerns,
individual producers, gas marketers and major pipeline companies, as well as
participants in other industries supplying energy and fuel to industrial,
commercial and individual consumers. If we are unable to compete effectively in
the acquisition of reserves, our future profitability may be negatively
impacted.
Our affiliate, El Paso CGP, is a wholly-owned subsidiary of El Paso
Corporation that also engages in the exploration for and the acquisition,
development and production of oil and natural gas, primarily in North America.
Although it is our affiliate, we compete with El Paso CGP for the acquisition of
domestic properties and leasehold interests. Because El Paso CGP is very active
onshore in the United States and offshore in the Gulf of Mexico, we may pursue
opportunities that are also being pursued by El Paso CGP. We and El Paso CGP do
not have an agreement regarding the allocation of business opportunities. As a
result,we may identify a particular opportunity that has been first identified,
pursued or obtained by El Paso CGP.
In addition, our officers, directors and personnel also provide services to
El Paso CGP and its subsidiaries pursuant to our shared services arrangement and
therefore share their time and services between us and El Paso CGP. These
persons may therefore have conflicts of interest between us and El Paso CGP.
WE ARE VULNERABLE TO RISKS ASSOCIATED WITH OPERATING IN THE GULF OF MEXICO.
Our operations and financial results could be significantly impacted by
conditions in the Gulf of Mexico because we explore and produce extensively in
that area. As a result of this activity, we are vulnerable to the risks
associated with operating in the Gulf of Mexico, including those relating to:
- adverse weather conditions;
- oil field service costs and availability;
- compliance with environmental and other laws and regulations;
19
- remediation and other costs resulting from oil spills or releases of
hazardous materials; and
- failure of equipment or facilities.
Further, production of reserves from reservoirs in the shallow waters of
the Gulf of Mexico shelf generally declines more rapidly than from reservoirs in
many other producing regions of the world. This results in recovery of a
relatively higher percentage of reserves from properties in the Gulf of Mexico
during the initial few years of production, and as a result, our reserve
replacement needs from new prospects may be greater there than for our
operations elsewhere. Also, our revenues and return on capital will depend
significantly on prices prevailing during these relatively short production
periods.
RISKS RELATED TO OUR AFFILIATION WITH EL PASO
EL PASO CORPORATION'S LIQUIDITY NEEDS SUBJECT US TO INCREASED COSTS OF DOING
BUSINESS.
Due to our relationship with El Paso Corporation, adverse developments or
announcements concerning El Paso Corporation could adversely affect our
financial condition, even if we have not suffered any similar development. The
outstanding senior unsecured indebtedness of El Paso Corporation has been
downgraded to below investment grade, currently rated Caa1 by Moody's and B by
Standard & Poor's and remains on a negative outlook by both agencies. These
downgrades will increase our cost of capital and could impede our access to
capital markets.
These downgrades are a result, at least in part, of the outlook generally
for the consolidated businesses of El Paso Corporation and its needs for
liquidity. If El Paso Corporation's liquidity needs are not satisfied, El Paso
Corporation could be forced to seek protection in bankruptcy from its creditors.
If rating agencies, lenders, vendors or other third parties believe that we
could be substantively consolidated or otherwise involved in El Paso
Corporation's bankruptcy, our cost of doing business could increase
significantly. Additionally, if El Paso Corporation were to seek bankruptcy
protection, we would have to use third parties to provide the services that we
currently obtain from El Paso Corporation, possibly at substantially higher
costs.
EL PASO CORPORATION'S FAILURE TO REPAY AMOUNTS OWED TO US COULD NEGATIVELY
IMPACT OUR ABILITY TO REPAY THE NOTES.
We have in the past and will in the future participate in El Paso
Corporation's cash management program. Under the program, we may act either as a
lender to or borrower from El Paso Corporation and its subsidiaries. So long as
neither El Paso Corporation nor any of its subsidiaries is in default under any
loan agreement or indenture, the indenture governing the notes does not restrict
our ability to advance cash to El Paso Corporation up to a specified maximum
amount. See "Description of Notes -- Covenants -- Limitation on Advances Under
Parent's Cash Management Program." We may make advances under the program to El
Paso Corporation even while El Paso Corporation's credit rating remains below
investment grade. Moreover, El Paso Corporation may use the proceeds of these
advances for any purposes, and those advances do not reduce or limit our ability
under the indenture to pay dividends to our stockholder. As of September 30,
2003, El Paso Corporation owed us approximately $701 million under the cash
management program. In addition, we conduct commercial transactions with El Paso
Corporation and its affiliates. As of September 30, 2003, we had receivables of
approximately $126.4 million from El Paso Corporation and its affiliated
companies, and we owed approximately $6.5 million to El Paso and its affiliated
companies. If it is unable to meet its liquidity needs, El Paso Corporation and
its affiliates may not repay their obligations to us. However, we might still be
required to satisfy any outstanding affiliated company payables. Our inability
to recover outstanding balances under the cash management program or
intercompany receivables owed to us could adversely affect our financial
condition and impair our ability to repay the notes.
20
WE COULD BE SUBSTANTIVELY CONSOLIDATED WITH EL PASO CORPORATION IF EL PASO
CORPORATION WERE FORCED TO SEEK PROTECTION FROM ITS CREDITORS IN BANKRUPTCY.
If El Paso Corporation were the subject of voluntary or involuntary
bankruptcy proceedings, El Paso Corporation and its other subsidiaries and their
creditors could attempt to make claims against us, including claims to
substantively consolidate our assets and liabilities with those of El Paso
Corporation and its other subsidiaries. The equitable doctrine of substantive
consolidation is a doctrine applied in bankruptcy cases to consolidate separate
debtors so that their assets and liabilities may be aggregated. The
consolidation creates a single entity from which all creditors of the individual
entities must then make their claims. El Paso Corporation and/or its other
subsidiaries or their respective creditors could attempt to advance such claims
in a bankruptcy proceeding and it is unknown how a bankruptcy court would
resolve the issue. If a bankruptcy court were to substantively consolidate us
with El Paso Corporation and/or its other subsidiaries, our assets would be
available to creditors of El Paso Corporation's consolidated group, and holders
of the notes would be general unsecured creditors of the consolidated group.
ONGOING LITIGATION AND INVESTIGATIONS REGARDING OUR PARENT, EL PASO CORPORATION,
AND ITS AFFILIATES COULD HARM OUR BUSINESS AND IMPAIR OUR ABILITY TO MAKE
PAYMENTS ON THE NOTES.
El Paso Corporation and several of its subsidiaries were named defendants
in numerous purported class action, municipal or individual lawsuits filed in
the California state courts. The suits contend that El Paso Corporation's
entities 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.
On June 26, 2003, El Paso Corporation entered into two definitive
settlement agreements (the Western Energy Settlement) with various public and
private claimants, including the states of California, Washington, Oregon, and
Nevada, to resolve this litigation. The final settlement will include aggregate
upfront cash payments of $343.5 million, a cash payment of $45 million per year
for twenty years, a price reduction under two power supply contracts and a
separate cash payment equal to the proceeds from the sale of approximately 26.4
million shares of El Paso Corporation common stock. El Paso Corporation has also
entered into a structural settlement in which it has agreed to, among other
things, provide firm capacity on its El Paso Natural Gas pipeline to California
over a period of five years and construct a new expansion on the pipeline. If
the settlements are not approved by the court or the FERC, the proceedings and
litigation will continue.
In addition, El Paso Corporation and a number of its affiliates have been
named defendants in various other lawsuits involving the State of California,
other energy markets and alleged violations of federal securities laws. At this
time, El Paso Corporation's legal exposure related to these lawsuits and claims
is not determinable. For more information regarding these and other claims
against our parent, please read "Business and Properties -- Legal Proceedings"
beginning on page 55 of this prospectus.
If El Paso Corporation does not prevail in these and other pending cases,
and if the remedies adopted in these cases substantially impair El Paso
Corporation's financial position, the long-term adverse impact on El Paso
Corporation's credit rating, liquidity and ability to raise capital to meet its
ongoing and future investing and financing needs could be substantial. It may
look to its subsidiaries, including us, to provide liquidity. To the extent we
are permitted under the indenture governing the notes, we may be required to
sell assets in order to provide El Paso Corporation with sufficient funds to
satisfy its obligations under any of these claims. In addition, if we had to
provide substantial amounts of cash to El Paso Corporation to assist it in
satisfying those obligations, our ability to make payments on the notes could be
materially adversely affected. Further, if El Paso Corporation does not prevail
in these cases and as a result its financial position is substantially impaired,
the secondary market value of the notes could be significantly reduced.
21
AS A MEMBER OF THE EL PASO CORPORATION GROUP THAT FILES CONSOLIDATED FEDERAL
INCOME TAX RETURNS, WE ARE SEVERALLY LIABLE FOR THE CONSOLIDATED FEDERAL INCOME
TAXES OF THE GROUP AND WE COULD BE REQUIRED TO PAY THE FULL TAXES DUE FOR THAT
GROUP IF EL PASO CORPORATION FAILS TO MAKE THE PAYMENTS.
We are a member of the El Paso Corporation group filing consolidated
federal income tax returns. Applicable federal income tax regulations provide
that each member of a group of corporations filing a consolidated federal income
tax return is severally liable for the entire consolidated federal income tax
liability of that group.
The Treasury Department may attempt to collect part or all of the
consolidated federal income tax liability from El Paso Corporation as the common
parent of the El Paso Corporation group or any other member of the group,
including us. A member of such a consolidated filing group cannot deny liability
for such taxes on the ground that it sustained a net operating loss for the year
or that such liability is not consistent with an agreement made between members
of the group. If El Paso Corporation or other members of the El Paso Corporation
group do not have the financial means to pay the consolidated federal income tax
liability of the El Paso Corporation group, we may, as a member of the El Paso
Corporation group, be required to pay any consolidated federal income tax
deficiencies of the El Paso Corporation group for any year we are a member of
that group. As of December 31, 2002 and September 30, 2003, the El Paso
Corporation group had no consolidated federal income tax liability due to the
existence of net operating loss carry-forwards.
THE PENSION BENEFIT GUARANTY CORPORATION COULD SEEK TO TERMINATE EL PASO'S
PENSION PLANS AND IMPOSE LIABILITY ON US.
A federal government corporation known as the Pension Benefit Guaranty
Corporation (PBGC) has the power under Title IV of the Employee Retirement
Income Security Act of 1974, as amended (ERISA), to terminate underfunded
defined benefit pension plans under various circumstances. Should such a
termination occur, liability for any underfunding of a plan, calculated by the
PBGC, may be imposed jointly and severally on all members of the contributing
sponsor's "controlled group" as of the date of termination (subject to certain
statutory limits). In addition, all members of the contributing sponsor's
controlled group would be jointly and severally liable for any due and unpaid
contributions, including any waived funding deficiencies plus interest. El Paso
Corporation's controlled group includes substantially all of El Paso
Corporation's subsidiaries and affiliates, including us and our subsidiaries.
El Paso Corporation currently sponsors, maintains and contributes to the
following three single-employer pension plans that are subject to Title IV of
ERISA: El Paso Corporation Pension Plan, Coastal Mart, Inc. Pension Plan and
Coastal Coal Company, LLC Pension Plan.
If the PBGC terminates one or more of these plans while we are members of
El Paso Corporation's controlled group, the PBGC could enforce the resulting
liability against us. The PBGC could demand that we pay this liability and, if
we fail to timely pay this liability, the PBGC could seek to perfect a statutory
lien against our property that automatically attaches in the PBGC's favor
against the assets of each member of the El Paso Corporation controlled group.
These liabilities could be substantial in amount and could adversely affect our
financial condition and liquidity and thus our ability to make payments on the
notes.
RESULTS OF INVESTIGATIONS INTO REPORTING OF TRADING INFORMATION COULD IMPAIR OUR
ABILITY TO REPAY THE NOTES.
In response to an October 2002 data request from the FERC, El Paso
Corporation is conducting an ongoing investigation into the accuracy of
information that employees of El Paso Merchant Energy, an El Paso Corporation
subsidiary, voluntarily reported to trade publications. As a part of that
investigation, El Paso Corporation has discovered that inaccurate information
was submitted to the trade publications. One of El Paso Merchant Energy's former
employees has been arrested and charged with knowingly submitting inaccurate
data to a trade publication. These investigations are continuing, and it is
unknown whether penalties or sanctions will be imposed on El Paso Corporation,
and if imposed, the amount of such penalties. If any monetary penalties imposed
caused El Paso Corporation to turn to its subsidiaries,
22
including us, for funding, our financial condition and our ability to repay the
notes could be negatively affected.
WE ARE A WHOLLY-OWNED SUBSIDIARY OF EL PASO CORPORATION. EL PASO CORPORATION CAN
EXERCISE SUBSTANTIAL CONTROL OVER OUR DIVIDEND POLICY AND BUSINESS AND
OPERATIONS.
El Paso Corporation has substantial control over:
- our payment of dividends;
- decisions on our financings and our capital raising activities;
- mergers or other business combinations;
- our acquisitions or dispositions of assets;
- our shared employees and shared services;
- our insurance coverage; and
- our participation in El Paso Corporation's cash management program.
El Paso Corporation may exercise this control in its own interest and not
necessarily in the interests of us or the holders of the notes.
In addition, our board of directors is comprised solely of employees of El
Paso Corporation. The indenture governing the notes requires our board of
directors to make several good faith determinations, including determinations of
fair market value in connection with asset sales and determinations of whether
transactions with our affiliates (including El Paso Corporation) are being
conducted at an arm's length basis. There are no independent or outside members
of our board of directors who would likely add an independent viewpoint to a
determination involving a conflict of interest with El Paso Corporation or its
affiliates, and we do not presently intend to have any such independent members
appointed to our board. In addition, we receive and will continue to receive
certain management services from affiliates of El Paso Corporation, and the
transactions pursuant to which we receive such services will be exempt from the
prohibitions of the indenture covenant addressing affiliate transactions.
Because of this, there is a risk that we could enter into transactions with El
Paso Corporation and its affiliates that comply with the indenture governing the
notes, but might be on terms that are different than the terms that would be
agreed to if we had independent members of our board.
RISKS RELATED TO THE NOTES
A SUBSIDIARY GUARANTEE COULD BE VOIDED IF IT CONSTITUTES A FRAUDULENT TRANSFER
UNDER U.S. BANKRUPTCY OR SIMILAR STATE LAW.
Under U.S. bankruptcy law and comparable provisions of state fraudulent
transfer laws, a guarantee can be voided, or claims under the guarantee may be
subordinated to all other debts of that guarantor if, among other things, the
guarantor received less than reasonably equivalent value or fair consideration
for the incurrence of the guarantee and:
- was insolvent or rendered insolvent by reason of the incurrence of the
guarantee;
- was engaged in a business or transaction for which the guarantor's
remaining assets constituted unreasonably small capital; or
- intended to incur, or believed that it would incur, debts beyond its
ability to pay those debts as they mature.
A guarantee may also be voided, without regard to the above factors, if a
court found that the guarantor entered into the guarantee with the actual intent
to hinder, delay or defraud its creditors.
A court would likely find that a guarantor did not receive reasonably
equivalent value or fair consideration for its guarantee if the guarantor did
not substantially benefit directly or indirectly from the
23
issuance of the guarantees. If a court were to void a subsidiary guarantee, you
would no longer have a claim against that subsidiary guarantor. Sufficient funds
to repay the notes may not be available from other sources, including the
remaining guarantors, if any. In addition, the court might direct you to repay
any amounts that you already received from the subsidiary guarantor.
UPON A CHANGE OF CONTROL, WE MAY NOT HAVE THE ABILITY TO RAISE THE FUNDS
NECESSARY TO FINANCE THE CHANGE OF CONTROL OFFER REQUIRED BY THE INDENTURE
GOVERNING THE NOTES, WHICH WOULD VIOLATE THE TERMS OF THE NOTES.
Upon the occurrence of a change of control (which does not include changes
of control of El Paso Corporation) followed by certain ratings downgrades of the
notes, holders of the notes will have the right to require us to purchase all or
any part of the holders' notes at a price equal to 101% of the principal amount
thereof, plus accrued and unpaid interest, if any, to the date of purchase. We
and our subsidiary guarantors may not have sufficient financial resources
available to satisfy all of our or their obligations under these notes in the
event of a change in control. Our failure to purchase the notes as required
under the indenture would result in a default under the indenture, which could
have material adverse consequences for us and the holders of the notes. See
"Description of Notes -- Change of Control."
THE NOTES WILL BE EFFECTIVELY SUBORDINATED TO LIABILITIES AND INDEBTEDNESS OF
OUR SUBSIDIARIES AND SUBORDINATED TO ANY OF OUR SECURED INDEBTEDNESS TO THE
EXTENT OF THE ASSETS SECURING SUCH INDEBTEDNESS.
We currently have no secured indebtedness outstanding. However, holders of
any secured indebtedness that we may incur in the future would have claims with
respect to our assets constituting collateral for the secured indebtedness that
are prior to your claims under the notes. In the event of a default on any such
secured indebtedness or our bankruptcy, liquidation or reorganization, those
assets would be available to satisfy claims of the secured creditors before any
payment could be made on the notes. The indenture governing the notes allows us
to secure some kinds of indebtedness without equally and ratably securing the
notes. To the extent the value of the collateral is not sufficient to satisfy
the secured indebtedness, the holders of that indebtedness would be entitled to
share with the holders of the notes and the holders of other claims against us
with respect to our other assets.
In addition, the notes may not be guaranteed by all of our subsidiaries in
the future, and any non-guarantor subsidiaries can incur some indebtedness under
the terms of the indenture. As a result, third party creditors of our
non-guarantor subsidiaries, including trade creditors and holders of
indebtedness or guarantees issued by these non-guarantor subsidiaries, will
generally have priority to the assets of the non-guarantor subsidiary over
holders of the notes. All of our existing wholly-owned subsidiaries are
guarantors of the notes.
AN ACTIVE TRADING MARKET MAY NOT DEVELOP FOR OUR NOTES.
Prior to the offering of the Old Notes, there was no market for the notes.
Although we expect the notes to trade in the Portal(SM) Market, the notes are
not listed on any securities exchange. In addition, the liquidity of the trading
market in the notes and the market price quoted for the notes may be adversely
affected by changes in the overall market for debt securities and by changes in
our financial performance or prospects or in the financial performance or
prospects of companies in our industry. As a result, an active trading market
may not develop or be maintained for our notes. If an active market does not
develop or is not maintained, the market price and liquidity of our notes may be
adversely affected.
A FINANCIAL FAILURE BY US OR ANY SUBSIDIARY GUARANTOR MAY HINDER THE RECEIPT OF
PAYMENT ON THE NOTES, AS WELL AS THE ENFORCEMENT OF REMEDIES UNDER THE
SUBSIDIARY GUARANTEES.
An investment in the notes, as in any type of security, involves insolvency
and bankruptcy considerations that investors should carefully consider. If we or
any of our subsidiary guarantors become a debtor subject to insolvency
proceedings under the bankruptcy code, it is likely to result in delays in the
payment of the notes and in the exercise of enforcement remedies under the notes
or the subsidiary guarantees. Provisions under the bankruptcy code or general
principles of equity that could result in the impairment of your rights include
the automatic stay, avoidance of preferential transfers by a trustee or a
debtor-in-possession, limitations of collectability of unmatured interest or
attorneys' fees and forced restructuring of the notes.
24
FORWARD-LOOKING STATEMENTS
In this prospectus we have made "forward-looking statements" which are
subject to risks and uncertainties. Forward-looking statements include
information concerning possible or assumed future results of operations of us
and our affiliates. These statements may relate to, but are not limited to,
information or assumptions about capital and other expenditures, dividends,
financing plans, capital structure, cash flow, pending legal and regulatory
proceedings and claims, including environmental matters, future economic
performance, operating income, cost savings, management's plans, goals and
objectives for future operations and growth. These forward-looking statements
generally are accompanied by words such as "intend," "anticipate," "believe,"
"estimate," "expect," "should" or similar expressions. It should be understood
that these forward-looking statements are necessarily estimates reflecting the
best judgment of our senior management, not guarantees of future performance.
They are subject to a number of assumptions, risks and uncertainties that could
cause actual results to differ materially from those expressed or implied in the
forward-looking statements. Forward-looking statements may relate to various
financial and operational matters, including, among other things: fluctuations
of the prices received or demand for our oil and natural gas; the amount, nature
and timing of capital expenditures; drilling of wells; competition and
government regulations; timing and amount of future production of oil and
natural gas; costs of exploiting and developing our properties and conducting
other operations, in the aggregate and on a per unit equivalent basis; increases
in proved reserves; operating costs and other expenses; cash flow and
anticipated liquidity; estimates of proved reserves, exploitation or property
acquisitions; marketing of oil and natural gas; and general economic conditions
and the other risks and uncertainties discussed in this prospectus and set forth
from time to time in our public reports, filings and public statements.
Undue reliance should not be placed on forward-looking statements, which
speak only as of the date of this prospectus.
For a description of risks relating to us and our business, see "Risk
Factors" beginning on page 14 of this prospectus.
All subsequent written and oral forward-looking statements attributable to
us or any person acting on our behalf are expressly qualified in their entirety
by the cautionary statements contained or referred to in this section and any
other cautionary statements that may accompany those forward-looking statements.
We do not undertake any obligation to release publicly any revisions to these
forward-looking statements to reflect events or circumstances after the date of
this document or to reflect the occurrence of unanticipated events, unless the
securities laws require us to do so.
25
USE OF PROCEEDS
We received net proceeds of approximately $1.17 billion from the issuance
of the Old Notes after deducting the initial purchasers' discounts and offering
expenses. We used the net proceeds from the issuance of the Old Notes together
with cash on hand to repay the $1.2 billion principal amount of intercompany
obligations to El Paso Corporation incurred in connection with the retirement of
its Trinity River financing, plus accrued and unpaid interest thereon. El Paso
Corporation then used these proceeds to repay its obligations under the El Paso
Corporation term loan.
We will not receive any cash proceeds from the issuance of the New Notes.
We will exchange outstanding Old Notes for New Notes in like principal amount as
contemplated in this prospectus. The terms of the New Notes are identical in all
material respects to the existing Old Notes except as otherwise described herein
under "Description of Notes." The Old Notes surrendered in exchange for the New
Notes will be retired and canceled and cannot be reissued. Accordingly, issuance
of the New Notes will not result in a change in our total debt and other
financing obligations.
CAPITALIZATION
The following table sets forth our historical consolidated capitalization
as of September 30, 2003. The exchange of the Old Notes for the New Notes will
not impact our overall capitalization. This table is unaudited and should be
read in conjunction with our consolidated financial statements and related notes
included in this prospectus.
<Table>
<Caption>
AS OF
SEPTEMBER 30,
2003
-------------
(UNAUDITED)
(IN MILLIONS)
Cash and cash equivalents................................... $ 118
Long-term debt:
Trinity River Term Loan................................... $ --
7 3/4% Senior Notes due 2013.............................. 1,170
------
Total debt........................................ 1,170
Total stockholder's equity.................................. 1,894
------
Total capitalization.............................. $3,064
======
</Table>
26
RATIO OF EARNINGS TO FIXED CHARGES
The following table presents the ratio of earnings to fixed charges for El
Paso Production and its consolidated subsidiaries for the periods indicated:
<Table>
<Caption>
NINE MONTHS
ENDED
YEAR ENDED SEPTEMBER 30,
------------------------------------ --------------
1998 1999 2000 2001 2002 2002 2003
---- ---- ---- ---- ---- ----- -----
Ratio of earnings to fixed
charges.......................... --(1) --(1) --(2) --(2) --(2) --(2) 6x(3)
</Table>
- ---------------
(1) Earnings were inadequate to cover fixed charges by $1,015 million and $322
million for the years ended December 31, 1998 and 1999, respectively.
(2) There were no fixed charges for the years ended December 31, 2000, 2001 and
2002 and for the nine months ended September 30, 2002 since we were funded
through equity contributions from El Paso.
(3) In 2003, we incurred interest costs related to the Trinity River refinancing
and the issuance of the Old Notes.
For the purposes of computing these ratios, earnings means pre-tax income (loss)
from continuing operations before:
- adjustment for minority interest in consolidated subsidiaries;
- income from equity investees, adjusted to reflect actual distributions
from equity investments; and
- fixed charges;
less:
- capitalized interest.
Fixed charges means the sum of the following:
- interest costs;
- amortization of debt costs;
- that portion of rental expenses which we believe represents an interest
factor; and
- preferred returns on consolidated subsidiaries.
27
SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA
You should read the following historical financial data in connection with
the financial statements and related notes and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in this
prospectus. The financial data as of and for each of the five years ended
December 31, 2002 were derived from our audited financial statements. The data
for the nine months ended September 30, 2002 and 2003 were derived from our
unaudited interim financial statements appearing in this prospectus. In the
opinion of management, this nine-month data includes all normal recurring
adjustments necessary for a fair statement of the results for those interim
periods. Our historical results are not necessarily indicative of results to be
expected in future periods.
<Table>
<Caption>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------- ---------------
1998 1999 2000 2001 2002 2002 2003
------- ------ ------ ------ ------ ------ ------
(IN MILLIONS)
OPERATING RESULTS DATA:
Operating revenues............................ $ 560 $ 498 $ 537 $ 604 $ 841 $ 630 $ 736
------- ------ ------ ------ ------ ------ ------
Operating expenses............................ 157 161 144 183 215 157 195
Restructuring charges and merger-related
costs....................................... 15 33 -- 2 -- -- 4
Depreciation, depletion and amortization...... 292 210 206 234 317 242 228
Ceiling test charges.......................... 1,035 352 -- -- -- -- --
------- ------ ------ ------ ------ ------ ------
Operating income (loss)....................... (939) (258) 187 185 309 231 309
------- ------ ------ ------ ------ ------ ------
Interest income (expense)(1).................. (75) (53) 8 9 8 5 (47)
Earnings from unconsolidated affiliates....... -- -- 11 29 6 5 8
Other income (expense)........................ 3 1 4 1 5 (3) 2
Minority interest in consolidated
subsidiaries................................ -- -- -- (4) (3) (2) (3)
------- ------ ------ ------ ------ ------ ------
Income (loss) before income taxes............. (1,011) (310) 210 220 325 236 269
Benefit (provision) for income taxes.......... 360 108 (70) (71) (112) (79) (105)
------- ------ ------ ------ ------ ------ ------
Income (loss) before cumulative effect of
accounting changes.......................... (651) (202) 140 149 213 157 164
Cumulative effect of accounting changes, net
of income taxes............................. -- -- -- -- -- -- (2)
------- ------ ------ ------ ------ ------ ------
Net income (loss)............................. $ (651) $ (202) $ 140 $ 149 $ 213 $ 157 $ 162
======= ====== ====== ====== ====== ====== ======
CASH FLOW DATA:
Net cash provided by operating activities..... $ 248 $ 231 $ 197 $ 352 $ 849 $ 658 $ 471
Net cash used in investing activities......... (263) (575) (522) (655) (891) (680) (75)
Net cash provided by (used in) financing
activities.................................. -- 346 323 303 198 22 (434)
FINANCIAL POSITION DATA:
Total assets.................................. $ 1,636 $2,174 $2,358 $3,236 $4,218 $3,695 $3,872
Total debt.................................... 961 -- -- -- -- -- 1,170
Total stockholder's equity.................... 449 1,895 2,147 2,798 3,309 2,979 1,894
</Table>
- ---------------
(1) Interest expense for 1998, 1999 and the nine months ended September 30, 2003
is shown net of capitalized interest of $3 million, $12 million and $3
million, respectively.
28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The following discussion and analysis of our results of operations and
financial condition should be read in conjunction with "Business and
Properties," "Selected Consolidated Historical Financial Data" and our audited
financial statements, our unaudited pro forma financial statements and
supplementary data beginning on page F-1 of this prospectus.
RESULTS OF OPERATIONS
We use earnings before interest and income taxes (EBIT) to assess the
operating results and effectiveness of our business. We define EBIT as operating
income, adjusted for earnings from unconsolidated affiliates, minority interest
in consolidated subsidiaries and other miscellaneous non-operating items. Items
that are not included in this measure are financing costs, including interest
and debt expense, income taxes, extraordinary items and the cumulative effect of
accounting changes. The following is a reconciliation of our operating results
to EBIT and net income for the periods indicated:
<Table>
<Caption>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------ -------------
2000 2001 2002 2002 2003
------ ------ ------ ----- -----
(IN MILLIONS) (UNAUDITED)
Operating revenues........................... $ 537 $ 604 $ 841 $ 630 $ 736
Operating expenses........................... (350) (419) (532) (399) (427)
----- ----- ----- ----- -----
Operating income........................... 187 185 309 231 309
Other income (expense)....................... 4 1 5 (3) 2
Earnings from unconsolidated affiliates...... 11 29 6 5 8
Minority interest in consolidated
subsidiaries............................... -- (4) (3) (2) (3)
----- ----- ----- ----- -----
EBIT....................................... 202 211 317 231 316
Interest income from affiliates.............. 8 9 8 5 7
Interest expense, net of capitalized
interest................................... -- -- -- -- (54)
Income taxes................................. (70) (71) (112) (79) (105)
----- ----- ----- ----- -----
Income from continuing operations............ 140 149 213 157 164
Cumulative effect of accounting changes, net
of income taxes............................ -- -- -- -- (2)
----- ----- ----- ----- -----
Net income................................... $ 140 $ 149 $ 213 $ 157 $ 162
===== ===== ===== ===== =====
</Table>
We believe EBIT is a useful measurement for our investors because it
provides information that can be used to evaluate the effectiveness of our
businesses and investments from an operational perspective, exclusive of the
costs to finance those activities and exclusive of income taxes. This measure is
used by El Paso Corporation to assess the performance of its business segments.
EBIT may not be comparable to measures used by other companies and should not be
used as a substitute for net income or other performance measures, or as a
substitute for liquidity measures such as operating cash flow.
OVERVIEW OF RESULTS OF OPERATIONS
Our operating results are driven by a variety of factors including the
ability to locate and develop economic natural gas and oil reserves, extract
those reserves with minimal production costs, sell the products at attractive
prices and operate at a low total cost level.
Since December 31, 2002, we have sold over 445 Bcfe of proved reserves
through multiple transactions involving various third parties. The cumulative
amounts of reserves sold through these various transactions represented over 15%
of our year end 2002 total reserve base, and generated total cash proceeds to
the company of $453 million. These sales were conducted as part of Parent EPC's
efforts to
29
reduce debt and improve its liquidity position. These sales, which included
proved developed producing reserves, combined with normal production declines,
mechanical failures on certain producing wells and higher finding and
development costs have resulted in our total equivalent production declining
each quarter since the first quarter of 2003. For the first nine months of 2003,
our total equivalent production has declined approximately 25 Bcfe or 12% as
compared to the same period in 2002. Future production trends will depend upon
the amount of capital spending, the level of success in our drilling program and
any future sales activity relating to our proved reserves.
We have historically engaged in hedging activities on our natural gas and
oil production to stabilize cash flows and reduce the risk of downward commodity
price movements on our sales. This is achieved primarily through natural gas and
oil swaps. In the past, our stated goal was to hedge approximately 75 percent of
our anticipated current year production, approximately 50 percent of our
anticipated succeeding year production and a lesser percentage thereafter. As a
component of Parent EPC's strategic repositioning plan in May 2002, we modified
our hedging strategy. Under our modified strategy, we may hedge up to 50 percent
of our anticipated production for a rolling 12-month forward period. This
modification of our hedging strategy will increase our exposure to changes in
commodity prices which could result in significant volatility in our reported
results of operations, financial position and cash flows from period to period.
As of September 30, 2003, we had hedged approximately 33 million MMBtus of our
anticipated remaining natural gas production for 2003 at a NYMEX Henry Hub price
of $3.19 per MMBtu before regional price differentials and transportation costs.
In addition, we have hedged approximately 75 million MMBtus at $3.12 per MMBtu
of our 2004 anticipated natural gas production, 79 million MMBtus at $3.16 per
MMBtu of our 2005 anticipated natural gas production and 84 million MMBtus at
$3.28 per MMBtu of our 2006 anticipated natural gas production. We have also
hedged additional volumes at various prices through 2012. We have been
conducting our hedging activities with an affiliate of Parent EPC that conducts
energy trading activities. This affiliate then enters into hedging arrangements
with third parties. Parent EPC has announced that it will exit the energy
trading business during the next 18 to 24 months. At such time, we may assume
responsibility for our hedging activities. As we have not been conducting our
hedging activities in the past, our future results of operations could be
adversely affected if we assume control over these activities.
During 2002, we continued an active onshore and offshore development
drilling program to take advantage of our large inventory of drillable prospects
and to develop our proved undeveloped reserve base. In March 2002, we acquired
natural gas and oil properties in South Texas from El Paso CGP, a subsidiary of
El Paso, for $395.5 million. Also in March 2002, we acquired the Prince offshore
platform from GulfTerra Energy Partners, L.P. (formerly El Paso Energy Partners,
L.P.) for $190 million. In July 2002, we acquired natural gas properties in the
Raton Basin for approximately $140 million. These Raton Basin properties were
acquired to expand our interest in the current coal seam project in the area. We
also completed asset dispositions in east Texas as part of Parent EPC's balance
sheet enhancement plan.
In the last two years, Parent EPC has recognized the need to strengthen its
capital structure and enhance its liquidity. One of the means to achieve these
objectives is to reduce capital spending. As a result, we will reduce our total
capital expenditures from approximately $1.4 billion in 2002 to approximately
$600 million in 2003. In the first nine months of 2003, our total capital
expenditures were approximately $516 million. We continually evaluate our
capital expenditure program and this estimate is subject to change based on
market conditions. We will continue to pursue strategic acquisitions of
production properties and the development of projects subject to acceptable
returns.
As a strategy to supplement our 2003 and 2004 capital budget, in October
2003 we entered into agreements with a wholly owned subsidiary of Lehman
Brothers (Lehman), an investment bank, and a wholly owned subsidiary of Nabors
Industries Ltd. (Nabors) that could collectively result in an additional $190
million of drilling activity over the next nine to 12 months. Under the
agreements, Lehman will contribute 50 percent of an estimated $270 million total
cost to develop a specified package of wells in exchange for a 50 percent net
profits interest (cash proceeds available after royalties and operating costs
have been paid), and Nabors will contribute 20 percent in exchange for a 20
percent net profits interest in the package of wells. Once a specified payout is
achieved, Lehman's and Nabors' net profits interests will
30
convert to an overriding royalty interest in the wells for the remainder of the
wells' productive lives. The remaining 30 percent of the $270 million of capital
will be contributed by us as part of our existing 2003 and 2004 capital budget.
Under the terms of the agreements, all parties have a right to cease further
investment with 30 days notice.
Parent EPC is considering, among other options, contributing to us other
exploration and production properties that it owns. Parent EPC has not, however,
made a final decision whether to make any such contribution. Any contribution of
these assets would be subject to numerous conditions precedent, including the
approval of Parent EPC's board of directors and approvals, waivers and consents
of third parties. Whether or not Parent EPC ultimately decides to contribute any
additional properties to us is beyond our control.
Below are the operating results for each of the periods indicated:
<Table>
<Caption>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------ --------------------
2000 2001 2002 2002 2003
-------- -------- -------- -------- --------
(IN MILLIONS, EXCEPT VOLUMES AND PRICES)
OPERATING REVENUES:
Natural gas............................... $ 441 $ 483 $ 640 $ 474 $ 604
Oil, condensate and liquids............... 91 120 211 165 126
Other..................................... 5 1 (10) (9) 6
-------- -------- -------- -------- --------
Total operating revenues............. 537 604 841 630 736
Transportation and net product costs...... (32) (43) (55) (42) (39)
-------- -------- -------- -------- --------
Total operating margin............... 505 561 786 588 697
Operating expenses(1)..................... (318) (376) (477) (357) (388)
-------- -------- -------- -------- --------
Operating income........................ 187 185 309 231 309
Other income (expense).................... 4 1 5 (3) 2
Earnings from unconsolidated affiliates... 11 29 6 5 8
Minority interest in consolidated
subsidiaries............................ -- (4) (3) (2) (3)
-------- -------- -------- -------- --------
EBIT.................................... $ 202 $ 211 $ 317 $ 231 $ 316
======== ======== ======== ======== ========
VOLUMES AND PRICES:
Natural gas
Volumes (MMcf).......................... 182,435 187,379 214,529 159,228 152,465
======== ======== ======== ======== ========
Average realized prices with hedges
($/Mcf)()(2)......................... $ 2.42 $ 2.57 $ 2.99 $ 2.98 $ 3.96
======== ======== ======== ======== ========
Average realized prices without hedges
($/Mcf)(2)........................... $ 3.98 $ 4.33 $ 3.25 $ 2.99 $ 5.79
======== ======== ======== ======== ========
Average transportation costs ($/Mcf).... $ 0.17 $ 0.21 $ 0.19 $ 0.19 $ 0.19
======== ======== ======== ======== ========
Oil, condensate and liquids
Volumes (MBbls)......................... 5,004 5,600 9,629 7,647 4,599
======== ======== ======== ======== ========
Average realized prices with hedges
($/Bbl)(2)........................... $ 18.22 $ 21.50 $ 21.87 $ 21.51 $ 27.33
======== ======== ======== ======== ========
Average realized prices without hedges
($/Bbl)(2)........................... $ 28.58 $ 23.19 $ 22.06 $ 21.48 $ 28.74
======== ======== ======== ======== ========
Average transportation costs ($/Bbl).... $ 0.20 $ 0.49 $ 1.23 $ 1.17 $ 1.20
======== ======== ======== ======== ========
</Table>
- ---------------
(1) Includes production costs, depletion, depreciation and amortization,
merger-related and restructuring costs, gain (loss) on long-lived assets,
corporate overhead, general and administrative expenses and severance and
other taxes.
(2) Prices are stated before transportation costs.
31
Below is an analysis of the results of our earnings before interest and
income taxes (EBIT), interest income, interest expense, and income tax expense
for the periods indicated.
EARNINGS BEFORE INTEREST AND TAXES
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 2002
For the nine months ended September 30, 2003 operating revenues were $106
million higher than in the same period in 2002. Our natural gas revenues,
including the impact of hedges, were $130 million higher in 2003 compared to
2002. Natural gas prices, before the impact of hedges, rose in 2003 by 94
percent, resulting in a $427 million increase in revenues when compared to the
same period in 2002. Our 2003 natural gas volumes decreased by four percent,
resulting in a $20 million decrease in revenues, from the same period in 2002.
The decrease in natural gas volumes was primarily due to the sales of producing
properties in Oklahoma, normal production declines, and mechanical failures in
certain producing wells. In addition, 2003 natural gas revenues included a
hedging loss of $279 million compared to 2002 which included a natural gas
hedging loss of $2 million. This caused 2003 natural gas revenues to be $277
million lower than 2002 as a result of hedging activities. Our oil, condensate
and liquids revenues, including the impact of hedges, were $39 million lower in
the first nine months of 2003 compared to 2002. Oil, condensate and liquids
prices, before the impact of hedges, rose in 2003 by 34 percent, resulting in a
$33 million increase in revenues, when compared to the same period in 2002. Our
2003 oil, condensate and liquids volumes decreased 40 percent, resulting in a
$65 million decrease in revenues from the same period in 2002. The decline in
volumes was primarily due to the property sales, normal production declines, and
mechanical failures mentioned above. In addition, 2003 oil, condensate and
liquids revenues included a hedging loss of $7 million compared to 2002 which
included an oil hedging loss of less than $1 million. This caused 2003 oil,
condensate and liquids revenues to be $7 million lower than 2002 as a result of
hedging activities. Further increasing revenues was a positive mark-to-market
adjustment of $16 million in 2003 compared to 2002 related to hedges of
anticipated future production that no longer qualified for hedge accounting when
we sold those properties in March 2002.
Transportation and net product costs for the nine months ended September
30, 2003, were $3 million lower than in 2002 due to lower gas volumes subject to
transportation fees partially offset by higher costs incurred to meet minimum
payment obligations under pipeline agreements.
Operating expenses for the nine months ended September 30, 2003, were $31
million higher than in 2002. Contributing to the increase were higher division
and allocated corporate overhead, net of fees billed out to others, of $35
million, higher severance and other taxes of $10 million due to higher commodity
prices, employee severance costs of $4 million incurred in 2003 and a $2 million
gain on non-full cost pool assets recognized in 2002. Partially offsetting the
increase was lower depletion expenses of $14 million comprised of a $28 million
decrease resulting from lower production volumes in 2003, offset by an $8
million increase resulting from higher depletion rates in 2003 and costs of $6
million related to the accretion of our liability for asset retirement
obligations from the adoption of SFAS No. 143. Further offsetting the increases
was lower oilfield services costs of $6 million in 2003.
Earnings from unconsolidated affiliates increased $3 million in the first
nine months of 2003 compared to the same period in 2002. This increase was
primarily due to an $8 million negative dividend adjustment booked in 2002 for
our Clydesdale investment, partially offset by lower earnings in our equity
investment in Noric, L.L.C., which we sold in April 2003.
Minority interest expense in consolidated subsidiaries increased $1 million
as income in Noric Holdings I increased. We sold our investment in Noric
Holdings I in April 2003.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
For the year ended December 31, 2002 operating revenues were $237 million
higher than the same period of 2001. Our natural gas revenues, including the
impact of hedges, were $157 million higher in 2002 compared to 2001. Natural gas
prices, before the impact of hedges, declined in 2002 by 25 percent,
32
resulting in a $232 million decrease in revenues, when compared to the same
period in 2001. Our 2002 natural gas volumes increased by 14 percent, resulting
in a $117 million increase in revenues, from the same period in 2001. The
increase was due largely to increased production in the offshore and coal seam
regions. In addition, 2002 natural gas revenues included a hedging loss of $56
million compared to 2001 which included a natural gas hedging loss of $328
million. This caused 2002 natural gas revenues to be $272 million higher than
2001 as a result of hedging activities. Our oil, condensate and liquids
revenues, including the impact of hedges, were $91 million higher in 2002
compared to 2001. Oil, condensate and liquid prices, before the impact of
hedges, declined in 2002 by five percent, resulting in a $10 million decrease in
revenues, when compared to the same period in 2001. Our 2002 oil, condensate and
liquids volumes increased 72 percent, resulting in a $93 million increase in
revenues from the same period in 2001. The increase in volumes was due largely
to increased production in the offshore region. In addition, 2002 oil,
condensate and liquids revenues included a hedging loss of $2 million compared
to 2001 which included an oil hedging loss of $10 million. This caused 2002 oil,
condensate and liquids revenues to be $8 million higher than 2001 as a result of
hedging activities. Decreasing operating revenues was a loss of $13 million in
2002 resulting from a mark-to-market adjustment of derivative positions that no
longer qualify as cash flow hedges. These hedges no longer qualify for hedge
accounting treatment since they were designated as hedges of anticipated future
production from natural gas and oil properties that were sold in March 2002.
Transportation and net product costs for the year ended December 31, 2002,
were $12 million higher than in 2001 primarily due to a higher percentage of gas
volumes subject to transportation fees and higher costs incurred to meet minimum
payment obligations under pipeline agreements.
Operating expenses for the year ended December 31, 2002, were $101 million
higher than in 2001. The unit of production depletion expense was higher by $83
million with $31 million due to higher depletion rates in 2002 and $52 million
from higher production volumes in 2002. Also contributing to increased expenses
were higher oilfield service costs of $13 million as a result of higher
production volumes in 2002. The higher production volumes in 2002 compared to
2001 caused an increase in labor, processing fees, compression, workovers, and
other oilfield service costs. Further increasing expenses were higher overhead
cost, net of fees billed to others, of $13 million. Offsetting higher expenses
were lower severance and other taxes of $4 million, a gain on the sale of
non-full cost pool assets of $2 million recorded in 2002, and merger-related
costs of $2 million incurred in 2001.
Equity earnings from our unconsolidated affiliates decreased $23 million
from 2001 to 2002. Equity earnings from our investment in Noric, L.L.C.
decreased $5 million due to lower realized natural gas prices and higher
operating expenses than in 2001. Dividends from our Clydesdale cost method
investment decreased $18 million from 2001 to 2002. In 2002 and 2001, we
received $1.1 million and $10.5 million in dividends, respectively from
Clydesdale. In May 2002, we were notified by Clydesdale that it had distributed
cash of $8.1 million in excess earnings to us because of a change in the pro
rata allocation between us and other Clydesdale investors, which we returned to
Clydesdale in 2002.
Minority interest expense for El Paso CGP's 42 percent ownership in Noric
Holdings I decreased by $1 million from 2001 to 2002.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
For the year ended December 31, 2001 operating revenues were $67 million
higher than the same period of 2000. Our natural gas revenues, including the
impact of hedges, were $42 million higher in 2001 compared to 2000. Natural gas
prices, before the impact of hedges, rose in 2001 by 9 percent, resulting in a
$65 million increase in revenues, when compared to the same period in 2000. Our
2001 natural gas volumes increased by 3 percent, resulting in a $20 million
increase in revenues, from the same period in 2000. The production volume
increase was due largely to increased production in the onshore region. In
addition, 2001 natural gas revenues included a hedging loss of $328 million
compared to 2000 which included a natural gas hedging loss of $285 million. This
caused 2001 natural gas revenues to be $43 million lower than 2000 as a result
of hedging activities. Our oil, condensate and liquids revenues,
33
including the impact of hedges, were $29 million higher in 2001. Oil, condensate
and liquids prices, before the impact of hedges, declined in 2001 by 19 percent,
resulting in a $30 million decrease in revenues, when compared to the same
period in 2000. Our 2001 oil, condensate and liquids volumes increased 12
percent, resulting in a $17 million increase in revenues from the same period in
2000. The increase in volumes was due largely to increased production in the
offshore region. In addition, 2001 oil, condensate and liquids revenues included
a hedging loss of $10 million compared to 2000 which included an oil hedging
loss of $52 million. This caused 2001 oil, condensate and liquids revenues to be
$42 million higher than 2000 as a result of hedging activities.
Transportation and net product costs for the year ended December 31, 2001,
were $11 million higher than in 2000 primarily due to a higher percentage of gas
volumes subject to transportation fees.
Operating expenses for the year ended December 31, 2001, were $58 million
higher than in 2000. Contributing to the increase was higher unit of production
depletion expense of $24 million, with $8 million resulting from higher
production volumes and $16 million due to higher depletion rates. In addition,
depreciation expense on non full-cost pool assets increased $4 million. Also
contributing to the increase in expenses was higher oilfield service costs of
$26 million as a result of higher production volumes in 2001. The higher
production volumes in 2001 compared to 2000 resulted in higher transportation
and equipment use, utilities, processing fees, compression, workovers and other
oilfield service costs. Further increasing expenses were higher severance and
other production taxes of $7 million and merger-related costs of $2 million
recorded in 2001. Offsetting these increases in expenses was lower overhead
cost, net of fees billed to others, of $5 million.
Equity earnings from unconsolidated affiliates increased $18 million from
2000 to 2001. Equity earnings from our investment in Noric, L.L.C. increased $9
million due to higher production volumes from additional properties contributed
by El Paso CGP. In addition, dividends from our Clydesdale cost method
investment increased $8 million. In 2002, $8 million of these dividends were
returned as Clydesdale notified us of a change in the pro rata allocation
between us and other investors.
Minority interest expense for El Paso CGP's ownership in Noric Holdings I
increased by $4 million from 2000 to 2001 after it contributed properties to
Noric.
INTEREST INCOME
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 2002
Interest income for the nine months ended September 30, 2003 increased $2
million compared to the same period in 2002 primarily due to higher interest
rates.
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
Interest income for the year ended December 31, 2002, was essentially
unchanged as the higher outstanding balances on our notes receivable from El
Paso was offset by lower interest rates.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
Interest income for the year ended December 31, 2001, was essentially
unchanged as the higher outstanding balances on our notes receivable from El
Paso was offset by lower interest rates.
INTEREST EXPENSE
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 2002
Interest expense, net of capitalized interest, increased $54 million in the
first nine months of 2003 compared to the same period in 2002 due to the Trinity
River refinancing obtained in March 2003 and the Old Notes issued in May 2003.
34
INCOME TAX EXPENSE
Income tax expense for the nine months ended September 30, 2003 was $105
million, resulting in an effective tax rate of 39 percent. Income tax expense
for the nine months ended September 30, 2002, was $79 million, resulting in an
effective tax rate of 33 percent. The difference in our effective tax rate from
the statutory tax rate of 35 percent was primarily the result of earnings from
unconsolidated affiliates where we anticipate receiving dividends, and the
impact of state income taxes on our income.
Income tax expense for the year ended December 31, 2002, was $112 million
resulting in an effective tax rate of 34 percent. For the year ended December
31, 2001, income tax expense was $71 million, resulting in an effective tax rate
of 32 percent. For the year ended December 31, 2000, income tax expense was $70
million, resulting in an effective tax rate of 33 percent. Differences in our
effective tax rates from the statutory tax rate of 35 percent in all years were
primarily a result of earnings from unconsolidated affiliates where we
anticipate receiving dividends, and state income taxes. See note 4 of our
historical consolidated audited financial statements included in this prospectus
for a reconciliation of the statutory rate of 35 percent to our effective tax
rates.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
We rely on cash generated from our internal operations and loans from
Parent EPC through its cash management program as our primary sources of
liquidity, as well as proceeds from asset sales and capital contributions from
Parent EPC. We expect that our future funding for working capital needs, capital
expenditures, dividends and other financing activities will continue to be
provided from some or all of these sources. Each of these sources are impacted
by factors that influence the overall amount of cash generated by us and the
capital available to us. For example, cash generated by our business operations
may be impacted by changes in commodity prices or demands for our commodities or
services due to weather patterns, competition from other providers or
alternative energy sources. Liquidity generated by future asset sales may depend
on the overall economic conditions of the industry served by these assets, the
condition and location of the assets and the number of interested buyers. In
addition, Parent EPC's credit ratings or general market conditions can restrict
Parent EPC's ability to access capital markets, which can have a significant
impact on our liquidity.
In response to the current liquidity concerns of Parent EPC, we have
reduced our 2003 capital expenditure budget to approximately $600 million,
compared to the $1.4 billion we spent on capital expenditures in 2002.
Historically, we have funded our capital expenditures in part through
contributions from Parent EPC. Parent EPC has no commitment to fund our future
capital needs and in the future may elect not, or may be unable, to do so. In
its 2003 Operational and Financial Plan, Parent EPC outlined actions needed to
meet its short term liquidity needs. These actions included the renegotiation of
its credit agreements and asset sales. If these plans are insufficient for
Parent EPC's liquidity needs, Parent EPC could reduce its planned contributions
for our capital expenditures. As a result, we would be more dependent on cash
generated from our internal operations to fund capital projects.
To augment our capital expenditure budget for 2003 and 2004, in October
2003 we entered into agreements with a wholly owned subsidiary of Lehman
Brothers (Lehman), an investment bank, and a wholly owned subsidiary of Nabors
Industries Ltd. (Nabors) that could collectively result in an additional $190
million of drilling activity over the next nine to 12 months. Under these
agreements, Lehman will contribute 50 percent of an estimated $270 million total
cost to develop a specified package of wells in exchange for a 50 percent net
profits interest (cash proceeds available after royalties and operating costs
have been paid), and Nabors will contribute 20 percent in exchange for a 20
percent net profits interest in the package of wells. Once a specified payout is
achieved, Lehman's and Nabors' net profits interests will convert to an
overriding royalty interest in the wells for the remainder of the wells'
productive lives. The remaining 30 percent of the $270 million of capital will
be contributed by us as part of our existing 2003 and 2004 capital budget. Under
the terms of the agreements, all parties have a right to cease further
investment with 30 days notice.
35
In a series of credit rating agency actions in late 2002 and early 2003,
the senior unsecured debt of Parent EPC was downgraded to Caa1 by Moody's and B
by Standard & Poor's. Parent EPC remains on negative outlook by both agencies.
In addition, in November 2003 Moody's reduced our rating outlook to negative
from stable. The downgrades of the Parent EPC debt will increase our cost of
capital and could impede access to capital markets in the future. The Parent EPC
downgrades also resulted in cash generated by our operations that collateralized
the Trinity River facility being largely unavailable to us for general corporate
purposes. Instead, we were required to use this cash to redeem preferred
securities issued in connection with this arrangement and for the operation of
those companies. In January 2003, we paid approximately $56 million under this
provision and set aside $55 million to be used for additional future paydowns of
the Trinity River facility. As of December 31, 2002, the total amount
outstanding on this arrangement owed by Parent EPC was approximately $980
million. In March 2003, Parent EPC obtained $1.2 billion in financing and
retired this facility. As a result of the retirement of this facility, we are no
longer required to use cash generated by our operations to redeem preferred
securities issued in connection with the Trinity River facility, or for the
operation of the Trinity River companies. In May 2003, we sold $1.2 billion of
senior unsecured notes. The proceeds were used to retire the $1.2 billion
obligation to Parent EPC for the Trinity River refinancing previously discussed.
A cash pool has been established for us to loan funds to or borrow funds
from Parent EPC. Loans are payable on demand and interest is based on the
Bloomberg Index H15 rate plus 10 basis points. As of December 31, 2002 we had
loaned $431 million to Parent EPC, compared to $220 million as of December 31,
2001. As of September 30, 2003, we had loaned $701 million to Parent EPC.
Our cash flow activities for the periods indicated are as follows:
<Table>
<Caption>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------ -------------
2000 2001 2002 2002 2003
------ ------ ------ ----- -----
(IN MILLIONS)
Cash flows from operating activities......... $ 197 $ 352 $ 849 $ 658 $ 471
Cash flows from investing activities(1)...... (522) (655) (891) (680) (75)
Cash flows from financing activities(2)...... 323 303 198 22 (434)
</Table>
- ---------------
(1) Investing activities include net proceeds from the sales of assets of $3
million, $20 million, $363 million, $356 million, and $447 million for years
ended December 31, 2000, 2001, and 2002, and the nine months ended September
30, 2002 and 2003. Also included is capital expenditures of $500 million,
$675 million, $1,290 million, $1,036 million, and $579 million for years
ended December 31, 2000, 2001, and 2002 and the nine months ended September
30, 2002 and 2003. The negative cash flows represent capital expenditures on
natural gas and oil exploration and development activities, offset by the
net proceeds from the sales of assets.
(2) Financing activities include contributions from Parent EPC of $101 million,
$568 million, $849 million, and $499 million for the years ended December
31, 2000, 2001, and 2002 and for the nine months ended September 30, 2002.
There were no contributions from Parent EPC for the nine months ended
September 30, 2003.
In order to improve Parent EPC's liquidity position, we have taken steps to
reduce our cash needs for 2003, including implementing cost savings plans and
reducing our overall capital spending program. In order to supplement our cash
generated from operations in 2002, we sold $382 million of assets in east Texas
in March 2002. We have continued to sell assets in 2003 to supplement our
liquidity. In March of 2003 we sold certain assets in Oklahoma and Texas to
Chesapeake Energy Corporation for $440 million. The proceeds from this sale were
not restricted under the Trinity River financing agreements and were loaned to
Parent EPC through Parent EPC's cash management program.
In addition to our sources of cash from internally generated funds, asset
sales and capital markets transactions, we also will rely on advances from
Parent EPC through the use of Parent EPC's cash management program. Our ability
to continue to rely on cash advances from Parent EPC can be impacted by Parent
EPC's own credit standing, its requirements to repay debt and other financing
obligations, and the cash demands from other parts of its business.
36
We do not have any material long-term debt, lease or similar contractual
obligations other than our payment obligations in respect of the notes.
We believe we will generate sufficient funds through our operations, asset
sales, financing activities and advances from Parent EPC to meet our short-term
capital requirements for existing operations.
CAPITAL EXPENDITURES
Our capital expenditures were $1.4 billion and $661 million for 2002 and
2001, respectively. In the first nine months of 2003, our total capital
expenditures were approximately $516 million. Under our current plan, we expect
to spend approximately $600 million in each of the next two years for capital
expenditures primarily through internally generated funds. These capital
expenditures will be primarily spent on exploratory and development drilling
projects. In addition, we have entered into agreements with wholly owned
subsidiaries of Lehman and Nabors described on page 35, which will supplement
our 2003 and 2004 capital expenditure budget.
DEBT
Issuances:
<Table>
<Caption>
DATE TYPE INTEREST RATE PRINCIPAL NET PROCEEDS DUE DATE
- -------- ------------ ------------- --------- ------------ --------
(IN MILLIONS)
May 2003 Senior notes 7.75% $1,200 $1,169(1) 2013
</Table>
- ---------------
(1) Proceeds were used to repay the $1.2 billion loan from Parent EPC related to
the Trinity River refinancing.
CRITICAL ACCOUNTING POLICIES
The selection and application of accounting policies is an important
process that has developed as our business activities have evolved and as the
accounting rules have developed. Accounting rules generally do not involve a
selection among alternatives, but involve an implementation and interpretation
of existing rules and the use of judgment to the specific set of circumstances
existing in our business. We make every effort to properly comply with all
applicable rules on or before their adoption, and we believe the proper
implementation and consistent application of the accounting rules is critical.
However, not all situations are specifically addressed in the accounting
literature. In these cases, we must use our best judgment to adopt a policy for
accounting for these situations. We accomplish this by analogizing to similar
situations and the accounting guidance governing them, and often consult with
our independent accountants about the appropriate interpretation and application
of these policies. The preparation of our financial statements requires the
selection and application of a number of accounting policies. We have defined
our critical accounting policies as those significant accounting policies that
involve critical accounting estimates in the preparation of our financial
statements. Please read note 1 to our historical consolidated audited financial
statements included in this prospectus for a discussion of our significant
accounting policies.
We consider a critical accounting estimate to be an accounting estimate
recognized in the financial statements that requires us to make assumptions
about matters that may be highly uncertain at the time the estimate is made. We
believe that an accounting estimate is only considered a critical accounting
estimate if changes in those estimates are reasonably likely to occur or if we
reasonably could have selected a different estimate, and either of these
differences would have resulted in a material impact on our financial condition
or results of operations.
Estimates and assumptions about future events and their effects cannot be
determined with certainty. We base our estimates on historical experience and on
various other assumptions that are believed to be reasonable under the
circumstances. These estimates may change as new events occur and as additional
information is obtained. In addition, management is periodically faced with
uncertainties, the outcomes of which are not within our control and will not be
known for prolonged periods of time. We have discussed
37
the development and selection of the critical accounting policies and related
disclosures with the Audit Committee of the El Paso Corporation Board of
Directors.
Our critical accounting policies include industry specific policies, such
as accounting for natural gas and oil producing activities and price risk
management activities, as well as broad policies that include accounting for
environmental reserves and pension and other post retirement benefits. Each of
these areas involves complex situations and a high degree of judgment in both
the application and interpretation of existing literature and in the development
of estimates that impact our financial statements. These critical accounting
policies have been identified for the current year, and there may be additional
critical accounting policies as and when new accounting pronouncements are
adopted. Recent accounting pronouncements are discussed in the section below
entitled New Accounting Pronouncements Adopted and New Accounting Policies Not
Yet Adopted.
Accounting for Natural Gas and Oil Producing Activities. We use the full
cost method to account for our natural gas and oil producing activities. Under
this accounting method, we capitalize substantially all of the costs incurred in
connection with the exploration, acquisition and development of natural gas and
oil reserves in full cost pools maintained by geographic areas, regardless of
whether reserves are actually located. This method differs from the successful
efforts method of accounting for these activities. The primary differences
between these two methods are the treatment of exploratory dry hole costs and
geological and geophysical costs, the manner of impairment testing and the
recognition of gains or losses when properties are sold. Exploratory dry hole
costs include exploration, acquisition and development costs on wells that do
not yield measurable reserves. Under the successful efforts method, these costs
are generally expensed when the determination is made that measurable reserves
do not exist. Geological and geophysical costs are also expensed under the
successful efforts. Under the full cost method, both dry hole costs and
geological costs are capitalized into the full cost pool. As a result, our
financial statements will differ from companies that apply the successful
efforts method since we could potentially reflect a higher level of capitalized
costs as well as a higher depletion rate.
Under the full cost accounting method, we are required to conduct quarterly
impairment tests of our capitalized costs in our full cost pool. This impairment
test is referred to as a ceiling test. Our total capitalized costs, net of
related income tax effects, are limited to a ceiling based on the present value
of future net revenues from proved reserves using end of period spot prices,
discounted at 10 percent, plus the lower of cost or fair market value of
unproved properties, net of related income tax effects. Our ceiling test
calculations include the effects of our derivative instruments, which we have
designated as cash flow hedges of our anticipated future natural gas and oil
production. If these discounted revenues are not equal to or greater than total
capitalized costs, we are required to write-down our capitalized costs to this
level. The primary factors that could result in a ceiling test write-down
include lower prices, higher capitalized costs in the full cost pool, a lower
reserve base, and the impact of our hedging program.
The ceiling test calculation assumes that the price in effect on the last
day of the quarter is held constant over the life of the reserves. As a result
of this pricing assumption, the resulting value is not indicative of the true
fair value of the reserves. The prices of natural gas and oil are volatile and
change from period to period. We attempt to realize more determinable cash flows
through the use of hedges, but a decline in commodity prices can impact the
results of our ceiling test. Ceiling test charges due to fluctuating prices, as
opposed to reductions to the underlying reserve quantities, should not be
considered an absolute indicator of the value of the related reserves.
The process of estimating natural gas and oil reserves is very complex,
requiring significant decisions in the evaluation of all available geological,
geophysical, engineering and economic data. The data for a given field may also
change substantially over time as a result of numerous factors, including
additional development activity, evolving production history and a continual
reassessment of the viability of production under changing economic conditions.
As a result, material revisions to existing reserve estimates occur from time to
time. Although every reasonable effort is made to ensure that reserve estimates
reported represent the most accurate assessments possible, the subjective
decisions and variances in available data for various fields increases the
likelihood of significant changes in these estimates. Our
38
reserve estimates impact several financial calculations. If all other factors
are held constant, an increase in estimated proved reserves decreases our unit
of production depletion rate. Higher reserves can also reduce the likelihood of
ceiling test impairments. Estimated reserves are used to calculate projected
future cash flows from our natural gas and oil properties, which can often be
used as collateral to secure financing for our operations. Please see note 15 to
our historical consolidated audited financial statements included in this
prospectus for supplemental disclosures relating to our natural gas and oil
operations.
Price Risk Management Activities. We account for our price risk management
activities in accordance with the requirements of SFAS No. 133, which requires
that we determine the fair value of the derivative instruments we use and
reflect them in our balance sheet at their fair values. Changes in the fair
value of derivative instruments are generally recognized in our income statement
when the hedge is settled.
Some of our derivative instruments are traded on active exchanges such as
the NYMEX, while others are valued using exchange prices, third party pricing
data and valuation techniques that incorporate specific contractual terms,
statistical and simulation analysis and present value concepts. One of the
primary factors that can have an impact on our results each period is the price
assumptions used to value our derivative instruments. Because of the exit by El
Paso's energy trading group from the trading business, our accessibility to
reliable forward market pricing data for purposes of estimating fair value was
significantly limited in late 2002. As a result, we obtained valuation
assistance from a third party valuation specialist in determining the fair value
of our trading and non-trading price risk management activities as of December
31, 2002. Based upon the specialist's input, our estimates of fair value are
based upon price curves derived from actual prices observed in the market,
pricing information supplied by the specialist and independent pricing sources
and models that rely on this forward pricing information. These estimates also
reflect factors for time value and volatility underlying the contracts, the
potential impact of liquidating our position in an orderly manner over a
reasonable time under present market conditions, modeling risk, credit risk of
our counterparties and operational risks, as needed.
The amounts we report in our financial statements change as these estimates
are revised to reflect actual results, changes in market conditions or other
factors, many of which are beyond our control.
Another factor that can impact our results each period is our ability to
estimate the level of correlation between future changes in the fair value of
the hedge instrument and the transaction being hedged, both at the time we enter
into the transaction and on an ongoing basis. By hedging risk, the derivative
instrument's value is intended to offset value changes in the item being hedged.
However, this is complicated in hedging energy commodities, because energy
commodity prices have qualitative and locational differences that can be
difficult to hedge effectively. Our estimates of fair value and our assessment
of correlation of our hedging derivatives are impacted by actual results and
changes in market conditions.
NEW ACCOUNTING PRONOUNCEMENTS ADOPTED
As of September 30, 2003, there were a number of accounting standards and
interpretations that had been issued and adopted by us. Below is a discussion of
the more significant standards that were adopted by us through September 30,
2003.
ACCOUNTING FOR ASSET RETIREMENT OBLIGATIONS
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 143, Accounting for Asset Retirement Obligations. This statement requires
companies to record a liability for the estimated retirement and removal costs
of long-lived assets used in their business. The liability is recorded at its
fair value, with a corresponding asset which is depreciated over the remaining
useful life of the long-lived asset to which the liability relates. An ongoing
expense will also be recognized for changes in the value of the liability as a
result of the passage of time. The provisions of SFAS No. 143 are effective for
fiscal years beginning after June 15, 2002. Upon our adoption of SFAS No. 143 on
January 1, 2003, we recognized current liabilities of $9.1 million, long-term
liabilities of $67.1 million, non-current retirement assets of
39
$73.2 million, and a pre-tax charge to earnings of $3.0 million as the
cumulative effect of an accounting change. Our liability relates primarily to
our obligations to plug abandoned wells over the next one to 99 years.
ACCOUNTING FOR COSTS ASSOCIATED WITH EXIT OR DISPOSAL ACTIVITIES
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. This statement will require us to recognize
costs associated with exit or disposal activities when they are incurred rather
than when we commit to an exit or disposal plan. Examples of costs covered by
this guidance include lease termination costs, employee severance costs
associated with a restructuring, discontinued operations, plant closings or
other exit or disposal activities. The statement is effective for fiscal years
beginning after December 31, 2002, and will impact any exit or disposal
activities we initiate after January 1, 2003. We applied the provisions of this
standard in accounting for the $4 million in employee severance and termination
costs which we incurred during the first nine months of 2003.
ACCOUNTING FOR GUARANTEES
In November 2002, the FASB issued FIN No. 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. This interpretation requires that companies record a
liability for all guarantees issued after January 31, 2003, including financial,
performance and fair value guarantees. This liability is recorded at its fair
value upon issuance and does not affect any existing guarantees issued before
January 31, 2003. This standard also requires expanded disclosures on all
existing guarantees at December 31, 2002. There was no financial statement
impact of adopting this standard.
AMENDMENT OF STATEMENT 133 ON DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In April 2003, the Financial Accounting Standards Board (FASB) issued SFAS
No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. This statement amends SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities to incorporate several interpretations of the
Derivatives Implementation Group (DIG), and also makes several minor
modifications to the definition of a derivative as it was defined in SFAS No.
133. SFAS No. 149 affects contracts entered into or modified after June 30,
2003. There was no initial financial statement impact of adopting this standard.
NEW ACCOUNTING POLICIES NOT YET ADOPTED
ACCOUNTING FOR INTANGIBLE ASSETS
The Securities and Exchange Commission (SEC) has recently suggested that
acquired natural gas and oil rights held under lease should be classified as an
intangible asset pursuant to SFAS No. 141, Business Combinations, and SFAS No.
142, Goodwill and Intangible Assets. However, the SEC is not requiring companies
to apply this classification or the disclosure requirements for intangible
assets. We will continue to classify the costs of acquired natural gas and oil
mineral rights held under lease as natural gas and oil properties at full cost
on our balance sheet until the SEC or the Financial Accounting Standards Board
provides definitive guidance on the issue. We believe that this classification
is consistent with current accounting and industry practice. If the costs of
acquired natural gas and oil mineral rights held under lease were deemed to be
intangible assets, mineral interests for undeveloped and developed leaseholds
would be reclassified from natural gas and oil properties at full cost to
intangible assets on our balance sheet but would be included in costs of natural
gas and oil properties in the Notes to Consolidated Financial Statements in
accordance with SFAS No. 69, Disclosures about Oil and Gas Producing Activities.
There would be no effect on our statements of income or cash flows.
40
CONSOLIDATION OF VARIABLE INTEREST ENTITIES, AN INTERPRETATION OF ARB NO. 51
In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51. This 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.
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. On October 9, 2003, the FASB issued FASB Staff Position, FSP
FIN No. 46-6, Effective Date of FASB Interpretation No. 46, Consolidation of
Variable Interest Entities. This staff position deferred our required adoption
date of FIN No. 46 to the fourth quarter of 2003. We are currently assessing the
impact of FIN No. 46 on our business.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We use derivative financial instruments and energy related contracts to
manage market risks associated with natural gas and oil. Our primary market risk
exposures are those related to changing commodity prices. Our market risks are
monitored by El Paso Corporation's corporate risk management committee to ensure
compliance with the stated risk management policies approved by the Audit
Committee of El Paso Corporation's Board of Directors. This committee operates
independently from us.
COMMODITY PRICE RISK
We have market risks related to the oil and natural gas we produce. We
attempt to mitigate market risk associated with these significant physical
transactions through the use of non-trading financial instruments, which could
include:
- exchange-traded future contracts involving cash settlements;
- forward contracts involving cash settlements or physical delivery of an
energy commodity;
- swap contracts which require payments to (or receipts from)
counterparties based on the difference between a fixed and a variable
price, or two variable prices, for a commodity; and
- exchange-traded and over-the-counter options.
The table below presents the hypothetical sensitivity to changes in fair
values arising from immediate selected potential changes in the quoted market
prices of the derivative commodity instruments we use to mitigate these market
risks as of December 31, 2002 and September 30, 2003. Any gain or loss on these
derivative commodity instruments would be substantially offset by a
corresponding gain or loss on the hedged commodity positions, which are not
included in the table.
<Table>
<Caption>
10% INCREASE 10% DECREASE
--------------------- ---------------------
FAIR VALUE FAIR VALUE INCREASE FAIR VALUE DECREASE
---------- ---------- -------- ---------- --------
Impact of changes in commodity prices on
derivative commodity instruments (net
liability in millions)
December 31, 2002......................... $(375) $(544) $(169) $(206) $169
September 30, 2003........................ $(423) $(554) $(131) $(292) $131
</Table>
Currently, we hedge our production with an affiliate of El Paso Corporation
which then enters into hedging arrangements with third parties, and therefore we
are not responsible for posting collateral. El Paso Corporation has announced
that it plans to exit the energy trading business within the next 18 to 24
months, although it has recently indicated that it may continue to provide us
with certain gas marketing and hedging services. If we assume responsibility for
our hedging arrangements, depending on our financial condition, we may be
required to begin posting cash collateral if prevailing prices exceed the prices
in those hedging arrangements. As we have not been conducting our hedging
activities in the past, our results of operations could be adversely affected if
we assume control over these activities.
41
BUSINESS AND PROPERTIES
GENERAL
We are a large independent natural gas and oil company engaged in the
exploration for and the acquisition, development and production of natural gas,
oil and natural gas liquids in selected major producing regions of the United
States, including Alabama, Colorado, Louisiana, New Mexico, Oklahoma, South
Texas and the Gulf of Mexico. As of December 31, 2002, pro forma for our asset
sale during the first quarter of 2003, our estimated proved reserves were
approximately 2.4 Tcfe, 91% of which were natural gas and 63% were proved
developed. The related PV-10 value of these proved reserves as of December 31,
2002 was $4.4 billion, using realized prices based on a Henry Hub spot price of
$4.79 per MMbtu for natural gas and a WTI Cushing spot price of $31.20 per Bbl
for oil. We believe our focus on natural gas reserves will allow us to realize
the benefits of favorable natural gas industry fundamentals in North America.
We are a wholly-owned subsidiary of El Paso Corporation, a diversified
energy company with core businesses in natural gas pipelines, natural gas and
oil production and midstream services. Parent EPC is one of the ten largest
independent oil and natural gas companies in the United States based on
estimated proved reserves. Parent EPC owns other exploration and production
assets in addition to those owned by us. Our proved reserves represent
approximately 50% of Parent EPC's total proved reserves. The majority of our
assets were acquired through Parent EPC's merger with Sonat Inc. in October
1999.
We have a balanced portfolio of development, exploitation and exploration
projects, including long-lived and shorter-lived properties. We own significant
coalbed methane operations in the Raton Basin of Colorado and New Mexico, the
Black Warrior Basin of Alabama and the Arkoma Basin of eastern Oklahoma.
Approximately 52% of our proved reserves are coalbed methane, which are
generally characterized by lower development expenditures, higher drilling
success rates and longer reserve lives. In the Gulf of Mexico we have interests
in 218 offshore blocks and approximately 100 active platforms. In South Texas,
our operations are focused on the prolific Vicksburg trend. Approximately 20%
and 11% of our proved reserves are located in the Gulf of Mexico and South
Texas, respectively, which are generally characterized by higher development
expenditures, higher returns on invested capital and shorter reserve lives. Our
remaining 17% of proved reserves are located in North Louisiana and are
generally characterized by lower development costs, higher drilling success
rates and longer reserve lives. Based on 2002 production and proved reserves at
December 31, 2002, we had an overall reserve-to-production ratio of 10 years.
We have a large inventory of drillable prospects and an active drilling
program. We have identified over 700 proved undeveloped drillable locations, as
well as over 1,800 additional potential locations, which combined represent more
than seven years of future drilling opportunities based on our current
expectations. In addition, our extensive 2-D and 3-D seismic inventory provides
us with significant data with respect to our core operating areas. We have
demonstrated the ability to apply sophisticated geophysical technology and
seismic data processing to successfully identify locations to explore for and
develop reserves. We combine in-house deep drilling expertise with hydraulic
fracturing technologies to optimize production with high-rate completions at
competitive finding and development costs.
We operate properties that contain approximately 94% of our proved reserves
and own an average working interest of 68% in 2,226 wells. A high percentage of
operational control allows us to more effectively manage our production costs,
capital costs and the timing of development and exploration activities for these
properties. During 2002, our pro forma average production cost was $0.42 per
Mcfe which was one of the lowest production cost structures as compared to
publicly traded independent oil and natural gas companies.
We manage our operations and financial resources to enable us to execute
our business plan within the volatile commodity market. Under our current
hedging policy, we may hedge up to 50% of our anticipated production for a
rolling 12-month forward period. As of September 30, 2003, we had hedged
approximately 33 million MMBtus of our anticipated remaining natural gas
production for 2003 at an average NYMEX Henry Hub price of $3.19 per MMBtu
before regional price differentials and
42
transportation costs. In addition, we have hedged approximately 75 million
MMBtus at $3.12 per MMBtu of our 2004 anticipated natural gas production, 79
million MMBtus at $3.16 per MMBtu of our 2005 anticipated natural gas production
and 84 million MMBtus at $3.28 per MMBtu of our 2006 anticipated natural gas
production. We have also hedged additional volumes at various prices through
2012. At September 30, 2003, the mark-to-market value of these hedges was a loss
of $423 million. We have no current plans to hedge additional volumes.
PROPERTIES
The following table sets forth a summary of our 2002 production and our
estimated proved reserves and the net present value of those reserves as of
December 31, 2002, by our core operating areas, after giving pro forma effect to
our asset sale in March 2003. In the event Parent EPC decides to contribute
additional exploration and production properties to us, our core areas could
change. For a description of this possible contribution, please see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Overview of Results of Operations."
<Table>
<Caption>
AS OF DECEMBER 31, 2002
------------------------------------------------------------------------
PROVED RESERVE QUANTITIES
---------------------------------------------- NET PRESENT
2002 TOTAL PROVED VALUE OF
NET PRODUCTION NATURAL RESERVES PROVED RESERVES
-------------- CRUDE NATURAL GAS ---------------- -----------------------
PERCENT OIL GAS LIQUIDS PERCENT AMOUNT PERCENT
BCFE (%) (MMBBL) (BCF) (MMBBL) (BCFE) (%) (IN MILLIONS) (%)
---- ------- ------- ------- ------- ------ ------- ------------- -------
Coalbed Methane............ 30 12% -- 1,242 -- 1,243 52% $1,551 35%
South Texas................ 34 14 0.4 219 7.3 265 11 516 12
North Louisiana............ 37 15 3.2 375 1.8 405 17 821 18
Gulf of Mexico............. 148 59 19.6 350 2.2 481 20 1,559 35
--- --- ---- ----- ---- ----- --- ------ ---
Total.................... 249 100% 23.2 2,187 11.3 2,394 100% $4,446 100%
=== === ==== ===== ==== ===== === ====== ===
</Table>
COALBED METHANE
As of December 31, 2002, coalbed methane (CBM), also referred to as coal
seam, represented approximately 52% of our total proved reserves and 51% of our
total proved undeveloped reserves. We plan to exploit this significant
development potential through our interests in six CBM projects that represent
approximately 1.4 million gross acres, of which 87% are undeveloped. All six
projects produce CBM using the dewatering process, which allows gas trapped by
water in coalbeds to flow to the surface by removing the water. Initially, CBM
wells produce large amounts of water and little methane; however, over time, gas
production increases and water production declines. The peak gas production rate
occurs between one and four years after a well is completed and declines slowly
thereafter. Since widespread commercial CBM production was initially stimulated
by the Section 29 tax credit in 1980, the industry has demonstrated that CBM
wells can be productive for over 20 years.
CBM reserves are strategic to us because they are generally characterized
by lower development expenditures, higher drilling success rates and longer
reserve lives. Shallow reserve depths, which typically allow wells to be drilled
and cased within two days, contribute to low finding and development costs.
These costs are further reduced by our scale. For example, our 2003 fracture
stimulation program, which consists of over 400 gross wells and more than 1,000
separate fracture stimulation treatments, is expected to obtain an estimated 45%
cost saving to the typical market cost. In addition, CBM reserves are generally
low risk to develop. In 2002, 328 of the 330 gross wells that we drilled on
proved undeveloped and additional in-field locations in our CBM regions were
productive. Our drilling success is partly attributable to our geological
expertise, which has been developed through our operating history in CBM
projects. Our CBM projects, most of which are in their initial stages of
production, contribute 23% of our current daily production. As dewatering
progresses and additional wells are added, production is expected to rise.
However, some CBM reservoirs do not demonstrate reduced water production, which
reduces or eliminates the actual economic recovery.
43
Black Warrior Basin
The Black Warrior Basin is located in north-central Alabama. Production in
the basin occurs from several coal bearing intervals. Wells are typically
fracture stimulated using three to six stages depending on the number and
distribution of coal seams. Well depths are typically 1,800 to 2,800 feet and
take approximately two days to drill and case. This basin represented
approximately 12% of our proved reserves at December 31, 2002, and 13% of the
PV-10 value of those reserves. It also contributes approximately 12% of our
current daily production. The Black Warrior Basin is divided into four
development areas.
- White Oak Creek Field. We operate the White Oak Creek Field within the
Black Warrior Basin and own 75% of the working interest. The White Oak
Creek Field currently produces 26 MMcf/d net from 367 wells with net
proved reserves at December 31, 2002 of 87 Bcf, 15 Bcf of which are
proved undeveloped. In 2003, we plan to drill wells on 23 proved
undeveloped and 10 additional locations in the field. In addition, we
plan to expand our development north and east of the current field.
- Short Creek Field. We began development of the Short Creek Field upon
acquiring a lease for a portion of the property in 2001. We operate the
field and own 100% of the working interest. The field currently produces
over 11 MMcf/d net from 111 wells with net proved reserves at December
31, 2002 of 73 Bcf. In 2003, we plan to drill wells on 12 proved
undeveloped and 9 additional locations in the field.
- Blue Creek West Field. We operate and own 100% of the working interest
in a portion of the Blue Creek West Field. Once capital costs have been
fully recovered, our interest will be reduced to 75%. The Blue Creek West
Field currently produces 8 MMcf/d net from 112 wells and has net proved
reserves at December 31, 2002 of 53 Bcf. In 2003, we plan to drill wells
on 23 proved undeveloped and 17 additional locations in the field.
- Brookwood Field. The Brookwood Field is being developed in coordination
with an active underground coal mine. We hold a 50% interest in the oil
and gas in the field pursuant to a 50% interest in a field-wide joint
operating agreement. Jim Walter Resources, Inc. owns the remaining
interest in the field and is also currently extracting coal from three
separate mines within the field development. Together, we equally own
Black Warrior Methane Corporation, which operates the field. The
Brookwood Field currently has net production of 17 MMcf/d and net proved
reserves at December 31, 2002 of 68 Bcf. In 2003, we plan to drill wells
on 35 proved undeveloped and two additional locations in the field.
Arkoma Basin
- Oklahoma Field. The Oklahoma Field is located within the CBM trend of
the Arkoma Basin in eastern Oklahoma. With net proved reserves of 165
Bcf, the Oklahoma Field represents 7% of our proved reserves at December
31, 2002, and 5% of the PV-10 value of those reserves. However, this
field contributes less than 2% of our current production since it is
still in the dewatering phase.
This field offers significant opportunities for additional development.
The coal seams in this area have high gas contents, reaching as high as
600 cubic feet per ton of coal. This compares with an average of 350 cubic
feet per ton in the Black Warrior Basin. While gas content is a
significant determinant of well productivity, it is not the sole
determinant. Coal in this field generally occurs between 1,000 feet and
3,000 feet, which helps maintain low drilling costs. In 2003, we plan to
drill wells on 65 proved undeveloped and 36 additional locations in the
field.
Horizontal wells are becoming the preferred CBM completion technique for
the Arkoma Basin. We currently have 45 horizontal wells, 37 of which are
actively producing. Our typical vertical well in this field produces
between 45 and 70 Mcf/d, peaking in three years to around 145 Mcf/d,
whereas our 37 horizontal wells average 325 Mcf/d with 10 wells producing
in excess of 500 Mcf/d. Generally, the peak rate for horizontal wells
occurs within 3 months. The cost of a typical horizontal well is
considerably higher than that of a vertical well.
44
We currently operate 280 CBM wells in the Oklahoma Field with an average
working interest of 65%. The operation currently produces a net 8 MMcf/d.
Considerable development potential exists in the Oklahoma Field as 90 Bcf
of the net proved reserves are not yet contributing to production.
Raton Basin
- Vermejo Park Ranch Field. We control CBM rights in the Raton Basin
through ownership of the oil and gas on the Vermejo Park Ranch located in
New Mexico and southern Colorado. This field represents 33% of our proved
reserves at December 31, 2002, and 17% of the PV-10 value of those
reserves. It also contributes about 10% of our current daily production.
Our initial 75% working interest in the field was acquired in 1999 from
Vermejo Minerals Corporation through a lease. In 2002, we acquired from
Devon Energy the remaining working interest in the project by acquiring
Vermejo Minerals Corporation. We now own 100% of the working interest and
91% of the net revenue interest.
We currently produce 50 MMcf/d net from 409 CBM wells. The Vermejo Park
Ranch Field is a key piece in our development portfolio with 269 Bcf of
proved undeveloped reserves out of a total of 796 Bcf of net proved
reserves. In 2003, we plan to drill wells on 20 proved undeveloped and 64
additional locations in the field.
In March 2003, we entered into an amended and restated agreement with
Vermejo Park LLC. These new provisions, which extend into 2008, allow us
more flexibility to develop the Vermejo Park Ranch Field.
SOUTH TEXAS REGION
Our South Texas operations are located primarily in the Gulf Coast basin of
South Texas, which is characterized by a series of thick pay sands. This region
represents 11% of our total proved reserves at December 31, 2002, and 12% of the
PV-10 value of those reserves. It contributes 13% of our current net production.
We have interests in 74 gross (approximately 70 net) producing wells in the
South Texas region.
Our strategy in the South Texas region is to focus on exploration and
exploitation of relatively tight gas reservoirs in the Vicksburg formation,
located in Hidalgo County, Texas. El Paso Corporation has more than 30 years
experience in the Vicksburg formation. This long-term experience gives us
advantages in the area, including a significant 3-D seismic data-base, detailed
structural mapping over large areas, and an understanding of the producing
capabilities of these reservoirs. In addition, El Paso Corporation has been the
most active driller in the trend since 1993, and our high activity level has
allowed us to develop and utilize new technologies in the area. Due to the
success of our deep drilling methods, mono-bore completion techniques and
massive hydraulic fracturing technology, we are now utilizing these approaches
in other geographic areas. In 2002, all 26 of the wells that we drilled on
proved undeveloped and additional locations in the two established fields
described below were productive.
- North Monte Christo Field. The North Monte Christo Field is located in
west central Hidalgo County, Texas, near the Rio Grande River. The field,
discovered in February 2000, produces gas and condensate from the Lower
Vicksburg formation at depths from 12,000 feet to 18,500 feet. We operate
47 producing wells in the field with an average working interest and net
revenue interest of 92% and 74%, respectively. The 32 wells that we have
drilled in the field have average initial production rates of 29 MMcfe/d,
with an average recovery per well of 7.9 Bcfe. Our current net production
is 42 MMcfe/d. In 2003, we have drilled three proved undeveloped
locations in this field and are currently drilling two additional wells.
As of December 31, 2002, the field had produced a total of 150 Bcfe
(gross) and had net remaining proved reserves of 185 Bcfe.
- Samano Field. Discovered in 1944, the Samano Field is located in
southeastern Starr County, Texas. With current hydraulic fracturing
technology, new wells in the field are capable of high levels of gas
deliverability from tight Lower Vicksburg reservoirs at depths from 7,500
feet to 11,000 feet. We have drilled 28 wells in the field since October
2000. Initial rates from these wells have averaged 16.3 MMcf/d with an
average recovery per well of 2.7 Bcfe. Our working interest is
45
100% and net revenue interest is approximately 75%. Current net
production is 23 MMcfe/d. In 2003, we have drilled four wells and expect
to drill one additional well in the field by the end of 2003. As of
December 31, 2002, the field had produced a total of 61 Bcf of natural
gas (gross) and 4.6 MMBbls of oil (gross) and had net remaining proved
reserves of 80 Bcfe.
NORTH LOUISIANA REGION
The North Louisiana region represents 17% of our total proved reserves at
December 31, 2002, and 18% of the PV-10 value of those reserves. The region
contributes 16% of our current net production. In 2002, 39 of the 40 wells that
we drilled on proved undeveloped and additional in-field locations in the North
Louisiana region were productive. One new-field exploration well was drilled and
was productive.
The North Louisiana region is primarily made up of properties in Louisiana,
but also includes properties in Arkansas and Texas. Reservoirs in this area tend
to be characterized by long producing lives in excess of 20 years. We employ two
parallel strategies in this region. Our acquisition approach is to increase
value by selectively acquiring established properties on which we can employ
completion techniques developed in South Texas. The Holly Field, described
below, is an example of how we have employed these techniques. In addition, we
have engaged in new-field exploration adjacent to the salt dome formations of
this region. The King's Dome Field is an example of this strategy. In 2003, we
have drilled and completed 27 wells and expect to drill 7 additional wells by
the end of the year in the North Louisiana region.
- Holly Field. The Holly Field is located in De Soto Parish, Louisiana and
our interest in it was acquired in 1996. Utilization of large energized
fluid fracturing techniques has resulted in wells with initial rates in
excess of 7 MMcf/d and has increased the gross field production rate from
18 MMcf/d in 1996 to about 50 MMcf/d currently. El Paso controls the
majority of the field which has a complete gathering system with
centralized compression and direct delivery into the Tennessee Gas
Pipeline system. Current net production rates from the field are 30
MMcf/d of natural gas and 83 Bbls/d of oil. At December 31, 2002, we had
189 Bcfe of net proved reserves which represent 8% of our total proved
reserves. Of these, 64% are proved undeveloped. Our average working
interest in wells that we operate is 88%.
- Bear Creek Field. The highly prolific Bear Creek Field is located in
Bienville Parish, Louisiana. The local geology offers numerous reservoirs
that provide most of the proved undeveloped locations in this field. New
fracturing technology is being applied to this previously bypassed lower
permeability rock, resulting in commercially productive wells. We control
the majority of the field and have a complete gathering system with
centralized compression and direct delivery into the Southern Natural Gas
pipeline system. Our average working interest in wells that we operate is
84%. Current net production rates from the field are 21 MMcf/d of natural
gas and 30 Bbls/d of oil. We had 60 Bcfe of net proved reserves at
December 31, 2002, of which 33% were proved undeveloped.
- North Shongaloo Field. The North Shongaloo Field is an area of Webster
Parish, Louisiana and Columbia County, Arkansas that includes portions of
the Red Rock Field. Production from this mature field is gathered by Duke
Energy and is delivered into its Springhill Plant for processing. Current
net production rates from the field are 9 MMcf/d of natural gas and 498
Bbls/d of oil and plant liquids. We had 57 Bcfe of net proved reserves at
December 31, 2002, 3% of which are proved undeveloped. Our average
working interest in wells that we operate is 93%.
- Ada/Sibley/West Bryceland Fields. These three fields surround the
Vacherie Salt Dome in Webster and Bienville Parishes of north Louisiana.
Numerous prolific reservoirs support dense spacing patterns in most
portions of these fields. These fields are primarily co-owned with three
other operators, resulting in an average working interest of 45% in wells
that we operate. Current net production rates are 9 MMcf/d of natural gas
and 15 Bbls/d of oil. Our net proved reserves in these fields were 43
Bcfe at December 31, 2002, of which 25% were proved undeveloped.
- King's Dome Field. The King's Dome is a recent discovery by us in
Bienville Parish, Louisiana. The initial well, in which we have a 98%
working interest reached initial gross production rates of
46
over 30 MMcf/d and is currently producing 1 MMcf/d. A second well has been
drilled and has tested multiple intervals with initial rates of over 5 MMcf/d,
and is in the completion phase. We are in the process of acquiring a 3-D seismic
survey to help further delineate this field. At December 31, 2002, we had
5 Bcfe of net proved reserves.
GULF OF MEXICO SHELF
The Gulf of Mexico region represents 20% of our total proved reserves at
December 31, 2002, and 35% of the PV-10 value of those reserves. The region
contributes 48% of our current net production. In 2002, 14 of the 16 wells that
we drilled on proved undeveloped and additional infield locations in the Gulf of
Mexico region were productive. In 2002, three of the 12 exploration wells that
we drilled in new-field areas were productive.
Our strategy in this area is similar to our strategy in South Texas, which
is to explore for reserves beneath regions with long producing histories. By
identifying reserves in these deep regions early, we have been able to amass a
sizeable acreage position and to find some of the largest reservoirs that have
been discovered in this area. In 2003, we bid successfully for 22 new leases in
the Gulf of Mexico of which the Minerals Management Service has awarded us 20
blocks and rejected our bid on the other 2 blocks. In addition, our scale of
operations and strong vendor relationships have given us a competitive advantage
in securing rigs which are powerful enough to drill ultra-deep wells. In 2003,
we plan to drill wells on two proved undeveloped locations and seven additional
locations in established fields. Eight new-field exploration wells are also
planned in 2003.
- South Timbalier 189/204 Field. Originally discovered in November 2000,
the South Timbalier 189/204 Field currently produces a net 50 MMcf/d and
2,356 Bbls/d of condensate and plant liquids from 11 active wells at
depths ranging from 4,500 to 18,000 feet comprising 12% of our current
daily production. The field has five platforms, which can process up to
400 MMcf/d of gross gas and 30,000 Bbls/d of gross oil. This processing
capacity is planned to be utilized by other nearby prospects/discoveries
located in this deep shelf trend. Proved reserves as of December 31, 2002
were 107 Bcfe. We have a 70% working interest in the field.
- Ewing Bank 1003 Field. Known as the Prince Field, Ewing Bank 1003 came
on-line in the fourth quarter of 2001. This field is currently not
producing due to mechanical failures. Net proved reserves as of December
31, 2002 were 66 Bcfe. We have a 100% working interest in the field and
own the Prince Tension Leg Platform (TLP), which handles production from
the Prince Field and is located in 1,600 feet of water. We are currently
recompleting one well, with plans to recomplete another well and
sidetrack a third well in 2004.
- East Cameron 81/84 Field. The East Cameron 81/84 Field is located in the
heart of a historically prolific trend offshore of Louisiana in 50 feet
of water. Mobil Oil originally developed the field in the 1980's and the
major producing horizons produced over 100 Bcfe. By drilling three new
deep discoveries in 2002 at depths up to 17,300 feet, we have revitalized
the field, which currently produces approximately 26 MMcfe/d from five
wells. Net proved reserves as of December 31, 2002 were 47 Bcfe. We have
an 81% average working interest in the field.
- Jim Bob Mountain and Mound Point Fields. Recent exploration efforts at
depths up to 21,500 feet have discovered gas that is rich in condensate
and has a high Btu content of 1.1 MMBtu per Mcf. In the third quarter of
2003, the first Jim Bob Mountain development well was drilled and is
currently being completed. We plan to drill an additional development
well in the field this year. Installation of upgraded processing
facilities is in process. Net proved reserves as of December 31, 2002
were 70 Bcfe. We have a 55% working interest in the Jim Bob Mountain
Field. At Mound Point, a discovery well was drilled earlier this year and
is currently producing. We have a 32% working interest in the Mound Point
Field. Both fields are subject to a reversionary interest that reduces
our interest by 50% after 100 Bcfe, net to our interest, is produced from
the fields.
- West Delta 137 Field. Originally discovered by an exploration well
drilled to a depth of 18,500 feet, the West Delta Field currently
produces 21 MMcf/d and 897 Bcp/d from the two
47
wells. Total proved reserves as of December 31, 2002 were 35 Bcfe. We
have a 100% working interest in the field.
47.1
- West Cameron 46/47. Located offshore Louisiana, the West Cameron 46/47
Field was discovered using state-of-the-art seismic processing. This
field currently produces 35 MMcfe/d from depths greater than 17,000 feet.
Total remaining proved reserves as of December 31, 2002 were 18.5 Bcfe.
We have a 40% working interest in this field.
NATURAL GAS AND OIL RESERVES
The table below details our proved reserves and PV-10 values at December
31, 2002. The estimates of proved reserves presented in this table are based on
the reserve report dated January 1, 2003, prepared internally by us. Huddleston
& Co., Inc., an independent petroleum engineering firm, prepared an independent
reserve estimate for 100% of our properties. The total estimate of proved
reserves prepared independently by Huddleston & Co., Inc. is within 5% of our
internally prepared estimate presented in the table. This information is
consistent with estimates of reserves filed with other federal agencies, except
for differences of less than 5 percent resulting from actual production,
acquisitions, property sales, necessary reserve revisions and additions to
reflect actual experience.
<Table>
<Caption>
NET PROVED RESERVES(1)(2)
-----------------------------------------------------
NATURAL GAS LIQUIDS(3) TOTAL PV-10 VALUES
----------- ---------- --------- --------------
(MMCF) (MBBLS) (MMCFE) (IN THOUSANDS)
Producing........................................ 1,439,264 21,717 1,569,570 $3,081,877
Non-Producing.................................... 159,847 7,940 207,487 551,115
Undeveloped...................................... 926,702 20,066 1,047,090 1,649,154
--------- ------ --------- ----------
Total proved................................... 2,525,813 49,723 2,824,147 5,282,146
--------- ------ --------- ----------
Non-consolidated interest(4)..................... 118,913 523 122,052 227,976
--------- ------ --------- ----------
Total.......................................... 2,644,726 50,246 2,946,199 $5,510,122
========= ====== ========= ==========
</Table>
- ---------------
(1) Net proved reserves exclude royalties and interests owned by others and
reflects contractual arrangements and royalty obligations in effect at the
time of the estimate.
(2) In March 2003, we sold assets including 0.4 Tcfe of net proved reserves to
Chesapeake Energy Corporation. Giving effect to such sale, our net proved
reserves and PV-10 values at December 31, 2002 would have been as follows:
<Table>
<Caption>
NET PROVED RESERVES
--------------------------------------------------
NATURAL GAS LIQUIDS TOTAL PV-10 VALUES
----------- ------- --------- --------------
(MMCF) (MBBLS) (MMCFE) (IN THOUSANDS)
Producing................................................... 1,231,701 16,055 1,328,031 $2,604,953
Non-Producing............................................... 143,812 7,347 187,893 496,400
Undeveloped................................................. 811,590 11,030 877,773 1,344,190
--------- ------ --------- ----------
Total proved.............................................. 2,187,103 34,432 2,393,697 $4,445,543
========= ====== ========= ==========
</Table>
(3) Includes oil, condensate and natural gas liquids.
(4) Reflects reserves attributable to our 58% equity interest in Noric Holdings
I, which we sold for $0.1 million to an affiliate of El Paso in April 2003.
The ratio of reserves to production as of December 31, 2000, 2001 and 2002,
and as of December 31, 2002 on a pro forma basis was 8.3x, 11.1x, 10.4x and
9.6x, respectively. The ratio of reserves to production was calculated by
dividing total net proved reserves by net production volumes for the year
indicated.
During 2002, as a result of Parent EPC's efforts to enhance its liquidity
position, we sold reserves totaling 0.4 Tcfe to various third parties. The
reserves sold were primarily located in east Texas.
There are numerous uncertainties inherent in estimating quantities of
proved reserves and in projecting future rates of production and timing of
development expenditures, including many factors beyond our control. The reserve
data represent only estimates. Reservoir engineering is a subjective process of
estimating underground accumulations of natural gas and oil that cannot be
measured in an exact manner. The accuracy of any reserve estimate is a function
of the quality of available data and of engineering and geological
interpretations and judgment. As a result, estimates of different engineers
often vary. Estimates are subject to revision based upon a number of factors,
including reservoir performance, prices, economic conditions and government
restrictions. In addition, results of drilling, testing and production
subsequent to the date of an estimate may justify revision of that estimate.
Reserve estimates
48
are often different from the quantities of natural gas and oil that are
ultimately recovered. The meaningfulness of reserve estimates is highly
dependent on the accuracy of the assumptions on which they were based. In
general, our volume of production from natural gas and oil properties declines
as reserves are depleted. Except to the extent we conduct successful exploration
and development activities or acquire additional properties containing proved
reserves, or both, our proved reserves will decline as reserves are produced.
ACREAGE AND WELLS
The following table details our gross and net interest in developed and
undeveloped onshore, offshore, and coal seam acreage at December 31, 2002. Any
acreage in which our interest is limited to owned royalty, overriding royalty
and other similar interests is excluded.
<Table>
<Caption>
DEVELOPED ACREAGE(1) UNDEVELOPED ACREAGE(1) TOTAL ACREAGE
---------------------- ----------------------- ---------------------
GROSS()(2) NET(3) GROSS(2) NET(3) GROSS(2) NET(3)
---------- --------- ---------- ---------- --------- ---------
Onshore....................... 422,017 230,147 622,382 439,451 1,044,399 669,598
Offshore...................... 310,857 196,167 607,433 560,748 918,290 756,915
Coal seam..................... 187,005 109,305 1,203,860 781,446 1,390,865 890,751
------- ------- --------- --------- --------- ---------
Total....................... 919,879 535,619 2,433,675 1,781,645 3,353,554 2,317,264
------- ------- --------- --------- --------- ---------
Non-consolidated
interest(4)................. 9,920 9,920 -- -- 9,920 9,920
------- ------- --------- --------- --------- ---------
Total....................... 929,799 545,539 2,433,675 1,781,645 3,363,474 2,327,184
======= ======= ========= ========= ========= =========
</Table>
- ---------------
(1) In March 2003, we sold approximately 126,249 net developed and 28,296 net
undeveloped acres in Oklahoma and Texas to Chesapeake Energy. Giving effect
to such sale, we would have had 664,550 gross (419,290 net) total developed
acres and 2,378,179 gross (1,753,349 net) total undeveloped acres at
December 31, 2002.
(2) Gross interest reflects the total acreage we participated in, regardless of
our ownership interests in the acreage.
(3) Net interest is the aggregate of the fractional working interest that we
have in our gross acreage.
(4) Reflects acres attributable to our 58% equity interest in Noric Holdings I,
which we sold for $0.1 million to an affiliate of Parent EPC in April 2003.
As of December 31, 2002, our net developed acreage was concentrated
primarily in the Gulf of Mexico (36%), Oklahoma (26%), Louisiana (18%), Texas
(8%), and New Mexico (7%). As of December 31, 2002, our net undeveloped acreage
was concentrated primarily in the Gulf of Mexico (31%), New Mexico (24%),
Louisiana (16%), Alabama (7%), Washington (7%) and Colorado (5%). Approximately
14%, 17% and 9% of our total net undeveloped acreage is held under leases that
have minimum remaining primary terms expiring in 2003, 2004 and 2005,
respectively. During 2002, we sold approximately 75,136 net developed and
367,640 net undeveloped acres primarily in east Texas as a result of El Paso's
efforts to enhance its liquidity position.
The following table details our working interests in onshore, offshore, and
coal seam natural gas and oil wells at December 31, 2002:
<Table>
<Caption>
PRODUCTIVE
NATURAL GAS PRODUCTIVE OIL TOTAL PRODUCTIVE NUMBER OF WELLS
WELLS(1) WELLS(1) WELLS(1) BEING DRILLED
------------------- ----------------- ----------------- -----------------
GROSS()(2) NET(3) GROSS(2) NET(3) GROSS(2) NET(3) GROSS(2) NET(3)
---------- ------ -------- ------ -------- ------ -------- ------
Onshore....................... 1,116 843 29 27 1,145 870 19 14
Offshore...................... 172 63 59 14 231 77 8 6
Coal seam..................... 1,102 745 -- -- 1,102 745 6 4
----- ----- -- -- ----- ----- -- --
Total....................... 2,390 1,651 88 41 2,478 1,692 33 24
----- ----- -- -- ----- ----- -- --
Non-consolidated
interest(4)................. 477 259 -- -- 477 259 -- --
----- ----- -- -- ----- ----- -- --
Total(5).................... 2,867 1,910 88 41 2,955 1,951 33 24
===== ===== == == ===== ===== == ==
</Table>
- ---------------
(1) Includes wells that are producing or that are capable of production.
(2) Gross interest reflects the total number of wells we participated in,
regardless of our ownership interests in the wells.
(3) Net interest is the aggregate of the fractional working interest that we
have in our gross wells.
49
(4) Reflects wells attributable to our 58% equity interest in Noric Holdings I,
which we sold for $0.1 million to an affiliate of Parent EPC in April 2003.
(5) In March 2003, we sold assets located in Oklahoma and Texas. Giving effect
to such sale, we would have had at December 31, 2002, working interests in
2,226 gross (1,512 net) total productive wells and 24 gross (18 net) wells
being drilled.
During 2002, as a result of Parent EPC's efforts to enhance its liquidity
position, we sold approximately 375 net wells located primarily in east Texas.
Of the 1,951 net productive wells at December 31, 2002, 1,720 were operated by
us.
DRILLING ACTIVITY
The following table details our exploratory and development wells drilled
during the years 2000 through 2002:
<Table>
<Caption>
NET EXPLORATORY NET DEVELOPMENT
WELLS DRILLED WELLS DRILLED
------------------ ------------------
2000 2001 2002 2000 2001 2002
---- ---- ---- ---- ---- ----
Productive(1).......................................... 5 8 7 186 263 336
Dry(2)................................................. 11 5 6 5 3 4
-- -- -- --- --- ---
Total................................................ 16 13 13 191 266 340
-- -- -- --- --- ---
Non-consolidated interest(3)........................... -- -- -- 15 20 15
-- -- -- --- --- ---
Total................................................ 16 13 13 206 286 355
== == == === === ===
</Table>
- ---------------
(1) An exploratory or development well that is found to be capable of producing
either oil or gas in sufficient quantities to justify completion.
(2) An exploratory or development well found to be incapable of producing either
oil or gas in sufficient quantities to justify completion.
(3) Reflects wells attributable to our 58% equity interest in Noric Holdings I,
which we sold for $0.1 million to an affiliate of Parent EPC in April 2003.
The information above should not be considered indicative of future
drilling performance, nor should it be assumed that there is any correlation
between the number of productive wells drilled and the amount of natural gas and
oil that may ultimately be recovered.
50
NET PRODUCTION, SALES PRICES, TRANSPORTATION AND PRODUCTION COSTS
The following table sets forth certain information regarding our historical
net production volumes, revenues, average prices realized, transportation costs
and production costs associated with sales of natural gas and oil for the
periods indicated, and our pro forma net production volumes, revenues, average
prices realized, transportation costs and production costs after giving effect
to our asset sale in March 2003 as if this transaction occurred on January 1,
2002.
<Table>
<Caption>
PRO FORMA NINE MONTHS PRO FORMA NINE
YEAR ENDED YEAR ENDED ENDED MONTHS ENDED
DECEMBER 31,(1) DECEMBER 31,(1) SEPTEMBER 30,(1) SEPTEMBER 30,(1)
------------------------ --------------- ----------------- ----------------
2000 2001 2002 2002 2002 2003 2003
------ ------ ------ --------------- ------- ------- ----------------
NET PRODUCTION VOLUMES
Natural Gas (Bcf)...................... 182 187 215 195 159 152 147
Oil, Condensate and Liquids (MMBbls)... 5 6 10 9 8 5 5
------ ------ ------ ------ ------ ------ ------
Total (Bcfe)......................... 212 221 272 249 205 180 174
NATURAL GAS AND OIL SALES (IN MILLIONS)
Natural Gas............................ $ 441 $ 483 $ 640 $ 582 $ 474 $ 604 $ 581
Oil, Condensate and Liquids............ 91 120 211 202 165 126 123
------ ------ ------ ------ ------ ------ ------
Total................................ $ 532 $ 603 $ 851 $ 784 $ 639 $ 730 $ 704
NATURAL GAS AVERAGE SALES PRICE (PER
MCF)(2)
Price excluding hedges................. $ 3.98 $ 4.33 $ 3.25 $ 3.24 $ 2.99 $ 5.79 $ 5.76
Price including hedges................. $ 2.42 $ 2.57 $ 2.99 $ 2.98 $ 2.98 $ 3.96 $ 3.94
OIL, CONDENSATE AND LIQUIDS AVERAGE SALES
PRICE (PER BBL)(2)
Price excluding hedges................. $28.58 $23.19 $22.06 $22.69 $21.48 $28.74 $28.66
Price including hedges................. $18.22 $21.50 $21.87 $22.49 $21.51 $27.33 $27.24
AVERAGE TRANSPORTATION COST
Natural gas (per Mcf).................. $ 0.17 $ 0.21 $ 0.19 $ 0.17 $ 0.19 $ 0.19 $ 0.18
Oil, Condensate and Liquids (per
Bbl)................................. $ 0.20 $ 0.49 $ 1.23 $ 1.32 $ 1.17 $ 1.20 $ 1.23
AVERAGE PRODUCTION COST AND PRODUCTION
TAXES (PER MCFE)
Average Production Cost(3)............. $ 0.34 $ 0.45 $ 0.40 $ 0.42 $ 0.39 $ 0.45 $ 0.44
Average Production Taxes............... $ 0.10 $ 0.11 $ 0.07 $ 0.07 $ 0.06 $ 0.12 $ 0.11
</Table>
- ---------------
(1) The information in this table does not include data with respect to our 58%
equity interest in Noric Holdings I, which we sold to an affiliate of Parent
EPC in April 2003 for $0.1 million.
(2) Prices are stated before transportation costs.
(3) Our production costs include direct lifting costs (labor, repairs and
maintenance, materials and supplies), the administrative costs of field
offices, insurance and property and severance taxes.
51
ACQUISITION, DEVELOPMENT AND EXPLORATION EXPENDITURES
The following table details information regarding our costs incurred in our
development, exploration and acquisition activities for each of the periods
indicated:
<Table>
<Caption>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------- -------------
2000 2001 2002 2002 2003
----- ----- ------- ------ ----
(IN MILLIONS)
Acquisition Costs:
Proved............................................... $ 73 $ 4 $ 339 $ 341 $ 5
Unproved............................................. 37 7 16 11 20
Development Costs(2)................................... 284 577 826 625 388
Exploration Costs:
Delay Rentals........................................ 6 5 3 2 2
Seismic Acquisition and Reprocessing................. 10 25 33 20 38
Drilling............................................. 80 40 159 112 49
---- ---- ------ ------ ----
Total............................................. $490 $658 $1,376 $1,111 $502
---- ---- ------ ------ ----
Non-consolidated interest(1)........................... 1 3 4 3 1
---- ---- ------ ------ ----
Total............................................. $491 $661 $1,380 $1,114 $503
==== ==== ====== ====== ====
</Table>
- ---------------
(1) Relates to expenditures attributable to our 58% equity interest in Noric
Holdings I, which we sold for $0.1 million to an affiliate of Parent EPC in
April 2003.
(2) Development costs for the year ended December 31, 2002 and the nine months
ended September 2002 and 2003 include $70 million, $48 million and $25
million, respectively, of expenditures related to the natural gas and oil
properties in Oklahoma and Texas that were sold in March 2003.
The table below details approximate amounts spent to develop proved
undeveloped reserves that were included in our reserve report as of January 1 of
each year:
<Table>
<Caption>
2000 2001 2002
---- ---- ----
(IN MILLIONS)
Cost to develop proved undeveloped reserves................. $71 $184 $269
</Table>
REGULATORY AND OPERATING ENVIRONMENT
Our natural gas and oil activities are regulated at the federal, state and
local levels. These regulations include, but are not limited to, the drilling
and spacing of wells, produced water disposal, conservation, forced pooling and
protection of correlative rights among interest owners. We are also subject to
governmental safety regulations in the jurisdictions in which we operate.
Our operations under federal natural gas and oil leases are regulated by
the statutes and regulations of the U.S. Department of the Interior that
currently impose liability upon lessees for the cost of environmental impacts
resulting from their operations. Royalty obligations on all federal leases are
regulated by the Minerals Management Service, which has promulgated valuation
guidelines for the payment of royalties by producers. These laws and regulations
relating to the protection of the environment affect our natural gas and oil
operations through their effect on the construction and operation of facilities,
drilling operations, production or the delay or prevention of future offshore
lease sales. We believe that our operations are in material compliance with the
applicable requirements. In addition, El Paso Corporation maintains insurance on
behalf of us for sudden and accidental spills and oil pollution liability.
In addition, the production of any oil and gas by us will be affected to
some degree by state regulations. Many states in which we operate have statutory
provisions regulating the drilling, well stimulation, production and sale of oil
and gas, including provisions regarding deliverability. Such statutes, and the
regulations promulgated in connection therewith, are generally intended to
prevent waste of oil and gas and to protect correlative rights to produce oil
and gas between owners of a common reservoir. Certain state regulatory
authorities also regulate the amount of oil and gas produced by assigning
allowable rates of production to each well or proration unit.
52
Our business has operating risks normally associated with the exploration
for and production of natural gas and oil, including blowouts, cratering,
pollution and fires, each of which could result in damage to life or property.
Offshore operations may encounter usual marine perils, including hurricanes and
other adverse weather conditions, governmental regulations and interruption or
termination by governmental authorities based on environmental and other
considerations. Customary with industry practices, El Paso maintains insurance
coverage on behalf of us with respect to potential losses resulting from these
operating hazards.
ENVIRONMENTAL REGULATION
General. Various federal, state and local laws and regulations governing
the discharge of materials into the environment, or otherwise relating to the
protection of the environment, affect our operations and costs. In particular,
our exploration, development and production operations, our activities in
connection with storage and transportation of crude oil and other liquid
hydrocarbons and our use of facilities for treating, processing or otherwise
handling hydrocarbons and produced water and related wastes are subject to or
may become subject to stringent environmental regulation. As with the industry
generally, compliance with these regulations increases our overall cost of
business. The areas affected include:
- unit production expenses primarily related to the control and limitation
of air emissions and the disposal of produced water;
- capital costs to drill exploration and development wells resulting from
expenses primarily related to the management and disposal of drilling
fluids and other oil and gas exploration wastes; and
- capital costs to construct, maintain and upgrade equipment and
facilities.
These laws and regulations have been changed frequently in the past, and in
general, these changes have imposed more stringent requirements that increase
operating costs or require capital expenditures in order to remain in
compliance. We believe that our business operations are in substantial
compliance with current laws and regulations and that continued compliance with
existing requirements will not materially impact our financial position or
results of operations. However, failure to comply with these requirements can
result in civil and criminal fines and liability for clean-up costs and other
environmental damages. It is also possible that unanticipated factual
developments or changes in law could cause us to make environmental expenditures
significantly greater than those we currently expect.
On March 21, 2003, the Louisiana Department of Environmental Quality (LDEQ)
issued a Consolidated Compliance Order and Notice of Potential Penalty to our
subsidiary, El Paso Production Company, alleging that it failed to timely obtain
air permits for specified oil and gas facilities. El Paso Production Company
requested an adjudicatory hearing on the matter. The hearing has been stayed by
agreement to allow El Paso Production Company and LDEQ time to possibly settle
this matter. The amount of any penalty to be sought by LDEQ, if any, has not
been specified.
Superfund. Under some environmental laws, such as the Comprehensive
Environmental Response, Compensation, and Liability Act of 1980, also known as
CERCLA or the Superfund law, and similar state statutes, responsibility for the
entire cost of cleanup of a contaminated site can be imposed upon any current or
former site owners or operators, or upon any party who sent waste to the site,
regardless of the lawfulness of the original activities that led to the
contamination. From time to time we have been named as a potentially responsible
party at Superfund sites, although our share of liability has typically been de
minimis. In addition to the risk of spills inherent in our own operations,
because we acquire or lease interests in properties that have for many years
been used for the exploration and production of oil and gas, we may be liable
for historical contamination caused by these former operators.
Oil Pollution Act of 1990. The Oil Pollution Act of 1990, as amended
(OPA), imposes potentially unlimited liability on responsible parties, without
regard to fault, for the costs of cleanup and other damages resulting from an
oil spill in U.S. waters. Responsible parties include (i) owners and operators
of onshore facilities and pipelines, (ii) owners and operators of tank vessels
and (iii) lessees or permittees of an area in which an offshore facility is
located. In addition, OPA requires responsible parties for offshore
53
facilities to provide financial assurance in the amount of $35 million, which
can be increased to $150 million if deemed necessary, to cover potential OPA
liabilities.
Clean Water Act. The Federal Water Pollution Control Act of 1972, as
amended (Clean Water Act), and comparable state statutes impose restrictions and
controls, primarily through the issuance of permits, on the discharge of
produced waters and other oil and gas wastes into navigable waters or in
downhole disposal zones. These controls have become more stringent over the
years, and it is possible that additional restrictions will be imposed in the
future including potential restrictions on the use of hydraulic fracturing.
These laws prohibit the discharge of produced waters and sand, drilling fluids,
drill cuttings and other substances related to the oil and gas industry into
coastal and offshore waters.
Resource Conservation and Recovery Act. The Resource Conservation and
Recovery Act (RCRA) is the principal federal statute governing the generation
and handling of hazardous wastes. RCRA imposes stringent operating requirements
on generators, among others, of hazardous waste. At present, RCRA includes a
statutory exemption that allows most crude oil and natural gas exploration and
production waste to be classified as solid waste. A similar exemption is
contained in many of the state counterparts to RCRA. As a result, we are not
required to comply with a substantial portion of RCRA's requirements because our
operations generate minimal quantities of hazardous wastes. At various times in
the past, proposals have been made to amend RCRA to rescind the exemption that
excludes crude oil and natural gas exploration and production wastes from
regulation or hazardous waste. Repeal or modification of the exemption by
administrative, legislative or judicial process, or modification of similar
exemptions in applicable state statutes, would increase the volume of hazardous
waste we are required to manage and dispose of and would cause us to incur
increased operating expenses.
OPERATING HAZARDS AND INSURANCE
The natural gas and oil business involves a variety of operating risks,
such as those described under "Risk Factors -- Our oil and natural gas drilling
and producing operations involve many risks and may not be profitable." In
accordance with industry practice, we maintain insurance against some, but not
all, potential risks and losses. For some risks, we may not obtain insurance if
we believe the cost of available insurance is excessive relative to the risks
presented. In addition, the nature of these operating risks is such that some
liabilities could exceed our insurance policy limits. Further, environmental
fines and penalties generally are not insurable. If a significant accident or
other event occurs and is not fully covered by insurance or exceeds our policy
limits, it could adversely affect us.
TITLE TO PROPERTIES
We believe that we have satisfactory title to all of our assets. Although
title to these properties is subject to encumbrances in some cases, such as
customary interests generally retained in connection with acquisition of real
property, liens related to environmental liabilities associated with historical
operations, liens for current taxes and other burdens and minor easements,
restrictions and other encumbrances to which the underlying properties were
subject at the time of acquisition by us or our predecessors, we believe that
none of these burdens will materially detract from the value of these properties
or from our interest in these properties or will materially interfere with our
use in the operation of our business. In addition, we believe that we have
obtained sufficient rights-of-way grants and permits from public authorities and
private parties for us to operate our business in all material respects as
described in this prospectus.
MARKETS AND COMPETITION
We sell our natural gas production primarily to Parent EPC's energy trading
group at monthly index prices. Through July 2003, we sold our oil and condensate
to Parent EPC's energy trading group at market prices. As of August 1, 2003, we
sell our oil and condensate production to third parties under monthly contracts.
We sell our natural gas liquids to third parties at market prices under monthly
or long-term contracts. As a result of Parent EPC's plan to exit the energy
trading business announced in November 2002, we are currently evaluating how we
will sell our natural gas production in the future. Alternatives being
considered include whether to assume responsibility for the sale of our
production to
54
third parties, or to enter into marketing agreements with third parties engaged
in the marketing of production. In addition, Parent EPC may continue to provide
certain gas marketing services to us.
We also engage in hedging activities on our natural gas and oil production
to stabilize our cash flows and reduce the risk of downward commodity price
movements on sales of our production. This is achieved primarily through natural
gas and oil swaps. Under our current hedging policy, we may hedge up to 50
percent of our anticipated production for a rolling 12-month forward period.
Currently, we hedge our production with an affiliate of Parent EPC which then
enters into hedging arrangements with third parties, and therefore we are not
responsible for posting collateral. As El Paso exits the energy trading
business, we may assume responsibility for our hedging arrangements and,
depending on our financial condition, may be required to begin posting cash
collateral if prevailing prices exceed the prices in those hedging arrangements.
As we have not been conducting our marketing and hedging activities in the past,
our results of operations could be adversely affected if we assume control over
these activities.
The natural gas and oil business is highly competitive in the search for
and acquisition of additional reserves and in the sale of natural gas, oil and
natural gas liquids. Our competitors include major and intermediate sized
natural gas and oil companies, independent natural gas and oil operations and
individual producers or operators with varying scopes of operations and
financial resources. Competitive factors include price, contract terms and
quality of service. Ultimately, our future success in the production business
will be dependent on our ability to find or acquire additional reserves at costs
that allow us to remain competitive.
EMPLOYEES
As of September 30, 2003, we had approximately 935 full-time employees,
none of whom is subject to collective bargaining arrangements.
LEGAL PROCEEDINGS
We are defendants in a number of lawsuits involving royalty claims,
contract claims, environmental claims and other disputes that evolve from the
normal course of business. While we cannot predict the outcomes of these legal
suits with certainty, we do not believe that the results from these cases will
cause material adverse effects on our financial results. Below is a discussion
of our more significant legal proceedings.
Grynberg. A number of El Paso Corporation entities, including our
subsidiary, El Paso Production Company, are defendants in actions brought in
1997 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 not currently determinable.
Will Price (formerly Quinque). A number of El Paso Corporation entities,
including our subsidiary, El Paso Production Company, were named as 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
55
from their properties been differently measured, analyzed, calculated and
reported, together with prejudgment and postjudgment interest, punitive damages,
treble damages, attorneys' fees, costs and expenses, and future injunctive
relief to require the defendants to adopt allegedly appropriate gas measurement
practices. No monetary relief has been specified in this case. Plaintiffs'
motion for class certification was denied on April 10, 2003. Plaintiffs motion
to file another amended petition to narrow the proposed class was granted on
July 28, 2003. Our costs and legal exposure related to this lawsuit are not
currently determinable.
Black Warrior Methane. These matters arise out of an explosion that
occurred on September 23, 2001 at the Brookwood Coal Mine #5 in Tuscaloosa,
Alabama. The explosion resulted in 13 fatalities and numerous other injuries. El
Paso has no ownership interest in the mine. However, El Paso Production is a 50%
stockholder in Black Warrior Methane Corporation, which was involved in the
extraction of methane from the mine, and which is a named defendant in 14 of the
lawsuits filed to date. In addition, El Paso Production has recently been added
as a defendant in several of the cases. There has been no substantive discovery
conducted to date.
Litigation Involving Our Parent, El Paso Corporation
El Paso Corporation and several of its subsidiaries are involved in various
lawsuits which, if resolved unfavorably to our parent, could have a material
adverse effect on us. We are not parties to nor the subject of such lawsuits and
investigations.
California Litigation. El Paso Corporation and several of its subsidiaries
were named defendants in sixteen purported class action, municipal or individual
lawsuits filed in the California state courts. These suits contend that El Paso
Corporation's entities 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 alleged that
El Paso Corporation's conduct violated California's antitrust statute
(Cartwright Act), constituted unfair and unlawful business practices prohibited
by California statutes, and amounted 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 post-judgment interest, (v) costs of prosecuting the actions and
(vi) attorney's fees. All of the class action and municipal lawsuits, and all
but one of the individual lawsuits, will be resolved upon finalization and
approval of the Western Energy Settlement described below. The remaining
individual lawsuit was settled separately.
In May 2002, two lawsuits challenging the validity of long-term power
contracts entered into by the California Department of Water Resources in early
2001 were filed in California state court against 26 separate companies,
including Parent EPC's subsidiary El Paso Merchant Energy. In general, the
plaintiffs allege unfair business practices and seek restitution damages and an
injunction against the enforcement of the contract provisions. Parent EPC's
costs and legal exposure related to these lawsuits and claims are not currently
determinable.
In January 2003, a lawsuit titled IMC Chemicals v. EPME, et al. was filed
in California state court against Parent EPC and its subsidiaries El Paso
Natural Gas and El Paso Merchant Energy. The suit arises out of a gas supply
contract between IMC Chemicals (IMCC), and El Paso Merchant Energy and seeks to
void the Gas Purchase Agreement between IMCC and El Paso Merchant Energy for gas
purposes until December 2003. IMCC contends that El Paso Merchant Energy 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. El Paso Merchant Energy intends to enforce
the terms of the contract and counterclaim for contract damages. El Paso
Corporation was dismissed from the case for lack of personal jurisdiction on
September 9, 2003.
In addition, in September 2001, El Paso Corporation received a civil
document subpoena from the California Attorney General, seeking information said
to be relevant to the Attorney General's ongoing investigation into the high
electricity prices in California in 2000 and 2001. El Paso Corporation has
56
cooperated in responding to the Attorney General's discovery requests. This
proceeding will be resolved upon finalization and approval of the Western Energy
Settlement discussed below.
Western Energy Settlement. On June 26, 2003, El Paso Corporation announced
that it had entered into two definitive settlement agreements (the Western
Energy Settlement) to resolve the principal litigation and claims against it and
its subsidiaries relating to the sale of or delivery of natural gas and/or
electricity to or in the Western United States. Parties to the settlement
agreements include various public and private claimants, including the states of
California, Washington, Oregon, and Nevada. The terms of the settlement
agreements include aggregate upfront cash payments of $343.5 million, a cash
payment of $45 million per year for twenty years, a price reduction under a
power supply contract and a separate cash payment equal to the proceeds from the
issuance of approximately 26.4 million shares of El Paso Corporation common
stock.
These definitive settlement agreements were in addition to a structural
settlement announced on June 4, 2003 where El Paso Corporation agreed to provide
structural relief to the settling parties. In the structural settlement, El Paso
Corporation agreed to do the following:
- Subject to the conditions in the settlement, provide 3.29 Bcf/d of
primary firm pipeline capacity on its El Paso Natural Gas system to
California delivery points during a five year period from the date of
settlement, and not add any firm incremental load to that system that
would prevent it from satisfying its obligation to provide this capacity;
- Construct a new $173 million, 320 million MMcf/d expansion project, and
forgo recovery of the cost of service of this expansion until El Paso
Natural Gas's next rate case before the Federal Energy Regulatory
Commission (FERC);
- Clarify the rights of Northern California shippers to recall some of El
Paso Natural Gas's system capacity to serve markets in PG&E's service
area; and
- With limited exceptions, bar any of its affiliated companies from
obtaining additional firm capacity on its El Paso Natural Gas pipeline
system during a five year period from the effective date of the
settlement.
The definitive settlement agreements are subject to approval by the California
Superior Court for San Diego County and the structural settlement is subject to
approval by the FERC. On November 13, 2003 the FERC announced that it had
approved the overall structural settlement as proposed, while rejecting a
proposal for dual primary firm delivery points and directed the parties to
modify the agreement accordingly. The FERC also declined to sever from the
settlement agreement other parties in the proceeding who contested the proposed
settlement. El Paso Corporation expects final approval of these settlement
agreements in early 2004.
Other Energy Market Lawsuits. The state of Nevada and two individuals
filed a class action lawsuit in Nevada state court naming El Paso Corporation
and a number of its subsidiaries and 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
lawsuit will be resolved upon finalization and approval of the Western Energy
Settlement.
A purported class action suit was filed in federal court in New York City
in December 2002 alleging that El Paso Corporation, El Paso Merchant Energy, El
Paso Natural Gas, and other non-affiliated defendants manipulated California's
natural gas market by manipulating the spot market of gas traded on the NYMEX.
Parent EPC's costs and legal exposure related to this lawsuit are not currently
determinable.
Two purported class action lawsuits were filed in federal court in New York
City in August 2003 and October 2003 alleging that El Paso Corporation, El Paso
Merchant Energy and other defendants manipulated the price of natural gas
futures and option contracts traded on the NYMEX. El Paso Corporation's costs
and legal exposure related to these lawsuits are not currently determinable.
In March 2003, the State of Arizona sued El Paso Natural Gas, El Paso
Merchant Energy, El Paso Corporation 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.
57
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. Parent EPC's costs and legal exposure
related to this lawsuit are not currently determinable.
In April 2003, Sierra Pacific Resources and its subsidiary, Nevada Power
Company filed a lawsuit against El Paso Corporation, El Paso Natural Gas, El
Paso Tennessee Pipeline Co., El Paso Merchant Energy and several other non-El
Paso defendants. In the now-amended complaint, 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
constitutes (1) violations of the Sherman Act, California antitrust statutes and
the Nevada Unfair Trade Practices Act; (2) fraud; (3) both a conspiracy to
violate and a violation of Nevada's RICO Act; (4) a violation of the federal
RICO statute; and (5) a civil conspiracy. The complaint seeks unspecified actual
damages from all the defendants, and requests that such damages be trebled.
Parent EPC's costs and legal exposure related to this lawsuit are not currently
determinable.
On April 28, 2003, a class action suit titled Jerry Egger, et al. v.
Dynegy, Inc., was filed in California state court. It specifically names El Paso
Corporation and 19 other non-El Paso companies as defendants and alleges a
conspiracy to manipulate electricity prices to consumers in nine states in the
West Coast Energy Market. The complaint seeks damages on behalf of the
electricity end-users in eight of the states, Oregon, Washington, Utah, Nevada,
Idaho, New Mexico, Arizona and Montana. The allegations assert the defendants
violated the California antitrust statute (the Cartwright Act) and committed
unfair business practices in violation of the California Business Code. The
complaint seeks actual and treble damages in an unspecified amount, restitution
and pre- and post-judgment interest. Parent EPC's costs and legal exposure
related to this lawsuit are not currently determinable.
Shareholder class action and derivative suits. Since July 2002, twelve
purported shareholder class action suits alleging violations of federal
securities laws have been filed against El Paso Corporation and several of its
officers. Eleven of these suits are now consolidated in federal court in Houston
before a single judge. The suits generally challenge the accuracy or
completeness of press releases and other public statements made during 2001 and
2002 by El Paso Corporation. The twelfth shareholder class action lawsuit was
dismissed in light of similar claims being asserted in the consolidated suits in
Houston. Two shareholder derivative actions have also been filed which generally
allege the same claims as those made in the consolidated shareholder class
action lawsuits. One was filed in federal court in Houston in August 2002, has
been consolidated with the shareholder class actions pending in Houston, and has
been stayed. The second shareholder derivative lawsuit, filed in Delaware State
Court in October 2002, generally alleges the same claims as those made in the
consolidated shareholder class action lawsuit and also has been stayed. The
other shareholder derivative lawsuits are now consolidated in state court in
Houston. Both generally allege that manipulation of California gas supply and
gas prices exposed us to claims of antitrust conspiracy, FERC penalties and
erosion of share value. At this time, Parent EPC's legal exposure related to
these lawsuits and claims is not determinable.
ERISA Class Action Suit. In December 2002, a purported class action
lawsuit was filed in federal court in Houston alleging generally that Parent
EPC's direct and indirect communications with participants in the El Paso
Corporation Retirement Savings Plan included misrepresentations and omissions
that caused members of the class to hold and maintain investments in El Paso
Corporation stock in violation of the Employee Retirement Income Security Act
(ERISA). Parent EPC's costs and legal exposure related to this lawsuit are not
currently determinable.
SEC Investigation. On October 6, 2003, Parent EPC announced that the SEC
had authorized the Staff of the Fort Worth Regional Office to conduct an
investigation of certain aspects of El Paso Corporation's periodic reports filed
with the SEC. The investigation appears to be focused principally on its power
plant contract restructurings and the related disclosures and accounting
treatment for the restructured power contracts, including in particular the
Eagle Point restructuring transaction completed in 2002. Parent EPC has
announced that it is cooperating with the SEC investigation.
58
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
All of the common stock of El Paso Production is owned by El Paso
Corporation.
The following table sets forth information as of October 31, 2003 (unless
otherwise noted) regarding beneficial ownership of El Paso Corporation common
stock by each director, our President and our two other executive officers, our
directors and executive officers as a group and each person or entity known by
us to own beneficially more than 5% of El Paso Corporation's outstanding shares
of common stock. No family relationship exists between any of our directors or
executive officers.
<Table>
<Caption>
BENEFICIAL
OWNERSHIP
(EXCLUDING STOCK PERCENT
TITLE OF CLASS NAME OF BENEFICIAL OWNER OPTIONS)(1) OPTIONS(2) TOTAL OF CLASS
- -------------- ------------------------ ----------- ---------- ---------- --------
Common Stock Pacific Financial Research
Inc.(3)
9601 Wilshire Boulevard,
Suite 800
Beverly Hills, CA 90210......... 65,634,839(3) --(3) 65,634,839(3) 10.9%
Common Stock Capital Research and Management
Company(4)
333 South Hope Street
Los Angeles, CA 90071........... 55,473,020(4) --(4) 55,473,020(4) 9.3%
Common Stock Brandes Investment Partners,
L.L.C.(5)
11988 El Camino Real
Suite 500
San Diego, CA 92130............. 32,719,428(5) --(5) 32,719,428(5) 5.5%
Common Stock Rodney D. Erskine............... 106,634 150,417 257,051 *
Common Stock Gene T. Waguespack.............. 35,224 61,606 96,830 *
Common Stock Randy L. Bartley................ 27,172 83,042 110,214 *
Common Stock D. Dwight Scott................. 60,775 115,247 176,022 *
Common Stock Directors and executive officers
as a group (4) persons
total(6)........................ 229,805 410,312 640,117 *
</Table>
- ---------------
* Less than 1%
(1) The individuals named in the table have sole voting and investment power
with respect to shares of El Paso Corporation common stock beneficially
owned. This column also includes shares of common stock held in the El Paso
Benefits Protection Trust as a result of deferral elections made in
accordance with El Paso Corporation benefit plans. These individuals share
voting power with the trustee under that plan and receive dividends on such
shares, but do not have the power to dispose of, or direct the disposition
of, such shares until such shares are distributed. In addition, some shares
of common stock reflected in this column for certain individuals are subject
to restrictions.
(2) The directors and executive officers have the right to acquire the shares of
common stock reflected in this column within 60 days of October 31, 2003,
through the exercise of stock options.
(3) According to a Schedule 13G filed on February 14, 2003, as of December 31,
2002, Pacific Financial Research Inc. had sole voting power over 60,087,639
shares of common stock and sole dispositive power over 65,634,839 shares of
common stock.
(4) According to a Schedule 13G filed on February 14, 2003, as of December 31,
2002, Capital Research and Management Company had sole dispositive power
over 55,473,020 shares of common stock.
(5) According to a Schedule 13G filed on February 14, 2003, as of December 31,
2002, Brandes Investment Partners, L.L.C. had shared voting power over
25,798,409 shares of common stock and dispositive power over 32,719,428
shares of common stock. The following persons and entities were reported on
such Schedule 13G to have shared voting and investment power as to all of
the shares beneficially owned by Brandes Investment Partners, L.L.C.:
Brandes Investment Partners, Inc., Brandes Worldwide Holdings, L.P., Charles
H. Brandes, Glenn R. Carlson and Jeffrey A. Busby.
(6) On November 17, 2003, Douglas L. Foshee was elected director of El Paso
Production Holding Company. Mr. Foshee's beneficial ownership as of such
date was as follows: 319,699 shares excluding options and no shares subject
to stock options exercisable within 60 days of October 31, 2003.
59
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following provides biographical information for each of our executive
officers and directors as of October 31, 2003. All of these individuals also
hold similar positions with our affiliate, El Paso CGP, and/or its subsidiaries.
<Table>
<Caption>
NAME AGE POSITION
- ---- --- --------
Rodney D. Erskine..................... 59 President and Director
Gene T. Waguespack.................... 47 Senior Vice President, Chief Financial
Officer and Controller
Randy L. Bartley...................... 50 Senior Vice President, Chief
Operations Officer
D. Dwight Scott....................... 40 Director
</Table>
Rodney D. Erskine. Mr. Erskine has been President of El Paso Production
since Parent EPC's merger with The Coastal Corporation (Coastal) in January 2001
and a director since June 2002. He was Senior Vice President of Coastal from
August 1997 to January 2001. He held various positions with Coastal Oil & Gas
Corporation, a subsidiary of Coastal, since 1994. Mr. Erskine has worked in the
energy industry since beginning his career with Union Oil of California in 1966.
In November 2003, Mr. Erskine resigned as President and director of El Paso
Production.
Gene T. Waguespack. Mr. Waguespack has been Senior Vice President, Chief
Financial Officer and Controller for El Paso Production since October 2002. From
the Coastal merger in January 2001 until September 2002, he served as a Vice
President in Parent EPC's corporate planning department. Prior to Parent EPC's
merger with Coastal, Mr. Waguespack was Vice President and Controller of Coastal
beginning in March 2000. He joined Coastal States Management, a subsidiary of
Coastal, in January 1990, and held various positions with that company until his
appointment as Vice President of Corporate Budgeting and Analysis in 1995.
Randy L. Bartley. Mr. Bartley has been Senior Vice President of El Paso
Production since Parent EPC's merger with Coastal in January 2001, and was
elected to the additional position of Chief Operations Officer in March 2003. He
held various positions with Coastal Oil & Gas, a subsidiary of Coastal,
beginning in 1978, and was named Senior Vice President -- Production of that
company in 1997. In November 2003, Mr. Bartley assumed the position of acting
President of El Paso Production.
D. Dwight Scott. Mr. Scott has been a director of El Paso Production since
June 2003. He has been Executive Vice President and Chief Financial Officer of
Parent EPC since October 2002. Mr. Scott served as Senior Vice President of
Finance and Planning for Parent EPC from July 2002 to September 2002. Mr. Scott
was Executive Vice President of Power for El Paso Merchant Energy from December
2001 to June 2002, and he served as Chief Financial Officer of El Paso Global
Networks from October 2000 to November 2001. From January 1999 to October 2000,
he served as a managing director in the energy investment banking practice of
Donaldson, Lufkin and Jenrette.
On November 17, 2003, Douglas L. Foshee (44) was elected director of El
Paso Production. Mr. Foshee has been president, chief executive officer, and a
director of El Paso Corporation since September 2003. Mr. Foshee became
executive vice president and chief operating officer of Halliburton in 2003
having joined that company in 2001 as executive vice president and chief
financial officer. Prior to that, Mr. Foshee was president, chief executive
officer, and chairman of the board at Nuevo Energy Company. From 1993 to 1997,
Mr. Foshee served Torch Energy Advisors Inc. in various capacities, including
chief operating officer and chief executive officer. He held various positions
in finance and new business ventures with ARCO International Oil and Gas Company
and spent seven years in commercial banking, primarily as an energy lender.
60
COMPENSATION OF EXECUTIVE OFFICERS
The following table and narrative text discuss the compensation earned by
or paid in 2002 and 2001 to our President and our two other executive officers.
They were compensated for their services provided in all capacities to El Paso
Production and its subsidiaries. None of the named executives were employed by
El Paso Production in 2000. The table also identifies the principal capacity in
which each of the named executives served El Paso Production at the end of
fiscal year 2002.
SUMMARY COMPENSATION TABLE
<Table>
<Caption>
LONG-TERM COMPENSATION
--------------------------------------
AWARDS PAYOUTS
ANNUAL COMPENSATION ----------------------- ------------
---------------------------------- RESTRICTED SECURITIES LONG-TERM
OTHER ANNUAL STOCK UNDERLYING INCENTIVE ALL OTHER
NAME AND SALARY BONUS COMPENSATION AWARDS OPTIONS PLAN PAYOUTS COMPENSATION
PRINCIPAL POSITION YEAR ($) ($) ($)(1) ($)(2) (#) ($) ($)(3)
- ------------------ ---- -------- -------- ------------ ---------- ---------- ------------ ---------------
Rodney D. Erskine(4)...... 2002 $375,000 $ 0 -- -- -- -- $ 40,962
President 2001 $321,879 $262,518 -- $524,963 183,750 -- $225,927
Gene T. Waguespack(5)..... 2002 $ 55,002 $ 22,002 $ 9,000 $ -- 4,329 -- $ 2,485
Senior Vice President, 2001 -- -- -- -- -- -- --
Chief Financial Officer
and Controller
Randy L. Bartley(4)....... 2002 $240,000 $ 98,000 $36,000 -- -- -- $ 19,974
Senior Vice President and 2001 $207,084 $ 98,006 $33,000 $195,987 101,375 -- $161,551
Chief Operations Officer
</Table>
- ---------------
(1) The amounts in this column include perquisite and benefit allowances.
(2) The amounts in this column reflect the market value of restricted stock of
El Paso Corporation on the date of grant. The shares of restricted stock
were awarded as part of the named executive's 2001 annual bonus and
generally vest four years from the date of grant. At December 31, 2002,
Messrs. Erskine, Waguespack and Bartley held a total of 42,316, 15,593 and
19,598 shares of restricted stock, respectively, having a market value on
such date of $294,519, $108,527 and $136,402, respectively.
(3) The compensation reflected in this column for fiscal year 2002 includes El
Paso Production's contributions to the El Paso Corporation Retirement
Savings Plan, a supplemental company match for the Retirement Savings Plan
under the Supplemental Benefits Plan, and the above-market interest earned
on deferred compensation. Specifically, these amounts for fiscal year 2002
were $9,000, $31,499 and $463 for Mr. Erskine; and $0, $2,475 and $10 for
Mr. Waguespack; and $9,000, $10,845 and $129 for Mr. Bartley, respectively.
(4) Messrs. Erskine and Bartley became employees of El Paso Production in
February 2001. Accordingly, 2001 information for Messrs. Erskine and Bartley
is for the period from February 1, 2001 through December 31, 2001.
(5) Mr. Waguespack became an employee of El Paso Production in October 2002.
Accordingly, information for Mr. Waguespack is for the period from October
1, 2002 through December 31, 2002.
STOCK OPTION GRANTS
This table sets forth the number of stock options to purchase El Paso
Corporation common stock granted at fair market value to the named executive
during the fiscal year 2002. In satisfaction of applicable SEC regulations, the
table further sets forth the potential realizable value of such stock options in
the year 2012 (the expiration date of the stock options) at an assumed
annualized rate of stock price appreciation of 5% and 10% over the full ten-year
term of the stock options. As the table indicates, annualized stock price
appreciation of 5% and 10% would result in stock prices in the year 2012 of
approximately $14.83 and $23.62, respectively. No gain to the named executive is
possible without an increase in stock price, which would benefit all
stockholders. Actual gains, if any, on stock option exercises and common stock
holdings are dependent on the future performance of the common stock and overall
stock market conditions. The potential realizable values shown in this table may
not be achieved.
61
OPTION GRANTS IN 2002
<Table>
<Caption>
INDIVIDUAL GRANTS(1)
------------------------------------------------------- POTENTIAL REALIZABLE VALUE AT
ASSUMED ANNUAL RATES OF STOCK
% OF TOTAL PRICE APPRECIATION FOR OPTION TERM
OPTIONS -------------------------------------
NUMBER OF GRANTED TO IF STOCK PRICE IF STOCK PRICE
SECURITIES EL PASO AT $14.83 AT $23.62
UNDERLYING CORPORATION IN 2012 IN 2012
OPTIONS EMPLOYEES IN EXERCISE PRICE EXPIRATION ----------------- -----------------
NAME GRANTED(#) 2002 ($/SHARE) DATE 5%($) 10%($)
- ---- ---------- ------------ -------------- ---------- ----------------- -----------------
Gene T. Waguespack...... 4,329 0.17% $9.10500 11/6/2012 $ 24,788 $ 62,818
</Table>
- ---------------
(1) The stock options granted in 2002 to the executive named above vest one-half
on each of the first two anniversaries of the grant. No stock options were
granted to any other of the named executives. There were no stock
appreciation rights granted in 2002. Any unvested stock options become fully
exercisable in the event of a "change in control" (see "-- Benefit
Plans -- Key Executive Severance Protection Plan" below for the definition
of the term "change in control"). Under the terms of El Paso Corporation's
2001 Omnibus Incentive Compensation Plan, the Compensation Committee of El
Paso Corporation may, in its sole discretion and at any time, change the
vesting of the stock options. Certain non-qualified stock options may be
transferred to immediate family members, directly or indirectly or by means
of a trust, corporate entity or partnership. Further, stock options are
subject to forfeiture and/or time limitations in the event of a termination
of employment.
OPTION EXERCISES AND YEAR-END VALUE TABLE
This table sets forth information concerning stock option exercises and the
fiscal year-end values of the unexercised stock options, provided on an
aggregate basis, for each of the named executives.
AGGREGATED OPTION EXERCISES IN 2002
AND FISCAL YEAR-END OPTION VALUES
<Table>
<Caption>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
OPTIONS AT FISCAL IN-THE-MONEY OPTIONS AT
SHARES ACQUIRED VALUE YEAR-END(#) FISCAL YEAR-END($)(1)
ON EXERCISE REALIZED --------------------------- ---------------------------
NAME (#) ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- --------------- -------- ----------- ------------- ----------- -------------
Rodney D. Erskine........... 0 $0 84,584 99,166 $0 $0
Gene T. Waguespack.......... 0 $0 31,109 45,995 $0 $0
Randy L. Bartley............ 0 $0 44,708 56,667 $0 $0
</Table>
- ---------------
(1) The figures presented in these columns have been calculated based upon the
difference between $7.00, the fair market value of the El Paso Corporation
common stock on December 31, 2002, for each in-the-money stock option, and
its exercise price. No cash is realized until the shares received upon
exercise of an option are sold. No executives named in this prospectus had
stock appreciation rights that were outstanding on December 31, 2002.
PENSION PLAN
Effective January 1, 1997, El Paso Corporation amended its pension plan to
provide pension benefits under a cash balance plan formula that defines
participant benefits in terms of a hypothetical account balance. Prior to
adopting a cash balance plan, El Paso Corporation provided pension benefits
under a plan (the "Prior Plan") that defined monthly benefits based on final
average earnings and years of service. Under the cash balance plan, an initial
account balance was established for each El Paso Corporation employee who was a
participant in the Prior Plan on December 31, 1996. The initial account balance
was equal to the present value of Prior Plan benefits as of December 31, 1996.
At the end of each calendar quarter, participant account balances are increased
by an interest credit based on 5-Year Treasury bond yields, subject to a minimum
interest credit of 4% per year, plus a pay credit equal to a percentage of
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salary and bonus. The pay credit percentage is based on the sum of age plus
service at the end of the prior calendar year according to the following
schedule:
<Table>
<Caption>
PAY CREDIT
AGE PLUS SERVICE PERCENTAGE
- ---------------- ----------
Less than 35................................................ 4%
35 to 49.................................................... 5%
50 to 64.................................................... 6%
65 and over................................................. 7%
</Table>
Under El Paso Corporation's pension plan and applicable Internal Revenue
Code provisions, compensation in excess of $200,000 cannot be taken into account
and the maximum payable benefit in 2002 was $160,000. Any excess benefits
otherwise accruing under El Paso Corporation's pension plan are payable under El
Paso Corporation's Supplemental Benefits Plan. Participants may elect to receive
benefits in the form of either a lump sum payment or actuarial equivalent
monthly payments over a period of time not less than five years and not more
than the participant's remaining life.
Participants with an initial account balance on January 1, 1997 are
provided minimum benefits equal to the Prior Plan benefit accrued as of the end
of 2001. The Prior Plan benefit is computed as follows: for each year of
credited service up to a total of 30 years, 1.1% of the first $26,800, plus 1.6%
of the excess over $26,800, of the participant's average annual earnings during
his five years of highest earnings. Upon retirement, the pension benefit equals
the greater of the cash balance formula benefit or the Prior Plan benefit
accrued as of the end of 2001.
Prior to El Paso Corporation's merger with Coastal, Coastal provided
non-contributory pension plans covering substantially all of its U.S. employees.
On April 1, 2001, Coastal's primary plan was merged into the El Paso Corporation
pension plan. Coastal employees who were participants in Coastal's primary plan
(including Messrs. Erskine, Bartley, and Waguespack) on March 31, 2001 receive
the greater of cash balance benefits or the Coastal plan benefits accrued
through March 31, 2006. The initial cash balance was equal to the present value
of Coastal plan benefits as of March 31, 2001. The Coastal primary plan benefit
at age 65 is computed as follows: 2.0% of the participant's highest five year
average annual salary for each year of service up to a total of 30 years, minus
1.5% of the participant's primary Social Security benefits for each year of
service up to a total of 33.33 years. Credited service as of March 31, 2006, for
each executive named in this prospectus is shown in the table below. Amounts
reported under Salary and Bonus for each executive named in this prospectus in
the Summary Compensation Table approximate earnings as defined under the pension
plan.
Estimated annual benefits payable from the pension plan and Supplemental
Benefits Plan upon retirement at the normal retirement age for each executive
named in this prospectus is reflected below (based on assumptions that each
executive named in this prospectus receives base salary shown in the Summary
Compensation Table with no pay increases, receives 75% of maximum annual bonuses
beginning with January 2004 bonus, and cash balances are credited with interest
at a rate of 4% per annum):
<Table>
<Caption>
CREDITED SERVICE PAY CREDIT ESTIMATED
AS OF PERCENTAGE ANNUAL
NAMED EXECUTIVE MARCH 31, 2006 DURING 2003 BENEFITS
- --------------- ---------------- ----------- ---------
Rodney D. Erskine....................................... 12 7% $ 85,644
Gene T. Waguespack...................................... 16 6% $ 81,380
Randy L. Bartley........................................ 27 7% $103,042
</Table>
EMPLOYMENT AGREEMENTS
Rodney D. Erskine. As part of El Paso Corporation's merger with Coastal,
Coastal entered into an employment agreement with Mr. Erskine effective January
29, 2001. The employment agreement was for a term of two years. On December 31,
2002, Mr. Erskine entered into an agreement to terminate that employment
agreement. Under this termination agreement, both El Paso Corporation and its
affiliates and
63
Mr. Erskine were released from their obligations under the employment agreement
and Mr. Erskine received a lump-sum payment in the amount of approximately $2.7
million in consideration for the release. Pursuant to the termination agreement,
if Mr. Erskine voluntarily terminates his employment before December 31, 2003,
he will be subject to a noncompetition provision through December 31, 2003. The
noncompetition provision does not apply if Mr. Erskine's employment is
terminated as a result of a "change in control" or if Mr. Erskine terminates his
employment for "good reason."
Gene T. Waguespack. As part of El Paso Corporation's merger with Coastal,
Coastal entered into an employment agreement with Mr. Waguespack effective
January 29, 2001, with a term of three years. Under the agreement, Mr.
Waguespack receives an annual base salary at a rate no less favorable than his
annual base salary on the date of the agreement. He is also eligible to receive
an annual cash bonus and participate in all incentive, savings, retirement, and
benefit plans applicable to other similarly situated senior officers. If Mr.
Waguespack's employment is terminated involuntarily without "cause" or is
voluntarily terminated by Mr. Waguespack for "good reason", Mr. Waguespack will
receive 2.99 times his annual salary and bonus in addition to a prorated portion
of his bonus, assuming all performance objectives were met for the year. In
addition, Mr. Waguespack will receive any accrued but unpaid salary or bonus
amounts, his benefits under the El Paso Production Company Long-Term Incentive
Plan will vest and he will receive the continuation of benefits through the end
of the term of the employment agreement. If Mr. Waguespack's employment is
terminated for "cause" or is voluntarily terminated by Mr. Waguespack other than
for "good reason", death or disability, Mr. Waguespack will receive any accrued
but unpaid salary and bonus amounts; however, his right to receive other
benefits will be determined according to the terms of the applicable plans. If
Mr. Waguespack's employment is involuntarily terminated for "cause" or other
than for "good reason", death or disability prior to the end of the term, he
will be subject to a noncompetition provision for a period of one year following
his termination date.
BENEFIT PLANS
Severance Pay Plan. The El Paso Corporation Severance Pay Plan is a
broad-based employee plan providing severance benefits following a "qualifying
termination" for all salaried employees of El Paso Corporation and certain of
its subsidiaries. The plan also includes an executive supplement, which provides
enhanced severance benefits for certain executive officers of El Paso
Corporation and certain of its subsidiaries, including El Paso Production. The
enhanced severance benefits available under the supplement include an amount
equal to two times the sum of the officer's annual salary, including annual
target bonus amounts as specified in the plan. A qualifying termination includes
an involuntary termination of the officer as a result of the elimination of the
officer's position or a reduction in force and a termination for "good reason"
(as defined under the plan). In the event the Severance Pay Plan is terminated,
the executive supplement will continue as a separate plan unless the action
terminating the Severance Pay Plan explicitly terminates the supplement. The
executive supplement of the Severance Pay Plan terminates on January 1, 2005,
unless extended. In the event of a "change in control" (as defined in the Key
Executive Severance Protection Plan), participants whose termination of
employment entitles them to severance pay under the executive supplement and the
Key Executive Severance Protection Plan will receive severance pay under the Key
Executive Severance Protection Plan, rather than under the executive supplement.
Key Executive Severance Protection Plan. This plan, initially adopted in
1992, provides severance benefits following a "change in control" of El Paso
Corporation for certain officers of El Paso Corporation and certain of its
subsidiaries, including El Paso Production. The benefits of the plan include:
(1) an amount equal to three times the participant's annual salary, including
maximum bonus amounts as specified in the plan; (2) continuation of life and
health insurance for an 18-month period following termination; (3) a
supplemental pension payment calculated by adding three years of additional
credited pension service; (4) additional payments to the terminated employee to
cover excise taxes if the payments made under the plan are subject to excise
taxes on golden parachute payments; and (5) payment of legal fees and expenses
incurred by the employee to enforce any rights or benefits under the plan.
Benefits are payable for any termination of employment for a participant in the
plan within two years of the date of a
64
change in control, except where termination is by reason of death, disability,
for cause or instituted by the employee for other than "good reason," as defined
below. A change in control occurs if: (i) any person or entity becomes the
beneficial owner of 20% or more of El Paso Corporation's common stock; (ii) any
person or entity (other than El Paso) purchases the common stock by way of a
tender or exchange offer; (iii) El Paso Corporation stockholders approve a
merger or consolidation, sale or disposition or a plan of liquidation or
dissolution of all or substantially all of El Paso Corporation's assets; or (iv)
if over a two-year period a majority of the members of the Board of Directors at
the beginning of the period cease to be directors. A change in control has not
occurred if El Paso Corporation is involved in a merger, consolidation or sale
of assets in which the same stockholders of El Paso Corporation before the
transaction own 80% of the outstanding common stock after the transaction is
complete. This plan generally may be amended or terminated at any time, provided
that no amendment or termination may impair participants' rights under the plan
or be made following the occurrence of a change in control. This plan has been
closed to new participants, unless the Board of Directors of El Paso Corporation
determines otherwise. All of the named executive officers of El Paso Production
participate in this plan.
"Good reason" is defined as: (i) a substantial reduction in a participant's
status, title, position or responsibilities; (ii) a reduction in the
participant's annual base salary; (iii) a requirement by El Paso Corporation
that the participant be based outside a 35-mile radius of his or her place of
employment prior to a change in control; (iv) the failure by El Paso Corporation
to continue any compensation or benefit plan in which the participant was
participating at the time of a change in control or provide the participant with
compensation and benefits at least equal to those provided to the participant
immediately prior to a change in control, or following a change in control, if
greater; (v) any material breach by El Paso Corporation of a provision of the
plan; or (vi) any purported termination of the participant's employment for
cause by El Paso Corporation which does not comply with the terms of the plan.
We are unable to predict which of our executive officers may be terminated in
the event of a change in control or may terminate their employment for "good
reason" and, accordingly, are unable to estimate the actual amount of severance
payments that may be triggered.
Supplemental Benefits Plan. This plan provides for certain benefits to
officers and key management employees of El Paso Corporation and its
subsidiaries, including El Paso Production. The benefits include: (1) a credit
equal to the amount that a participant did not receive under El Paso
Corporation's pension plan because the pension plan does not consider deferred
compensation (whether in deferred cash or deferred restricted common stock) for
purposes of calculating benefits and eligible compensation is subject to certain
Internal Revenue Code limitations; and (2) a credit equal to the amount of El
Paso Corporation's matching contribution to El Paso Corporation's Retirement
Savings Plan that cannot be made because of a participant's deferred
compensation and Internal Revenue Code limitations. The plan may not be
terminated so long as the pension plan and/or Retirement Savings Plan remain in
effect. The management committee of this plan designates who may participate and
also administers the plan. Benefits under El Paso's Supplemental Benefits Plan
are paid upon termination of employment in a lump-sum payment, in annuity or in
periodic installments. In the event of a change in control (as defined under the
Key Executive Severance Protection Plan), the supplemental pension benefits
become fully vested and nonforfeitable.
Senior Executive Survivor Benefit Plan. This plan provides certain senior
executives (including each of the named executives in this prospectus) of El
Paso Corporation and its subsidiaries, including El Paso Production, who are
designated by the plan administrator with survivor benefit coverage in lieu of
the coverage provided generally for employees under El Paso Corporation's group
life insurance plan. The amount of benefits provided, on an after-tax basis, is
two and one-half times the executive's annual salary. Benefits are payable in
installments over 30 months beginning within 31 days after the executive's
death, except that the plan administrator may, in its discretion, accelerate
payments.
COMPENSATION PLANS
El Paso Production Companies Long-Term Incentive Plan. This plan provides
for a long-term incentive award in the form of a cash payment to officers and
key employees of El Paso Production at the
65
end of the performance cycle; provided, however, in the event (i) of an initial
offering of El Paso Production's common stock to the public or (ii) El Paso
Production is spun-off from El Paso Corporation during the performance cycle,
any awards under the plan will be in the form of restricted common stock in El
Paso Production or the newly created entity. The amount of any awards under the
plan is based on El Paso Production's performance against a performance peer
group. If a "change in control" occurs, all restrictions placed on awards
automatically lapse. A change in control has occurred following an initial
public offering if: (i) any person or entity other than El Paso Corporation or
any of its subsidiaries or affiliates becomes the beneficial owner of 20% or
more of El Paso Production's common stock; (ii) any person or entity (other than
El Paso Production, El Paso Corporation or any of their subsidiaries or
affiliates) purchases the common stock by way of a tender or exchange offer;
(iii) El Paso Production's stockholders approve a merger or consolidation, sale
or disposition or a plan of liquidation or dissolution of all or substantially
all of its assets; or (iv) if over a two year period a majority of the members
of the Board of Directors at the beginning of the period cease to be directors.
A change in control has not occurred if El Paso Production is involved in a
merger, consolidation or sale of assets in which the same stockholders of El
Paso Production before the transaction own 80% of the outstanding common stock
after the transaction is complete. Notwithstanding the above, (i) a change in
control has occurred upon (x) a qualifying change in control of El Paso
Corporation provided El Paso Corporation owns at least 80% of the outstanding
common stock of El Paso Production at the time of the qualifying change in
control, or (y) El Paso Corporation sells or disposes (other than pursuant to a
public offering or spin-off of El Paso Production) of all of its shares of El
Paso Production and in the event of clause (y) the participant's employment is
terminated (other than a termination for cause or a voluntary termination by the
participant) within six months of such sale or disposition and (ii) a change in
control does not occur upon (x) a public offering of El Paso Production's common
stock or (y) any spin-off of El Paso Production. A "qualifying change in
control" is any change in control, as defined above, except a change in control
that results solely from a change to the Board of Directors of El Paso
Corporation. The plan generally may be amended or terminated at any time;
provided, however, that no amendment or termination may impair participants'
rights under the plan.
2001 Omnibus Incentive Compensation Plan. This plan provides for the grant
to officers and key employees of El Paso Corporation and its subsidiaries,
including El Paso Production, of stock options, stock appreciation rights,
limited stock appreciation rights, performance units and restricted stock. The
plan administrator designates which employees are eligible to participate, the
amount of any grant and the terms and conditions (not otherwise specified in the
plan) of such grant. If a "change in control" (defined in substantially the same
manner as under the Key Executive Severance Protection Plan) occurs: (1) all
outstanding stock options become fully exercisable; (2) stock appreciation
rights and limited stock appreciation rights become immediately exercisable; (3)
designated amounts of performance units become fully vested; (4) all
restrictions placed on awards of restricted common stock automatically lapse;
and (5) the current year's maximum incentive award for each officer
participating in the plan becomes fully payable within 30 days, except that no
incentive award will become payable in connection with a change in control that
results solely from a change to the Board of Directors of El Paso Corporation.
The plan generally may be amended or terminated at any time. Any amendment
following a change in control that impairs participants' rights requires
participant consent.
1999 Omnibus Incentive Compensation Plan. This plan provided for the grant
to officers and key employees of El Paso Corporation and its subsidiaries,
including El Paso Production, of stock options, stock appreciation rights,
limited stock appreciation rights, performance units and restricted stock. This
plan was replaced by the 2001 Omnibus Incentive Compensation Plan. Although this
plan has been terminated with respect to new grants, certain shares of
restricted El Paso Corporation common stock and performance units remain
outstanding under it. If a "change in control" of El Paso Corporation occurs,
all restrictions placed on restricted common stock lapse and designated amounts
of performance units become fully vested. For purposes of the plan, the term
"change in control" has the same meaning given such term in the Key Executive
Severance Protection Plan.
66
Strategic Stock Plan. This plan provides for the grant of stock options,
stock appreciation rights, limited stock appreciation rights and shares of
restricted common stock to non-employee members of El Paso Corporation's Board
of Directors, officers and key employees of El Paso Corporation and its
subsidiaries, including El Paso Production, primarily in connection with El Paso
Corporation's strategic acquisitions. The plan administrator determines which
employees are eligible to participate, the amount of any grant and the terms and
conditions (not otherwise specified in the plan) of such grant. If a change in
control, as defined earlier under the Key Executive Severance Protection Plan,
occurs: (1) all outstanding stock options become fully exercisable; (2) stock
appreciation rights and limited stock appreciation rights become immediately
exercisable; and (3) all restrictions placed on awards of restricted common
stock automatically lapse. The plan generally may be amended or terminated at
any time. Any amendment following a change in control that impairs participants'
rights requires participant consent.
Omnibus Plan for Management Employees. This plan provides for the grant of
stock options, stock appreciation rights, limited stock appreciation rights and
shares of restricted common stock to salaried employees (other than employees
covered by a collective bargaining agreement) of El Paso Corporation and its
subsidiaries, including El Paso Production. If a change in control, as defined
earlier under the Key Executive Severance Protection Plan, occurs: (1) all
outstanding stock options become fully exercisable; (2) stock appreciation
rights and limited stock appreciation rights become immediately exercisable; and
(3) all restrictions placed on awards of restricted common stock automatically
lapse. The plan generally may be amended or terminated at any time. Any
amendment following a change in control that impairs participants' rights
requires participant consent.
67
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Set forth below is a summary of certain material transactions between us
and El Paso Corporation and its affiliates. For a more complete discussion of
these transactions, see Note 3 to our historical consolidated audited financial
statements included in this prospectus. Prior to the issuance of the Old Notes,
we were not required in our affiliate transactions to obtain terms as favorable
to us as could have been obtained from third parties in arm's length
negotiations, and accordingly, the transactions described below have not
necessarily met that standard. However, the indenture governing the notes
requires us to conduct our affiliate transactions as we would with unaffiliated
third parties. See "Description of Notes -- Covenants -- Limitation on Affiliate
Transactions".
CASH MANAGEMENT AGREEMENTS
Pursuant to cash management agreements between Parent EPC and each of our
wholly owned subsidiaries El Paso Production Company and El Paso Production GOM,
Inc., a cash pool has been established for these subsidiaries to loan funds to,
or borrow funds from, Parent EPC. Any funds advanced pursuant to the cash
management agreements will earn interest based on the month-end cash pool
balance, at an interest rate that approximates Parent EPC's short term borrowing
and/or investing rate, and are payable on demand. At December 31, 2002 and
September 30, 2003, Parent EPC owed these subsidiaries a total of approximately
$431 million and $701 million, respectively, pursuant to these agreements.
Following the offering of the Old Notes, we entered into a cash management
agreement with terms similar to those agreements between Parent EPC and our
subsidiaries.
AFFILIATED MARKETING ARRANGEMENTS
We sell the majority of our production to Parent EPC's energy trading
group, pursuant to various marketing agreements and arrangements, at monthly
index prices for natural gas and market prices for oil and condensate. Before
consideration of hedges, sales of natural gas to these affiliates accounted for
approximately 85% of our natural gas sales in 2001, 75% of our natural gas sales
in 2002, 90% of our natural gas sales for the nine months ended September 30,
2003 and 85% of our natural gas sales for the nine months ended September 30,
2002. Affiliate sales of oil and condensate production accounted for 21% of our
oil, condensate and liquids sales in 2001, 82% of our oil, condensate and
liquids sales in 2002, 86% of our oil, condensate and liquids sales for the nine
months ended September 30, 2003 and 83% of our oil, condensate and liquids sales
for the nine months ended September 30, 2002.
Prior to January 1, 2003, we paid Parent EPC's energy trading group an
overhead fee of $0.015 per Mcf of natural gas and $52,000 per month for oil and
condensate. In November 2002, Parent EPC announced its intention to exit the
energy trading business over the next 18 to 24 months. Effective January 1,
2003, we no longer pay an overhead fee to Parent EPC's energy trading group,
although we continue to sell our production to this group. After Parent EPC has
implemented its exit strategy, we may assume the responsibility for marketing
our own production.
GULFTERRA ENERGY PARTNERS, EL PASO FIELD SERVICES AND OTHER EL PASO AFFILIATES
GulfTerra Energy Partners, L.P. (formerly El Paso Energy Partners, L.P.) is
a publicly traded master limited partnership that provides natural gas and oil
gathering, transportation, processing, storage and other related services. A
wholly owned subsidiary of Parent EPC serves as the general partner and owns 19%
of the outstanding common units of the partnership, all outstanding Series B
preferred units and all outstanding Series C common units. For the nine months
ended September 30, 2003 and 2002, and for the years ended December 31, 2002 and
2001, we paid $3.0 million, $13.4 million, $17.3 million and $10.3 million,
respectively, to GulfTerra for gathering, transportation and processing
services. During 2002, our subsidiary, El Paso Production GOM, acquired the
Prince offshore platform from GulfTerra for $190 million. Parent EPC provided an
equity contribution to El Paso Production GOM of $190 million to pay for the
acquisition.
68
We also contract for services with El Paso Field Services and Parent EPC's
regulated interstate pipelines. These companies provide transportation,
gathering, processing, and treating for our natural gas, oil, condensate and
liquids production. For the nine months ended September 30, 2003 and 2002, and
for the years ended December 31, 2002 and 2001, we paid $0.7 million, $1.8
million, $3.1 million and $1.0 million, respectively, to El Paso Field Services
for those services. For the nine months ended September 30, 2003 and 2002, and
for the years ended December 31, 2002 and 2001, we paid $7.7 million, $4.6
million, $13.2 million and $5.0 million, respectively, to Parent EPC's regulated
interstate pipelines, including Tennessee Gas Pipeline Company and Colorado
Interstate Gas Company for services they provided.
ACCOUNTS RECEIVABLE AND ACCOUNTS PAYABLE
In the ordinary course of our business, we conduct commercial activities
with affiliates of Parent EPC as discussed above. These activities result in
affiliate receivables and payables that are settled on a monthly basis. Accounts
receivable due from affiliates at December 31, 2002 and September 30, 2003 was
$90.1 million and $126.4 million, respectively. Accounts payable due to
affiliates at December 31, 2002 and September 30, 2003 was $9.7 million and $6.5
million, respectively.
TRINITY RIVER FINANCING
During 1999, Parent EPC formed a series of companies referred to as Trinity
River. The Trinity River companies were formed to raise money to be used for
Parent EPC's general working capital needs. To secure the financing made to the
Trinity River companies, Parent EPC pledged assets that included all of our
equity interests in certain of our subsidiaries.
In connection with the Trinity River financing, we converted $1 billion we
owed to Parent EPC under its cash management program to two $500 million notes
payable to Parent EPC. Parent EPC then contributed those notes receivable to
certain of our subsidiaries as a capital contribution. Interest on the notes was
payable by us, to these subsidiaries, at a rate of LIBOR plus 0.5% per year. The
subsidiaries then loaned to Parent EPC the interest we paid, at the same
interest rate. In connection with the repayment of the Trinity River financing,
these notes were cancelled. However, the interest amounts loaned by our
subsidiaries to Parent EPC remained outstanding at December 31, 2002 and totaled
$150 million. In March 2003, we dividended this receivable to Parent EPC.
In March 2002, we sold to third parties certain natural gas and oil
properties that had been serving as collateral for the Trinity River financing,
for an aggregate of $382.2 million. To maintain adequate collateral for the
financing, we then had to acquire replacement properties. We did this by
acquiring comparable south Texas natural gas and oil properties from an
affiliate of Parent EPC, for $395.5 million plus $3.9 million of transaction
costs.
In March 2003, Parent EPC entered into a $1.2 billion term loan secured by
substantially all of the natural gas and oil reserves of our subsidiaries. The
purpose of this loan was to repay in full the Trinity River financing. To
accomplish this, Parent EPC loaned the proceeds of this term loan to our
subsidiaries, which in turn used the funds to repay the outstanding $913 million
net balance on the Trinity River financing. We provided a guarantee for this
loan. As a result of these transactions, (i) the Trinity River financing was
paid in full; (ii) our wholly owned subsidiaries owe $1.2 billion to Parent EPC;
(iii) we are a guarantor of these subsidiaries' loans; and (iv) substantially
all of the natural gas and oil reserves of our subsidiaries are pledged to
secure the Parent EPC term loan. For the nine months ended September 30, 2003,
the interest expense related to these loans was $23.0 million. We repaid our
subsidiaries' loans with the net proceeds of the offering of the Old Notes.
CLYDESDALE FINANCING
During 2000, Parent EPC formed a series of companies referred to as
Clydesdale for the purpose of raising money for Parent EPC's general working
capital needs. To secure Clydesdale's borrowings, Parent EPC pledged as
collateral $85.3 million of our assets.
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Also in connection with the Clydesdale financing, we and two other Parent
EPC affiliates formed an entity called Noric Holdings I. Through a series of
contributions of economic interests in natural gas and oil properties, we
obtained a 58% equity interest in Noric Holdings I. On April 16, 2003, we sold
our 58% equity interest in Noric Holdings I to an indirect subsidiary of Parent
EPC for $100,000. This sale was required by the terms of our subsidiaries' $1.2
billion loan agreement with Parent EPC, as discussed in "Trinity River
Financing" above. At the time of the sale, the book value of our combined
interest in Noric Holdings I was approximately $159.7 million. Because this sale
involved entities under the common control of Parent EPC, we recorded the
difference between the cash consideration price and the book value of the
investment as a dividend to Parent EPC.
CORPORATE OVERHEAD AND AFFILIATE SERVICE AGREEMENTS
We are allocated a portion of Parent EPC's corporate overhead, with our
allocable share of Parent EPC's overhead determined as of the beginning of each
calendar year. This overhead allocation covers expenses related to management,
legal, financial, tax, consultative, administrative, insurance, bonding and
other services, including employee benefits, annual incentive bonuses, rent,
insurance, and information technology. In the first nine months of 2003, and in
2002 and 2001, we were allocated $99.9 million, $104.4 million and $68.3
million, respectively, in corporate overhead. In connection with the offering of
the Old Notes, we entered into a Services Agreement with El Paso Energy Service
Company, an affiliate of Parent EPC, pursuant to which El Paso Energy Service
Company agreed to continue to provide these overhead services. We have agreed to
reimburse El Paso Energy Service Company for our allocable share of Parent EPC's
corporate overhead on a basis substantially similar to how our allocable share
has been determined in the past, subject to such changes as El Paso Energy
Service Company determines in its sole discretion to be appropriate. The
Services Agreement is terminable upon 30 days' advance notice by either party to
the other or at the election of a party upon a change of control of the other
party.
We allocate a portion of our general corporate overhead, labor, and general
and administrative expenses to affiliates of El Paso CGP, a subsidiary of Parent
EPC, based upon the relative values of the plant, property and equipment of El
Paso compared to our plant, property and equipment. We provide management,
legal, accounting, financial, tax, consulting, administrative, and other
services to these affiliates who are engaged in the ownership of natural gas and
oil properties. During the first nine months of 2003, and during 2002 and 2001,
we allocated $99.7 million, $140.6 million and $97.7 million of our expenses to
affiliates of El Paso CGP. In connection with the offering of the Old Notes, we
entered into a Services Agreement with El Paso Production Oil & Gas Company, an
affiliate of El Paso CGP, pursuant to which we agreed to continue to provide
these overhead services. El Paso Production Oil & Gas Company has agreed to
reimburse us for its allocable share of our corporate overhead on a basis
substantially similar to how its allocable share of our corporate overhead has
been determined in the past, subject to such changes as we determine in our sole
discretion to be appropriate. The Services Agreement is terminable upon 30 days'
advance notice by either party to the other or at the election of a party upon a
change of control of the other party.
TAX REIMBURSEMENT AGREEMENT
As a member of Parent EPC's consolidated group of companies, we are
required to reimburse Parent EPC for our proportionate share of the consolidated
federal and state income taxes. Specifically, Parent EPC has in effect with us a
Tax Billing Agreement, effective from January 1, 2002, under which we are
obligated to reimburse Parent EPC in accordance with its Accounting Policy for
the Accrual of U.S. Federal Income Taxes (the "Tax Policy"). Under this policy
we reimburse Parent EPC based upon the taxable income of our consolidated group
times the statutory income tax rate, with adjustments if we have a taxable loss
instead of a gain or we have capital gains that are taxed at a rate different
than the rate on ordinary taxable income. The Tax Policy also specifies
treatment for items such as tax benefits for general business credits, Section
29 credits, valuation allowances and other matters. As of December 31, 2002,
Parent EPC owed us a total of $131 million under the Tax Policy. As of September
30, 2003, we
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owed Parent EPC a total of $89.5 million for our allocable portion of income
taxes under the Tax Policy. We are obligated to reimburse Parent EPC in
accordance with the Tax Policy in effect from time to time.
AFFILIATED HEDGING AGREEMENT
We are parties to a master hedging contract with El Paso Merchant Energy,
L.P., an affiliate of Parent EPC that conducts energy trading activities.
Pursuant to that agreement, we hedge our production with El Paso Merchant Energy
which then enters into hedging arrangements with third parties. Under the master
hedging agreement, neither we nor El Paso Merchant Energy is obligated to post
cash or other collateral.
Parent EPC has announced that it will exit the energy trading business
within the next 18 to 24 months. As a result, we may be assuming responsibility
for our future hedging activities. Until Parent EPC has exited this business,
any hedging activities that El Paso Merchant Energy conducts on our behalf will
be conducted under the existing master hedging contract.
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THE EXCHANGE OFFER
EXCHANGE TERMS
Old Notes in an aggregate principal amount of $1.2 billion are currently
issued and outstanding. The maximum aggregate principal amount of New Notes that
will be issued in exchange for Old Notes is $1.2 billion. The terms of the New
Notes and the Old Notes are substantially the same in all material respects,
except that the New Notes will not contain terms with respect to transfer
restrictions, registration rights and payments of liquidated damages.
The New Notes will bear interest at a rate of 7 3/4% per year, payable
semi-annually on June 1 and December 1 of each year, beginning on December 1,
2003. Interest on the New Notes will accrue from May 23, 2003. Holders of New
Notes will not receive any interest on Old Notes tendered and accepted for
exchange. In order to exchange your Old Notes for transferable New Notes in the
exchange offer, you will be required to make the following representations,
which are included in the letter of transmittal:
- the New Notes that you receive will be acquired in the ordinary course of
your business;
- you are not participating, and have no arrangement or understanding with
any person or entity to participate, in the distribution of the New
Notes; and
- you are not our "affiliate," as defined in Rule 405 of the Securities
Act, or a broker-dealer tendering Old Notes acquired directly from us for
resale pursuant to Rule 144A or any other available exemption under the
Securities Act; and
- if you are not a broker-dealer, that you are not engaged in and do not
intend to engage in the distribution of the New Notes.
Upon the terms and subject to the conditions set forth in this prospectus
and in the letter of transmittal, we will accept for exchange any Old Notes
properly tendered in the exchange offer, and the exchange agent will deliver the
New Notes promptly after the expiration date of the exchange offer.
If you tender your Old Notes, you will not be required to pay brokerage
commissions or fees or, subject to the instructions in the letter of
transmittal, transfer taxes with respect to the exchange of the Old Notes in
connection with the exchange offer. We will pay all charges, expenses and
transfer taxes in connection with the exchange offer, other than the taxes
described below under "-- Transfer Taxes."
WE MAKE NO RECOMMENDATION TO YOU AS TO WHETHER YOU SHOULD TENDER OR REFRAIN
FROM TENDERING ALL OR ANY PORTION OF YOUR EXISTING OLD NOTES INTO THIS EXCHANGE
OFFER. IN ADDITION, NO ONE HAS BEEN AUTHORIZED TO MAKE THIS RECOMMENDATION. YOU
MUST MAKE YOUR OWN DECISION WHETHER TO TENDER INTO THIS EXCHANGE OFFER AND, IF
SO, THE AGGREGATE AMOUNT OF OLD NOTES TO TENDER AFTER READING THIS PROSPECTUS
AND THE LETTER OF TRANSMITTAL AND CONSULTING WITH YOUR ADVISORS, IF ANY, BASED
ON YOUR FINANCIAL POSITION AND REQUIREMENTS.
EXPIRATION DATE; EXTENSIONS; TERMINATION; AMENDMENTS
The exchange offer expires at 5:00 p.m., New York City time, on ,
2003, unless we extend the exchange offer, in which case the expiration date
will be the latest date and time to which we extend the exchange offer.
We expressly reserve the right, so long as applicable law allows:
- to delay our acceptance of Old Notes for exchange, provided, that we will
not delay acceptance subsequent to expiration of the exchange offer
unless we are awaiting necessary government approvals;
- prior to expiration of the exchange offer, to terminate the exchange
offer if any of the conditions set forth under "-- Conditions of the
Exchange Offer" exist;
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- prior to expiration of the exchange offer, to waive any condition to the
exchange offer, other than those relating to necessary government
approvals;
- to amend any of the terms of the exchange offer; and
- to extend the expiration date and retain all Old Notes tendered in the
exchange offer, subject to your right to withdraw your tendered Old Notes
as described under "-- Withdrawal of Tenders."
Any waiver or amendment to the exchange offer will apply to all Old Notes
tendered, regardless of when or in what order the Old Notes were tendered. If
the exchange offer is amended in a manner that we think constitutes a material
change, or if we waive a material condition of the exchange offer, we will
promptly disclose the amendment or waiver by means of a prospectus supplement
that will be distributed to the registered holders of the Old Notes, and we will
extend the exchange offer to the extent required by Rule 14e-1 under the
Exchange Act.
We will promptly follow any delay in acceptance, termination, extension or
amendment by oral or written notice of the event to the exchange agent, followed
promptly by oral or written notice to the registered holders. Should we choose
to delay, extend, amend or terminate the exchange offer, we will have no
obligation to publish, advertise or otherwise communicate this announcement,
other than by making a timely release to an appropriate news agency.
In the event we terminate the exchange offer, all Old Notes previously
tendered and not accepted for payment will be returned promptly to the tendering
holders.
In the event that the exchange offer is withdrawn or otherwise not
completed, New Notes will not be given to holders of Old Notes who have validly
tendered their Old Notes.
RESALE OF NEW NOTES
Based on interpretations of the SEC staff set forth in no action letters
issued to third parties, we believe that New Notes issued under the exchange
offer in exchange for Old Notes may be offered for resale, resold and otherwise
transferred by you without compliance with the registration and prospectus
delivery requirements of the Securities Act, if:
- you are acquiring New Notes in the ordinary course of your business;
- you are not participating, and have no arrangement or understanding with
any person or entity to participate, in the distribution of the New
Notes; and
- you are not our "affiliate" within the meaning of Rule 405 under the
Securities Act; and
- you are not a broker-dealer who purchased Old Notes directly from us for
resale pursuant to Rule 144A or any other available exemption under the
Securities Act.
If you tender Old Notes in the exchange offer with the intention of
participating in any manner in a distribution of the New Notes:
- you cannot rely on those interpretations by the SEC staff, and
- you must comply with the registration and prospectus delivery
requirements of the Securities Act in connection with a secondary resale
transaction and such a secondary resale transaction must be covered by an
effective registration statement containing the selling security holder
information required by Item 507 or 508, as applicable, of Regulation
S-K.
Only broker-dealers that acquired the Old Notes as a result of
market-making activities or other trading activities may participate in the
exchange offer. Each broker-dealer that receives New Notes for its own account
in exchange for Old Notes, where such Old Notes were acquired by such
broker-dealer as a result of market-making activities or other trading
activities, must acknowledge that it will deliver a prospectus in connection
with any resale of the New Notes. Please read the section captioned "Plan of
Distribution" for more details regarding the transfer of New Notes.
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ACCEPTANCE OF OLD NOTES FOR EXCHANGE
We will accept for exchange Old Notes validly tendered pursuant to the
exchange offer, or defectively tendered, if such defect has been waived by us.
We will not accept Old Notes for exchange subsequent to the expiration date of
the exchange offer. Tenders of Old Notes will be accepted only in denominations
of $1,000 and integral multiples thereof.
We expressly reserve the right, in our sole discretion, to:
- delay acceptance for exchange of Old Notes tendered under the exchange
offer, subject to Rule 14e-1 under the Exchange Act, which requires that
an offeror pay the consideration offered or return the securities
deposited by or on behalf of the holders promptly after the termination
or withdrawal of a tender offer, or
- terminate the exchange offer prior to expiration and not accept for
exchange any Old Notes not theretofore accepted for exchange, if any of
the conditions set forth below under "-- Conditions of the Exchange
Offer" have not been satisfied or waived by us. In all cases, New Notes
will be issued only after timely receipt by the exchange agent of
certificates representing Old Notes, or confirmation of book-entry
transfer, a properly completed and duly executed letter of transmittal,
or a manually signed facsimile thereof, and any other required documents.
For purposes of the exchange offer, we will be deemed to have accepted
for exchange validly tendered Old Notes, or defectively tendered Old
Notes with respect to which we have waived such defect, if, as and when
we give oral, confirmed in writing, or written notice to the exchange
agent. Promptly after the expiration date, we will deposit the New Notes
with the exchange agent, who will act as agent for the tendering holders
for the purpose of receiving the New Notes and transmitting them to the
holders. The exchange agent will deliver the New Notes to holders of Old
Notes accepted for exchange after the exchange agent receives the New
Notes.
If, for any reason, we delay acceptance for exchange of validly tendered
Old Notes or we are unable to accept for exchange validly tendered Old Notes,
then the exchange agent may, nevertheless, on our behalf, retain tendered Old
Notes, without prejudice to our rights described under "-- Expiration Date;
Extensions; Termination; Amendments", "-- Conditions of the Exchange Offer" and
"-- Withdrawal of Tenders", subject to Rule 14e-1 under the Exchange Act, which
requires that an offeror pay the consideration offered or return the securities
deposited by or on behalf of the holders thereof promptly after the termination
or withdrawal of a tender offer.
If any tendered Old Notes are not accepted for exchange for any reason, or
if certificates are submitted evidencing more Old Notes than those that are
tendered, certificates evidencing Old Notes that are not exchanged will be
returned, without expense, to the tendering holder, or, in the case of Old Notes
tendered by book-entry transfer into the exchange agent's account at a
book-entry transfer facility under the procedure set forth under "-- Procedures
for Tendering Old Notes -- Book-Entry Transfer", such Old Notes will be credited
to the account maintained at such book-entry transfer facility from which such
Old Notes were delivered, unless otherwise requested by such holder under
"Special Delivery Instructions" in the letter of transmittal, promptly following
the expiration date or the termination of the exchange offer.
Tendering holders of Old Notes exchanged in the exchange offer will not be
obligated to pay brokerage commissions or transfer taxes with respect to the
exchange of their Old Notes other than as described in "-- Transfer Taxes" or in
Instruction 13 to the letter of transmittal. We will pay all other charges and
expenses in connection with the exchange offer.
PROCEDURES FOR TENDERING OLD NOTES
Any beneficial owner whose Old Notes are registered in the name of a
broker, dealer, commercial bank, trust company or other nominee or held through
a book-entry transfer facility and who wishes to tender Old Notes should contact
such registered holder promptly and instruct such registered holder to tender
Old Notes on such beneficial owner's behalf.
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TENDER OF OLD NOTES HELD THROUGH DEPOSITORY TRUST COMPANY
The exchange agent and Depository Trust Company ("DTC") have confirmed that
the exchange offer is eligible for the DTC's automated tender offer program.
Accordingly, DTC participants may electronically transmit their acceptance of
the exchange offer by causing DTC to transfer Old Notes to the exchange agent in
accordance with DTC's automated tender offer program procedures for transfer.
DTC will then send an agent's message to the exchange agent.
The term "agent's message" means a message transmitted by DTC, received by
the exchange agent and forming part of the book-entry confirmation, which states
that DTC has received an express acknowledgment from the participant in DTC
tendering Old Notes that are the subject of that book-entry confirmation that
the participant has received and agrees to be bound by the terms of the letter
of transmittal, and that we may enforce such agreement against such participant.
In the case of an agent's message relating to guaranteed delivery, the term
means a message transmitted by DTC and received by the exchange agent which
states that DTC has received an express acknowledgment from the participant in
DTC tendering Old Notes that they have received and agree to be bound by the
notice of guaranteed delivery.
TENDER OF OLD NOTES HELD IN CERTIFICATED FORM
For a holder to validly tender Old Notes held in certificated form:
- the exchange agent must receive at its address set forth in this
prospectus a properly completed and validly executed letter of
transmittal, or a manually signed facsimile thereof, together with any
signature guarantees and any other documents required by the instructions
to the letter of transmittal, and
- the exchange agent must receive certificates for tendered Old Notes at
such address, or such Old Notes must be transferred pursuant to the
procedures for book-entry transfer described below. A confirmation of
such book-entry transfer must be received by the exchange agent prior to
the expiration date of the exchange offer. A holder who desires to tender
Old Notes and who cannot comply with the procedures set forth herein for
tender on a timely basis or whose Old Notes are not immediately available
must comply with the procedures for guaranteed delivery set forth below.
LETTERS OF TRANSMITTAL AND OLD NOTES SHOULD BE SENT ONLY TO THE EXCHANGE
AGENT, AND NOT TO US OR TO DTC.
THE METHOD OF DELIVERY OF OLD NOTES, LETTERS OF TRANSMITTAL AND ALL OTHER
REQUIRED DOCUMENTS TO THE EXCHANGE AGENT IS AT THE ELECTION AND RISK OF THE
HOLDER TENDERING OLD NOTES. DELIVERY OF SUCH DOCUMENTS WILL BE DEEMED MADE ONLY
WHEN ACTUALLY RECEIVED BY THE EXCHANGE AGENT. IF SUCH DELIVERY IS BY MAIL, WE
SUGGEST THAT THE HOLDER USE PROPERTY INSURED, REGISTERED MAIL WITH RETURN
RECEIPT REQUESTED, AND THAT THE MAILING BE MADE SUFFICIENTLY IN ADVANCE OF THE
EXPIRATION DATE OF THE EXCHANGE OFFER TO PERMIT DELIVERY TO THE EXCHANGE AGENT
PRIOR TO SUCH DATE. NO ALTERNATIVE, CONDITIONAL OR CONTINGENT TENDERS OF OLD
NOTES WILL BE ACCEPTED.
SIGNATURE GUARANTEE
Signatures on the letter of transmittal must be guaranteed by an eligible
institution unless:
- the letter of transmittal is signed by the registered holder of the Old
Notes tendered therewith, or by a participant in one of the book-entry
transfer facilities whose name appears on a security position listing it
as the owner of those Old Notes, or if any Old Notes for principal
amounts not tendered are to be issued directly to the holder, or, if
tendered by a participant in one of the book-entry transfer facilities,
any Old Notes for principal amounts not tendered or not accepted for
exchange are to be credited to the participant's account at the
book-entry transfer facility, and neither the "Special Issuance
Instructions" nor the "Special Delivery Instructions" box on the letter
of transmittal has been completed, or
- the Old Notes are tendered for the account of an eligible institution.
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An eligible institution is a firm that is a member of a registered national
securities exchange or of the National Association of Securities Dealers, Inc.,
a commercial bank or a trust company having an office or correspondent in the
United States or an "eligible guarantor institution" within the meaning of Rule
17Ad-15 under the Exchange Act.
BOOK-ENTRY TRANSFER
The exchange agent will seek to establish a new account or utilize an
existing account with respect to the Old Notes at DTC promptly after the date of
this prospectus. Any financial institution that is a participant in the DTC
system and whose name appears on a security position listing as the owner of the
Old Notes may make book-entry delivery of Old Notes by causing DTC to transfer
such Old Notes into the exchange agent's account. HOWEVER, ALTHOUGH DELIVERY OF
OLD NOTES MAY BE EFFECTED THROUGH BOOK-ENTRY TRANSFER INTO THE EXCHANGE AGENT'S
ACCOUNT AT DTC, A PROPERLY COMPLETED AND VALIDLY EXECUTED LETTER OF TRANSMITTAL,
OR A MANUALLY SIGNED FACSIMILE THEREOF, MUST BE RECEIVED BY THE EXCHANGE AGENT
AT ONE OF ITS ADDRESSES SET FORTH IN THIS PROSPECTUS ON OR PRIOR TO THE
EXPIRATION DATE OF THE EXCHANGE OFFER, OR ELSE THE GUARANTEED DELIVERY
PROCEDURES DESCRIBED BELOW MUST BE COMPLIED WITH. The confirmation of a
book-entry transfer of Old Notes into the exchange agent's account at DTC is
referred to in this prospectus as a "book-entry confirmation." Delivery of
documents to DTC in accordance with DTC's procedures does not constitute
delivery to the exchange agent.
GUARANTEED DELIVERY
If you wish to tender your Old Notes and:
(1) certificates representing your Old Notes are not lost but are not
immediately available,
(2) time will not permit your letter of transmittal, certificates
representing your Old Notes and all other required documents to reach the
exchange agent on or prior to the expiration date of the exchange offer, or
(3) the procedures for book-entry transfer cannot be completed on or
prior to the expiration date of the exchange offer, you may nevertheless
tender if all of the following conditions are complied with:
- your tender is made by or through an eligible institution; and
- on or prior to the expiration date of the exchange offer, the exchange
agent has received from the eligible institution a properly completed
and validly executed notice of guaranteed delivery, by manually signed
facsimile transmission, mail or hand delivery, in substantially the
form provided with this prospectus. The notice of guaranteed delivery
must:
(a) set forth your name and address, the registered number(s) of
your Old Notes and the principal amount of Old Notes tendered;
(b) state that the tender is being made thereby;
(c) guarantee that, within three New York Stock Exchange trading
days after the expiration date, the letter of transmittal or facsimile
thereof properly completed and validly executed, together with
certificates representing the Old Notes, or a book-entry confirmation,
and any other documents required by the letter of transmittal and the
instructions thereto, will be deposited by the eligible institution with
the exchange agent; and
(d) the exchange agent receives the properly completed and validly
executed letter of transmittal or facsimile thereof with any required
signature guarantees, together with certificates for all Old Notes in
proper form for transfer, or a book-entry confirmation, and any other
required documents, within three New York Stock Exchange trading days
after the expiration date.
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OTHER MATTERS
New Notes will be issued in exchange for Old Notes accepted for exchange
only after timely receipt by the exchange agent of:
- certificates for (or a timely book-entry confirmation with respect to)
your Old Notes,
- a properly completed and duly executed letter of transmittal or facsimile
thereof with any required signature guarantees, or, in the case of a
book-entry transfer, an agent's message, and
- any other documents required by the letter of transmittal.
We will determine, in our sole discretion, all questions as to the form of
all documents, validity, eligibility, including time of receipt, and acceptance
of all tenders of Old Notes. Our determination will be final and binding on all
parties. ALTERNATIVE, CONDITIONAL OR CONTINGENT TENDERS OF OLD NOTES WILL NOT BE
CONSIDERED VALID. WE RESERVE THE ABSOLUTE RIGHT TO REJECT ANY OR ALL TENDERS OF
OLD NOTES THAT ARE NOT IN PROPER FORM OR THE ACCEPTANCE OF WHICH, IN OUR
OPINION, WOULD BE UNLAWFUL. WE ALSO RESERVE THE RIGHT TO WAIVE ANY DEFECTS,
IRREGULARITIES OR CONDITIONS OF TENDER AS TO PARTICULAR OLD NOTES. TO THE EXTENT
WE WAIVE ANY SUCH DEFECTS, IRREGULARITIES OR CONDITIONS OF TENDER WITH RESPECT
TO ANY OLD NOTES, WE WILL WAIVE THE SAME FOR ALL OTHER TENDERS OF OLD NOTES.
Our interpretation of the terms and conditions of the exchange offer,
including the instructions in the letter of transmittal, will be final and
binding.
Any defect or irregularity in connection with tenders of Old Notes must be
cured within the time we determine, unless waived by us. We will not consider
the tender of Old Notes to have been validly made until all defects and
irregularities have been waived by us or cured. Neither we, the exchange agent,
or any other person will be under any duty to give notice of any defects or
irregularities in tenders of Old Notes, or will incur any liability to holders
for failure to give any such notice.
WITHDRAWAL OF TENDERS
Except as otherwise provided in this prospectus, you may withdraw your
tender of Old Notes at any time prior to the expiration date.
For a withdrawal to be effective:
- the exchange agent must receive a written notice of withdrawal at one of
the addresses set forth below under "-- Exchange Agent", or
- you must comply with the appropriate procedures of DTC's automated tender
offer program system.
Any notice of withdrawal must:
- specify the name of the person who tendered the Old Notes to be
withdrawn, and
- identify the Old Notes to be withdrawn, including the principal amount of
the Old Notes.
If Old Notes have been tendered pursuant to the procedure for book-entry
transfer described above, any notice of withdrawal must specify the name and
number of the account at DTC to be credited with the withdrawn Old Notes and
otherwise comply with the procedures of DTC.
We will determine all questions as to validity, form, eligibility and time
of receipt of any withdrawal notices. Our determination will be final and
binding on all parties. We will deem any Old Notes so withdrawn not to have been
validly tendered for exchange for purposes of the exchange offer.
Any Old Notes that have been tendered for exchange but that are not
exchanged for any reason will be returned to their holder without cost to the
holder or, in the case of Old Notes tendered by book-entry transfer into the
exchange agent's account at DTC according to the procedures described above,
such Old Notes will be credited to an account maintained with DTC for the Old
Notes. This return or crediting will take place promptly after withdrawal,
rejection of tender or termination of the exchange offer. You may
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retender properly withdrawn Old Notes by following one of the procedures
described under "-- Procedures for Tendering Old Notes" at any time on or prior
to the expiration date.
CONDITIONS OF THE EXCHANGE OFFER
Pursuant to the terms of the registration rights agreement, notwithstanding
any other provisions of the exchange offer, if, on or prior to the expiration
date, we determine, in our reasonable judgment, that the exchange offer, or the
making of an exchange by a holder of Old Notes, would violate applicable law or
any applicable interpretation of the staff of the SEC, we will not be required
to accept for exchange, or to exchange, any tendered Old Notes. Prior to
termination of the exchange offer, we may also terminate, waive any conditions
to or amend the exchange offer. In addition, prior to termination we may
postpone the acceptance for exchange of tendered Old Notes, subject to Rule
14e-1 under the Exchange Act, which requires that an offeror pay the
consideration offered or return the securities deposited by or on behalf of the
holders thereof promptly after the termination or withdrawal of the exchange
offer.
TRANSFER TAXES
We will pay all transfer taxes applicable to the transfer and exchange of
Old Notes pursuant to the exchange offer. If, however:
- delivery of the New Notes and/or certificates for Old Notes for principal
amounts not exchanged, are to be made to any person other than the record
holder of the Old Notes tendered;
- tendered certificates for Old Notes are recorded in the name of any
person other than the person signing any letter of transmittal; or
- a transfer tax is imposed for any reason other than the transfer and
exchange of Old Notes to us or our order,
the amount of any such transfer taxes, whether imposed on the record holder or
any other person, will be payable by the tendering holder prior to the issuance
of the New Notes.
CONSEQUENCES OF FAILING TO EXCHANGE
If you do not exchange your Old Notes for New Notes in the exchange offer,
you will remain subject to the restrictions on transfer of the Old Notes:
- as set forth in the legend printed on the Old Notes as a consequence of
the issuance of the Old Notes pursuant to the exemptions from, or in
transactions not subject to, the registration requirements of the
Securities Act and applicable state securities laws; and
- otherwise set forth in the offering circular distributed in connection
with the private offering of the Old Notes.
In general, you may not offer or sell the Old Notes unless they are
registered under the Securities Act, or if the offer or sale is exempt from
registration under the Securities Act and applicable state securities laws.
Except as required by the registration rights agreement, we do not intend to
register resales of the Old Notes under the Securities Act.
ACCOUNTING TREATMENT
The New Notes will be recorded at the same carrying value as the Old Notes,
as reflected in our accounting records on the date of the exchange. Accordingly,
we will not recognize any gain or loss for accounting purposes upon the
consummation of the exchange offer. We will amortize the expenses of the
exchange offer over the term of the exchange notes.
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EXCHANGE AGENT
Wilmington Trust Company has been appointed as exchange agent for the
exchange offer. You should direct questions and requests for assistance,
requests for additional copies of this prospectus, the letter of transmittal or
any other documents to the exchange agent. You should send certificates for Old
Notes, letters of transmittal and any other required documents to the exchange
agent addressed as follows:
WILMINGTON TRUST COMPANY
<Table>
By Overnight Delivery: By Mail: By Hand Delivery:
1100 North Market St. DC 1615 Reorg Services (9:00 a.m. - 5:00 p.m.
Wilmington, DE 19890-1615 P.O. Box 8861 New York City Time)
Attn: Aubrey Rosa Wilmington, DE 19899-8861 1100 North Market St.
Corporate Trust Reorg Services Attn: Aubrey Rosa Wilmington, DE 19890-1615
Corporate Trust Reorg Services Attn: Aubrey Rosa
Corporate Trust Reorg Services
By Facsimile:
(302) 636-4145
Confirm receipt of facsimile
by telephone:
(302) 636-6472
</Table>
79
DESCRIPTION OF NOTES
El Paso Production Holding Company issued the Old Notes, and will issue the
New Notes, under an Indenture (the "Indenture") among itself, the Subsidiary
Guarantors and Wilmington Trust Company, as Trustee. The terms of the Notes
include those stated in the Indenture and those made part of the Indenture by
reference to the Trust Indenture Act.
Certain terms used in this description are defined under the subheading
"-- Definitions." In this description, the word "El Paso Production" and the
words "we," "us" and "our" refer only to El Paso Production Holding Company and
not to any of its subsidiaries.
The following description is only a summary of the material provisions of
the Indenture and the Registration Rights Agreement. We urge you to read the
Indenture and the Registration Rights Agreement because they, not this
description, define your rights as holders of these Notes. You may request
copies of these agreements at our address set forth under the heading
"Prospectus Summary."
BRIEF DESCRIPTION OF THE NOTES
The Notes:
- are unsecured senior obligations of El Paso Production;
- are senior in right of payment to any future Subordinated Obligations of
El Paso Production;
- are guaranteed by each Subsidiary Guarantor; and
- will be subject to the provisions of the Registration Rights Agreement.
PRINCIPAL, MATURITY AND INTEREST
We will issue the Notes initially with a maximum aggregate principal amount
of $1.2 billion. We will issue the Notes in denominations of $1,000 and any
integral multiple of $1,000. The Notes will mature on June 1, 2013. We may issue
more Notes under the Indenture on the same terms and conditions and with the
same CUSIP numbers as the Notes in an unlimited aggregate principal amount (the
"Additional Notes"), without the consent of the holders if such Additional Notes
are fungible with the applicable Notes for U.S. Federal income tax purposes. Any
issuance of Additional Notes is subject to all of the covenants in the
Indenture, including the covenant described under the subheading
"-- Covenants -- Limitation on Indebtedness." The Notes and any Additional Notes
will be treated as a single class for all purposes of the Indenture, including
waivers, amendments, redemptions and offers to purchase. Unless the context
otherwise requires, for all purposes of the Indenture and this "Description of
Notes", references to the Notes include any Additional Notes actually issued.
Interest on the Notes will:
- accrue at the rate of 7 3/4% per annum and
- be payable semiannually in arrears on June 1 and December 1, commencing
on December 1, 2003.
We will pay interest on:
- the Notes to the holders of record on the immediately preceding May 15
and November 15, and
- overdue principal at 1 percentage point per annum in excess of the above
rate, and
- overdue installments of interest at such higher rate to the extent
lawful.
Interest on the Notes will:
- accrue from the date of original issuance and
- be computed on the basis of a 360-day year comprised of twelve 30-day
months.
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If an interest payment date falls on a day that is not a Business Day, the
interest payment to be made on such interest payment date will be made on the
next succeeding Business Day with the same force and effect as if made on such
interest payment date, and no additional interest will accrue as a result of
such delayed payment.
We may become liable for liquidated damages on the Notes in certain
circumstances pursuant to the Registration Rights Agreement. See "-- Exchange
Offer and Registration Rights."
OPTIONAL REDEMPTION
Except as set forth below, we will not be entitled to redeem the Notes
prior to June 1, 2008. On or after June 1, 2008, we are entitled to redeem the
Notes at our option, at any time, in whole or in part, upon not less than 30 nor
more than 60 days' notice, at the redemption prices (expressed as percentages of
principal amount) set forth below plus accrued and unpaid interest thereon to
the applicable redemption date (subject to the right of the Holders of record on
the relevant record date to receive interest due on the relevant interest
payment date), if redeemed during the twelve-month period beginning on June 1 of
the years indicated below:
<Table>
<Caption>
YEAR PERCENTAGE
- ---- ----------
2008........................................................ 103.875%
2009........................................................ 102.583%
2010........................................................ 101.292%
2011 and thereafter......................................... 100.000%
</Table>
In addition, on or prior to June 1, 2006, El Paso Production may on any one
or more occasions redeem up to 35% of the aggregate principal amount of Notes
(including Additional Notes) issued under the Indenture at a redemption price of
107.750% of the principal amount thereof, plus accrued and unpaid interest
thereon, if any, and liquidated damages, if any, to the redemption date, with
the net cash proceeds of a public offering or private placement of common stock
of El Paso Production or the net cash proceeds of a capital contribution to El
Paso Production's common equity; provided, however, that:
(1) at least 65% of the aggregate principal amount of Notes (including
Additional Notes) remains outstanding immediately after the occurrence of
such redemption (excluding Notes held by El Paso Production and its
Affiliates); and
(2) each such redemption occurs within 90 days after the related
offering or capital contribution.
If less than all the Notes are to be redeemed at any time, selection of
Notes for redemption will be made by the Trustee in compliance with the
requirements of the principal national securities exchange, if any, on which the
Notes are listed, or, if the Notes are not so listed, on a pro rata basis, by
lot or by such method as the Trustee shall deem fair and appropriate.
MANDATORY REDEMPTION; OFFERS TO PURCHASE; OPEN MARKET PURCHASES
We are not required to make any mandatory redemption or sinking fund
payments with respect to the Notes. However, under certain circumstances, we may
be required to offer to purchase Notes as described under the captions
"-- Change of Control" and "-- Covenants -- Limitation on Sales of Assets and
Subsidiary Stock." We may at any time and from time to time purchase Notes in
the open market or otherwise.
GUARANTEES
The Subsidiary Guarantors will fully and unconditionally, and jointly and
severally, guarantee, on a senior unsecured basis, our obligations under the
Notes and will be liable on a joint and several basis for the payment of
liquidated damages, if any, on the Notes. Holders of the Notes will be direct
creditors of each Subsidiary Guarantor by virtue of its Subsidiary Guarantee.
Nonetheless, in the event of the
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bankruptcy or financial difficulty of a Subsidiary Guarantor, such Subsidiary
Guarantor's obligations under its Subsidiary Guarantee may be subject to review
and avoidance under state and federal fraudulent transfer laws. Among other
things, such obligations may be avoided if a court concludes that such
obligations were incurred for less than reasonably equivalent value or fair
consideration at a time when the Subsidiary Guarantor was insolvent, was
rendered insolvent, or was left with inadequate capital to conduct its business.
A court would likely conclude that a Subsidiary Guarantor did not receive
reasonably equivalent value or fair consideration to the extent that the
aggregate amount of its liability on its Subsidiary Guarantee exceeds the
economic benefits it receives from the issuance of the Subsidiary Guarantee.
The obligations of each Subsidiary Guarantor under its Subsidiary Guarantee
will be limited in a manner intended to cause it not to be a fraudulent
conveyance under applicable law, although no assurance can be given that a court
would give the Holder the benefit of such provision. See "Risk Factors -- A
subsidiary guarantee could be voided if it constitutes a fraudulent transfer
under U.S. bankruptcy or similar state law, which would prevent the holders of
the notes from relying on that subsidiary to satisfy claims." If the obligations
of a Subsidiary Guarantor under its Subsidiary Guarantee were avoided, Holders
of Notes would have to look to the assets of any remaining Subsidiary Guarantors
for payment. There can be no assurance in that event that such assets would
suffice to pay the outstanding principal and interest on the Notes.
Each Subsidiary Guarantor that makes a payment under its Subsidiary
Guarantee will be entitled upon payment in full of all guarantied obligations
under the Indenture to a contribution from each other Subsidiary Guarantor in an
amount equal to such other Subsidiary Guarantor's pro rata portion of such
payment based on the respective net assets of all the Subsidiary Guarantors at
the time of such payment determined in accordance with GAAP.
If a Subsidiary Guarantee were rendered voidable, it could be subordinated
by a court to all other indebtedness (including guarantees and other contingent
liabilities) of the applicable Subsidiary Guarantor, and, depending on the
amount of such indebtedness, a Subsidiary Guarantor's liability on its
Subsidiary Guarantee could be reduced to zero. See "Risk Factors -- A subsidiary
guarantee could be voided if it constitutes a fraudulent transfer under U.S.
bankruptcy or similar state law, which would prevent the holders of the notes
from relying on that subsidiary to satisfy claims."
Pursuant to the Indenture, a Subsidiary Guarantor may consolidate with,
merge with or into, or transfer all or substantially all its assets to any other
Person to the extent described below under "-- Covenants -- Merger and
Consolidation"; provided, however, that if such other Person is not El Paso
Production, such Subsidiary Guarantor's obligations under its Subsidiary
Guarantee must be expressly assumed by such other Person, subject to the
following paragraph.
The Subsidiary Guarantee of a Subsidiary Guarantor will be released:
- upon the sale or other disposition (including by way of consolidation or
merger) of a Subsidiary Guarantor;
- upon the sale or disposition of all or substantially all the assets of a
Subsidiary Guarantor; or
- upon the designation of such Subsidiary Guarantor as an Unrestricted
Subsidiary;
in the case of the first and second bullet points above (a) other than to El
Paso Production or an Affiliate of El Paso Production and as permitted by the
Indenture and (b), if in connection therewith El Paso Production provides an
Officers' Certificate to the Trustee to the effect that El Paso Production will
comply with its obligations under the covenant described under
"-- Covenants -- Limitation on Sales of Assets and Subsidiary Stock" in respect
of such disposition.
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RANKING
SENIOR INDEBTEDNESS VERSUS NOTES
The indebtedness evidenced by these Notes and the Subsidiary Guarantees
will be unsecured and will rank pari passu in right of payment to the Senior
Indebtedness of El Paso Production and the Subsidiary Guarantors, as the case
may be. The Notes will be guaranteed by the Subsidiary Guarantors.
As of June 30, 2003, after giving effect to the offering of Old Notes and
the application of the proceeds therefrom:
- El Paso Production's Senior Indebtedness is approximately $1.2 billion;
and
- the Subsidiary Guarantors do not have any Senior Indebtedness (other than
their guarantees of the Notes).
The Notes are unsecured obligations of El Paso Production. Secured debt and
other secured obligations of El Paso Production or the Subsidiary Guarantors
will be effectively senior to the Notes or the Subsidiary Guarantees,
respectively, to the extent of the value of the assets securing such debt or
other obligations.
LIABILITIES OF SUBSIDIARIES VERSUS NOTES
We conduct our operations through our subsidiaries. Accordingly, our
ability to meet our cash obligations is dependent upon the ability of our
subsidiaries to make cash distributions to us. Furthermore, any right we have to
receive the assets of any such subsidiary upon such subsidiary's liquidation or
reorganization (and the consequent right of the Holders of the Notes to
participate in the distribution of the proceeds of those assets) effectively
will be subordinated by operation of law to the claims of such subsidiary's
creditors (including trade creditors) and holders of its preferred stock, except
to the extent that such subsidiaries guarantee our obligations under the Notes,
and except to the extent that we are recognized as a creditor or preferred
stockholder of such subsidiary, in which case our claims would still be
subordinate to any indebtedness or preferred stock of such subsidiary senior in
right of payment to that held by us.
As of the Issue Date, all our continuing existing subsidiaries will be
Subsidiary Guarantors. Although the Indenture limits the incurrence of
Indebtedness and preferred stock of certain of our subsidiaries, such limitation
is subject to a number of significant qualifications. Moreover, the Indenture
does not impose any limitation on the incurrence by such subsidiaries of
liabilities that are not considered Indebtedness under the Indenture. See
"-- Covenants -- Limitation on Indebtedness."
EXCHANGE OFFER AND REGISTRATION RIGHTS
In connection with the issuance of the Old Notes, we entered into a
Registration Rights Agreement with the Initial Purchasers. In the Registration
Rights Agreement, we agree to:
- file with the SEC within 90 days after the Issue Date this registration
statement relating to an offer to exchange the Notes for new notes of El
Paso Production (the "New Notes") with principal amount and terms
identical in all material respects to the principal amount and terms of
the Old Notes, except that the New Notes will not contain terms with
respect to transfer restrictions under the Securities Act or the payment
of liquidated damages;
- use our reasonable best efforts to cause the exchange offer registration
statement to be declared effective under the Securities Act within 210
days after the Issue Date;
- commence the exchange offer promptly after the exchange offer
registration statement has been declared effective;
- use our reasonable best efforts to keep the exchange offer registration
statement effective until the closing of the exchange offer; and
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- use our reasonable best efforts to cause the exchange to be completed
within 30 business days after the SEC declares the exchange offer
registration statement effective.
Promptly after the exchange offer registration statement has been declared
effective, we will offer the New Notes in exchange for surrender of the Old
Notes. We will keep the exchange offer open for at least 20 business days, or
longer if required by applicable law, after the effective date of the
registration statement. Interest will accrue on each New Note from the last
interest payment date on which we paid interest on the Old Note tendered in the
exchange offer, or if we have not paid interest on the tendered Old Note, from
the date of original issuance of the New Note.
Based on existing interpretations of the Securities Act by the staff of the
SEC set forth in several no-action letters to third parties, we believe that
Holders other than our affiliates may offer for resale, resell and otherwise
transfer the New Notes without further compliance with the registration and
prospectus delivery requirements of the Securities Act. However, any holder that
is an affiliate of ours and who intends to participate in the exchange offer for
the purpose of distributing the New Notes or any broker-dealer who purchased the
Old Notes for the purpose of reselling the Old Notes under Rule 144A or any
other available exemption under the Securities Act:
- will not be able to rely on the interpretation of the staff of the SEC
set forth in these letters;
- will not be entitled to tender their Old Notes in the exchange offer; and
- must comply with the registration and prospectus delivery requirements of
the Securities Act in connection with any resale or transfer of the Old
Notes unless the resale or transfer is made under an exemption from those
requirements.
Any holder wishing to exchange its Old Notes for New Notes in the exchange
offer will be required to represent that:
- it is not an affiliate of ours;
- at the time of the exchange offer, it has no arrangement or understanding
with any person to participate in the distribution, within the meaning of
the Securities Act, of the Registered Notes; and
- it is acquiring the New Notes in the ordinary course of its business.
In addition, any broker-dealer who acquired the Old Notes for its own
account as a result of market-making or other trading activities must deliver a
prospectus meeting the requirements of the Securities Act in connection with any
resale of the New Notes. The SEC has taken the position that broker-dealers may
use the prospectus contained in the registration statement to fulfill this
prospectus delivery requirement. Under the Registration Rights Agreement, we
must allow broker-dealers and any other persons subject to prospectus delivery
requirements to use the prospectus contained in the registration statement in
connection with the resale of the New Notes.
If:
(1) we determine that applicable law or the applicable interpretations
of the staff of the SEC do not permit us to effect the exchange offer;
(2) for any other reason the exchange offer has not been consummated
within 260 days after the Issue Date; or
(3) in the written opinion of counsel for holders of the Old Notes, a
shelf registration statement must be filed and a prospectus must be
delivered by a holder of the Old Notes in connection with its reoffering or
resale of the Old Notes,
then in addition to, or instead of, effecting the registration of the New Notes
under the exchange offer registration statement, we will file a shelf
registration statement covering resales of the Old Notes within
84
75 days after the determination described in clause (1), the last date described
in clause (2) or our receipt of the opinion described in clause (3), as
applicable.
If required to file a resale shelf registration statement, we will:
- use our reasonable best efforts to cause the shelf registration statement
to be declared effective under the Securities Act within 60 days after
filing the registration statement;
- use our reasonable best efforts to keep the shelf registration statement
continuously effective until the earlier of:
(1) the expiration of the period referred to in Rule 144(k) under the
Securities Act, or similar successor rule, with respect to the Old Notes;
or
(2) such time as all of the Old Notes have been sold under the shelf
registration statement or otherwise cease to be Registrable Notes within
the meaning of the Registration Rights Agreement.
If we file a shelf registration statement, we will notify each holder for
whom such shelf registration statement was filed when the shelf registration
statement has become effective and take other actions which are required to
permit unrestricted resales of the Old Notes. Each holder who sells Old Notes
under the shelf registration statement will be:
- required to deliver information to be used in connection with the shelf
registration statement;
- required to be named as a selling securityholder in the related
prospectus;
- required to deliver a prospectus to purchasers;
- subject to certain of the civil liability provisions under the Securities
Act in connection with the sales; and
- bound by some of the provisions of the Registration Rights Agreement,
including those regarding indemnification rights and obligations.
By accepting an Old Note, a holder is deemed to have agreed to be bound by
the provisions of the Registration Rights Agreement. Under the Registration
Rights Agreement, upon receipt of notice from us of the occurrence of any event
which makes any statement of a material fact in the prospectus which is part of
the exchange registration statement or shelf registration statement untrue or
which requires the making of any changes in the prospectus in order to make the
statements in the prospectus not misleading, any holder must suspend the
disposition of the Old Notes until we have amended or supplemented the
prospectus to correct the misstatement or omission and have furnished copies of
the amended or supplemented prospectus.
For purposes of the Registration Rights Agreement, "Registrable Notes"
means each Old Note until the earliest on the date of which:
(1) a registration statement with respect to such Old Notes has been
declared effective and such Old Notes have been exchanged for New Notes
pursuant to an exchange offer registration statement or disposed of under a
shelf registration statement, as applicable;
(2) such Old Notes have been sold to the public pursuant to Rule 144
or are saleable pursuant to Rule 144(k) (or any similar provision then in
force, but not Rule 144A); or
(3) such Old Notes have ceased to be outstanding.
If:
- we do not file with the SEC a registration statement which we are
required to file under the Registration Rights Agreement on or prior to
the date specified in the Registration Rights Agreement and described
above;
85
- the SEC does not declare a registration statement effective on or prior
to the date specified in the Registration Rights Agreement and described
above;
- we do not consummate the exchange offer within 260 days after the Issue
Date; or
- we have filed, and the SEC has declared effective, the shelf registration
statement and at any time prior to the expiration of the period referred
to in Rule 144(k) under the Securities Act, or similar successor rule,
with respect to the Old Notes, other than after all the Old Notes have
been disposed of under the shelf registration statement or cease to be
Registrable Notes under the Registration Rights Agreement, the shelf
registration statement ceases to be effective, or fails to be usable for
its intended purpose without being succeeded within two business days by
a post-effective amendment which cures the failure and that is itself
immediately declared effective;
(each, a "Registration Default") then we agree to pay each holder of transfer
restricted securities affected thereby liquidated damages in an amount equal to
0.25% per annum of the principal amount of transfer restricted securities held
by such holder for the first 90 day period immediately following the occurrence
of a Registration Default, and such annual rate will increase by an additional
0.25% with respect to each subsequent 90-day period, increasing to a maximum of
1.00% per annum, from and including the date on which any such Registration
Default occurs. We shall not be required to pay liquidated damages for more than
one Registration Default at any given time. Following the cure of all
Registration Defaults, the accrual of liquidated damages will cease.
We have agreed to pay all expenses incident to the exchange offer and to
indemnify the Initial Purchasers and holders of the Notes against some
liabilities, including liabilities under the Securities Act.
All references in the Indenture, in any context, to any interest or other
amount payable on or with respect to the Notes shall be deemed to include any
liquidated damages pursuant to the Registration Rights Agreement.
We have not completely summarized the provisions of the Registration Rights
Agreement in this prospectus and our summary is subject to, and is qualified in
its entirety by reference to, the actual Registration Rights Agreement. For a
complete description of the terms of the Registration Rights Agreement, read the
Registration Rights Agreement. We will provide a copy of the Registration Rights
Agreement without charge upon request. In addition, do not construe our
description of the interpretations of, and positions taken by, the staff of the
SEC as legal advice. Holders should consult their own legal advisor about this
matter.
CHANGE OF CONTROL
Upon the occurrence of any of the following events (each a "Change of
Control"), each Holder shall have the right to require that El Paso Production
repurchase all or any part (equal to $1,000 or an integral multiple thereof) of
such Holder's Notes at a purchase price in cash equal to 101% of the principal
amount thereof on the date of purchase plus accrued and unpaid interest, if any,
and liquidated damages, if any, to the date of purchase (subject to the right of
holders of record on the relevant record date to receive interest due on the
relevant interest payment date):
(1) prior to the first public offering of common stock of El Paso
Production, the Permitted Holders cease to be the "beneficial owner" (as
defined in Rules 13d-3 and 13d-5 under the Exchange Act), directly or
indirectly, of a majority in the aggregate of the total voting power of the
Voting Stock of El Paso Production, whether as a result of issuance of
securities of El Paso Production, any merger, consolidation, liquidation or
dissolution of El Paso Production, or any direct or indirect transfer of
securities (for purposes of this clause (1) and clause (2) below, the
Permitted Holders shall be deemed to beneficially own any Voting Stock of a
Person (the "specified person") held by any other Person (the "parent
entity") so long as the Permitted Holders beneficially own (as so defined),
directly or indirectly, in the aggregate a majority of the voting power of
the Voting Stock of the parent entity);
86
(2) any "person" (as such term is used in Sections 13(d) and 14(d) of
the Exchange Act), other than one or more Permitted Holders, is or becomes
the beneficial owner (as defined in clause (1) above, except that for
purposes of this clause (2) such person shall be deemed to have "beneficial
ownership" of all shares that any such person has the right to acquire,
whether such right is exercisable immediately or only after the passage of
time), directly or indirectly, of more than 40% of the total voting power
of the Voting Stock of El Paso Production; provided, however, that the
Permitted Holders beneficially own (as defined in clause (1) above),
directly or indirectly, in the aggregate a lesser percentage of the total
voting power of the Voting Stock of El Paso Production than such other
person and do not have the right or ability by voting power, contract or
otherwise to elect or designate for election a majority of the Board of
Directors (for the purposes of this clause (2), such other person shall be
deemed to beneficially own any Voting Stock of a specified Person held by a
parent entity, if such other person is the beneficial owner (as defined in
this clause (2)), directly or indirectly, of more than 40% of the voting
power of the Voting Stock of such parent entity and the Permitted Holders
beneficially own (as defined in clause (1) above), directly or indirectly,
in the aggregate a lesser percentage of the voting power of the Voting
Stock of such parent entity and do not have the right or ability by voting
power, contract or otherwise to elect or designate for election a majority
of the board of directors of such parent entity);
(3) the adoption of a plan relating to the liquidation or dissolution
of El Paso Production; or
(4) the merger or consolidation of El Paso Production with or into
another Person or the merger of another Person with or into El Paso
Production, or the sale of all or substantially all the assets of El Paso
Production (determined on a consolidated basis) to another Person other
than:
(A) a transaction in which the survivor or transferee is a Person
that is controlled by the Permitted Holders; or
(B) a transaction following which (a) in the case of a merger or
consolidation transaction, holders of securities that represented 100%
of the Voting Stock of El Paso Production immediately prior to such
transaction (or other securities into which such securities are
converted as part of such merger or consolidation transaction) own
directly or indirectly at least a majority of the voting power of the
Voting Stock of the surviving Person in such merger or consolidation
transaction immediately after such transaction and in substantially the
same proportion as before the transaction and (b) in the case of a sale
of assets transaction, each transferee becomes an obligor in respect of
the Notes and a Subsidiary of the transferor of such assets.
provided, however, that the events set forth above under paragraphs (1) through
(4) shall constitute a Change of Control if, but only if, within 30 days after
such an event, any downgrade in the ratings of the Notes by either S&P or
Moody's shall have occurred.
Within 30 days following any downgrade in the ratings of the Notes by
either S&P or Moody's following any Change of Control, we will mail a notice to
each Holder with a copy to the Trustee (the "Change of Control Offer") stating:
(1) that a Change of Control has occurred and that such Holder has the
right to require us to purchase such Holder's Notes at a purchase price in
cash equal to 101% of the principal amount thereof on the date of purchase,
plus accrued and unpaid interest, if any, and liquidated damages, if any,
to the date of purchase (subject to the right of Holders of record on the
relevant record date to receive interest on the relevant interest payment
date);
(2) the circumstances and relevant facts regarding such Change of
Control (including information with respect to pro forma historical income,
cash flow and capitalization, in each case after giving effect to such
Change of Control);
(3) the purchase date (which shall be no earlier than 30 days nor
later than 60 days from the date such notice is mailed); and
87
(4) the instructions, as determined by us, consistent with the
covenant described hereunder, that a Holder must follow in order to have
its Notes purchased.
We will not be required to make a Change of Control Offer following a
Change of Control if a third party makes the Change of Control Offer in the
manner, at the times and otherwise in compliance with the requirements set forth
in the Indenture applicable to a Change of Control Offer made by us and
purchases all Notes validly tendered and not withdrawn under such Change of
Control Offer.
We will comply, to the extent applicable, with the requirements of Section
14(e) of the Exchange Act and any other securities laws or regulations in
connection with the repurchase of Notes as a result of a Change of Control. To
the extent that the provisions of any securities laws or regulations conflict
with the provisions of the covenant described hereunder, we will comply with the
applicable securities laws and regulations and will not be deemed to have
breached our obligations under the covenant described hereunder by virtue of our
compliance with such securities laws or regulations.
The Change of Control purchase feature of the Notes may in certain
circumstances make more difficult or discourage a sale or takeover of El Paso
Production and, thus, the removal of incumbent management. The Change of Control
purchase feature is a result of negotiations between El Paso Production and the
Initial Purchaser. We have no present intention to engage in a transaction
involving a Change of Control, although it is possible that we could decide to
do so in the future. Subject to the limitations discussed below, we could, in
the future, enter into certain transactions, including acquisitions,
refinancings or other recapitalizations, that would not constitute a Change of
Control under the Indenture, but that could increase the amount of indebtedness
outstanding at such time or otherwise affect our capital structure or credit
ratings. Restrictions on our ability to Incur additional Indebtedness are
contained in the covenants described under "-- Covenants -- Limitation on
Indebtedness", "-- Limitation on Liens" and "-- Limitation on Sale/Leaseback
Transactions." Such restrictions can only be waived with the consent of the
holders of a majority in principal amount of the Notes then outstanding. Except
for the limitations contained in such covenants, however, the Indenture will not
contain any covenants or provisions that may afford holders of the Notes
protection in the event of a highly leveraged transaction.
Future indebtedness that we may incur may contain prohibitions on the
occurrence of certain events that would constitute a Change of Control or
require the repurchase of such indebtedness upon a Change of Control. Moreover,
the exercise by the holders of their right to require us to repurchase their
Notes could cause a default under such indebtedness, even if the Change of
Control itself does not, due to the financial effect of such repurchase on us.
Finally, our ability to pay cash to the holders of Notes following the
occurrence of a Change of Control may be limited by our then existing financial
resources. There can be no assurance that sufficient funds will be available
when necessary to make any required repurchases.
The definition of "Change of Control" includes a disposition of all or
substantially all of the assets of El Paso Production to any Person. Although
there is a limited body of case law interpreting the phrase "substantially all,"
there is no precise established definition of the phrase under applicable law.
Accordingly, in certain circumstances there may be a degree of uncertainty as to
whether a particular transaction would involve a disposition of "all or
substantially all" of the assets of El Paso Production. As a result, it may be
unclear as to whether a Change of Control has occurred and whether a holder of
Notes may require El Paso Production to make an offer to repurchase the Notes as
described above.
The provisions under the Indenture relative to our obligation to make an
offer to repurchase the Notes as a result of a Change of Control may be waived
or modified or terminated with the written consent of the holders of a majority
in principal amount of the Notes.
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COVENANTS
COVENANT TERMINATION
From and after any time that the Notes have both a Moody's rating of BaaB
or higher and an S&P rating of BBB- or higher and no Default has occurred and is
then continuing, El Paso Production and the Restricted Subsidiaries will cease
to be subject to the following covenants:
- "-- Limitation on Indebtedness;"
- "-- Limitation on Advances under Parent's Cash Management Program;"
- "-- Limitation on Restricted Payments;"
- "-- Limitation on Restrictions on Distributions from Restricted
Subsidiaries;"
- "-- Limitation on Sales of Assets and Subsidiary Stock;"
- "-- Limitation on Affiliate Transactions;"
- "-- Limitation on Line of Business;"
- clause (3) of the covenant described under "-- Merger and Consolidation;"
- "-- Future Guarantors;" and
- "-- Change of Control."
LIMITATION ON INDEBTEDNESS
El Paso Production will not, and will not permit any Restricted Subsidiary
to, Incur, directly or indirectly, any Indebtedness; provided, however, that El
Paso Production and the Subsidiary Guarantors may Incur Indebtedness if, on the
date of such Incurrence and after giving effect thereto (and the application of
the proceeds thereof) on a pro forma basis, no Default has occurred and is
continuing and the Consolidated Coverage Ratio exceeds 2.0 to 1.
The first paragraph of this covenant will not prohibit the Incurrence of
any or all of the following items of Indebtedness:
(1) Indebtedness Incurred by El Paso Production and its Restricted
Subsidiaries under any Credit Facility; provided, however, that,
immediately after giving effect to any such Incurrence, the aggregate
principal amount of all Indebtedness Incurred under this clause (1) and
then outstanding does not exceed the lesser of (x) $200 million plus 20% of
ACNTA of El Paso Production as of the date of such Incurrence and (y) prior
to May 15, 2005, $400 million and thereafter, $500 million;
(2) Indebtedness owed to and held by El Paso Production or a
Restricted Subsidiary; provided, however, that any subsequent issuance or
transfer of any Capital Stock which results in any such Restricted
Subsidiary ceasing to be a Restricted Subsidiary or any subsequent transfer
of such Indebtedness (other than to El Paso Production or a Subsidiary)
will be deemed, in each case, to constitute the Incurrence of such
Indebtedness by the obligor thereon;
(3) the Old Notes and the New Notes (other than any Additional Notes)
and all Subsidiary Guarantees;
(4) Indebtedness outstanding on the Issue Date (other than
Indebtedness described in clause (1), (2) or (3) of this paragraph);
(5) Indebtedness of a Restricted Subsidiary Incurred and outstanding
on or before the date on which such Subsidiary became a Restricted
Subsidiary or was acquired by El Paso Production (other than Indebtedness
Incurred in connection with, or to provide all or any portion of the funds
or credit support utilized to consummate, the transaction or series of
related transactions pursuant to which such Subsidiary became a Subsidiary
or was acquired by El Paso Production); provided, however, that
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on the date of the acquisition and after giving pro forma effect to the
acquisition, El Paso Production would have been able to Incur at least
$1.00 of additional Indebtedness pursuant to the first paragraph of this
covenant;
(6) Refinancing Indebtedness in respect of Indebtedness Incurred
pursuant to the first paragraph of this covenant or pursuant to clause (3),
(4) or (5) or this clause (6); provided, however, that to the extent such
Refinancing Indebtedness directly or indirectly Refinances Indebtedness of
a Subsidiary Incurred pursuant to clause (5), such Refinancing Indebtedness
will be Incurred only by such Subsidiary;
(7) Hedging Obligations consisting of Interest Rate Agreements
directly related to Indebtedness permitted to be Incurred by El Paso
Production and the Restricted Subsidiaries pursuant to the Indenture;
(8) Hedging Obligations consisting of Oil and Natural Gas Hedging
Contracts and Currency Agreements entered into in the ordinary course of
business for the purpose of limiting risks that arise in the ordinary
course of business of El Paso Production and its Subsidiaries;
(9) obligations in respect of completion bonds, performance bonds, bid
bonds, appeal bonds, surety bonds, insurance obligations or bonds and other
similar bonds and obligations incurred by El Paso Production or any
Restricted Subsidiary in the ordinary course of business and any guarantees
or letters of credit functioning as or supporting any of the foregoing
bonds or obligations;
(10) Indebtedness arising from the honoring by a bank or other
financial institution of a check, draft or similar instrument drawn against
insufficient funds in the ordinary course of business; provided, however,
that such Indebtedness is extinguished within five Business Days of its
Incurrence;
(11) Indebtedness consisting of the Subsidiary Guarantee of a
Subsidiary Guarantor and any Guarantee by a Subsidiary Guarantor of
Indebtedness Incurred pursuant to the first paragraph of this covenant or
pursuant to clause (1), (2), (3) or (4) or pursuant to clause (6) of this
paragraph to the extent the Refinancing Indebtedness Incurred thereunder
directly or indirectly Refinances Indebtedness Incurred pursuant to the
first paragraph of this covenant or pursuant to clause (3) or (4);
(12) Indebtedness represented by Capital Lease Obligations, mortgage
financings or purchase money obligations, in each case, Incurred for the
purpose of financing all or any part of the purchase price, cost of
construction or improvement or carrying cost of assets used in the business
of El Paso Production and its Restricted Subsidiaries and related financing
costs, and Refinancing Indebtedness Incurred to Refinance any Indebtedness
Incurred pursuant to this clause (12), in an aggregate principal amount at
any one time outstanding not to exceed $50 million;
(13) Indebtedness arising from any agreement providing for
indemnities, Guarantees, purchase price adjustments, holdbacks, contingency
payment obligations based on the performance of the acquired or disposed
assets or similar obligations (other than Guarantees of Indebtedness)
Incurred by any Person in connection with the acquisition or disposition of
assets;
(14) in-kind obligations relating to net oil or natural gas balancing
positions arising in the ordinary course of business;
(15) any obligation of El Paso Production or any of its Restricted
Subsidiaries to reimburse any of its vendors (or any assignee of a vendor)
for services, materials, equipment or other items furnished by such vendor
in the ordinary course of business to the extent such obligation (a)
involves an obligation to reimburse such vendor for the cost of such
services, materials, equipment or other items so furnished plus a specified
return thereon and (b) is to be satisfied from the production of oil, gas
and other hydrocarbons attributable to an overriding royalty interest, net
profits interest, Dollar-Denominated Production Payment or Volumetric
Production Payment or other similar interest that is granted by El Paso
Production or a Restricted Subsidiary in consideration for such vendor(s)
agreement not to seek a cash payment from El Paso Production or its
Restricted Subsidiaries therefor (the "Vendor Program");
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(16) Capital Stock (other than Disqualified Stock) of El Paso
Production or of any of the Subsidiary Guarantors;
(17) Indebtedness, including Refinancing Indebtedness, Incurred by a
Foreign Restricted Subsidiary in an aggregate amount not to exceed 20% of
such Foreign Restricted Subsidiary's ACNTA at any time outstanding;
(18) all contracts, Indebtedness and other obligations, agreements
instruments or arrangements described in clauses (13), (15), (16), (19) or
(24) of the definition of "Permitted Liens" to the extent any of the
contracts, obligations, agreements, instruments, liens or arrangements
referred to in such clauses may constitute Indebtedness;
(19) Indebtedness of El Paso Production or of any of the Subsidiary
Guarantors in an aggregate principal amount which, when taken together with
all other Indebtedness of El Paso Production and its Restricted
Subsidiaries outstanding on the date of such Incurrence (other than
Indebtedness permitted by clauses (1) through (18) of this paragraph or the
first paragraph of this covenant does not exceed $50 million.
Neither El Paso Production nor any Subsidiary Guarantor will Incur any
Indebtedness pursuant to the second paragraph of this covenant if the proceeds
thereof are used, directly or indirectly, to Refinance any Subordinated
Obligations of El Paso Production or any Subsidiary Guarantor unless such
Indebtedness shall be subordinated to the Notes or the applicable Subsidiary
Guarantee to at least the same extent as such Subordinated Obligations.
For purposes of determining compliance with this covenant:
(1) in the event that an item of Indebtedness (or any portion thereof)
meets the criteria of more than one of the types of Indebtedness described
above, El Paso Production, in its sole discretion, will classify such item
of Indebtedness (or any portion thereof) at the time of Incurrence and will
only be required to include the amount and type of such Indebtedness in one
of the above clauses;
(2) El Paso Production will be entitled to divide and classify an item
of Indebtedness in more than one of the types of Indebtedness described
above; and
(3) the dollar-equivalent principal amount of any Indebtedness
denominated in a foreign currency and incurred pursuant to any
dollar-denominated restriction on the incurrence of Indebtedness will be
calculated based on the relevant currency.
LIMITATION ON ADVANCES UNDER PARENT'S CASH MANAGEMENT PROGRAM
El Paso Production will not, and will not permit any Restricted Subsidiary
to, advance any funds to the Parent or any of its Subsidiaries (other than to El
Paso Production and any of its Subsidiaries) pursuant to Parent's Cash
Management Program if any default occurs or exists under any bond, debenture,
note or other evidence of debt for money borrowed or under any mortgage,
indenture or instrument under which there may be issued or by which there may be
secured or evidenced any debt for money borrowed, in each case, by Parent or any
of its Subsidiaries (or the payment of which is Guaranteed by Parent or any of
its Subsidiaries) whether such debt or Guarantee now exists, or is created after
the Issue Date, if such default:
(1) is caused by a failure to pay principal of, or interest or
premium, if any, on such debt of Parent or such Subsidiary prior to the
expiration of the grace period provided in such debt of Parent or such
Subsidiary on the date of such default (a "Payment Default"); or
(2) results in the acceleration (without cure or revocation within
five business days) of debt of Parent or such Subsidiary prior to its
express maturity,
and, in each case, the principal amount of any such debt of Parent or such
Subsidiary, together with the principal amount of any other such debt of Parent
or such Subsidiary under which there has been a Payment Default or the maturity
of which has been so accelerated, aggregates $50 million or more, until
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such acceleration has been cured or revoked or such payment of such debt of
Parent or such Subsidiary has been made in full.
El Paso Production will not, and will not permit any Restricted Subsidiary
to, advance any funds at any time after the Issue Date, to the Parent or any of
its Subsidiaries (other than El Paso Production and any of its Restricted
Subsidiaries) pursuant to Parent's Cash Management Program if, after giving pro
forma effect to any proposed advance, the aggregate amount of all funds so
advanced and not repaid would exceed the sum of:
(1) $125 million; plus
(2) an amount equal to 5% of the ACNTA of El Paso Production
attributable to:
(A) oil and natural gas reserves or properties contributed to or
acquired by El Paso Production or any of its Restricted Subsidiaries
after the Issue Date, to the extent such reserves or properties were
contributed by or acquired from Parent or its Subsidiaries; or
(B) any Person that became a Restricted Subsidiary of El Paso
Production after the Issue Date, to the extent such Person was
contributed by or acquired from Parent or its Subsidiaries.
Neither El Paso Production nor any of its Subsidiaries shall be precluded
by this covenant from paying or repaying any Indebtedness or other obligation
owed to any Person.
LIMITATION ON RESTRICTED PAYMENTS
El Paso Production will not, and will not permit any Restricted Subsidiary,
directly or indirectly, to make a Restricted Payment if at the time El Paso
Production or such Restricted Subsidiary makes such Restricted Payment:
(1) a Default shall have occurred and be continuing (or would result
therefrom);
(2) El Paso Production is not entitled to Incur an additional $1.00 of
Indebtedness pursuant to the first paragraph of the covenant described
under "-- Limitation on Indebtedness"; or
(3) the aggregate amount of such Restricted Payment and all other
Restricted Payments since the Issue Date would exceed the sum of (without
duplication):
(A) 100% of Free Cash Flow accrued during the period (treated as
one accounting period) from the beginning of the fiscal quarter
immediately following the fiscal quarter during which the Issue Date
occurs to the most recent date for which financial information is
publicly available (or, in case such Free Cash Flow shall be a deficit,
minus 100% of such deficit); plus
(B) 100% of the aggregate Net Cash Proceeds, and the fair market
value (as determined by El Paso Production's board of directors in good
faith) of property or securities other than cash (including Capital
Stock of Persons engaged in the Oil and Gas Business or assets used in
the Oil and Gas Business), in each case received by El Paso Production
from the issuance or sale of its Capital Stock (other than Disqualified
Stock) after the Issue Date (other than an issuance or sale to a
Subsidiary of El Paso Production and other than an issuance or sale to
an employee stock ownership plan or to a trust established by El Paso
Production or any of its Subsidiaries for the benefit of their
employees) and 100% of any cash and 100% of the fair market value (as
determined by El Paso Production's board of directors in good faith) of
property or securities other than cash (including Capital Stock of
Persons engaged in the Oil and Gas Business or assets used in the Oil
and Gas Business), in each case received by El Paso Production as a
capital contribution from its shareholders after the Issue Date; plus
(C) the amount by which Indebtedness of El Paso Production is
reduced on El Paso Production's balance sheet upon the conversion or
exchange after the Issue Date of any Indebtedness of El Paso Production
convertible or exchangeable for Capital Stock (other than Disqualified
Stock) of El Paso Production (less the amount of any cash, or the fair
value of any
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other property, distributed by El Paso Production upon such conversion
or exchange); provided, however, that the foregoing amount shall not
exceed the Net Cash Proceeds received by El Paso Production or any
Restricted Subsidiary from the sale of such Indebtedness (excluding Net
Cash Proceeds from sales to a Subsidiary of El Paso Production or to an
employee stock ownership plan or to a trust established by El Paso
Production or any of its Subsidiaries for the benefit of their
employees); plus
(D) an amount equal to the sum of (x) the net reduction in the
Investments (other than Permitted Investments) made after the Issue Date
by El Paso Production or any Restricted Subsidiary in any Person
resulting from repurchases, repayments or redemptions of such
Investments by such Person, proceeds realized on the sale of such
Investment and proceeds representing the return of capital (excluding
dividends and distributions), in each case received by El Paso
Production or any Restricted Subsidiary, and (y) to the extent such
Person is an Unrestricted Subsidiary, the portion (proportionate to El
Paso Production's equity interest in such Subsidiary) of the fair market
value of the net assets of such Unrestricted Subsidiary at the time such
Unrestricted Subsidiary is designated a Restricted Subsidiary.
The preceding provisions will not prohibit:
(1) any Restricted Payment made out of the Net Cash Proceeds of:
(A) the substantially concurrent sale of, or made by exchange for,
Capital Stock of El Paso Production (other than (x) Disqualified Stock
(unless the proposed Restricted Payment is the purchase, redemption or
other acquisition or retirement of Disqualified Stock) and (y) Capital
Stock issued or sold to a Subsidiary of El Paso Production or an
employee stock ownership plan or to a trust established by El Paso
Production or any of its Subsidiaries for the benefit of their
employees); or
(B) a substantially concurrent cash capital contribution received
by El Paso Production from its shareholders;
provided, however, that (a) such Restricted Payment will be excluded in the
calculation of the amount of Restricted Payments and (b) the Net Cash Proceeds
from such sale or such cash capital contribution (to the extent so used for such
Restricted Payment) will be excluded from the calculation of amounts under
clause (3)(B) of the first paragraph of this covenant;
(2) any purchase, repurchase, redemption, defeasance or other
acquisition or retirement for value of Subordinated Obligations of El Paso
Production or any Subsidiary Guarantor made by exchange for, or out of the
proceeds of the substantially concurrent sale of, Subordinated Obligations
of such Person which is permitted to be Incurred pursuant to the covenant
described under "-- Limitation on Indebtedness"; provided, however, that
such purchase, repurchase, redemption, defeasance or other acquisition or
retirement for value will be excluded in the calculation of the amount of
Restricted Payments;
(3) the payment of any dividend or making of any distribution paid
within 60 days after the date of declaration of the dividend or
distribution if at such date of declaration such dividend would have
complied with this covenant; provided, however, that such dividend will be
included in the calculation of the amount of Restricted Payments;
(4) so long as no Default has occurred and is continuing, the
repurchase or other acquisition of Capital Stock of Parent, El Paso
Production or any of its Subsidiaries from employees, former employees,
directors or former directors of El Paso Production or any of its
Subsidiaries (or permitted transferees or heirs or estates of such
employees, former employees, directors or former directors), pursuant to
the terms of the agreements (including employment agreements) or plans (or
amendments thereto) approved by the Board of Directors under which such
individuals purchase or sell or are granted the option to purchase or sell,
such Capital Stock; provided, however, that the aggregate amount of such
repurchases and other acquisitions made during any fiscal year shall not
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exceed the greater of (a) $5.0 million and (b) the difference between (1)
the product of $5.0 million times the number (which may be a fraction) of
fiscal years elapsed after the Issue Date and (2) the aggregate amount of
such repurchases and other acquisitions made since the Issue Date; provided
further, however, that such repurchases and other acquisitions will be
excluded in the calculation of the amount of Restricted Payments;
(5) repurchases, redemptions or other acquisitions or retirements for
value of Capital Stock of Parent or El Paso Production deemed to occur upon
exercise or exchange of warrants, options or rights to acquire Capital
Stock if such Capital Stock represents a portion of the exercise or
exchange price of such warrants, options or rights, and any repurchases,
redemptions or other acquisitions or retirements for value of Capital Stock
made in lieu of withholding taxes in connection with any exercise or
exchange of warrants, options or rights to acquire Capital Stock; provided,
however, that any payment pursuant to this clause (5) will be excluded in
the calculation of the amount of Restricted Payments;
(6) payments or distributions, directly or indirectly through any
Parent, to dissenting stockholders pursuant to applicable law or in
connection with the settlement or other satisfaction of legal claims made
pursuant to or in connection with a consolidation, merger or transfer of
assets; provided, however, that any payment pursuant to this clause (6)
will be excluded in the calculation of the amount of Restricted Payments;
(7) cash payments in lieu of the issuance of fractional shares;
provided, however, that any payment pursuant to this clause (7) will be
excluded in the calculation of the amount of Restricted Payments;
(8) payments of dividends, distributions or other amounts by us to
fund the payment by Parent or its Affiliates of administrative, legal,
financial, accounting or other similar expenses relating to Parent's direct
or indirect ownership of us and to pay other corporate overhead expenses
relating to such ownership interest, including directors' fees,
indemnifications and similar arrangements, so long as such payments are
fair and reasonable and are paid as and when needed by Parent; provided,
however, that any payment pursuant to this clause (8) will be excluded in
the calculation of the amount of Restricted Payments;
(9) any transfers, advances, loans or other payments by El Paso
Production or any of its Restricted Subsidiaries pursuant to the Cash
Management Program of the Parent and its Subsidiaries, consistent with past
practices; provided, however, (a) no Default or Event of Default shall have
occurred and be continuing at the time of or immediately after giving
effect to any such transfers, advances, loans or other payments and (b)
that any such transfer, advance, loan or other payment pursuant to this
clause (9) will be excluded in the calculation of the amount of Restricted
Payments;
(10) payments to Parent to enable Parent to pay foreign, federal,
state or local tax liabilities ("Tax Payment"), not to exceed the amount of
any tax liabilities that would be otherwise payable by El Paso Production
and its Subsidiaries to the appropriate taxing authorities if each of El
Paso Production and such Subsidiaries filed a separate tax return, to the
extent that Parent has an obligation to pay such tax liabilities relating
to the operations, assets or capital of El Paso Production or its
Subsidiaries; provided, however, that any payment pursuant to this clause
(10) will be excluded in the calculation of the amount of Restricted
Payments;
(11) the grant from time to time by El Paso Production or any
Restricted Subsidiary of any Lien described in clause (24) of the
definition of "Permitted Liens," and any sale, transfer or other
disposition of properties mentioned in such clause (24) made (a) upon or
pursuant to foreclosure of any such Lien (or in lieu of such a foreclosure)
or (b) by a dividend, distribution or other transfer of such properties by
El Paso Production or any of its Restricted Subsidiaries to Parent;
provided, however that any such grant, sale, transfer, disposition,
dividend or distribution will be excluded in the calculation of the amount
of Restricted Payments; and
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(12) other Restricted Payments not in excess of $50 million in the
aggregate since the Issue Date; provided, however, that (a) no Default or
Event of Default shall have occurred and be continuing at the time of or
immediately after giving effect to any such Restricted Payment and (b) any
Restricted Payment made pursuant to this clause (12) will be included in
the calculation of Restricted Payments.
LIMITATION ON RESTRICTIONS ON DISTRIBUTIONS FROM RESTRICTED SUBSIDIARIES
El Paso Production will not, and will not permit any Restricted Subsidiary
to, create or otherwise cause or permit to exist or become effective any
consensual encumbrance or restriction on the ability of any Restricted
Subsidiary to:
(1) pay dividends or make any other distributions on its Capital Stock
to El Paso Production or a Restricted Subsidiary or pay any Indebtedness
owed to El Paso Production; or
(2) make any loans or advances to El Paso Production; or
(3) transfer any of its property or assets to El Paso Production.
However, the preceding restrictions will not apply to the following
encumbrances or restrictions:
(1) with respect to clauses (1), (2) and (3) of the first paragraph of
the covenant:
(A) any encumbrance or restriction pursuant to or by reason of an
agreement in effect at or entered into on the Issue Date;
(B) customary encumbrances and restrictions contained in agreements
of the types described in the definition of "Permitted Business
Investments";
(C) encumbrances and restrictions contained in contracts entered
into in the ordinary course of business, not relating to any
Indebtedness, and that do not, individually or in the aggregate, detract
from the value of, or from the ability of El Paso Production and the
Restricted Subsidiaries to realize the value of, property or assets of
El Paso Production or any Restricted Subsidiary in any manner material
to El Paso Production or any Restricted Subsidiary;
(D) any encumbrance or restriction with respect to a Restricted
Subsidiary pursuant to or by reason of an agreement relating to any
Indebtedness Incurred by such Restricted Subsidiary on or before the
date on which such Restricted Subsidiary was acquired by El Paso
Production (other than Indebtedness Incurred as consideration in, or to
provide all or any portion of the funds or credit support utilized to
consummate, the transaction or series of related transactions pursuant
to which such Restricted Subsidiary became a Restricted Subsidiary or
was acquired by El Paso Production) and outstanding on such date;
(E) with respect to any Subsidiary Guarantor, any encumbrance or
restriction contained in the terms of any Indebtedness or any agreement
or instrument pursuant to which such Indebtedness was Incurred if:
(a) the encumbrance or restriction applies only in the event of
a payment default or a default with respect to a financial covenant
contained in such Indebtedness or agreement;
(b) the encumbrance or restriction is not materially more
disadvantageous to the Holders of the Notes than is customary in
comparable financings (as determined by El Paso Production); and
(c) El Paso Production determines that any such encumbrance or
restriction will not materially affect its ability to make principal
or interest payments on the Notes, as determined in good faith by the
Board of Directors of El Paso Production, whose determination shall
be conclusive;
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(F) with respect to any Foreign Subsidiary, any encumbrance or
restriction contained in the terms of any Indebtedness or any agreement
pursuant to which such Indebtedness was Incurred if:
(a) either (x) the encumbrance or restriction applies only in
the event of a payment default or a default with respect to a
financial covenant in such Indebtedness or agreement or (y) El Paso
Production determines that any such encumbrance or restriction will
not materially affect its ability to make principal or interest
payments on the Notes, as determined in good faith by the Board of
Directors of El Paso Production, whose determination shall be
conclusive; and
(b) the encumbrance or restriction is not materially more
disadvantageous to the Holders of the Notes than is customary in
comparable financing (as determined by El Paso Production);
(G) any encumbrance or restriction pursuant to an agreement
effecting a Refinancing of Indebtedness Incurred pursuant to an
agreement referred to in clauses (A) through (F) of clause (1) of this
paragraph or this clause (G) or contained in any amendment to an
agreement referred to in clauses (A) through (F) of clause (1) of this
paragraph or this clause (G); provided, however, that the encumbrances
and restrictions with respect to such Restricted Subsidiary contained in
any such refinancing agreement or amendment taken as a whole are no less
favorable to the Noteholders than encumbrances and restrictions with
respect to such Restricted Subsidiary contained in such predecessor
agreements;
(H) any encumbrance or restriction with respect to a Restricted
Subsidiary imposed pursuant to an agreement entered into for the sale or
disposition of all or substantially all the Capital Stock or assets of
such Restricted Subsidiary pending the closing of such sale or
disposition; and
(2) with respect to clause (3) only of the first paragraph of the
covenant:
(A) any encumbrance or restriction consisting of customary
nonassignment provisions (including provisions forbidding subletting) in
leases governing leasehold interests or Farm-In Agreements or Farm-Out
Agreements relating to leasehold interests in oil and gas properties to
the extent such provisions restrict the transfer of the lease, the
property leased thereunder or the other interests therein;
(B) any encumbrance or restriction contained in security
agreements, mortgages, purchase money agreements or similar instruments
securing Indebtedness of a Restricted Subsidiary to the extent such
encumbrance or restriction restricts the transfer of the property
subject to such security agreements, mortgages, purchase money
agreements or similar instruments;
(C) any encumbrance or restriction contained in (a) any instrument
giving rise to any Lien described in clause (24) of the definition of
"Permitted Liens" or (b) any instrument giving rise to an obligation
secured by any such Lien, in each case to the extent such encumbrance or
restriction restricts the transfer of the property subject to such Lien;
(D) restrictions on cash or other deposits imposed by customers
under contracts entered into in the ordinary course of business; and
(E) provisions with respect to the disposition or distribution of
assets or property in operating agreements, joint venture agreements,
development agreements, area of mutual interest agreements and other
agreements that are customary in the Oil and Gas Business and entered
into in the ordinary course of business.
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LIMITATION ON SALES OF ASSETS AND SUBSIDIARY STOCK
El Paso Production will not, and will not permit any Restricted Subsidiary
to, directly or indirectly, consummate any Asset Disposition unless:
(1) El Paso Production or such Restricted Subsidiary receives
consideration at the time of such Asset Disposition at least equal to the
fair market value (including as to the value of all non-cash
consideration), as determined in good faith by the Board of Directors, of
the shares and assets subject to such Asset Disposition;
(2) at least 85% of the consideration thereof received by El Paso
Production or such Restricted Subsidiary is in the form of cash or cash
equivalents; and
(3) an amount equal to 100% of the Net Available Cash from such Asset
Disposition is applied by El Paso Production (or such Restricted
Subsidiary, as the case may be):
(A) first, to the extent El Paso Production elects (or is required
by the terms of any Indebtedness), to prepay, repay, redeem or purchase
Senior Indebtedness of El Paso Production or of a Subsidiary Guarantor
or Indebtedness (other than any Disqualified Stock) of any Wholly Owned
Subsidiary that is not a Subsidiary Guarantor (in each case other than
Indebtedness owed to El Paso Production or an Affiliate of El Paso
Production) within one year from the later of the date of such Asset
Disposition or the receipt of such Net Available Cash;
(B) second, to the extent of the balance of such Net Available Cash
after application in accordance with clause (A), to the extent El Paso
Production elects, to acquire or pay for Additional Assets within one
year from the later of the date of such Asset Disposition or the receipt
of such Net Available Cash; and
(C) third, to the extent of the balance of such Net Available Cash
after application in accordance with clauses (A) and (B), to make an
offer to the holders of the Notes (and to holders of other Senior
Indebtedness of El Paso Production or of a Subsidiary Guarantor
designated by El Paso Production) to purchase Notes (and such other
Senior Indebtedness of El Paso Production or of a Subsidiary Guarantor)
pursuant to and subject to the conditions contained in the Indenture;
provided, however, that in connection with any prepayment, repayment or purchase
of Indebtedness pursuant to clause (A) or (C) of this paragraph, El Paso
Production or such Restricted Subsidiary will permanently retire such
Indebtedness and will cause the related loan commitment (if any) to be
permanently reduced in an amount equal to the principal amount so prepaid,
repaid or purchased.
However, El Paso Production and the Restricted Subsidiaries will not be
required to apply any Net Available Cash in accordance with this covenant except
to the extent that the aggregate Net Available Cash from all Asset Dispositions
which is not applied in accordance with this covenant exceeds $25 million.
Pending application of Net Available Cash pursuant to this covenant, such Net
Available Cash will be invested in Temporary Cash Investments or applied to
temporarily reduce revolving credit indebtedness.
For the purposes of this covenant, the following are deemed to be cash or
cash equivalents:
(1) the assumption of Indebtedness of El Paso Production (other than
obligations in respect of Disqualified Stock of El Paso Production) or any
Restricted Subsidiary (other than obligations in respect of Disqualified
Stock or Preferred Stock of a Subsidiary Guarantor) and the release of El
Paso Production or such Restricted Subsidiary from all liability on such
Indebtedness in connection with such Asset Disposition; and
(2) securities received by El Paso Production or any Restricted
Subsidiary from the transferee that are promptly converted by El Paso
Production or such Restricted Subsidiary into cash, to the extent of cash
received in that conversion.
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In lieu of the release described in clause (1) of this paragraph, the acquirer
or its parent company may agree to indemnify and hold El Paso Production or such
Restricted Subsidiary harmless from and against any loss, liability or cost in
respect of such assumed Indebtedness; provided, however, that such indemnifying
party (or its long term debt securities) has both a Moody's rating of Baa3 or
higher and an S&P rating of BBB- or higher (with no indication of a negative
outlook or credit watch with negative implications, in any case, that
contemplates such indemnifying party (or its long term debt securities) failing
to have those ratings) at the time the indemnity is entered into.
The 85% limitation referred to in clause (2) of the first paragraph of this
covenant will be deemed satisfied with respect to any Asset Disposition in which
the cash or cash equivalents portion of the consideration received, determined
in accordance with the foregoing provision on an after-tax basis, is equal to or
greater than what the after-tax proceeds would have been had such Asset
Disposition complied with the 85% limitation.
The requirement of clause (3)(B) of the first paragraph of this covenant
will be deemed to be satisfied if an agreement (including a lease, whether a
capital lease or an operating lease) committing to make the acquisitions or
expenditures referred to therein is entered into by El Paso Production or its
Restricted Subsidiary within the time period specified in clause (3)(B) and such
Net Available Cash is subsequently applied in accordance with such agreement
within six months following such agreement.
If an Asset Disposition requires the purchase of Notes (and other Senior
Indebtedness of El Paso Production or of a Subsidiary Guarantor) pursuant to
clause (3)(C) of the first paragraph of this covenant, El Paso Production will
purchase Notes tendered pursuant to an offer by El Paso Production for the Notes
(and such other Senior Indebtedness) at a purchase price of 100% of their
principal amount (or, if such other Senior Indebtedness of El Paso Production
was issued with significant original issue discount, 100% of the accreted value
thereof) without premium, plus accrued but unpaid interest and liquidated
damages, if any, (or, in respect of such other Senior Indebtedness of El Paso
Production or of a Subsidiary Guarantor, such lesser price, if any, as may be
provided for by the terms of such Senior Indebtedness) in accordance with the
procedures (including prorating in the event of oversubscription) described in
the Indenture. If the aggregate purchase price of the securities tendered
exceeds the Net Available Cash allotted to their purchase, El Paso Production
will select the securities to be purchased on a pro rata basis but in round
denominations, which in the case of the Notes will be denominations of $1,000
principal amount or multiples thereof. El Paso Production will not be required
to make such an offer to purchase Notes (and other Senior Indebtedness of El
Paso Production or of a Subsidiary Guarantor) pursuant to this covenant if the
Net Available Cash available for an offer is less than $100 million (which
lesser amount will be carried forward for purposes of determining whether such
an offer is required with respect to the Net Available Cash from any subsequent
Asset Disposition). Upon completion of such an offer to purchase, Net Available
Cash will be deemed to be reduced by the aggregate amount of such offer.
El Paso Production will comply, to the extent applicable, with the
requirements of Section 14(e) of the Exchange Act and any other securities laws
or regulations in connection with the repurchase of Notes pursuant to this
covenant. To the extent that the provisions of any securities laws or
regulations conflict with provisions of this covenant, El Paso Production will
comply with the applicable securities laws and regulations and will not be
deemed to have breached its obligations under this covenant by virtue of its
compliance with such securities laws or regulations.
LIMITATION ON AFFILIATE TRANSACTIONS
El Paso Production will not, and will not permit any Restricted Subsidiary
to, enter into or permit to exist any transaction (including the purchase, sale,
lease or exchange of any property, employee
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compensation arrangements or the rendering of any service) with, or for the
benefit of, any Affiliate of El Paso Production (an "Affiliate Transaction")
unless:
(1) the terms of the Affiliate Transaction are no less favorable to El
Paso Production or such Restricted Subsidiary than those that could be
obtained at the time of the Affiliate Transaction in arm's-length dealings
with a Person who is not an Affiliate;
(2) if such Affiliate Transaction involves payments or value in excess
of $25 million, the Board of Directors approves such Affiliate Transaction
and determines, in the good faith judgment of the Board of Directors, that
such Affiliate Transaction complies with clause (1) of this paragraph; and
(3) if such Affiliate Transaction involves an amount in excess of $100
million, the Board of Directors shall also have received a written opinion
from an investment banking firm, accounting firm or appraisal firm of
national standing, provided, that such firm is not an Affiliate of El Paso
Production, to the effect that such Affiliate Transaction is fair, from a
financial standpoint, to El Paso Production and its Restricted Subsidiaries
or is not less favorable to El Paso Production and its Restricted
Subsidiaries than could reasonably be expected to be obtained at the time
in an arm's-length transaction with a Person who was not an Affiliate.
The provisions of the first paragraph of this covenant will not prohibit:
(1) any Investment (other than a Permitted Investment) or other
Restricted Payment, in each case permitted to be made pursuant to the
covenant described under "-- Limitation on Restricted Payments";
(2) any issuance of securities, or other payments, awards or grants in
cash, securities or otherwise pursuant to, or the funding of, employment or
severance arrangements, stock options and stock ownership, phantom stock or
other incentive compensation plans approved by the Board of Directors;
(3) loans or advances to employees in the ordinary course of business
in accordance with the past practices of El Paso Production or its
Restricted Subsidiaries, but in any event not to exceed $5.0 million in the
aggregate outstanding at any one time;
(4) the payment of reasonable fees to directors of El Paso Production
and its Restricted Subsidiaries;
(5) any transaction with a Restricted Subsidiary or joint venture or
similar entity which would constitute an Affiliate Transaction solely
because El Paso Production or a Restricted Subsidiary owns, directly or
indirectly, an equity interest in or otherwise controls such Restricted
Subsidiary, joint venture or similar entity;
(6) the issuance or sale of any Capital Stock (other than Disqualified
Stock) of El Paso Production or the receipt by El Paso Production of any
capital contribution from its shareholders;
(7) indemnities of officers, directors and employees of El Paso
Production or any of its Restricted Subsidiaries permitted by bylaw or
statutory provisions and any employment agreement or other employee
compensation plan or arrangement entered into in the ordinary course of
business by El Paso Production or any of its Restricted Subsidiaries;
(8) the grant from time to time by El Paso Production or any
Restricted Subsidiary of any Lien described in clause (24) of the
definition of "Permitted Liens," and any sale, transfer or other
disposition of properties mentioned in such clause (24) made (A) upon or
pursuant to foreclosure of any such Lien (or in lieu of such a foreclosure)
or (B) by a dividend or distribution of such properties by El Paso
Production or any of its Restricted Subsidiaries to Parent; and
(9) transactions and arrangements in effect on the Issue Date,
including any modifications, extensions or renewals of those transactions
and arrangements or payments or repayments pursuant to
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those transactions and arrangements that do not adversely affect El Paso
Production and its Restricted Subsidiaries, considered as a single
enterprise.
LIMITATION ON LINE OF BUSINESS
El Paso Production will not, and will not permit any Restricted Subsidiary
to, engage in any business other than a Related Business.
LIMITATION ON LIENS
El Paso Production will not, and will not permit any Restricted Subsidiary
to, directly or indirectly, Incur or permit to exist any Lien (the "Initial
Lien") of any nature whatsoever on any of its properties (including Capital
Stock of a Restricted Subsidiary), whether owned at the Issue Date or thereafter
acquired, securing any Indebtedness, other than Permitted Liens, without
effectively providing that the Notes shall be secured equally and ratably with
(or prior to) the obligations so secured for so long as such obligations are so
secured.
Any Lien created for the benefit of the Holders of the Notes pursuant to
the preceding sentence will provide by its terms that such Lien will be
automatically and unconditionally released and discharged upon the release and
discharge of the Initial Lien.
LIMITATION ON SALE/LEASEBACK TRANSACTIONS
El Paso Production will not, and will not permit any Restricted Subsidiary
to, enter into any Sale/ Leaseback Transaction with respect to any property
unless:
(1) El Paso Production or such Restricted Subsidiary would be entitled
to (A) Incur Indebtedness in an amount equal to the Attributable Debt with
respect to such Sale/Leaseback Transaction pursuant to the covenant
described under "-- Limitation on Indebtedness" and (B) create a Lien on
such property securing such Attributable Debt without equally and ratably
securing the Notes pursuant to the covenant described under "-- Limitation
on Liens";
(2) the net proceeds received by El Paso Production or any Restricted
Subsidiary in connection with such Sale/Leaseback Transaction are at least
equal to the fair value (as determined by the Board of Directors) of such
property; and
(3) El Paso Production applies the proceeds of such transaction in
compliance with the covenant described under "-- Limitation on Sale of
Assets and Subsidiary Stock."
FUTURE GUARANTORS
El Paso Production will cause each Domestic Restricted Subsidiary that
Incurs any Indebtedness to, at the same time, execute and deliver to the Trustee
a Guarantee Agreement pursuant to which such Restricted Subsidiary will
Guarantee payment of the Notes on the same terms and conditions set forth in the
Indenture.
MERGER AND CONSOLIDATION
El Paso Production will not consolidate with or merge with or into, or
convey, transfer or lease, in one transaction or a series of transactions,
directly or indirectly, all or substantially all its assets to, any Person,
unless:
(1) the resulting, surviving or transferee Person (the "Successor
Company") shall be a Person organized and existing under the laws of the
United States of America, any State thereof or the District of Columbia and
the Successor Company (if other than El Paso Production) shall expressly
assume, by an indenture supplemental thereto, executed and delivered to the
Trustee, in form satisfactory to the Trustee, all the obligations of El
Paso Production under the Notes and the Indenture;
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(2) immediately after giving pro forma effect to such transaction (and
treating any Indebtedness which becomes an obligation of the Successor
Company or any Subsidiary as a result of such transaction as having been
Incurred by such Successor Company or such Subsidiary at the time of such
transaction), no Default shall have occurred and be continuing;
(3) immediately after giving pro forma effect to such transaction, the
Successor Company would be able to Incur an additional $1.00 of
Indebtedness pursuant to the first paragraph of the covenant described
under "-- Limitation on Indebtedness"; provided, however, that this clause
(3) will not be applicable to (A) a Restricted Subsidiary consolidating
with, merging into or transferring all or part of its properties and assets
to El Paso Production or (B) El Paso Production merging with an Affiliate
solely for the purpose and with the sole effect of reincorporating El Paso
Production in another jurisdiction;
(4) El Paso Production shall have delivered to the Trustee an
Officers' Certificate and an Opinion of Counsel, each stating that such
consolidation, merger or transfer and such supplemental indenture (if any)
comply with the Indenture; and
(5) El Paso Production shall have delivered to the Trustee an Opinion
of Counsel to the effect that the Holders will not recognize income, gain
or loss for Federal income tax purposes as a result of such transaction and
will be subject to Federal income tax on the same amounts, in the same
manner and at the same times as would have been the case if such
transaction had not occurred.
For purposes of this covenant, the sale, lease, conveyance, assignment,
transfer or other disposition of all or substantially all of the properties and
assets of one or more Subsidiaries of El Paso Production, which properties and
assets, if held by El Paso Production instead of such Subsidiaries, would
constitute all or substantially all of the properties and assets of El Paso
Production on a consolidated basis, will be deemed to be the transfer of all or
substantially all of the properties and assets of El Paso Production.
The Successor Company will be the successor to El Paso Production and will
succeed to, and be substituted for, and may exercise every right and power of,
El Paso Production under the Indenture, and the predecessor Company, except in
the case of a lease, will be released from the obligation to pay the principal
of and interest on the Notes.
El Paso Production will not permit any Subsidiary Guarantor to consolidate
with or merge with or into, or convey, transfer or lease, in one transaction or
a series of transactions, all or substantially all of its assets to any Person
unless:
(1) (except in the case of a Subsidiary Guarantor that has been
disposed of in its entirety to another Person (other than to El Paso
Production or an Affiliate of El Paso Production), whether through a
merger, consolidation or sale of Capital Stock or assets, if in connection
therewith El Paso Production provides an Officers' Certificate to the
Trustee to the effect that El Paso Production will comply with its
obligations under the covenant described under "-- Limitation on Sales of
Assets and Subsidiary Stock" in respect of such disposition), the
resulting, surviving or transferee Person (if not such Subsidiary) shall be
a Person organized and existing under the laws of the jurisdiction under
which such Subsidiary was organized or under the laws of the United States
of America, or any State thereof or the District of Columbia, and such
Person shall expressly assume, by a Guarantee Agreement, in a form
satisfactory to the Trustee, all the obligations of such Subsidiary, if
any, under its Subsidiary Guarantee;
(2) immediately after giving effect to such transaction or
transactions on a pro forma basis (and treating any Indebtedness which
becomes an obligation of the resulting, surviving or transferee Person as a
result of such transaction as having been issued by such Person at the time
of such transaction), no Default shall have occurred and be continuing; and
(3) El Paso Production delivers to the Trustee an Officers'
Certificate and an Opinion of Counsel, each stating that such
consolidation, merger or transfer and such Guarantee Agreement, if any,
complies with the Indenture.
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SEC REPORTS
Whether or not required by the SEC's rules and regulations, El Paso
Production will file with the SEC (to the extent the SEC has adopted rules
expressly providing that it will accept such filings) and in any event will
provide the Trustee and Noteholders with the annual reports and the information,
documents and other reports specified in Sections 13 and 15(d) of the Exchange
Act and applicable to a U.S. corporation subject to such Sections. El Paso
Production will file and provide such information, documents and other reports
at the times specified for the filings of such information, documents and
reports under Sections 13 and 15(d) of the Exchange Act.
If any of El Paso Production's Subsidiaries are Unrestricted Subsidiaries,
then the quarterly and annual financial information required by the preceding
paragraph will include a reasonably detailed presentation, either on the face of
the financial statements or in the footnotes thereto, and in "Management's
Discussion and Analysis of Financial Condition and Results of Operations", of
the financial condition and results of operations of El Paso Production and its
Restricted Subsidiaries separate from the financial condition and results of
operations of the Unrestricted Subsidiaries of El Paso Production.
In addition, El Paso Production will furnish to the Holders of the Notes
and to prospective investors, upon the requests of such Holders, any information
required to be delivered pursuant to Rule 144A(d)(4) under the Securities Act so
long as the Notes are not freely transferable under the Securities Act.
USE OF PROCEEDS
Notwithstanding any other provision of the Indenture to the contrary, the
use of proceeds of the issuance of the Notes on the Issue Date, as described in
this prospectus, and the transactions reasonably necessary to or related to such
use of proceeds, will not be prohibited by any provision of the Indenture.
DEFAULTS
Each of the following is an Event of Default:
(1) a default in the payment of interest or liquidated damages, if
any, on the Notes when due, continued for 30 days;
(2) a default in the payment of principal of any Note when due at its
Stated Maturity, upon optional redemption, upon declaration of acceleration
or otherwise;
(3) the failure by El Paso Production to comply with its obligations
under "-- Covenants -- Merger and Consolidation" above or to consummate a
purchase of Notes when required pursuant to the covenants described above
under "-- Change of Control" or "-- Covenants -- Limitation on Sales of
Assets and Subsidiary Stock";
(4) the failure by El Paso Production to comply for 30 days after
receipt of written notice with any of its obligations in the covenants
described above under:
(A) "-- Change of Control" (other than a failure to purchase
Notes); or
(B) "-- Covenants" under:
- "-- Limitation on Indebtedness",
- "-- Limitation on Advances under Parent's Cash Management
Program",
- "-- Limitation on Restricted Payments",
- "-- Limitation on Restrictions on Distributions from
Restricted Subsidiaries",
- "-- Limitation on Sales of Assets and Subsidiary Stock" (other
than a failure to purchase Notes),
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- "-- Limitation on Affiliate Transactions",
- "-- Limitation on Line of Business",
- "-- Limitation on Liens",
- "-- Limitation on Sale/Leaseback Transactions",
- "-- Future Guarantors" or
- "-- SEC Reports";
(5) the failure by El Paso Production or any Subsidiary Guarantor to
comply for 60 days after notice with its other agreements contained in the
Indenture;
(6) (A) Indebtedness of El Paso Production, any Subsidiary Guarantor
or any Significant Subsidiary (x) is not paid within any applicable grace
period after final maturity, and such defaulted payment shall not have been
made, waived or extended within 10 days of such payment default or (y) is
accelerated by the holders thereof because of a default, and such
Indebtedness has not been discharged in full or such acceleration has not
been rescinded or annulled within 10 days of such acceleration; and
(B) the total amount of such Indebtedness unpaid or accelerated
exceeds $25 million (the "cross acceleration provision");
(7) certain events of bankruptcy, insolvency or reorganization of El
Paso Production, a Subsidiary Guarantor or any Significant Subsidiary (the
"bankruptcy provisions");
(8) any final judgment or decree (to the extent not covered by
insurance) for the payment of money in excess of $100 million is entered
against El Paso Production, a Subsidiary Guarantor or any Significant
Subsidiary, and is not paid or discharged, and there is any period of 60
consecutive days following entry of such final judgment or decree during
which a stay of enforcement of such final judgment or decree, by reason of
pending appeal or otherwise, is not in effect (the "judgment default
provision"); provided, however, that if any such final judgment or decree
described above requires the payment by El Paso Production, a Subsidiary
Guarantor or a Significant Subsidiary of money in excess of $100 million,
which payment(s) are to be made over a stipulated future period after the
date of such final judgment or decree or upon or following the future
occurrence of specified events, an Event of Default shall not occur under
this clause (8), unless (A) any such payment is not made within 60 days of
its due date and (B) such amount that is not paid within 60 days of its due
date, together with any other amounts in respect of such judgment or decree
that have become due and payable, including as a result of such nonpayment
discussed in clause (A), and have not been paid, exceeds $100 million; or
(9) a Subsidiary Guarantee ceases to be in full force and effect
(other than in accordance with the terms of such Subsidiary Guarantee as
set forth in the Indenture) or a Subsidiary Guarantor denies or disaffirms
its obligations under its Subsidiary Guarantee.
However, a default under clauses (4) and (5) will not constitute an Event of
Default until the Trustee or the holders of 25% in principal amount of the
outstanding Notes notify El Paso Production in writing of the default and El
Paso Production does not cure such default within the time specified after
receipt of such notice.
If an Event of Default occurs and is continuing, the Trustee or the holders
of at least 25% in principal amount of the outstanding Notes may declare the
principal of and accrued but unpaid interest and liquidated damages, if any, on
all the Notes to be due and payable. Upon such a declaration, such principal and
interest and liquidated damages, if any, will be due and payable immediately. If
an Event of Default relating to certain events of bankruptcy, insolvency or
reorganization of El Paso Production occurs and is continuing, the principal of
and interest and liquidated damages, if any, on all the Notes will ipso facto
become and be immediately due and payable without any declaration or other act
on the part of the
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Trustee or any holders of the Notes. Under certain circumstances, the holders of
a majority in principal amount of the outstanding Notes may rescind any such
acceleration with respect to the Notes and its consequences.
Subject to the provisions of the Indenture relating to the duties of the
Trustee, in case an Event of Default occurs and is continuing, the Trustee will
be under no obligation to exercise any of the rights or powers under the
Indenture at the request or direction of any of the holders of the Notes unless
such holders have offered to the Trustee reasonable indemnity or security
against any loss, liability or expense. Except to enforce the right to receive
payment of principal, premium (if any) or interest when due, no holder of a Note
may pursue any remedy with respect to the Indenture or the Notes unless:
(1) such holder has previously given the Trustee notice that an Event
of Default is continuing;
(2) holders of at least 25% in principal amount of the outstanding
Notes have requested the Trustee to pursue the remedy;
(3) such holders have offered the Trustee reasonable security or
indemnity against any loss, liability or expense;
(4) the Trustee has not complied with such request within 60 days
after the receipt thereof and the offer of security or indemnity; and
(5) holders of a majority in principal amount of the outstanding Notes
have not given the Trustee a direction inconsistent with such request
within such 60-day period.
Subject to restrictions set forth in the indenture, the holders of a majority in
principal amount of the outstanding Notes are given the right to direct the
time, method and place of conducting any proceeding for any remedy available to
the Trustee or of exercising any trust or power conferred on the Trustee. The
Trustee, however, may refuse to follow any direction that conflicts with law or
the Indenture or that the Trustee determines is unduly prejudicial to the rights
of any other holder of a Note or that would involve the Trustee in personal
liability.
If a Default occurs, is continuing and is known to the Trustee, the Trustee
must mail to each holder of the Notes notice of the Default within 90 days after
it occurs. Except in the case of a Default in the payment of principal of or
interest or liquidated damages, if any, on any Note, the Trustee may withhold
notice if and so long as a committee of its Trust Officers determines that
withholding notice is not opposed to the interest of the holders of the Notes.
In addition, we are required to deliver to the Trustee, within 120 days after
the end of each fiscal year, a certificate indicating whether the signers
thereof know of any Default that occurred during the previous year. We are
required to deliver to the Trustee, within 30 days after the occurrence thereof,
written notice of any event which would constitute certain Defaults, their
status and what action we are taking or propose to take in respect thereof.
AMENDMENTS AND WAIVERS
Except as described in the next three paragraphs, the Indenture may be
amended with the consent of the holders of a majority in principal amount of the
Notes then outstanding (including consents obtained in connection with a tender
offer or exchange for the Notes) and any past default or compliance with any
provisions may also be waived with the consent of the holders of a majority in
principal amount of the Notes then outstanding.
However, without the consent of each holder of an outstanding Note affected
thereby, an amendment or waiver may not, among other things:
(1) reduce the amount of Notes whose holders must consent to an
amendment;
(2) reduce the rate of or extend the time for payment of interest on
any Note;
(3) reduce the principal of or change the Stated Maturity of any Note;
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(4) reduce the amount payable upon the redemption of any Note or
change the time at which any Note may be redeemed as described under
"-- Optional Redemption" above; provided, however, that for the avoidance
of doubt, redemption will not be deemed to include any purchase or
repurchase of Notes;
(5) make any Note payable in money other than that stated in the Note;
(6) impair the right of any holder of the Notes to receive payment of
principal of and interest on such holder's Notes on or after the due dates
therefor or to institute suit for the enforcement of any payment on or with
respect to such holder's Notes;
(7) make any change in the amendment provisions which require each
holder's consent or in the waiver provisions;
(8) make any change in the ranking or priority of any Note that would
adversely affect the Noteholders; or
(9) make any change in, or release other than in accordance with the
Indenture, any Subsidiary Guarantee that would adversely affect the
Noteholders.
Notwithstanding the preceding, without the consent of any holder of the
Notes, El Paso Production, the Subsidiary Guarantors and Trustee may amend the
Indenture:
(1) to cure any ambiguity, omission, defect or inconsistency;
(2) to provide for the assumption by a successor corporation of the
obligations of El Paso Production, or any Subsidiary Guarantor under the
Indenture;
(3) to provide for uncertificated Notes in addition to or in place of
certificated Notes (provided that the uncertificated Notes are issued in
registered form for purposes of Section 163(f) of the Internal Revenue Code
of 1986, as amended, or in a manner such that the uncertificated Notes are
described in Section 163(f)(2)(B) of the Internal Revenue Code of 1986, as
amended);
(4) to add Guarantees with respect to the Notes, including any
Subsidiary Guarantees, or to secure the Notes or any Guarantees;
(5) to effect the release of a Subsidiary Guarantor from its
Subsidiary Guarantee and the termination of such Subsidiary Guarantee, all
in accordance with the provision of the Indenture governing such release
and termination;
(6) to add to the covenants of El Paso Production or a Subsidiary
Guarantor for the benefit of the holders of the Notes or to surrender any
right or power conferred upon El Paso Production or a Subsidiary Guarantor;
(7) to make any change that does not adversely affect the rights of
any holder of the Notes; or
(8) to comply with any requirement of the SEC in connection with the
qualification of the Indenture under the Trust Indenture Act.
The consent of the holders of the Notes is not necessary under the
Indenture to approve the particular form of any proposed amendment. It is
sufficient if such consent approves the substance of the proposed amendment.
After an amendment under the Indenture becomes effective, we are required
to mail to holders of the Notes a notice briefly describing such amendment.
However, the failure to give such notice to all holders of the Notes, or any
defect therein, will not impair or affect the validity of the amendment.
TRANSFER
The Notes will be issued in registered form and will be transferable only
upon the surrender of the Notes being transferred for registration of transfer.
We may require payment of a sum sufficient to cover
105
any tax, assessment or other governmental charge payable in connection with
certain transfers and exchanges.
DEFEASANCE
At any time, we may terminate all our obligations under the Notes and the
Indenture ("legal defeasance"), except for certain obligations, including those
respecting the defeasance trust and obligations to register the transfer or
exchange of the Notes, to replace mutilated, destroyed, lost or stolen Notes and
to maintain a registrar and paying agent in respect of the Notes.
In addition, at any time we may terminate:
- our obligations under "-- Change of Control" and under the covenants
described under "-- Covenants" (other than the covenant described under
"-- Merger and Consolidation");
- the operation of the cross acceleration provision, the bankruptcy
provisions with respect to Subsidiary Guarantors and Significant
Subsidiaries and the judgment default provision described under
"-- Defaults" above; and
- the limitations contained in clause (3) of the first paragraph under
"-- Covenants -- Merger and Consolidation" above.
This termination is referred to as "covenant defeasance."
We may exercise our legal defeasance option notwithstanding our prior
exercise of our covenant defeasance option. If we exercise our legal defeasance
option, payment of the Notes may not be accelerated because of an Event of
Default with respect to the Notes. If we exercise our covenant defeasance
option, payment of the Notes may not be accelerated because of an Event of
Default specified in clause (4), (6), (7) (with respect only to Significant
Subsidiaries and Subsidiary Guarantors) or (8) under "-- Defaults" above or
because of the failure of El Paso Production to comply with clause (3) of the
first paragraph under "-- Covenants -- Merger and Consolidation" above. If we
exercise our legal defeasance option or our covenant defeasance option, each
Subsidiary Guarantor will be released from all of its obligations with respect
to its Subsidiary Guarantee.
In order to exercise either of our defeasance options, we must irrevocably
deposit in trust (the "defeasance trust") with the Trustee money or U.S.
Government Obligations for the payment of principal and interest on the Notes to
redemption or maturity, as the case may be. In addition, we must also comply
with other specified conditions, including delivery to the Trustee of an Opinion
of Counsel to the effect that holders of the Notes will not recognize income,
gain or loss for Federal income tax purposes as a result of such deposit and
defeasance and will be subject to Federal income tax on the same amounts and in
the same manner and at the same times as would have been the case if such
deposit and defeasance had not occurred (and, in the case of legal defeasance
only, such Opinion of Counsel must be based on a ruling of the Internal Revenue
Service or other change in applicable Federal income tax law).
SATISFACTION AND DISCHARGE
The Indenture will be discharged and will cease to be of further effect
(except as to surviving rights of registration of transfer or exchange of Notes)
as to all outstanding Notes when either:
(1) all such Notes that have been authorized and delivered (except
lost, stolen or destroyed Notes which have been replaced or paid and Notes
for whose payment money has been deposited in trust or segregated and held
in trust by El Paso Production and thereafter repaid to El Paso Production
or discharged from such trust) have been delivered to the Trustee for
cancellation; or
(2) (A) El Paso Production shall have given irrevocable and
unconditional notice of redemption for all of the outstanding Notes within
60 days of such Notes pursuant to the redemption provisions of the
Indenture or all Notes that have not been delivered to the Trustee for
cancellation otherwise have become due and payable, and El Paso Production
has irrevocably deposited or caused to be
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deposited with the Trustee as trust funds in the trust for such purpose an
amount of money sufficient to pay and discharge the entire indebtedness on
the Notes that have not been delivered to the Trustee for cancellation, for
principal, premium, if any, and accrued interest;
(B) El Paso Production has paid all sums payable by it under the
Indenture;
(C) El Paso Production has delivered irrevocable instructions to
the Trustee to apply the deposited money toward the payment of the Notes
at maturity or the redemption date, as the case may be, and
(D) the holders of the Notes have a valid, perfected, exclusive
security interest in such trust.
In addition, El Paso Production must deliver an Officers' Certificate and an
Opinion of Counsel stating that all conditions precedent to satisfaction and
discharge have been complied with.
CONCERNING THE TRUSTEE
Wilmington Trust Company is to be the Trustee under the Indenture. We have
appointed Wilmington Trust Company as Registrar and Paying Agent with regard to
the Notes.
If the Trustee becomes a creditor of El Paso Production or a Subsidiary
Guarantor, the Indenture limits the rights of the Trustee to obtain payment of
claims in certain cases, or to realize on certain property received in respect
of any such claim as security or otherwise. The Trustee will be permitted to
engage in other transactions; however, if it acquires any conflicting interest
it must either eliminate such conflict within 90 days, apply to the SEC for
permission to continue or resign.
The Holders of a majority in principal amount of the outstanding Notes will
have the right to direct the time, method and place of conducting any proceeding
for exercising any remedy available to the Trustee, subject to certain
exceptions. If an Event of Default occurs (and is not cured), the Trustee will
be required, in the exercise of its power, to use the degree of care of a
prudent man in the conduct of his own affairs. Subject to such provisions, the
Trustee will be under no obligation to exercise any of its rights or powers
under the Indenture at the request of any Holder of Notes, unless such Holder
shall have offered to the Trustee security and indemnity satisfactory to it
against any loss, liability or expense and then only to the extent required by
the terms of the Indenture.
NO PERSONAL LIABILITY OF DIRECTORS, OFFICERS, EMPLOYEES AND STOCKHOLDERS
No director, officer, employee, incorporator or stockholder of El Paso
Production or any Subsidiary Guarantor will have any liability for any
obligations of El Paso Production or any Subsidiary Guarantor under the Notes,
any Subsidiary Guarantee or the Indenture or for any claim based on, in respect
of, or by reason of such obligations or their creation. Each Holder of the Notes
by accepting a Note waives and releases all such liability. The waiver and
release are part of the consideration for issuance of the Notes. The waiver and
release may not be effective to waive liabilities under the U.S. Federal
securities laws, and it is the view of the SEC that such a waiver is against
public policy.
GOVERNING LAW
The Indenture and the Notes will be governed by, and construed in
accordance with, the laws of the State of New York.
DEFINITIONS
"Additional Assets" means:
(1) any asset used in a Related Business, including capital
expenditures;
(2) the Capital Stock of a Person that becomes a Restricted Subsidiary
as a result of the acquisition of such Capital Stock by El Paso Production
or another Restricted Subsidiary;
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(3) Capital Stock constituting a minority interest in any Person that
at such time is a Restricted Subsidiary; or
(4) any Permitted Business Investment
provided, however, that any such Restricted Subsidiary described in clause (2)
or (3) above is primarily engaged in a Related Business.
"Adjusted Consolidated Net Tangible Assets" or "ACNTA" of a Person means
(without duplication), as of the date of termination:
(a) the sum of:
(1) discounted future net revenue from proved crude oil and natural
gas reserves of such Person and its Restricted Subsidiaries calculated
in accordance with SEC guidelines before any state or federal income
taxes, as estimated in a reserve report prepared as of the end of the
fiscal year ending at least 45 days prior to the date of determination,
which reserve report is prepared or audited or reviewed by independent
petroleum engineers, as increased by, as of the date of determination,
the discounted future net revenue of:
(A) estimated proved crude oil and natural gas reserves of such
Person and its Restricted Subsidiaries attributable to acquisitions
consummated, or constituting reserves contributed to such Person or
any of its Restricted Subsidiaries since the date of such reserve
report, and
(B) estimated crude oil and natural gas reserves of such Person
and its Restricted Subsidiaries attributable to extensions,
discoveries and other additions and upward determinations of
estimates of proved crude oil and natural gas reserves (including
previously estimated development costs Incurred during the period and
the accretion of discount since the prior period end) due to
exploration, development or exploitation, production or other
activities which reserves were not reflected in such reserve report
which would, in accordance with standard industry practice, result in
such determinations, in each case calculated in accordance with SEC
guidelines (utilizing the prices utilized in such year-end reserve
report),
and decreased by, as of the date of determination, the discounted future
net revenue attributable to:
(C) estimated proved crude oil and natural gas reserves of such
Person and its Restricted Subsidiaries reflected in such reserve
report produced or disposed of since the date of such reserve report,
and
(D) reductions in the estimated oil and natural gas reserves of
such Person and its Restricted Subsidiaries reflected in such reserve
report since the date of such reserve report attributable to downward
determinations of estimates of proved crude oil and natural gas
reserves due to exploration, development or exploitation, production
or other activities conducted or otherwise occurring since the date
of such reserve report which would, in accordance with standard
industry practice, result in such determinations, in each case
calculated in accordance with SEC guidelines (utilizing the prices
utilized in such reserve report);
provided, however, that, in the case of each of the determinations made
pursuant to clauses (A) through (D), such increases and decreases will
be estimated by El Paso Production's engineers, except that if as a
result of such acquisitions, dispositions, discoveries, extensions or
revisions, there is a Material Change, then such increases and decreases
in the discounted future net revenue will be reviewed and confirmed in
writing by an independent petroleum engineer;
(2) the capitalized costs that are attributable to crude oil and
natural gas properties of such Person and its Restricted Subsidiaries to
which no proved crude oil and natural gas reserves are
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attributed, based on such Person's books and records as of a date no
earlier than the most recent fiscal quarter for which financial
information is publicly available;
(3) the Net Working Capital of such Person as of the end of the
most recent fiscal quarter for which financial information is publicly
available; and
(4) the greater of (A) the net book value as of the date no earlier
than the most recent fiscal quarter for which financial information is
publicly available and (B) the appraised value, as estimated by
independent appraisers, of other tangible assets of such Person and its
Restricted Subsidiaries as of a date no earlier than the most recent
fiscal year for which financial information is publicly available
(provided that such Person will not be required to obtain such an
appraisal of such assets if no such appraisal has been performed); minus
(b) to the extent not otherwise taken into account in the immediately
preceding clause (a), the sum of:
(1) minority interests;
(2) any net natural gas balancing liabilities of such Person and
its Restricted Subsidiaries reflected in such Person's latest audited
financial statements;
(3) the discounted future net revenue, calculated in accordance
with SEC guidelines (using the same prices used in such Person's
year-end reserve report), attributable to reserves subject to
participation interests, overriding royalty interests or other interests
of third parties, pursuant to participation, partnership, vendor
financing or other agreements then in effect, or which otherwise are
required to be delivered to third parties;
(4) the discounted future net revenue calculated in accordance with
SEC guidelines (using the same prices used in such Person's year-end
reserve report), attributable to reserves that are required to be
delivered to third parties to fully satisfy the obligations of such
Person and its Restricted Subsidiaries with respect to Volumetric
Production Payments on the schedules specified with respect thereto; and
(5) the discounted future net revenue, calculated in accordance
with SEC guidelines, attributable to reserves subject to
Dollar-Denominated Production Payments that, based on the estimates of
production included in determining the discounted future net revenue
specified in the immediately preceding clause (a)(1) (using the same
prices used in such Person's year-end reserve report), would be
necessary to satisfy fully the obligations of such Person and its
Restricted Subsidiaries with respect to Dollar-Denominated Production
Payments on the schedules specified with respect thereto.
If El Paso Production changes its method of accounting from the full costs
method to the successful efforts method or a similar method of accounting,
"ACNTA" will continue to be calculated as if El Paso Production were still using
the full costs method of accounting.
"Affiliate" of any specified Person means any other Person, directly or
indirectly, controlling or controlled by or under direct or indirect common
control with such specified Person. For the purposes of this definition,
"control" when used with respect to any Person means the power to direct the
management and policies of such Person, directly or indirectly, whether through
the ownership of voting securities, by contract or otherwise. The terms
"controlling" and "controlled" have meanings correlative to the foregoing. For
purposes of the covenants described under "-- Covenants -- Limitation on
Restricted Payments", "-- Covenants -- Limitation on Affiliate Transactions" and
"-- Covenants -- Limitation on Sales of Assets and Subsidiary Stock" only,
"Affiliate" shall also mean any beneficial owner of Capital Stock representing
10% or more of the total voting power of the Voting Stock (on a fully diluted
basis) of El Paso Production or of rights or warrants to purchase such Capital
Stock (whether or not currently exercisable) and any Person who would be an
Affiliate of any such beneficial owner pursuant to the first sentence hereof.
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"Asset Disposition" means any sale, lease, transfer or other disposition
(or series of related sales, leases, transfers or dispositions) by El Paso
Production or any Restricted Subsidiary, including any disposition by means of a
merger, consolidation or similar transaction (each referred to for the purposes
of this definition as a "disposition"), of:
(1) any shares of Capital Stock of a Restricted Subsidiary (other than
directors' qualifying shares or shares required by applicable law to be
held by a Person other than El Paso Production or a Restricted Subsidiary);
(2) all or substantially all the assets of any division or line of
business of El Paso Production or any Restricted Subsidiary; or
(3) any other assets of El Paso Production or any Restricted
Subsidiary outside of the ordinary course of business of El Paso Production
or such Restricted Subsidiary.
Notwithstanding the preceding paragraph, "Asset Disposition" will not include
any transaction (or any component of any transaction) described below:
(1) a disposition by a Restricted Subsidiary to El Paso Production or
by El Paso Production or a Restricted Subsidiary to a Wholly Owned
Subsidiary;
(2) for purposes of the covenant described under
"-- Covenants -- Limitation on Sales of Assets and Subsidiary Stock" only,
(a) a disposition that constitutes a Restricted Payment (or would
constitute a Restricted Payment but for the exclusions from the definition
thereof) and that is not prohibited by the covenant described under
"-- Covenants -- Limitation on Restricted Payments" or that constitutes a
Permitted Investment and (b) a disposition of all or substantially all the
assets of El Paso Production in accordance with the covenant described
under "-- Covenants -- Merger and Consolidation";
(3) the trade or exchange by El Paso Production or any Restricted
Subsidiary of any oil or natural gas property or interest therein of El
Paso Production or such Restricted Subsidiary for any oil or natural gas
property or interest therein of another Person, including any cash or cash
equivalents necessary in order to achieve an exchange of equivalent value;
provided, however, that the value of the oil or natural gas property or
interest therein received by El Paso Production or any Restricted
Subsidiary in such trade or exchange (including any cash or cash
equivalents) is at least equal to the fair market value (as determined in
good faith by the Board of Directors, an Officer or an officer of such
Restricted Subsidiary with responsibility for such transaction, which
determination will be conclusive evidence of compliance with this
provision) of the oil or natural gas property or interest therein
(including any cash or cash equivalents) so traded or exchanged;
(4) the consummation of any Permitted Business Investment;
(5) the creation of any Permitted Lien;
(6) a disposition of oil and natural gas properties in connection with
tax credit transactions complying with Section 29 or any successor or
analogous provisions of the Internal Revenue Code of 1986, as amended;
(7) surrender or waiver of contract rights, oil and gas leases, or the
settlement, release or surrender of contract, tort or other claims of any
kind;
(8) any disposition of defaulted receivables that arose in the
ordinary course of business for collection;
(9) the grant to a vendor or its assignee of an overriding royalty
interest, net profits interest or similar interest in production in
connection with the Vendor Program;
(10) any sale, assignment, lease, license, transfer, abandonment or
other disposition of (a) damaged, worn-out, unserviceable or other obsolete
property or (b) other property no longer necessary for the proper conduct
of the business of El Paso Production or any of its Subsidiaries;
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(11) any sale, assignment, transfer or other disposition of oil and
gas for properties having an SEC PV-10 Value as of the end of the calendar
year preceding the date of such sale, assignment, transfer or other
disposition of up to, together with the SEC PV-10 Value of all other oil
and gas properties of El Paso Production and its Restricted Subsidiaries
sold, assigned, transferred or otherwise disposed of since the Issue Date
in reliance on this clause (11), $200 million, which sale, assignment,
transfer or other disposition is made (a) upon or pursuant to foreclosure
of the Lien permitted by clause (24) of the definition of Permitted Lien
(or in lieu of such a foreclosure) or (b) by a dividend, distribution or
other transfer of such properties by El Paso Production and its Restricted
Subsidiaries to Parent; and
(12) a disposition of assets with a fair market value of less than
$10.0 million.
"Attributable Debt" in respect of a Sale/Leaseback Transaction means, as at
the time of determination, (1) if such sale/leaseback Transaction does not
result in a Capital Lease Obligation, the amount of Indebtedness represented
thereby shall be the present value (discounted at the interest rate borne by the
Notes, compounded annually) of the total obligations of the lessee for rental
payments during the remaining term of the lease included in such Sale/Leaseback
Transaction (including any period for which such lease has been extended) and
(2) if such Sale/Leaseback Transaction results in a Capital Lease Obligation,
the amount of Indebtedness represented thereby will be determined in accordance
with the definition of "Capital Lease Obligation."
"Average Life" means, as of the date of determination, with respect to any
Indebtedness, the quotient obtained by dividing:
(1) the sum of the products of the numbers of years from the date of
determination to the dates of each successive scheduled principal payment
of or redemption or similar payment with respect to such Indebtedness
multiplied by the amount of such payment by
(2) the sum of all such payments.
"Board of Directors" means the Board of Directors of El Paso Production or
any committee thereof duly authorized to act on behalf of such Board.
"Business Day" means each day other than a Saturday, a Sunday or a day on
which banking institutions are not required to be open in the State of New York.
"Capital Lease Obligation" means an obligation that is required to be
classified and accounted for as a capital lease for financial reporting purposes
in accordance with GAAP, and the amount of Indebtedness represented by such
obligation will be the capitalized amount of such obligation determined in
accordance with GAAP. The Stated Maturity of a Capital Lease Obligation will be
the date of the last payment of rent or any other amount due under such lease
prior to the first date upon which such lease may be terminated by the lessee
without payment of a penalty. For purposes of the covenant described under
"-- Covenants -- Limitations on Liens", a Capital Lease Obligation will be
deemed to be secured by a Lien on the property being leased.
"Capital Stock" of any Person means any and all shares, interests, rights
to purchase, warrants, options, participations or other equivalents of or
interests in (however designated) equity of such Person, including any Preferred
Stock, but excluding any debt securities convertible into such equity.
"Cash Management Program" means the Parent's cash management program
applicable to the Parent and its subsidiaries, as in effect from time to time;
provided, however, that any advances or loans made by El Paso Production or any
Restricted Subsidiary to any Affiliate of El Paso Production (other than any
Restricted Subsidiary of El Paso Production) are recorded as receivables on the
consolidated balance sheet of El Paso Production in accordance with GAAP.
"Consolidated Coverage Ratio" as of any date of determination means the
ratio of (x) the aggregate amount of EBITDA for the period of the most recent
four consecutive fiscal quarters ending prior to the
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date of such determination and for which financial information is then publicly
available to (y) Consolidated Interest Expense for such four fiscal quarters;
provided, however, that:
(1) if El Paso Production or any Restricted Subsidiary has Incurred
any Indebtedness since the beginning of such period that remains
outstanding on the date of determination or if the transaction giving rise
to the need to calculate the Consolidated Coverage Ratio is an Incurrence
of Indebtedness, or both, EBITDA and Consolidated Interest Expense for such
period shall be calculated after giving effect on a pro forma basis to such
Indebtedness and the use of proceeds thereof as if such Indebtedness had
been Incurred on the first day of such period and such proceeds had been
applied as of such date;
(2) if El Paso Production or any Restricted Subsidiary has repaid,
repurchased, defeased or otherwise discharged any Indebtedness since the
beginning of such period or if any Indebtedness is to be repaid,
repurchased, defeased or otherwise discharged (in each case other than
Indebtedness Incurred under any revolving credit facility unless such
Indebtedness has been permanently repaid and has not been replaced) on the
date of the transaction giving rise to the need to calculate the
Consolidated Coverage Ratio, EBITDA and Consolidated Interest Expense for
such period shall be calculated on a pro forma basis as if such discharge
had occurred on the first day of such period and as if El Paso Production
or such Restricted Subsidiary had not earned the interest income actually
earned during such period in respect of cash or Temporary Cash Investments
used to repay, repurchase, defease or otherwise discharge such
Indebtedness;
(3) if since the beginning of such period El Paso Production or any
Restricted Subsidiary shall have made any Asset Disposition, EBITDA for
such period will be reduced by an amount equal to EBITDA (if positive)
directly attributable to the assets which are the subject of such Asset
Disposition for such period, or increased by an amount equal to EBITDA (if
negative) directly attributable thereto for such period and Consolidated
Interest Expense for such period will be reduced by an amount equal to the
Consolidated Interest Expense directly attributable to any Indebtedness of
El Paso Production or any Restricted Subsidiary repaid, repurchased,
defeased or otherwise discharged with respect to El Paso Production and its
continuing Restricted Subsidiaries in connection with or with the proceeds
from such Asset Disposition for such period (or, if the Capital Stock of
any Restricted Subsidiary is sold, the Consolidated Interest Expense for
such period directly attributable to the Indebtedness of such Restricted
Subsidiary to the extent El Paso Production and its continuing Restricted
Subsidiaries are no longer liable for such Indebtedness after such sale);
(4) if since the beginning of such period El Paso Production or any
Restricted Subsidiary (by merger or otherwise) shall have made an
Investment in any Restricted Subsidiary (or any Person which becomes a
Restricted Subsidiary) or an acquisition (or shall have received a
contribution) of assets, including any acquisition or contribution of
assets occurring in connection with a transaction requiring a calculation
to be made hereunder, which constitutes all or substantially all of an
operating unit of a business, EBITDA and Consolidated Interest Expense for
such period will be calculated after giving pro forma effect thereto
(including the Incurrence of any Indebtedness) as if such Investment or
acquisition or contribution occurred on the first day of such period; and
(5) if since the beginning of such period any Person (that
subsequently became a Restricted Subsidiary or was merged with or into El
Paso Production or any Restricted Subsidiary since the beginning of such
period) shall have made any Asset Disposition, any Investment or
acquisition of assets that would have required an adjustment pursuant to
clause (3) or (4) above if made by El Paso Production or a Restricted
Subsidiary during such period, EBITDA and Consolidated Interest Expense for
such period shall be calculated after giving pro forma effect thereto as if
such Asset Disposition, Investment or acquisition occurred on the first day
of such period.
For purposes of this definition, whenever pro forma effect is to be given to an
acquisition of assets, the amount of income or earnings relating thereto and the
amount of Consolidated Interest Expense associated with any Indebtedness
Incurred in connection therewith, the pro forma calculations will be determined
in good faith by a responsible financial or accounting Officer of El Paso
Production. If any Indebtedness
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bears a floating rate of interest and is being given pro forma effect, the
interest on such Indebtedness will be calculated as if the rate in effect on the
date of determination had been the applicable rate for the entire period (taking
into account any Interest Rate Agreement applicable to such Indebtedness, but if
the remaining term of such Interest Rate Agreement is less than 12 months, then
such Interest Rate Agreement shall only be taken into account for that portion
of the period equal to the remaining term thereof).
The Consolidated Interest Expense for a period attributable to interest on
any Indebtedness Incurred during such period under a Revolving Credit Facility,
the outstanding principal balance of which is required to be computed on a pro
forma basis in accordance with the foregoing, will be computed, to the extent
the chief financial officer determines in good faith that the principal amount
(or applicable portion thereof) of such Indebtedness was Incurred for working
capital purposes in the ordinary course of business, based upon the average
daily balance of such Indebtedness during the applicable period, provided that
such average daily balance will take into account the amount of any repayment of
Indebtedness under such Revolving Credit Facility during the applicable period,
to the extent such repayment permanently reduced the commitments or amounts
available to be borrowed under such facility.
"Consolidated Interest Expense" means, for any period, the total interest
expense of El Paso Production and its consolidated Restricted Subsidiaries,
plus, to the extent not included in such total interest expense, and to the
extent Incurred by El Paso Production or its Restricted Subsidiaries, without
duplication:
(1) interest expense attributable to Capital Lease Obligations and the
interest expense attributable to leases constituting part of a
Sale/Leaseback Transaction;
(2) amortization of debt discount and debt issuance cost;
(3) capitalized interest;
(4) non-cash interest expense;
(5) commissions, discounts and other fees and charges owed with
respect to letters of credit and bankers' acceptance financing;
(6) net payments pursuant to Hedging Obligations (other than any Oil
and Natural Gas Hedging Contract);
(7) dividends accrued in respect of all Preferred Stock held by
Persons other than El Paso Production or a Wholly Owned Subsidiary (other
than dividends payable solely in Capital Stock (other than Disqualified
Stock) of El Paso Production);
(8) interest incurred in connection with Investments in discontinued
operations;
(9) interest accruing on any Indebtedness of any other Person to the
extent such Indebtedness is Guaranteed by (or secured by the assets of) El
Paso Production or any Restricted Subsidiary; and
(10) the cash contributions to any employee stock ownership plan or
similar trust to the extent such contributions are used by such plan or
trust to pay interest or fees to any Person (other than El Paso Production)
in connection with Indebtedness Incurred by such plan or trust
minus, to the extent included above, write-off of deferred financing costs and
interest attributable to Dollar-Denominated Production Payments.
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"Consolidated Net Income" means, for any period, the net income of El Paso
Production and its consolidated Subsidiaries; provided, however, that the
following will not be included in such Consolidated Net Income:
(1) any net income of any Person (other than El Paso Production) if
such Person is not a Restricted Subsidiary, except that:
(A) subject to the exclusion contained in clause (4) below, El Paso
Production's equity in the net income of any such Person for such period
will be included in such Consolidated Net Income up to the aggregate
amount of cash actually distributed by such Person during such period to
El Paso Production or a Restricted Subsidiary as a dividend or other
distribution (subject, in the case of a dividend or other distribution
paid to a Restricted Subsidiary, to the limitations contained in clause
(3) below); and
(B) El Paso Production's equity in a net loss of any such Person
for such period shall not be included in determining such Consolidated
Net Income, except to the extent of the aggregate cash actually
contributed to such Person by El Paso Production or a Restricted
Subsidiary during such period;
(2) any net income (or loss) of any Person acquired by El Paso
Production or a Subsidiary in a pooling of interests transaction for any
period prior to the date of such acquisition;
(3) any net income of any Restricted Subsidiary if such Restricted
Subsidiary is subject to restrictions, directly or indirectly, on the
payment of dividends or the making of distributions by such Restricted
Subsidiary, directly or indirectly, to El Paso Production, except that:
(A) subject to the exclusion contained in clause (4) below, El Paso
Production's equity in the net income of any such Restricted Subsidiary
for such period will be included in such Consolidated Net Income up to
the aggregate amount of cash that could have been distributed by such
Restricted Subsidiary during such period to El Paso Production or
another Restricted Subsidiary as a dividend or other distribution
(subject, in the case of a dividend, interest payment or other
distribution paid to another Restricted Subsidiary, to the limitation
contained in this clause); and
(B) El Paso Production's equity in a net loss of any such
Restricted Subsidiary for such period will be included in determining
such Consolidated Net Income;
(4) any gain (or loss) realized upon the sale or other disposition of
any assets of El Paso Production, its consolidated Subsidiaries or any
other Person (including pursuant to any sale-and-leaseback arrangement)
which are not sold or otherwise disposed of in the ordinary course of
business and any gain (or loss) realized upon the sale or other disposition
of any Capital Stock of any Person;
(5) extraordinary gains or losses; and
(6) the cumulative effect of a change in accounting principles.
For the purposes of the covenant described under "-- Covenants -- Limitation on
Restricted Payments" only, there will be excluded from Consolidated Net Income
any repurchases, repayments or redemptions of Investments, proceeds realized on
the sale of Investments or return of capital to El Paso Production or a
Restricted Subsidiary to the extent such repurchases, repayments, redemptions,
proceeds or returns increase the amount of Restricted Payments permitted under
such covenant pursuant to clause (3)(D) of the first paragraph of that covenant.
"Credit Facility" means one or more debt facilities (including a Revolving
Credit Facility) or commercial paper facilities with banks or other lenders,
including Affiliates, providing revolving credit loans, term loans, production
payments, receivables financing (including through the sale of receivables) or
letters of credit, in each case, as amended, restated, modified, renewed,
refunded, replaced or refinanced in whole or in part from time to time.
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"Currency Agreement" means any foreign exchange contract, currency swap
agreement or other similar agreement with respect to currency values.
"Default" means any event which is, or after notice or passage of time or
both would be, an Event of Default.
"Disqualified Stock" means, with respect to any Person, any Capital Stock
which by its terms (or by the terms of any security into which it is convertible
or for which it is exchangeable at the option of the holder) or upon the
happening of any event:
(1) matures or is mandatorily redeemable (other than redeemable only
for Capital Stock of such Person which is not itself Disqualified Stock)
pursuant to a sinking fund obligation or otherwise;
(2) is convertible or exchangeable at the option of the holder for
Indebtedness or Disqualified Stock; or
(3) is mandatorily redeemable or must be purchased upon the occurrence
of certain events or otherwise, in whole or in part;
in each case on or prior to the first anniversary of the Stated Maturity of the
Notes; provided, however, that any Capital Stock that would not constitute
Disqualified Stock but for provisions thereof giving holders thereof the right
to require such Person to purchase or redeem such Capital Stock upon the
occurrence of an "asset sale" or "change of control" occurring prior to the
first anniversary of the Stated Maturity of the Notes will not constitute
Disqualified Stock if:
(1) the "asset sale" or "change of control" provisions applicable to
such Capital Stock are not more favorable to the holders of such Capital
Stock than the terms applicable to the Notes and described under
"-- Covenants -- Limitation on Sales of Assets and Subsidiary Stock" and
"-- Change of Control"; and
(2) any such requirement only becomes operative after compliance with
such terms applicable to the Notes, including the purchase of any Notes
tendered pursuant thereto (or concurrently therewith, provided that all of
the Notes validly tendered for purchase and not withdrawn pursuant to the
requirements described under "-- Covenants -- Limitation on Sales of Assets
and Subsidiary Stock" and "-- Change of Control" are so purchased).
The amount of any Disqualified Stock that does not have a fixed redemption,
repayment or repurchase price will be calculated in accordance with the terms of
such Disqualified Stock as if such Disqualified Stock were redeemed, repaid or
repurchased on any date on which the amount of such Disqualified Stock is to be
determined pursuant to the Indenture; provided, however, that if such
Disqualified Stock could not be required to be redeemed, repaid or repurchased
at the time of such determination, the redemption, repayment or repurchase price
will be the book value of such Disqualified Stock as reflected in the most
recent financial statements of such Person.
"Dollar-Denominated Production Payments" means production payment
obligations recorded as liabilities in accordance with GAAP, together with all
undertakings and obligations in connection therewith.
"Domestic Restricted Subsidiary" means a Restricted Subsidiary incorporated
or organized under the laws of the United States of America, any State thereof
or the District of Columbia.
"EBITDA" for any period means the sum of Consolidated Net Income, plus the
following to the extent deducted in calculating such Consolidated Net Income,
without duplication:
(1) all income tax expense of El Paso Production and its consolidated
Restricted Subsidiaries;
(2) Consolidated Interest Expense;
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(3) any depreciation, depletion, exploration and amortization expense
of El Paso Production and its consolidated Restricted Subsidiaries
(excluding amortization expense attributable to a prepaid operating
activity item that was paid in cash in a prior period);
(4) all other non-cash charges of El Paso Production and its
consolidated Restricted Subsidiaries (excluding any such non-cash charge to
the extent that it represents an accrual of or reserve for cash
expenditures in any future period); and
(5) any unrealized noncash gains or losses or charges in respect of
Hedging Obligations (including those resulting from the application of FAS
133),
in each case for such period, and less, to the extent included in calculating
such Consolidated Net Income and in excess of any costs or expenses attributable
thereto and deducted in calculating such Consolidated Net Income, the sum of:
(A) the amount of deferred revenues that are amortized during such
period and are attributable to reserves that are subject to Volumetric
Production Payments; and
(B) amounts recorded in accordance with GAAP as repayments of
principal and interest pursuant to Dollar-Denominated Production Payments.
The provision for taxes based on the income or profits of, and the
depreciation and amortization and non-cash charges of, a Restricted Subsidiary
will be added to Consolidated Net Income to compute EBITDA only to the extent
(and in the same proportion, including by reason of minority interests) that the
net income or loss of such Restricted Subsidiary was included in calculating
Consolidated Net Income and only if a corresponding amount would be permitted at
the date of determination to be dividended to El Paso Production by such
Restricted Subsidiary without prior approval (that has not been obtained),
pursuant to the terms of its charter and all agreements, instruments, judgments,
decrees, orders, statutes, rules and governmental regulations applicable to such
Restricted Subsidiary or its stockholders.
"Exchange Act" means the U.S. Securities Exchange Act of 1934, as amended.
"Farm-In Agreement" means an agreement whereby a Person agrees to pay all
or a share of the drilling, completion or other expenses of an exploratory or
development well (which agreement may be subject to a maximum payment
obligation, after which expenses are shared in accordance with the working or
participation interest therein or in accordance with the agreement of the
parties) or perform the drilling, completion or other operation on such well in
exchange for an ownership interest in an oil or gas property.
"Farm-Out Agreement" means a Farm-In Agreement, viewed from the standpoint
of the party that transfers an ownership interest to another.
"Free Cash Flow" for any period means EBITDA for such period minus the sum
of the following:
(1) all income tax expense of El Paso Production and its consolidated
Restricted Subsidiaries for such period, but only to the extent actually
paid in cash during such period;
(2) Consolidated Interest Expense for such period, but only to the
extent actually paid in cash during such period; and
(3) (a) for any period through March 31, 2005, 125% of, and (b) for
any period thereafter, 105% of, in each case any depreciation, depletion,
exploration and amortization expense of El Paso Production and its
consolidated Restricted Subsidiaries for such period, regardless of whether
actually paid in cash during such period.
"GAAP" means generally accepted accounting principles in the United States
of America as in effect from time to time, including those set forth in:
(1) the opinions and pronouncements of the Accounting Principles Board
of the American Institute of Certified Public Accountants;
(2) statements and pronouncements of the Financial Accounting
Standards Board;
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(3) such other statements by such other entity as approved by a
significant segment of the accounting profession; and
(4) the rules and regulations of the SEC governing the inclusion of
financial statements (including pro forma financial statements) in periodic
reports required to be filed pursuant to Section 13 of the Exchange Act,
including opinions and pronouncements in staff accounting bulletins and
similar written statements from the accounting staff of the SEC.
"Guarantee" means any obligation, contingent or otherwise, of any Person
directly or indirectly guaranteeing any Indebtedness of any Person and any
obligation, direct or indirect, contingent or otherwise, of such Person:
(1) to purchase or pay (or advance or supply funds for the purchase or
payment of) such Indebtedness of such Person (whether arising by virtue of
partnership arrangements, or by agreements to keep-well, to purchase
assets, goods, securities or services, to take-or-pay or to maintain
financial statement conditions or otherwise); or
(2) entered into for the purpose of assuring in any other manner the
obligee of such Indebtedness of the payment of the Indebtedness or to
protect such obligee against loss in respect thereof (in whole or in part);
provided, however, that the term "Guarantee" will not include endorsements for
collection or deposit in the ordinary course of business. The term "Guarantee"
used as a verb has a corresponding meaning.
"Guarantee Agreement" means a supplemental indenture, in a form
satisfactory to the Trustee, pursuant to which a Subsidiary Guarantor guarantees
El Paso Production's obligations with respect to the Notes on the terms provided
for in the Indenture.
"Hedging Obligations" of any Person means the obligations of such Person
pursuant to any Interest Rate Agreement, Oil and Natural Gas Hedging Contract or
Currency Agreement.
"Holder" or "Noteholder" means the Person in whose name a Note is
registered on the Registrar's books.
"Incur" means issue, assume, Guarantee, incur or otherwise become liable
for; provided, however, that any Indebtedness or Capital Stock of a Person
existing at the time such Person becomes a Restricted Subsidiary (whether by
merger, consolidation, acquisition or otherwise) shall be deemed to be Incurred
by such Person at the time it becomes a Restricted Subsidiary. The term
"Incurrence" when used as a noun shall have a correlative meaning.
Notwithstanding the foregoing, solely for purposes of determining compliance
with "-- Covenants -- Limitation on Indebtedness," the following will not be
deemed to be the Incurrence of Indebtedness:
(1) amortization of debt discount or the accretion of principal with
respect to a non-interest bearing or other discount security;
(2) the payment of regularly scheduled interest in the form of
additional Indebtedness of the same instrument or the payment of regularly
scheduled dividends on Capital Stock in the form of additional Capital
Stock of the same class and with the same terms; and
(3) the obligation to pay a premium in respect of Indebtedness arising
in connection with the issuance of a notice of redemption or making of a
mandatory offer to purchase such Indebtedness; and
(4) unrealized losses or charges in respect of Hedging Obligations
(including those resulting from the application of FAS 133).
"Indebtedness" means, with respect to any Person on any date of
determination (without duplication):
(1) the principal in respect of (A) indebtedness of such Person for
money borrowed and (B) indebtedness evidenced by notes, debentures, bonds
or other similar instruments for the payment
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of which such Person is responsible or liable, including, in each case, any
premium on such indebtedness to the extent such premium has become due and
payable;
(2) all Capital Lease Obligations of such Person and all Attributable
Debt in respect of Sale/ Leaseback Transactions entered into by such
Person, to the extent such Capital Lease Obligations would appear as
liabilities on the consolidated balance sheet of such Person in accordance
with GAAP;
(3) all obligations of such Person representing the balance deferred
and unpaid of the purchase price of property, all conditional sale
obligations of such Person and all obligations of such Person under any
title retention agreement, to the extent such obligations would appear as
liabilities upon the consolidated balance sheet of such Person in
accordance with GAAP;
(4) all obligations of such Person for the reimbursement of any
obligor on any letter of credit, bankers' acceptance or similar credit
transaction, excluding obligations with respect to letters of credit
securing obligations (other than obligations described in clauses (1)
through (3) above) entered into in the ordinary course of business of such
Person to the extent such letters of credit are not drawn upon or, if and
to the extent drawn upon, such drawing is reimbursed no later than the
tenth Business Day following payment on the letter of credit;
(5) (A) the amount of all mandatory payment obligations of such Person
with respect to the redemption, repayment or other repurchase of any
Disqualified Stock of such Person or (B) the amount of all obligations of
any Subsidiary of such Person with respect to the redemption, repayment or
other repurchase of any Capital Stock of such Subsidiary or that are
determined by the value of such Capital Stock, in each case the principal
amount of such obligations for purposes of this clause (5) to be determined
in accordance with the Indenture (but excluding, in each case, any accrued
dividends) (and the term "Incur Indebtedness" and similar terms include
issuances of such Disqualified Stock and Preferred Stock and the term
"Indebtedness" includes such Disqualified Stock and Preferred Stock);
(6) all obligations of the type referred to in clauses (1) through (5)
of other Persons and all dividends of other Persons for the payment of
which, in either case, such Person is responsible or liable, directly or
indirectly, as obligor, guarantor or otherwise, including by means of any
Guarantee;
(7) all obligations of the type referred to in clauses (1) through (6)
of other Persons secured by any Lien on any property or asset of such
Person (whether or not such obligation is assumed by such Person), the
amount of such obligation being deemed to be the lesser of the fair market
value of such property (as determined in good faith by the Board of
Directors of such Person) or assets and the amount of the obligation so
secured;
(8) to the extent not otherwise included in this definition, net
Hedging Obligations of such Person; and
(9) any Guarantee by such Person of production or payment with respect
to a Dollar-Denominated Production Payment or a Volumetric Production
Payment;
provided, however, that any Indebtedness which has been defeased in accordance
with GAAP or defeased pursuant to the deposit of cash or Temporary Cash
Investments (in an amount sufficient to satisfy all such indebtedness
obligations at maturity or redemption, as applicable, and all payments of
interest and premium, if any) in a trust or account created or pledged for the
sole benefit of the holders of such Indebtedness, and subject to no other Liens,
and the other applicable terms of the instrument governing such indebtedness,
will not constitute "Indebtedness."
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None of the following will constitute "Indebtedness":
(1) accrued expenses and trade accounts payable arising in the
ordinary course of business;
(2) except as expressly provided in clause (9) of the first paragraph
of this definition, Production Payments and Reserve Sales; and
(3) any obligation of a Person in respect of a Farm-In Agreement or
similar arrangement.
In connection with the purchase by El Paso Production or any Restricted
Subsidiary of any business, the term "Indebtedness" will exclude post-closing
payment adjustments to which the seller may become entitled to the extent such
payment is determined by a final closing balance sheet or such payment depends
on the performance of such business after the closing; provided, however, that,
at the time of closing, the amount of any such payment is not determinable and,
to the extent such payment thereafter becomes fixed and determined, the amount
is paid within 30 days thereafter.
The amount of Indebtedness of any Person at any date will be the
outstanding balance at such date of all unconditional obligations as described
above and the maximum liability, upon the occurrence of the contingency giving
rise to the obligation, of any contingent obligations at such date; provided,
however, that in the case of Indebtedness sold at a discount, the amount of such
Indebtedness at any time will be the accreted value thereof at such time.
"Interest Rate Agreement" means any interest rate swap agreement, interest
rate cap agreement or other financial agreement or arrangement with respect to
exposure to interest rates.
"Investment" in any Person means any direct or indirect advance, loan
(other than advances to customers in the ordinary course of business that are
recorded as accounts receivable on the balance sheet of the lender) or other
extensions of credit (including by way of a Guarantee or similar arrangement) or
capital contribution to (by means of any transfer of cash or other property to
others or any payment for property or services for the account or use of
others), or any purchase or acquisition of Capital Stock, Indebtedness or other
similar instruments issued by such Person. Except as otherwise provided for
herein, the amount of an Investment shall be its fair value at the time the
Investment is made and without giving effect to subsequent changes in value.
For purposes of the definition of "Unrestricted Subsidiary", the definition
of "Restricted Payment" and the covenant described under
"-- Covenants -- Limitation on Restricted Payments":
(1) "Investment" will include the portion (proportionate to El Paso
Production's equity interest in such Subsidiary) of the fair market value
of the net assets of any Subsidiary of El Paso Production at the time that
such Subsidiary is designated an Unrestricted Subsidiary; provided,
however, that upon a redesignation of such Subsidiary as a Restricted
Subsidiary, El Paso Production shall be deemed to continue to have a
"Investment" in an Unrestricted Subsidiary equal to the amount (if
positive) of (A) El Paso Production's "Investment" in such Subsidiary at
the time of such redesignation less (B) the portion (proportionate to El
Paso Production's equity interest in such Subsidiary) of the fair market
value of the net assets of such Subsidiary at the time of such
redesignation; and
(2) any property transferred to or from an Unrestricted Subsidiary
will be valued at its fair market value at the time of such transfer, in
each case as determined in good faith by the Board of Directors.
"Issue Date" means the date of first issuance of any Notes under the
Indenture.
"Legal Holiday" means a Saturday, a Sunday or a day on which banking
institutions are not required to be open in the State of New York.
"Lien" means any mortgage, pledge, security interest, encumbrance, lien or
charge of any kind (including any conditional sale or other title retention
agreement or lease in the nature thereof).
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"Material Change" means an increase or decrease (excluding changes that
result solely from changes in prices and changes resulting from the incurrence
of previously estimated development costs) of more than 50% during a fiscal
quarter in the discounted future net revenues from proved oil and natural gas
reserves of El Paso Production and its Restricted Subsidiaries, calculated in
accordance with clause (a)(1) of the definition of ACNTA; provided, however,
that the following will be excluded from the calculation of Material Change:
(1) any acquisitions or contribution to capital during such fiscal
quarter of oil and natural gas reserves that have been estimated by
independent petroleum engineers and with respect to which a report or
reports of such engineers exist; and
(2) any disposition of properties existing at the beginning of such
fiscal quarter that have been disposed of in compliance with the covenant
described under "-- Covenants -- Limitation on Sales of Assets and
Subsidiary Stock."
"Moody's" means Moody's Investors Service, Inc.
"Net Available Cash" from an Asset Disposition means cash payments received
therefrom (including any cash payments received by way of deferred payment of
principal pursuant to a note or installment receivable or otherwise and proceeds
from the sale or other disposition of any securities received as consideration,
but only as and when received, but excluding any other consideration received in
the form of assumption by the acquiring Person of Indebtedness or other
obligations relating to such properties or assets or received in any other
non-cash form), in each case net of:
(1) all legal, title and recording tax expenses, commissions and other
fees and expenses incurred, and all Federal, state, provincial, foreign and
local taxes required to be accrued as a liability under GAAP, as a
consequence of such Asset Disposition;
(2) all payments made on any Indebtedness which is secured by any
assets subject to such Asset Disposition, in accordance with the terms of
any Lien upon or other security agreement of any kind with respect to such
assets, or which must by its terms, or in order to obtain a necessary
consent to such Asset Disposition, or by applicable law, be repaid out of
the proceeds from such Asset Disposition;
(3) all distributions and other payments required to be made to
minority interest holders in Restricted Subsidiaries as a result of such
Asset Disposition; and
(4) the deduction of appropriate amounts provided by the seller as a
reserve, in accordance with GAAP, against any liabilities associated with
the property or other assets disposed in such Asset Disposition and
retained by El Paso Production or any Restricted Subsidiary after such
Asset Disposition.
"Net Cash Proceeds", with respect to any issuance or sale of Capital Stock
or Incurrence of Indebtedness, means the cash proceeds of such issuance, sale or
Incurrence net of attorneys' fees, accountants' fees, underwriters' or placement
agents' fees, discounts or commissions and brokerage, consultant and other fees
actually incurred in connection with such issuance or sale and net of taxes paid
or payable as a result thereof.
"Net Working Capital" means
(1) all current assets of El Paso Production and its Restricted
Subsidiaries, except (A) current assets from commodity price risk
management activities arising in the ordinary course of business and (B)
receivables from affiliates; minus
(2) all current liabilities of El Paso Production and its Restricted
Subsidiaries, except current liabilities included in Indebtedness and
current liabilities from commodity price risk management activities arising
in the ordinary course of business, determined in accordance with GAAP.
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"Obligations" means, with respect to any Indebtedness, all obligations for
principal, premium, interest, penalties, fees, indemnifications, reimbursements,
and other amounts payable pursuant to the documentation governing such
Indebtedness.
"Officer" means the Chairman of the Board, the President, any Vice
President, the Treasurer or the Secretary of El Paso Production.
"Officers' Certificate" means a certificate signed by two Officers.
"Oil and Gas Business" means:
(1) the acquisition, exploration, exploitation, development, operation
and disposition of interests in oil, gas and other hydrocarbon properties;
(2) the gathering, marketing, distribution, treating, processing,
storage, refining, selling and transporting of any production from such
interests or properties and the marketing of oil and gas obtained from
unrelated Persons;
(3) any business relating to or arising from exploration for or
exploitation, development, production, treatment, processing, storage,
refining, transportation, gathering or marketing of oil, gas and other
hydrocarbons, minerals and products produced in association therewith;
(4) any other related energy business, including power generation and
electrical transmission business, directly or indirectly, from hydrocarbons
produced substantially from properties in which El Paso Production or its
Restricted Subsidiaries, directly or indirectly, participates;
(5) any business relating to oil field sales and service; and
(6) any activity necessary, appropriate or incidental to the
activities described in the preceding clauses (1) through (5) of this
definition.
"Oil and Natural Gas Hedging Contract" means any oil and natural gas
hedging agreement, and other agreement or arrangement designed to protect El
Paso Production or any Restricted Subsidiary against fluctuations in oil and
natural gas prices.
"Opinion of Counsel" means a written opinion from legal counsel who is
acceptable to the Trustee. The counsel may be an employee of or counsel to El
Paso Production or the Trustee.
"Parent" means El Paso Corporation, a Delaware corporation, and its
successors.
"Permitted Business Investments" means Investments and expenditures made in
the ordinary course of, and of a nature that is or shall have become customary
in, the Oil and Gas Business as a means of actively exploiting, exploring for,
acquiring, developing, processing, gathering, marketing or transporting oil,
natural gas, other hydrocarbons and minerals through agreements, transactions,
interests or arrangements that permit one to share risks or costs, comply with
regulatory requirements regarding local ownership or satisfy other objectives
customarily achieved through the conduct of the Oil and Gas Business jointly
with third parties, including:
(1) ownership interests in oil, natural gas, other hydrocarbons and
minerals properties or gathering, transportation, processing, storage or
related systems; and
(2) entry into, and Investments and expenditures in the form of or
pursuant to, operating agreements, working interests, royalty interests,
mineral leases, processing agreements, Farm-In Agreements, Farm-Out
Agreements, contracts for the sale, transportation or exchange of oil,
natural gas, other hydrocarbons and minerals production sharing agreements,
development agreements, area of mutual interest agreements, unitization
agreements, pooling arrangements, joint bidding agreements, service
contracts, joint venture agreements, partnership agreements (whether
general or limited), limited liability company agreements, subscription
agreements, stock purchase agreements, stockholder agreements and other
similar agreements with third parties (including Unrestricted
Subsidiaries).
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"Permitted Holders" means the Parent and its Wholly Owned Subsidiaries.
Except for a Permitted Holder specifically identified by name, in determining
whether Voting Stock is owned by a Permitted Holder, only Voting Stock acquired
by a Permitted Holder in its described capacity will be treated as "beneficially
owned" by such Permitted Holder.
"Permitted Investment" means an Investment by El Paso Production or any
Restricted Subsidiary in:
(1) El Paso Production, a Restricted Subsidiary or a Person that will,
upon the making of such Investment, become a Restricted Subsidiary;
provided, however, that the primary business of such Restricted Subsidiary
is a Related Business;
(2) another Person if, as a result of such Investment, such other
Person is merged or consolidated with or into, or transfers or conveys all
or substantially all its assets to, El Paso Production or a Restricted
Subsidiary; provided, however, that such Person's primary business is a
Related Business;
(3) cash and Temporary Cash Investments;
(4) receivables owing to El Paso Production or any Restricted
Subsidiary if created or acquired in the ordinary course of business and
payable or dischargeable in accordance with customary trade terms;
provided, however, that such trade terms may include such concessionary
trade terms as El Paso Production or any such Restricted Subsidiary deems
reasonable under the circumstances;
(5) payroll, travel and similar advances to cover matters that are
expected at the time of such advances ultimately to be treated as expenses
for accounting purposes and that are made in the ordinary course of
business;
(6) loans or advances to employees made in the ordinary course of
business consistent with past practices of El Paso Production or such
Restricted Subsidiary;
(7) stock, obligations or securities received in settlement of debts
created in the ordinary course of business and owing to El Paso Production
or any Restricted Subsidiary or in satisfaction of judgments;
(8) any Person to the extent such Investment represents the non-cash
portion of the consideration received for an Asset Disposition as permitted
pursuant to the covenant described under "-- Covenants -- Limitation on
Sales of Assets and Subsidiary Stock";
(9) any Person where such Investment was acquired by El Paso
Production or any of its Restricted Subsidiaries (a) in exchange for any
other Investment or accounts receivable held by El Paso Production or any
such Restricted Subsidiary in connection with or as a result of a
bankruptcy, workout, reorganization or recapitalization of the issuer of
such other Investment or accounts receivable or (b) as a result of a
foreclosure by El Paso Production or any of its Restricted Subsidiaries
with respect to any secured Investment or other transfer of title with
respect to any secured Investment in default;
(10) any Person to the extent such Investments consist of prepaid
expenses, negotiable instruments held for collection and lease, utility and
workers' compensation, performance and other similar deposits made in the
ordinary course of business by El Paso Production or any Restricted
Subsidiary;
(11) any Person to the extent such Investments consist of Hedging
Obligations otherwise permitted under the covenant described under
"-- Covenants -- Limitation on Indebtedness";
(12) Persons to the extent such Investments are in existence on the
Issue Date;
(13) Permitted Business Investments;
(14) Guarantees of performance or other obligations (other than
Indebtedness) arising in the ordinary course in the Oil and Gas Business,
including obligations under oil and natural gas
122
exploration, development, joint operating, and related agreements and
licenses or concessions related to the Oil and Gas Business;
(15) Persons to the extent such Investments, when taken together with
all other Investments made pursuant to this clause (15) outstanding on the
date such Investment is made, do not exceed $50 million.
"Permitted Liens" means, with respect to any Person:
(1) pledges or deposits by such Person under worker's compensation
laws, unemployment insurance laws, social security or old age pension laws
or similar legislation, or good faith deposits in connection with bids,
tenders, contracts (other than contracts for the payment of Indebtedness)
or leases to which such Person is a party, or deposits (which may be
secured by a Lien) to secure public or statutory obligations of such Person
including letters of credit and bank guarantees required or requested by
the United States, any State thereof or any foreign government or any
subdivision, department, agency, organization or instrumentality of any of
the foregoing in connection with any contract or statute (including lessee
or operator obligations under statutes, governmental regulations, contracts
or instruments related to the ownership, exploration and production of oil,
natural gas, other hydrocarbons and minerals on State, Federal or foreign
lands or waters); or deposits of cash or United States government bonds to
secure surety, stay appeal, indemnity performance or other similar bonds to
which such Person is a party, or deposits as security for contested taxes
or import duties or for the payment of rent, in each case Incurred in the
ordinary course of business;
(2) statutory and contractual Liens of landlords and Liens imposed by
law, such as carriers', warehousemen's, royalty Liens and mechanics' Liens,
in each case for sums not yet due or being contested in good faith by
appropriate proceedings or other Liens arising out of judgments, decrees,
orders or awards against such Person with respect to which such Person
shall then be proceeding with an appeal or other proceedings for review and
Liens arising solely by virtue of any statutory or common law provision
relating to banker's Liens, rights of set-off or similar rights and
remedies as to deposit accounts or other funds maintained with a creditor
depository institution; provided, however, that (A) such deposit account is
not a dedicated cash collateral account and is not subject to restrictions
against access by El Paso Production in excess of those set forth by
regulations promulgated by the Federal Reserve Board and (B) such deposit
account is not intended by El Paso Production or any Restricted Subsidiary
to provide collateral to the depository institution;
(3) Liens for taxes, assessments and governmental charges or claims
not yet subject to penalties for non-payment or which are being contested
in good faith by appropriate proceedings;
(4) Liens in favor of issuers of surety bonds or letters of credit
issued pursuant to the request of and for the account of such Person in the
ordinary course of its business; provided, however, that such letters of
credit do not constitute Indebtedness;
(5) survey exceptions, encumbrances, easements or reservations of, or
rights of others for, licenses, rights-of-way, sewers, electric lines,
telegraph and telephone lines and other similar purposes, or zoning or
other restrictions as to the use of real property, minor defects in title
or Liens incidental to the conduct of the business of such Person or to the
ownership of its properties which were not incurred or created to secure
the payment of borrowed money which do not in the aggregate materially
adversely affect the value of said properties or materially impair their
use in the operation of the business of such Person;
(6) Liens securing Indebtedness Incurred to finance the construction,
purchase or lease of, or repairs, improvements or additions to, property,
plant or equipment of such Person; provided, however, that the Lien may not
extend to any other property owned by such Person or any of its Restricted
Subsidiaries at the time the Lien is Incurred (other than assets and
property affixed or appurtenant thereto), and the Indebtedness (other than
any interest thereon) secured by the Lien may not be Incurred more than 180
days after the later of the acquisition, completion of construction,
repair, improvement, addition or commencement of full operation of the
property subject to the Lien;
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(7) (A) Liens to secure Indebtedness permitted under the provisions
described in clause (1) of the second paragraph under
"-- Covenants -- Limitation on Indebtedness"; provided, however, that the
holder of such Indebtedness is not an Affiliate of El Paso Production; and
(B) Liens to secure obligations permitted under the provisions described in
clause (9) of the second paragraph under "-- Covenants -- Limitation on
Indebtedness";
(8) Liens existing on the Issue Date;
(9) Liens on property or shares of Capital Stock of another Person at
the time such other Person becomes a Subsidiary of such Person; provided,
however, that the Liens may not extend to any other property owned by such
Person or any of its Restricted Subsidiaries (other than assets and
property affixed or appurtenant thereto);
(10) Liens on property at the time such Person or any of its
Subsidiaries acquires the property, including any acquisition by means of a
merger or consolidation with or into such Person or a Subsidiary of such
Person; provided, however, that the Liens may not extend to any other
property owned by such Person or any of its Restricted Subsidiaries (other
than assets and property affixed or appurtenant thereto);
(11) Liens securing Indebtedness or other obligations of a Subsidiary
of such Person owing to such Person or a Wholly Owned Subsidiary of such
Person;
(12) Liens securing Hedging Obligations so long as such Hedging
Obligations relate to Indebtedness that is, and is permitted to be under
the Indenture, secured by a Lien on the same property securing such Hedging
Obligations;
(13) Liens on, or related to, assets to secure all or part of the
costs incurred in the ordinary course of the Oil and Gas Business for the
exploration, drilling, development, production, processing, transportation,
marketing, storage or operation thereof to the extent such Liens (A) do not
secure Indebtedness and (B) are customary in the Oil and Gas Business, are
granted to the Person performing the service to which such costs relate and
are discharged in the ordinary course of business;
(14) Liens on pipeline or pipeline facilities that arise under
operation of law;
(15) Liens arising under operating agreements, joint venture
agreements, partnership agreements, oil, gas, other hydrocarbons and
minerals leases, the Vendor Program, Farm-Out Agreements or Farm-In
Agreements, assignments, purchase and sale agreements, division orders,
contracts for the sale, purchase, transportation, processing (but not
refining) or exchange of oil, gas or other hydrocarbons, unitization and
pooling declarations and agreements, development agreements, area of mutual
interest agreements and other agreements that are customary in the Oil and
Gas Business;
(16) Liens reserved in oil, gas or other hydrocarbons minerals leases
for bonus, royalty or rental payments and for compliance with the terms of
such leases;
(17) Liens upon specific items of inventory or other goods and
proceeds of any Person securing such Person's obligations in respect of
bankers' acceptances issued or created for the account of such Person to
facilitate the purchase, shipment or storage of such inventory or other
goods;
(18) Liens in favor of El Paso Production or a Subsidiary Guarantor;
(19) leases, pooling agreements, unitization agreements, subleases,
licenses or sublicenses, royalties, joint interest billing arrangements,
net profits interests, participation agreements, and arrangements similar
to any of the foregoing, entered into in the ordinary course of business;
(20) Liens arising under the Indenture in favor of the Trustee for its
own benefit and similar Liens in favor of other trustees, agents and
representatives arising under instruments governing Indebtedness permitted
to be incurred under the Indenture, provided, however, that such Liens are
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solely for the benefit of the trustees, agents or representatives in their
capacities as such and not for the benefit of the holders of such
Indebtedness;
(21) Liens arising from the deposit of funds or securities in trust
for the purpose of decreasing or defeasing Indebtedness so long as such
deposit of funds or securities and such decreasing or defeasing of
Indebtedness are permitted under the covenant described under
"-- Covenants -- Limitation on Restricted Payments;"
(22) Liens to secure Dollar-Denominated Production Payments or
Volumetric Production Payments, to the extent such Liens are limited to the
assets that are the subject of such Dollar-Denominated Production Payments
or Volumetric Production Payments;
(23) Liens in favor of collecting or payer banks having a right of
setoff, revocation, refused or charge back with respect to money or
instruments of El Paso Production or any Subsidiary of El Paso Production
on deposit with or in possession of such bank;
(24) Liens on oil and gas properties of El Paso Production or any of
its Restricted Subsidiaries, securing any Indebtedness or other obligation
of the Parent or any of its Subsidiaries; provided, however, that at the
date of grant of such Liens the SEC PV-10 Value of the oil and gas
properties to be so subject to such Lien, together with the SEC PV-10 Value
of all other oil and gas properties of El Paso Production and its
Restricted Subsidiaries subject to Liens described in this clause (24) and
then outstanding, does not exceed $200 million (based on the SEC PV-10
Value of all such oil and gas properties as of the end of the calendar year
preceding the date of the grant in respect of which such determination is
being made);
(25) Liens to secure any Refinancing (or successive Refinancings) as a
whole, or in part, of any Indebtedness secured by any Lien referred to in
the foregoing clause (6), (8), (9) or (10); provided, however, that:
(A) such new Lien shall be limited to all or part of the same
property and assets that secured or, under the written agreements
pursuant to which the original Lien arose, could secure the original
Lien (plus improvements and accessions to, such property or proceeds or
distributions thereof); and
(B) the Indebtedness secured by such Lien at such time is not
increased to any amount greater than the sum of (x) the outstanding
principal amount or, if greater, committed amount of the Indebtedness
described under clause (6), (8), (9) or (10) at the time the original
Lien became a Permitted Lien and (y) an amount necessary to pay any fees
and expenses, including premiums, related to such refinancing,
refunding, extension, renewal or replacement;
(26) Liens to secure Indebtedness having an aggregate principal amount
which, when added together with all other Indebtedness secured by Liens
Incurred pursuant to this clause (26) and then outstanding, does not exceed
$100 million.
In each case set forth above, notwithstanding any stated limitation on the
assets that may be subject to such Lien, a Permitted Lien on a specified asset
or group or type of assets may include Liens on all improvements, additions and
accessions thereto and all products and proceeds thereof (including dividends,
distributions and increases in respect thereof).
Notwithstanding the foregoing, "Permitted Liens" will not include any Lien
described in clause (6), (9) or (10) above to the extent such Lien applies to
any Additional Assets acquired directly or indirectly from Net Available Cash
pursuant to the covenant described under "-- Covenants -- Limitation on Sale of
Assets and Subsidiary Stock." For purposes of this definition, the term
"Indebtedness" shall be deemed to include interest on such Indebtedness.
"Person" means any individual, corporation, partnership, limited liability
company, joint venture, association, joint-stock company, trust, unincorporated
organization, government or any agency or political subdivision thereof or any
other entity.
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"Preferred Stock", as applied to the Capital Stock of any Person, means
Capital Stock of any class or classes (however designated) which is preferred as
to the payment of dividends or distributions, or as to the distribution of
assets upon any voluntary or involuntary liquidation or dissolution of such
Person, over shares of Capital Stock of any other class of such Person.
"principal" of a Note means the principal of the Note plus the premium, if
any, payable on the Note which is due or overdue or is to become due at the
relevant time.
"Production Payments and Reserve Sales" means the grant or transfer to any
Person of a Dollar-Denominated Production Payment, Volumetric Production
Payment, royalty, overriding royalty, net profits interest, master limited
partnership interest or other interest in oil and natural gas properties,
reserves or the right to receive all or a portion of the production or the
proceeds from the sale of production attributable to such properties.
"Refinance" means, in respect of any Indebtedness, to refinance, extend,
renew, refund, repay, prepay, redeem, defease or retire, or to issue other
Indebtedness in exchange or replacement for, such indebtedness. "Refinanced" and
"Refinancing" shall have correlative meanings.
"Refinancing Indebtedness" means Indebtedness that Refinances any
Indebtedness of El Paso Production or any Restricted Subsidiary existing on the
Issue Date or Incurred in compliance with the Indenture, including Indebtedness
that Refinances Refinancing Indebtedness; provided, however, that:
(1) such Refinancing Indebtedness has a Stated Maturity no earlier
than the Stated Maturity of the Indebtedness being Refinanced;
(2) such Refinancing Indebtedness has an Average Life at the time such
Refinancing Indebtedness is Incurred that is equal to or greater than the
Average Life of the Indebtedness being Refinanced;
(3) such Refinancing Indebtedness has an aggregate principal amount
(or if Incurred with original issue discount, an aggregate issue price)
that is equal to or less than the aggregate principal amount (or if
Incurred with original issue discount, the aggregate accreted value) then
outstanding or committed (plus fees and expenses, including any premium and
defeasance costs) under the Indebtedness being Refinanced; and
(4) if the Indebtedness being Refinanced is subordinated in right of
payment to the Notes, such Refinancing Indebtedness is subordinated in
right of payment to the Notes at least to the same extent as the
Indebtedness being Refinanced;
However, Refinancing Indebtedness will not include:
(1) Indebtedness of a Subsidiary (other than a Subsidiary Guarantor)
that Refinances Indebtedness of El Paso Production; or
(2) Indebtedness of El Paso Production or a Restricted Subsidiary that
Refinances Indebtedness of an Unrestricted Subsidiary.
"Registration Rights Agreement" means the Registration Rights Agreement
dated as of the Issue Date among El Paso Production, Credit Suisse First Boston
LLC, Citigroup Global Markets Inc. and the other initial purchasers.
"Related Business" means the Oil and Gas Business and any business in which
El Paso Production was engaged on the Issue Date and any business related,
ancillary or complementary to any business of El Paso Production in which El
Paso Production was engaged on the Issue Date.
"Restricted Payment" with respect to any Person means:
(1) the declaration or payment of any dividends or any other
distributions of any sort in respect of its Capital Stock (including any
payment in connection with any merger or consolidation involving such
Person) or similar payment to the direct or indirect holders of its Capital
Stock (other than
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dividends or distributions payable solely in its Capital Stock (other than
Disqualified Stock) and dividends or distributions payable solely to El
Paso Production or a Restricted Subsidiary, and other than pro rata
dividends or other distributions made by a Subsidiary that is not a Wholly
Owned Subsidiary to minority stockholders (or owners of an equivalent
interest in the case of a Subsidiary that is an entity other than a
corporation));
(2) the purchase, redemption or other acquisition or retirement for
value of any Capital Stock of El Paso Production held by any Person or of
any Capital Stock of a Restricted Subsidiary held by any Affiliate of El
Paso Production (other than a Restricted Subsidiary), including in
connection with any merger or consolidation and including the exercise of
any option to exchange any Capital Stock (other than into Capital Stock of
El Paso Production that is not Disqualified Stock);
(3) the purchase, repurchase, redemption, defeasance or other
acquisition or retirement for value, prior to scheduled maturity, scheduled
repayment or scheduled sinking fund payment of any Subordinated Obligations
of such Person (other than the purchase, repurchase or other acquisition of
Subordinated Obligations purchased in anticipation of satisfying a sinking
fund obligation, principal installment or final maturity, in each case due
within one year of the date of such purchase, repurchase or other
acquisition); or
(4) the making of any Investment (other than a Permitted Investment)
in any Person.
"Restricted Subsidiary" means any Subsidiary of El Paso Production that is
not an Unrestricted Subsidiary.
"Revolving Credit Facility" means any revolving credit facility (or
facilities) pursuant to written agreements from time to time in effect.
"S&P" means Standard and Poor's Ratings Group.
"Sale/Leaseback Transaction" means an arrangement relating to property
owned by El Paso Production or a Restricted Subsidiary on the Issue Date or
thereafter acquired by El Paso Production or a Restricted Subsidiary whereby El
Paso Production or a Restricted Subsidiary transfers such property to a Person
and El Paso Production or a Restricted Subsidiary leases it from such Person.
"SEC PV-10 Value" means the estimated future gross revenue to be generated
from the production of proved reserves, net of estimated production and future
development costs, using prices and costs in effect at the determination date,
before income taxes, and without giving effect to non-property-related expenses,
discounted to a present value using an annual discount rate of 10% in accordance
with the guidelines of the SEC.
"Securities Act" means the U.S. Securities Act of 1933, as amended.
"Senior Indebtedness" means with respect to any Person:
(1) Indebtedness of such Person, whether outstanding on the Issue Date
or thereafter Incurred; and
(2) all other Obligations of such Person (including interest accruing
on or after the filing of any petition in bankruptcy or for reorganization
relating to such Person whether or not post-filing interest is allowed in
such proceeding) in respect of Indebtedness described in clause (1) above
unless, in the case of clauses (1) and (2), in the instrument creating or
evidencing the same or pursuant to which the same is outstanding, it is provided
that such Indebtedness or other Obligations are subordinate in right of payment
to the Notes or the Subsidiary Guarantee of such Person, as the case may be.
However, Senior Indebtedness will not include:
(1) any obligation of such Person to El Paso Production or any
Subsidiary;
(2) any liability for Federal, state, local or other taxes owed or
owing by such Person;
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(3) any accounts payable or other liability to trade creditors arising
in the ordinary course of business (including guarantees thereof or
instruments evidencing such liabilities);
(4) any Indebtedness or other Obligation of such Person which is
subordinate or junior in any respect to any other Indebtedness or other
Obligation of such Person; or
(5) that portion of any Indebtedness which at the time of Incurrence
is Incurred in violation of the Indenture.
"Significant Subsidiary" means any Restricted Subsidiary that would be a
"Significant Subsidiary" of El Paso Production within the meaning of Rule 1-02
under Regulation S-X promulgated by the SEC.
"Stated Maturity" means, with respect to any security, the date specified
in such security as the fixed date on which the final payment of principal of
such security is due and payable, including pursuant to any mandatory redemption
provision (but excluding any provision providing for the repurchase of such
security at the option of the holder thereof upon the happening of any
contingency unless such contingency has occurred).
"Subordinated Obligation" means, with respect to a Person, any Indebtedness
of such Person (whether outstanding on the Issue Date or thereafter Incurred)
which is subordinate or junior in right of payment to the Notes or a Subsidiary
Guarantee of such Person, as the case may be, pursuant to a written agreement to
that effect.
"Subsidiary" means, with respect to any Person, any corporation,
association, partnership or other business entity of which more than 50% of the
total voting power of shares of Voting Stock is at the time owned or controlled,
directly or indirectly, by:
(1) such Person;
(2) such Person and one or more Subsidiaries of such Person; or
(3) one or more Subsidiaries of such Person.
"Subsidiary Guarantor" means each of El Paso Production GOM, Inc., El Paso
Energy Raton, L.L.C., El Paso Production Company and Vermejo Minerals
Corporation and each other Subsidiary of El Paso Production that executes the
Indenture as a guarantor on the Issue Date and each other Subsidiary of El Paso
Production that thereafter guarantees the Notes pursuant to the terms of the
Indenture.
"Subsidiary Guarantee" means a Guarantee by a Subsidiary Guarantor of El
Paso Production's obligations with respect to the Notes.
"Temporary Cash Investments" means any of the following:
(1) any investment in direct obligations of the United States of
America or any agency thereof or obligations guaranteed by the United
States of America or any agency thereof;
(2) investments in demand and time deposit accounts, certificates of
deposit and money market deposits maturing within 180 days of the date of
acquisition thereof issued by a bank or trust company which is organized
under the laws of the United States of America, any State thereof or any
foreign country recognized by the United States of America, and which bank
or trust company has capital, surplus and undivided profits aggregating in
excess of $50.0 million (or the foreign currency equivalent thereof) and
has outstanding debt which is rated "A" (or such similar equivalent rating)
or higher by at least one nationally recognized statistical rating
organization (as defined in Rule 436 under the Securities Act) or any
money-market fund sponsored by a registered broker dealer or mutual fund
distributor;
(3) repurchase obligations with a term of not more than 30 days for
underlying securities of the types described in clause (1) above entered
into with a bank meeting the qualifications described in clause (2) above;
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(4) investments in deposits available for withdrawal on demand with
any commercial bank that is organized under the laws of any country in
which El Paso Production or any Restricted Subsidiary maintains an office
or is engaged in the Oil and Gas Business;
(5) investments in commercial paper, maturing not more than 90 days
after the date of acquisition, issued by a corporation (other than an
Affiliate of El Paso Production) organized and in existence under the laws
of the United States of America or any foreign country recognized by the
United States of America with a rating at the time as of which any
investment therein is made of "P-1" (or higher) according to Moody's or
"A-1" (or higher) according to S&P; and
(6) investments in securities with maturities of six months or less
from the date of acquisition issued or fully guaranteed by any state,
commonwealth or territory of the United States of America, or by any
political subdivision or taxing authority thereof, and rated at least "A"
by S&P or "A" by Moody's.
"Trust Officer" means the Chairman of the Board, the President or any other
officer or assistant officer of the Trustee assigned by the Trustee to
administer its corporate trust matters.
"Unrestricted Subsidiary" means:
(1) any Subsidiary of El Paso Production that at the time of
determination shall be designated an Unrestricted Subsidiary by the Board
of Directors in the manner provided below; and
(2) any Subsidiary of an Unrestricted Subsidiary.
The Board of Directors may designate any Subsidiary of El Paso Production
(including any newly acquired or newly formed Subsidiary) to be an Unrestricted
Subsidiary unless such Subsidiary or any of its Subsidiaries owns any Capital
Stock or Indebtedness of, or holds any Lien on any property of, El Paso
Production or any other Subsidiary of El Paso Production that is not a
Subsidiary of the Subsidiary to be so designated; provided, however, that either
(A) the Subsidiary to be so designated has total assets of $1,000 or less or (B)
if such Subsidiary has assets greater than $1,000, such designation would be
permitted under the covenant described under "-- Covenants -- Limitation on
Restricted Payments."
The Board of Directors may designate any Unrestricted Subsidiary to be a
Restricted Subsidiary; provided, however, that immediately after giving effect
to such designation (A) El Paso Production could Incur $1.00 of additional
Indebtedness under the first paragraph of the covenant described under
"-- Covenants -- Limitation on Indebtedness" and (B) no Default shall have
occurred and be continuing. Any such designation by the Board of Directors shall
be evidenced to the Trustee by promptly filing with the Trustee a copy of the
resolution of the Board of Directors giving effect to such designation and an
Officers' Certificate certifying that such designation complied with the
foregoing provisions.
"U.S. Government Obligations" means direct obligations (or certificates
representing an ownership interest in such obligations) of the United States of
America (including any agency or instrumentality thereof) for the payment of
which the full faith and credit of the United States of America is pledged and
which are not callable at the issuer's option.
"Volumetric Production Payments" means production payment obligations
recorded as deferred revenue in accordance with GAAP, together with all
undertakings and obligations in connection therewith.
"Voting Stock" of a Person means all classes of Capital Stock or other
interests (including partnership interests) of such Person then outstanding and
normally entitled (without regard to the occurrence of any contingency) to vote
in the election of directors, managers or trustees thereof.
"Wholly Owned Subsidiary" means a Restricted Subsidiary all the Capital
Stock of which (other than directors' qualifying shares) is owned directly or
indirectly by El Paso Production.
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MATERIAL UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following discussion of the material U.S. federal income tax
consequences applicable to the exchange of New Notes for Old Notes in the
exchange offer and, in the case of an initial beneficial owner of the notes that
is a "non-United States holder," the material U.S. federal income tax
consequences of the ownership and disposition of the New Notes constitutes the
opinion of Andrews Kurth LLP, our legal counsel, insofar as it relates to
matters of U.S. federal income tax and legal conclusions with respect to those
matters. The following discussion is not a complete discussion of all the
potential tax consequences that may be relevant to you. This discussion is based
upon the Internal Revenue Code of 1986, as amended, its legislative history,
existing and proposed regulations thereunder, published rulings, and court
decisions, all as in effect on the date of this document, and all of which are
subject to change, possibly on a retroactive basis. For purposes of this
discussion, you are a "United States holder" if you are a beneficial owner of
notes and you are a "United States person" for United States federal tax
purposes or a "non-United States holder" if you are a beneficial owner of notes
and are not a "United States holder." A "United States person" is:
- a citizen or resident of the United States,
- a corporation, partnership, or other entity treated as a corporation or
partnership for United States federal income tax purposes, created or
organized in the United States or under the laws of the United States or
of any state thereof including the District of Columbia,
- an estate whose income is subject to United States federal income
taxation regardless of its source, or
- a trust if a U.S. court is able to exercise primary supervision over the
administration of the trust and one or more United States persons have
the authority to control all substantial decisions of the trust or
certain electing trusts that were in existence on August 19, 1996, and
treated as a domestic trust on that date.
If a partnership holds notes, the tax treatment of a partner will generally
depend on the status of the partner and on the activities of the partnership.
Partners of partnerships holding notes should consult their tax advisors.
This discussion only applies to you if you are a beneficial owner of notes
who holds the notes as capital assets. The tax treatment of holders of the notes
may vary depending upon their particular situations. Certain holders, including
insurance companies, tax exempt organizations, financial institutions,
broker-dealers and persons holding the notes as part of a "straddle," "hedge" or
"conversion transaction," may be subject to special rules not discussed below.
TAX CONSEQUENCES OF THE EXCHANGE OFFER
The exchange of New Notes for Old Notes pursuant to the exchange offer will
not be a taxable event for United States federal income tax purposes. United
States holders and non-United States Holders will not recognize any taxable gain
or loss as a result of the exchange and will have the same tax basis and holding
period in the New Notes as they had in the Old Notes immediately before the
exchange.
TAX CONSEQUENCES TO NON-UNITED STATES HOLDERS
Interest. Interest that we pay to you will not be subject to U.S. federal
income tax and withholding of U.S. federal income tax will not be required on
that payment if you:
- do not actually or constructively own 10% or more of the total combined
voting power of all classes of our stock,
- are not a controlled foreign corporation with respect to which we are a
related person,
- are not a bank receiving interest on a loan entered into in the ordinary
course of business within the meaning of the Internal Revenue Code, and
130
- you certify to us, our payment agent, or the person who would otherwise
be required to withhold United States tax, on Form W-8BEN or applicable
substitute form, under penalties of perjury, that you are not a United
States person and provide your name and address.
If you do not satisfy the preceding requirements, your interest on a New
Note would generally be subject to United States withholding tax at a flat rate
of 30% unless that rate is reduced or eliminated pursuant to an applicable tax
treaty.
If you are engaged in trade or business in the United States, and if
interest on a New Note is effectively connected with the conduct of that trade
or business or in the case of an applicable tax treaty, is attributable to a
permanent establishment you maintain in the United States, you will be exempt
from United States withholding tax but will be subject to regular United States
federal income tax on the interest in the same manner as if you were a United
States person. Because this discussion does not address the United States
federal income tax consequences of the ownership and disposition of exchange
notes by a United States holder, you should consult your own tax advisor if you
are engaged in a trade or business in the United States. In order to establish
an exemption from United States withholding tax, you may provide to us, our
payment agent or the person who would otherwise be required to withhold United
States tax, a properly completed and executed IRS Form W-8ECI or applicable
substitute form. In addition to regular United States federal income tax, if you
are a foreign corporation, you may be subject to a United States branch profits
tax.
Gain on Disposition. You generally will not be subject to United States
federal income tax with respect to gain recognized on a sale, redemption,
exchange or other disposition of a New Note unless:
- the gain is effectively connected with your conduct of a trade or
business within the United States, or, under an applicable tax treaty, is
attributable to a permanent establishment you maintain in the United
States; or
- if you are an individual, you are present in the United States for 183 or
more days in the taxable year of the disposition and certain other
requirements are met.
Information Reporting and Backup Withholding. Backup withholding and
information reporting generally will not apply to payments of principal or
interest on the New Notes by us or our paying agent to you if you certify as to
your non-U.S. status under penalties of perjury or otherwise establish an
exemption, provided that neither we nor our paying agent has actual knowledge
that you are a United States person or that the conditions of any other
exemptions are not in fact satisfied. However, information reporting on IRS Form
1042-S may still apply with respect to interest payments.
The payment of the proceeds of the disposition of New Notes to or through
the United States office of a United States or foreign broker will be subject to
information reporting and backup withholding unless you provide the
certification described above or otherwise establish an exemption. The proceeds
of a disposition effected outside the United States by you of New Notes to or
through a foreign office of a broker generally will not be subject to backup
withholding or information reporting. However, if that broker is a United States
person, a controlled foreign corporation for United States tax purposes, a
foreign person 50% or more of whose gross income from all sources for certain
periods is actively connected with a trade or business in the United States, or
a foreign partnership that is engaged in the conduct of a trade or business in
the United States or that has one or more partners that are United States
persons who in the aggregate hold more than 50% of the income or capital
interests in the partnership, information reporting requirements will apply
unless that broker has documentary evidence in its files of your non-U.S. status
and has no actual knowledge to the contrary or unless you otherwise establish an
exemption.
Any amounts withheld from a payment to you under the backup withholding
rules will be allowed as a credit against your United States federal income tax
liability and may entitle you to a refund, provided you furnish the required
information to the United States Internal Revenue Service.
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PLAN OF DISTRIBUTION
Based on interpretations by the staff of the SEC set forth in no action
letters issued to third parties, we believe that you may transfer New Notes
issued under the exchange offer in exchange for Old Notes unless you are:
- our "affiliate" within the meaning of Rule 405 under the Securities Act;
- a broker-dealer that acquired Old Notes directly from us; or
- a broker-dealer that acquired Old Notes as a result of market-making or
other trading activities without compliance with the registration and
prospectus delivery provisions of the Securities Act;
provided that you acquire the New Notes in the ordinary course of your business
and you are not engaged in, and do not intend to engage in, and have no
arrangement or understanding with any person to participate in, a distribution
of the New Notes. Broker-dealers receiving New Notes in the exchange offer will
be subject to a prospectus delivery requirement with respect to resales of the
New Notes.
Each broker-dealer that receives New Notes for its own account pursuant to
the exchange offer must acknowledge that it will deliver a prospectus in
connection with any resale of such New Notes. This prospectus, as it may be
amended or supplemented from time to time, may be used by a broker-dealer in
connection with resales of New Notes received in exchange for Old Notes where
such Old Notes were acquired as a result of market-making activities or other
trading activities. In addition, until [ ], 2003, all dealers
effecting transactions in the New Notes may be required to deliver a prospectus.
We will not receive any proceeds from any sale of New Notes by
broker-dealers. New Notes received by broker-dealers for their own account
pursuant to the exchange offer may be sold from time to time in one or more
transactions in the over-the-counter market, in negotiated transactions, through
the writing of options on the New Notes or a combination of such methods of
resale, at market prices prevailing at the time of resale, at prices related to
such prevailing market prices or negotiated prices. Any such resale may be made
directly to purchasers or to or through brokers or dealers who may receive
compensation in the form of commissions or concessions from any such
broker-dealer or the purchasers of any such New Notes. Any broker-dealer that
resells New Notes that were received by it for its own account pursuant to the
exchange offer and any broker or dealer that participates in a distribution of
such New Notes may be deemed to be an "underwriter" within the meaning of the
Securities Act and any profit on any such resale of New Notes and any commission
or concessions received by any such persons may be deemed to be underwriting
compensation under the Securities Act. The letter of transmittal states that, by
acknowledging that it will deliver and by delivering a prospectus, a
broker-dealer will not be deemed to admit that it is an "underwriter" within the
meaning of the Securities Act.
We have agreed to pay all expenses incident to the exchange offer
(including the expenses of one counsel for the holders of the notes), other than
commissions or concessions of any brokers or dealers, and will indemnify the
holders of the notes (including any broker-dealers) against specified
liabilities, including liabilities under the Securities Act.
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LEGAL MATTERS
The validity of the notes and certain other matters will be passed upon for
us by Andrews Kurth LLP, Houston, Texas.
EXPERTS
The financial statements as of December 31, 2002 and 2001 and for each of
the three years in the period ended December 31, 2002 included in this
Prospectus have been so included in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
Certain estimates of our natural gas and oil reserves and related
information as of December 31, 2002, 2001 and 2000 included in this prospectus
have been derived from engineering reports reviewed by Huddleston & Co., Inc.,
Houston, Texas and all such information has been so included on the authority of
such firm as experts regarding the matters contained in its report. The review
conducted by Huddleston & Co., Inc. meets the standard of an "estimate" as
defined by the Society of Petroleum Engineers.
AVAILABLE INFORMATION
We have not been subject to the reporting requirements of the Securities
Exchange Act of 1934, as amended. We have filed with the SEC a registration
statement on Form S-4 under the Securities Act, with respect to the offer to
exchange New Notes for Old Notes pursuant to this prospectus. This prospectus,
filed as a part of the registration statement, does not contain all of the
information set forth in the registration statement or the exhibits and
schedules thereto in accordance with the rules and regulations of the SEC and
reference is hereby made to such omitted information. Statements made in this
prospectus concerning the contents of any contract, agreement or other document
filed as an exhibit to the registration statement are summaries of the terms of
such contracts, agreements or documents and are not necessarily complete.
Reference is made to each such exhibit for a more complete description of the
matters involved and such statements shall be deemed qualified in their entirety
by such reference. The registration statement and the exhibits and schedules
thereto filed with the SEC may be inspected, without charge, and copies may be
obtained at prescribed rates, at the public reference facility maintained by the
SEC at Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549. You may
call the SEC at 1-800-SEC-0330 for further information on the operation of the
public reference rooms. In addition, the registration statement and other public
filings can be obtained from the SEC internet site at http://www.sec.gov. For
further information pertaining to the notes and to us, reference is made to the
registration statement.
As a result of the filing of the Form S-4 and the exchange of New Notes for
Old Notes, we will become subject to information and periodic reporting
requirements of the Exchange Act, and we will file periodic reports and other
information with the SEC. These reports and other information may be inspected
and copied at the SEC's public reference facility at prescribed rates or
obtained from the SEC's internet website.
Our parent El Paso Corporation files reports, proxy statements and other
information with the SEC under the Exchange Act. Each holder of Old Notes should
consider the information disclosed therein in addition to the matters described
in this prospectus before making a decision to participate in the exchange
offer.
133
GLOSSARY OF TERMS
The terms defined in this section are used throughout this prospectus:
/d......................... Per day.
Bbl........................ One stock tank barrel, of 42 U.S. gallons liquid
volume, used herein in reference to crude oil,
condensate or natural gas liquids.
Bbtu....................... Billion British thermal units.
Bbls/d..................... Barrels of oil produced per day.
Bcf........................ One billion cubic feet of natural gas.
Bcfe....................... One billion cubic feet of natural gas equivalent
using the ratio of one barrel of crude oil,
condensate or natural gas liquids to 6 Mcf of
natural gas.
Bcp/d...................... Barrels of condensate per day.
BOE........................ One barrel of oil equivalent using the ratio of one
barrel of crude oil, condensate or natural gas
liquids to 6 Mcf of natural gas.
BOE/d...................... BOEs produced per day.
Btu........................ British thermal unit, which is the heat required to
raise the temperature of a one-pound mass of water
from 58.5 to 59.5 degrees Fahrenheit.
Finding and development
costs per Mcfe............. Total capital costs related to acquisition,
exploration and development activities divided by
total proved reserve revisions, extensions,
discoveries and proved reserve acquisitions.
Henry Hub spot price....... The price of natural gas, in dollars per MMbtu,
being traded at the Henry Hub in Louisiana in
transactions for next-day delivery, measured
downstream from the wellhead after the natural gas
liquids have been removed and a transportation cost
has been incurred.
MBbls...................... One thousand barrels of crude oil, condensate or
natural gas liquids.
MBOE....................... One thousand BOEs.
Mcf........................ One thousand cubic feet of natural gas.
Mcf/d...................... Mcf produced per day.
Mcfe....................... One thousand cubic feet of natural gas equivalents.
A-1
MMBbls..................... One million barrels of crude oil, condensate or
natural gas liquids.
MMBOE...................... One million BOEs.
MMBtu...................... One million British thermal units.
MMcf....................... One million cubic feet of natural gas.
MMcf/d..................... MMcf produced per day.
MMcfe...................... One million cubic feet of natural gas equivalents.
Net Present Value of Proved
Reserves................... See "PV-10 value" definition.
NYMEX...................... The New York Mercantile Exchange.
NYMEX Henry Hub price...... The NYMEX trading price of natural gas futures
contracts providing for delivery at the Henry Hub
in Louisiana.
PV-10 value................ When used with respect to oil and natural gas
reserves, PV-10 value means the estimated future
gross revenue to be generated from the production
of proved reserves, net of estimated production and
future development costs, using prices and costs in
effect at the determination date, before income
taxes, and without giving effect to non-property-
related expenses, discounted to a present value
using an annual discount rate of 10% in accordance
with the guidelines of the SEC.
Proved developed
reserves................... Reserves that can be expected to be recovered
through existing wells with existing equipment and
operating methods. See Rule 4-10(a), paragraph (3)
of Regulation S-X under the Exchange Act for a
complete definition.
Proved reserves............ The estimated quantities of crude oil, natural gas
and natural gas liquids which geological and
engineering data demonstrate with reasonable
certainty to be recoverable in future years from
known reservoirs under existing economic and
operating conditions. See Rule 4-10(a), paragraphs
(2), (2i), (2ii), and (2iii) of Regulation S-X
under the Exchange Act for a complete definition.
Proved undeveloped
reserves................... Reserves that are expected to be recovered from new
wells on undrilled acreage or from existing wells
where a relatively major expenditure is required.
See Rule 4-10(a), paragraph (4) of Regulation S-X
under the Exchange Act for a complete definition.
Reserve Estimate........... Estimates of the total amount and net present value
of proved reserves are determined under the rules
established by Regulation S-X Rule 4-10. Reserve
estimates are made using established generally
accepted geologic and engineering methods. For a
complete discussion of the standards for estimating
reserves and other reserve information, please
refer to the Society of Petroleum Engineers website
at www.spe.org under "About Oil and Natural
Gas -- Petroleum Reserves and Resource
Definitions".
Standardized Measure of
Discounted Future Net Cash
Flows...................... Represents the future cash inflows based on
year-end prices and proved reserves, less future
development and production costs assuming current
costs and economic conditions, less future income
tax
A-2
expenses at the statutory rate, discounted at the
SEC mandated 10% rate.
Tcf........................ One trillion cubic feet of natural gas.
Tcfe....................... One trillion cubic feet of natural gas equivalents.
WTI Cushing spot price..... The price of West Texas Intermediate grade crude
oil, in dollars per barrel, in transactions for
immediate delivery at Cushing, Oklahoma.
A-3
INDEX TO FINANCIAL STATEMENTS
<Table>
<Caption>
PAGE
----
HISTORICAL CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Accountants........................... F-2
Consolidated Statements of Income for the years ended
December 31, 2002, 2001 and 2000.......................... F-3
Consolidated Balance Sheets as of December 31, 2002 and
2001...................................................... F-4
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000.......................... F-5
Consolidated Statements of Stockholder's Equity for the
years ended December 31, 2002, 2001 and 2000.............. F-6
Consolidated Statements of Comprehensive Income for the
years ended December 31, 2002, 2001 and 2000.............. F-7
Notes to Consolidated Financial Statements.................. F-8
Condensed Consolidated Statements of Income (Unaudited) for
the nine months ended September 30, 2003 and 2002......... F-30
Condensed Consolidated Balance Sheets (Unaudited) as of
September 30, 2003 and December 31, 2002.................. F-31
Condensed Consolidated Statements of Cash Flows (Unaudited)
for the nine months ended September 30, 2003 and 2002..... F-32
Condensed Consolidated Statements of Comprehensive Income
(Unaudited) for the nine months ended September 30, 2003
and 2002.................................................. F-33
Notes to Condensed Consolidated Financial Statements
(Unaudited)............................................... F-34
PRO FORMA FINANCIAL STATEMENTS
Note regarding Pro Forma Financial Statements............... F-45
Unaudited Pro Forma Income Statement for the nine months
ended September 30, 2003.................................. F-46
Unaudited Pro Forma Income Statement for the year ended
December 31, 2002......................................... F-47
Notes to Unaudited Pro Forma Financial Statements........... F-48
</Table>
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholder of
El Paso Production Holding Company:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of income, of stockholder's equity, of
comprehensive income and of cash flows present fairly, in all material respects,
the financial position of El Paso Production Holding Company (the "Company") at
December 31, 2002 and 2001, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2002 in
conformity with accounting principles generally accepted in the United States of
America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
April 25, 2003, except for the last paragraph of Note 14,
for which the date is May 20, 2003
F-2
EL PASO PRODUCTION HOLDING COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(IN MILLIONS)
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-------------------------
2002 2001 2000
------- ------ ------
Operating revenues
Natural gas and oil sales -- third parties................ $ 166 $106 $307
Natural gas and oil sales -- affiliates................... 685 497 225
Other..................................................... (10) 1 5
----- ---- ----
Total operating revenues............................... 841 604 537
Operating expenses
Cost of sales............................................. 55 43 32
Operation and maintenance................................. 137 111 90
Merger-related costs...................................... -- 2 --
Gain on long-lived assets................................. (2) -- --
Depreciation, depletion and amortization.................. 317 234 206
Taxes, other than income taxes............................ 25 29 22
----- ---- ----
Total operating expenses............................... 532 419 350
----- ---- ----
Operating income............................................ 309 185 187
Other income................................................ 5 1 4
Interest income from affiliates............................. 8 9 8
Earnings from unconsolidated affiliates..................... 6 29 11
Minority interest in consolidated subsidiaries.............. (3) (4) --
----- ---- ----
Income before income taxes.................................. 325 220 210
Income taxes................................................ (112) (71) (70)
----- ---- ----
Net income.................................................. $ 213 $149 $140
===== ==== ====
</Table>
See accompanying notes.
F-3
EL PASO PRODUCTION HOLDING COMPANY
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE AMOUNTS)
<Table>
<Caption>
DECEMBER 31,
---------------
2002 2001
------ ------
ASSETS
Current assets
Cash and cash equivalents................................. $ 156 $ --
Accounts and notes receivable
Customer, net of allowance of $5 in 2002 and $6 in
2001................................................... 114 164
Affiliates.............................................. 676 536
Other................................................... 4 4
Assets from price risk management activities.............. 34 11
Income tax receivable from affiliate...................... 131 152
Other..................................................... 21 9
------ ------
Total current assets............................... 1,136 876
------ ------
Property, plant and equipment, at cost
Natural gas and oil properties
Proved properties -- full cost method................... 6,927 6,465
Unevaluated costs excluded from full cost base.......... 276 132
Other..................................................... 107 116
------ ------
7,310 6,713
Less accumulated depreciation, depletion and
amortization............................................ 4,502 4,612
------ ------
Total property, plant and equipment, net........... 2,808 2,101
------ ------
Other assets
Investments in unconsolidated affiliates.................. 232 256
Assets from price risk management activities.............. -- 3
Restricted cash........................................... 6 --
Notes receivable-affiliates............................... 36 --
------ ------
274 259
------ ------
Total assets....................................... $4,218 $3,236
====== ======
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Accounts payable
Trade................................................... $ 73 $ 33
Affiliates.............................................. 10 7
Other................................................... 161 40
Deferred income taxes..................................... -- 61
Liabilities from price risk management activities......... 9 20
Other..................................................... 12 24
------ ------
Total current liabilities.......................... 265 185
------ ------
Other
Liabilities from price risk management activities......... 400 62
Deferred income taxes..................................... 120 57
Other..................................................... 11 24
------ ------
531 143
------ ------
Commitments and contingencies
Minority interest of consolidated subsidiaries.............. 113 110
Stockholder's equity
Common stock, par value $1 per share; 1,000 shares
authorized and outstanding.............................. -- --
Additional paid-in capital................................ 3,465 2,956
Retained earnings (accumulated deficit)................... 68 (114)
Accumulated other comprehensive loss...................... (224) (44)
------ ------
Total stockholder's equity......................... 3,309 2,798
------ ------
Total liabilities and stockholder's equity......... $4,218 $3,236
====== ======
</Table>
See accompanying notes.
F-4
EL PASO PRODUCTION HOLDING COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
------- ----- -----
Cash flows from operating activities
Net income................................................ $ 213 $ 149 $ 140
Adjustments to reconcile net income to net cash from
operating activities
Depreciation, depletion and amortization............... 317 234 206
Deferred income tax expense............................ 73 141 --
Gain on long-lived assets.............................. (2) -- --
Undistributed earnings from unconsolidated
affiliates............................................ (13) (18) (10)
Other non-cash income items............................ 28 (1) (11)
Working capital changes, net of non-cash
transactions.......................................... 233 (153) (128)
------- ----- -----
Net cash provided by operating activities............ 849 352 197
------- ----- -----
Cash flows from investing activities
Capital expenditures...................................... (1,290) (675) (500)
Net proceeds from the sale of assets...................... 363 20 3
Investments and other..................................... 36 -- (25)
------- ----- -----
Net cash used in investing activities................ (891) (655) (522)
------- ----- -----
Cash flows from financing activities
Change in notes receivable from parent.................... (271) (237) 214
Restricted cash........................................... (6) -- 11
Dividends................................................. (374) (28) (3)
Contributions from parent................................. 849 568 101
------- ----- -----
Net cash provided by financing activities............ 198 303 323
------- ----- -----
Increase in cash and cash equivalents....................... 156 -- (2)
Cash and cash equivalents
Beginning of period....................................... -- -- 2
------- ----- -----
End of period............................................. $ 156 $ -- $ --
======= ===== =====
</Table>
See accompanying notes.
F-5
EL PASO PRODUCTION HOLDING COMPANY
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(IN MILLIONS, EXCEPT SHARES OF COMMON STOCK)
<Table>
<Caption>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------------------
2002 2001 2000
--------------- --------------- ---------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------ ------ ------ ------ ------ ------
Common stock, $1.00 par:
Balance at beginning of year.............. 1,000 $ -- 1,000 $ -- 1,000 $ --
----- ------ ----- ------ ----- ------
Balance at end of year................. 1,000 -- 1,000 -- 1,000 --
----- ------ ----- ------ ----- ------
Additional paid-in capital:
Balance at beginning of year.............. 2,956 2,382 2,267
Contribution from parent.................. 849 568 101
Tax benefit of equity plans............... 3 6 14
Dividends................................. (343) -- --
------ ------ ------
Balance at end of year................. 3,465 2,956 2,382
------ ------ ------
Retained earnings:
Balance at beginning of year.............. (114) (235) (372)
Net income................................ 213 149 140
Dividends................................. (31) (28) (3)
------ ------ ------
Balance at end of year................. 68 (114) (235)
------ ------ ------
Accumulated other comprehensive (loss):
Balance at beginning of year.............. (44) -- --
Other comprehensive (loss)................ (180) (44) --
------ ------ ------
Balance at end of year................. (224) (44) --
------ ------ ------
Total stockholder's equity.................. 1,000 $3,309 1,000 $2,798 1,000 $2,147
===== ====== ===== ====== ===== ======
</Table>
See accompanying notes.
F-6
EL PASO PRODUCTION HOLDING COMPANY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN MILLIONS)
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-----------------------
2002 2001 2000
------ ------ -----
Net income.................................................. $ 213 $ 149 $140
----- ----- ----
Net gains (losses) from cash flow hedging activities:
Cumulative-effect of transition adjustment (net of income
tax of $359)........................................... -- (667) --
Unrealized mark-to-market gains (losses) arising during
period (net of income tax of $(122) and $200 in 2002
and 2001).............................................. (203) 386 --
Reclassification adjustments for changes in initial value
to settlement date (net of income tax of $18 and $137
in 2002 and 2001)...................................... 23 237 --
----- ----- ----
Other comprehensive (loss)............................. (180) (44) --
----- ----- ----
Comprehensive income........................................ $ 33 $ 105 $140
===== ===== ====
</Table>
See accompanying notes.
F-7
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
Our consolidated financial statements include the accounts of all
majority-owned, controlled subsidiaries after the elimination of all significant
intercompany accounts and transactions. Our financial statements for prior
periods include reclassifications that were made to conform to the current year
presentation. Those reclassifications did not impact our reported net income or
stockholder's equity.
PRINCIPLES OF CONSOLIDATION
We consolidate entities when we have the ability to control the operating
and financial decisions and policies of that entity. Where we can exert
significant influence over, but do not control, those policies and decisions, we
apply the equity method of accounting. We use the cost method of accounting
where we are unable to exert significant influence over the entity. The
determination of our ability to control or exert significant influence over an
entity involves the use of judgment as to the extent of our control or influence
and that of the other equity owners or participants of the entity.
USE OF ESTIMATES
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles requires the use of estimates and assumptions
that affect the amounts we report as assets, liabilities, revenues, and expenses
and our disclosures in these financial statements. In addition, our accounting
policies for asset impairments, natural gas and oil properties, environmental
costs and other contingencies, asset retirement obligation, and price risk
management activities require estimates that involve complex situations and a
high degree of judgment. Actual results can, and often do, differ from those
estimates.
CASH AND CASH EQUIVALENTS
We consider short-term investments with an original maturity of less than
three months to be cash equivalents.
RESTRICTED CASH
We classify cash in bank accounts that is unavailable for immediate
withdrawal, that is subject to limitations on its use, or that is considered a
compensating balance as restricted cash. At December 31, 2002 we had $6 million
in restricted cash.
ACCOUNTS RECEIVABLE AND ACCOUNTS PAYABLE
Trade receivables and payables are due to and from third parties. We
designate transactions with our parent, El Paso Corporation, and its
subsidiaries and related parties as affiliates. Our accounts payable-other
consists of payables related to our operating expenses, capitalized costs and
checks in transit.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
We establish provisions for losses on accounts receivable and for natural
gas imbalances due from shippers and operators if we determine that we will not
collect all or part of the outstanding balance. We regularly review
collectibility and establish or adjust our allowance as necessary using the
specific identification method. Our allowance was $5 million and $6 million as
of December 31, 2002 and 2001, respectively.
F-8
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
INVENTORY
Materials and supplies are valued at lower of cost or market with cost
determined using the average cost method.
NATURAL GAS AND OIL IMBALANCES
Natural gas and oil imbalances occur when the actual amount of natural gas
or oil delivered from or received by a pipeline system, processing plant or
storage facility differs from the contractual amount scheduled to be delivered
or received. We record these imbalances due to or from shippers and operators at
an appropriate market index price. Imbalances are settled in cash subject to the
contractual terms of settlement and tariffs.
Imbalances due from others are reported in our balance sheet as accounts
receivable from customers. Imbalances owed to others are reported on the balance
sheet as trade accounts payable. In addition, all imbalances are classified as
current or long-term depending on when we expect to settle them.
ASSET IMPAIRMENTS
We apply the provisions of SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, to account for asset impairments related to
non-full cost pool assets. Under this standard, we evaluate an asset for
impairment when events or circumstances indicate that a long-lived asset's
carrying value may not be recovered. These events include market declines,
changes in the manner in which we intend to use an asset or decisions to sell an
asset and adverse changes in the legal or business environment such as adverse
actions by regulators. When we decide to exit or sell a long-lived asset or
group of assets, we adjust the carrying value of these assets downward, if
necessary, to the estimated sales price, less costs to sell. We also reclassify
the asset or assets as either held for sale or as discontinued operations,
depending on whether they have independently determinable cash flows.
NATURAL GAS AND OIL PROPERTIES
We use the full cost method to account for our natural gas and oil
properties. Under the full cost method, substantially all productive and
nonproductive costs incurred in connection with the acquisition, exploration and
development of natural gas and oil reserves are capitalized. These capitalized
amounts include the costs of all unproved properties, internal costs directly
related to acquisition, development and exploration activities and capitalized
interest.
We amortize these costs using the unit of production method over the life
of our proved reserves. Each quarter, we calculate the unit of production
depletion rate based on our estimated production and an estimate of proved
reserves. Capitalized costs associated with unproved properties are excluded
from amortizable costs until these properties are evaluated. Future development
costs and dismantlement, restoration and abandonment costs, net of estimated
salvage values, are included in costs subject to amortization.
Our capitalized costs, net of related income tax effects, are limited to a
ceiling based on the present value of future net revenues using end of period
spot prices discounted at 10 percent, plus the lower of cost or fair market
value of unproved properties, net of related income tax effects. If these
discounted revenues are not equal to or greater than total capitalized costs, we
are required to write down our capitalized costs to this level. We perform this
ceiling test calculation each quarter. Any required write-downs are included in
our income statement as a ceiling test charge. Our ceiling test calculations
include the effects of derivative instruments we have designated as cash flow
hedges of our anticipated future natural gas and oil production.
F-9
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
We do not recognize a gain or loss on sales of our natural gas and oil
properties, unless those sales would significantly alter the relationship
between capitalized costs and proved reserves. We treat sales proceeds on
non-significant sales as an adjustment to the cost of our properties.
REVENUE RECOGNITION
Our revenues are derived principally through physical sales of natural gas,
oil and natural gas liquids produced. Revenues from sales of these products are
recorded upon the passage of title using the sales method, net of any royalty
interests or other profit interests in the produced product. When actual natural
gas sales volumes exceed our entitled share of sales volumes, an overproduced
imbalance occurs. To the extent the overproduced imbalance exceeds our share of
the remaining estimated proved natural gas reserves for a given property, we
record a liability. Costs associated with the transportation and delivery of
production are included in cost of sales.
TAXES OTHER THAN INCOME TAXES
Severance taxes, payroll taxes, ad valorem taxes, franchise taxes, and
miscellaneous other taxes are included in taxes other than income taxes on the
income statement.
ENVIRONMENTAL COSTS AND OTHER CONTINGENCIES
We expense or capitalize expenditures for ongoing compliance with
environmental regulations that relate to past or current operations as
appropriate. We expense amounts for clean up of existing environmental
contamination caused by past operations which do not benefit future periods by
preventing or eliminating future contamination. We record liabilities when our
environmental assessments indicate that remediation efforts are probable, and
the costs can be reasonably estimated. Estimates of our liabilities are based on
currently available facts, existing technology and presently enacted laws and
regulations taking into consideration the likely effects of inflation and other
societal and economic factors, and include estimates of associated legal costs.
These amounts also consider prior experience in remediating contaminated sites,
other companies' clean-up experience and data released by the EPA or other
organizations. These estimates are subject to revision in future periods based
on actual costs or new circumstances and are included in our balance sheet in
other current and long-term liabilities at their undiscounted amounts. We
evaluate recoveries from insurance coverage, government sponsored and other
programs separately from our liability and, when recovery is assured, we record
and report an asset separately from the associated liability in our financial
statements.
We recognize liabilities for other contingencies when we have an exposure
that, when fully analyzed, indicates it is both probable that an asset has been
impaired or that a liability has been incurred and the amount of impairment or
loss can be reasonably estimated. Funds spent to remedy these contingencies are
charged against a reserve, if one exists, or expensed. When a range of probable
loss can be estimated, we accrue the most likely amount or at least the minimum
within the range of probable loss.
PRICE RISK MANAGEMENT ACTIVITIES
We engage in hedging activities on our natural gas and oil production to
obtain more determinable cash flows and to mitigate the risk of downward price
movements on sales of these commodities. We do this through natural gas and oil
swaps with our affiliate, El Paso Merchant, who then enters into third party
transactions.
We account for our non-trading derivative instruments under SFAS No. 133
Accounting for Derivatives and Hedging Activities. Under SFAS No. 133, all
derivatives are reflected in our balance sheet at their fair value as price risk
management activities. We classify our price risk management activities as
F-10
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
either current or non-current assets or liabilities based on our overall
position by counterparty and their anticipated settlement date. Cash inflows and
outflows associated with the settlement of our price risk management activities
are recognized in operating cash flows, and any receivables and payables
resulting from these settlements are reported separately from price risk
management activities in our balance sheet as trade receivables and payables.
The accounting for revenues and expenses associated with our price risk
management activities varies based on whether those activities are trading
activities or non-trading activities. See Note 6 for a further description of
our price risk management activities.
In November 2002, El Paso announced its intention to exit the energy
trading business over the next 18 to 24 months. After El Paso has implemented
its exit strategy, we will assume the responsibility for managing our own third
party derivative transactions.
INCOME TAXES
We report current income taxes based on our taxable income, and we provide
for deferred income taxes to reflect estimated future tax payments and receipts.
Deferred taxes represent the tax impacts of differences between the financial
statement and tax bases of assets and liabilities and carryovers at each year
end. We account for tax credits under the flow-through method, which reduces the
provision for income taxes in the year the tax credits first become available.
We reduce deferred tax assets by a valuation allowance when, based on our
estimates, it is more likely than not that a portion of those assets will not be
realized in a future period. The estimates utilized in recognition of deferred
tax assets are subject to revision, either up or down, in future periods based
on new facts or circumstances.
El Paso maintains a tax accrual policy to record both regular and
alternative minimum taxes for companies included in its consolidated federal
income tax return. The policy provides, among other things, that (i) each
company in a taxable income position will accrue a current expense equivalent to
its federal income tax, and (ii) each company in a tax loss position will accrue
a benefit to the extent its deductions, including general business credits, can
be utilized in the consolidated return. El Paso pays all federal income tax
directly to the IRS and, under a separate tax billing agreement, El Paso may
bill or refund its subsidiaries for their portion of these income tax payments.
NEW ACCOUNTING PRONOUNCEMENTS ISSUED BUT NOT YET ADOPTED
As of December 31, 2002, there were a number of accounting standards and
interpretations that had been issued, but not yet adopted by us. Below is a
discussion of the more significant standards that could impact us.
Accounting for Asset Retirement Obligations
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS
No. 143, Accounting for Asset Retirement Obligations. This statement requires
companies to record a liability for the estimated retirement and removal costs
of long-lived assets used in their business. The liability is recorded at its
fair value, with a corresponding asset which is depreciated over the remaining
useful life of the long-lived asset to which the liability relates. An ongoing
expense will also be recognized for changes in the value of the liability as a
result of the passage of time. The provisions of SFAS No. 143 are effective for
fiscal years beginning after June 15, 2002. Upon our adoption of SFAS No. 143 on
January 1, 2003, we recognized current liabilities of $9.1 million, long-term
liabilities of $67.1 million, non-current retirement assets of $73.2 million,
and a pre-tax charge to earnings of $3.0 million as the cumulative effect of an
accounting change. Our liability relates primarily to our obligations to plug
abandoned wells over the next one to 99 years.
F-11
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Accounting for Costs Associated with Exit or Disposal Activities
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. This statement will require us to recognize
costs associated with exit or disposal activities when they are incurred rather
than when we commit to an exit or disposal plan. Examples of costs covered by
this guidance include lease termination costs, employee severance costs
associated with a restructuring, discontinued operations, plant closings or
other exit or disposal activities. The statement is effective for fiscal years
beginning after December 31, 2002, and will impact any exit or disposal
activities we initiate after January 1, 2003. We do not expect any significant
impact to result from the adoption of this statement.
Accounting for Guarantees
In November 2002, the FASB issued FIN No. 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others. This interpretation requires that companies record a
liability for all guarantees issued after January 31, 2003, including financial,
performance and fair value guarantees. This liability is recorded at its fair
value upon issuance and does not affect any existing guarantees issued before
January 31, 2003. This standard also requires expanded disclosures on all
existing guarantees at December 31, 2002. El Paso issues any guarantees needed
on our behalf. While we currently do not believe that there will be any initial
impact of adopting this standard, it will impact any guarantees we might issue
in the future.
2. MERGERS, ACQUISITIONS AND DIVESTITURES
MERGER
In January 2001, El Paso merged with The Coastal Corporation (El Paso CGP).
El Paso accounted for the transaction as a pooling of interests and converted
each share of El Paso CGP's common stock and Class A common stock on a tax-free
basis into 1.23 shares of El Paso's stock. El Paso also exchanged El Paso CGP's
outstanding convertible preferred stock for its common stock on the same basis
as if the preferred stock had been converted into El Paso CGP common stock
immediately prior to the merger. In the merger, El Paso issued approximately 271
million shares of its common stock, including 4 million shares in exchange for
El Paso CGP stock options. As part of the merger, we recorded a pre-tax merger-
related charge in 2001 of $2.1 million to consolidate offices.
ACQUISITIONS
In March 2002, we acquired natural gas and oil properties located in south
Texas from an affiliate of El Paso CGP for $395.5 million and the Prince
offshore platform from GulfTerra (formerly El Paso Energy Partners) for $190
million. For more information on these transactions, refer to Note 3.
In July 2002, we also acquired Vermejo Mineral Corporation from a third
party for approximately $140 million. The acquisition was accounted for as a
purchase and all of the purchase price was assigned to natural gas and oil
properties in our full cost pool.
DIVESTITURES
In March 2002, we sold natural gas and oil properties and related non-full
cost properties in east Texas to third parties for $382.2 million. We treated
the full cost pool sales proceeds as adjustment to the cost of the properties in
our full cost pool. We recognized a gain of $2.4 million on the sale of the
non-full cost pool assets.
F-12
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. RELATED PARTY TRANSACTIONS
SALES
We sell our natural gas primarily to affiliates of El Paso at spot-market
prices. Before consideration of hedges, sales of natural gas to affiliates of El
Paso accounted for approximately 75 percent of our sales in 2002 and 85 percent
of sales in 2001. Before consideration of hedges, sales of oil and condensate to
affiliates accounted for 82 and 21 percent of our sales in 2002 and 2001.
In November 2002, El Paso announced its intention to exit the energy
trading business over the next 18 to 24 months. After El Paso has implemented
its exit strategy, we will assume the responsibility for marketing our own
natural gas production.
ACCOUNTS RECEIVABLE AND ACCOUNTS PAYABLE
Accounts receivable due from affiliates at December 31, 2002 and 2001 was
$90.1 million and $176.6 million, respectively. Accounts payable due to
affiliates at December 31, 2002 and 2001 was $9.7 million and $6.7 million,
respectively. These affiliate receivables and payables were created during the
normal course of business and are settled on a monthly basis.
RED RIVER FINANCING (also referred to as Trinity River)
During 1999 El Paso formed Sabine River Investors, L.L.C., a wholly owned
limited liability company, and other separate legal entities, for the purpose of
generating funds for El Paso to invest in capital projects and other assets. El
Paso pledged assets to collateralize the Sabine borrowings, including 100
percent of our investments in Sabine River Investors VI, L.L.C., Sabine River
Investors VII, L.L.C., Sabine River Investors VIII, L.L.C., and Sabine River
Investors IX, L.L.C. In the event of default on the provisions of the financing,
El Paso will transfer its investment in Sabine River Investors VI, L.L.C.,
Sabine River Investors VII, L.L.C., and Sabine River Investors VIII, L.L.C. to
the third party investors who provided the financing. At December 31, 2002 and
2001, El Paso's investment in Sabine River Investors VI, L.L.C. was $1,081.0
million and $678.3 million, Sabine River Investors VII, L.L.C. was $577.6
million and $563.8 million, and Sabine River Investors VIII, L.L.C. was $577.6
million and $563.8 million, respectively. El Paso's investment in Sabine River
Investors IX, L.L.C. was $1,172.8 million and $707.7 million, respectively.
RED RIVER NOTES RECEIVABLE AND PAYABLE
Prior to December 31, 1999, we regularly borrowed funds from El Paso. On
December 31, 1999, the $1 billion in borrowings under this agreement were
converted into two $500 million notes payable from El Paso Production. El Paso
then contributed its two $500 million notes receivable to our subsidiaries
Sabine River Investors VII, L.L.C. and Sabine River Investors VIII, L.L.C., as a
capital contribution. These notes are due on June 30, 2009 and carry an interest
rate based on a London InterBank Offered Rate (LIBOR) plus 0.5% per year, which
was 2.3% at December 31, 2002. These notes receivable and payable are eliminated
in conjunction with the preparation of our consolidated financial statements.
Interest earned on the notes receivable is subsequently loaned back to El Paso.
At December 31, 2002 and 2001, the Sabine River Investors VII, L.L.C. and Sabine
River Investors VIII, L.L.C. had both loaned $74.6 million and $63.8 million,
respectively, back to El Paso. These amounts are reflected as notes receivable
from affiliates in our balance sheets and carry an interest rate based on a
London InterBank Offered Rate (LIBOR) plus 0.5% per year, which was 2.3% at
December 31, 2002. The interest earned on these notes is added back to the note
receivable balance until it is paid. These notes are payable by El Paso on
demand.
F-13
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RED RIVER REPLACEMENT PROPERTIES
During March 2002, we acquired natural gas and oil properties from an
affiliate of El Paso CGP for $395.5 million in cash. In order to maintain an
adequate collateral balance for our Red River financing, these properties were
acquired to replace comparable properties in south and east Texas that were sold
to third parties. This agreement was facilitated through a series of
investments, contributions, and sales through various affiliated legal entities.
We provided an additional $3.9 million in cash to accomplish the series of
steps. Because this property acquisition involved entities under the common
control of El Paso, we recorded the acquired properties at their El Paso CGP
carryover basis net book value of $343.1 million, along with an associated
deferred tax asset of $17.0 million. The $31.5 million difference between the
cash consideration price and the carryover basis of the acquired properties was
reflected as a dividend.
We accounted for this transaction as a pooling of interests in accordance
with FAS 141, "Business Combinations", under the exceptions for transfers of net
assets between entities under common control. The following table presents the
revenues and net income of the previously separate business entities and the
combined amounts presented in these audited financial statements. Adjustments to
revenues and expenses were made to add the impact of this transaction to prior
periods. The adjustments we have made in these statements require us to use
estimates and assumptions based on currently available information. We believe
our estimates and assumptions are reasonable, however actual results may differ
from the estimates and assumptions used. You should not assume that these
financial statements are indicative of future results or the results we would
have achieved had the transaction occurred at the dates presented.
<Table>
<Caption>
YEAR ENDED
DECEMBER 31,
-------------
2002 2001
----- -----
(IN MILLIONS)
REVENUES
El Paso Production Holding Company........................ $826 $531
El Paso CGP affiliate replacement properties.............. 15 73
---- ----
Combined.................................................. $841 $604
---- ----
NET INCOME (LOSS)
El Paso Production Holding Company........................ $214 $121
El Paso CGP affiliate replacement properties.............. (1) 28
---- ----
Combined.................................................. $213 $149
---- ----
</Table>
CASH MANAGEMENT SERVICES
El Paso provides us with cash management services. A cash pool has been
established for us to loan funds to or borrow funds from El Paso. We receive
interest on loaned funds based on the month-end cash pool balance. The interest
rate is based on the Bloomberg Index H15 rate plus 10 basis points. The H15 rate
is the average dealer placed Commercial Paper offering rate for AA rated U.S.
Industrial Companies. The cash pool was initially funded on December 31, 1999,
through a $400 million capital contribution from El Paso to our subsidiary. At
December 31, 2002 and 2001, the balance in the cash pool totaled $431.4 million
and $220.2 million, respectively, and is reflected as notes receivable from
affiliates in our balance sheets. This cash pool is payable by El Paso on
demand.
MUSTANG FINANCING
During 2000, El Paso formed Noric Holdings I, and other separate legal
entities, for the purpose of generating funds for El Paso to invest in capital
projects and other assets. El Paso used $85.3 million of
F-14
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
our assets, net of deferred income taxes of $14.4 million, as collateral for the
borrowings. As such, we contributed our economic interest in these assets to
Noric, L.L.C. in exchange for an investment in the company. As a part of this
transaction, El Paso also contributed $25 million to us, which was subsequently
used to make a $25 million investment in Clydesdale Associates, L.P.
(Clydesdale) in return for an 8.2% voting interest. These funds were then used
by Clydesdale to invest in Noric, L.L.C.
During 2001, we contributed additional assets to Noric, L.L.C. valued at
$5.3 million, net of deferred income taxes, of $2.5 million, and two other El
Paso CGP affiliates contributed assets valued at $105.6 million, net of deferred
income taxes of $46.7 million. As a result of these contributions we have a 58%
equity interest in Noric Holdings I. The 42% interest held by the other two El
Paso CGP affiliates is shown as a minority interest in our balance sheets and
our statements of income. As of December 31, 2002 and 2001, the minority
interest expense was $3.5 million and $4.4 million, respectively.
Our investment in Clydesdale is accounted for using the cost method. Our
investment in Clydesdale was $25 million at December 31, 2002 and 2001. During
2002 and 2001, we received $1.1 million and $10.5 million in dividends,
respectively, from Clydesdale. These appear on our statements of income as
earnings from unconsolidated affiliated companies. In May 2002, we were notified
by Clydesdale that it had distributed cash of $8.1 million in excess earnings to
us because of a change in the pro rata allocation between us and other
Clydesdale investors. We returned the excess earnings to Clydesdale by demanding
El Paso repay part of our affiliated notes receivable. This return of earnings
is reflected in our statements of income as a reduction in earnings from
affiliated companies.
Our investment in Noric, L.L.C. is accounted for using the equity method,
because of our ability to exert significant influence over, but not control, its
operating and financial policies. As of December 31, 2002 and 2001, our
investment in Noric, L.L.C. was $200.3 million and $224.1 million, respectively.
During 2002 and 2001, we recognized $12.7 million and $18.2 million in equity
earnings from this unconsolidated affiliate. For additional information on our
investment in Noric, L.L.C., refer to Note 11.
CORPORATE OVERHEAD AND AFFILIATE SERVICE AGREEMENTS
We are allocated a portion of El Paso's corporate overhead. This overhead
allocation covers expenses related to management, legal, financial, tax,
consultative administrative and other services, including employee benefits,
annual incentive bonuses, rent, insurance, and information technology. In 2002
and 2001, we were allocated $104.4 million and $68.3 million, respectively, in
corporate overhead.
We allocate a portion of our general corporate overhead, labor, and general
and administrative expenses to affiliates of El Paso CGP. We provide management,
legal, accounting, financial, tax, consulting, administrative, and other
services to these affiliates who are engaged in the ownership of natural gas and
oil properties. During 2002 and 2001, we allocated $140.6 million and $97.7
million of our expenses to affiliates of El Paso CGP. This allocation is
reflected on our statements of income as a reduction in operations and
maintenance expense.
GULFTERRA ENERGY PARTNERS
GulfTerra Energy Partners, L.P. (formerly El Paso Energy Partners, L.P.) is
a publicly traded master limited partnership that provides natural gas and oil
gathering, transportation, processing, storage, and other related services.
Affiliates of El Paso serve as the general partner and own 26.5% of the
outstanding common units of the partnership, all outstanding Series B preferred
units and all outstanding Series C common units. During 2002 and 2001, we used
$17.3 million and $10.3 million, respectively, in services from GulfTerra.
During 2002, El Paso Production GOM acquired the Prince offshore platform from
GulfTerra for $190 million. El Paso provided a capital contribution to pay for
the acquisition. At December 31, 2002 and 2001, we had no material receivables
or payables with GulfTerra.
F-15
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
AFFILIATED HEDGING AGREEMENT
We are parties to a master hedging contract with El Paso Merchant Energy,
L.P., an affiliate of El Paso that conducts energy trading activities. Pursuant
to that agreement, we hedge our production with El Paso Merchant Energy which
then enters into hedging agreements with third parties. Under the master hedging
agreement, we are not obligated to post cash or other collateral.
OTHER SERVICES
We also contract for services with El Paso Field Services and El Paso's
regulated interstate pipelines. These companies provide transportation,
gathering, processing, and treating for our natural gas, oil, condensate, and
liquids production. During 2002 and 2001, we used $3.1 million and $1.0 million,
respectively, in services from El Paso Field Services. During 2002 and 2001, we
used $13.2 million and $5.0 million, respectively, in services from El Paso's
regulated interstate pipelines, including Tennessee Gas Pipeline Company and
Colorado Interstate Gas Company.
4. INCOME TAXES
Pretax income is composed of the following for each of the three years
ended December 31:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
(IN MILLIONS)
Pretax income............................................... $325 $220 $210
==== ==== ====
</Table>
The following table reflects the components of income tax expense (benefit)
included in income for each of the three years ended December 31:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
(IN MILLIONS)
Current
Federal................................................... $ 39 $(61) $ 70
State..................................................... -- (9) --
---- ---- ----
39 (70) 70
---- ---- ----
Deferred
Federal................................................... 71 137 --
State..................................................... 2 4 --
---- ---- ----
73 141 --
---- ---- ----
Total income tax expense.......................... $112 $ 71 $ 70
==== ==== ====
</Table>
F-16
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Our tax expense, included in income, differs from the amount computed by
applying the statutory federal income tax rate of 35 percent for the following
reasons for each of the three years ended December 31:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
(IN MILLIONS)
Tax expense at the statutory federal rate of 35%............ $114 $77 $73
Increase (decrease)
State income tax, net of federal income tax benefit....... 2 (3) --
Earnings from unconsolidated affiliates................... (4) (6) (3)
Other..................................................... -- 3 --
---- --- ---
Income tax expense.......................................... $112 $71 $70
==== === ===
Effective tax rate.......................................... 34% 32% 33%
==== === ===
</Table>
The following are the components of our net deferred tax liability as of
December 31:
<Table>
<Caption>
2002 2001
----- -----
(IN MILLIONS)
Deferred tax liabilities
Property, plant and equipment............................. $398 $298
Employee benefits......................................... 16 --
Merger related costs...................................... 47 46
Other..................................................... -- 5
---- ----
Total deferred tax liability........................... 461 349
---- ----
Net operating loss carryforwards.......................... 190 177
U.S. tax credit carryovers................................ 23 23
Employee benefits......................................... -- 7
Price risk management activities.......................... 136 24
Other..................................................... 4 --
---- ----
Total deferred tax asset............................... 353 231
---- ----
Net deferred tax liability.................................. $108 $118
==== ====
</Table>
Under El Paso's tax accrual policy, we are allocated the tax benefit
associated with our employees' exercise of nonqualified stock options. This
allocation decreased the deferred tax liability by $2.6 million in 2002 and $6.3
million in 2001. This benefit is included in additional paid-in capital in our
Balance Sheets.
At December 31, 2002, we had available net operating loss carryforwards of
approximately $542 million for income tax purposes. The net operating loss
carryforward periods end primarily in the years 2015 through 2021. We also have
alternative minimum tax credit carryforwards of approximately $22.9 million,
which are carried forward indefinitely. In assessing the realizability of
deferred tax assets, we consider whether it is more likely than not that all, or
a portion, of the deferred tax assets will not be realized, given appropriate
consideration of El Paso's tax accrual policy. We believe the remaining deferred
tax assets will be realized through the future reversal of existing taxable
temporary differences within the carryforward period or through the
consideration of taxable income expected to be generated in future periods.
F-17
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. FINANCIAL INSTRUMENTS
Following are the carrying amounts and estimated fair values of our
financial instruments as of December 31:
<Table>
<Caption>
2002 2001
--------------------- ---------------------
CARRYING CARRYING
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
(IN MILLIONS)
Price risk management activities.............. $(375) $(375) $(68) $(68)
</Table>
As of December 31, 2002 and 2001, our carrying amounts of cash and cash
equivalents and trade receivables and payables are representative of fair value
because of the short-term nature of these instruments. We estimated the fair
value of all derivative financial instruments based on quoted market prices,
current market conditions, estimates we obtained from third-party brokers or
dealers, or amounts derived using valuation models.
6. PRICE RISK MANAGEMENT ACTIVITIES
We use derivative financial instruments to hedge the impact of our market
price risk exposures on our forecasted transactions related to our natural gas
and oil production. We engage in hedges of cash flow exposure. Hedges of cash
flow exposure are entered into to hedge a forecasted transaction or the
variability of cash flows to be received or paid related to a recognized asset
or liability. On the date that we enter into the derivative contract, we
designate the derivative as a cash flow hedge. Changes in derivative fair values
that are designated as cash flow hedges are deferred to the extent that they are
effective and are recorded as a component of accumulated other comprehensive
income until the hedged transactions occur and are recognized in earnings. The
ineffective portion of a cash flow hedge's change in value is recognized
immediately in earnings as a component of operating revenues in our income
statement.
As required by SFAS No. 133, we formally document all relationships between
hedging instruments and hedged items, as well as our risk management objectives,
strategies for undertaking various hedge transactions and our methods for
assessing and testing correlation and hedge ineffectiveness. All hedging
instruments are linked to the hedged asset, liability, firm commitment or
forecasted transaction. We also assess, both at the inception of the hedge and
on an on-going basis, whether the derivatives that are used in our hedging
transactions are highly effective in offsetting changes in cash flows or fair
values of the hedged items. We discontinue hedge accounting prospectively if we
determine that a derivative is no longer highly effective as a hedge or if we
decide to discontinue the hedging relationship.
The fair value of our hedging instruments reflects our best estimate and is
based on exchange or over-the-counter quotations when they are available. Quoted
valuations may not be available due to location differences or terms that extend
beyond the period for which quotations are available. Where quotes are not
available, we utilize other valuation techniques or models to estimate market
values. These modeling techniques require us to make estimations of future
prices, price correlation and market volatility and liquidity. Our actual
results may differ from our estimates, and these differences can be positive or
negative.
On January 1, 2001, we adopted the provisions of SFAS No. 133 and recorded
a cumulative-effect adjustment of $667 million, net of income taxes, in
accumulated other comprehensive income to recognize the fair value of all
derivatives designated as hedging instruments. The majority of the initial
charge related to hedging cash flows from anticipated sales of natural gas for
2001 and 2002. During the year ended December 31, 2001, $475 million, net of
income taxes, of this initial transition adjustment was
F-18
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
reclassified to earnings as a result of hedged sales and purchases during the
year. A discussion of our hedging activities is as follows:
Cash Flow Hedges. A majority of our commodity sales and purchases are at
spot market or forward market prices. We use futures, forward contracts and
swaps to limit our exposure to fluctuations in the commodity markets and allow
for a fixed cash flow stream from these activities. As of December 31, 2002 and
2001, the value of cash flow hedges included in accumulated other comprehensive
income was a net unrealized loss of $224 million and a net unrealized loss of
$44 million, net of income taxes. We estimate that unrealized losses of $129
million, net of income taxes, will be reclassified from accumulated other
comprehensive income during 2003. Reclassifications occur upon physical delivery
of the hedge commodity and the corresponding expiration of the hedge. The
maximum term of our cash flow hedges is 10 years; however, most of our cash flow
hedges expire within the next 24 months. We had a net liability from price risk
management activities of $375 million as of December 31, 2002 and a net
liability from price risk management activities of $68 million as of December
31, 2001 associated with our cash flow hedges. This net change of $307 million
during 2002 resulted from net payments on settlements of $18 million during 2002
and a decrease of $325 million in the fair value of our cash flow hedge
positions during 2002.
For the years ended December 31, 2002 and 2001, we recognized a net loss of
$11 million and a net loss of $2 million, net of income taxes, related to the
ineffective portion of all cash flow hedges.
In March 2002, we sold natural gas and oil properties whose anticipated
future production had been hedged. As a result, the derivative positions no
longer qualify as cash flow hedges under SFAS No. 133. Changes in the value of
these hedges are recorded through the income statement.
In May 2002, we announced a plan to reduce the volumes of natural gas that
we have hedged. We removed the hedging designation on derivatives that had a
fair value loss of $20 million at December 31, 2002. This amount, net of income
taxes of $7 million, is reflected in accumulated other comprehensive income and
will be reclassified to income as the original hedged transactions are settled
through 2003.
7. OTHER ASSETS AND LIABILITIES
Below is the detail of our other current and non-current assets and
liabilities on our balance sheets as of December 31:
<Table>
<Caption>
2002 2001
----- -----
(IN MILLIONS)
Other current assets
Deferred income taxes..................................... $12 $--
Prepaid assets............................................ 9 9
--- ---
Total.................................................. $21 $ 9
=== ===
Other current liabilities
Accrued taxes, other than income.......................... $ 7 $16
Other..................................................... 5 8
--- ---
Total.................................................. $12 $24
=== ===
Other non-current liabilities
Other deferred credits.................................... $11 $24
--- ---
Total.................................................. $11 $24
=== ===
</Table>
F-19
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. PROPERTY, PLANT AND EQUIPMENT
Presented below are capitalized costs of natural gas and oil properties by
year of expenditure that are not being amortized, pending determination as the
existence of proved reserves.
<Table>
<Caption>
COSTS
CUMULATIVE EXCLUDED FOR CUMULATIVE
BALANCE YEAR ENDED BALANCE
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2002 2002 2001
------------ ------------ ------------
(IN MILLIONS)
Acquisition..................................... $108 $ 59 $ 49
Exploration..................................... 108 78 30
Development..................................... 60 60 --
---- ---- ----
$276 $197 $ 79
==== ==== ====
</Table>
During 2002 and 2001, our weighted average unit of production depletion
rate per equivalent unit was $1.13 and $1.02, respectively.
9. COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
We are defendants in a number of lawsuits involving royalty claims,
contract claims, environmental claims and other disputes that evolve from the
normal course of business. While we cannot predict the outcomes of these legal
suits with certainty, we do not believe that the results from these cases will
cause material adverse effects on our financial results. Below is a discussion
of our more significant legal proceedings.
Grynberg. A number of El Paso entities, including our subsidiary, El Paso
Production Company, are 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 not currently determinable.
Will Price (formerly Quinque). Seventeen El Paso entities, including our
subsidiary, El Paso Production Company, were named as 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
F-20
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
injunctive relief to require the defendants to adopt allegedly appropriate gas
measurement practices. No monetary relief has been specified in this case.
Plaintiffs' motion for class certification was denied on April 10, 2003. Our
costs and legal exposure related to this lawsuit are not currently determinable.
COMMITMENTS AND PURCHASE OBLIGATIONS
Commitments. We lease office space and various equipment under operating
leases. As of December 31, 2002, the annual minimum lease payments under
noncancelable future operating lease commitments total $2 million as follows:
2003 -- $1.1 million, 2004 -- $0.4 million, 2005 -- $0.3 million and
2006 -- $0.2 million. During the years ended December 31, 2002 2001 and 2000,
rental expense charged to operations was $0.2 million $1.8 million and $8.4
million, respectively.
Other Commercial Commitments. We have transportation commitments with
various natural gas pipelines that extend through 2012. At December 31, 2002 we
valued these commitments at $101 million.
10. SUPPLEMENTAL CASH FLOW INFORMATION
The detail of our cash flow changes in working capital for the three years
ending December 31 are as follows:
<Table>
<Caption>
2002 2001 2000
---- ----- -----
(IN MILLIONS)
Working capital changes
Accounts and notes receivable............................. $136 $ 18 $(176)
Income tax receivable..................................... 42 (85) 68
Accounts payable.......................................... 80 (99) (13)
Accrued liabilities and other............................. (25) 16 (5)
Other working capital changes............................. -- (3) (2)
---- ----- -----
Total................................................ $233 $(153) $(128)
==== ===== =====
Supplemental cash flow information
Accrued capital expenditures.............................. 90 3 33
Contributions of tax benefits from El Paso................ 3 6 14
</Table>
During each of the three years in the period ended December 31, 2002, we
had no cash interest payments because we had no outstanding third party debt. We
paid no cash taxes because our parent paid our taxes as part of our tax sharing
agreement.
F-21
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED AFFILIATES
Summarized financial information for our investment in Noric, L.L.C. is
shown below. Our share is presented using a book value liquidation methodology.
The net income appears in our statements of income as earnings from
unconsolidated affiliates and the net investment appears in our balance sheets
as a component of Investments in unconsolidated affiliates.
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------
2002 2001 2000
------ ------ ------
(IN MILLIONS)
RESULTS OF OPERATIONS
Revenues.................................................... $ 35 $ 40 $ 19
Operating expenses.......................................... (12) (6) (1)
Depreciation, depletion and amortization.................... (19) (14) (6)
Taxes other than income and other expenses.................. (2) (3) (1)
---- ---- ----
Operating income............................................ 2 17 11
Interest income............................................. 4 3 1
Income tax benefit (provision).............................. 7 (2) (2)
---- ---- ----
Net income.................................................. $ 13 $ 18 $ 10
---- ---- ----
FINANCIAL POSITION
Current assets.............................................. $ 7 $ 4 $ 1
Non-current assets.......................................... 199 222 93
---- ---- ----
Total assets................................................ 206 226 94
Current liabilities......................................... 6 2 (1)
---- ---- ----
Total net investment........................................ $200 $224 $ 95
==== ==== ====
</Table>
We hold an investment in an unconsolidated affiliate, Black Warrior
Transmission Corporation, of which we have a 50 percent net ownership interest.
We account for this investment using the equity method of accounting. Our
investment was $7 million as of December 31, 2002 and 2001.
We hold an investment in an unconsolidated affiliate, Clydesdale
Associates, L.P., of which we have a 2 percent net ownership interest. We
account for this investment using the cost method of accounting. Our investment
was $25 million as of December 31, 2002 and 2001.
12. RETIREMENT BENEFITS
PENSION AND RETIREMENT BENEFITS
Our employees participate in the El Paso Corporation Pension Plan. El Paso
maintains a pension plan to provide benefits determined under a cash balance
formula covering substantially all of its U.S. employees, including our
employees. El Paso also maintains a defined contribution plan covering its U.S.
employees, including our employees. Prior to May 1, 2002, El Paso matched 75
percent of participant basic contributions up to 6 percent, with matching
contributions being made to the defined contribution plan's stock fund, which
participants could diversify at any time. After May 1, 2002, the defined
contribution plan was amended to allow for matching contributions to be invested
in the same manner as that of participant contributions. Effective March 1,
2003, El Paso temporarily suspended the matching contribution. El Paso is
responsible for benefits accrued under its plans and allocates the related costs
to its affiliates. See Note 3 for a summary of transactions with affiliates.
F-22
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OTHER POSTRETIREMENT BENEFITS
We provide limited postretirement life insurance benefits for current and
retired employees. The liability for these benefits is expensed under El Paso
and the liability for us is not material. We do not provide subsidized
postretirement medical benefits.
13. SUPPLEMENTAL SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Financial information by quarter is summarized below:
<Table>
<Caption>
QUARTERS ENDED
-----------------------------------------------
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31 TOTAL
----------- ------------ ------- -------- -----
(IN MILLIONS)
2002
Operating revenues............... $211 $245 $218 $167 $841
Gain on long-lived assets........ -- -- -- (2) (2)
Operating income................. 78 108 80 43 309
Net income....................... 56 76 48 33 213
</Table>
<Table>
<Caption>
QUARTERS ENDED
-----------------------------------------------
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31 TOTAL
----------- ------------ ------- -------- -----
(IN MILLIONS)
2001
Operating revenues............... $171 $167 $127 $139 $604
Merger-related costs............. -- -- -- 2 2
Operating income................. 59 55 34 37 185
Net income....................... 45 43 22 39 149
</Table>
14. SUBSEQUENT EVENTS
AMORTIZATION OF RED RIVER FINANCINGS
On January 7, 2003, we used $56 million of our cash from operations to
amortize the Red River financing. As of March 1, 2003, we had $55 million in
restricted cash from operations and $6 million restricted cash from interest on
the Red River notes receivable and payable. We have elected not to use this
restricted cash to amortize the Red River financing.
On February 7, 2003, Noric used $4.2 million of its funds from operations
and $9.4 million from asset sales to amortize the Mustang financing. As of March
1, 2003, Noric had $3.2 million in restricted cash from operations.
RED RIVER RESTRUCTURING
In March 2003, El Paso obtained a new $1.2 billion fully underwritten
financing commitment arranged by Salomon Smith Barney and Credit Suisse First
Boston. The proceeds of the new financing were used by El Paso to retire the
$913 million net balance of the Red River financing on March 13, 2003. The cash
generated from the assets supporting Red River was restricted so that El Paso
did not have full access to this cash. Upon the retirement of the Red River
financing, El Paso no longer has to utilize the cash flow from the assets
supporting Red River to amortize the facility. The new $1.2 billion financing is
secured by substantially all of the natural gas and oil reserves of our
subsidiaries. The new financing has scheduled maturities of $300 million in June
2004, $300 million in September 2004, and the $600 million
F-23
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
balance in March 2005. The financing commitment also contains customary
conditions for closing and various restrictive covenants and reporting
requirements that we are required to follow.
ASSET DIVESTITURE
In March 2003, we sold natural gas and oil properties located in Oklahoma
and Texas to Chesapeake Energy Corp. for approximately $440 million. The
proceeds from the sale of these natural gas and oil properties were treated as
an adjustment to the cost of our properties in the full cost pool. The proceeds
from this sale were not restricted under the Red River financing agreements and
they were loaned to El Paso through our cash pool.
DIVIDEND OF CARVED OUT SUBSIDIARIES
In March 2003, we distributed our investment in El Paso Energy Oil
Transmission L.L.C., El Paso Energy Minerals, L.L.C., and El Paso Energy
Minerals Leasing, L.L.C. to El Paso CGP. At December 31, 2002 and 2001, our
combined investment in the three subsidiaries was $24 million and $22.8 million,
respectively.
TRANSFER OF NORIC HOLDINGS I INVESTMENT
In April 2003, we sold our interest in Noric Holdings I to El Paso for $0.1
million. At December 31, 2002 and 2001, our investment in Noric Holdings I was
$156.1 million and $151.2 million, respectively. Because this sale involved
entities under the common control of El Paso, we will record the difference
between the cash consideration price and book value of the investment as a
dividend.
NOTE OFFERING
On May 20, 2003, we offered and sold $1.2 billion of senior unsecured notes
to refinance our liability to El Paso for the Red River refinancing discussed
above. The senior unsecured notes are fully and unconditionally guaranteed by
our 100% owned subsidiary guarantors on a joint and several basis. We have no
independent assets or operations, and any other subsidiaries, other than the
subsidiary guarantors, are minor. There are no restrictions on us or our
subsidiaries to obtain funds from our subsidiaries by dividend or loan.
15. SUPPLEMENTAL NATURAL GAS AND OIL OPERATIONS (UNAUDITED)
At December 31, 2002, we had interests in natural gas and oil properties in
16 states and offshore operations and properties in federal and state waters in
the Gulf of Mexico.
Capitalized costs relating to natural gas and oil producing activities and
related accumulated depreciation, depletion and amortization were as follows at
December 31 (in millions):
<Table>
<Caption>
2002 2001
------ ------
Natural gas and oil properties:
Costs subject to amortization............................. $7,034 $6,581
Costs not subject to amortization......................... 276 132
------ ------
7,310 6,713
Less accumulated DD&A....................................... 4,502 4,612
------ ------
Net capitalized costs....................................... $2,808 $2,101
====== ======
Net capitalized costs -- Non-Consolidated Interest.......... $ 148 $ 244
====== ======
</Table>
F-24
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Costs incurred in natural gas and oil producing activities, whether
capitalized or expensed, were as follows at December 31 (in millions):
<Table>
<Caption>
2002 2001 2000
------ ---- ----
Property acquisition costs
Proved properties......................................... $ 339 $ 4 $ 73
Unproved properties....................................... 16 7 37
Exploration costs........................................... 195 70 96
Development costs........................................... 826 577 284
------ ---- ----
Total costs incurred...................................... $1,376 $658 $490
====== ==== ====
Total costs incurred -- Non-Consolidated Interest......... $ 4 $ 3 $ 1
====== ==== ====
</Table>
Per our January 1, 2003 reserve report, the amounts estimated to be spent
in 2003, 2004 and 2005 to develop our booked proved undeveloped reserves are
$247 million, $201 million and $90 million.
Presented below is an analysis of the capitalized costs of natural gas and
oil properties by year of expenditure that are not being amortized as of
December 31, 2002, pending determination of proved reserves.
<Table>
<Caption>
CUMULATIVE COSTS EXCLUDED FOR YEARS CUMULATIVE
BALANCE ENDED DECEMBER 31, BALANCE
------------ -------------------------- ------------
DECEMBER 31, DECEMBER 31,
2002 2002 2001 2000 1999
------------ ------ ------ ------ ------------
(IN MILLIONS)
Acquisition............................ $108 $ 59 $18 $28 $ 3
Exploration............................ 108 78 17 9 4
Development............................ 60 60 -- -- --
---- ---- --- --- ---
$276 $197 $35 $37 $ 7
==== ==== === === ===
</Table>
Projects presently excluded from amortization are in various stages of
evaluation. The majority of these costs are expected to be included in the
amortization calculation in the years 2003 through 2006. Total amortization
expense per Mcfe was $1.17, $1.06, and $0.97 in 2002, 2001 and 2000.
All of our proved properties are located in the United States.
F-25
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Net quantities of proved developed and undeveloped reserves of natural gas
and liquids, including condensate and crude oil, and changes in these reserves
are presented below. The estimates of proved reserves presented in this table
are based on the reserve report dated January 1, 2003, prepared internally by
us. Huddleston & Co., Inc., an independent petroleum engineering firm, prepared
an independent reserve estimate for 100% of our properties. The total estimate
of proved reserves prepared independently by Huddleston & Co., Inc. is within 5%
of our internally prepared estimate presented in the table. This information is
consistent with estimates of reserves filed with other federal agencies except
for differences of less than five percent resulting from actual production,
acquisitions, property sales, necessary reserve revisions and additions to
reflect actual experience.
<Table>
<Caption>
NATURAL GAS LIQUIDS(1)
(IN BCF) (IN MBBLS)
----------- ----------
Net proved developed and undeveloped reserves(2)
January 1, 2000........................................... 1,275 30,447
Revisions of previous estimates........................ (46) (815)
Extensions, discoveries and other...................... 566 5,639
Purchases of reserves in place......................... 78 1,043
Sales of reserves in place............................. (105) (1,093)
Production............................................. (182) (5,004)
----- ------
December 31, 2000......................................... 1,586 30,217
Revisions of previous estimates........................ (64) 9,545
Extensions, discoveries and other...................... 812 21,648
Purchases of reserves in place......................... 29 47
Sales of reserves in place............................. (54) (71)
Production............................................. (187) (5,600)
----- ------
December 31, 2001......................................... 2,122 55,786
Revisions of previous estimates........................ (106) (5,705)
Extensions, discoveries and other...................... 578 13,007
Purchases of reserves in place......................... 440 1,429
Sales of reserves in place............................. (293) (5,165)
Production............................................. (215) (9,629)
----- ------
December 31, 2002......................................... 2,526 49,723
===== ======
December 31, 2002 -- Non-Consolidated Interest............ 119 523
===== ======
Proved developed reserves
December 31, 2000......................................... 1,001 17,839
December 31, 2001......................................... 1,210 37,444
December 31, 2002......................................... 1,599 29,657
Proved developed reserves -- Non-Consolidated Interest
December 31, 2000......................................... 97 940
December 31, 2001......................................... 215 1,091
December 31, 2002......................................... 116 523
</Table>
- ---------------
(1) Includes oil, condensate, and natural gas liquids.
(2) Net proved reserves exclude royalties and interests owned by others and
reflects contractual arrangements and royalty obligations in effect at the
time of the estimate.
There are numerous uncertainties inherent in estimating quantities of
proved reserves and in projecting future rates of production and timing of
development expenditures, including many factors
F-26
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
beyond our control. The reserve data represents only estimates. Reservoir
engineering is a subjective process of estimating underground accumulations of
natural gas and oil that cannot be measured in an exact manner.
The significant changes to reserves, other than purchases, sales or
production, are due to reservoir performance in existing fields and from
drilling additional wells in existing fields. There have been no major
discoveries or other events, favorable or adverse, that may be considered to
have caused a significant change in the estimated proved reserves since December
31, 2002.
Results of operations from producing activities by fiscal year were as
follows at December 31 (in millions):
<Table>
<Caption>
2002 2001 2000
----- ----- -----
Net Revenues
Sales to external customers............................... $ 111 $ 68 $ 283
Affiliated sales.......................................... 675 493 222
----- ----- -----
Total..................................................... 786 561 505
Production costs(1)......................................... (108) (99) (73)
Depreciation, depletion and amortization.................... (317) (234) (206)
----- ----- -----
361 228 226
Income tax expense.......................................... (126) (80) (79)
----- ----- -----
Results of operations from producing activities............. $ 235 $ 148 $ 147
===== ===== =====
Results of operations from producing
activities -- Non-Consolidated Interest................... $ 11 $ 14 $ 15
===== ===== =====
</Table>
- ---------------
(1) Production costs include direct lifting costs (labor, repairs and
maintenance, materials and supplies) and the administrative costs of field
offices, insurance and property and severance taxes.
F-27
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The standardized measure of discounted future net cash flows relating to
proved natural gas and oil reserves follows at December 31 (in millions):
<Table>
<Caption>
2002 2001 2000
------- ------- -------
Future cash inflows(1)(2)(3)............................ $12,755 $ 6,351 $16,724
Future production costs................................. (2,303) (1,502) (1,674)
Future development costs................................ (884) (818) (459)
Future income tax expenses.............................. (2,815) (806) (4,727)
------- ------- -------
Future net cash flows................................... 6,753 3,225 9,864
10% annual discount for estimated timing of cash
flows................................................. (2,994) (1,228) (3,787)
------- ------- -------
Standardized measure of discounted future net cash
flows................................................. $ 3,759 $ 1,997 $ 6,077
======= ======= =======
Standardized measure of discounted future net cash
flows, including effects of hedging activities........ $ 3,436 $ 2,155 $ 5,287
======= ======= =======
Standardized measure of discounted future net cash
flows -- Non-Consolidated Interest(4)................. $ 120 $ 149 $ 314
======= ======= =======
Standardized measure of discounted future net cash
flows, including effects of hedging
activities -- Non-Consolidated Interest............... $ 120 $ 149 $ 300
======= ======= =======
</Table>
- ---------------
(1) Excludes $597 million of future net cash outflows attributable to 2002
hedging activities.
(2) Excludes $290 million of future net cash inflows attributable to 2001
hedging activities.
(3) Excludes $1,417 million of future net cash outflows attributable to 2000
hedging activities.
(4) Excludes $22 million of future net cash outflows attributable to 2000
hedging activities.
For the calculations in the preceding table, estimated future cash inflows
from estimated future production of proved reserves were computed using year-end
market natural gas and oil prices. We may receive amounts different than the
standardized measure of discounted cash flow for a number of reasons, including
price changes and the effects of our hedging activities.
We do not rely upon the standardized measure when making investment and
operating decisions. These decisions are based on various factors including
probable and proved reserves, different price and cost assumptions, actual
economic conditions, capital availability, and corporate investment criteria.
F-28
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following are the principal sources of change in the standardized
measure of discounted future net cash flows (in millions):
<Table>
<Caption>
YEARS ENDED DECEMBER 31,(1)
------------------------------------------------
2002 2001 2000
-------------- -------------- --------------
(IN MILLIONS)
Sales and transfers of natural gas and oil
produced net of production costs.......... $ (678) $ (462) $ (432)
Net changes in prices and production
costs..................................... 2,326 (7,096) 5,275
Extensions, discoveries and improved
recovery, less related costs.............. 1,119 779 3,076
Changes in estimated future development
costs..................................... 77 10 44
Previously estimated development costs
incurred during the period................ 249 173 111
Revision of previous quantity estimates..... (310) (8) (271)
Accretion of discount....................... 242 897 144
Net change in income taxes.................. (1,089) 2,473 (2,651)
Purchases of reserves in place.............. 839 25 441
Sale of reserves in place................... (606) (44) (597)
Change in production rates, timing and
other..................................... (407) (827) (256)
------- ------- -------
Net change.................................. $ 1,762 $(4,080) $ 4,884
======= ======= =======
Net change -- Non-Consolidated Interest..... $ (29) $ (165) $ 314
======= ======= =======
</Table>
- ---------------
(1) This disclosure reflects changes in the standardized measure calculation
excluding the effects of hedging activities.
F-29
EL PASO PRODUCTION HOLDING COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN MILLIONS)
(UNAUDITED)
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------
2003 2002
------ -----
Operating revenues
Natural gas and oil sales -- third parties................ $ 110 $ 96
Natural gas and oil sales -- affiliates................... 620 543
Other..................................................... 6 (9)
----- ----
Total operating revenues............................... 736 630
Operating expenses
Cost of sales............................................. 39 42
Operation and maintenance................................. 129 100
Restructuring costs....................................... 4 --
Gain on long-lived assets................................. -- (2)
Depreciation, depletion and amortization.................. 228 242
Taxes, other than income taxes............................ 27 17
----- ----
Total operating expenses............................... 427 399
----- ----
Operating income............................................ 309 231
Other income (expense)...................................... 2 (3)
Interest income from affiliates............................. 7 5
Interest expense............................................ (57) --
Interest capitalized........................................ 3 --
Earnings from unconsolidated affiliates..................... 8 5
Minority interest in consolidated subsidiaries.............. (3) (2)
----- ----
Income before income taxes.................................. 269 236
Income taxes................................................ (105) (79)
----- ----
Income from continuing operations before cumulative effect
of accounting changes..................................... 164 157
----- ----
Cumulative effect of accounting changes, net of income
taxes..................................................... (2) --
----- ----
Net income.................................................. $ 162 $157
===== ====
</Table>
See accompanying notes.
F-30
EL PASO PRODUCTION HOLDING COMPANY
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
ASSETS
Current assets
Cash and cash equivalents................................. $ 118 $ 156
Accounts and notes receivable
Customer, net of allowance of $5 in 2003 and 2002....... 78 114
Affiliates.............................................. 827 676
Other................................................... 4 4
Assets from price risk management activities.............. -- 34
Income tax receivable from affiliate...................... -- 131
Other..................................................... 8 21
------ ------
Total current assets................................. 1,035 1,136
------ ------
Property, plant and equipment, at cost
Natural gas and oil properties
Proved properties-full cost method...................... 6,960 6,927
Unevaluated costs excluded from full cost base.......... 290 276
Other..................................................... 122 107
------ ------
7,372 7,310
Less accumulated depreciation, depletion and amortization... 4,599 4,502
------ ------
Total property, plant and equipment, net................ 2,773 2,808
------ ------
Other assets
Investments in unconsolidated affiliates.................. 6 232
Restricted cash........................................... -- 6
Notes receivable-affiliates............................... -- 36
Other..................................................... 58 --
------ ------
64 274
------ ------
Total assets......................................... $3,872 $4,218
====== ======
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities
Accounts payable
Trade................................................... $ 42 $ 73
Affiliates.............................................. 7 10
Other................................................... 77 161
Liabilities from price risk management activities......... 157 9
Income tax payable to affiliate........................... 89 --
Other..................................................... 100 12
------ ------
Total current liabilities............................ 472 265
------ ------
Debt
Long-term financing obligations........................... 1,170 --
Other
Liabilities from price risk management activities......... 265 400
Deferred income taxes..................................... -- 120
Other..................................................... 71 11
------ ------
336 531
------ ------
Commitments and contingencies
Minority interests of consolidated subsidiaries............. -- 113
Stockholder's equity
Common stock, par value $1 per share; 1,000 shares
authorized and outstanding.............................. -- --
Additional paid-in capital................................ 2,082 3,465
Retained earnings......................................... 67 68
Accumulated other comprehensive loss...................... (255) (224)
------ ------
Total stockholder's equity........................... 1,894 3,309
------ ------
Total liabilities and stockholder's equity........... $3,872 $4,218
====== ======
</Table>
See accompanying notes.
F-31
EL PASO PRODUCTION HOLDING COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
2003 2002
------- -------
Cash flows from operating activities
Net income................................................ $ 162 $ 157
Adjustments to reconcile net income to net cash
Depreciation, depletion and amortization............... 228 242
Deferred income tax expense............................ (120) (49)
Gain on long-lived assets.............................. -- (2)
Undistributed earnings of unconsolidated affiliates.... (8) (12)
Cumulative effect of accounting change................. 2 --
Other non-cash income items............................ 5 10
Working capital changes, net of non-cash
transactions.......................................... 202 312
------- -------
Net cash provided by operating activities............ 471 658
------- -------
Cash flows from investing activities
Capital expenditures...................................... (579) (1,036)
Net proceeds from the sale of assets...................... 447 356
Investments and other..................................... 57 --
------- -------
Net cash used in investing activities................ (75) (680)
------- -------
Cash flows from financing activities
Change in notes receivable from parent.................... (374) (102)
Net proceeds from the issuance of long-term debt.......... 1,169 --
Dividends................................................. (1,235) (375)
Restricted cash........................................... 6 --
Contributions from parent................................. -- 499
------- -------
Net cash provided by (used in) financing
activities.......................................... (434) 22
------- -------
Decrease in cash and cash equivalents....................... (38) --
Cash and cash equivalents
Beginning of period....................................... 156 --
------- -------
End of period............................................. $ 118 $ --
======= =======
</Table>
See accompanying notes.
F-32
EL PASO PRODUCTION HOLDING COMPANY
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN MILLIONS)
(UNAUDITED)
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
2003 2002
------ ------
Net income.................................................. $ 162 $ 157
Net gains (losses) from cash flow hedging activities:
Unrealized mark-to-market losses arising during period
(net of income tax of $105 in 2003 and $80 in 2002).... (177) (127)
Reclassification adjustments for changes in initial value
to settlement date (net of income tax of $89 in 2003
and $3 in 2002)........................................ 146 (3)
----- -----
Other comprehensive loss............................. (31) (130)
----- -----
Comprehensive income........................................ $ 131 $ 27
===== =====
</Table>
See accompanying notes.
F-33
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
Our consolidated financial statements include the accounts of all
majority-owned, controlled subsidiaries after the elimination of all significant
intercompany accounts and transactions. 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 historical audited consolidated financial statements which include
a summary of our significant accounting policies and other disclosures. The
financial statements as of September 30, 2003, and for the nine months ended
September 30, 2003 and 2002 are unaudited. We derived the balance sheet as of
December 31, 2002, from the audited balance sheet filed in our 2002 historical
audited consolidated financial statements. In our opinion, we have made all
adjustments, all of which are of a normal, recurring nature (except for the
items in Notes 2 through 5), to fairly present our interim period results. Due
to the seasonal nature of our businesses, information for interim periods may
not 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.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
SIGNIFICANT ACCOUNTING POLICIES UPDATE
Our accounting policies are consistent with those discussed in our 2002
historical audited consolidated financial statements, except as follows:
Accounting for Asset Retirement Obligations. On January 1, 2003, we
adopted Statement of Financial Accounting Standards (SFAS) No. 143, Accounting
for Asset Retirement Obligations. SFAS No. 143 requires that we record a
liability for retirement and removal costs of long-lived assets used in our
business. This liability is recorded at its estimated fair value, with a
corresponding increase to property, plant and equipment. This asset is
depreciated over the remaining useful life of the long-lived asset to which that
liability relates. An ongoing expense is recognized for changes in the value of
the liability as a result of the passage of time, which we record in
depreciation, depletion and amortization expense in our income statement. In the
first quarter of 2003, we recorded a charge as a cumulative effect of accounting
change of approximately $2 million, net of income taxes related to our adoption
of SFAS No. 143. We also recorded non-current retirement assets as a part of
property, plant and equipment of $73 million, current retirement obligations of
$9 million and non-current retirement obligations of $67 million on January 1,
2003. Our asset retirement obligations are associated with our natural gas and
oil wells and related infrastructure. We have obligations to plug those wells
when production on those wells is exhausted, and we are required to abandon
those wells. We currently forecast that these obligations will be met at various
times over the next one hundred years, based on the expected natural gas and oil
contained in the wells and the estimated timing of plugging and abandoning the
wells. We are not legally required to reserve any assets to fund the obligations
to plug these wells. The net asset retirement obligation liability as of January
1, 2003 and September 30, 2003, reported in other liabilities in our balance
sheet, and the changes in the net liability for the nine months ended September
30, 2003, was as follows (in millions):
<Table>
Liability at January 1, 2003................................ $ 76
Liability settled in 2003................................... (12)
Accretion expense in 2003................................... 6
----
Net liability at September 30, 2003......................... $ 70
====
</Table>
F-34
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
We did not have any new asset retirement obligations incurred in 2003 or
any revisions in the estimated fair values of our asset retirement obligations
in 2003.
Accounting for Costs Associated with Exit or Disposal Activities. On
January 1, 2003, we adopted 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. We applied the provisions of SFAS
No. 146 in accounting for the $4 million in employee severance and termination
costs which we incurred during 2003.
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 their fair value when they are issued. There was no
initial financial statement impact of adopting this standard.
Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. In April 2003, the Financial Accounting Standards Board (FASB)
issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and
Hedging Activities. This statement amends SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities to incorporate several
interpretations of the Derivatives Implementation Group (DIG), and also makes
several minor modifications to the definition of a derivative as it was defined
in SFAS No. 133. SFAS No. 149 affects contracts entered into or modified after
June 30, 2003. There was no initial financial statement impact of adopting this
standard.
NEW ACCOUNTING POLICIES NOT YET ADOPTED
Accounting for Intangible Assets. The Securities and Exchange Commission
(SEC) has recently suggested that acquired natural gas and oil rights held under
lease should be classified as an intangible asset pursuant to SFAS No. 141,
Business Combinations, and SFAS No. 142, Goodwill and Intangible Assets.
However, the SEC is not requiring companies to apply this classification or the
disclosure requirements for intangible assets. We will continue to classify the
costs of acquired natural gas and oil mineral rights held under lease as natural
gas and oil properties at full cost on our balance sheet until the SEC or the
Financial Accounting Standards Board provides definitive guidance on the issue.
We believe that this classification is consistent with current accounting and
industry practice. If the costs of acquired natural gas and oil mineral rights
held under lease were deemed to be intangible assets, mineral interests for
undeveloped and developed leaseholds would be reclassified from natural gas and
oil properties at full cost to intangible assets on our balance sheet but would
be included in costs of natural gas and oil properties in the Notes to
Consolidated Financial Statements in accordance with SFAS No. 69, Disclosures
about Oil and Gas Producing Activities. There would be no effect on our
statements of income or cash flows.
Consolidation of Variable Interest Entities, an Interpretation of ARB No.
51. In January 2003, the FASB issued FIN No. 46, Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51. This 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.
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. On October 9, 2003, the FASB issued FASB Staff Position, FSP
FIN No. 46-6, Effective Date of FASB Interpretation No. 46, Consolidation of
Variable Interest Entities. This staff position deferred our required adoption
date of FIN No. 46 to the fourth quarter of 2003. We are currently assessing the
impact of FIN No. 46 on our business.
F-35
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
3. GAIN ON LONG-LIVED ASSETS
Our net realized gain on sales of long-lived assets for the nine months
ended September 30, 2002 of $2 million related to the sale of non-full cost pool
assets.
4. CEILING TEST CHARGES
Under the full cost method of accounting for natural gas and oil
properties, we perform quarterly ceiling tests to determine whether the carrying
value of natural gas and oil properties exceeds the present value of future net
revenues, discounted at 10 percent, plus the lower of cost or fair market value
of unproved properties, net of related income tax effects. For the quarters and
nine months ended September 30, 2003 and 2002, we did not record ceiling test
charges.
We use financial instruments to hedge against the volatility of natural gas
and oil prices. The impact of these hedges was considered in determining our
ceiling test charges and will be factored into future ceiling test calculations.
5. DIVESTITURES
During 2003, we completed the sales of a number of assets as part of El
Paso Corporation's plan to improve its liquidity and respond to changing market
conditions. These sales transactions occurred as follows:
<Table>
<Caption>
SIGNIFICANT ASSETS AND PRETAX
INVESTMENTS SOLD PROCEEDS GAIN (LOSS)
- ---------------------- -------- -----------
Natural gas and oil properties located in Oklahoma, Texas
and Gulf of Mexico -- March 2003.......................... $453 $ --(1)
---- -----
$453 $ --
==== =====
</Table>
- ---------------
(1) We did not recognize a gain or loss on these sales because we apply the full
cost method of accounting for our natural gas and oil operations (which
require that gains or losses on property sales are only recognized in
certain circumstances).
In March 2002, we sold natural gas and oil properties located in east and
south Texas. Net proceeds from these sales were approximately $382 million. We
did not recognize a gain or loss on these sales because we apply the full cost
method of accounting for our natural gas and oil operations (which require that
gains or losses on property sales are only recognized in certain circumstances).
In March 2003, we distributed our investment in El Paso Energy Oil
Transmission L.L.C., El Paso Energy Minerals, L.L.C., and El Paso Energy
Minerals Leasing, L.L.C. to El Paso CGP. Prior to the distribution, our combined
investment in the three subsidiaries was $24 million.
In April 2003, we sold our interest in Noric Holdings I to an El Paso
Corporation affiliate for $0.1 million. Our interest in Noric Holdings I, at the
time of the sale was $159.7 million. Because this sale involved entities under
the common control of El Paso Corporation, we recorded the difference between
the cash consideration price and book value of the investment as a dividend.
F-36
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
6. FINANCIAL INSTRUMENTS AND PRICE RISK MANAGEMENT ACTIVITIES
The following table summarizes the carrying value of our non-trading price
risk management assets and liabilities as of September 30, 2003 and December 31,
2002:
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
(IN MILLIONS)
Net liabilities
Non-trading contracts
Derivatives designated as hedges....................... $(423) $(375)
----- -----
Total energy contracts.................................... (423) (375)
----- -----
Net liabilities from price risk management
activities(1).......................................... $(423) $(375)
===== =====
</Table>
- ---------------
(1) Net liabilities from price risk management activities include current and
non-current assets and current and non-current liabilities from price risk
management activities on the balance sheet.
7. DEBT AND OTHER CREDIT FACILITIES
In March 2003, El Paso Corporation obtained $1.2 billion in financing under
a new underwritten commitment arranged by Salomon Smith Barney and Credit Suisse
First Boston. The proceeds of the new financing were used by El Paso Corporation
to retire the $913 million net balance of the Red River financing (also referred
to as Trinity River) on March 13, 2003. The cash generated from the assets
supporting Red River was restricted such that El Paso Corporation did not have
full access to this cash. Upon the retirement of the Red River financing, El
Paso Corporation no longer had to utilize the cash flow from the assets
supporting Red River to amortize the facility. The new $1.2 billion financing
was secured by substantially all of the natural gas and oil reserves of our
subsidiaries. El Paso Corporation loaned the financing proceeds to our
subsidiaries El Paso Production Company, El Paso Energy Raton, L.L.C., Vermejo
Minerals Corporation and El Paso Production GOM, Inc. The new financing had
scheduled maturities of $300 million in June 2004, $300 million in September
2004, and the $600 million balance in March 2005. The financing commitment also
contained customary conditions for closing and various restrictive covenants and
reporting requirements that we were required to follow. The interest rate per
annum on the financing was LIBOR plus 4.25%. The minimum LIBOR rate under the
facility was 3.5%. Additionally, the loan facility required us to pay a facility
fee equal to 2% per annum on the average daily aggregate outstanding principal
amount on the loan.
On May 20, 2003, we offered and sold $1.2 billion of senior unsecured notes
to refinance our liability to El Paso Corporation for the Red River refinancing
discussed above and in Note 10. The senior unsecured notes are fully and
unconditionally guaranteed by our 100% owned subsidiary guarantors on a joint
and several basis. We have no independent assets or operations, and any other
subsidiaries, other than the subsidiary guarantors, are minor. There are no
restrictions on us or our subsidiaries to obtain funds from our subsidiaries by
dividend or loan.
ISSUANCES
<Table>
<Caption>
INTEREST NET
DATE TYPE RATE PRINCIPAL PROCEEDS DUE DATE
- ---- ---- -------- --------- -------- --------
2003
May.............................. Senior notes 7.75% $1,200 $1,169 2013
</Table>
F-37
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
8. COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
We are defendants in a number of lawsuits involving royalty claims,
contract claims, environmental claims and other disputes that evolve from the
normal course of business. While we cannot predict the outcomes of these legal
suits with certainty, we do not believe that the results from these cases will
cause material adverse effects on our financial results. Below is a discussion
of our more significant legal proceedings.
Grynberg. A number of El Paso Corporation entities, including our
subsidiary, El Paso Production Company, are defendants in actions brought in
1997 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 not currently determinable.
Will Price (formerly Quinque). A number of El Paso Corporation entities,
including our subsidiary, El Paso Production Company, were named as 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, attorneys' fees, costs
and expenses, and future injunctive relief to require the defendants to adopt
allegedly appropriate gas measurement practices. No monetary relief has been
specified in this case. Plaintiffs' motion for class certification was denied on
April 10, 2003. Plaintiff's motion to file another amended petition to narrow
the proposed class to royalty owners in wells in Kansas, Wyoming and Colorado
was granted on July 28, 2003. Our costs and legal exposure related to this
lawsuit are not currently determinable.
Black Warrior Methane. These matters arise out of an explosion that
occurred on September 23, 2001 at the Brookwood Coal Mine #5 in Tuscaloosa,
Alabama. The explosion resulted in 13 fatalities and numerous other injuries. El
Paso has no ownership interest in the mine. However, El Paso Production Company
is a 50% stockholder in Black Warrior Methane Corporation, which was involved in
the extraction of methane from the mine, and which is a named defendant in 14 of
the lawsuits filed to date. In addition, El Paso Production has recently been
added as a defendant in several of the cases. There has been no substantive
discovery conducted to date.
F-38
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
9. INVESTMENTS IN UNCONSOLIDATED AFFILIATES
In April 2003, we sold our interest in Noric Holdings I to an El Paso
affiliate for $0.1 million. Our interest in Noric Holdings I, at the time of the
sale, was $159.7 million. Because this sale involved entities under the common
control of El Paso Corporation, we recorded the difference between the cash
consideration price and book value of the investment as a dividend.
Due to the sale of Noric Holdings I, we no longer have an investment in
Noric, L.L.C. Summarized financial information for Noric, L.L.C., for the nine
months ended September 30, 2003 and 2002, is shown below. Our share is presented
using a book value liquidation methodology. The net income appears in our
statements of income as Earnings from unconsolidated affiliates and the net
investment appears in our balance sheets as a component of Investments in
unconsolidated affiliates.
<Table>
<Caption>
NINE MONTHS
ENDED
SEPTEMBER 30,
--------------
2003 2002
----- -----
(IN MILLIONS)
Operating results data
Operating revenues........................................ $21 $30
Operating expenses........................................ 10 29
--- ---
Income from continuing operations......................... 11 1
Interest income........................................... 1 3
Tax benefit/(provision)................................... (5) 8
Cumulative effect of accounting change, net of taxes...... 1 --
--- ---
Net income................................................ $ 8 $12
=== ===
</Table>
Due to the sale of Noric Holdings I, we no longer have our investment in an
unconsolidated affiliate, Clydesdale Associates, L.P., in which we had a 2
percent net ownership interest. We accounted for this investment using the cost
method of accounting. Prior to the sale, our investment was $25 million.
We hold an investment in an unconsolidated affiliate, Black Warrior
Transmission Corporation, in which we have a 50 percent net ownership interest.
We account for this investment using the equity method of accounting. Our
investment was $6 million as of September 30, 2003.
10. RELATED PARTY TRANSACTIONS
SALES
We sell our natural gas primarily to affiliates of El Paso Corporation at
spot-market prices. For the nine months ended September 30, 2003 and 2002, our
sales of natural gas to affiliates of El Paso Corporation, before consideration
of hedges, accounted for approximately 90 percent and 85 percent of our sales,
respectively. For the nine months ended September 30, 2003 and 2002, our sales
of oil and condensate to affiliates of El Paso Corporation, before consideration
of hedges, accounted for approximately 86 percent and 83 percent of our sales,
respectively.
ACCOUNTS RECEIVABLE AND ACCOUNTS PAYABLE
Accounts receivable due from affiliates at September 30, 2003 was $126.4
million. Accounts payable due to affiliates at September 30, 2003 was $6.5
million. These affiliate receivables and payables were created during the normal
course of business and are settled on a monthly basis.
F-39
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
RED RIVER REFINANCING
In March 2003, El Paso Corporation obtained a new $1.2 billion fully
underwritten financing commitment arranged by Salomon Smith Barney and Credit
Suisse First Boston. The new $1.2 billion financing was secured by substantially
all of the natural gas and oil reserves of our subsidiaries. El Paso Corporation
loaned the financing proceeds to our subsidiaries El Paso Production Company, El
Paso Energy Raton, L.L.C., Vermejo Minerals Corporation and El Paso Production
GOM, Inc. The new financing had scheduled maturities of $300 million in June
2004, $300 million in September 2004, and the $600 million balance in March
2005. For the nine months ended September 30, 2003 the interest expense related
to these loans was $23.0 million. The liability was retired in May 2003 with the
proceeds of the bond offering discussed in Note 7.
RED RIVER NOTES RECEIVABLE AND PAYABLE
Prior to December 31, 1999, we regularly borrowed funds from El Paso
Corporation. On December 31, 1999, the $1 billion in borrowings under this
agreement were converted into two $500 million notes payable from El Paso
Production. El Paso Corporation then contributed its two $500 million notes
receivable to our subsidiaries Sabine River Investors VII, L.L.C. and Sabine
River Investors VIII, L.L.C., as a capital contribution. These notes are due on
June 30, 2009 and carry an interest rate based on a London InterBank Offered
Rate (LIBOR) plus 0.5% per year, which was 2.3% at December 31, 2002. These
notes receivable and payable are eliminated in conjunction with the preparation
of our consolidated financial statements. Interest earned on the notes
receivable is subsequently loaned back to El Paso Corporation. At December 31,
2002, the Sabine River Investors VII, L.L.C. and Sabine River Investors VIII,
L.L.C. had both loaned $74.6 million back to El Paso Corporation. These amounts
are reflected as notes receivable from affiliates in our balance sheets and
carry an interest rate based on a London InterBank Offered Rate (LIBOR) plus
0.5% per year, which was 2.3% at December 31, 2002. The interest earned on these
notes is added back to the note receivable balance until it is paid. These notes
are payable by El Paso Corporation on demand. At March 31, 2003 we dividended
this receivable to El Paso Corporation.
RED RIVER REPLACEMENT PROPERTIES
During March 2002, we acquired natural gas and oil properties from an
affiliate of El Paso CGP for $395.5 million in cash. In order to maintain an
adequate collateral balance for our Red River financing, these properties were
acquired to replace comparable properties in south and east Texas that were sold
to third parties. This agreement was facilitated through a series of
investments, contributions, and sales through various affiliated legal entities.
We provided an additional $3.9 million in cash to accomplish the series of
steps. Because this property acquisition involved entities under the common
control of El Paso Corporation, we recorded the acquired properties at their El
Paso CGP carryover basis net book value of $343.1 million, along with an
associated deferred tax asset of $17.0 million. The $31.5 million difference
between the cash consideration price and the carryover basis of the acquired
properties was reflected as a dividend.
F-40
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
We accounted for this transaction as a pooling of interests in accordance
with FAS 141, "Business Combinations", under the exceptions for transfers of net
assets between entities under common control. The following table presents the
revenues and net income of the previously separate business entities and the
combined amounts presented in these audited financial statements. Adjustments to
revenues and expenses were made to add the impact of this transaction to prior
periods. The adjustments we have made in these statements require us to use
estimates and assumptions based on currently available information. We believe
our estimates and assumptions are reasonable, however actual results may differ
from the estimates and assumptions used. You should not assume that these
financial statements are indicative of future results or the results we would
have achieved had the transaction occurred at the dates presented.
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30, 2002
------------------
(IN MILLIONS)
REVENUES
El Paso Production Holding Company........................ $615
El Paso CGP affiliate replacement properties.............. 15
----
Combined.................................................. $630
====
NET INCOME
El Paso Production Holding Company........................ $155
El Paso CGP affiliate replacement properties.............. 2
----
Combined.................................................. $157
====
</Table>
CASH MANAGEMENT SERVICES
El Paso Corporation provides us with cash management services. A cash pool
has been established for us to loan funds to or borrow funds from El Paso
Corporation. We receive interest on loaned funds based on the month-end cash
pool balance. The interest rate is based on the Bloomberg Index H15 rate plus 10
basis points. The H15 rate is the average dealer placed Commercial Paper
offering rate for AA rated U.S. Industrial Companies. The cash pool was
initially funded on December 31, 1999, through a $400 million capital
contribution from El Paso Corporation to our subsidiary. At September 30, 2003
the balance in the cash pool totaled $700.5 million and is reflected as notes
receivable from affiliates in our balance sheets. This cash pool is payable by
El Paso Corporation on demand.
In September 2003 we loaned $125 million to El Paso Corporation in
accordance with covenants under the senior unsecured notes, discussed in Note 7.
MUSTANG FINANCING
During 2000, El Paso Corporation formed Noric Holdings I, and other
separate legal entities, for the purpose of generating funds for El Paso
Corporation to invest in capital projects and other assets. El Paso Corporation
used $85.3 million of our assets, net of deferred income taxes of $14.4 million,
as collateral for the borrowings. As such, we contributed our economic interest
in these assets to Noric, L.L.C. in exchange for an investment in the company.
As a part of this transaction, El Paso Corporation also contributed $25 million
to us, which was subsequently used to make a $25 million investment in
Clydesdale Associates, L.P. (Clydesdale) in return for an 8.2% voting interest.
These funds were then used by Clydesdale to invest in Noric, L.L.C.
During 2001, we contributed additional assets to Noric, L.L.C. valued at
$5.3 million, net of deferred income taxes, of $2.5 million, and two other El
Paso CGP affiliates contributed assets valued at
F-41
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
$105.6 million, net of deferred income taxes of $46.7 million. As a result of
these contributions we had a 58% equity interest in Noric Holdings I. The 42%
interest held by the other two El Paso CGP affiliates is shown as a minority
interest in our balance sheets and our statements of income. For the nine months
ended September 30, 2003 and 2002, the minority interest expense was $3.5
million and $1.9 million, respectively.
With the sale of our interest in Noric Holdings I, we no longer have an
investment in Clydesdale. Prior to the sale, our investment in Clydesdale was
$25 million. For the nine months ended September 30, 2003 and 2002, we received
$0.3 million and $0.9 million in dividends, respectively, from Clydesdale. These
appear on our statements of income as earnings from unconsolidated affiliates.
In May 2002, we were notified by Clydesdale that it had distributed cash of $8.1
million in excess earnings to us because of a change in the pro rata allocation
between us and other Clydesdale investors. We returned the excess earnings to
Clydesdale by demanding El Paso Corporation repay part of our affiliated notes
receivable. This return of earnings is reflected in our statements of income as
a reduction in earnings from unconsolidated affiliates.
Our investment in Noric, L.L.C. was accounted for using the equity method,
because of our ability to exert significant influence over, but not control, its
operating and financial policies. Prior to the sale, our investment in Noric,
L.L.C. was $151.9 million. For the nine months ended September 30, 2003 and
2002, we recognized $8.5 million and $11.8 million in equity earnings from this
unconsolidated affiliate. For additional information on our investment in Noric,
L.L.C., refer to Note 9.
CORPORATE OVERHEAD AND AFFILIATE SERVICE AGREEMENTS
We are allocated a portion of El Paso Corporation's corporate overhead.
This overhead allocation covers expenses related to management, legal,
financial, tax, consultative, administrative and other services, including
employee benefits, annual incentive bonuses, rent, insurance, and information
technology. For the nine months ended September 30, 2003 and 2002, we were
allocated $99.9 million and $75.5 million, respectively, in corporate overhead
which is reflected in our statements of income as operation and maintenance
expense.
We allocate a portion of our general corporate overhead, labor, and general
and administrative expenses to affiliates of El Paso CGP. We provide management,
legal, accounting, financial, tax, consulting, administrative, and other
services to these affiliates who are engaged in the ownership of natural gas and
oil properties. For the nine months ended September 30, 2003 and 2002, we
allocated $99.7 million and $100.3 million of our expenses to affiliates of El
Paso CGP. This allocation is reflected on our statements of income as a
reduction in operation and maintenance expense.
GULFTERRA ENERGY PARTNERS
GulfTerra Energy Partners, L.P. (formerly El Paso Energy Partners, L.P.) is
a publicly traded master limited partnership that provides natural gas and oil
gathering, transportation, processing, storage, and other related services.
Affiliates of El Paso Corporation serve as the general partner and own 19% of
the outstanding common units of the partnership, all outstanding Series B
preferred units and all outstanding Series C common units. As of September 30
2003 and 2002, we used $3.0 million and $13.4 million, respectively, in services
from GulfTerra. During 2002, El Paso Production GOM acquired the Prince offshore
platform from GulfTerra for $190 million. El Paso Corporation provided a capital
contribution to pay for the acquisition. At September 30, 2003, we had no
material receivables or payables with GulfTerra.
F-42
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
AFFILIATED HEDGING AGREEMENT
We are parties to a master hedging contract with El Paso Merchant Energy,
L.P., an affiliate of El Paso Corporation that conducts energy trading
activities. Pursuant to that agreement, we hedge our production with El Paso
Merchant Energy which then enters into hedging agreements with third parties.
Under the master hedging agreement, we are not obligated to post cash or other
collateral.
DIVIDENDS
During 2003 and 2002 we made cash dividends of $1.2 billion and $375
million, respectively, to our shareholder El Paso Corporation. During 2003 and
2002 we made non-cash dividends of $331 million and $32 million, respectively,
to our shareholder El Paso Corporation. These dividends are related to the Red
River refinancing and the Red River replacement properties pooling of interests.
All of these transactions are fully discussed in Notes 5, 7, 9 and above.
OTHER SERVICES
We also contract for services with El Paso Field Services and El Paso
Corporation's regulated interstate pipelines. These companies provide
transportation, gathering, processing, and treating for our natural gas, oil,
condensate, and liquids production. For the nine months ended September 30, 2003
and 2002, we used $0.7 million and $1.8 million, respectively, in services from
El Paso Field Services. For the nine months ended September 30, 2003 and 2002,
we used $7.7 million and $4.6 million, respectively, in services from El Paso
Corporation's regulated interstate pipelines, including Tennessee Gas Pipeline
Company and Colorado Interstate Gas Company.
11. SUBSEQUENT EVENTS
DRILLING VENTURE PROGRAM
In October 2003, we entered into agreements with a wholly owned subsidiary
of Lehman Brothers (Lehman), an investment bank, and a wholly owned subsidiary
of Nabors Industries Ltd. (Nabors) that could collectively result in an
additional $190 million of drilling activity over the next nine to 12 months.
Lehman will contribute 50 percent of an estimated $270 million total cost to
develop a specified package of wells in exchange for a 50 percent net profits
interest (cash proceeds available after royalties and operating costs have been
paid), and Nabors will contribute 20 percent in exchange for a 20 percent net
profits interest in the package of wells. Once a specified payout is achieved,
Lehman's and Nabors' net profits interests will convert to an overriding royalty
interest in the wells for the remainder of the wells' productive lives. The
remaining 30 percent of the $270 million of capital will be contributed by us as
part of our existing 2003 and 2004 capital budget. Under the terms of the
agreements, all parties have a right to cease further investment with 30 days
notice.
RESERVOIR ENGINEER
As of January 1, 2003, our reserve estimates were prepared internally by us
and reviewed by Huddleston & Co, Inc. During the fourth quarter of 2003, we
appointed Ryder Scott Co. as our primary reservoir engineer.
MOODY'S INVESTORS SERVICE
On November 11, 2003, Moody's Investors Service reduced our rating outlook
to negative from stable until production trends, proven developed reserve
levels, reserve replacement cost trends, or other business or organizational
developments demonstrate the compatibility of our debt and B2 rating. Moody's
indicated
F-43
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
that a negative outlook will remain until sustainable production, proved
developed reserves, and total unit-full cycle costs can be reliably gauged.
DIVIDENDS
In November 2003, we made a cash dividend of $40 million to our shareholder
El Paso Corporation.
F-44
EL PASO PRODUCTION HOLDING COMPANY
NOTE REGARDING PRO FORMA FINANCIAL STATEMENTS
The accompanying pro forma financial statements have been prepared to
reflect the following transactions:
- The sale in April 2003 of our 58% equity interest in Noric Holdings I,
L.L.C. to an affiliate of El Paso Corporation;
- The sale in March 2003 of our natural gas and oil reserves located in
Oklahoma and Texas to Chesapeake Energy Corporation; and
- This offering's impact on unaffiliated interest expense using the actual
interest rate of 7.75%.
The historical financial statements from which these pro forma financial
statements have been prepared include the income statements of El Paso
Production Holding Company for the nine months ended September 30, 2003, and the
year ended December 31, 2002. These pro forma statements are unaudited. The pro
forma income statements are derived from the income statements presented in our
unaudited consolidated financial statements for the nine months ended September
30, 2003, and our audited financial statements for the year ended December 31,
2002. These income statements include the impacts of the above transactions as
though they occurred on January 1, 2002.
These pro forma financial statements were prepared under rules established
by the Securities and Exchange Commission in Article 11 of Regulation S-X. These
pro forma financial statements do not purport to be indicative of future results
or the results we would have achieved had the transactions occurred on the dates
presented.
You should read these pro forma financial statements in conjunction with
the historical consolidated financial statements of El Paso Production Holding
Company. The pro forma adjustments we have made in these statements require us
to use estimates and assumptions based on currently available information, which
includes estimates of income taxes (where we assumed a statutory rate). We also
used the actual interest rate on the notes of 7.75%. We believe our estimates
and assumptions are reasonable, and that the significant effects of the
transactions discussed above have been properly reflected in these pro forma
financial statements. Actual results may differ from the estimates and
assumptions used.
F-45
EL PASO PRODUCTION HOLDING COMPANY
UNAUDITED PRO FORMA INCOME STATEMENT
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003
(IN MILLIONS)
<Table>
<Caption>
ASSET EPPH BOND PRO
EPPH DISPOSITION HISTORICAL OFFERING FORMA
HISTORICAL ADJUSTMENTS(A) AS ADJUSTED ADJUSTMENTS COMBINED
---------- -------------- ----------- ----------- --------
Operating revenues
Natural gas and oil sales -- third
party........................... $110 $ 19 $129 $ -- $129
Natural gas and oil
sales -- affiliates............. 620 (45) 575 -- 575
Other.............................. 6 -- 6 -- 6
---- ---- ---- ---- ----
Total operating revenues........ 736 (26) 710 -- 710
---- ---- ---- ---- ----
Operating expenses
Cost of sales...................... 39 (3) 36 -- 36
Operation and maintenance.......... 129 (1) 128 -- 128
Merger related and restructuring
costs........................... 4 -- 4 -- 4
Depreciation, depletion and
amortization.................... 228 (7) 221 -- 221
Taxes, other than income taxes..... 27 (3) 24 -- 24
---- ---- ---- ---- ----
Total operating expenses........ 427 (14) 413 -- 413
---- ---- ---- ---- ----
Operating income (loss).............. 309 (12) 297 -- 297
Other income......................... 2 2 2
Interest income (expense) from/to
affiliates......................... (16) -- (16) 23(b) 7
Interest expense..................... (34) -- (34) (36)(b) (70)
Interest capitalized................. 3 -- 3 -- 3
Earnings from unconsolidated
affiliates......................... 8 (8) -- -- --
Minority interest in consolidated
subsidiaries....................... (3) 3 -- -- --
---- ---- ---- ---- ----
Income (loss) before income taxes.... 269 (17) 252 (13) 239
Income taxes......................... (105) 4 (101) 4(b) (97)
---- ---- ---- ---- ----
Income (loss) before cumulative
effect of accounting changes....... $164 $(13) $151 $ (9) $142
==== ==== ==== ==== ====
</Table>
F-46
EL PASO PRODUCTION HOLDING COMPANY
UNAUDITED PRO FORMA INCOME STATEMENT
FOR THE YEAR ENDED DECEMBER 31, 2002
(IN MILLIONS)
<Table>
<Caption>
ASSET EPPH BOND
EPPH DISPOSITION HISTORICAL OFFERING PRO FORMA
HISTORICAL ADJUSTMENTS(A) AS ADJUSTED ADJUSTMENTS COMBINED
---------- -------------- ----------- ----------- ---------
Operating revenues
Natural gas and oil sales -- third
party.......................... $ 166 $(23) $ 143 $ -- $143
Natural gas and oil
sales -- affiliates............ 685 (44) 641 -- 641
Other............................. (10) -- (10) -- (10)
----- ---- ----- ---- ----
Total operating revenues....... 841 (67) 774 -- 774
Operating expenses
Cost of sales..................... 55 (7) 48 -- 48
Operation and maintenance......... 137 (2) 135 -- 135
Gain on long-lived assets......... (2) -- (2) -- (2)
Depreciation, depletion and
amortization................... 317 (26) 291 -- 291
Taxes, other than income taxes.... 25 (3) 22 -- 22
----- ---- ----- ---- ----
Total operating expenses....... 532 (38) 494 -- 494
----- ---- ----- ---- ----
Operating income (loss)............. 309 (29) 280 -- 280
Other income........................ 5 -- 5 -- 5
Interest income from affiliates..... 8 -- 8 -- 8
Interest expense.................... -- -- -- (93)(b) (93)
Interest capitalized................ -- -- -- 3(b) 3
Earnings from unconsolidated
affiliates........................ 6 (6) -- -- --
Minority interest in consolidated
subsidiaries...................... (3) 3 -- -- --
----- ---- ----- ---- ----
Income (loss) before income taxes... 325 (32) 293 (90) 203
Income taxes........................ (112) 10 (102) 31(b) (71)
----- ---- ----- ---- ----
Net income (loss)................... $ 213 $(22) $ 191 $(59) $132
===== ==== ===== ==== ====
</Table>
F-47
EL PASO PRODUCTION HOLDING COMPANY
NOTES TO UNAUDITED PRO FORMA FINANCIAL STATEMENTS
(a) This column reflects the sale of our equity investment in Noric Holdings I,
which was sold to our parent company in connection with the renegotiation
of our parent company's revolving credit facility and the restructuring of
the Clydesdale preferred interest. The pro forma income statement
adjustments reflect the elimination of earnings from unconsolidated
affiliates associated with our investment. This column also reflects the
sale of natural gas and oil reserves located in Oklahoma and Texas to
Chesapeake Energy Corporation. The pro forma income statement adjustments
reflect the elimination of the revenue, hedging impact, and direct expenses
associated with the assets sold.
(b) To record an increase in unaffiliated interest expense associated with the
issuance of $1.2 billion of notes, using the actual interest rate of 7.75%.
F-48
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
WE HAVE NOT AUTHORIZED ANY DEALER, SALESPERSON OR OTHER PERSON TO GIVE YOU
WRITTEN INFORMATION OTHER THAN THIS PROSPECTUS OR TO MAKE REPRESENTATIONS AS TO
MATTERS NOT STATED IN THIS PROSPECTUS. YOU MUST NOT RELY ON UNAUTHORIZED
INFORMATION. THIS PROSPECTUS IS NOT AN OFFER TO SELL THE NOTES OR OUR
SOLICITATION OF YOUR OFFER TO BUY THE NOTES IN ANY JURISDICTION WHERE THAT WOULD
NOT BE PERMITTED OR LEGAL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALES
MADE HEREUNDER AFTER THE DATE OF THIS PROSPECTUS SHALL CREATE AN IMPLICATION
THAT THE INFORMATION CONTAINED HEREIN OR THE AFFAIRS OF THE COMPANY HAVE NOT
CHANGED SINCE THE DATE OF THIS PROSPECTUS.
UNTIL , ALL DEALERS THAT EFFECT TRANSACTIONS IN THESE SECURITIES,
WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A
PROSPECTUS. THIS IS IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNUSED
ALLOTMENTS OR SUBSCRIPTIONS.
EL PASO PRODUCTION HOLDING COMPANY
$1,200,000,000
OFFER TO EXCHANGE
REGISTERED 7 3/4% SENIOR NOTES DUE 2013
FOR
ALL OUTSTANDING 7 3/4% SENIOR NOTES DUE 2013
-------------------------
PROSPECTUS
-------------------------
, 2003
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PART II
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 145 of the Delaware General Corporation Law (the "DGCL") provides
that a corporation may indemnify directors and officers as well as other
employees and individuals against expenses (including attorneys' fees),
judgments, fines, and amounts paid in settlement in connection with specified
actions, suits, proceedings whether civil, criminal, administrative, or
investigative (other than action by or in the right of the corporation -- a
"derivative action"), if they acted in good faith and in a manner they
reasonably believed to be in or not opposed to the best interests of the
corporation and, with respect to any criminal action or proceeding, had no
reasonable cause to believe their conduct was unlawful. A similar standard is
applicable in the case of derivative actions, except that indemnification only
extends to expenses (including attorneys' fees) incurred in connection with the
defense or settlement of such action, and the statute requires court approval
before there can be any indemnification where the person seeking indemnification
has been found liable to the corporation. The statute provides that it is not
exclusive of other indemnification that may be granted by a corporation's
charter, by-laws, disinterested director vote, stockholder vote, agreement, or
otherwise.
Article VI, Section 4 of the by-laws of El Paso Production requires El Paso
Production to indemnify to the full extent authorized by law any person made or
threatened to be made a party to any action, suit or proceeding, whether
criminal, civil, administrative or investigative, by reason of the fact that he,
his testator or intestate, is or was a director, officer or employee of El Paso
Production or any predecessor of El Paso Production or serves or served any
other enterprise as a director, or officer or employee at the request of El Paso
Production or any predecessor of El Paso Production. In the event that the Board
of Directors or stockholders refuse or fail to provide indemnity, a person may
seek indemnity from El Paso Production in court and have the court substitute
its judgment as to the propriety of indemnity, or determine such propriety in
the absence of any determination thereof by the Board or by stockholders.
Article VI, Section 4 of the by-laws of each of El Paso Production Company, El
Paso Production GOM Inc. and Vermejo Minerals Corporation contains identical
provisions.
Article IX, Section 9.01 of the Second Amended and Restated Limited
Liability Company Agreement of El Paso Energy Raton, L.L.C. ("EPER") requires
that, except to the extent expressly prohibited by the DGCL, EPER shall
indemnify each person made or threatened to be made a party to any action or
proceeding, whether civil or criminal, by reason of the fact that such person or
such person's testator or intestate is or was a member or officer of EPER,
against judgments, fines (including excise taxes assessed on a person with
respect to an employee benefit plan), penalties, amounts paid in settlement and
reasonable expenses, including attorneys' fees, actually and necessarily
incurred in connection with such action or proceeding, or any appeal therefrom;
provided that no such indemnification shall be made if a judgment or other final
adjudication adverse to such person establishes that his conduct did not meet
the then applicable minimum statutory standards of conduct; and provided,
further, that no such indemnification shall be required in connection with any
settlement or other non-adjudicated disposition of any threatened or pending
action or proceeding unless EPER has given its prior consent to such settlement
or such other disposition, which consent shall not be unreasonably withheld.
Section 102(b)(7) of the DGCL permits a corporation to provide in its
certificate of incorporation that a director of the corporation shall not be
personally liable to the corporation or its stockholders for monetary damages
for breach of fiduciary duty as a director, except for liability for (i) any
breach of the director's duty of loyalty to the corporation or its stockholders,
(ii) acts of omissions not in good faith or which involve intentional misconduct
or a knowing violation of law, (iii) payment of unlawful dividends or unlawful
stock purchases or redemptions, or (iv) any transaction from which the director
derived an improper personal benefit.
Article Eighth of El Paso Production's amended and restated certificate of
incorporation provides that no director of El Paso Production shall be
personally liable to El Paso Production or its stockholders for monetary damages
for breach of fiduciary duty as a director, for any act or omission, except that
a director
II-1
may be liable (i) for breach of the director's duty of loyalty to the
corporation or its stockholders, (ii) for acts or omissions not in good faith or
that involve intentional misconduct or a knowing violation of law, (iii) under
Section 174 of the DGCL, or (iv) for any transaction from which the director
derived an improper personal benefit. If the DGCL is amended to authorize
corporate action further eliminating or limiting the personal liability of
directors, then the liability of the directors shall be eliminated or limited to
the fullest extent permitted by the DGCL, as so amended. The elimination and
limitation of liability shall continue after a director has ceased to occupy
such position as to acts or omissions occurring during such director's term or
terms of office. Any amendment, repeal or modification of such Article Eighth
shall not adversely affect any right of protection of a director of El Paso
Production existing at the time of such repeal or modification. Article Eighth
of the amended and restated certificates of incorporation of each of El Paso
Production Company, El Paso Production GOM Inc. and Vermejo Minerals Corporation
contains identical provisions.
El Paso Corporation maintains directors' and officers' liability insurance
which provides for payment, on behalf of the directors and officers of El Paso
Corporation and its subsidiaries, of certain losses of such persons (other than
matters uninsurable under law) arising from claims, including claims arising
under the Securities Act of 1933, as amended ("Securities Act") for acts or
omissions by such persons while acting as directors or officers of El Paso
Corporation and/or its subsidiaries, as the case may be.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits.
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
*1.1 -- Purchase Agreement dated as of May 20, 2003, between El Paso
Production Holding Company, the Subsidiary Guarantors named
therein and Credit Suisse First Boston LLC, Citigroup Global
Markets Inc., Banc of America Securities LLC, Deutsche Bank
Securities Inc., Lehman Brothers Inc. and Scotia Capital
(USA) Inc., (collectively, the "Initial Purchasers").
*3.1 -- Amended and Restated Certificate of Incorporation of El Paso
Production Holding Company, as filed with the Delaware
Secretary of State on May 23, 2003.
*3.2 -- By-Laws of El Paso Production Holding Company effective as
of June 24, 2002.
*3.3 -- Amended and Restated Certificate of Incorporation of El Paso
Production Company, as filed with the Delaware Secretary of
State on May 23, 2003.
*3.4 -- By-Laws of El Paso Production Company effective as of June
24, 2002.
*3.5 -- Amended and Restated Certificate of Incorporation of El Paso
Production GOM Inc., as filed with the Delaware Secretary of
State on May 23, 2003.
*3.6 -- By-Laws of El Paso Production GOM Inc. effective as of June
24, 2002.
*3.7 -- Amended and Restated Certificate of Incorporation of Vermejo
Minerals Corporation, as filed with the Delaware Secretary
of State on May 23, 2003.
*3.8 -- By-Laws of Vermejo Minerals Corporation effective as of June
24, 2002.
*3.9 -- Certificate of Formation of El Paso Energy Raton, L.L.C., as
filed with the Delaware Secretary of State on March 17,
1999, as amended by the Certificate of Amendment to the
Certificate of Formation, as filed with the Delaware
Secretary of State on December 17, 1999.
*3.10 -- Second Amended and Restated Limited Liability Company
Agreement of El Paso Energy Raton, L.L.C., effective as of
May 23, 2003.
*4.1 -- Indenture (including form of Note) dated as of May 23, 2003,
by and between El Paso Production Holding Company, the
Subsidiary Guarantors named therein and Wilmington Trust
Company, as Trustee.
*4.2 -- Registration Rights Agreement dated as of May 20, 2003, by
and between El Paso Production Holding Company, the
Subsidiary Guarantors named therein and the Initial
Purchasers.
5.1 -- Opinion of Andrews & Kurth L.L.P. as to the legality of the
New Notes.
8.1 -- Opinion of Andrews & Kurth L.L.P. regarding tax matters.
</Table>
II-2
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
*10.1 -- ISDA Master Agreement, dated as of January 1, 2001, between
El Paso Merchant Energy, L.P. and El Paso Production
Company.
*10.2 -- Services Agreement, dated as of May 23, 2003, between El
Paso Energy Service Company and El Paso Production Holding
Company.
*10.3 -- Services Agreement, dated as of May 23, 2003, between El
Paso Production Oil & Gas Company and El Paso Production
Holding Company.
**+10.4 -- 1999 Omnibus Incentive Compensation Plan dated January 20,
1999 (Exhibit 10.1 to El Paso's Form S-8 (Registration No.
333-78979) filed May 20, 1999); Amendment No. 1 effective as
of February 7, 2001 to the 1999 Omnibus Incentive
Compensation Plan (Exhibit 10.V.1 to El Paso's First Quarter
Form 10-Q).
*+10.5 -- Amendment No. 2 effective as of May 1, 2003 to the 1999
Omnibus Incentive Compensation Plan.
**+10.6 -- 2001 Omnibus Incentive Compensation Plan, effective as of
January 29, 2001. (Exhibit 10.1 to El Paso's Form S-8
(Registration No. 333-64236) filed June 29, 2001); Amendment
No. 1 effective as of February 7, 2001 to the 2001 Omnibus
Incentive Compensation Plan (Exhibit 10.J.1 to El Paso's
2001 Form 10-K); Amendment No. 3 effective as of July 17,
2002 to the 2001 Omnibus Incentive Compensation Plan
(Exhibit 10.J.1 to El Paso's 2002 Second Quarter Form 10-Q);
Amendment No. 2 effective as of April 1, 2001 to the 2001
Omnibus Incentive Compensation Plan (Exhibit 10.J.1 to El
Paso's 2002 Form 10-K).
*+10.7 -- Amendment No. 4 effective as of May 1, 2003 to the 2001
Omnibus Incentive Compensation Plan.
**+10.8 -- Supplemental Benefits Plan, Amended and Restated effective
December 7, 2001. (Exhibit 10.K to El Paso's 2001 Form
10-K); Amendment No. 1 effective November 7, 2002 to the
Supplemental Benefits Plan (Exhibit 10.K.1 to El Paso's 2002
Form 10-K).
**+10.9 -- Amended and Restated El Paso Corporation Senior Executive
Survivor Benefit Plan, effective as of August 1, 1998
(Exhibit 10.M to El Paso's 1998 Third Quarter Form 10-Q);
Amendment No. 1 effective as of February 7, 2001 to the
Senior Executive Survivor Benefit Plan (Exhibit 10.I.1 to El
Paso's 2001 First Quarter Form 10-Q); Amendment No. 2 to the
Senior Executive Survivor Benefit Plan (Exhibit 10.L.1 to El
Paso's 2002 Form 10-K).
**+10.10 -- Key Executive Severance Protection Plan, Amended and
Restated effective as of August 1, 1998 (Exhibit 10.0 to El
Paso's 1998 Third Quarter Form 10-Q); Amendment No. 1
effective as of February 7, 2001, to the Key Executive
Severance Protection Plan (Exhibit 10.K.1 to El Paso's 2001
First Quarter Form 10-Q); Amendment No. 2 effective November
7, 2002 to the Key Executive Severance Protection Plan and
Amendment No. 3 effective as of December 6, 2002 to the Key
Executive Severance Protection Plan (Exhibit 10.N.1 to El
Paso's 2002 Form 10-K).
**+10.11 -- Strategic Stock Plan, Amended and Restated effective as of
December 3, 1999 (Exhibit 10.1 to El Paso's Form S-8 filed
January 14, 2000); Amendment No. 1 effective as of February
7, 2001, to the Strategic Stock Plan (Exhibit 10.M.1 to El
Paso's 2001 First Quarter Form 10-Q); Amendment No. 2
effective November 7, 2002 to the Strategic Stock Plan;
Amendment No. 3 effective as of December 6, 2002 to the
Strategic Stock Plan and Amendment No. 4 effective January
29, 2003 to the Strategic Stock Plan (Exhibit 10.P.1 to El
Paso's 2002 Form 10-K).
**+10.12 -- El Paso Production Companies Long-Term Incentive Plan,
effective as of January 1, 2003 (Exhibit 10.A.A to El Paso's
2003 First Quarter Form 10-Q).
*+10.13 -- Amendment No. 1 to El Paso Production Companies Long-Term
Incentive Plan, effective as of June 6, 2003.
**+10.14 -- Severance Pay Plan effective as of October 1, 2002;
Supplement No. 1 effective as of January 1, 2003 to the
Severance Pay Plan; Amendment No. 1 to the Supplement No. 1
effective March 21, 2003 (Exhibit 10.Z to El Paso's 2003
First Quarter Form 10-Q).
</Table>
II-3
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
**+10.15 -- Omnibus Plan for Management Employees, Amended and Restated
effective as of December 3, 1999 and Amendment No. 1
effective as of December 1, 2000 to the Omnibus Plan for
Management Employees (Exhibit 10.1 to El Paso's Form S-8
(Registration No. 333-52100) filed December 18, 2000);
Amendment No. 2 effective as of February 7, 2001 to the
Omnibus Plan for Management Employees (Exhibit 10.U.1 to El
Paso's 2001 First Quarter Form 10-Q); Amendment No. 3
effective as of December 7, 2001 to the Omnibus Plan for
Management Employees (Exhibit 10.1 to El Paso's Form S-8
(Registration No. 333-82506) filed February 11, 2002).
*+10.16 -- Employment Agreement between El Paso CGP Company and Gene T.
Waguespack, effective as of January 17, 2000.
*+10.17 -- Termination of Employment Agreement between El Paso CGP
Company and Rodney D. Erskine, effective as of December 16,
2002.
*10.18 -- Federal and State Tax Reimbursement Agreement among El Paso
and the Controlled Entities (named therein), effective as of
May 22, 2003.
*10.19 -- El Paso Corporation and Consolidated Subsidiaries Accounting
Policy for the Accrual of U.S. Federal Income Taxes,
effective as of January 1, 2002.
*10.20 -- Intercompany State Income Tax Allocation and Payments
Policy, effective for tax years beginning after January 29,
2001.
10.21 -- Purchase and Sale Agreement (Red River) by and among El Paso
Production Company, El Paso Production GOM Inc. and Lehman
Commercial Paper Inc., dated October 3, 2003.
10.22 -- First Amendment to Purchase and Sale Agreement by and among
El Paso Production Company, El Paso Production GOM Inc. and
Lehman Commercial Paper Inc., dated October 6, 2003.
10.23 -- Purchase and Sale Agreement (Red River) by and among El Paso
Production Company, El Paso Production GOM Inc. and Ramshorn
Investments, Inc., dated October 8, 2003.
12.1 -- Computation of Ratio of Earnings to Fixed Charges.
*21.1 -- Subsidiaries of El Paso Production Holding Company.
23.1 -- Consent of PricewaterhouseCoopers LLP.
23.2 -- Consent of Andrews & Kurth L.L.P. (included in Exhibit 5.1).
23.3 -- Consent of Huddleston & Co.
24.1 -- Power of Attorney (included on signature pages).
*25.1 -- Form T-1 Statement of Eligibility under the Trust Indenture
Act of 1939 of Wilmington Trust Company to act as Trustee
under the Indenture.
***99.1 -- Form of Letter of Transmittal.
*99.2 -- Form of Notice of Guaranteed Delivery.
*99.3 -- Form of Letter to Brokers, Dealers, Commercial Banks, Trust
Companies and Other Nominees.
*99.4 -- Form of Letter to Clients.
*99.5 -- Form of Exchange Agency Agreement.
</Table>
All supporting schedules have been omitted because they are not required or
the information required to be set forth therein is included in the consolidated
financial statements or in the notes thereto.
- ---------------
* Previously filed with this registration statement on Form S-4 on June 27,
2003.
** Previously filed by our parent El Paso Corporation (SEC File No. 1-14365) as
indicated.
*** Previously filed with Amendment No. 1 to this registration statement on Form
S-4 on October 3, 2003.
+ Management contract or compensatory plan or arrangement required to be filed
as an exhibit to this registration statement pursuant to Item 21(a) of Form
S-4.
II-4
ITEM 22. UNDERTAKINGS.
(A) The undersigned Registrants hereby undertake:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of this registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in this registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Securities and Exchange Commission pursuant to Rule 424(b)
under the Securities Act, if, in the aggregate, the changes in volume
and price represent no more than a 20% change in the maximum aggregate
offering price set forth in the "Calculation of Registration Fee" table
in the effective registration statement; and
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in this registration statement
or any material change to such information in this Registration
Statement; provided, however, that the undertakings set forth in
paragraphs (1)(i) and (ii) above do not apply if the information
required to be included in a post-effective amendment by those
paragraphs is contained in periodic reports filed by the registrant
pursuant to Section 13 or Section 15(d) of the Securities Exchange Act
of 1934, as amended (the "Exchange Act") that are incorporated by
reference in this registration statement.
(2) That, for the purpose of determining any liability under the
Securities Act each such post-effective amendment shall be deemed to be a
new registration statement relating to the securities offered therein, and
the offering of such securities at that time be deemed to be the initial
bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
(B) The undersigned Registrants hereby undertake that, for purposes of
determining any liability under the Securities Act, each filing of the
Registrants' annual reports pursuant to Section 13(a) or 15(d) of the Exchange
Act (and, where applicable, each filing of an employee benefit plan's annual
report pursuant to Section 15(d) of the Exchange Act) that is incorporated by
reference in the Registration Statement shall be deemed to be a new registration
statement relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be the initial bona fide offering
thereof.
(C) The undersigned Registrants hereby undertake:
(1) That, prior to any public reoffering of the securities registered
hereunder through use of a prospectus which is a part of this Registration
Statement, by any person or party who is deemed to be an underwriter within
the meaning of Rule 145(c), the issuer undertakes that such reoffering
prospectus will contain the information called for by the applicable
registration form with respect to reofferings by persons who may be deemed
underwriters, in addition to the information called for by the other items
of the applicable form.
(2) That every prospectus (i) that is filed pursuant to paragraph (1)
immediately preceding, or (ii) that purports to meet the requirements of
Section 10(a)(3) of the Securities Act and is used in connection with an
offering of securities subject to Rule 415, will be filed as a part of an
amendment to the Registration Statement and will not be used until such
amendment is effective, and that, for purposes of determining any liability
under the Securities Act, each such post-effective amendment
II-5
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
(D) Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers and controlling persons of the
Registrants pursuant to the foregoing provisions, or otherwise, the Registrants
have been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the Registrants of expenses
incurred or paid by a director, officer or controlling person of the Registrants
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrants will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.
(E) The undersigned Registrants hereby undertake:
(1) To respond to requests for information that is incorporated by
reference into the prospectus pursuant to Item 4, 10(b), 11, 13 of this
Form S-4, within one business day of receipt of such request, and to send
the incorporated documents by first class mail or other equally prompt
means. This includes information contained in documents filed subsequent to
the effective date of the Registration Statement through the date of
responding to the request.
(2) To supply by means of a post-effective amendment all information
concerning a transaction, and the company being acquired involved therein,
that was not the subject of and included in the Registration Statement when
it became effective.
II-6
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the undersigned
Subsidiary Guarantor Registrant has duly caused this Amendment No. 2 to the
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Houston, State of Texas, on November 24, 2003.
EL PASO PRODUCTION HOLDING COMPANY
By: /s/ GENE T. WAGUESPACK
------------------------------------
Gene T. Waguespack
Senior Vice President,
Chief Financial Officer and
Controller
POWER OF ATTORNEY
Each person whose individual signature appears below hereby authorizes
Robert W. Baker and Gene T. Waguespack, and each of them, as attorney-in-fact
with full power of substitution, to execute in the name and on behalf of such
person, individually and in each capacity stated below, and to file any and all
amendments to this Registration Statement, including any and all post-effective
amendments.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates as indicated.
<Table>
<Caption>
SIGNATURE TITLE DATE
--------- ----- ----
/s/ RANDY L. BARTLEY Acting President November 24, 2003
------------------------------------------------ (Principal Executive Officer)
(Randy L. Bartley)
/s/ GENE T. WAGUESPACK Senior Vice President, November 24, 2003
------------------------------------------------ Chief Financial Officer
(Gene T. Waguespack) and Controller
(Principal Financial
and Accounting Officer)
/s/ DOUGLAS L. FOSHEE Director November 24, 2003
------------------------------------------------
(Douglas L. Foshee)
/s/ D. DWIGHT SCOTT Director November 24, 2003
------------------------------------------------
(D. Dwight Scott)
</Table>
II-7
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the undersigned
Subsidiary Guarantor Registrant has duly caused this Amendment No. 2 to the
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Houston, State of Texas, on November 24, 2003.
EL PASO PRODUCTION COMPANY
By: /s/ GENE T. WAGUESPACK
------------------------------------
Gene T. Waguespack
Senior Vice President,
Chief Financial Officer and
Controller
POWER OF ATTORNEY
Each person whose individual signature appears below hereby authorizes
Robert W. Baker and Gene T. Waguespack, and each of them, as attorney-in-fact
with full power of substitution, to execute in the name and on behalf of such
person, individually and in each capacity stated below, and to file any and all
amendments to this Registration Statement, including any and all post-effective
amendments.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates as indicated.
<Table>
<Caption>
SIGNATURE TITLE DATE
--------- ----- ----
/s/ RANDY L. BARTLEY Acting President November 24, 2003
------------------------------------------------ (Principal Executive Officer)
(Randy L. Bartley)
/s/ GENE T. WAGUESPACK Senior Vice President, November 24, 2003
------------------------------------------------ Chief Financial Officer
(Gene T. Waguespack) and Controller
(Principal Financial
and Accounting Officer)
/s/ DOUGLAS L. FOSHEE Director November 24, 2003
------------------------------------------------
(Douglas L. Foshee)
/s/ D. DWIGHT SCOTT Director November 24, 2003
------------------------------------------------
(D. Dwight Scott)
</Table>
II-8
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the undersigned
Subsidiary Guarantor Registrant has duly caused this Amendment No. 2 to the
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Houston, State of Texas, on November 24, 2003.
EL PASO PRODUCTION GOM INC.
By: /s/ GENE T. WAGUESPACK
------------------------------------
Gene T. Waguespack
Senior Vice President,
Chief Financial Officer and
Controller
POWER OF ATTORNEY
Each person whose individual signature appears below hereby authorizes
Robert W. Baker and Gene T. Waguespack, and each of them, as attorney-in-fact
with full power of substitution, to execute in the name and on behalf of such
person, individually and in each capacity stated below, and to file any and all
amendments to this Registration Statement, including any and all post-effective
amendments.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates as indicated.
<Table>
<Caption>
SIGNATURE TITLE DATE
--------- ----- ----
/s/ RANDY L. BARTLEY Acting President November 24, 2003
------------------------------------------------ (Principal Executive Officer)
(Randy L. Bartley)
/s/ GENE T. WAGUESPACK Senior Vice President, November 24, 2003
------------------------------------------------ Chief Financial Officer and
(Gene T. Waguespack) Controller
(Principal Financial
and Accounting Officer)
/s/ DOUGLAS L. FOSHEE Director November 24, 2003
------------------------------------------------
(Douglas L. Foshee)
/s/ D. DWIGHT SCOTT Director November 24, 2003
------------------------------------------------
(D. Dwight Scott)
</Table>
II-9
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the undersigned
Subsidiary Guarantor Registrant has duly caused this Amendment No. 2 to the
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Houston, State of Texas, on November 24, 2003.
VERMEJO MINERALS CORPORATION
By: /s/ GENE T. WAGUESPACK
------------------------------------
Gene T. Waguespack
Senior Vice President,
Chief Financial Officer and
Controller
POWER OF ATTORNEY
Each person whose individual signature appears below hereby authorizes
Robert W. Baker and Gene T. Waguespack, and each of them, as attorney-in-fact
with full power of substitution, to execute in the name and on behalf of such
person, individually and in each capacity stated below, and to file any and all
amendments to this Registration Statement, including any and all post-effective
amendments.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates as indicated.
<Table>
<Caption>
SIGNATURE TITLE DATE
--------- ----- ----
/s/ RANDY L. BARTLEY Acting President November 24, 2003
------------------------------------------------ (Principal Executive Officer)
(Randy L. Bartley)
/s/ GENE T. WAGUESPACK Senior Vice President, November 24, 2003
------------------------------------------------ Chief Financial Officer and
(Gene T. Waguespack) Controller
(Principal Financial
and Accounting Officer)
/s/ DOUGLAS L. FOSHEE Director November 24, 2003
------------------------------------------------
(Douglas L. Foshee)
/s/ D. DWIGHT SCOTT Director November 24, 2003
------------------------------------------------
(D. Dwight Scott)
</Table>
II-10
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the undersigned
Subsidiary Guarantor Registrant has duly caused this Amendment No. 2 to the
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Houston, State of Texas, on November 24, 2003.
EL PASO ENERGY RATON, L.L.C.
By: /s/ GENE T. WAGUESPACK
------------------------------------
Gene T. Waguespack
Senior Vice President,
Chief Financial Officer and
Controller
POWER OF ATTORNEY
Each person whose individual signature appears below hereby authorizes
Robert W. Baker and Gene T. Waguespack, and each of them, as attorney-in-fact
with full power of substitution, to execute in the name and on behalf of such
person, individually and in each capacity stated below, and to file any and all
amendments to this Registration Statement, including any and all post-effective
amendments.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates as indicated.
<Table>
<Caption>
SIGNATURE TITLE DATE
--------- ----- ----
/s/ RANDY L. BARTLEY Acting President November 24, 2003
------------------------------------------------ (Principal Executive Officer)
(Randy L. Bartley)
/s/ GENE T. WAGUESPACK Senior Vice President, November 24, 2003
------------------------------------------------ Chief Financial Officer and
(Gene T. Waguespack) Controller
(Principal Financial
and Accounting Officer)
</Table>
II-11
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
*1.1 -- Purchase Agreement dated as of May 20, 2003, between El Paso
Production Holding Company, the Subsidiary Guarantors named
therein and Credit Suisse First Boston LLC, Citigroup Global
Markets Inc., Banc of America Securities LLC, Deutsche Bank
Securities Inc., Lehman Brothers Inc. and Scotia Capital
(USA) Inc., (collectively, the "Initial Purchasers").
*3.1 -- Amended and Restated Certificate of Incorporation of El Paso
Production Holding Company, as filed with the Delaware
Secretary of State on May 23, 2003.
*3.2 -- By-Laws of El Paso Production Holding Company effective as
of June 24, 2002.
*3.3 -- Amended and Restated Certificate of Incorporation of El Paso
Production Company, as filed with the Delaware Secretary of
State on May 23, 2003.
*3.4 -- By-Laws of El Paso Production Company effective as of June
24, 2002.
*3.5 -- Amended and Restated Certificate of Incorporation of El Paso
Production GOM Inc., as filed with the Delaware Secretary of
State on May 23, 2003.
*3.6 -- By-Laws of El Paso Production GOM Inc. effective as of June
24, 2002.
*3.7 -- Amended and Restated Certificate of Incorporation of Vermejo
Minerals Corporation, as filed with the Delaware Secretary
of State on May 23, 2003.
*3.8 -- By-Laws of Vermejo Minerals Corporation effective as of June
24, 2002.
*3.9 -- Certificate of Formation of El Paso Energy Raton, L.L.C., as
filed with the Delaware Secretary of State on March 17,
1999, as amended by the Certificate of Amendment to the
Certificate of Formation, as filed with the Delaware
Secretary of State on December 17, 1999.
*3.10 -- Second Amended and Restated Limited Liability Company
Agreement of El Paso Energy Raton, L.L.C., effective as of
May 23, 2003.
*4.1 -- Indenture (including form of Note) dated as of May 23, 2003,
by and between El Paso Production Holding Company, the
Subsidiary Guarantors named therein and Wilmington Trust
Company, as Trustee.
*4.2 -- Registration Rights Agreement dated as of May 20, 2003, by
and between El Paso Production Holding Company, the
Subsidiary Guarantors named therein and the Initial
Purchasers.
5.1 -- Opinion of Andrews & Kurth L.L.P. as to the legality of the
New Notes.
8.1 -- Opinion of Andrews & Kurth L.L.P. regarding tax matters.
*10.1 -- ISDA Master Agreement, dated as of January 1, 2001, between
El Paso Merchant Energy, L.P. and El Paso Production
Company.
*10.2 -- Services Agreement, dated as of May 23, 2003, between El
Paso Energy Service Company and El Paso Production Holding
Company.
*10.3 -- Services Agreement, dated as of May 23, 2003, between El
Paso Production Oil & Gas Company and El Paso Production
Holding Company.
**+10.4 -- 1999 Omnibus Incentive Compensation Plan dated January 20,
1999 (Exhibit 10.1 to El Paso's Form S-8 (Registration No.
333-78979) filed May 20, 1999); Amendment No. 1 effective as
of February 7, 2001 to the 1999 Omnibus Incentive
Compensation Plan (Exhibit 10.V.1 to El Paso's First Quarter
Form 10-Q).
*+10.5 -- Amendment No. 2 effective as of May 1, 2003 to the 1999
Omnibus Incentive Compensation Plan.
</Table>
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
**+10.6 -- 2001 Omnibus Incentive Compensation Plan, effective as of
January 29, 2001. (Exhibit 10.1 to El Paso's Form S-8
(Registration No. 333-64236) filed June 29, 2001); Amendment
No. 1 effective as of February 7, 2001 to the 2001 Omnibus
Incentive Compensation Plan (Exhibit 10.J.1 to El Paso's
2001 Form 10-K); Amendment No. 3 effective as of July 17,
2002 to the 2001 Omnibus Incentive Compensation Plan
(Exhibit 10.J.1 to El Paso's 2002 Second Quarter Form 10-Q);
Amendment No. 2 effective as of April 1, 2001 to the 2001
Omnibus Incentive Compensation Plan (Exhibit 10.J.1 to El
Paso's 2002 Form 10-K).
*+10.7 -- Amendment No. 4 effective as of May 1, 2003 to the 2001
Omnibus Incentive Compensation Plan.
**+10.8 -- Supplemental Benefits Plan, Amended and Restated effective
December 7, 2001. (Exhibit 10.K to El Paso's 2001 Form
10-K); Amendment No. 1 effective November 7, 2002 to the
Supplemental Benefits Plan (Exhibit 10.K.1 to El Paso's 2002
Form 10-K).
**+10.9 -- Amended and Restated El Paso Corporation Senior Executive
Survivor Benefit Plan, effective as of August 1, 1998
(Exhibit 10.M to El Paso's 1998 Third Quarter Form 10-Q);
Amendment No. 1 effective as of February 7, 2001 to the
Senior Executive Survivor Benefit Plan (Exhibit 10.I.1 to El
Paso's 2001 First Quarter Form 10-Q); Amendment No. 2 to the
Senior Executive Survivor Benefit Plan (Exhibit 10.L.1 to El
Paso's 2002 Form 10-K).
**+10.10 -- Key Executive Severance Protection Plan, Amended and
Restated effective as of August 1, 1998 (Exhibit 10.0 to El
Paso's 1998 Third Quarter Form 10-Q); Amendment No. 1
effective as of February 7, 2001, to the Key Executive
Severance Protection Plan (Exhibit 10.K.1 to El Paso's 2001
First Quarter Form 10-Q); Amendment No. 2 effective November
7, 2002 to the Key Executive Severance Protection Plan and
Amendment No. 3 effective as of December 6, 2002 to the Key
Executive Severance Protection Plan (Exhibit 10.N.1 to El
Paso's 2002 Form 10-K).
**+10.11 -- Strategic Stock Plan, Amended and Restated effective as of
December 3, 1999 (Exhibit 10.1 to El Paso's Form S-8 filed
January 14, 2000); Amendment No. 1 effective as of February
7, 2001, to the Strategic Stock Plan (Exhibit 10.M.1 to El
Paso's 2001 First Quarter Form 10-Q); Amendment No. 2
effective November 7, 2002 to the Strategic Stock Plan;
Amendment No. 3 effective as of December 6, 2002 to the
Strategic Stock Plan and Amendment No. 4 effective January
29, 2003 to the Strategic Stock Plan (Exhibit 10.P.1 to El
Paso's 2002 Form 10-K).
**+10.12 -- El Paso Production Companies Long-Term Incentive Plan,
effective as of January 1, 2003 (Exhibit 10.A.A to El Paso's
2003 First Quarter Form 10-Q).
*+10.13 -- Amendment No. 1 to El Paso Production Companies Long-Term
Incentive Plan, effective as of June 6, 2003.
**+10.14 -- Severance Pay Plan effective as of October 1, 2002;
Supplement No. 1 effective as of January 1, 2003 to the
Severance Pay Plan; Amendment No. 1 to the Supplement No. 1
effective March 21, 2003 (Exhibit 10.Z to El Paso's 2003
First Quarter Form 10-Q).
**+10.15 -- Omnibus Plan for Management Employees, Amended and Restated
effective as of December 3, 1999 and Amendment No. 1
effective as of December 1, 2000 to the Omnibus Plan for
Management Employees (Exhibit 10.1 to El Paso's Form S-8
(Registration No. 333-52100) filed December 18, 2000);
Amendment No. 2 effective as of February 7, 2001 to the
Omnibus Plan for Management Employees (Exhibit 10.U.1 to El
Paso's 2001 First Quarter Form 10-Q); Amendment No. 3
effective as of December 7, 2001 to the Omnibus Plan for
Management Employees (Exhibit 10.1 to El Paso's Form S-8
(Registration No. 333-82506) filed February 11, 2002).
*+10.16 -- Employment Agreement between El Paso CGP Company and Gene T.
Waguespack, effective as of January 17, 2000.
</Table>
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
*+10.17 -- Termination of Employment Agreement between El Paso CGP
Company and Rodney D. Erskine, effective as of December 16,
2002.
*10.18 -- Federal and State Tax Reimbursement Agreement among El Paso
and the Controlled Entities (named therein), effective as of
May 22, 2003.
*10.19 -- El Paso Corporation and Consolidated Subsidiaries Accounting
Policy for the Accrual of U.S. Federal Income Taxes,
effective as of January 1, 2002.
*10.20 -- Intercompany State Income Tax Allocation and Payments
Policy, effective for tax years beginning after January 29,
2001.
10.21 -- Purchase and Sale Agreement (Red River) by and among El Paso
Production Company, El Paso Production GOM Inc. and Lehman
Commercial Paper Inc., dated October 3, 2003.
10.22 -- First Amendment to Purchase and Sale Agreement by and among
El Paso Production Company, El Paso Production GOM Inc. and
Lehman Commercial Paper Inc., dated October 6, 2003.
10.23 -- Purchase and Sale Agreement (Red River) by and among El Paso
Production Company, El Paso Production GOM Inc. and Ramshorn
Investments, Inc., dated October 8, 2003.
12.1 -- Computation of Ratio of Earnings to Fixed Charges.
*21.1 -- Subsidiaries of El Paso Production Holding Company.
23.1 -- Consent of PricewaterhouseCoopers LLP.
23.2 -- Consent of Andrews & Kurth L.L.P. (included in Exhibit 5.1).
23.3 -- Consent of Huddleston & Co.
24.1 -- Power of Attorney (included on signature pages).
*25.1 -- Form T-1 Statement of Eligibility under the Trust Indenture
Act of 1939 of Wilmington Trust Company to act as Trustee
under the Indenture.
***99.1 -- Form of Letter of Transmittal.
*99.2 -- Form of Notice of Guaranteed Delivery.
*99.3 -- Form of Letter to Brokers, Dealers, Commercial Banks, Trust
Companies and Other Nominees.
*99.4 -- Form of Letter to Clients.
*99.5 -- Form of Exchange Agency Agreement.
</Table>
- ---------------
* Previously filed with this registration statement on Form S-4 on June 27,
2003.
** Previously filed by our parent El Paso Corporation (SEC File No. 1-14365) as
indicated.
*** Previously filed with Amendment No. 1 to this registration statement on Form
S-4 on October 3, 2003.
+ Management contract or compensatory plan or arrangement required to be filed
as an exhibit to this registration statement pursuant to Item 21(a) of Form
S-4.