Notes to Consolidated Financial Statements (continued)
<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period-----------to-----------
COMMISSION FILE NO. 0-25842
Pacific Gas Transmission Company
(Exact name of registrant as specified in its charter)
California 94-1512922
(State or other jurisdiction of (I.R.S. employer
Identification No.) incorporation or organization)
2100 SW River Parkway, Portland, OR 97201
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (503) 833-4000
Securities registered pursuant to Section 12(g) of the Act: Common Stock, No
Par Value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date.
Class Outstanding at August 14, 1996
Common Stock 1,000 Shares
Registrant meets the conditions set forth in General Instruction (H) (1) (a) and
(b) of Form 10-Q and is therefore filing this Form 10-Q with the reduced
disclosure format.
<PAGE>
TABLE OF CONTENTS
PART I. Financial Information
Item 1. Consolidated Financial Statements
Statements of Consolidated Income
Consolidated Balance Sheets
Statements of Consolidated Cash Flows
Notes to Consolidated Financial Statements
Note 1. Basis of Presentation
Note 2. Contingencies
Note 3. Subsequent Event - Acquisition of State Gas Pipeline Unit
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
PART II. Other Information
Item 1. Legal Proceedings
Item 6. Exhibits and Reports on Form 8-K
Signature
<PAGE>
PART I: FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
STATEMENTS OF CONSOLIDATED INCOME
(UNAUDITED)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
ENDED JUNE 30, ENDED JUNE 30,
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
(In Thousands) 1996 1995 1996 1995
- -----------------------------------------------------------------------------
OPERATING REVENUES:
Gas transportation $44,564 $43,351 $92,714 $88,876
Gas transportation for PG&E 8,851 10,531 17,833 21,824
Gas supply restructuring cost recovery
from PG&E 7,528 8,740 14,618 21,108
Gas supply restructuring cost recovery 5,564 4,037 10,579 8,167
Other 182 134 367 274
- -----------------------------------------------------------------------------
TOTAL OPERATING REVENUES 66,689 66,793 136,111 140,249
- -----------------------------------------------------------------------------
OPERATING EXPENSES:
Gas supply restructuring costs 13,092 12,767 25,197 29,265
Operations 10,280 13,300 23,107 26,630
Maintenance 1,006 746 2,003 1,778
Depreciation and amortization 9,236 9,846 18,352 19,421
Income taxes 7,849 6,265 16,314 13,175
Property and other taxes 2,892 3,339 5,898 6,771
- -------------------------------------------------------------------------------
TOTAL OPERATING EXPENSES 44,355 46,263 90,871 97,040
- -------------------------------------------------------------------------------
OPERATING INCOME 22,334 20,530 45,240 43,209
- -------------------------------------------------------------------------------
OTHER INCOME AND (INCOME DEDUCTIONS):
Allowance for equity funds used during
construction 107 332 196 593
Interest income 432 1,898 1,183 3,958
Other - net (202) (639) (476) (1,537)
- -------------------------------------------------------------------------------
TOTAL OTHER INCOME AND (INCOME DEDUCTIONS) 337 1,591 903 3,014
- -------------------------------------------------------------------------------
INTEREST EXPENSE:
Interest on long-term debt 10,018 11,549 20,327 24,190
Allowance for borrowed funds used during
construction (83) (290) (154) (552)
Other interest charges 1,047 353 2,030 655
- -------------------------------------------------------------------------------
NET INTEREST EXPENSE 10,982 11,612 22,203 24,293
- -------------------------------------------------------------------------------
NET INCOME $11,689 $10,509 $23,940 $21,930
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</TABLE>
The accompanying Notes to Consolidated Financial Statements are an integral
part of these statements.
<PAGE>
CONSOLIDATED BALANCE SHEETS
- -------------------------------------------------------------------------------
ASSETS
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(In Thousands) JUNE 30, 1996 DECEMBER 31, 1995
- -------------------------------------------------------------------------------
(UNAUDITED)
<S>
UTILITY PLANT: <C> <C>
Gas plant in service - at original cost $1,439,052 $1,418,044
Accumulated depreciation (399,174) (380,585)
- -------------------------------------------------------------------------------
Net utility plant in service 1,039,878 1,037,459
Construction work in progress 16,333 14,515
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UTILITY PLANT - NET 1,056,211 1,051,974
- -------------------------------------------------------------------------------
CURRENT ASSETS:
Cash and cash equivalents 12,532 9,839
Accounts receivable from PG&E 7,570 7,021
Accounts receivable - other 25,514 27,697
Gas supply restructuring costs recoverable 6,217 30,531
Deferred income taxes 10,484 -
Inventories (at average cost) 6,177 7,687
Other 7,125 10,216
- -------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 75,619 92,991
- -------------------------------------------------------------------------------
DEFERRED CHARGES:
Income tax related 26,353 26,740
Deferred charge on reacquired debt 15,461 16,064
Unamortized debt expense 4,561 4,754
Other 18,582 13,682
- -------------------------------------------------------------------------------
TOTAL DEFERRED CHARGES 64,957 61,240
- -------------------------------------------------------------------------------
TOTAL ASSETS $1,196,787 $1,206,205
- --------------------------------------------------------------------------------
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an integral
part of these statements.
<PAGE>
- -------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
- -------------------------------------------------------------------------------
CAPITALIZATION AND LIABILITIES
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(In Thousands) JUNE 30,1996 December 31,1995
- -------------------------------------------------------------------------------
(UNAUDITED)
<S>
CAPITALIZATION: <C> <C>
Common stock - no par value; 1,000 shares
authorized, issued and outstanding $ 85,474 $ 85,474
Additional paid-in capital 182,000 182,000
Reinvested earnings 164,006 150,066
- --------------------------------------------------------------------------------
Total common stock equity 431,480 417,540
Long-term debt 556,704 592,471
- -------------------------------------------------------------------------------
TOTAL CAPITALIZATION 988,184 1,010,011
- -------------------------------------------------------------------------------
CURRENT LIABILITIES:
Long-term debt - current portion 357 355
Payable to PG&E 17,962 8,003
Accounts payable and accrued liabilities 17,612 27,527
Accrued taxes 6,206 8,646
Deferred income taxes - 1,716
Reserve for pending regulatory issues 30,569 23,201
- -------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 72,706 69,448
- -------------------------------------------------------------------------------
DEFERRED CREDITS:
Deferred income taxes 125,578 117,353
Other 10,319 9,393
- -------------------------------------------------------------------------------
TOTAL DEFERRED CREDITS 135,897 126,746
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
TOTAL CAPITALIZATION AND LIABILITIES $1,196,787 $1,206,205
- -------------------------------------------------------------------------------
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an integral
part of these statements.
<PAGE>
STATEMENTS OF CONSOLIDATED CASH FLOWS
(UNAUDITED)
- -----------------------------------------------------------------------------
Six Months Ended
June 30,
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(In Thousands) 1996 1995
- -------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
<S> <C> <C>
Net income $ 23,940 $ 21,930
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 19,398 20,381
Deferred income taxes (3,588) 3,462
Gas supply restructuring costs 24,314 26,713
Allowance for equity funds used
during construction (196) (593)
Changes in operating assets and liabilities:
Accounts receivable 1,634 1,472
Accounts payable and accrued liabilities (9,915) (9,676)
Payable to PG&E 9,959 (7,875)
Accrued taxes (2,440) 1,503
Regulatory accruals 7,368 4,699
Other working capital 1,421 (840)
Other - net (4,055) (1,589)
- -------------------------------------------------------------------------------
Net cash provided by operating activities 67,840 59,587
- -------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Construction expenditures (19,059) (30,208)
Allowance for borrowed funds used during construction (154) (552)
- -------------------------------------------------------------------------------
Net cash used in investing activities (19,213) (30,760)
- -------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long-term debt (36,272) (691,781)
Long-term debt issued - 596,906
Long-term debt issuance costs - (5,458)
Construction financing 338 8,024
Payments for swap termination - (3,898)
Dividend paid to PG&E (10,000) -
- -------------------------------------------------------------------------------
Net cash used in financing activities (45,934) (96,207)
- -------------------------------------------------------------------------------
NET CHANGE IN CASH AND CASH EQUIVALENTS 2,693 (67,380)
CASH AND CASH EQUIVALENTS AT JANUARY 1 9,839 74,664
- -------------------------------------------------------------------------------
CASH AND CASH EQUIVALENTS AT JUNE 30 $12,532 $ 7,284
- -------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for:
Interest $21,652 $32,416
Income taxes 10,208 18,240
- -------------------------------------------------------------------------------
</TABLE>
The accompanying Notes to Consolidated Financial Statements are an integral
part of these statements.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Pacific Gas
Transmission Company (PGT) and its wholly owned subsidiaries (collectively, the
Company) have been prepared in accordance with interim period reporting
requirements. This information should be read in conjunction with the
Consolidated Financial Statements and Notes to Consolidated Financial Statements
included in Item 8: Financial Statements and Supplementary Data in the Company's
Form 10-K for the fiscal year ended December 31, 1995.
In the opinion of management, the accompanying statements reflect all
adjustments which are necessary to present a fair statement of the financial
position and results of operations for the interim periods. All material
adjustments are of a normal recurring nature unless otherwise disclosed in this
Form 10-Q. Prior year's amounts in the consolidated financial statements have
been reclassified where necessary to conform to the 1996 presentation. Results
of operations for interim periods are not necessarily indicative of results to
be expected for a full year.
NOTE 2: CONTINGENCIES
REGULATORY MATTERS
Pipeline Expansion - On November 1, 1993, the Company placed in service a
major expansion of its natural gas transmission system in Idaho, Washington and
Oregon. The new facilities, which were authorized by the Federal Energy
Regulatory Commission (FERC or Commission) on August 1, 1991, run parallel to
and connect with the existing system and provide additional firm transportation
service capacity of 150,000 Decatherms per day (Dt/d) to the Pacific Northwest
and 766,000 Dt/d to California. Similarly, the California Public Utilities
Commission (CPUC) authorized Pacific Gas and Electric Company (PG&E), the parent
of the registrant, to expand its gas pipeline facilities in California to
connect with the PGT expansion at the California-Oregon border. PGT's total cost
of the 1993 expansion is currently estimated to be approximately $852 million.
In the August 1, 1991, order, the FERC found that transportation
arrangements for PG&E's facilities were discriminatory and initially declined to
authorize the start of construction. In particular, the FERC found that the
CPUC-imposed restraints on access by PGT's 1993 expansion shippers to PG&E's
pre-expansion facilities were discriminatory. However, on October 24, 1991, the
FERC permitted PGT to commence construction, while the CPUC re-examined the
features of its rate design for PG&E, but imposed a lower penalty return on
equity, 10.13 percent, instead of the previously prescribed 12.5 percent on the
1993 expansion, until such time that PGT demonstrated that neither its rates nor
its transportation policies nor PG&E's CPUC-approved rates and policies resulted
in unduly discriminatory restraints. PGT requested a rehearing of this feature
of the FERC's certificate. In October 1992, the CPUC reaffirmed its policies
which resulted in renewed petitions to the FERC requesting, among other things,
revocation of the Company's authorization to operate the 1993 expansion
facilities.
On March 16, 1993, the FERC issued an order addressing the various
petitions for rehearing of its prior decisions related to the interstate portion
of the 1993 expansion. In the order, the FERC upheld its decision to authorize
the construction and operation of the 1993 expansion and raised PGT's authorized
return to 12.75 percent, but reaffirmed the 10.13 percent penalty return on
equity for PGT's 1993 expansion facilities. The FERC denied a request for
rehearing of the March 16, 1993 order. PGT appealed the 10.13 percent penalty
return to the United States Court of Appeals. Irrespective of what the court
may ultimately decide, in the proposed settlement of the 1994 rate case (see
<PAGE>
"1994 Rate Case," below), it was agreed that the reduced rate of return would
not apply in the Company's 1994 rate case or in any subsequent rate case. The
Company agreed not to retroactively bill its customers for the period from
November 1, 1993, through August 31, 1994, for a rate higher than the 10.13
percent penalty return previously approved by the FERC. The proposed settlement
is subject to approval by the FERC and has been opposed by several parties. In
the event the FERC rejects the settlement, PGT's 1994 rate case would proceed to
a FERC decision based upon the evidence in the case.
In addition to PGT's appeal to the United States Court of Appeals, a number
of parties also sought rehearing of all of these FERC orders and have petitioned
for judicial review in the same court. On June 4, 1993, the Court of Appeals
consolidated the cases for processing. The consolidated cases were argued on
November 14, 1995, with a group of petitioners requesting the court to direct
the FERC to provide for compensation to shippers for alleged damages they
suffered as a result of the discriminatory conditions discussed above.
Petitioners did not specify the extent of the alleged damages or a basis for
computing such damages.
The Company is unable to assess the extent of any claims for damages that
could be asserted in the consolidated cases currently pending before the Court
of Appeals, or the validity of such claims if they are eventually made to the
FERC. However, the Company believes that the ultimate resolution of the issues
discussed above will not have a material adverse impact on its financial
position, liquidity or results of operations.
1994 Rate Case - On February 28, 1994, PGT filed an application with the
FERC to change its rates for transportation services. These rates are based on
an overall cost of service of approximately $217 million, including a return on
equity of 13 percent. The proposed rate of return on equity applied to all
facilities and discontinued the penalty rate of return on equity
of 10.13 percent that the FERC had earlier required to be used to develop
initial rates for PGT's expansion facilities, discussed in more detail above.
The major issue in this proceeding is whether PGT's mainline transportation
rates should be equalized through the use of rolled-in cost allocation, or
whether they should continue to reflect the current use of incremental costs to
determine rates to be paid by firm shippers. PGT proposed that mainline rates
reflect the rolled-in approach on a prospective basis. As an alternative to its
primary proposal, PGT also filed a separate set of tariff sheets providing
for continued incremental pricing pending the adjudication of PGT's primary,
rolled-in rates proposal.
On March 31, 1994, the FERC issued an order that accepted PGT's alternative
incremental rates, and authorized PGT to place these rates into effect on
September 1, 1994, when the Company was permitted to begin charging the
increased rates subject to refund, and established a hearing before an
administrative law judge to consider the reasonableness of the primary rolled-
in rates proposal. Although the FERC rejected the proposal to place rolled-in
rates into effect on September 1, 1994, the FERC indicated that PGT would be
afforded the opportunity at the hearing to support and justify a rolled-in rate
proposal. Evidentiary hearings before an administrative law judge were
concluded in September 1995. Initial briefs were submitted in November 1995.
On March 21, 1996, the Company filed a proposed settlement with the FERC
which would resolve all issues in this case. On May 2, 1996, the administrative
law judge certified the settlement for decision by the FERC. Of primary
significance to the case, the proposed settlement provides that rolled-in rates
will become effective on the latter of November 1, 1996, or upon an initial
order by the Commission. Under the terms of the proposed settlement, to
mitigate the impact of the higher rolled-in rates, most of the firm pre-1993
expansion shippers would receive a reduction from the rolled-in rates for six
years, while the 1993 expansion shippers would pay a surcharge in <PAGE>
addition to the rolled-in rates to offset the effect of the mitigation.
Although the implementation of rolled-in rates by itself would not change PGT's
total revenue requirement, the settlement does provide for, among other things,
a lower total cost of service of $206 million, lower depreciation rates, and a
return on equity of 12.2 percent. If the settlement becomes effective, up to
three percent of PGT's firm transportation service capacity would be turned back
to PGT to be subscribed to other shippers.
The overall effect of the settlement on current rates, including mitigation
measures and agreed upon lower cost of service, will be to decrease PGT's
current 100 percent load factor transportation rates for the full distance of
the pipeline (from the Canadian-U.S. border to the Oregon-California border)
from $.48 to $.33 per Decatherm (Dt) for the 1993 expansion shippers, and to
increase the transportation rate for most of the pre-1993 expansion shippers
from $.16 to either $.20 or $.24 per Dt depending upon the level of mitigation.
The rolled-in rate for the full distance would be $.26 per Dt.
The proposed settlement is subject to approval by the FERC and is primarily
opposed by one competitor and by four shippers representing approximately five
percent of PGT's total firm transportation service capacity. In the event the
FERC rejects the settlement, PGT's 1994 rate case would proceed to a FERC
decision based upon the evidence in the case.
PGT has recorded a reserve for revenues subject to refund and related
interest of $30.6 million at June 30, 1996. PGT believes that the ultimate
resolution of this rate case will not have a material impact on its financial
position, liquidity or results of operations.
Gas Supply Restructuring (GSR) Costs - Through June 30, 1996, PGT has
incurred total Gas Supply Restructuring (GSR) costs of $239.7 million. Pursuant
to the Transition Cost Recovery Mechanism (TCRM), the FERC has approved the
recovery of $168.5 million of such GSR costs, of which $56.2 million was
recovered through direct bills principally to PG&E and $112.3 million, plus
carrying costs, is being recovered on a monthly basis through no later than
November 14, 1996, via a surcharge applicable to volumes transported under
certain of PGT's rate schedules. As of June 30, 1996, the balance of
unrecovered GSR costs was $6.2 million.
On January 25, 1996, the CPUC sought judicial review of the FERC's approval
of approximately $10.9 million of GSR costs. However, as part of the proposed
settlement of PGT's 1994 rate case discussed above, the CPUC agreed to withdraw
its petition for judicial review in consideration of PGT's agreement to refund
$3.2 million of the GSR costs direct billed to PG&E, if the rate case settlement
is approved by the FERC. Accordingly, PGT has recorded a reserve of $3.2
million, which is included in Reserve for Pending Regulatory Issues on the
Consolidated Balance Sheet.
LEGAL MATTERS
Norcen Litigation: On March 17, 1994, Norcen Energy Resources Limited
(Norcen Energy) and Norcen Marketing Incorporated (Norcen Marketing) filed a
complaint in the U.S. District Court, Northern District of California, against
PG&E and PGT. In April 1991, Norcen Marketing signed a 30-year firm service
agreement with PGT for transportation of approximately 47,000 Dt/d on the PGT
1993 expansion. The annual demand charges under the contract currently are
approximately $7.8 million, and will decrease to approximately $5.5 million
effective November 1996 if the proposed settlement of the 1994 rate case
discussed above is approved by the FERC. Norcen Energy is a guarantor of the
30-year transportation contract between PGT and Norcen Marketing.
The complaint alleged that PGT and PG&E wrongfully induced Norcen Energy
and Norcen Marketing to enter into the 30-year contract by concealing legal
<PAGE>
action taken by PG&E before the CPUC (requesting clarification that gas shipped
on the PGT expansion should pay PG&E's incremental expansion rates for
intrastate service) two days before Norcen Marketing's contract became binding.
The complaint further alleged breach of representations to plaintiffs that PG&E
would not "unreasonably" build its expansion with less than "sufficient" firm
subscription. The complaint also alleged breach of an agreement between PGT and
a Norcen predecessor relating to the installation of additional capacity.
The complaint also alleged various federal and state antitrust, contractual
and other claims against the defendants and seeks rescission, restitution and
recovery of unspecified damages. In a pleading filed in June 1994, the
plaintiffs indicated a claim for $140 million (before trebling) based on
defendants' allegedly exclusionary business behavior, as well as an unspecified
amount of contract damages.
On September 19, 1994, the U.S. District Court, Northern District of
California, granted PGT's and PG&E's motion to dismiss all federal antitrust
claims in the complaint originally filed in this case, and dismissed the
remaining state law claims for lack of jurisdiction.
On October 18, 1994, plaintiffs filed an amended complaint. The amended
complaint reasserted part of the original complaint's antitrust claims, asserted
new antitrust claims based upon the same facts, and specifically alleged
diversity jurisdiction for the state law contract claims. On July 27, 1995, the
District Court issued an order on PGT's and PG&E's motions to dismiss the
amended complaint. The order dismissed all of plaintiffs' federal and state
antitrust claims with prejudice, but did not dismiss various state law contract
claims, including claims based on fraudulent inducement and breach of contract.
Plaintiffs have the right to appeal the dismissal of the antitrust claims to the
Court of Appeals. Plaintiffs still seek rescission of their gas transportation
contracts and compensatory and punitive damages in connection with their
remaining state law claims. The Company believes plaintiffs in this action
might seek contract damages of approximately $50 million in connection with such
claims.
The Company is unable to predict the ultimate outcome of this matter, but
such outcome could have a material adverse impact on the Company's results of
operations in a future reporting period. The Company believes that the ultimate
outcome of this matter will not have a material adverse impact on its financial
position or liquidity.
NOTE 3: SUBSEQUENT EVENT - ACQUISITION OF STATE GAS PIPELINE UNIT
On July 1, 1996, the PGT Queensland Unit Trust (PGT Trust), a unit trust
created under the laws of Australia, purchased all of the assets comprising the
Queensland State Gas Pipeline (Pipeline) from the Government of the State of
Queensland, Australia. The purchase was effected pursuant to the State Gas
Pipeline Sale Agreement between the Secretary for Mines of the State of
Queensland and PGT Australia Pty Limited (PGT Australia), as Trustee of the
PGT Trust. PGT Australia is an Australian corporation which is a wholly
owned subsidiary of the registrant.
The record owners of all of the issued and outstanding units of the PGT
Trust, who as such own all of the beneficial interest in the PGT Trust, are
Pacific Gas Transmission International, Inc. (PGT International), a California
corporation which is a wholly owned subsidiary of the registrant, and PGT
Queensland Pty Limited (PGT Queensland), an Australian corporation which is also
a wholly owned subsidiary of the registrant.
The Pipeline is an approximately 389 mile 12 inch pipeline constructed in
1990 which extends from Wallumbilla to Gladstone and Rockhampton in Queensland,
Australia. The pipeline was operated by the Government of the state of
Queensland, Australia to provide natural gas transportation service to
<PAGE>
customers in the vicinity of the Pipeline. The PGT Trust intends to continue
such operations.
The purchase price, including related stamp duty taxes, for the Pipeline
was approximately US$133 million. Additional incurred and projected acquisition
costs, including financing costs and working capital, are approximately US$6
million. The purchase price for the assets comprising the Pipeline was
established through negotiations with the Government of Queensland following a
bidding process in which the registrant was the winning bidder.
The acquisition of the Pipeline by the PGT Trust was financed through a
combination of equity contributions from the registrant and aggregate loan
proceeds of US$91 million drawn under a recourse loan agreement and a non-
recourse loan agreement. The non-recourse loan agreement between PGT Australia,
in its capacity as trustee of the PGT Trust, and a group of lenders provided for
loans denominated in both United States and Australian Dollars totaling
approximately US$60 million. Repayment of amounts outstanding under the non-
recourse agreement is secured by a first mortgage and first security interest
in substantially all of the assets owned by the PGT Trust (with certain limited
exceptions), but is otherwise non-recourse to PGT Australia, PGT International,
PGT Queensland and the registrant. PGT Australia, in its capacity as trustee of
the PGT Trust, also entered into a recourse loan agreement with a group of
lenders providing for loans in United States Dollars in the amount of US$40
million. Repayments of amounts outstanding under the recourse agreement are
not secured by mortgage or security interests in the assets of the PGT Trust.
In connection with this financing, PG&E, the parent of the registrant, has
entered into a Capital Infusion Agreement with the registrant (Capital Infusion
Agreement), under which PG&E has agreed to make capital contributions to the
registrant, under certain circumstances, in an aggregate amount not exceeding
US$40 million; the registrant has assigned its rights under the Capital
Infusion Agreement to the Facility Agent as agent for and on behalf of the
lenders under the Recourse Facility Agreement. In the event of a default by the
PGT Trust in its obligations under the Recourse Facility Agreement, the Facility
Agent may cause PG&E to pay directly to the Facility Agent, as agent for and on
behalf of the lenders under the Recourse Facility Agreement, all amounts due
thereunder up to PG&E's maximum obligation under the Capital Infusion Agreement.
In certain circumstances, an unconditional guaranty by the registrant may be
substituted for the Capital Infusion Agreement as credit support for the PGT
Trust's obligations under the recourse agreement. In addition, the registrant
has issued a guarantee in favor of the Facility Agent with respect to all
interest, fees, expenses and other obligations under the recourse agreement,
other than principal, in an aggregate amount not to exceed US$2 million. PGT
International has guaranteed the repayment in full by the PGT Trust of all
amounts payable under the recourse agreement.
In connection with the financing associated with PGT's acquisition of the
Queensland State Gas Pipeline, PGT Australia, to hedge its exposure to interest
rate movement, entered into interest rate swap agreements with domestic and
international banks, under which floating rate interest payment obligations
denominated in United States Dollars and Australian Dollars were swapped for
fixed rate interest payment obligations (see Part I, Item 2, "Liquidity and
Capital Resources"). PGT Australia's payment obligations under these swap
agreements (see Part I, Item 2, "Liquidity and Capital Resources") are
guaranteed by the registrant up to an amount not exceeding US$ 9 million.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion includes some forward-looking statements that
involve a number of risks and uncertainties. Importantly, the ultimate impact
of increased competition and the changing regulatory environment on future
results is uncertain, but is expected to cause changes in the way Pacific Gas
Transmission Company (PGT) conducts its business and to cause earnings to be
more volatile. This outcome, and other matters discussed below, including the
outcome of certain litigation with a firm shipper of PGT, may cause future
results to differ materially from historical results or from results or outcomes
currently expected or sought by the Company.
GENERAL
PGT is an interstate natural gas pipeline company and a wholly owned
subsidiary of Pacific Gas and Electric (PG&E). PGT's transportation system
provides access to natural gas from producing fields in western Canada and
extends from the British Columbia-Idaho border to the Oregon-California border.
PGT's transportation system also provides service to various delivery points in
Idaho, Washington and Oregon. The Company's natural gas transportation services
are regulated by the United States Department of Energy, in particular the
Federal Energy Regulatory Commission (FERC). Various safety issues are subject
to the jurisdiction of the United States Department of Transportation.
The PG&E Board of Directors has authorized, and shareholders and the FERC have
approved, a plan to restructure the corporate organization of PG&E and its
subsidiaries. The result of the change in corporate structure will be to have
PG&E become a separate subsidiary of a parent holding company (ParentCo) with
the present holders of PG&E common stock becoming holders of ParentCo common
stock. As part of the change in structure, it is contemplated that PG&E will
transfer its ownership interests in its two principal subsidiaries, PGT and PG&E
Enterprises, to ParentCo, so that PGT and PG&E Enterprises will become
subsidiaries of ParentCo. The debt and preferred stock of PG&E would remain
outstanding at the PG&E level and would not become obligations or securities of
ParentCo.
CHANGING REGULATORY ENVIRONMENT
Prior to November 1, 1993, PGT's business was primarily to provide bundled
natural gas sales and transportation services to PG&E, firm transportation
service to Pacific Interstate Transmission Company and to Northwest Pipeline,
and open-access interruptible transportation service to various other customers.
In 1992, the FERC issued Order 636, which required open-access pipelines to
provide firm and interruptible transportation services on an equal basis for all
gas supplies, whether purchased from the pipeline or from another gas supplier,
and required the termination of all pipeline bundled sales and transportation
service. PGT implemented the provisions of Order 636 effective November 1,
1993, pursuant to the FERC orders dated July 12, 1993 and October 1, 1993.
Effective November 1, 1993, PG&E terminated its gas purchases from PGT and PG&E
began receiving an equivalent amount of firm transportation service from PGT
under a long-term contract.
Order 636 authorized PGT to adopt the straight fixed-variable (SFV) rate
design method for all rate schedules, which it did effective November 1, 1993.
Under the SFV rate design, a pipeline company's fixed costs, including return on
equity and related taxes, associated with firm transportation service are
collected through the reservation charge component of the pipeline company's
firm transportation service rates.
As a result of the current SFV rate design and PGT's existing long-term
contracts, there are presently only minor financial effects due to fluctuating
levels of throughput on PGT's system. While the Company believes that SFV
rate design is likely to continue as the basis for ratemaking for PGT over the
near term, any departure from SFV rate design (whereby a portion of fixed costs
would be assigned to the commodity or delivery component of rates) could cause
PGT's operating results to be affected by fluctuations in the volumes of gas
transported on its system. Similarly, if PGT did not have all of its firm
transportation service capacity subscribed under long-term contracts, variations
in PGT's throughput would have a more significant impact on its operating
results. See discussion of PGT's 1994 rate case below, which would place PGT at
risk for resubscription of certain capacity if a proposed settlement of that
case is approved. In addition, see "Legal Matters - Norcen Litigation" in Note
2 of the Notes to Consolidated Financial Statements contained in Part I, Item 1,
above, for a discussion of litigation filed against PGT by one of its long-term
firm transportation service customers which is seeking a recision of that
contract.
As discussed more fully in "Regulatory Matters - 1994 Rate Case" in Note 2
of the Notes to Consolidated Financial Statements contained in Item 1, above, on
March 21, 1996, PGT filed a proposed settlement at FERC which would resolve all
issues in this pending rate case. This proposed settlement, among other things,
provides for the adoption of rolled-in rates beginning on the latter of November
1, 1996, or upon an initial order by the Commission. Although the
implementation of rolled-in rates by itself would not change PGT's total
revenue requirement, the settlement does provide for, among other things, a
lower total cost of service of $206 million, lower depreciation rates, and a
return on equity of 12.2 percent. In addition, at such time as the settlement
becomes effective, up to three percent of PGT's firm transportation service
capacity will be turned back to PGT for subscription to other shippers. To
mitigate the impact of the higher rates, most of the firm pre-1993 expansion
shippers will be receiving a reduction from the rolled-in rates for six years,
while the 1993 expansion shippers will pay a surcharge in addition to the
rolled-in rates to offset the effect of the mitigation on PGT's total revenue
requirement. The proposed settlement is subject to approval by the FERC and is
primarily opposed by one competitor and by four shippers representing
approximately five percent of PGT's total firm transportation service capacity.
In the event the FERC rejects the settlement, PGT's 1994 rate case would proceed
to a FERC decision based upon the evidence in the case.
On January 31, 1996, the FERC issued a policy statement on alternative
methods for setting rates. The policy statement provides guidelines the FERC
will use in evaluating market-based incentive rate and negotiated rate proposals
by pipelines. Of particular note is the negotiated/recourse rate program which
provides a framework to allow negotiated terms and/or conditions for
individual shippers, with the traditional cost of service rates and tariffs
made available to all shippers as a default or recourse. The FERC is
currently requesting comments on the policy statement. The statement is
not expected to have a material impact on PGT's financial position, liquidity or
results of operations in the foreseeable future.
On July 17, 1996, the FERC adopted a new rule which standardizes
technology and operating procedures for pipelines in order to promote greater
integration of the national gas grid. On July 31, 1996, the FERC issued a
Notice of Proposed Rulemaking (NOPR) to improve the efficiency of capacity
release procedures and to allow rates above the cost-based rate cap in markets
that pipelines demonstrate lack of market power.
COMPETITION
Competition to provide natural gas transportation services has intensified
in recent years. Regulatory changes, such as Order 636, have significantly
increased customers' flexibility, choices and responsibility to directly manage
their gas supplies.
PGT has in the past, and will in the future, actively compete with other
pipeline companies for transportation customers on the basis of transportation
rates, access to competitively priced gas supply basins, and quality and
reliability of transportation services. In the current open access environment,
the competitiveness of the pipeline's transportation services in the market it
serves is determined generally on the basis of delivered natural gas prices, of
which transportation cost is a portion of the total delivered price. Because
PGT's firm transportation service capacity is currently fully subscribed under
long-term contracts, and because of the current SFV rate design, there are no
material financial effects due to fluctuating levels of throughput on its system
because of changes in market conditions. However, under the proposed settlement
of its 1994 rate case, which if approved, would be effective on the latter of
November 1, 1996, or upon an initial order by the Commission, up to three
percent of PGT's firm transportation service capacity would be turned back to
PGT. As a result, PGT would be at risk for the subscription of this capacity.
In addition, any departure from SFV rate design would also subject PGT's revenue
to variations in throughput volumes. On July 16, 1996, the United States Court
of Appeals for the District of Columbia Circuit affirmed the FERC's adoption of
the SFV rate design for all natural gas pipelines under FERC's jurisdiction. In
light of the Court's decision, it appears unlikely that FERC will mandate any
departure from the SFV rate design in the near future.
FUTURE EXPANSIONS AND BUSINESS DEVELOPMENT
PGT has received preliminary expressions of interest in providing firm
transportation service to parties who cannot be accommodated with PGT's existing
available firm transportation service capacity and whose needs may not be met
through the release of capacity by PGT's current firm transportation service
customers. PGT intends to continue to solicit such expressions of interest, and
will consider adding additional firm transportation service capacity to its
mainline system in the future if sufficient demand develops.
In addition to mainline expansions, PGT is also considering opportunities
to expand its core pipeline business through other means, such as through
extensions off its mainline system or the acquisition of gas storage and other
gas-related properties. Such opportunities may be located outside the Pacific
Northwest and California, and outside of the United States.
Consistent with this strategy, on July 1, 1996, a wholly owned subsidiary
of PGT acquired a 389-mile natural gas pipeline in northeastern Australia, from
the state of Queensland, Australia. (See Note 3, "Subsequent Event - Acquisition
of State Gas Pipeline Unit" in the Notes to Consolidated Financial Statements in
Part I, Item 1, Consolidated Financial Statements.)
ACCOUNTING FOR THE EFFECTS OF REGULATION
The Company currently accounts for the economic effects of regulation in
accordance with the provisions of Statement of Financial Accounting Standards
(SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation." As
a result of applying the provisions of SFAS No. 71, the Company has accumulated
approximately $59.6 million of regulatory assets as of June 30, 1996.
Management expects to recover all of these costs through rates charged to
customers.
<PAGE>
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------ -------- ------- -------
1996 1995 1996 1995
------ -------- ------- -------
(in millions) (in millions)
<S> <C> <C> <C> <C>
Operating revenues $ 66.7 $ 66.8 $ 136.1 $ 140.2
Operating expenses 44.4 46.3 90.9 97.0
------ ------- ------- -------
Operating income 22.3 20.5 45.2 43.2
Other income and (income deductions) 0.3 1.6 0.9 3.0
Net interest expense (10.9) (11.6) (22.2) (24.3)
------ ------- ------- -------
Net Income $ 11.7 $ 10.5 $ 23.9 $ 21.9
====== ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
At June 30, At December 31,
1996 1995
------------ -- -----------
(in millions)
<S> <C> <C>
Total Assets $ 1,196.8 $ 1,206.2
============ ============
</TABLE>
<PAGE>
NET INCOME
Net income was $11.7 million and $23.9 million, respectively, for the
three and six months ended June 30, 1996, compared with $10.5 million
and $21.9 million for the same periods in 1995. The $1.2 million and
$2.0 million respective increases during the three and six month periods
ended June 30, 1996, compared to the same periods in 1995, were primarily
the result of lower operations and maintenance expenses and lower long-term
debt interest expense. The effects of these items were offset, in part, by
reduced interest income.
Operating Revenues - The components of total operating revenues are as
follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1996 1995 1996 1995
---- ----- ---- ----
(in millions) (in millions)
<S> <C> <C> <C> <C>
Gas transportation $53.4 $53.9 $110.5 $110.7
Gas supply restructuring (GSR) cost 13.1 12.8 25.2 29.3
Other 0.2 0.1 0.4 0.2
------ ----- ------- -----
Total Operating Revenues $66.7 $66.8 $136.1 $140.2
====== ===== ======= ======
</TABLE>
Gas transportation revenues for the three- and six- month periods ended
June 30, 1996, approximated the results for the equivalent periods during
1995.
GSR cost recovery revenues reflect the collection from customers through
volumetric surcharges and direct bills of deferred GSR costs over a three-year
period, beginning November 15, 1993, as permitted by the transition cost
recovery mechanism (TCRM) approved by the FERC. These revenues have no effect
on income as they are fully offset by the amortization of like amounts of
deferred GSR costs. The decrease for the six month period ended June 30,
1996, compared to the same period in 1995, resulted primarily from a direct
billing of $4.7 million of GSR costs to PG&E in March 1995, pursuant to the
January 1995 GSR filing approved by the FERC.
<PAGE>
Operating Expenses - The components of total operating expenses are as
follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- -----------------
1996 1995 1996 1995
---- ---- ---- -----
(in millions) (in millions)
<S> <C> <C> <C> <C>
Gas supply restructuring (GSR) costs $ 13.1 $ 12.8 $ 25.2 $ 29.3
Operations and maintenance 11.3 14.0 25.1 28.4
Depreciation and amortization 9.2 9.9 18.4 19.4
Income taxes 7.9 6.3 16.3 13.1
Property and other taxes 2.9 3.3 5.9 6.8
--------- -------- ------ ------ -------
Total Operating Expenses $ 44.4 $ 46.3 $ 90.9 $ 97.0
========= ======== ====== =======
</TABLE>
GSR costs for the six-month periods ended June 30, 1996, and 1995, include
the amortization of the deferred GSR costs which were billed to customers
during the same period.
Operations and maintenance expenses for the three and six months ended
June 30, 1996, decreased by $2.7 million and $3.3 million, respectively,
compared to the same periods in 1995. The reductions were primarily due to
decreased regulatory expenses, lower general expenses and reduced rent
expense. Lower rent expense resulted from the capital lease of PGT's new
corporate office in Portland, Oregon, effective July 1995. This decline in
rent expense was offset by the combination of additional depreciation expense
and interest expense associated with the lease. However, due to lower
depreciation rates applied in anticipation of FERC approval of the proposed
settlement of PGT's 1994 rate case, total depreciation and amortization
expense declined for the three and six months ended June 30, 1996, compared
to the same periods in 1995. Variations in income taxes were primarily due to
changes in taxable income as PGT's effective tax rate remained relatively
unchanged. Property and other taxes for the three and six months ended
June 30, 1996, decreased by $0.4 million and $0.9 million, respectively,
compared to the same periods in 1995, due to lower property taxes for PGT's
facilities in Oregon.
Other Income and (Income Deductions) - Other income for the three and six
months ended June 30, 1996, decreased $1.3 million and $2.1 million,
respectively, compared to the same periods in 1995, primarily due to a
decrease in interest income resulting from the combination of lower invested
cash balances in 1996 and reduced unrecovered GSR balances, which earn
interest.
INTEREST EXPENSE
Interest expense, excluding AFUDC debt, for the three and six months ended
June 30, 1996, decreased $0.8 million and $2.5 million, respectively,
compared to the same periods in 1995, primarily due to lower long-term debt
interest offset, in part, by an increase in interest associated with the
capital lease of PGT's corporate office, which was effective July 1995.
Interest on long-term debt decreased because of a reduction in the average
interest rate from 7.9 percent in the six months ended June 30, 1995, compared
<PAGE>
to 7.4 percent during the same period in 1996. In addition, the average balance
of long-term debt outstanding during the six months ended June 30, 1995 was $610
million compared to $553 million during the same period in 1996.
AFUDC debt for the three and six months ended June 30, 1996, decreased $0.2
million and $0.4 million, respectively, compared to the same periods in 1995 due
to completion of the construction of Oregon Extensions, which were placed in
service on November 1, 1995.
LIQUIDITY AND CAPITAL RESOURCES
Sources of Capital - The Company's capital requirements are funded from
cash provided by operations and, to the extent necessary, external financing and
capital contributions from PG&E. The Company pays dividends to PG&E as part of
a balanced approach for managing its capital structure, funding its operations
and capital expenditures and maintaining appropriate cash balances.
Cash Provided by Operating Activities - For the six months ended June 30,
1996, net cash provided by operating activities was $67.8 million, as compared
with net cash provided by operating activities of $59.6 million for the same
period in 1995.
Cash Used in Investing Activities - The Company's expenditures for
property, plant and equipment (including the allowance for borrowed funds used
during construction) were $19.2 million and $30.8 million for the six months
ended June 30 1996, and 1995, respectively. The increased construction activity
in 1995 was associated with PGT's Oregon Extensions.
Cash Used in Financing Activities - For the six months ended June 30, 1996,
cash used in financing activities amounted to $45.9 million and included a net
$35.9 million reduction in long-term debt and a $10.0 million dividend paid to
PG&E. For the six months ended June 30, 1995, cash used in financing activities
amounted to $96.2 million and included a net $92.3 million reduction in long-
term debt.
Financing for New Acquisition - On July 1, 1996, the PGT Queensland Unit
Trust (PGT Trust), a unit trust created under the laws of Australia, purchased
all of the assets comprising the Queensland State Gas Pipeline from the
Government of the State of Queensland, Australia. (See Note 3 "Subsequent Event
- - acquisition of the State Gas Pipeline Unit" in the Notes to Consolidated
Financial Statements contained in Part I, Item 1.)
This acquisition was financed through a combination of equity contributions
from the registrant and bank loans. PGT Australia, in it's capacity as trustee
of the PGT Trust, entered into non-recourse and recourse agreements with
domestic and international banks providing loans to the PGT Trust in connection
with the acquisition and operation of the pipeline denominated in both United
States Dollars and Australian Dollars totaling approximately US$100 million of
which approximately US$91 million was used for the acquisition. The loans were
issued for a five-year term with interest rates based upon the LIBOR rate plus a
margin dependent upon a rating level. The registrant has guaranteed interest,
fees, expenses, and other obligations under this recourse agreement, other than
principal, in an aggregate amount not to exceed US$2 million.
In connection with this financing, PGT Australia, entered into interest
rate swap agreements with domestic and international banks, under which certain
floating rate interest payment obligations were swapped for fixed rate interest
payment obligations as described below:
<PAGE>
FIXED
SWAP
<TABLE>
<CAPTION>
EFFECTIVE DATE PERIOD OF TIME AMOUNT RATE TYPE OF DEBT
- ------------- -------------- (In Millions) ----- ------------
-------------
<S> <C> <C> <C> <C>
July 3, 1996 5 years US$22 6.684% Recourse
July 3, 1996 2 years US$4 6.70% Non-Recourse
July 3, 1996 5 years US$41 6.70% Non-Recourse
July 2, 1996 2 years A$1 8.7175% Non-Recourse
July 2, 1996 5 years A$12 8.7175% Non-Recourse
</TABLE>
PGT Australia's payment obligations under such swap agreements are
guaranteed by the registrant up to an amount not exceeding US$9 million.
LEGAL MATTERS
In the normal course of business, the Company is named as a party in a
number of claims and lawsuits. In the past, substantially all of these have
been litigated or settled with no significant impact on the Company's financial
position, liquidity, or results of operations.
There is one litigation case discussed in the "Legal Matters" section of
Note 2 "Contingencies" in the Notes to Consolidated Financial Statements
contained in Part I, Item 1, Consolidated Financial Statements, above. This
case involves antitrust and state law contract claims for damages related to a
30-year contract with a transportation customer. The Company is unable to
predict the ultimate outcome of this matter, but it could have a material
adverse impact on the Company's results of operations in a future reporting
period. The Company believes that the ultimate outcome of this matter will
not have a material adverse impact on its financial position or liquidity.
NEW ACCOUNTING STANDARD
The Financial Accounting Standards Board has issued SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" (SFAS No. 121). The Company adopted SFAS No. 121 effective
January 1, 1996.
The general provisions of SFAS No. 121 require, among other things, that
the existence of an impairment be evaluated whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be fully
recoverable, and prescribes standards for the recognition and measurement of
impairment losses. In addition, SFAS No. 121 requires that regulatory assets
continue to be probable of recovery in rates, rather than only at the time the
regulatory asset is recorded. Regulatory assets currently recorded would be
written off if recovery is no longer probable. Under current ratemaking
circumstances, there was not any material impact of adopting the standard on
PGT's financial position, liquidity or results of operations.
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information responding to this Item is included in the "Legal Matters"
section of Note 2 "Contingencies" in the Notes to Consolidated Financial
Statements in Part I, Item 1, Consolidated Financial Statements, above, which
information is hereby incorporated herein by reference.
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Reports on Form 8-K during the second quarter of 1996 and through the date
hereof:
July 15, 1996
Item 2. Acquisition or Disposition of Assets - acquisition of an
Australian natural gas pipeline from the state of Queensland.
August 13, 1996
Item 7. Financial Statements and Exhibits - pro forma financial
information and consent of independent public accountants regarding the
acquisition of an Australian natural gas pipeline from the state of Queensland.
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PACIFIC GAS TRANSMISSION COMPANY
(Registrant)
August 14, 1996 By: /s/ STANLEY C. KARCZEWSKI
Name: Stanley C. Karczewski
Title: Vice President of Finance and
Controller
and Chief Financial Officer
