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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 8-K
CURRENT REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT: JANUARY 21, 1997
(DATE OF EARLIEST EVENT REPORTED: DECEMBER 11, 1996)
TENNESSEE GAS PIPELINE COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE
(STATE OR OTHER JURISDICTION OF INCORPORATION)
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<S> <C>
1-4101 74-1056569
(COMMISSION FILE NUMBER) (I.R.S. EMPLOYER IDENTIFICATION NO.)
EL PASO ENERGY BUILDING
1001 LOUISIANA
HOUSTON, TEXAS 77002
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</TABLE>
(713) 757-2131
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
1010 MILAM
HOUSTON, TEXAS 77002
(FORMER ADDRESS IF CHANGED SINCE LAST REPORT)
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ITEM 5. OTHER EVENTS.
On December 11, 1996, Tennessee Gas Pipeline Company ("TGP") made a
distribution to its sole stockholder, Tenneco Inc., of all of the capital stock
of New Tenneco Inc. ("New Tenneco") and Newport News Shipbuilding Inc. ("Newport
News"). TGP's sole stockholder then effected the Distributions to its
stockholders as discussed below. These distributions constituted a disposition
of a substantial portion of the assets of TGP.
In order to properly reflect these distributions, TGP is required under
applicable accounting rules and regulations to restate its financial statements
as of December 31, 1995 and 1994 and September 30, 1996, and for the three years
in the period ended December 31, 1995, and for each of the nine month periods
ended September 30, 1996 and 1995, and to present a Management's Discussion and
Analysis of Results of Operations ("MD&A") with respect to such restated
financial statements, all as set forth herein.
The financial information and MD&A included in this Form 8-K modify and
supersede the financial information and MD&A that are contained in TGP's Annual
Report on Form 10-K for the year ended December 31, 1995, as amended by TGP's
Form 10-K/A dated October 30, 1996, and TGP's Quarterly Reports on Form 10-Q for
the quarterly periods ended March 31, 1996, June 30, 1996 and September 30,
1996.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
The following information should be read in conjunction with the combined
financial statements and related notes presented on pages F-3 to F-27. As used
herein, unless the context otherwise requires, the "Company" refers to TGP and
those subsidiaries owned directly or indirectly by TGP subsequent to the
Distributions and Merger transactions (as described below), including certain
businesses which historically were not conducted by subsidiaries of TGP, and
does not include the automotive parts, packaging and shipbuilding businesses
which were conducted by subsidiaries of TGP prior to the Distributions and
Merger. TGP meets the conditions of General Instruction I to Form 10-K and
General Instruction H to Form 10-Q and is therefore filing this report with a
reduced disclosure format as permitted by such instructions.
MERGER TRANSACTION
On December 12, 1996, TGP became an indirect subsidiary of El Paso Natural
Gas Company ("El Paso") as a result of a merger (the "Merger") of Tenneco Inc.
(the parent company of TGP and referred to herein as "Old Tenneco") and an
indirect subsidiary of El Paso. Prior to the Merger, Old Tenneco and its
subsidiaries, including TGP, effected various intercompany transfers and
distributions which restructured, divided and separated their businesses, assets
and liabilities so that all the assets, liabilities and operations related to
their automotive parts, packaging and administrative services businesses
(collectively, the "Industrial Business") and their shipbuilding business (the
"Shipbuilding Business") were spun-off to Old Tenneco's then existing common
stockholders (the "Distributions"). In connection with the Distributions,
certain assets relating to the Industrial Business and the Shipbuilding Business
were transferred from TGP to New Tenneco and Newport News, respectively.
Following the Distributions, the remaining operations of the Company consisted
primarily of those operations related to the transmission and marketing of
natural gas and other existing and discontinued operations of Old Tenneco. Old
Tenneco was renamed El Paso Tennessee Pipeline Co. ("El Paso Tennessee") and New
Tenneco was renamed Tenneco Inc. As a result of the Merger, El Paso indirectly
owns 100% of the common stock of El Paso Tennessee, representing at the
effective time of the Merger approximately 75% of the equity value of El Paso
Tennessee; the balance of the equity value of El Paso Tennessee is held by the
holders of its 8 1/4% Cumulative Preferred Stock, Series A that was originally
issued in a registered public offering in November 1996 and remained outstanding
after the Merger.
In preparation for the Merger and Distributions, Old Tenneco initiated a
realignment of its indebtedness. As part of this debt realignment, Old Tenneco
initiated tender offers for certain issues of its consolidated debt and certain
other debt issues were exchanged, defeased or otherwise retired. Upon completion
of the debt realignment transactions, the Company is responsible for the
remaining debt after giving effect to the debt
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realignment which was not tendered, exchanged, defeased or otherwise redeemed
(approximately $120 million aggregate principle amount of such debt remained
outstanding immediately after the debt realignment). The Company recognized an
after-tax extraordinary charge of approximately $100 million related to the
Company's debt realignment.
Immediately subsequent to the Merger, El Paso Tennessee had approximately
$2.1 billion of borrowings under its $3 billion Revolving Credit and Competitive
Advance Facility Agreement (the "Credit Agreement") dated as of November 4,
1996. In addition El Paso Tennessee had approximately $300 million of 8 1/4%
Cumulative Preferred Stock, Series A outstanding and approximately $134 million
aggregate principle amount of Old Tenneco debt after giving effect to the debt
realignment which was not redeemed or retired as part of the debt realignment
transactions. Borrowings under the Consolidated Credit Agreement are guaranteed
by El Paso. The primary assets of El Paso Tennessee consist of its investment in
TGP and management anticipates that the funds necessary to service the debt and
other securities of El Paso Tennessee will be provided by El Paso or the
operations of the Company. Consequently, the Company may provide funds from
operating activities, as well as proceeds from asset sales or financings, to El
Paso Tennessee to fund its debt and preferred stock servicing requirements.
The consideration paid by El Paso in the Merger was approximately $4
billion, which included El Paso common stock valued at approximately $914
million at December 9, 1996. The acquisition will be accounted for under the
purchase method of accounting which requires the assets and liabilities of the
Company to be adjusted to reflect their estimated fair values at the time of the
acquisition. A final determination of required purchase accounting adjustments,
including the allocation of the purchase price to the assets acquired and
liabilities assumed based on their respective fair values, has not been made. El
Paso has commenced a study to determine the values of such assets and
liabilities and will make necessary purchase accounting adjustments upon
completion of that study. These purchase price adjustments will be reflected in
the consolidated financial statements of the Company subsequent to the Merger.
In connection with the Merger, responsibility for various debts,
liabilities and obligations was contractually allocated among Old Tenneco, New
Tenneco, Newport News and their respective subsidiaries. It is possible that a
court would disregard this contractual allocation of debts, liabilities and
obligations among the parties and require the Company to assume responsibility
for obligations allocated to another party, particularly if such other party
were to refuse or was unable to pay or perform any of its allocated obligations.
In addition, each of El Paso Tennessee, New Tenneco and Newport News has agreed
to indemnify the other parties (and certain related persons) from and after
consummation of the Distributions with respect to certain debts, liabilities and
obligations.
Although the separation of the Industrial Business and Shipbuilding
Business prior to the Merger was structured as a "spin-off" of New Tenneco and
Newport News for legal, tax and other reasons, New Tenneco succeeded to certain
important aspects of the Old Tenneco business, organization and affairs, namely:
(i) New Tenneco was renamed "Tenneco Inc." subsequent to the consummation of the
Merger; (ii) New Tenneco is headquartered at Old Tenneco's former headquarters
in Greenwich, Connecticut; (iii) New Tenneco's Board of Directors consists of
those persons previously constituting the Old Tenneco Board of Directors prior
to the Merger; (iv) New Tenneco's executive management consists substantially of
the Old Tenneco executive management prior to the Merger; and (v) the businesses
conducted by New Tenneco consist largely of the Industrial Business, which
represented over half of the assets, revenues and operating income of the
businesses, operations and companies of Old Tenneco and its subsidiaries prior
to the Merger. Consequently, the Company has restated its historical
consolidated financial statements to reflect the financial position, results of
operations and cash flows of the energy and other businesses of the Company
after the Distributions and Merger on a separate and stand alone basis (see the
"Basis of Presentation" discussion in Note 2 to the combined financial
statements included elsewhere herein). In Old Tenneco's Quarterly Report on Form
10-Q for the quarterly period ended September 30, 1996, Old Tenneco stated that
the Shipbuilding Business and its energy business, including the Company, will
be reflected as discontinued operations in New Tenneco's financial statements
subsequent to the Distributions and Merger.
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El Paso is engaged in a comprehensive review of the business and operations
of the Company. Following completion of such review, El Paso intends to
integrate, for the most part, the operations of the Company to increase
operating and administrative efficiency through consolidation and reengineering
of facilities, workforce reductions and coordination of purchasing, sales and
marketing activities. El Paso anticipates that the complementary interstate and
intrastate pipeline operations and gas marketing activities of El Paso and the
Company should provide the combined company with increased operating flexibility
and access to additional customers and markets, although the amount and timing
of realization of such benefits will depend upon the ability of El Paso to
integrate successfully the businesses and operations of the companies, and the
time period over which such integration is effected.
Subsequent to the Merger in December 1996, the Company received
approximately $400 million in proceeds from the debt financing and sale of a 70%
interest in the Company's two Australian pipelines. It also has completed the
sale of its oil and gas exploration, production and financing unit, formerly
known as Tenneco Ventures Corporation ("Tenneco Ventures"), for $105 million.
The net proceeds from these monetization transactions were loaned to El Paso
Tennessee and used to repay outstanding borrowings under the Credit Agreement.
The Company is also pursuing the monetization of certain other assets.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
Net income for the first nine months of 1996 of $117 million increased by
60% compared with $73 million in the first nine months of 1995.
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NINE MONTHS
ENDED
SEPTEMBER 30,
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1996 1995
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Net sales and operating revenues........................... $ 1,997 $ 1,368
Operating income........................................... 233 174
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Net Sales and Operating Revenues
Net sales and operating revenues for the first nine months of 1996
increased by 46% compared with the year ago period.
Revenues from the energy-related operations of the Company which are
subject to regulation by the Federal Energy Regulatory Commission ("FERC")
(generally referred to herein as its "regulated" operations) increased to $641
million, or 16%, primarily due to increased transportation volumes, benefits
derived from a new rate structure implemented on July 1, 1995 which resulted in
a $12 million increase and regulatory adjustments of $70 million (which had no
operating income impact). Revenues from the energy-related operations of the
Company which are not generally subject to regulation by the FERC (generally
referred to herein as its "nonregulated" operations) increased to $1,352
million, or 67%, primarily due to higher natural gas prices resulting in a $430
million increase and an increase in gas volumes resulting in a $58 million
increase. Additionally, the acquisition of the assets of the Pipeline Authority
of South Australia ("PASA") in June 1995 and new processing and gathering
projects increased revenues by $38 million. Revenues from other operations were
$4 million compared with $2 million in the prior-year period.
Income Before Interest Expense and Income Taxes (Operating Income)
Operating income from regulated operations increased to $251 million, or
21%. The increase included $22 million from legal settlements and a $4 million
gain on the sale of the Company's interest in Iroquois Gas Transmission System,
L.P. ("Iroquois"). Higher transportation revenues contributed $12 million to the
increase and improved operating efficiencies contributed $21 million.
Additionally, 1995 included a loss of $7 million from the sale of the Company's
interest in Ozark Gas Transmission System ("Ozark") which added to the 1996
increase. Partially offsetting these increases was the absence of earnings
contributed by the Kern River Gas Transmission Company ("Kern River"), which
added $24 million in the year-ago period. The Company's 50 percent interest in
Kern River was sold in late 1995.
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Nonregulated operating income increased to $31 million or 48% in the first
nine months of 1996 due to higher operating income from the oil and gas
production of Tenneco Ventures of $14 million and the acquisition of PASA in
June 1995 which contributed $10 million. Partially offsetting the nonregulated
operating income increase were lower income from marketing activities of $10
million and $5 million in legal settlements.
The other operations of the Company reported an operating loss of $49
million during the first nine months of 1996 compared with an operating loss of
$54 million in the first nine months of 1995. The decrease in other operations
operating loss is primarily due to a $25 million reserve for liquidation of
surplus real estate holdings and notes recorded in the 1995 period, partially
offset by higher administrative costs in the 1996 period and the continuing
liquidation of the Case Corporation retail receivables held by Tenneco Credit
Corporation (now renamed El Paso Energy Credit Corporation).
In anticipation of the Merger, the Company sold all of the Case Corporation
retail receivables to New Tenneco for an amount equal to their book value and
the proceeds were distributed to El Paso Tennessee. Accordingly, the results
from the Company's other operations will be substantially reduced in future
periods.
Interest Expense (net of interest allocated to affiliates)
Interest expense decreased from $48 million in the first nine months of
1995 to $33 million in the first nine months of 1996. The decrease was primarily
attributable to lower levels of debt and a greater amount of corporate interest
allocated to TGP's non-energy operations.
TGP's historical practice has been to incur indebtedness for its
consolidated group at the parent company level or at a limited number of
subsidiaries, rather than at an operating company level, and to centrally manage
various cash functions. Consequently, the corporate debt of TGP and its related
interest expense have been allocated to TGP's former automotive, packaging and
shipbuilding businesses ("TGP's former non-energy operations") based upon the
portion of TGP's investment in TGP's former non-energy operations which is
deemed to be debt, generally based upon the ratio of TGP's former non-energy
operations' net assets to TGP's consolidated net assets plus debt. Interest
expense was allocated at a rate equivalent to the weighted average cost of all
TGP corporate debt, which was 11.4 percent, 11.0 percent and 10.1 percent for
1995, 1994 and 1993, respectively. Total pre-tax interest expense allocated to
TGP's former non-energy operations in 1995, 1994 and 1993 was $60 million, $61
million and $90 million, respectively. TGP's former non-energy operations have
also been allocated tax benefits approximating 35 percent of the allocated
pre-tax interest expense. Although interest expense and the related tax effects
have been allocated to TGP's former non-energy operations for financial
reporting on a historical basis, TGP's former non-energy operations have not
been billed for these amounts. The changes in allocated corporate debt and the
after-tax allocated interest expense have been included as a component of the
combined equity of the Company. Although management believes that the historical
allocation of corporate debt and interest is reasonable, it is not necessarily
indicative of the Company's debt upon completion of the debt realignment, or the
debt it may incur in the future.
Income Taxes
Income tax expense for the first nine months of 1996 was $82 million
compared with $53 million for the comparable period in 1995. The effective tax
rate for the first nine months of 1996 was 41 percent compared with 42 percent
in the prior year first nine months.
Capital Expenditures
Capital expenditures in the first nine months of 1996 for regulated
operations were $103 million for pipeline additions and improvements.
Non-regulated capital expenditures were $164 million for international pipeline
construction and domestic gathering, processing, and reserve acquisition
programs.
Capital expenditures in the first nine months of 1995 for regulated
operations were $124 million for pipeline additions and improvements.
Non-regulated capital expenditures were $100 million for international pipeline
construction and domestic gathering, processing, and reserve acquisition
programs.
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The Company estimates that expenditures aggregating approximately $299
million will be required after September 30, 1996 to complete facilities and
projects authorized at such date, and substantial commitments have been made in
connection therewith.
Changes in Accounting Principles
In June 1996, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("FAS") No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," which
establishes new accounting and reporting standards for transfers and servicing
of financial assets and extinguishment of liabilities. The statement is
effective for transactions occurring after December 31, 1996. The new standard
is not expected to have a material impact on the financial position or results
of operations of the Company.
The Company adopted FAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of," in the first
quarter of 1996. FAS No. 121 establishes new accounting standards for measuring
the impairment of long-lived assets. The adoption of the new standard did not
have a material effect on the combined financial position or results of
operations of the Company.
RESULTS OF OPERATIONS FOR THE YEARS 1995 AND 1994
1995 STRATEGIC ACTIONS
In December 1995, the Company sold its 50% interest in Kern River, a joint
venture that owns a 904-mile pipeline extending from Wyoming to California. The
sales price was $206 million, resulting in a pre-tax gain of $30 million.
The Company acquired the natural gas pipeline assets of PASA, which
includes a 488-mile pipeline, in June 1995 for approximately $225 million and a
50 percent interest in two gas-fired cogeneration plants from ARK Energy in
November 1995 for approximately $65 million.
RESULTS OF OPERATIONS
The Company's net income for 1995 of $164 million decreased by 9 percent
compared with $181 million in 1994. The decreased results occurred in both the
regulated and nonregulated businesses, as discussed below.
Significant transactions affecting the comparability of operating income
between 1995 and 1994 are:
- Pre-tax gains on sales of assets and businesses of $11 million in 1995
(primarily the Company's interest in Kern River) compared with gains of
$24 million in 1994 (primarily from the sale of a 20% interest in Tenneco
Energy Resources Corporation).
- Reserves established in 1995 of $25 million for the liquidation of
surplus real estate holdings and notes and $30 million for estimated
regulatory and legal settlement costs.
- A gain from a 1994 contract settlement between the Company and Columbia
Gas Transmission Corporation ("Columbia Gas") of $11 million.
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<CAPTION>
1995 1994
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(MILLIONS)
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Net sales and operating revenues............................ $1,921 $2,381
Operating income............................................ 260 367
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Net Sales and Operating Revenues
The regulated operations experienced a decline in net sales and operating
revenues of $157 million, or 17%, from $918 million in 1994 to $761 million in
1995. Lower regulated merchant gas sales caused a decline of approximately $222
million. Under FERC Order 636, customers assume the responsibility for acquiring
their gas supplies, reducing sales by the pipeline. Other non-recurring
regulatory adjustments, that had no operating income impact, partially offset
the decrease in net sales and operating revenues by $63 million.
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Net sales and operating revenues from nonregulated operations in 1995 were
$1,155 million, down $305 million, or 21%, compared with 1994. Average natural
gas prices were lower in 1995 compared with 1994, contributing approximately
$175 million to the revenue decrease. Furthermore, natural gas volumes declined,
contributing $148 million to the revenue decrease. Warmer weather in early 1995
resulted in lower levels of storage activity during the year, decreasing demand
for natural gas and forcing prices lower. These effects were offset somewhat by
$18 million in revenues earned by the PASA assets which were acquired by the
Company in June 1995.
Net sales and operating revenues from the other operations of the Company
were $5 million compared with $3 million in 1994.
Income Before Interest Expense and Income Taxes (Operating Income)
Operating income from regulated operations was down by $27 million, or 8%,
in 1995 as compared with 1994. The Company's regulated business operating income
decrease of approximately $18 million was primarily due to the termination or
expiration of transportation contracts and one-time adjustments for employee
benefit programs recognized in 1994. The 1995 results also included the $30
million pre-tax gain on the sale of the Company's interest in Kern River, a $7
million loss on the sale of the Company's interest in Ozark and a $21 million
reserve for estimated regulatory and legal settlement costs while 1994 included
the $11 million benefit from the Columbia Gas contract settlement.
The 1995 operating income for the nonregulated business decreased $55
million, or 86%, compared with 1994. Operating income in 1994 included a $23
million gain from the sale of a 20 percent interest in Tenneco Energy Resources
Corporation to Ruhrgas AG; the Company repurchased this interest in September
1996. The remainder of the operating income decline was due to a $9 million
reserve for estimated legal settlement costs, lower margins and volumes due to
lower demand in gas marketing which resulted in a $9 million decrease, increased
administrative and general expenses related to increased startup and development
costs on international programs of approximately $12 million, and an increase in
administrative costs of approximately $5 million. Operating results of the
Company included $9 million in income from operating the PASA assets during the
last half of 1995.
The Company's other operations reported a decrease in operating income of
$25 million in 1995 compared to 1994. This decrease was primarily attributable
to a $25 million charge to establish a reserve for liquidation of surplus real
estate holdings and notes.
Interest Expense (net of interest allocated to affiliates)
Interest expense reflected in the combined statements of income is
presented net of corporate interest expense allocated to affiliates (as
described below). Interest expense decreased from $97 million in 1994 to $65
million in 1995 primarily due to lower overall debt levels and higher corporate
interest expense allocated to affiliates.
For a discussion of the historical allocation of the corporate debt and
interest expense of TGP, see "Results of Operations for the Nine Months Ended
September 30, 1996 and 1995 -- Interest Expense (net of interest allocated to
affiliates)."
Income Taxes
Income tax expense for 1995 was $31 million compared with income tax
expense of $89 million in 1994. The effective tax rate for 1995 was 16 percent
compared with 33 percent in 1994. The low effective tax rate in 1995 was
primarily due to the benefit realization of unrecognized deferred tax assets,
principally certain capital loss carryforwards.
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Capital Expenditures
Capital expenditures in 1995 for regulated operations were $191 million for
pipeline additions and improvements. Non-regulated capital expenditures were
$146 million for international pipeline construction and domestic gathering,
processing, and reserve acquisition programs.
Capital expenditures in 1994 for the regulated operations were $221 million
for pipeline additions and improvements. Non-regulated capital expenditures were
$124 million for processing, gathering, and reserve acquisitions.
Cumulative Effect of a Change in Accounting Principle
Effective January 1, 1994, the Company adopted FAS No. 112, "Employers'
Accounting for Postemployment Benefits," using the cumulative catch-up method.
It requires employers to account for postemployment benefits for former or
inactive employees after employment but before retirement on the accrual basis
rather than the "pay-as-you-go" basis. The adoption of this new standard had no
material impact on the financial position or results of operations of the
Company.
OUTLOOK
The regulated natural gas pipeline industry is experiencing increasing
competition, which results from actions taken by the FERC to strengthen market
forces throughout the industry. In a number of key markets, the Company's
interstate pipelines face competitive pressure from other major pipeline
systems, enabling local distribution companies and end users to choose a
supplier or switch suppliers based on the short term price of gas and the cost
of transportation. Competition between pipelines is particularly intense in
certain of the Company's markets. In some instances, the Company has been
required to discount its transportation rates in order to maintain market share.
Additionally, transportation contracts representing approximately 70% of firm
transportation capacity will be expiring over the next five years, principally
in the year 2000. The renegotiation of these contracts may be adversely impacted
by these competitive factors. There can be no assurance that these contracts (or
a substantial portion thereof) will in fact be renegotiated or as to whether the
terms of any renegotiated contracts will be as favorable to the Company as the
existing contracts. Accordingly, the Company presently is unable to ascertain
whether or not the expiration and renegotiation of these transportation
contracts will have a material adverse effect on the Company's combined
financial position or results of operations.
FERC MATTERS
Restructuring Proceedings
On April 8, 1992, the FERC issued Order 636 ("Order 636") which
restructured the natural gas industry by requiring mandatory unbundling of
pipeline sales and transportation services. Numerous parties appealed, to the
U.S. Court of Appeals for the D.C. Circuit, challenging the legality of Order
636 generally, as well as the legality of specific provisions of Order 636. On
July 16, 1996, the court issued its decision upholding, in large part, Order 636
and remanded to the FERC several issues for further explanation, including
further explanation of the FERC's decision to allow pipelines to recover 100% of
their gas supply realignment ("GSR") costs.
TGP implemented revisions to its tariff, effective on September 1, 1993,
which restructured its transportation, storage and sales services to convert TGP
from primarily a merchant to primarily a transporter of gas as required by Order
636. As a result of this restructuring, TGP's gas sales declined while certain
obligations to producers under long-term gas supply contracts continued, causing
TGP to incur significant restructuring transition costs. Pursuant to the
provisions of Order 636 allowing for the recovery of transition costs related to
the restructuring, TGP has made filings to recover GSR costs resulting from
remaining gas purchase obligations, costs related to its Bastian Bay facilities,
the remaining unrecovered balance of purchased gas ("PGA") costs and the
"stranded" costs of TGP's continuing contractual obligations to pay for capacity
on other pipeline systems ("TBO costs").
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TGP's filings to recover costs related to its Bastian Bay facilities have
been rejected by the FERC based on the continued use of the gas production from
the field; however, the FERC recognized the ability of TGP to file for the
recovery of losses upon disposition of these assets. TGP has filed for appellate
review of the FERC actions and is confident that the Bastian Bay costs will
ultimately be recovered as transition costs under Order 636; the FERC has not
contested the ultimate recoverability of these costs.
The filings implementing TGP's recovery mechanisms for the following
transition costs were accepted by the FERC effective September 1, 1993; recovery
was made subject to refund pending FERC review and approval for eligibility and
prudence: 1) direct-billing of unrecovered PGA costs to its former sales
customers over a twelve-month period; 2) recovery of TBO costs, which TGP is
obligated to pay under existing contracts, through a surcharge from firm
transportation customers, adjusted annually; and 3) recovery of 90% of GSR costs
over a period of up to 36 months from firm transportation customers and recovery
of 10% of such costs from interruptible transportation customers over a period
of up to 60 months.
Following negotiations with its customers, TGP filed in July 1994 with the
FERC a Stipulation and Agreement (the "PGA Stipulation"), which provides for the
recovery of PGA costs of approximately $100 million and the recovery of costs
associated with the transfer of storage gas inventory to new storage customers
in TGP's restructuring proceeding. The PGA Stipulation eliminates all challenges
to the PGA costs, but establishes a cap on the charges that may be imposed upon
former sales customers. On November 15, 1994, the FERC issued an order approving
the PGA Stipulation and resolving all outstanding issues. On April 5, 1995, the
FERC issued an order on rehearing affirming its initial approval of the PGA
Stipulation. TGP implemented the terms of the PGA Stipulation and made refunds
in May 1995. The refunds had no material effect on the Company's reported net
income. The orders approving the PGA Stipulation have been appealed to the D.C.
Circuit Court of Appeals by certain customers. TGP believes the FERC orders
approving the PGA Stipulation will be upheld on appeal.
TGP is recovering through a surcharge, subject to refund, TBO costs
formerly incurred to perform its sales function. The FERC issued an order
requiring TGP to refund certain costs from this surcharge and refunds were made
in May 1996. TGP is appealing this decision and believes such appeal will likely
be successful.
In order to resolve litigation concerning purchases made by TGP of
synthetic gas produced from the Great Plains coal gasification plant ("Great
Plains"), TGP, along with three other pipelines, executed four separate
settlement agreements with Dakota Gasification Company ("Dakota") and the U.S.
Department of Energy and initiated four separate proceedings at the FERC seeking
approval to implement the settlement agreements. The FERC previously ruled that
the costs related to the Great Plains project are eligible for recovery through
GSR and other special recovery mechanisms and that the costs are eligible for
recovery for the duration of the term of the original gas purchase agreements.
On October 18, 1994, the FERC consolidated the four proceedings and set them for
hearing before an administrative law judge ("ALJ"). The hearing, which concluded
in July 1995, was limited to the issue of whether the settlement agreements are
prudent. The ALJ concluded, in his initial decision issued in December 1995,
that the settlement was imprudent. TGP has filed exceptions to this initial
decision. The Company believes that this decision will not impair TGP's recovery
of the costs resulting from this contract. Oral arguments were held before the
full FERC on September 25, 1996. A decision by the FERC is expected by the end
of the year.
Also related to TGP's GSR costs, on October 14, 1993, TGP was sued in the
State District Court of Ector County, Texas, by ICA Energy, Inc. ("ICA") and
TransTexas Gas Corporation ("TransTexas"). In that suit, ICA and TransTexas
contended that TGP had an obligation to purchase gas production which TransTexas
unilaterally attempted to add to the reserves originally dedicated to a 1979 gas
contract. An amendment to the pleading sought $1.5 billion from TGP for alleged
damages caused by TGP's refusal to purchase gas produced from the TransTexas
leases covering the new production and lands. In June 1996, TGP reached a
settlement with ICA and TransTexas for $125 million wherein ICA and TransTexas
agreed to terminate their contract rights, released TGP from liability under the
contract, and indemnified TGP against future claims, including royalty owner
claims. TGP has filed with the FERC to recover from its customers the amount
paid to ICA and TransTexas. In July 1996, certain royalty interest owners filed
a claim against TGP
8
<PAGE> 10
alleging that they are sellers entitled to tender gas to TGP under the settled
contract. This claim fell under the indemnification provisions of TGP's
settlement with ICA and TransTexas, requiring ICA and TransTexas to defend and
indemnify TGP.
TGP has been engaged in other settlement and contract reformation
discussions with other holders of certain gas purchase contracts who have sued
TGP. One of these matters involved a dispute between TGP, as purchaser, under a
contract with Lenape Resources Corp., the Coastal Corp., and Tesoro. On August
1, 1995, the Texas Supreme Court affirmed a ruling of the Texas Court of Appeals
favorable to TGP in one of these matters and indicated that it would remand the
case to the trial court. On April 18, 1996, however, the Texas Supreme Court
withdrew its initial opinion and issued an opinion reversing the Court of
Appeals opinion. The Texas Supreme Court ruling, however, explicitly preserves
TGP's defenses based on bad faith conduct of the producers. In June 1996, TGP
filed a motion for rehearing with the Texas Supreme Court that was denied in
August 1996. Nothing in the Texas Supreme Court's decision affects TGP's ability
to seek recovery from its customers of its above-market costs of purchasing gas
under the contract as GSR costs in the phased proceedings currently pending
before the FERC. In addition, TGP has initiated two lawsuits against the holders
of this gas purchase contract seeking damages related to their conduct in
connection with that contract.
During the course of this action, TGP had either paid, or provided for the
payment of, amounts it believes were appropriate to cover the resolution of its
contract reformation litigation, including providing a bond in the amount of
$206 million. On September 30, 1996, TGP paid approximately $193 million to the
producers and the producers agreed to release all but approximately $2 million
of the bonded amount. On November 1, 1996, a final order was issued which
assessed only $456,000 of the $2 million to TGP and TGP will request release
from this remaining bond amount. On October 1, 1996, TGP filed to recover from
its customers the $193 million paid in relation to this matter. It is
anticipated that TGP will also continue to pay the above-market contract price
for the gas tendered by the producers through the expiration of the contract in
1999, and will seek recovery of those amounts from its customers in the FERC
proceedings as well. TGP plans to amend its complaint in one of the separate
lawsuits pending against the producers to seek recovery of amounts TGP believes
it is entitled to recover as a result of the producers' bad faith conduct.
As of September 30, 1996, TGP has deferred GSR costs yet to be recovered
from its customers of approximately $527 million, net of $414 million previously
recovered from its customers, subject to refund. A phased proceeding is underway
at the FERC with respect to the recovery of TGP's GSR costs. Testimony has been
completed in connection with Phase I of that proceeding relating to the
eligibility of GSR cost recovery; oral argument on eligibility issues was
originally set by a FERC ALJ for late October 1996. The Chief Judge of the FERC
has since issued orders (i) canceling the October 1996 oral argument, (ii)
convening settlement discussions which commenced on October 9, 1996, and (iii)
postponing scheduling oral argument on eligibility issues.
Phase II of the proceeding on the prudency of the costs to be recovered and
on certain contract specific eligibility issues has not yet been scheduled, but
will likely occur sometime after the ALJ's decision in Phase I is issued. The
FERC has generally encouraged pipelines to settle such issues through
negotiations with customers. Although the Order 636 transition cost recovery
mechanism provides for complete recovery by pipelines of eligible and prudently
incurred transition costs, certain customers have challenged the prudence and
eligibility of TGP's GSR costs and TGP has engaged in settlement discussions
with its customers concerning the amount of such costs in response to the FERC
statements acknowledging the desirability of such settlements.
On October 23, 1996, in anticipation of consummation of the Merger, El Paso
reached a preliminary understanding with certain of TGP's customers (the "El
Paso Preliminary GSR Understanding"). Under the El Paso Preliminary GSR
Understanding, El Paso will settle the customers' challenges to TGP's GSR and
other transition costs, effective January 1, 1997. It is unlikely that the El
Paso Preliminary GSR Understanding will be finalized and filed with the FERC
prior to January 31, 1997. Assuming the El Paso Preliminary GSR Understanding is
finalized and filed with the FERC, non-consenting customers will have the
9
<PAGE> 11
opportunity to object to the proposed settlement, which may have to be modified
if any such objection is successful.
Given the uncertainty over whether the FERC will approve the proposed GSR
cost recovery settlement in the form ultimately presented to it and the
uncertainty related to predicting the outcome of its gas purchase contract
reformation efforts and the associated litigation, TGP is unable to predict the
timing or the ultimate impact that the resolution of these issues will have on
its combined financial position or results of operations.
Rate Proceedings
On December 30, 1994, TGP filed for a general rate increase (the "1995 Rate
Case"). On January 25, 1995, the FERC accepted the filing, suspended its
effectiveness for the maximum period of five months pursuant to normal
regulatory process, and set the matter for hearing. On July 1, 1995, TGP began
collecting rates, subject to refund, reflecting an $87 million increase in TGP's
annual revenue requirement. A Stipulation and Agreement was filed with an ALJ in
this proceeding on April 5, 1996. This Stipulation proposes to resolve the rates
which are the subject of the 1995 Rate Case, including structural rate design
and increased revenue requirements, and TGP is reserving revenues it believes
are adequate to cover the income impact from any refunds that may be required
upon final settlement of this proceeding. On October 30, 1996, the FERC approved
the Stipulation for the Settlement of the 1995 Rate Case, with certain
modifications and clarifications which are not material and which should not
cause changes which are adverse to TGP. Two parties have filed requests for
rehearing of the order approving the settlement. TGP believes that the order
approving the settlement will be upheld on rehearing. TGP has reserved revenues
it believes adequate to cover the income impact of any refunds that may be
required.
TGP, as with all interstate pipelines, is subject to FERC audit review of
its books and records. TGP currently has an open audit covering the years
1991-1994. The FERC audit staff is expected to issue an audit report in early
1997.
For a discussion of recent FERC proceedings relating to the recovery by the
Company of certain environmental costs as a component of the rates charged by
its interstate pipeline operations see "-- Environmental Matters."
ENVIRONMENTAL MATTERS
TGP and certain of its subsidiaries are parties to environmental
proceedings. Expenditures for ongoing compliance with environmental regulations
that relate to current operations are expensed or capitalized as appropriate.
Expenditures that relate to an existing condition caused by past operations and
that do not contribute to current or future revenue generation are expensed.
Liabilities are recorded when environmental assessments indicate that remedial
efforts are probable and the costs can be reasonably estimated. Estimates of the
liability are based upon 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. All available
evidence is considered, including prior experience in remediation of
contaminated sites, other companies' cleanup experience and data released by the
United States Environmental Protection Agency ("EPA") or other organizations.
These estimated liabilities are subject to revision in future periods based on
actual costs or new circumstances. These liabilities are included in the balance
sheet at their undiscounted amounts. Recoveries are evaluated separately from
the liability and, when recovery is assured, are recorded and reported
separately from the associated liability in the financial statements.
TGP is a party in proceedings involving federal and state authorities
regarding the past use by TGP of a lubricant containing polychlorinated
biphenyls ("PCBs") in its starting air systems. TGP has executed a consent order
with the EPA governing the remediation of certain of its compressor stations and
is working with the Pennsylvania and New York environmental agencies to specify
the remediation requirements at the Pennsylvania and New York stations.
Remediation activities in Pennsylvania are essentially complete; in addition,
pursuant to the Consent Order dated August 1, 1995, between TGP and the
Pennsylvania Department of Environmental Protection, TGP funded an
environmentally beneficial project for $450,000 in April 1996 and paid a
$500,000 civil penalty in September 1996. Remediation and characterization work
at
10
<PAGE> 12
the compressor stations under its consent order with the EPA and the
jurisdiction of the New York Department of Environmental Conservation is
ongoing. TGP believes that the ultimate resolution of these matters will not
have a material adverse effect on the combined financial position or results of
operations of the Company.
In 1996, TGP sold its subsidiary which owns a 13.2% general partnership
interest in Iroquois Gas Transmission, L.P. ("Iroquois") to ANR Iroquois Inc., a
subsidiary of The Coastal Corporation. Iroquois owns an interstate gas pipeline
from the Canadian border through the states of New York and Connecticut to Long
Island. TGP is still under contract to provide gas dispatching as well as
post-construction field operation and maintenance services for the operator of
Iroquois, but TGP is not the operator and is not an affiliate of the operator of
Iroquois' pipeline system. In the second quarter of 1996, global settlement was
entered into by Iroquois and the operator of Iroquois' pipeline system with the
Federal and New York State authorities resolving all criminal, civil and
administrative enforcement actions contemplated by such authorities as a result
of their investigation of alleged environmental violations which occurred during
the construction of the pipeline. No fines or penalties were imposed on TGP, and
TGP believes that any environmental matters relating to the construction and
operation of the pipeline system by Iroquois will not have a material adverse
effect on the combined financial position or results of operations of the
Company.
TGP has identified other sites in its various subsidiaries included within
the Company where environmental remediation expense may be required should there
be a change in ownership, operations or applicable regulations. These
possibilities cannot be predicted or quantified at this time and, accordingly,
no provision has been recorded. However, provisions have been made for all
instances where it has been determined that the incurrence of any material
remedial expense is reasonably possible. TGP believes that the provisions
recorded for environmental exposures of the Company are adequate based on
current estimates.
TGP has established a reserve for environmental expenses, which includes:
(i) expected remediation expense and associated onsite, offsite and groundwater
technical studies; (ii) legal fees; and (iii) settlement of third-party and
governmental litigation, including civil penalties. Through September 30, 1996,
TGP has charged approximately $160 million against the environmental reserve,
excluding recoveries related to TGP's environmental settlement as discussed
below. Of the remaining reserve at September 30, 1996, $24 million has been
recorded on the combined balance sheet under "Payables -- trade" and $128
million under "Deferred credits and other liabilities."
In Commonwealth of Kentucky, Natural Resources and Environmental Protection
Cabinet v. Tennessee Gas Pipeline Company (Franklin County Circuit Court, Docket
No. 88-C1-1531, November 16, 1988), the Kentucky environmental agency alleged
that TGP discharged pollutants into the waters of the state without a permit and
disposed of PCBs without a permit. The agency sought an injunction against
future discharges, an order to remediate or remove PCBs, and a civil penalty.
TGP has entered into agreed orders with the agency to resolve many of the issues
raised in the original allegations, has received water discharge permits for its
Kentucky stations from the agency, and continues to work to resolve the
remaining issues. Counsel for TGP are unable to express an opinion as to the
ultimate outcome. TGP believes that the resolution of this issue will not have a
material adverse effect on the combined financial position or results of
operations of the Company.
TPG and certain of its subsidiaries have been designated, have received
notice that they could be designated or have been asked for information to
determine whether they could be designated as potentially responsible parties
("PRP") with respect to 26 sites under the Comprehensive Environmental Response,
Compensation and Liability Act (CERCLA or Superfund) or state equivalents. There
are 24 sites related to discontinued operations of the Company. The Company has
sought to resolve its liability as a PRP with respect to these Superfund sites
through indemnification by third parties and/or settlements which provide for
payment of the Company's allocable share of remediation costs. As of September
30, 1996, the Company has estimated its share of the remediation costs at these
sites to be between $7 million and $41 million and has provided reserves that it
believes are adequate for such costs. Because the clean-up costs are estimates
and are subject to revision as more information becomes available about the
extent of remediation required, the Company's estimate of its share of
remediation costs could change. Moreover, liability under the federal Superfund
statute is joint and several, meaning that the Company could be required to pay
in excess of its pro
11
<PAGE> 13
rata share of remediation costs. The Company's understanding of the financial
strength of other PRPs has been considered, where appropriate, in its
determination of its estimated liability as described herein. The Company
presently believes that the costs associated with the current status of such
entities as PRPs at the Superfund sites referenced above will not have a
material adverse effect on the combined financial position or results of
operations of the Company.
In addition, the Company's liabilities include liabilities to remediate a
number of formerly owned or leased sites, and certain other sites associated
with its discontinued operations, pursuant to state and federal laws enacted for
the protection of the environment. As of September 30, 1996, the Company
estimates that its share of the remediation costs at these sites to be between
$23 million and $43 million and has provided reserves that it believes are
adequate for such costs. Because the clean-up costs are estimates and are
subject to revision as more information becomes available about the extent of
remediation required, the Company's estimate of its share of remediation costs
could change. The Company presently believes that the costs to remediate these
sites will not have a material adverse effect on its combined financial position
or results of operations.
HEDGING ACTIVITIES
The Company has utilized financial instruments for many years to mitigate
its exposure to various risks. The Company currently is party to financial
instruments to hedge its exposure to changes in interest rates and natural gas
prices. Although losses could occur, the derivatives contracts used by the
Company are generally designated as hedges whose fair value correlates to price
movements of natural gas. As a result, gains or losses resulting from market
changes should generally be offset by losses or gains on the hedged transaction.
12
<PAGE> 14
INDEX TO COMBINED FINANCIAL STATEMENTS AND SCHEDULE OF THE
ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of independent public accountants............................................... F-2
Combined statements of income for each of the three years in the period ended
December 31, 1995 and the nine months ended September 30, 1996 and 1995.............. F-3
Combined balance sheets -- December 31, 1995 and 1994 and September 30, 1996........... F-4
Combined statements of cash flows for each of the three years in the period ended
December 31, 1995 and the nine months ended September 30, 1996 and 1995.............. F-5
Statements of changes in combined equity for each of the three years in the period
ended December 31, 1995 and the nine months ended September 30, 1996................. F-6
Notes to combined financial statements................................................. F-7
FINANCIAL STATEMENT SCHEDULE
Schedule II -- Valuation and qualifying accounts....................................... S-1
</TABLE>
F-1
<PAGE> 15
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Tennessee Gas Pipeline Company:
We have audited the accompanying combined balance sheets of the Energy
Businesses of Tennessee Gas Pipeline Company as of December 31, 1995 and 1994,
and the related combined statements of income, cash flows and changes in
combined equity for each of the three years in the period ended December 31,
1995. These combined financial statements and the schedule referred to below are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these combined financial statements and schedule based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the combined financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the combined financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall combined
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the combined financial position of the Energy
Businesses of Tennessee Gas Pipeline Company as of December 31, 1995 and 1994,
and the results of their combined operations and cash flows for each of the
three years in the period ended December 31, 1995, in conformity with generally
accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
combined financial statements taken as a whole. The supplemental schedule listed
in the Index to the Combined Financial Statements and Schedule of the Energy
Businesses of Tennessee Gas Pipeline Company is presented for purposes of
complying with the Securities and Exchange Commission's rules and is not part of
the basic combined financial statements. The supplemental schedule has been
subjected to the auditing procedures applied in the audits of the basic combined
financial statements and, in our opinion, fairly states in all material respects
the financial data required to be set forth therein in relation to the basic
combined financial statements of the Energy Businesses of Tennessee Gas Pipeline
Company taken as a whole.
ARTHUR ANDERSEN LLP
Houston, Texas
February 8, 1996
(except with respect to
the matters discussed in
Notes 1 and 2, as to which the
date is December 12, 1996)
F-2
<PAGE> 16
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
COMBINED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
-------------------------- -----------------
1995 1994 1993 1996 1995
------ ------ ------ ------ ------
(MILLIONS) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUES
Net sales and operating revenues................. $1,921 $2,381 $2,866 $1,997 $1,368
Other income --
Interest income................................ 84 65 25 44 63
Equity in net income of affiliated companies... 65 51 47 25 51
Gain (loss) on sale of assets, net............. 11 1 62 5 (7)
Gain on the sale by a subsidiary of its
stock....................................... -- 23 -- -- --
Other income (loss), net....................... 21 18 (2) 26 (15)
------ ------ ------ ------ ------
2,102 2,539 2,998 2,097 1,460
------ ------ ------ ------ ------
COSTS AND EXPENSES
Cost of gas sold................................. 954 1,472 1,786 1,156 671
Operating expenses............................... 414 380 442 331 262
General and administrative....................... 199 143 168 164 146
Finance charges.................................. 79 75 51 51 66
Depreciation, depletion and amortization......... 196 102 170 162 141
------ ------ ------ ------ ------
1,842 2,172 2,617 1,864 1,286
------ ------ ------ ------ ------
Income before interest expense and income
taxes.......................................... 260 367 381 233 174
Interest expense (net of interest allocated to
affiliates).................................... 65 97 117 33 48
------ ------ ------ ------ ------
Income before income taxes....................... 195 270 264 200 126
Income tax expense............................... 31 89 100 82 53
------ ------ ------ ------ ------
Income before extraordinary loss................. 164 181 164 118 73
Extraordinary loss, net of income tax............ -- -- (25) (1) --
------ ------ ------ ------ ------
Net income....................................... $ 164 $ 181 $ 139 $ 117 $ 73
====== ====== ====== ====== ======
</TABLE>
The accompanying notes to combined financial statements are an integral part of
these combined statements of income.
F-3
<PAGE> 17
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
COMBINED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------- SEPTEMBER 30,
1995 1994 1996
------ ------ -------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
(MILLIONS)
Current assets:
Cash and temporary cash investments........................ $ 305 $ 109 $ 35
Receivables --
Customer notes and accounts (net)....................... 508 961 415
Affiliated companies.................................... 243 56 90
Gas transportation and exchange......................... 64 214 144
Income taxes............................................ -- 80 --
Other................................................... 419 115 353
Inventories................................................ 24 22 25
Deferred income taxes...................................... 5 19 43
Prepayments and other...................................... 83 92 89
------ ------ ------
1,651 1,668 1,194
------ ------ ------
Investments and other assets:
Investment in affiliated companies......................... 280 358 252
Long-term notes and other receivables (net)................ 324 669 166
Goodwill................................................... 22 25 48
Other...................................................... 584 298 601
------ ------ ------
1,210 1,350 1,067
------ ------ ------
Plant, property and equipment, at cost....................... 6,272 5,768 6,518
Less -- Reserves for depreciation, depletion and
amortization............................................ 3,431 3,327 3,546
------ ------ ------
2,841 2,441 2,972
------ ------ ------
$5,702 $5,459 $ 5,233
====== ====== ======
LIABILITIES AND COMBINED EQUITY
Current liabilities:
Short-term debt (including current maturities on long-term
debt)................................................... $ 275 $ 360 $ 324
Payables --
Trade................................................... 353 293 240
Affiliated companies.................................... 108 153 74
Gas transportation and exchange......................... 28 159 103
Taxes accrued.............................................. 430 -- 47
Interest accrued........................................... 42 64 47
Natural gas pipeline revenue reservation................... 27 190 73
Other...................................................... 422 232 314
------ ------ ------
1,685 1,451 1,222
------ ------ ------
Long-term debt............................................... 702 1,016 584
------ ------ ------
Deferred income taxes........................................ 347 730 442
------ ------ ------
Postretirement benefits...................................... 260 288 239
------ ------ ------
Deferred credits and other liabilities....................... 446 319 306
------ ------ ------
Commitments and contingencies
Minority interest............................................ 19 19 --
------ ------ ------
Combined equity.............................................. 2,243 1,636 2,440
------ ------ ------
$5,702 $5,459 $ 5,233
====== ====== ======
</TABLE>
The accompanying notes to combined financial statements are an integral part
of these combined balance sheets.
F-4
<PAGE> 18
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
COMBINED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
------------------------ -----------------
1995 1994 1993 1996 1995
------ ------ ------ ------- -------
(MILLIONS) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income........................................... $ 164 $ 181 $ 139 $ 117 $ 73
Adjustments to reconcile net income to net cash
provided (used) by operating activities --
Extraordinary loss, net of tax..................... -- -- 25 1 --
Depreciation, depletion and amortization........... 196 102 170 162 141
Equity in net income of affiliated companies, net
of dividends.................................... (12) (3) (5) (2) (6)
Deferred income taxes.............................. 47 34 73 42 13
(Gain) loss on sale of assets, net................. (11) (24) (62) (5) 7
Cash paid for interest allocated to affiliates, net
of tax.......................................... (39) (40) (59) (24) (29)
Changes in components of working capital --
(Increase) decrease in receivables.............. 246 23 162 270 398
(Increase) decrease in prepayments and other
current assets................................ 8 35 51 19 8
Increase (decrease) in payables................. (135) (278) (400) (248) (293)
Increase (decrease) in taxes accrued............ 30 (204) 109 (74) (83)
Increase (decrease) in interest accrued......... (52) (39) (26) (12) (24)
Increase (decrease) in natural gas pipeline
revenue reservation........................... (156) (91) 136 23 (169)
Increase (decrease) in other current
liabilities................................... (94) (60) (122) (40) (43)
(Increase) decrease in long-term notes and other
receivables, net................................ 332 228 -- 182 260
Take-or-pay recoupments (refunds to customers),
net............................................. 36 26 (34) 1 34
Other.............................................. (83) (52) (2) (407) 26
------- ------- ------- ------- -------
Net cash provided (used) by operating activities..... 477 (162) 155 5 313
------- ------- ------- ------- -------
INVESTING ACTIVITIES
Net proceeds from sale of assets..................... 17 68 114 283 14
Expenditures for plant, property and equipment....... (337) (345) (171) (267) (224)
Acquisitions of businesses........................... (241) -- -- -- (225)
Investments and other................................ 24 48 22 (36) 28
------- ------- ------- ------- -------
Net cash provided (used) by investing activities..... (537) (229) (35) (20) (407)
------- ------- ------- ------- -------
FINANCING ACTIVITIES
Redemption of equity securities by a subsidiary...... -- (160) -- -- --
Net increase (decrease) in short-term debt excluding
current maturities on long-term debt............... 19 (92) 46 11 273
Retirement of long-term debt......................... (478) (358) (1,079) (325) (376)
Net (increase) decrease in notes and advances with
Tenneco Inc........................................ (239) (2,504) 657 451 353
Net cash contributions from (distributions to)
affiliates......................................... 954 3,434 387 (392) 326
------- ------- ------- ------- -------
Net cash provided (used) by financing activities..... 256 320 11 (255) 576
------- ------- ------- ------- -------
Increase (decrease) in cash and temporary cash
investments........................................ 196 (71) 131 (270) 482
Cash and temporary cash investments, at beginning of
period............................................. 109 180 49 305 109
------- ------- ------- ------- -------
Cash and temporary cash investments, at end of
period............................................. $ 305 $ 109 $ 180 $ 35 $ 591
======= ======= ======= ======= =======
Cash paid during the year for interest............... $ 254 $ 264 $ 271 $ 125 $ 176
Cash paid during the year for income taxes (net of
refunds and tax payments from affiliates).......... $ 136 $ (137) $ 81 $ 422 $ 181
</TABLE>
- ---------------
Note: Cash and temporary cash investments include highly liquid investments with
a maturity of three months or less at the date of purchase.
The accompanying notes to combined financial statements are an integral part
of these combined statements of cash flows.
F-5
<PAGE> 19
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
STATEMENTS OF CHANGES IN COMBINED EQUITY
<TABLE>
<CAPTION>
(MILLIONS)
----------
<S> <C>
Balance, December 31, 1992........................................................ $ 131
Net income...................................................................... 139
Cash paid for interest allocated to affiliates, net of tax...................... (59)
Change in corporate debt allocated to affiliates................................ (644)
Net change in notes and advances with Tenneco Inc. ............................. 657
Cash contributions from (distributions to) affiliates, net...................... 387
Noncash contributions from (distributions to) affiliates, net................... 309
-------
Balance, December 31, 1993........................................................ 920
Net income...................................................................... 181
Cash paid for interest allocated to affiliates, net of tax...................... (40)
Change in corporate debt allocated to affiliates................................ (23)
Net change in notes and advances with Tenneco Inc. ............................. (2,504)
Cash contributions from (distributions to) affiliates, net...................... 3,434
Noncash contributions from (distributions to) affiliates, net................... (332)
-------
Balance, December 31, 1994........................................................ 1,636
Net income...................................................................... 164
Cash paid for interest allocated to affiliates, net of tax...................... (39)
Change in corporate debt allocated to affiliates................................ (47)
Net change in notes and advances with Tenneco Inc. ............................. (239)
Cash contributions from (distributions to) affiliates, net...................... 954
Noncash contributions from (distributions to) affiliates, net................... (186)
-------
Balance, December 31, 1995........................................................ 2,243
Net income...................................................................... 117
Cash paid for interest allocated to affiliates, net of tax...................... (24)
Change in corporate debt allocated to affiliates................................ (230)
Net change in notes and advances with Tenneco Inc. ............................. 451
Cash contributions from (distributions to) affiliates, net...................... (392)
Noncash contributions from (distributions to) affiliates, net................... 275
-------
Balance, September 30, 1996 (unaudited)........................................... $ 2,440
=======
</TABLE>
The accompanying notes to combined financial statements are an integral part of
these statements of changes in combined equity.
F-6
<PAGE> 20
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1996 AND 1995 IS UNAUDITED.)
1. MERGER AND DISTRIBUTIONS
On December 12, 1996, Tennessee Gas Pipeline Company ("TGP") became an
indirect subsidiary of El Paso Natural Gas Company ("El Paso"), as a result of a
merger (the "Merger") of Tenneco Inc. (the parent company of TGP and referred to
herein as "Old Tenneco") and an indirect subsidiary of El Paso. Prior to the
Merger, Old Tenneco and its subsidiaries, including TGP, effected various
intercompany transfers and distributions which restructured, divided and
separated their businesses, assets and liabilities so that all the assets,
liabilities and operations related to their automotive parts, packaging and
administrative services businesses (collectively, the "Industrial Business") and
their shipbuilding businesses (the "Shipbuilding Business") were spun-off to Old
Tenneco's then existing common stockholders (the "Distributions"). In connection
with the Distributions, certain assets relating to the Industrial Business and
the Shipbuilding Business were transferred from TGP to New Tenneco Inc. ("New
Tenneco") and Newport News Shipbuilding Inc. ("Newport News"), respectively.
Following the Distributions, the remaining operations of the Company consisted
primarily of those operations related to the transmission and marketing of
natural gas and other existing and discontinued operations of Old Tenneco. Old
Tenneco was renamed El Paso Tennessee Pipeline Co. and New Tenneco was renamed
Tenneco Inc.
As used herein, unless the content otherwise requires, the "Company" refers
to TGP and those businesses and operations owned directly or indirectly by TGP
subsequent to the Distributions and Merger transactions, including certain
businesses which historically were not conducted by subsidiaries of TGP, and
does not include the automotive parts, packaging and shipbuilding businesses
which were conducted by subsidiaries of TGP prior to the Distributions and
Merger transactions.
In preparation for the Merger and Distributions, Old Tenneco initiated a
realignment of its indebtedness. As part of this debt realignment, Old Tenneco
initiated tender offers for certain issues of its consolidated debt and certain
other debt issues were exchanged, defeased or otherwise retired. Upon completion
of the debt realignment transactions, the Company is responsible for the
remaining debt subject to the debt realignment which was not tendered,
exchanged, defeased or otherwise redeemed (approximately $120 million aggregate
principle amount of such debt remained outstanding immediately after the debt
realignment). The Company recognized an after-tax extraordinary charge of
approximately $100 million related to the Company's debt realignment.
Immediately subsequent to the Merger, El Paso Tennessee had approximately
$2.1 billion of borrowings under its $3 billion Revolving Credit and Competitive
Advance Facility Agreement dated as of November 4, 1996. In addition El Paso
Tennessee had approximately $300 million of 8 1/4% Cumulative Preferred Stock,
Series A outstanding and approximately $134 million aggregate principal amount
of Old Tenneco debt subject to the debt realignment which was not redeemed or
retired as part of the debt realignment transactions. Borrowings under the
revolving credit facility are guaranteed by El Paso. The primary assets of El
Paso Tennessee consist of its investment in TGP and management anticipates that
the funds necessary to service the debt and other securities of El Paso
Tennessee will be provided by El Paso or the operations of the Company.
Consequently, the Company may provide funds from operating activities, as well
as proceeds from asset sales or financings, to El Paso Tennessee to fund its
debt and preferred stock servicing requirements.
The consideration paid by El Paso in the Merger was approximately $4
billion, which included El Paso common stock valued at approximately $914
million at December 9, 1996. The acquisition will be accounted for under the
purchase method of accounting which requires the assets and liabilities of the
Company to be adjusted to reflect their estimated fair values at the time of the
acquisition. A final determination of required purchase accounting adjustments,
including the allocation of the purchase price to the assets acquired and
liabilities assumed based on their respective fair values, has not been made. El
Paso will undertake a study to determine the values of such assets and
liabilities and will make necessary purchase accounting adjustments
F-7
<PAGE> 21
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
upon completion of that study. These purchase price adjustments will be
reflected in the consolidated financial statements of the Company subsequent to
the Merger.
Although the separation of the Industrial Business and Shipbuilding
Business prior to the Merger was structured as a "spin-off" of New Tenneco and
Newport News for legal, tax and other reasons, New Tenneco succeeded to certain
important aspects of the Old Tenneco business, organization and affairs, namely:
(i) New Tenneco was renamed "Tenneco Inc." subsequent to the consummation of the
Merger; (ii) New Tenneco is headquartered at Old Tenneco's former headquarters
in Greenwich, Connecticut; (iii) New Tenneco's Board of Directors consists of
those persons previously constituting the Old Tenneco Board of Directors prior
to the Merger; (iv) New Tenneco's executive management consists substantially of
the Old Tenneco executive management prior to the Merger; and (v) the businesses
conducted by New Tenneco consist largely of the Industrial Business, which
represented over half of the assets, revenues and operating income of the
businesses, operations and companies constituting Old Tenneco and its
subsidiaries prior to the Merger and Distributions transactions. Consequently,
the Company has restated its historical consolidated financial statements to
reflect the financial position, results of operations and cash flows of the
energy and other businesses held by the Company after the Distribution and
Merger transactions on a separate and stand alone basis (see the "Basis of
Presentation" discussion in Note 2 below). In Old Tenneco's Quarterly Report on
Form 10-Q for the quarterly period ended September 30, 1996, Old Tenneco stated
that the spin-off of the Shipbuilding Business and its energy business,
including the Company, will be reflected as discontinued operations in New
Tenneco's financial statements subsequent to the Distributions and Merger.
2. CONTROL, BASIS OF PRESENTATION AND DESCRIPTION OF BUSINESS
Control
All of the outstanding common stock of TGP is owned by Old Tenneco.
Subsequent to the Merger, all of the outstanding common stock of Old Tenneco
(renamed El Paso Tennessee Pipeline Co.) is indirectly owned by El Paso.
Basis of Presentation
The accompanying combined financial statements represent the historical
financial position, results of operations and cash flows of those businesses and
operations owned directly or indirectly by TGP subsequent to the Distributions
and Merger transactions (as described above), including certain businesses which
historically were not controlled by subsidiaries of TGP and does not include the
Industrial Business and Shipbuilding Business which were owned by TGP prior to
the Distributions and Merger transactions.
Investments in 20% to 50% owned companies where the Company has the ability
to exert significant influence over operating and financial policies are carried
at cost plus equity in undistributed earnings since date of acquisition.
Reference is made to Note 11, "Investment in Affiliated Companies," for
information concerning significant equity method investees. All significant
transactions and balances among combined businesses have been eliminated.
Description of Business
The Company is engaged primarily in the interstate transportation of
natural gas. The Company is also engaged in related businesses that are not
generally subject to regulation by the Federal Energy Regulatory Commission
("FERC"). The principal activities of these businesses have historically been
the intrastate transportation and marketing of natural gas, the development of
and participation in international natural gas pipelines, primarily in
Australia, the participation in international and domestic gas-fired power
generation projects and the development of natural gas production and production
financing programs, primarily in the
F-8
<PAGE> 22
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
United States. The Company, through a combined financing business held by
Tenneco Credit Corporation (renamed El Paso Energy Credit Corporation, but
referred to herein as "TCC"), has historically been involved in financing, on a
nonrecourse basis, receivables of certain current and former operating divisions
of Old Tenneco.
3. SUMMARY OF ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions in determining the reported amounts of the Company's assets,
liabilities, revenues and expenses. Reference is made to the "Revenue
Recognition" and "Income Taxes" sections of this footnote and Notes 9, 12, 13
and 14 for additional information on significant estimates included in the
Company's combined financial statements.
Unaudited Interim Information
The unaudited interim combined financial statements as of September 30,
1996 and for each of the nine month periods ended September 30, 1996 and 1995,
included herein, have been prepared by management of TGP in accordance with the
Securities and Exchange Commission's rules and regulations for interim financial
reporting. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of the Company's management, the unaudited interim
combined financial statements contain all adjustments (consisting of normal
recurring adjustments) considered necessary for a fair presentation. The interim
financial results may not be indicative of operating results for an entire year.
Notes Receivable and Allowance for Doubtful Accounts and Notes
Short-term notes receivable of $290 million and $296 million were
outstanding at December 31, 1995 and 1994, respectively, of which $216 million
and $284 million, respectively, related to TCC. These notes receivable are
presented net of unearned finance charges of $26 million and $43 million at
December 31, 1995 and 1994, respectively, which related to TCC. At December 31,
1995 and 1994, unearned finance charges related to long-term notes and other
receivables were $23 million and $66 million, respectively, which related to
TCC.
At December 31, 1995 and 1994, the allowance for doubtful accounts and
notes receivable was $49 million and $21 million, respectively.
Inventory
Inventories, consisting of materials and supplies, are valued at the lower
of average cost or market.
Property, Plant and Equipment, at Cost
The majority of the Company's property, plant and equipment consists of its
investment in interstate and intrastate pipeline systems. At December 31, 1995
and 1994, $223 million and $160 million, respectively, of the Company's
property, plant and equipment balance is construction work in progress.
Additionally, the Company has recorded capitalized interest and an allowance for
equity funds used during construction for its FERC-regulated operations in the
cost of property, plant and equipment. Pursuant to a FERC order, TGP has
recorded its natural gas in storage held for operating purposes as a fixed
asset. As of December 31, 1995 and 1994, the balance of TGP's natural gas in
storage included in property, plant and equipment was $96 million.
F-9
<PAGE> 23
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Depreciation, Depletion and Amortization
Depreciation of the Company's regulated transmission plants are provided
using the composite method over the estimated useful lives of the depreciable
facilities. The rates for depreciation range from 2% to 5%. Costs of properties
that are not operating units, as defined by the FERC, which are retired, sold or
abandoned by the regulated businesses are credited or charged, net of salvage,
to accumulated depreciation. Gains or losses on sales of operating units are
credited or charged to income.
Depreciation of the Company's nonregulated properties is provided using the
straight line or composite method which, in the opinion of management, is
adequate to allocate the cost of properties over their estimated useful lives.
Goodwill
Goodwill is being amortized over a 15-year period using the straight-line
method. Such amortization amounted to $1.8 million for 1995, 1994 and 1993 and
is included in "Other income, net" in the accompanying combined statements of
income. Accumulated amortization of goodwill was $5.4 million and $3.6 million
at December 31, 1995 and 1994, respectively.
Environmental Liabilities
Expenditures for ongoing compliance with environmental regulations that
relate to current operations are expensed or capitalized as appropriate.
Expenditures that relate to an existing condition caused by past operations, and
which do not contribute to current or future revenue generation, are expensed.
Liabilities are recorded when environmental assessments indicate that remedial
efforts are probable and the costs can be reasonably estimated. Estimates of the
liability are based upon 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. All available
evidence is considered including prior experience in remediation of contaminated
sites, other companies, clean-up experience and data released by the United
States Environmental Protection Agency ("EPA") or other organizations. These
estimated liabilities are subject to revision in future periods based on actual
costs or new circumstances. These liabilities are included in the combined
balance sheets at their undiscounted amounts. Recoveries are evaluated
separately from the liability and, when recovery is assured, are recorded and
reported separately from the associated liability in the combined financial
statements. Reference is made to Note 14, "Commitments and
Contingencies -- Environmental Matters" for further information on this subject.
Revenue Recognition
The regulated businesses of the Company are subject to FERC regulations
and, accordingly, revenues are collected subject to possible refunds pending
final FERC orders. The regulated subsidiaries record rate refund accruals based
on management's estimate of the expected income impact of the rate proceedings.
The Company has recorded revenue reservations of $27 million and $190 million as
of December 31, 1995 and 1994, respectively. The Company believes the estimate
for revenues subject to refund is adequate.
Other Income
Gains or losses on the sale by a subsidiary of TGP of its stock are
included in "Other Income, net" in the accompanying combined statements of
income.
Income Taxes
The Company utilizes the liability method of accounting for income taxes
whereby it recognizes deferred tax assets and liabilities for the future tax
consequences of temporary differences between the tax basis of
F-10
<PAGE> 24
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
assets and liabilities and their reported amounts in the combined financial
statements. Deferred tax assets are reduced by a valuation allowance when, based
upon management's estimates, it is more likely than not that a portion of the
deferred tax assets will not be realized in a future period. The estimates
utilized in the recognition of deferred tax assets are subject to revision in
future periods based on new facts or circumstances.
Old Tenneco, together with certain of its subsidiaries which are owned 80%
or more (including the Company), have entered into an agreement to file a
consolidated U.S. federal income tax return. Such agreement provides, among
other things, that (i) each company in a taxable income position will be
currently charged with an amount equivalent to its federal income tax computed
on a separate return basis, and (ii) each company in a tax loss position will be
reimbursed currently to the extent its deductions, including general business
credits, are utilized in the consolidated return. The income tax amounts
reflected in the combined financial statements of the Company under the
provisions of the tax sharing arrangement are not materially different from the
income taxes which would have been provided had the Company filed a separate tax
return. Under the tax sharing agreement, Old Tenneco pays all federal taxes
directly and bills or refunds, as applicable, its subsidiaries, including those
comprising the Company, for the applicable portion of the total tax payments.
Changes in Accounting Principles
In June 1996, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("FAS") No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," which
establishes new accounting and reporting standards for transfers and servicing
of financial assets and extinguishments of liabilities. The statement is
effective for transactions occurring after December 31, 1996. The new standard
is not expected to have a material impact on the combined financial position or
results of operations of the Company.
Effective January 1, 1996, the Company adopted FAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of". FAS No. 121 establishes new accounting standards for measuring the
impairment of long-lived assets. The adoption of this new standard had no
material impact on the Company's combined financial position or results of
operations.
Effective January 1, 1994, the Company adopted FAS No. 112, "Employers'
Accounting for Postemployment Benefits." This new accounting rule requires
employers to account for postemployment benefits for former or inactive
employees, after employment but before retirement, on the accrual basis rather
than the "pay-as-you-go" basis. The adoption of this new standard had no
material impact on the Company's combined financial position or results of
operations.
Risk Management Activities
The Company is currently a party to financial instruments and commodity
contracts to hedge its exposure to changes in interest rates and natural gas
prices. These financial instruments and commodity contracts are accounted for on
the accrual basis with gains and losses being recognized based on the type of
contract and exposure being hedged. The amounts paid or received under interest
rate swap agreements are recognized, on the accrual basis, as an adjustment to
interest expense. Net gains and losses on energy commodity contracts and
financial instruments are deferred and recognized when the hedged transaction is
consummated. In the combined statements of cash flows, cash receipts or payments
related to these financial instruments and commodity contracts are classified
consistent with the cash flows from the transactions being hedged.
4. ACQUISITIONS
During 1995, the Company acquired the natural gas pipeline assets of the
Pipeline Authority of South Australia, which includes a 488-mile pipeline, for
approximately $225 million. Also during 1995, the Company
F-11
<PAGE> 25
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
acquired a 50% interest in two gas-fired cogeneration plants from ARK Energy, a
privately-owned power generation company, for approximately $65 million. Each of
the acquisitions was accounted for as a purchase. If these assets and
investments had been acquired January 1, 1995, net income would not have been
significantly different from the reported amount.
5. DISPOSITION OF ASSETS AND EXTRAORDINARY LOSS
Disposition of Assets
During the first nine months of 1996, the Company sold its 13.2% interest
in Iroquois Gas Transmission System, L.P., its 50% interest in Dauphin Island
Gathering System and certain other assets, resulting in a pre-tax gain of $5
million.
In December 1995, the Company sold its 50% interest in Kern River Gas
Transmission Company ("Kern River") for a pre-tax gain of $30 million. Kern
River owns a 904-mile pipeline extending from Wyoming to California. Also in
1995, the Company sold certain other facilities and assets for a combined pretax
loss of $19 million.
In 1994, Tenneco Energy Resources Corporation, a TGP subsidiary which
operated the Company's nonregulated gas marketing and intrastate pipeline
businesses, issued 50 shares of its common stock, diluting Old Tenneco's
ownership in this subsidiary to 80% and resulting in a gain of $23 million. No
taxes were provided on the gain because management expects that the recorded
investment will be recovered in a tax-free manner.
During 1993, the Company disposed of two wholly-owned companies, Viking Gas
Transmission Company and Dean Pipeline Company, and certain other assets for a
total pre-tax gain of $62 million.
Extraordinary Loss
In April 1993, Old Tenneco issued 23.5 million shares of its common stock
for approximately $1.1 billion, a portion of which was funded to the Company and
used to retire $688 million of long-term TGP debt. In November 1993, TGP retired
DM250 million bonds. The Company recorded the redemption premium related to the
retirement of its long-term debt resulting from these two transactions ($25
million, net of income tax benefits of $13 million) as an extraordinary loss.
6. TRANSACTIONS WITH AFFILIATES
Combined Equity
The "Combined equity" caption in the accompanying combined financial
statements represents Old Tenneco's cumulative investment in the combined
businesses of the Company and is reflected net of demand notes and advances from
the Company to Old Tenneco. The Company has historically utilized the demand
notes and advances for cash funding requirements between the Company and Old
Tenneco. The Company had a net balance of demand notes and advances receivable
from Old Tenneco of $3,493 million and $3,254 million at December 31, 1995 and
1994, respectively, and $3,042 million at September 30, 1996. In addition, the
majority of the demand notes between the Company and Tenneco were
interest-bearing. The demand notes and advances held by Old Tenneco are expected
to be transferred to TGP as part of the corporate restructuring transactions
preceding the Distributions and Merger. The changes in the demand notes and
advances balance due to cash funding between the Company and Old Tenneco and
interest accruals have been reflected as changes in Combined equity in the
accompanying combined financial statements. Changes in the "Combined equity"
caption also include the net income of the Company, cash paid for interest
allocated to affiliates, net of tax, changes in corporate debt allocated to
affiliates and net cash and noncash contributions from (distributions to)
affiliates. Reference is made to the Statements of Changes in Combined Equity
for an
F-12
<PAGE> 26
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
analysis of activity in the "Combined equity" caption for each of the three
years ended December 31, 1995 and for the nine months ended September 30, 1996.
General and Administrative Expenses
Included in the total general and administrative expenses for 1995, 1994
and 1993, is $16 million, $13 million, and $17 million, respectively, which
represents the Company's share of Old Tenneco's corporate general and
administrative costs for legal, financial, communication and other
administrative services. Old Tenneco's corporate general and administrative
expenses are allocated based on the estimated level of effort devoted to Old
Tenneco's various operations and relative size based on revenues, gross property
and payroll. The Company's management believes the method for allocating
corporate general and administrative expenses is reasonable. Total general and
administrative expenses reflected in the accompanying combined statements of
income are reasonable when compared with the total general and administrative
costs the Company would have incurred on a stand-alone basis.
Corporate Debt and Interest Allocations
TGP's historical practice has been to incur indebtedness for its
consolidated group at the parent company level or at a limited number of
subsidiaries, rather than at the operating company level, and to centrally
manage various cash functions. Consequently, corporate debt of TGP and its
related interest expense have been allocated to TGP's former automotive,
packaging, and shipbuilding businesses ("TGP's former non-energy operations")
based upon the portion of TGP's investment in TGP's former non-energy operations
that is deemed to be debt, generally based upon the ratio of TGP's former
non-energy operations' net assets to TGP's consolidated net assets plus debt.
Interest expense was allocated at a rate equivalent to the weighted-average cost
of all TGP corporate debt, which was 11.4%, 11.0% and 10.1% for 1995, 1994 and
1993, respectively. Total pre-tax interest expense allocated to TGP's former
non-energy operations in 1995, 1994 and 1993 was $60 million, $61 million and
$90 million, respectively. TGP's former non-energy operations have also been
allocated tax benefits approximating 35% of the allocated pre-tax interest
expense. Although interest expense, and the related tax effects, have been
allocated to TGP's former non-energy operations for financial reporting on a
historical basis, TGP's former non-energy operations have not been billed for
these amounts. The changes in allocated corporate debt and the after-tax
allocated interest expense have been included as a component of the Company's
combined equity. Although management believes that the historical allocation of
corporate debt and interest expense is reasonable, it may not necessarily be
indicative of the Company's debt upon completion of the debt realignment or the
debt it may incur in the future.
Notes and Advances Receivable or Payable with Affiliates
"Cash contributions from (distributions to) affiliates" in the Statements
of Changes in Combined Equity consist of net cash changes in notes and advances
receivable or payable between the Company and New Tenneco and Newport News which
have been included in combined equity. Historically, TGP has utilized notes and
advances to centrally manage cash funding requirements for its consolidated
group.
At December 31, 1995 and 1994, the Company had a non-interest bearing note
payable to Newport News totalling $965 million and $991 million, respectively,
which is due on demand and is included as a component of the Company's combined
equity.
Accounts Receivable and Accounts Payable -- Affiliated Companies
The "Payables -- Affiliated companies" balance primarily includes billings
for general and administrative costs and benefits costs incurred by Old Tenneco
and charged to the Company. The "Receivables -- Affiliated Companies" balance
primarily relates to billings for income taxes between the Company and Old
Tenneco. Affiliated accounts receivable and accounts payable between the Company
and Old Tenneco will be settled, capitalized or converted into ordinary trade
accounts, as applicable, as part of the Distributions.
F-13
<PAGE> 27
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Employee Benefits
Certain employees of the Company participate in Old Tenneco's employee
stock ownership and employee stock purchase plans. The Old Tenneco employee
stock ownership plan provides for the grant of Old Tenneco common stock options
and other stock awards at a price not greater than market value at the date of
grant. The Old Tenneco employee stock purchase plan allows employees to purchase
Old Tenneco common stock at a 15% discount subject to certain thresholds. In
connection with the Distributions, outstanding options on Old Tenneco common
stock held by the Company's employees will be vested so that they become fully
exercisable prior to the Merger. If not exercised prior to the Merger, such
options will be cancelled upon consummation of the Merger.
Employees of the Company also participate in certain Old Tenneco
postretirement and pension plans. Reference is made to Notes 12 and 13 for a
further discussion of the plans.
Sales of Receivables
TCC purchased $513 million and $384 million of trade receivables from Old
Tenneco's automotive and packaging companies at December 31, 1995 and 1994,
respectively. TCC sells these trade receivables to a third party in the ordinary
course of business.
7. LONG-TERM DEBT, SHORT-TERM DEBT AND FINANCING ARRANGEMENTS
Long-Term Debt
A summary of long-term debt obligations of the Company at December 31, 1995
and 1994, is set forth in the following table:
<TABLE>
<CAPTION>
1995 1994
------ ------
(MILLIONS)
<S> <C> <C>
Tennessee Gas Pipeline Company --
Debentures due 2011, effective interest rate 15.1% in 1995 and
1994 (net of $216 million in 1995 and $219 million in 1994 of
unamortized discount)......................................... $ 184 $ 181
Notes due 1996 through 1997, average effective interest rate 9.7%
in 1995 and 10.1% in 1994 (net of $5 million in 1995 and $8
million in 1994 of unamortized discount)...................... 573 808
Tenneco Credit Corporation --
Senior notes due 1996 through 2001, average effective interest
rate 9.7% in 1995 and 9.6% in 1994 (net of $1 million in 1995
and $2 million in 1994 of unamortized discount)............... 549 749
Medium-term notes due 1996 through 2002, average interest rate
9.0% in 1995 and 9.4% in 1994................................. 38 73
Subordinated notes due 1998 through 2001, average interest rate
9.9% in 1995 and 1994......................................... 92 92
Other subsidiaries --
Notes due 1996 through 2014, average effective interest rate 8.6%
in 1995 and 8.0% in 1994 (net of $14 million in 1995 and $15
million in 1994 of unamortized discount)...................... 8 4
------ ------
1,444 1,907
Less -- Current maturities......................................... 406 477
------ ------
Total long-term debt..................................... $1,038 $1,430
====== ======
</TABLE>
F-14
<PAGE> 28
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The aggregate maturities and sinking fund requirements applicable to the
issues outstanding at December 31, 1995, are $406 million, $498 million and $69
million for 1996, 1997 and 1998, respectively, and none for 1999 and 2000.
Long-Term Corporate Debt Allocation
<TABLE>
<CAPTION>
1995 1994
------ ------
(MILLIONS)
<S> <C> <C>
Total long-term debt............................................... $1,038 $1,430
Less: Long-term corporate debt allocated to TGP's former non-energy
operations....................................................... (336) (414)
------ ------
Total long-term corporate debt, net of allocation to
TGP's former non-energy operations..................... $ 702 $1,016
====== ======
</TABLE>
- ---------------
Note: Reference is made to Note 6 for information concerning the method of
allocating corporate debt to TGP's former non-energy operations.
Short-Term Debt
The Company uses lines of credit and overnight borrowings to finance its
short-term capital requirements. Information regarding short-term debt for the
years ended December 31, 1995 and 1994 follows:
<TABLE>
<CAPTION>
1995 1994
---- ----
(MILLIONS)
<S> <C> <C>
Outstanding borrowings at end of year................................. $ 35 $ 18
Weighted average interest rate on outstanding borrowings at end of
year................................................................ 8.5% 10.7%
Approximate maximum month-end outstanding borrowings during year...... $130 $ 18
Approximate average month-end outstanding borrowings during year...... $ 34 $ 8
</TABLE>
- ---------------
Note: Includes borrowings under both committed credit facilities and uncommitted
lines of credit and similar arrangements.
Short-Term Corporate Debt Allocation
<TABLE>
<CAPTION>
1995 1994
----- -----
<S> <C> <C>
Current maturities on long-term debt................................ $ 406 $ 477
Credit agreements................................................... 35 18
----- -----
Total short-term debt (including current maturities on
long-term debt)............................................... 441 495
Less: Short-term corporate debt allocated to TGP's former
non-energy
operations................................................... (166) (135)
----- -----
Total short-term debt, net of allocation to TGP's former
non-energy operations................................... $ 275 $ 360
===== =====
</TABLE>
- ---------------
Note: Reference is made to Note 6 for information concerning the method of
allocating corporate debt to TGP's former non-energy operations.
F-15
<PAGE> 29
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Financing Arrangements
As of December 31, 1995, the Company had arranged committed credit
facilities of approximately $479 million:
<TABLE>
<CAPTION>
TERM COMMITMENTS UTILIZED AVAILABLE
-------- ----------- -------- ---------
(MILLIONS)
<S> <C> <C> <C> <C>
Committed credit agreements(a)............... various $ 479(b) $ 35 $ 444
</TABLE>
- ---------------
Notes: (a) These facilities generally require the payment of commitment fees on
the unused portion of the total commitment and facility fees on the
total commitment.
(b) Of the total committed credit facilities, $400 million are only
available to TCC.
8. FINANCIAL INSTRUMENTS
The carrying and estimated fair values of the Company's financial
instruments by class at December 31, 1995 and 1994, were as follows:
<TABLE>
<CAPTION>
1995 1994
------------------ ------------------
CARRYING FAIR CARRYING FAIR
ASSETS (LIABILITIES) AMOUNT VALUE AMOUNT VALUE
-------------------------------------------------------- ------- ------- ------- -------
(MILLIONS)
<S> <C> <C> <C> <C>
Asset and Liability Instruments
Cash and temporary cash investments................... $ 305 $ 305 $ 109 $ 109
Receivables (customer and long-term).................. 832 832 1,630 1,630
Accounts payable (trade).............................. (353) (353) (293) (293)
Short-term debt (excluding current maturities)........ (35) (35) (18) (18)
Long-term debt (including current maturities)......... (1,444) (1,727) (1,907) (2,076)
Instruments With Off-Balance-Sheet Risk
Derivative
Interest rate swaps:
In a net payable position........................ -- (18) -- (10)
Natural gas swaps, futures and options.............. -- 3 -- (5)
Non-derivative financial guarantees................... -- (14) -- (14)
</TABLE>
- ---------------
Note: The carrying amounts and estimated fair values of short-term debt and
long-term debt are before allocation of corporate debt to TGP's former
non-energy operations. Reference is made to Note 6 for information
concerning the method of allocating corporate debt to TGP's former
non-energy operations.
Asset and Liability Instruments
The fair value of cash and temporary cash investments, receivables,
accounts payable, and short-term debt in the above table was considered to be
the same as or was determined not to be materially different from the carrying
amount. At December 31, 1995 and 1994, respectively, the Company's aggregate
customer and long-term receivable balance was concentrated by industry as
follows: energy industry 23% and 22%; automotive parts industry 9% and 11%;
packaging industry 8% and 13%; and farm and construction equipment industry 55%
and 47%; all other amounts were not significant. Receivables in the automotive
parts, packaging and farm and construction equipment industries result from
TCC's financing receivables of current and former operating divisions of Old
Tenneco. TCC sells these trade receivables to a third party in the ordinary
course of business.
F-16
<PAGE> 30
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Long-term debt -- The fair value of fixed-rate long-term debt was based on
the market value of debt with similar maturities and interest rates; the
carrying amount of floating-rate debt was assumed to approximate its fair value.
Instruments With Off-Balance-Sheet Risk
Derivative
Interest Rate Swaps -- The fair value of interest rate swaps was based on
the cost that would have been incurred to buy out those swaps in a loss position
and the consideration that would have been received to terminate those swaps in
a gain position. At both December 31, 1995 and 1994, the Company was a party to
swaps with a notional value of $750 million. At December 31, 1995 and 1994, the
entire $750 million was in a net payable position. Notional amounts associated
with these swaps do not represent future cash payment requirements. These
contractual amounts are only used as a base to measure amounts to be exchanged
at specified settlement dates.
Consistent with its overall policy, the Company uses these instruments from
time to time only to hedge known, quantifiable risks arising from fluctuations
in interest rates. The counterparties to these interest rate swaps are major
international financial institutions. The risk associated with counterparty
default on interest rate swaps is measured as the cost of replacing, at the
prevailing market rates, those contracts in a gain position. In the event of
non-performance by the counterparties, the cost to replace outstanding interest
rate swaps at December 31, 1995 and 1994, would not have been material.
Price Risk Management -- The Company uses exchange-traded futures and
option contracts and over-the-counter option and swap contracts to reduce its
exposure to fluctuations in the prices of natural gas. The fair value of these
contracts is based upon the estimated consideration that would be received to
terminate those contracts in a gain position and the estimated cost that would
be incurred to terminate those contracts in a loss position. As of December 31,
1995 and 1994, these contracts, maturing through 1997 and 1996, respectively,
had an absolute notional contract quantity of 321 Bcf and 187 Bcf, respectively.
Since the contracts described above are designated as hedges whose fair values
correlate to price movements of natural gas, any gains or losses on the
contracts resulting from market changes will be offset by losses or gains on the
hedged transactions. The Company has off-balance sheet risk of credit loss in
the event of non-performance by counterparties to all over-the-counter
contracts. However, the Company does not anticipate non-performance by the
counterparties.
Non-derivative
Guarantees -- At December 31, 1995 and 1994, the Company had guaranteed
payment and performance of approximately $14 million, primarily with respect to
letters of credit and other guarantees supporting various financing and
operating activities.
9. FEDERAL ENERGY REGULATORY COMMISSION REGULATORY MATTERS
Restructuring Proceedings
On April 8, 1992, the FERC issued Order 636 which restructured the natural
gas industry by requiring mandatory unbundling of pipeline sales and
transportation services. Numerous parties appealed, to the U.S. Court of Appeals
for the D.C. Circuit Court, challenging the legality of Order 636 generally, as
well as the legality of specific provisions of Order 636. On July 16, 1996, the
Court issued its decision upholding, in large part, Order 636 and remanded to
the FERC several issues for further explanation, including further explanation
of the FERC's decision to allow pipelines to recover 100% of their gas supply
realignment ("GSR") costs.
F-17
<PAGE> 31
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
TGP implemented revisions to its tariff, effective on September 1, 1993,
which restructured its transportation, storage and sales services to convert TGP
from primarily a merchant to primarily a transporter of gas as required by Order
636. As a result of this restructuring, TGP's gas sales declined while certain
obligations to producers under long-term gas supply contracts continued, causing
TGP to incur significant restructuring transition costs. Pursuant to the
provisions of Order 636 allowing for the recovery of transition costs related to
the restructuring, TGP has made filings to recover GSR costs resulting from
remaining gas purchase obligations, costs related to its Bastian Bay facilities,
the remaining unrecovered balance of purchased gas ("PGA") costs and the
"stranded" cost of TGP's continuing contractual obligation to pay for capacity
on other pipeline systems ("TBO costs").
TGP's filings to recover costs related to its Bastian Bay facilities have
been rejected by the FERC based on the continued use of the gas production from
the field; however, the FERC recognized the ability of TGP to file for the
recovery of losses upon disposition of these assets. TGP has filed for appellate
review of the FERC actions and is confident that the Bastian Bay costs will
ultimately be recovered as transition costs under Order 636; the FERC has not
contested the ultimate recoverability of these costs.
The filings implementing TGP's recovery mechanisms for the following
transition costs were accepted by the FERC effective September 1, 1993; recovery
was made subject to refund pending FERC review and approval for eligibility and
prudence: 1) direct-billing of unrecovered PGA costs to its former sales
customers over a twelve-month period; 2) recovery of TBO costs, which TGP is
obligated to pay under existing contracts, through a surcharge from firm
transportation customers, adjusted annually; and 3) recovery of 90% of GSR costs
over a period of up to 36 months from firm transportation customers and recovery
of 10% of such costs from interruptible transportation customers over a period
of up to 60 months.
Following negotiations with its customers, TGP filed in July 1994 with the
FERC a Stipulation and Agreement (the "PGA Stipulation"), which provides for the
recovery of PGA costs of approximately $100 million and the recovery of costs
associated with the transfer of storage gas inventory to new storage customers
in TGP's restructuring proceeding. The PGA Stipulation eliminates all challenges
to the PGA costs, but establishes a cap on the charges that may be imposed upon
former sales customers. On November 15, 1994, the FERC issued an order approving
the PGA Stipulation and resolving all outstanding issues. On April 5, 1995, the
FERC issued its order on rehearing affirming its initial approval of the PGA
Stipulation. TGP implemented the terms of the PGA Stipulation and made refunds
in May 1995. The refunds had no material effect on the Company's reported net
income. The orders approving the PGA Stipulation have been appealed to the D.C.
Circuit Court of Appeals by certain customers. TGP believes the FERC orders
approving the PGA Stipulation will be upheld on appeal.
TGP is recovering through a surcharge, subject to refund, TBO costs
formerly incurred to perform its sales function. The FERC subsequently issued an
order requiring TGP to refund certain costs from this surcharge and refunds were
made in May 1996. TGP is appealing this decision and believes such appeal will
likely be successful.
In order to resolve litigation concerning purchases made by TGP of
synthetic gas produced from the Great Plains coal gasification plant ("Great
Plains"), TGP, along with three other pipelines, executed four separate
settlement agreements with Dakota Gasification Company ("Dakota") and the U.S.
Department of Energy and initiated four separate proceedings at the FERC seeking
approval to implement the settlement agreements. The FERC previously ruled that
the costs related to the Great Plains project are eligible for recovery through
GSR and other special recovery mechanisms and that the costs are eligible for
recovery for the duration of the term of the original gas purchase agreements.
On October 18, 1994, the FERC consolidated the four proceedings and set them for
hearing before an administrative law judge ("ALJ"). The hearing, which concluded
in July 1995, was limited to the issue of whether the settlement agreements are
prudent. The ALJ concluded, in his initial decision issued in December 1995,
that the settlement was imprudent. TGP has filed exceptions to this initial
decision. The Company believes that this decision will not
F-18
<PAGE> 32
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
impair TGP's recovery of the costs resulting from this contract. Oral arguments
were held before the full FERC on September 25, 1996. A decision by the FERC is
expected by the end of the year.
Also related to TGP's GSR costs, on October 14, 1993, TGP was sued in the
State District Court of Ector County, Texas, by ICA Energy, Inc. ("ICA") and
TransTexas Gas Corporation ("TransTexas"). In that suit, ICA and TransTexas
contended that TGP had an obligation to purchase gas production which TransTexas
unilaterally attempted to add to the reserves originally dedicated to a 1979 gas
contract. An amendment to the pleading sought $1.5 billion from TGP for alleged
damages caused by TGP's refusal to purchase gas produced from the TransTexas
leases covering the new production and lands. In June 1996, TGP reached a
settlement with ICA and TransTexas for $125 million wherein ICA and TransTexas
agreed to terminate their contract rights, released TGP from liability under the
contract, and indemnified TGP against future claims, including royalty owner
claims. TGP has filed with the FERC to recover from its customers the amount
paid to ICA and TransTexas. In July 1996, certain royalty interest owners filed
a claim against TGP alleging that they are sellers entitled to tender gas to TGP
under the settled contract. This claim fell under the indemnification provisions
of TGP's settlement with ICA and TransTexas, requiring ICA and TransTexas to
defend and indemnify TGP.
TGP has been engaged in other settlement and contract reformation
discussions with other holders of certain gas purchase contracts who have sued
TGP. One of the matters involved a dispute between TGP, as purchaser, under a
contract with Lenape Resources Corp., the Coastal Corp., and Tesoro. On August
1, 1995, the Texas Supreme Court affirmed a ruling of the Texas Court of Appeals
favorable to TGP in one of these matters and indicated that it would remand the
case to the trial court. On April 18, 1996, however, the Texas Supreme Court
withdrew its initial opinion and issued an opinion reversing the Court of
Appeals opinion. That Texas Supreme Court ruling, however, explicitly preserves
TGP's defenses based on bad faith conduct of the producers. In June 1996, TGP
filed a motion for rehearing with the Texas Supreme Court which was denied on
August 16, 1996. Nothing in the Texas Supreme Court's decision affects TGP's
ability to seek recovery from its customers of its above-market costs of
purchasing gas under the contract as GSR costs in the phased proceedings
currently pending before the FERC. In addition, TGP has initiated two lawsuits
against the holders of this gas purchase contract seeking damages related to
their conduct in connection with that contract.
During the course of this action, TGP had either paid, or provided for the
payment of, amounts it believes were appropriate to cover the resolution of its
contract reformation litigation, including providing a bond in the amount of
$206 million. On September 30, 1996, TGP paid approximately $193 million to the
producers and the producers agreed to release all but approximately $2 million
of the bonded amount. On November 1, 1996, a final order was issued which
assessed only $456,000 of the $2 million to TGP and TGP will request release
from this remaining bond amount. On October 1, 1996, TGP filed to recover from
its customers the $193 million paid in relation to this matter. It is
anticipated that TGP will also continue to pay the above-market contract price
for the gas tendered by the producers through the expiration of the contract in
1999, and will seek recovery of those amounts from its customers in the FERC
proceedings as well. TGP plans to amend its complaint in one of the separate
lawsuits pending against the producers to seek recovery of amounts TGP believes
it is entitled to recover as a result of the producers' bad faith conduct.
As of September 30, 1996, TGP has deferred GSR costs yet to be recovered
from its customers of approximately $527 million, net of $414 million previously
recovered from its customers, subject to refund. A phased proceeding is underway
at the FERC with respect to the recovery of TGP's GSR costs. Testimony has been
completed in connection with Phase I of that proceeding relating to the
eligibility of GSR cost recovery; oral argument on eligibility issues was
originally set by a FERC ALJ for late October 1996. The Chief Judge of the FERC
has since issued orders (i) canceling the October oral argument, (ii) convening
settlement discussions which commenced on October 9, 1996, and (iii) postponing
scheduling oral argument on eligibility issues.
F-19
<PAGE> 33
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Phase II of the proceeding on the prudency of the costs to be recovered and
on certain contract specific eligibility issues has not yet been scheduled, but
will likely occur sometime after the ALJ's decision in Phase I is issued. The
FERC has generally encouraged pipelines to settle such issues through
negotiations with customers. Although the Order 636 transition cost recovery
mechanism provides for complete recovery by pipelines of eligible and prudently
incurred transition costs, certain customers have challenged the prudence and
eligibility of TGP's GSR costs and TGP has engaged in settlement discussions
with its customers concerning the amount of such costs in response to the FERC
statements acknowledging the desirability of such settlements.
On October 23, 1996, in anticipation of consummation of the Merger, El Paso
reached a preliminary understanding with certain of TGP's customers (the "El
Paso Preliminary GSR Understanding"). Under the El Paso Preliminary GSR
Understanding, El Paso will settle the customers' challenges to TGP's GSR and
other transition costs, effective January 1, 1997. It is unlikely that the El
Paso Preliminary GSR Understanding will be finalized and filed with the FERC
prior to January 31, 1997. Assuming the El Paso Preliminary GSR Understanding is
finalized and filed with the FERC, non-consenting customers will have the
opportunity to object to the proposed settlement, which may have to be modified
if any such objection is successful.
Given the uncertainty over whether the FERC will approve the proposed GSR
cost recovery settlement in the form ultimately presented to it and the
uncertainty related to predicting the outcome of its gas purchase contract
reformation efforts and the associated litigation, TGP is unable to predict the
timing or the ultimate impact that the resolution of these issues will have on
its consolidated financial position or results of operations.
Rate Proceedings
On December 30, 1994, TGP filed for a general rate increase (the "1995 Rate
Case"). On January 25, 1995, the FERC accepted the filing, suspended its
effectiveness for the maximum period of five months pursuant to normal
regulatory process, and set the matter for hearing. On July 1, 1995, TGP began
collecting rates, subject to refund, reflecting an $87 million increase in TGP's
annual revenue requirement. A Stipulation and Agreement was filed with an ALJ in
this proceeding on April 5, 1996. This Stipulation proposed to resolve the rates
subject to the 1995 Rate Case, including structural rate design changes and
increased revenue requirements. On October 30, 1996, the FERC approved the
Stipulation for the settlement of the 1995 Rate Case, with certain modifications
and clarifications which are not material and which should not cause changes
which are adverse to TGP. TGP has reserved revenues it believes adequate to
cover the income impact of any refunds that may be required.
F-20
<PAGE> 34
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
10. INCOME TAXES
Following is a comparative analysis of the components of combined income
tax expense for the years 1995, 1994 and 1993:
<TABLE>
<CAPTION>
1995 1994 1993
---- ---- ----
(MILLIONS)
<S> <C> <C> <C>
Current --
U.S......................................................... $(13) $ 59 $ 5
State and local............................................. (3) (4) 22
----- ----- -----
(16) 55 27
----- ----- -----
Deferred --
U.S......................................................... 35 22 60
State and local............................................. 12 12 13
----- ----- -----
47 34 73
----- ----- -----
Income tax expense............................................ $ 31 $ 89 $100
===== ===== =====
</TABLE>
Following is a reconciliation of income taxes computed at the statutory
U.S. federal income tax rate (35% for all years presented) to the income tax
expense reflected in the combined statements of income for the years 1995, 1994
and 1993:
<TABLE>
<CAPTION>
1995 1994 1993
---- ---- ----
(MILLIONS)
<S> <C> <C> <C>
Tax expense computed at the statutory U.S. federal income tax
rate........................................................ $ 68 $ 95 $ 92
Increases (reductions) in income tax expense resulting from:
State and local taxes on income, net of U.S. federal income
tax benefit.............................................. 6 5 21
U.S. federal income tax rate change......................... -- -- 4
Permanent differences on sales of assets.................... 12 (7) (15)
Realization of unrecognized deferred tax assets............. (49) -- --
Other....................................................... (6) (4) (2)
---- ---- ----
Income tax expense............................................ $ 31 $ 89 $100
==== ==== ====
</TABLE>
Current U.S. income tax expense for the years ended December 31, 1995, 1994 and
1993, includes a reduction in tax benefits of $21 million, $22 million and $32
million, respectively, related to the allocation of corporate interest expense
to TGP's former non-energy operations. Reference is made to Note 6 for
information concerning the method of allocating corporate debt to TGP's former
non-energy operations.
F-21
<PAGE> 35
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The components of the Company's net deferred tax liability at December 31,
1995 and 1994, were as follows:
<TABLE>
<CAPTION>
1995 1994
----- ------
(MILLIONS)
<S> <C> <C>
Deferred tax assets --
U.S. capital loss carryforwards.................................. $ 88 $ 88
Postretirement benefits other than pensions...................... 104 107
GSR reserve...................................................... 141 --
Environmental reserve............................................ 75 81
Other............................................................ 76 119
Valuation allowance.............................................. (65) (114)
----- ------
Net deferred tax asset........................................... 419 281
----- ------
Deferred tax liabilities --
Tax over book depreciation....................................... 440 437
Asset related to GSR costs of operations regulated by the FERC... 141 --
Other regulatory assets.......................................... 67 56
Debt related items............................................... 43 44
Book versus tax gains and losses on asset disposals.............. 34 332
Other............................................................ 36 123
----- ------
Total deferred tax liability..................................... 761 992
----- ------
Net deferred tax liability............................... $ 342 $ 711
===== ======
</TABLE>
As reflected by the valuation allowance in the table above, the Company had
potential tax benefits of $65 million and $173 million at December 31, 1995 and
1994, respectively, which were not recognized in the combined statements of
income when generated. These benefits resulted primarily from U.S. capital loss
carryforwards which are available to reduce future capital gains. During 1995,
the Company reduced its deferred tax asset valuation allowance due to the
recognition of U.S. capital loss carryforwards utilized to offset income taxes
payable on asset dispositions. During 1996, these capital loss carryforwards
were utilized to offset taxes on capital gain transactions.
11. INVESTMENT IN AFFILIATED COMPANIES
The Company holds investments in various affiliates which are accounted for
on the equity method of accounting. The principal equity method investments were
the Company's 50% investment in Kern River, and joint venture interests in power
generation plants, interstate pipelines, gathering systems and natural gas
storage facilities.
At December 31, 1995 and 1994, the Company's combined equity included
equity in undistributed earnings from equity method investments of $25 million
and $69 million, respectively. Dividends and distributions received from
affiliates accounted for on the equity method were $53 million, $48 million and
$42 million during 1995, 1994 and 1993, respectively.
F-22
<PAGE> 36
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Summarized financial information of the Company's proportionate share of
50% or less owned companies accounted for by the equity method of accounting as
of December 31, 1995, 1994 and 1993, and for the years then ended is as follows:
<TABLE>
<CAPTION>
1995 1994 1993
---- ---- ----
(MILLIONS)
<S> <C> <C> <C>
Current assets................................................ $ 60 $ 47 $ 41
Non-current assets............................................ 543 901 829
Short-term debt............................................... 122 19 17
Other current liabilities..................................... 24 61 37
Long-term debt................................................ 152 494 496
Other non-current liabilities................................. 25 16 13
Equity in net assets.......................................... 280 358 307
Revenues and other income..................................... 184 183 164
Costs and expenses............................................ 119 132 117
Net income.................................................... 65 51 47
</TABLE>
- ---------------
Note: Balance sheet amounts related to Kern River are not included in the table
above as of December 31, 1995, due to the Company's sale of its investment
in Kern River in December 1995. Reference is made to Note 5 for
information concerning the sale of Kern River.
12. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS
Postretirement Benefits
Old Tenneco has postretirement health care and life insurance plans which
cover substantially all of its employees. For salaried employees, the plans
cover employees retiring from the Company on or after attaining age 55 who have
had at least 10 years service with the Company after attaining age 45. For
hourly employees, the postretirement benefit plans generally cover employees who
retire pursuant to one of Old Tenneco's hourly employee retirement plans. The
Company is also obligated to provide certain benefits to former employees of
operations previously disposed of by Old Tenneco. The Company will retain this
liability after the Distributions. In addition, the Company will retain
liabilities with respect to welfare benefits of its current and former employees
of the Company and their dependents in connection with the Distributions. All of
these benefits may be subject to deductibles, copayment provisions and other
limitations, and Old Tenneco has reserved the right to change these benefits.
The majority of Old Tenneco's postretirement benefit plans are not funded.
In June 1994, two trusts were established to fund postretirement benefits for
certain plan participants of the Company. The contributions are collected from
customers in FERC approved rates. As of December 31, 1995, cumulative
contributions were $10 million. Plan assets consist principally of fixed income
securities.
F-23
<PAGE> 37
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The funded status of the postretirement benefit plans reconciles with
amounts recognized on the combined balance sheets at December 31, 1995 and 1994,
as follows:
<TABLE>
<CAPTION>
1995 1994
----- -----
(MILLIONS)
<S> <C> <C>
Actuarial present value of accumulated postretirement benefit
obligation at September 30:
Retirees.......................................................... $ 320 $ 321
Fully eligible active plan participants........................... 5 5
Other active plan participants.................................... 2 2
----- -----
Total accumulated postretirement benefit obligation................. 327 328
Plan assets at fair value at September 30........................... 3 2
----- -----
Accumulated postretirement benefit obligation in excess of plan
assets at September 30............................................ (324) (326)
Claims paid during the fourth quarter............................... 14 10
Unrecognized reduction of prior service obligations resulting from
plan amendments................................................... (68) (83)
Unrecognized net loss resulting from plan experience and changes in
actuarial assumptions............................................. 74 65
----- -----
Accrued postretirement benefit cost at December 31.................. $(304) $(334)
===== =====
</TABLE>
- ---------------
Note: The accrued postretirement benefit cost has been recorded based upon
certain actuarial estimates as described below. Those estimates are
subject to revision in future periods given new facts or circumstances.
The net periodic postretirement benefit cost for the years 1995, 1994 and
1993 consist of the following components:
<TABLE>
<CAPTION>
1995 1994 1993
---- ---- ----
(MILLIONS)
<S> <C> <C> <C>
Service cost for benefits earned during the year................. $ 1 $ 1 $ 1
Interest cost on accumulated postretirement benefit obligation... 26 17 8
Net amortization of unrecognized amounts......................... (13) (6) (1)
---- --- ---
Net periodic postretirement benefit cost......................... $ 14 $12 $ 8
==== === ===
</TABLE>
The initial weighted average assumed health care cost trend rate used in
determining the 1995, 1994 and 1993 accumulated postretirement benefit
obligation was 7%, 8% and 9%, respectively, declining to 5% in 1997 and
remaining at that level thereafter.
Increasing the assumed health care cost trend rate by one percentage-point
in each year would increase the 1995, 1994 and 1993 accumulated postretirement
benefit obligations by approximately $14 million, $14 million and $7 million,
respectively, and would increase the aggregate of the service cost and interest
cost components of the net postretirement benefit cost for 1995, 1994 and 1993
by approximately $1 million, $3 million and $1 million, respectively.
The discount rates (which are based on long-term market rates) used in
determining the 1995, 1994 and 1993 accumulated postretirement benefit
obligations were 7.75%, 8.25% and 7.50%, respectively.
F-24
<PAGE> 38
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Postemployment Benefits
The Company adopted FAS No. 112, "Employers' Accounting for Postemployment
Benefits," in the first quarter of 1994. This new accounting rule requires
employers to account for postemployment benefits for former or inactive
employees after employment but before retirement on the accrual basis rather
than the "pay-as-you-go" basis. The adoption of this new standard had no
material impact on the Company's combined financial position or results of
operations.
13. PENSION PLANS
Old Tenneco has retirement plans which cover substantially all of the
Company's employees. Benefits are based on years of service and, for most
salaried employees, on final average compensation. Old Tenneco's funding
policies are to contribute to the plans amounts necessary to satisfy the funding
requirements of federal laws and regulations. Plan assets consist principally of
listed equity and fixed income securities. Certain employees of the Company
participate in the Tenneco Inc. Retirement Plan (the "TRP").
New Tenneco will become the sole sponsor of the TRP upon consummation of
the Distributions. The benefits accrued by the employees of the Company who
participate in the TRP will be frozen as of the last day of the calendar month
including the Distributions and New Tenneco will amend the TRP to provide that
all benefits accrued through that day by the employees of the Company are fully
vested and non-forfeitable.
The funded status of the plans reconciles with amounts recognized on the
combined balance sheets at December 31, 1995 and 1994, as follows:
<TABLE>
<CAPTION>
ALL PLANS
-------------
1995 1994
---- ----
(MILLIONS)
<S> <C> <C>
Actuarial present value of benefits based on service to date and
present pay levels at September 30:
Vested benefit obligation............................................ $187 $169
Non-vested benefit obligation........................................ 12 11
---- ----
Accumulated benefit obligation....................................... 199 180
Additional amounts related to projected salary increases............... 41 37
---- ----
Total projected benefit obligation at September 30..................... 240 217
Plan assets at fair value at September 30.............................. 259 224
---- ----
Plan assets in excess of total projected benefit obligation at
September 30......................................................... 19 7
Unrecognized net loss resulting from plan experience and changes in
actuarial assumptions................................................ 14 26
Unrecognized prior service obligations resulting from plan
amendments........................................................... 2 3
Remaining unrecognized net asset at initial application................ (14) (16)
---- ----
Prepaid pension cost at December 31.......................... $ 21 $ 20
==== ====
</TABLE>
- ---------------
Note: Assets of one plan may not be utilized to pay benefits of other plans.
Additionally, the prepaid pension cost has been recorded based upon
certain actuarial estimates as described below. Those estimates are
subject to revision in future periods given new facts or circumstances.
F-25
<PAGE> 39
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Net periodic pension income for the years 1995, 1994 and 1993 consist of
the following components:
<TABLE>
<CAPTION>
1995 1994 1993
----------- ----------- -----------
(MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Service cost -- benefits earned during the
year......................................... $ 6 $ 6 $ 7
Interest accrued on prior year's projected
benefit obligation........................... 18 16 15
Expected return on plan assets --
Actual (return) loss......................... (45) 4 (31)
Unrecognized excess (deficiency) of actual
return over expected return............... 22 (26) 10
---- ---- ----
(23) (22) (21)
Net amortization of unrecognized
amounts............................ (2) (2) (2)
---- ---- ----
Net periodic pension income.......... $ (1) $ (2) $ (1)
==== ==== ====
</TABLE>
The weighted average discount rates (which are based on long-term market
rates) used in determining the 1995, 1994 and 1993 actuarial present value of
the benefit obligations were 7.8%, 8.3% and 7.5%, respectively. The rate of
increase in future compensation was 4.9%, in 1995, 1994, and 1993. The weighted
average expected long-term rate of return on plan assets was 10% in 1995, 1994
and 1993.
14. COMMITMENTS AND CONTINGENCIES
Capital Commitments
The Company estimates that expenditures aggregating approximately $636
million will be required after December 31, 1995, to complete facilities and
projects authorized at such date, and substantial commitments have been made in
connection therewith.
Purchase Obligations
In connection with the financing commitments of certain joint ventures, the
Company has entered into unconditional purchase obligations for products and
services of $145 million ($106 million on a present value basis) at December 31,
1995. The Company's annual obligations under these agreements are $22 million
for the years 1996 through 2000. Payments under such obligations, including
additional purchases in excess of contractual obligations, were $26 million, $34
million and $31 million for the years 1995, 1994 and 1993, respectively. In
addition, in connection with the Great Plains coal gasification project (Dakota
Gasification Company), TGP has contracted to purchase 30% of the output of the
plant's original design capacity for a remaining period of 14 years. TGP has
executed a settlement of this contract as a part of its gas supply realignment
negotiations discussed in Note 9.
Litigation
Reference is made to Note 9, "Federal Energy Regulatory Commission
Regulatory Matters," for information concerning gas supply litigation. The
Company is party to numerous other legal proceedings arising from their
operations. The Company believes that the outcome of these other proceedings,
individually and in the aggregate, will have no material effect on the combined
financial position or results of operations of the Company.
F-26
<PAGE> 40
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Environmental Matters
Since 1988, TGP has been engaged in an internal project to identify and
deal with the presence of polychlorinated biphenyls ("PCBs") and other
substances of concern, including substances on the U.S. Environmental Protection
Agency ("EPA") List of Hazardous Substances ("HS List") at compressor stations
and other facilities operated by both its interstate and intrastate natural gas
pipeline systems. While conducting this project, TGP has been in frequent
contact with federal and state regulatory agencies, both through informal
negotiation and formal entry of consent orders, in order to assure that its
efforts meet regulatory requirements.
The Company has established a reserve for TGP's environmental expenses,
which includes: 1) expected remediation expense and associated onsite, offsite
and groundwater technical studies, 2) legal fees and 3) settlement of third
party and governmental litigation, including civil penalties. Through September
30, 1996, and December 31, 1995, the Company has charged approximately $160
million and $147 million, respectively, against the environmental reserve,
excluding recoveries related to TGP's environmental settlement as discussed
below. Of the remaining reserve at September 30, 1996 and December 31, 1995, $24
million and $38 million, respectively, has been recorded on the combined balance
sheets under "Payables-trade" and $128 million and $126 million, respectively,
under "Deferred credits and other liabilities."
Due to the current uncertainty regarding the further activity necessary for
TGP to address the presence of the PCBs, the substances on the HS List and other
substances of concern on its sites, including the requirements for additional
site characterization, the actual amount of such substances at the sites, and
the final, site-specific cleanup decisions to be made with respect to cleanup
levels and remediation technologies, TGP cannot at this time accurately project
what additional costs, if any, may arise from future characterization and
remediation activities. While there are still many uncertainties relating to the
ultimate costs which may be incurred, based upon TGP's evaluation and experience
to date, TGP continues to believe that the recorded estimate for the reserve is
adequate.
Following negotiations with its customers, TGP in May 1995 filed with the
FERC a separate Stipulation and Agreement (the "Environmental Stipulation") that
establishes a mechanism for recovering a substantial portion of the
environmental costs. In November 1995, the FERC issued an order approving the
Environmental Stipulation. Although one shipper filed for rehearing, the FERC
denied rehearing of its order on February 20, 1996. This shipper filed a
Petition for Review on April 22, 1996 in the D.C. Circuit Court of Appeals; TGP
believes the FERC Order approving the Environmental Stipulation will be upheld
on appeal. The effects of the Environmental Stipulation, which was effective as
of July 1, 1995, have been recorded with no material effect on the Company's
combined financial position or results of operations. As of September 30, 1996,
and December 31, 1995, the balance of the regulatory asset is $54 million and
$74 million, respectively.
The Company has completed settlements with and has received payments from
the majority of its liability insurance policy carriers for remediation costs
and related claims. The Company believes that the likelihood of recovery of a
portion of its remediation costs and claims against the remaining carriers in
its pending litigation is reasonably possible. In addition, TGP has settled its
pending litigation against and received payment from the manufacturer of the
PCB-containing lubricant. These recoveries have been considered in TGP's
recording of its environmental settlement with its customers.
The Company has identified other sites where environmental remediation
expense may be required should there be a change in ownership, operations or
applicable regulations. These possibilities cannot be predicted or quantified at
this time and accordingly, no provision has been recorded. However, provisions
have been made for all instances where it has been determined that the
incurrence of any material remedial expense is reasonably possible. The Company
believes that the provisions recorded for environmental exposures are adequate
based on current estimates.
F-27
<PAGE> 41
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
15. QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
NET SALES INCOME
AND BEFORE INTEREST
OPERATING EXPENSE AND NET
QUARTER REVENUES INCOME TAXES INCOME
- ------------------------------------------------------------ --------- --------------- ------
(MILLIONS)
<S> <C> <C> <C>
1996 1st.................................................... $ 748 $ 88 $ 75
2nd................................................... 622 69 22
3rd................................................... 627 76 20
------ ---- ----
$ 1,997 $ 233 $117
====== ==== ====
1995 1st.................................................... $ 505 $ 71 $ 33
2nd................................................... 434 61 20
3rd................................................... 429 43 5
4th................................................... 553 85 106
------ ---- ----
$ 1,921 $ 260 $164
====== ==== ====
1994 1st.................................................... $ 693 $ 89 $ 25
2nd................................................... 607 80 67
3rd................................................... 549 71 (31)
4th................................................... 532 127 120
------ ---- ----
$ 2,381 $ 367 $181
====== ==== ====
</TABLE>
- ---------------
Note: Reference is made to Notes 4 and 5 and "Managements' Discussion and
Analysis of Financial Condition and Results of Operations" included
elsewhere herein for discussion of items affecting quarterly results.
The preceding notes to combined financial statements are an integral part of
the foregoing combined financial statements.
F-28
<PAGE> 42
SCHEDULE II
THE ENERGY BUSINESSES OF TENNESSEE GAS PIPELINE COMPANY
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
(MILLIONS)
<TABLE>
<CAPTION>
COLUMN C
-----------------------
COLUMN B ADDITIONS COLUMN E
---------- ----------------------- --------
COLUMN A BALANCE AT CHARGED TO CHARGED TO COLUMN D BALANCE
- -------------------------------------------- BEGINNING COSTS AND OTHER ---------- AT END
DESCRIPTION OF YEAR EXPENSES ACCOUNTS DEDUCTIONS OF YEAR
- -------------------------------------------- ---------- ---------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C>
Allowance for Doubtful Accounts Deducted
from Assets to Which it Applies:
Year Ended December 31, 1995.............. $ 21 $ 26 $ 9 $ 7 $ 49
=== === === === ===
Year Ended December 31, 1994.............. $ 37 $ 2 $ 2 $ 20 $ 21
=== === === === ===
Year Ended December 31, 1993.............. $ 15 $ 23 $ 3 $ 4 $ 37
=== === === === ===
</TABLE>
S-1
<PAGE> 43
ITEM 7. FINANCIAL STATEMENTS AND EXHIBITS.
(c) Exhibits.
The following exhibit is filed with this Current Report on Form 8-K.
<TABLE>
<C> <S>
27.1 -- Financial Data Schedule
27.2 -- Financial Data Schedule
</TABLE>
S-2
<PAGE> 44
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TENNESSEE GAS PIPELINE CO.
By /s/ JEFFREY I. BEASON
--------------------------------------
Jeffrey I. Beason
Vice President and Controller
Date: January 21, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C> <C>
<PERIOD-TYPE> 9-MOS YEAR
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1995
<PERIOD-START> JAN-01-1996 JAN-01-1995
<PERIOD-END> SEP-30-1996 DEC-31-1995
<CASH> 35 305
<SECURITIES> 0 0
<RECEIVABLES> 415 508
<ALLOWANCES> 0 0
<INVENTORY> 25 24
<CURRENT-ASSETS> 1,194 1,651
<PP&E> 6,518 6,272
<DEPRECIATION> 3,546 3,431
<TOTAL-ASSETS> 5,233 5,702
<CURRENT-LIABILITIES> 1,222 1,685
<BONDS> 584 702
0 0
0 0
<COMMON> 0 0
<OTHER-SE> 2,440 2,243
<TOTAL-LIABILITY-AND-EQUITY> 5,233 5,702
<SALES> 1,997 1,921
<TOTAL-REVENUES> 1,997 1,921
<CGS> 1,487 1,368
<TOTAL-COSTS> 1,487 1,368
<OTHER-EXPENSES> 377 474
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 33 65
<INCOME-PRETAX> 200 195
<INCOME-TAX> 82 31
<INCOME-CONTINUING> 118 164
<DISCONTINUED> 0 0
<EXTRAORDINARY> (1) 0
<CHANGES> 0 0
<NET-INCOME> 117 164
<EPS-PRIMARY> 0 0
<EPS-DILUTED> 0 0
</TABLE>
