-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AqSGJFYgYL7zeJ0xKgQZFeuXKyOQPuIYsNKJyzrB++A8CbXAVwx/y02C+YmicqsA Pu921Z1CZS8QaiMM5Cu0Tw== 0000099250-00-000002.txt : 20000411 0000099250-00-000002.hdr.sgml : 20000411 ACCESSION NUMBER: 0000099250-00-000002 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TRANSCONTINENTAL GAS PIPE LINE CORP CENTRAL INDEX KEY: 0000099250 STANDARD INDUSTRIAL CLASSIFICATION: NATURAL GAS TRANSMISSION [4922] IRS NUMBER: 741079400 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-07584 FILM NUMBER: 583212 BUSINESS ADDRESS: STREET 1: 2800 POST OAK BLVD STREET 2: P O BOX 1396 CITY: HOUSTON STATE: TX ZIP: 77251 BUSINESS PHONE: 7134392000 MAIL ADDRESS: STREET 1: 2800 POST OAK BLVD STREET 2: P O BOX 1396 CITY: HOUSTON STATE: TX ZIP: 77251 10-K 1 TRANSCO 1999 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO ---------- ----------- COMMISSION FILE NUMBER 1-7584 TRANSCONTINENTAL GAS PIPE LINE CORPORATION ------------------------------------------------------ (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 74-1079400 - ------------------------------- -------------------- (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 2800 POST OAK BLVD., P. O. BOX 1396, HOUSTON, TEXAS 77251 - --------------------------------------------------- -------- (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) ZIP CODE REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (713) 215-2000 -------------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO --- --- INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS FORM 10-K. [X] THE NUMBER OF SHARES OF COMMON STOCK, PAR VALUE $1.00 PER SHARE, OUTSTANDING AT JANUARY 31, 2000 WAS 100. THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION (I)(1)(a) AND (b) OF FORM 10-K AND IS THEREFORE FILING THIS FORM 10-K WITH THE REDUCED DISCLOSURE FORMAT. PART I ITEM 1. BUSINESS. GENERAL Transcontinental Gas Pipe Line Corporation (Transco) is an interstate natural gas transmission company which owns a natural gas pipeline system extending from Texas, Louisiana, Mississippi and the Gulf of Mexico through the states of Alabama, Georgia, South Carolina, North Carolina, Virginia, Maryland, Pennsylvania and New Jersey to the New York City metropolitan area. Transco also holds a minority interest in an intrastate natural gas pipeline in North Carolina. Transco's principal business is the transportation of natural gas. The number of full time employees of Transco at December 31, 1999 was 1,467. Transco is an indirect wholly-owned subsidiary of The Williams Companies, Inc. (Williams). At December 31, 1999, Transco's system had a mainline delivery capacity of approximately 3.8 Bcf of gas per day from production areas to its primary markets. Using its Leidy Line and market-area storage capacity, Transco can deliver an additional 2.9 Bcf of gas per day for a system-wide delivery capacity total of approximately 6.7 Bcf of gas per day. The system is composed of approximately 10,500 miles of mainline and branch transmission pipelines, 45 compressor stations, seven storage locations and four processing plants. Compression facilities at sea level rated capacity total approximately 1.3 million horsepower. Transco has natural gas storage capacity in five underground storage fields located on or near its pipeline system and/or market areas and operates three of these storage fields. In addition, Transco has storage capacity in two liquefied natural gas (LNG) storage facilities and operates both of these facilities. The total top gas storage capacity available to Transco and its customers in such storage fields and LNG facilities and through storage service contracts is approximately 220 Bcf of gas. Storage capacity permits Transco's customers to inject gas into storage during the summer and off-peak periods for delivery during peak winter demand periods. As used in this report, the term "Mcf" means thousand cubic feet, the term "MMcf" means million cubic feet, the term "Bcf" means billion cubic feet, the term "Tcf" means trillion cubic feet, the term "Mcf/d" means thousand cubic feet per day, the term "MMcf/d" means million cubic feet per day, the term "Bcf/d" means billion cubic feet per day, the term "MMBtu" means million British Thermal Units, the term "TBtu" means trillion British Thermal Units and the term "Dt" means dekatherm. Transco's gas pipeline facilities are generally owned in fee. However, a substantial portion of such facilities are constructed and maintained pursuant to rights-of-way, easements, permits, licenses or consents on and across real property owned by others. Compressor stations, with appurtenant facilities, are located in whole or in part either on lands owned or on sites held under leases or permits issued or approved by public authorities. The storage facilities are either owned or contracted for under long-term leases or easements. In 1992, the Federal Energy Regulatory Commission (FERC) issued Order 636 which made fundamental changes in the way natural gas pipelines conduct their businesses. The FERC's stated purpose of Order 636 was to improve the competitive structure of the natural gas pipeline industry by, among other things, unbundling a pipeline's merchant service from its transportation services; ensuring "equality" of transportation services including equal access to all sources of gas; providing "no-notice" firm transportation services that are equal in quality to bundled sales service; establishing a capacity release program and changing rate design methodology from modified fixed-variable (MFV) to straight fixed-variable (SFV), unless the pipeline and its customers agree to, and the FERC approves, a different form of rate design methodology. Effective November 1, 1993, Transco implemented its Order 636 restructuring plan. On February 9, 2000, the FERC issued Order 637 which further revised its regulations with the stated purpose of improving the efficiency of the market while protecting against the exercise of market power by waiving the price ceiling on short term capacity releases, allowing pipelines to file for peak/offpeak rates and term differentiated rates, clarifying certain transportation service policies, and increasing transaction reporting requirements. Through an agency agreement with Transco, Williams Energy Services Company (WESCO), an affiliate of Transco, manages Transco's jurisdictional merchant gas sales. In May 1995, the operation of certain production area facilities were transferred to Williams Field Services Group, Inc. (WFS), an affiliated company. In February 1996, Transco filed an application with the FERC for an order authorizing the abandonment of certain facilities located onshore and offshore in Texas, Louisiana and Mississippi by conveyance to Williams Gas Processing - Gulf Coast Company (Gas Processing), an affiliate of Transco. The net book value recorded by Transco at December 31, 1999 of the facilities was approximately $475 million. Operating income recorded by Transco for the year ended December 31, 1999 associated with the facilities was $11 million; however, such operating income may not be representative of the effects of the spin-down on Transco's future operating income due to various factors, including future regulatory actions. Concurrently, Gas Processing filed a petition for declaratory order requesting a determination that its gathering services and rates be exempt from FERC regulation under the Natural Gas Act of 1938 (NGA). On September 25, 1996, the FERC issued an order dismissing Transco's application and Gas Processing's petition for declaratory order. On October 25, 1996, Transco and Gas Processing filed a joint request for rehearing of the FERC's September 25 order and, in August 1997, filed a request that rehearing be expedited. In February 1998, Transco filed an application with the FERC seeking authorization to abandon Transco's onshore Tilden/McMullen Gathering System located in Texas by conveyance to Gas Processing. Gas Processing filed a contemporaneous request that the FERC declare that the facilities sought to be abandoned would be considered nonjurisdictional gathering facilities upon transfer to Gas Processing. In May 1999, the FERC issued an order in which it determined that certain of the facilities would be gathering facilities upon transfer to Gas Processing, i.e., 1) those facilities upstream of and including the Tilden Plant, 2) the South McMullen and Goebel Laterals located downstream of the Tilden Plant, and 3) the small, short laterals which branch out from the McMullen Lateral downstream of the Tilden Plant at several points along its length. However, the FERC determined that the McMullen Lateral itself, as well as two compressor units, are jurisdictional facilities, but authorized their abandonment subject to Gas Processing obtaining a certificate to operate those facilities. The net book value at December 31, 1999 of the Tilden/McMullen facilities was approximately $62 million. Operating income for the year ended December 31, 1999 associated with those facilities is estimated to be less than $3 million; however, such operating income may not be representative of the effects of the spin-down on Transco's future operating income due to various factors, including future regulatory actions. On June 3, 1999, Transco and Gas Processing filed for rehearing of the order with regard to the facilities classified by the FERC as jurisdictional facilities, and on October 5, 1999, the FERC denied the rehearing request. On March 7, 2000, Transco filed a limited NGA section 4 filing with the FERC, notifying the FERC that Transco intended to effectuate the spin-down to Gas Processing of the Tilden-McMullen facilities determined by the FERC to be gathering facilities to be effective April 1, 2000, and adjusting Transco's rates on a prospective basis effective with the spin-down to reflect a decrease in Transco's overall cost of service, rate base and operation and maintenance expense resulting from the spin-down. The net book value of the facilities included in this limited NGA filing is approximately $19 million and annual operating income associated with these facilities is estimated to be less than $1 million. MARKETS AND TRANSPORTATION Transco's natural gas pipeline system serves customers in Texas and eleven southeast and Atlantic seaboard states including major metropolitan areas in Georgia, North Carolina, New York, New Jersey and Pennsylvania. Transco's major gas transportation customers are public utilities and municipalities that provide service to residential, commercial, industrial and electric generation end users. Shippers on Transco's pipeline system include public utilities, municipalities, intrastate pipelines, direct industrial users, electrical generators, gas marketers and producers. Transco's two largest customers in 1999 were Public Service Electric and Gas Company and Consolidated Edison Company of New York, Inc., which accounted for approximately 8.5 percent and 7.6 percent, respectively, of Transco's total operating revenues. Transco's firm transportation agreements are generally long-term agreements with various expiration dates and account for the major portion of Transco's business. Additionally, Transco offers interruptible transportation services under shorter term agreements. Transco's total system deliveries for the years 1999, 1998 and 1997 are shown below.
Transco System Deliveries (TBtu) 1999 1998 1997 - ---------------------------------------- ------------- ------------ ------------ Market-area deliveries Long-haul transportation ......................... 820.0 857.8 940.2 Market-area transportation ....................... 622.6 522.1 438.9 ------------- ------------ ------------ Total market-area deliveries ..................... 1,442.6 1,379.9 1,379.1 Production-area transportation ......................... 222.0 214.0 242.0 ------------- ------------ ------------ Total system deliveries ................................ 1,664.6 1,593.9 1,621.1 ============= ============ ============ Average Daily Transportation Volumes (TBtu) ............ 4.6 4.4 4.4 Average Daily Firm Reserved Capacity (TBtu) ............ 6.3 5.8 5.5
Transco's facilities are divided into seven rate zones. Four are located in the production area and three are located in the market area. Long-haul transportation is gas that is received in one of the production-area zones and delivered in a market-area zone. Market-area transportation is gas that is both received and delivered within market-area zones. Production-area transportation is gas that is both received and delivered within production-area zones. PIPELINE PROJECTS PROJECTS IN SERVICE In 1999, Pine Needle LNG Company, LLC and Cardinal Pipeline Company, LLC, both of which are owned by wholly-owned subsidiaries of Transco and several of its customers, completed construction of, and placed into service, two major projects, a LNG storage facility and the Cardinal Pipeline Project (Cardinal), respectively. Transco contributed $19 million to the total cost of the LNG storage facility which is located in Guilford County, North Carolina. The facility was placed into service in May 1999 and has 4 Bcf of storage capacity and 400 MMcf/d of withdrawal capacity. Wholly-owned subsidiaries of Transco operate the facility and have a 35% ownership interest. On November 1, 1999, Cardinal Pipeline Company, LLC, a North Carolina limited liability company formed between wholly-owned subsidiaries of Transco and three of Transco's North Carolina customers, placed Cardinal into service. Transco contributed $24 million to the total cost of this project which involved the acquisition of an existing 37-mile pipeline in North Carolina and construction of an approximately 67-mile extension of the pipeline to new interconnections near Clayton County, North Carolina. This pipeline provides transportation service of up to 270 MMcf/d of natural gas. Transco's wholly-owned subsidiary has a 45% ownership interest in Cardinal and a separate wholly-owned subsidiary of Transco is the operator of Cardinal. CUMBERLAND PIPELINE PROJECT In 1999, Cumberland Gas Pipeline Company, a partnership between wholly-owned subsidiaries of Transco and AGL Resources Inc., decided not to pursue its pipeline project at this time. In lieu of the project, Transco intends to expand the capacity of its North Georgia extension as part of the SouthCoast Expansion Project (see below) to meet the firm transportation service requirements of its shippers. MARKETLINK EXPANSION PROJECT On May 13, 1998, Transco filed an application with the FERC for approval to construct and operate mainline and Leidy Line facilities to create an additional 676 MMcf/d of firm transportation capacity to serve increased demand in the mid-Atlantic and south Atlantic regions of the United States by a targeted in-service date of November 1, 2000. The estimated cost of the proposed facilities is $529 million. On December 17, 1999, the FERC issued an interim order giving Transco conditional approval for MarketLink, along with the Independence Pipeline Project (see below) and ANR Pipeline Company's Supply Link Project but withholding final certificate authorization until Independence Pipeline Company (Independence) and ANR Pipeline Company (ANR) file long-term, executed contracts with nonaffiliated shippers for at least 35% of the capacity of their respective projects. While the FERC has treated the three projects as interrelated, should Independence and ANR fail to meet the executed contract conditions, the interim order states that Transco may amend its MarketLink project to go forward on a stand-alone basis. Once construction begins, the order also imposed a number of additional environmental conditions, beyond those recommended in the Final Environmental Impact Statement. Transco has filed for rehearing of the interim order. INDEPENDENCE PIPELINE PROJECT In March 1997, as amended in December 1997, Independence filed an application with FERC for approval to construct and operate a new pipeline consisting of approximately 400 miles of 36-inch pipe from ANR Pipeline Company's existing compressor station at Defiance, Ohio to Transco's facilities at Leidy, Pennsylvania. The Independence Pipeline Project is proposed to provide approximately 916 MMcf/d of firm transportation capacity by a requested in-service date of November 2000. Independence is owned equally by wholly-owned subsidiaries of Transco, ANR, and National Fuel Gas Company. The estimated cost of the project is $678 million, and Transco's equity contributions are estimated to be approximately $68 million based on its expected one-third ownership interest in the project. As mentioned above in connection with the MarketLink Project, on December 17, 1999 the FERC gave conditional approval for the Independence Pipeline project, subject to Independence filing long-term, executed contracts with nonaffiliated shippers for at least 35% of the capacity of the project. Also, the FERC imposed a number of additional environmental conditions once construction begins on the project. Independence has filed for rehearing of the interim order. CROSS BAY PIPELINE PROJECT Subsidiaries of Transco, Duke Energy and KeySpan Energy have formed Cross Bay SM Pipeline Company, L.L.C.(Cross Bay). The Cross Bay Pipeline Project is designed to increase natural gas deliveries into the New York City metropolitan area by installing compression and looping to expand the capacity of Transco's existing Long Beach Lateral by approximately 121 MMcf/d. The project is targeted to be placed into service in the winter of 2001-2002 and is estimated to cost approximately $50 million. Wholly-owned subsidiaries of Transco will operate Cross Bay and have a 37.5% ownership interest. Transco expects to make equity investments of approximately $5 million in this project. BUCCANEER PIPELINE PROJECT In December 1999, Transco assigned its 100% equity interest in the Buccaneer Gas Pipeline Company, L.L.C. (Buccaneer) to Transco's parent, Williams Gas Pipeline Company (WGP). Buccaneer is a proposed natural gas pipeline project extending from the Mobile Bay area in Alabama to delivery points in Florida. SOUTHCOAST EXPANSION PROJECT In April 1999, Transco filed an application with the FERC for its approval of the SouthCoast Expansion Project, which is designed to create approximately 200 MMcf/d of additional firm transportation capacity on Transco's system from the terminus of Transco's existing Mobile Bay Lateral in Choctaw County, Alabama, to delivery points in Transco's Rate Zone 4 (Alabama and Georgia). The project has a target in-service date of November 1, 2000 and an estimated cost of approximately $108 million. SUNDANCE EXPANSION PROJECT In April 1999, Transco announced its Sundance Expansion Project, which would create approximately 228 MMcf/d of additional firm transportation capacity from Transco's Station 65 in Louisiana to delivery points in Georgia, South Carolina and North Carolina. Transco plans to file for FERC approval of the project in the first quarter of 2000. The project has a target in-service date of May 2002 and an estimated cost of approximately $129 million. REGULATORY MATTERS Transco's transportation rates are established through the FERC ratemaking process. Key determinants in the ratemaking process are (i) volume throughput assumptions, (ii) costs of providing service, including depreciation expense and (iii) allowed rate of return, including the equity component of a pipeline's capital structure and related income taxes. Rate design and the allocation of costs between the demand and commodity rates also impact profitability. As a result of the ratemaking process, a portion of Transco's revenues may have been collected subject to refund. Effective September 1, 1992, Transco changed from the MFV method of rate design to the SFV method of rate design. Under MFV rate design, substantially all fixed costs, with the exception of return on equity and income taxes, are included in a demand charge to customers and return on equity and income taxes are recovered as part of a volumetric charge to customers. Accordingly, under MFV rate design, overall throughput has a significant impact on operating income. Under the SFV method of rate design, substantially all fixed costs, including return on equity and income taxes, are included in a demand charge to customers and all variable costs are recovered through a commodity charge to customers. While the use of SFV rate design limits Transco's opportunity to earn incremental revenues through increased throughput, it also limits Transco's risk associated with fluctuations in throughput. For a discussion of additional regulatory matters, see "Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 3. Contingent Liabilities and Commitments - Rate and Regulatory Matters." SALES SERVICE As discussed above, WESCO manages Transco's jurisdictional merchant gas sales, which are made to customers pursuant to a blanket sales certificate issued by the FERC. Most of these sales are made through a Firm Sales (FS) program which gives customers the option to purchase daily quantities of gas from Transco at market-responsive prices in exchange for a demand charge payment. Transco's gas sales volumes managed by WESCO for the years 1999, 1998 and 1997 are shown below.
Gas Sales Volumes (TBtu) 1999 1998 1997 - ------------------------------ -------------- ------------- ------------- Long-term sales ........................ 196.2 176.0 192.9 Short-term sales ....................... 38.4 25.0 21.8 -------------- ------------- ------------- Total gas sales ................. 234.6 201.0 214.7 ============== ============= =============
TRANSACTIONS WITH AFFILIATES Transco engages in transactions with Williams and other Williams subsidiaries, characteristic of group operations. See "Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements- 2. Summary of Significant Accounting Policies and 8. Transactions With Major Customers and Affiliates." REGULATION INTERSTATE GAS PIPELINE OPERATIONS Transco's interstate transmission and storage activities are subject to regulation by the FERC under the NGA and under the Natural Gas Policy Act of 1978 (NGPA), and, as such, Transco's rates and charges for the transportation of natural gas in interstate commerce, the extension, enlargement or abandonment of jurisdictional facilities, and accounting, among other things, are subject to regulation. Transco holds certificates of public convenience and necessity issued by the FERC authorizing ownership and operation of all pipelines, facilities and properties considered jurisdictional for which certificates are required under the NGA. Transco is also subject to the Natural Gas Pipeline Safety Act of 1968, as amended by Title I of the Pipeline Safety Act of 1979, which regulates safety requirements in the design, construction, operation and maintenance of interstate gas transmission facilities. INTRASTATE GAS PIPELINE OPERATIONS The Cardinal Pipeline System Project (see Part I, Item 1, Pipeline Projects) is a North Carolina natural gas pipeline project which is subject to the jurisdiction of the North Carolina Utilities Commission. ENVIRONMENTAL Transco is subject to the National Environmental Policy Act and federal, state and local laws and regulations relating to environmental quality control. Management believes that Transco's pipeline competitors are also subject to similar laws and regulations relating to environmental quality control. Management further believes that, with respect to any capital expenditures and operation and maintenance expenses required to meet applicable environmental standards and regulations, the FERC would grant the requisite rate relief so that, for the most part, such expenditures would be recoverable in rates. For these reasons, management believes that compliance with applicable environmental requirements is not likely to have a material effect upon its competitive position or earnings. See "Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 3. Contingent Liabilities and Commitments - Environmental Matters." COMPETITION The natural gas industry has undergone tremendous change since the issuance of FERC Order 636 in 1992. Order 636 required that the natural gas sales, transportation, and other services that were formerly provided in bundled form by pipelines be separated, resulting in non-discriminatory open access transportation services, and encouraged the establishment of market hubs. These and other factors have led to a commodity market in natural gas and to increasingly competitive markets in natural gas services, including competitive secondary markets in pipeline capacity. As a result, pipeline capacity is being used more efficiently, and peaking and storage services are increasingly effective substitutes for annual pipeline capacity. These efficiencies have increased the risk for pipelines of contract non-renewal or capacity turnback. In July 1998, the FERC issued a Notice of Proposed Rulemaking (NOPR) concerning the regulation of short-term transportation services and a Notice of Inquiry (NOI) addressing long-term transportation services. The scope of the inquiry initiated by these two proceedings and the potential policy implications are unprecedented in the history of natural gas regulation. On February 9, 2000, the FERC issued a final rule, Order 637, in response to the comments received on the NOPR and NOI. The FERC adopts in Order 637 certain policies that it finds are necessary to adjust its current regulatory model to the needs of the evolving markets, but determines that any fundamental changes to its regulatory policy, which changes were raised and commented on in the NOPR and NOI, will be considered after further study and evaluation of the evolving marketplace. The Order revises its pricing policy to waive, for a two-year period, the maximum price ceilings for short-term releases of capacity of less than one year, and permits pipelines to file proposals to implement seasonal rates for short-term services and term-differentiated rates, subject to certain requirements including the requirement that a pipeline be limited to recovering its annual revenue requirement under those rates. At the state level, both LDC unbundling and electric industry restructuring are affecting Transco's markets. On the gas side, several state jurisdictions have been involved in implementing changes similar to the changes that have occurred at the federal level under Order 636. New York, New Jersey, Pennsylvania, Maryland, Delaware and Georgia have established regulations for LDC unbundling and are currently implementing them on a company-by-company basis. To date, none of these changes at the state level have required renegotiations of Transco's current LDC contracts nor have these states required significant alteration in the operation of the pipeline. The potential impact of electric power industry restructuring is particularly uncertain. Gas competes with electricity in residential, commercial, and industrial end uses, and also competes with other fuels, especially coal and fuel oil, in electricity generation. Gas use for power generation is expected to increase sharply during the next decade due to both regulatory changes and new power generation technologies, although the size of this increase remains uncertain. In addition, the restructuring of both the gas and electric industries is facilitating the convergence of the two industries, resulting in mergers and acquisitions that are changing the face and business mix of Transco's competitors. FORWARD-LOOKING STATEMENTS Certain matters discussed in this report, excluding historical information, include forward-looking statements -- statements that discuss Transco's expected future results based on current and pending business operations. Transco makes these forwarding-looking statements in reliance on the safe harbor protections provided under the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as "anticipates," "believes," "expects," "planned," "scheduled" or similar expressions. Although Transco believes these forward-looking statements are based on reasonable assumptions, statements made regarding future results are subject to numerous assumptions, uncertainties and risks that may cause future results to be materially different from the results stated or implied in this document. The following are important factors that could cause actual results to differ materially from any results projected, forecasted, estimated or budgeted by Transco in forward-looking statements: (i) risks and uncertainties related to changes in general economic conditions in the United States, changes in laws and regulations to which Transco is subject, including tax, environmental and employment laws and regulations, the cost and effects of legal and administrative claims and proceedings against Transco or its subsidiaries or which may be brought against Transco or its subsidiaries, the effect of changes in accounting policies, and conditions of the capital markets Transco utilizes to access capital to finance operations; (ii) risks and uncertainties related to the impact of future federal and state regulation of business activities, including allowed rates of return, the pace of deregulation in retail natural gas markets, and the resolution of other regulatory matters discussed herein; (iii) risks and uncertainties related to the ability to develop expanded markets as well as maintaining existing markets; (iv) risks and uncertainties related to the ability to obtain governmental and regulatory approval of various expansion projects; (v) risks and uncertainties related to the ability to successfully implement key systems such as a service delivery system, and (vi) risks and uncertainties related to the ability to control costs. In addition, future utilization of pipeline capacity can depend on energy prices, competition from other pipelines and alternative fuels, the general level of natural gas demand, decisions by customers not to renew expiring natural gas transportation contracts and weather conditions, among other things. Further, gas prices which directly impact transportation and operating profits may fluctuate in unpredictable ways. ITEM 2. PROPERTIES. See "Item 1. Business." ITEM 3. LEGAL PROCEEDINGS. GATHERING FACILITIES SPIN-DOWN ORDER (DOCKET NOS. CP96-206-000 AND CP96-207- 000) In February 1996, Transco filed an application with the FERC for an order authorizing the abandonment of certain facilities located onshore and offshore in Texas, Louisiana and Mississippi by conveyance to Gas Processing, an affiliate of Transco. The net book value recorded by Transco at December 31, 1999 of the facilities was approximately $475 million. Operating income recorded by Transco for the year ended December 31, 1999 associated with the facilities was $11 million; however, such operating income may not be representative of the effects of the spin-down on Transco's future operating income due to various factors, including future regulatory actions. Concurrently, Gas Processing filed a petition for declaratory order requesting a determination that its gathering services and rates be exempt from FERC regulation under the NGA. On September 25, 1996, the FERC issued an order dismissing Transco's application and Gas Processing's petition for declaratory order. On October 25, 1996, Transco and Gas Processing filed a joint request for rehearing of the FERC's September 25 order and, in August 1997, filed a request that rehearing be expedited. TILDEN/MCMULLEN FACILITIES SPIN-DOWN PROCEEDING (DOCKET NOS. CP98-236 AND 242) In February 1998, Transco filed an application with the FERC seeking authorization to abandon Transco's onshore Tilden/McMullen Gathering System located in Texas by conveyance to Gas Processing. Gas Processing filed a contemporaneous request that the FERC declare that the facilities sought to be abandoned would be considered nonjurisdictional gathering facilities upon transfer to Gas Processing. In May 1999, the FERC issued an order in which it determined that certain of the facilities would be gathering facilities upon transfer to Gas Processing, i.e., 1) those facilities upstream of and including the Tilden Plant, 2) the South McMullen and Goebel Laterals located downstream of the Tilden Plant, and 3) the small, short laterals which branch out from the McMullen Lateral downstream of the Tilden Plant at several points along its length. However, the FERC determined that the McMullen Lateral itself, as well as two compressor units, are jurisdictional facilities, but authorized their abandonment subject to Gas Processing obtaining a certificate to operate those facilities. The net book value at December 31, 1999 of the Tilden/McMullen facilities was approximately $62 million. Operating income for the year ended December 31, 1999 associated with those facilities is estimated to be less than $3 million; however, such operating income may not be representative of the effects of the spin-down on Transco's future operating income due to various factors, including future regulatory actions. On June 3, 1999, Transco and Gas Processing filed for rehearing of the order with regard to the facilities classified by the FERC as jurisdictional facilities, and on October 5, 1999, the FERC denied the rehearing request. On March 7, 2000, Transco filed a limited NGA section 4 filing with the FERC, notifying the FERC that Transco intended to effectuate the spin-down to Gas Processing of the Tilden-McMullen facilities determined by the FERC to be gathering facilities to be effective April 1, 2000, and adjusting Transco's rates on a prospective basis effective with the spin-down to reflect a decrease in Transco's overall cost of service, rate base and operation and maintenance expense resulting from the spin-down. The net book value of the facilities included in this limited NGA filing is approximately $19 million and annual operating income associated with these facilities is estimated to be less than $1 million. ROYALTY CLAIMS AND LITIGATION In connection with Transco's renegotiations with producers to resolve take-or-pay and other contract claims and to amend gas purchase contracts, Transco entered into certain settlements which may require the indemnification by Transco of certain claims for additional royalties which the producers may be required to pay as a result of such settlements. Transco has been made aware of demands on producers for additional royalties and such producers may receive other demands which could result in claims against Transco pursuant to the indemnification provisions in their respective settlements. Indemnification for royalties will depend on, among other things, the specific lease provisions between the producer and the lessor and the terms of the settlement between the producer and Transco. On March 15, 1994, a lawsuit was filed in the 189th Judicial District Court of Harris County, Texas (Texaco, Inc. vs. Transcontinental Gas Pipe Line Corporation). In this lawsuit, the plaintiff has claimed approximately $23 million, including interest and attorneys' fees for reimbursements of settlement amounts paid to royalty owners. On October 16, 1997, a jury verdict in this case found that Transco was required to pay Texaco damages of $14.5 million plus $3.75 million in attorney's fees. The trial judge initially deferred entering judgment and directed the parties to participate in mediation of this matter. Following mediation in 1998, which did not result in a resolution of this matter, the trial judge entered judgment consistent with the jury verdict and also awarded prejudgment interest of $5.0 million. Transco is appealing the verdict and continues to believe that it has meritorious defenses to Texaco's claims. In addition, Transco was notified by Freeport-McMoRan, Inc. (FMP) in February 1995, that pursuant to a settlement with the Mineral Management Service (MMS) of the MMS' claim for royalties due under gas contracts between Transco and FMP which had been modified pursuant to settlement agreements made in 1986 and 1989, FMP was asserting a claim for indemnification of approximately $6 million, including interest, under the excess royalty provisions of those settlement agreements. On or about March 30, 1995, FMP filed a petition for specific performance seeking recovery against Transco for the sums claimed under the settlement agreements. In May 1998, FMP filed a motion for summary judgment which Transco opposed. In September 1998, the court granted FMP's motion finding that at least a portion of FMP's payment to the MMS was subject to indemnification. Transco has appealed the court's ruling. In August 1996, a lawsuit was filed against Transco and certain Transco affiliates by a royalty owner in a gas producing field in Brooks County, Texas alleging a claim for incorrect computation of royalties. Transco is alleged to have purchased gas from the field. Transco has filed an answer denying liability for the claim. In 1998, the United States Department of Justice informed Williams that Jack Grynberg, an individual, had filed claims in the United States District Court for the District of Colorado under the False Claims Act against Williams and certain of its wholly owned subsidiaries including Transco. Mr. Grynberg has also filed claims against approximately 300 other energy companies and alleges that the defendants violated the False Claims Act in connection with the measurement and purchase of hydrocarbons. The relief sought is an unspecified amount of royalties allegedly not paid to the federal government, treble damages, a civil penalty, attorneys' fees, and costs. On April 9, 1999, the United States Department of Justice announced that it was declining to intervene in any of the Grynberg qui tam cases; including the action filed against the Williams entities in the United States District Court for the District of Colorado. On October 21, 1999, the Panel on Multi-District Litigation transferred all of the Grynberg qui tam cases, including those filed against Williams, to the United States District Court for the District of Wyoming for pre-trial purposes. ENVIRONMENTAL MATTERS In July 1999, Transco received a letter stating that the U.S. Department of Justice (DOJ), at the request of the U.S. Environmental Protection Agency (EPA), intends to file a civil action against Transco arising from its waste management practices at Transco's compressor stations and metering stations located in eleven (11) states from Texas to New Jersey. DOJ stated in the letter that its complaint will seek civil penalties and injunctive relief under federal environmental laws. DOJ offered to discuss settlement of the claim and discussions began in September 1999. While no specific amount was proposed, DOJ stated that any settlement must include an appropriate civil penalty for the alleged violations. Transco cannot reasonably estimate the amount of its potential liability, if any, at this time. However, Transco believes it has substantially addressed environmental concerns on its system through ongoing voluntary remediation and management programs. Transco is subject to extensive federal, state and local environmental laws and regulations which affect Transco's operations related to the construction and operation of its pipeline facilities. Appropriate governmental authorities may enforce these laws and regulations with a variety of civil and criminal enforcement measures, including monetary penalties, assessment and remediation requirements and injunctions as to future compliance. Transco's use and disposal of hazardous materials are subject to the requirements of the federal Toxic Substances Control Act (TSCA), the federal Resource Conservation and Recovery Act (RCRA) and comparable state statutes. The Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), also known as "Superfund," imposes liability, without regard to fault or the legality of the original act, for release of a "hazardous substance" into the environment. Because these laws and regulations change from time to time, practices that have been acceptable to the industry and to the regulators have to be changed and assessment and monitoring have to be undertaken to determine whether those practices have damaged the environment and whether remediation is required. Since 1989, Transco has had studies underway to test certain of its facilities for the presence of toxic and hazardous substances to determine to what extent, if any, remediation may be necessary. On the basis of the findings to date, Transco estimates that environmental assessment and remediation costs that will be incurred over the next five years under TSCA, RCRA, CERCLA and comparable state statutes will total approximately $25 million to $30 million, measured on an undiscounted basis. This estimate depends upon a number of assumptions concerning the scope of remediation that will be required at certain locations and the cost of remedial measures to be undertaken. Transco is continuing to conduct environmental assessments and is implementing a variety of remedial measures that may result in increases or decreases in the total estimated costs. At December 31, 1999, Transco had a reserve of approximately $25 million for these estimated costs that has been recorded in current liabilities and other long-term liabilities in the accompanying Consolidated Balance Sheet. Transco considers environmental assessment and remediation costs and costs associated with compliance with environmental standards to be recoverable through rates, since they are prudent costs incurred in the ordinary course of business. To date, Transco has been permitted recovery of environmental costs incurred, and it is Transco's intent to continue seeking recovery of such costs, as incurred, through rate filings. Therefore, these estimated costs of environmental assessment and remediation have been recorded as regulatory assets in the accompanying Consolidated Balance Sheet. Transco has used lubricating oils containing polychlorinated biphenyls (PCBs) and, although the use of such oils was discontinued in the 1970s, has discovered residual PCB contamination in equipment and soils at certain gas compressor station sites. Transco has worked closely with the U. S. Environmental Protection Agency (EPA) and state regulatory authorities regarding PCB issues, and has a program to assess and remediate such conditions where they exist, the costs of which are included in the $25 million to $30 million range discussed above. Civil penalties have been assessed by the EPA against other major pipeline companies for the alleged improper use and disposal of PCBs. Transco has received and responded to information requests from the EPA. Although penalties have not presently been asserted except as indicated above in reference to the July, 1999 DOJ letter, no assurance can be given that the EPA will not seek such penalties in the future. Transco has been identified as a potentially responsible party (PRP) at various Superfund and state waste disposal sites. Based on present volumetric estimates and other factors, Transco's estimated aggregate exposure for remediation of these sites is less than $500,000. The estimated remediation costs for all such sites have been included in Transco's environmental reserve discussed above. Liability under CERCLA (and applicable state law) can be joint and several with other PRPs. Although volumetric allocation is a factor in assessing liability, it is not necessarily determinative; thus, the ultimate liability could be substantially greater than the amounts described above. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Since Transco meets the conditions set forth in General Instruction (I)(1)(a) and (b) of Form 10-K, this information is omitted. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Transco is an indirect wholly-owned subsidiary of Williams; therefore, Transco's common stock is not publicly traded. ITEM 6. SELECTED FINANCIAL DATA. Since Transco meets the conditions set forth in General Instruction (I)(1)(a) and (b) of Form 10-K, this information is omitted. ITEM 7. MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS. (THIS DISCUSSION SHOULD BE READ IN CONJUNCTION WITH ITEM 8, FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.) RESULTS OF OPERATIONS 1999 COMPARED TO 1998 NET INCOME AND OPERATING INCOME Transco's net income for 1999 was $161.2 million compared with net income of $135.7 million for 1998. Operating income for 1999 was $297.2 million compared to operating income of $273.7 million for 1998. The higher operating income of $23.5 million was primarily the result of higher transportation revenues, partially offset by higher administrative and general expense and depreciation and amortization expense discussed below. The increase in net income was attributable to the increased operating income, as well as lower net interest expense, due primarily to the adjustment to reserves for rate refunds discussed below and rate refunds made in 1998 and 1999, partially offset by lower allowance for funds used during construction due to lower capital expenditures. TRANSPORTATION REVENUES Transco's operating revenues related to its transportation services increased $42 million to $691 million for 1999 when compared to 1998. The higher transportation revenues were primarily due to positive adjustments to the reserve for rate refunds in Transco's general rate case Docket No. RP95-197 ($28.1 million) and rate case Docket No. RP97-71 ($23.4 million), benefits of expansion projects placed into service in 1998 ($14.2 million) and new services begun in 1998 ($2.4 million). These increases were partly offset by a decrease in commodity revenues ($11.2 million) due primarily to lower interruptible transportation volumes and firm long-haul transportation volumes, a lower level of reimbursable costs ($5.1 million) that are included in operating expenses and recovered in Transco's rates, lower demand revenues ($5.2 million) and the positive impact of a $4 million adjustment recorded in 1998 related to settlement rates contained in the January 1998 stipulation and agreement in Transco's general rate case Docket No. RP97-71 approved by the FERC in June 1998. During the first half of 1999, Transco engaged in an analysis of the court appeal related to Transco's general rate case Docket No. RP95-197 and, particularly, its likely results. Based on developments in regulatory proceedings in the second quarter of 1999 involving Transco and others, and advice received from counsel, Transco adjusted its reserve for rate refunds ($28.1 million of principal and $5.9 million of interest) in the second quarter of 1999 to reflect the FERC's revised rate of return methodology as applied in the July 29, 1998, and December 1, 1998 orders. In addition, based on developments in regulatory proceedings involving Transco and others, and advice received from counsel, in the fourth quarter of 1999, Transco adjusted its Docket No. RP97-71 reserve for rate refunds ($23.4 million, of which $14.4 million was applicable to revenues collected in 1998 and 1997, and $2.6 million of interest) to reflect its conclusion that risk associated with one of the issues in this proceeding has been eliminated. Transco is continuing to reserve amounts to account for other issues that may ultimately affect Transco's rate of return in this proceeding. Transco's market-area deliveries for 1999 increased 62.7 trillion British Thermal Units (TBtu), or 5%, when compared to 1998. The increased deliveries were mainly due to higher deliveries under the Mobile Bay Lateral Expansion Project and the Cherokee Expansion Project, which were placed into service in the latter part of 1998. Transco's production area deliveries for 1999 increased 8.0 Tbtu, or 4%, when compared to 1998 due to increased liquifiables transportation which resulted from higher prices paid for liquifiables in 1999. As a result of a straight fixed-variable (SFV) rate design, increases or decreases in firm transportation volumes in comparable facilities have no significant impact on operating income; however, because interruptible transportation rates have components of fixed and variable cost recovery, increases or decreases in interruptible transportation volumes do have an impact on operating income. SALES REVENUES Transco makes jurisdictional merchant gas sales to customers pursuant to a blanket sales certificate issued by the FERC, with most of those sales being made through a Firm Sales (FS) program which gives customers the option to purchase daily quantities of gas from Transco at market-responsive prices in exchange for a demand charge payment. Through an agency agreement with Transco, WESCO, an affiliate of Transco, manages Transco's jurisdictional merchant gas sales. The long-term purchase agreements managed by WESCO remain in Transco's name, as do the corresponding sales of such purchased gas. Therefore, Transco continues to record natural gas sales revenues and the related accounts receivable and cost of natural gas sales and the related accounts payable for the jurisdictional merchant sales that are managed by WESCO. Through the agency agreement, WESCO receives all margins associated with jurisdictional merchant gas sales business and, as Transco's agent, assumes all market and credit risk associated with Transco's jurisdictional merchant gas sales. Consequently, Transco's merchant gas sales service has no impact on Transco's operating income or results of operations. Transco's operating revenues related to its sales services, including Transco's cash out sales in settlement of gas imbalances, increased $178 million to $703 million for 1999, when compared to 1998. The increase was primarily due to higher cash out sales related to the settlement of imbalances, higher sales volumes and a higher average sales price of $2.27 per Dt for 1999 versus $2.10 per Dt in 1998. STORAGE REVENUES Transco's operating revenues related to storage services decreased $6 million to $137 million for 1999 when compared to 1998. This revenue decrease included a $6.9 million decrease due to lower underground storage rates charged by others, the majority of which is included in operation and maintenance expenses, and a $0.8 million decrease primarily due to lower storage demand charges, partly offset by the impact of a $1.5 million adjustment recorded in 1998 to the revenue refund reserve to reflect the actual rates contained in the RP97-71 Settlement Agreement. OTHER REVENUES Other operating revenues increased $4 million to $12 million for 1999 when compared to 1998, primarily due to an increase of $2.3 million in Parking and Borrowing Service revenues. OPERATING COSTS AND EXPENSES Excluding the cost of sales and transportation of $741 million and $568 million for 1999 and 1998, respectively, Transco's operating expenses were approximately $21 million higher in 1999 compared to 1998. This increase was primarily attributable to higher administrative and general expense and higher depreciation and amortization expense. The higher administrative and general expense was primarily attributable to higher building rent ($1.2 million), pension expense ($1.9 million), group insurance ($3.0 million) and labor ($3.3 million). The higher depreciation and amortization expense was due to a $3.8 million adjustment related to the RP97-71 settlement rates recorded in 1998, a $3.2 million adjustment on computer software recorded in 1998 and a $3.1 million increase in 1999, primarily due to plant and property additions. Operation and maintenance expense increased only slightly in 1999 ($0.2 million) over 1998, primarily attributable to the effects of a $5.7 million adjustment recorded in 1998 related to the RP97-71 settlement rates and higher professional services ($1.3 million), mostly offset by lower underground storage rates charged by others ($6.6 million). 1998 COMPARED TO 1997 NET INCOME AND OPERATING INCOME Transco's net income for 1998 was $135.7 million compared with net income of $111.4 million for 1997. The 1997 results include an after-tax extraordinary gain on reacquired debt of $2.9 million. Excluding this gain, Transco's net income for 1997 would have been $108.5 million. Operating income for 1998 was $273.7 million compared to operating income of $232.0 million for 1997. Excluding the extraordinary gain on reacquired debt for 1997, the higher net income of $27.2 million and higher operating income of $41.7 million for 1998 were primarily due to benefits of expansion projects placed into service in 1998 and the fourth quarter of 1997, new services that began in the last half of 1997, the positive impact of an adjustment related to settlement rates contained in the January 1998 Stipulation and Agreement in Transco's general rate case Docket No. RP97-71 approved by the FERC in June 1998 and lower operating expenses, partially offset by the effects of lower interruptible transportation and liquefiables volumes and a $5.4 million credit to the cost of natural gas transportation recorded in 1997 as a result of a settlement related to a prior rate proceeding. TRANSPORTATION REVENUES Transco's operating revenues related to its transportation services increased $21 million to $649 million for 1998, when compared to 1997. The higher transportation revenues were primarily due to benefits of the expansion projects placed into service in 1998 and the fourth quarter of 1997 ($26 million), new services that began in the last half of 1997 ($4 million) and an adjustment related to the RP97-71 settlement rates ($4 million), partly offset by the effects of lower interruptible transportation and liquefiables volumes ($11 million). Transco's market-area deliveries for 1998 were comparable to 1997. Transco's production-area deliveries for 1998 decreased 28.0 TBtu, or 12%, when compared to 1997, primarily as a result of milder weather conditions. SALES REVENUES Transco's operating revenues related to its sales services, including cash out sales in settlement of gas imbalances, decreased $146 million to $525 million for 1998, when compared to 1997. The decrease was primarily due to a lower average gas sales price of $2.10 per Dt for 1998 versus $2.51 per Dt in 1997 and lower sales volumes. STORAGE REVENUES Transco's operating revenues related to storage services increased $2 million to $143 million for 1998, when compared to 1997. This revenue increase included $5.8 million to recover higher underground storage rates charged by others that is included in operation and maintenance expense, partly offset by a $1.5 million adjustment related to the RP97-71 settlement rates and a $2.1 million decrease due primarily to lower storage withdrawals and lower demand charges. OTHER REVENUES Other operating revenues increased $4 million to $8 million for 1998 when compared to 1997, due to new services that began in the last half of 1997 and increased liquids transportation. OPERATING COSTS AND EXPENSES Excluding the cost of sales and transportation of $568 million and $706 million for 1998 and 1997, respectively, Transco's operating expenses were $22 million lower in 1998 than in 1997. The decrease was primarily due to lower expenses for operation and maintenance, administrative and general, depreciation and amortization and taxes other than income taxes. The lower operation and maintenance expense of $12.4 million was primarily attributable to a $9.2 million decrease in charges from others for the operation of certain Transco facilities, including a $4.1 million adjustment related to the RP97-71 settlement rates; a $1.6 million adjustment in pipe recoating costs, also related to the RP97-71 settlement rates; and lower costs of contractual services ($3.6 million), materials ($3.9 million) and professional services ($1.5 million); partly offset by a $6.0 million increase in underground storage expense. As described above, the increase in underground storage expense was largely offset by an increase in underground storage revenues. The lower administrative and general expense of $3.5 million was primarily due to lower costs of group insurance ($2.6 million) and the employee retirement plan ($1.1 million). The lower depreciation and amortization expense of $6.5 million resulted from a $9.9 million decrease due to lower depreciation rates on offshore transmission facilities, including a $3.8 million adjustment related to the RP97-71 settlement rates, and a $3.2 million decrease on computer software, partly offset by a $6.6 million increase due to plant and property additions. The lower taxes other than income taxes of $2.4 million was primarily due to lower payroll, sales and use taxes. RATE AND REGULATORY MATTERS See Note 3 of the Notes to Consolidated Financial Statements, included in Item 8 herein, for a discussion of Transco's rate and regulatory matters. GENERAL RATE CASE (DOCKET NO. RP97-71) On March 17, 2000, Transco received a favorable order from the FERC related to the rate of return and capital structure issues in Docket No. RP97-71. Transco is evaluating the effect of the order. Preliminary indications are that Transco's reserve for rate refunds may be considerably reduced in 2000. EFFECT OF INFLATION Transco generally has experienced increased costs due to the effect of inflation on the cost of labor, materials and supplies, and property, plant and equipment. A portion of the increased labor and materials and supplies cost can directly affect income through increased maintenance and operating costs. The cumulative impact of inflation over a number of years has resulted in increased costs for current replacement of productive facilities. The majority of Transco's property, plant and equipment and inventory is subject to ratemaking treatment, and under current FERC practices, recovery is limited to historical costs. While amounts in excess of historical cost are not recoverable under current FERC practices, Transco believes it will be allowed to recover and earn a return based on increased actual cost incurred when existing facilities are replaced. Cost based regulation along with competition and other market factors limit Transco's ability to price services or products based upon inflation's effect on costs. CAPITAL RESOURCES AND LIQUIDITY METHOD OF FINANCING Transco funds its capital requirements with cash flows from operating activities, including the sale of trade receivables, by accessing capital markets, by repayments of funds advanced to Williams, by borrowings under a bank credit agreement and short-term money market facilities and, if required, advances from Williams. In 1997, Transco filed a registration statement with Securities and Exchange Commission and, at December 31, 1999, the amount of $200 million of shelf availability remains under this registration statement which may be used to issue debt securities. Interest rates and market conditions will affect amounts borrowed, if any, under this arrangement. Transco believes any additional financing arrangements, if required, can be obtained on reasonable terms. Williams and certain of its subsidiaries, including Transco, are parties to a $1 billion credit agreement (Credit Agreement), under which Transco can borrow up to $400 million if the funds available under the Credit Agreement have not been borrowed by Williams or other subsidiaries. At December 31, 1999, Transco had no outstanding borrowings under the Credit Agreement. Transco's short-term money market facility expired in 1999. As a participant in Williams' cash management program, Transco and its subsidiaries have made advances to Williams. At December 31, 1999, net advances due Transco and its subsidiaries by Williams totaled $482 million. Additionally, Transco has made advances to WGP. At December 31, 1999, the advances due Transco by WGP totaled $13.7 million and were classified as long-term advances to affiliates in the accompanying Consolidated Balance Sheet. CAPITAL EXPENDITURES As shown in the table below, Transco's capital expenditures for 1999 included $43 million for market-area projects, primarily for the MarketLink and SouthCoast Projects, $4 million for supply-area projects and $140 million for maintenance of existing facilities and other projects. Transco has budgeted approximately $445 million in the year 2000 for capital expenditures related to expansion projects in the market area and the maintenance of existing facilities.
Budget Actual -------------- -------------------------------------------------- Capital Expenditures 2000 1999 1998 1997 - -------------------------- -------------- -------------- -------------- -------------- (In millions) Market-Area Projects ............ $ 227.0 $ 43.0 $ 78.2 $ 91.8 Supply-Area Projects ............ 1.5 3.7 127.6 47.7 Maintenance of Existing Facilities and Other Projects ............ 216.8 138.7 97.9 103.3 -------------- -------------- -------------- -------------- Total Capital Expenditures $ 445.3 $ 185.4 $ 303.7 $ 242.8 ============== ============== ============== ==============
OTHER CAPITAL REQUIREMENTS AND CONTINGENCIES ORDER 636 TRANSITION COSTS Transco implemented Order 636 services effective November 1, 1993. Transco does not expect to incur Gas Supply Realignment (GSR) costs associated with its firm sales service. Transco's non-GSR transition costs are anticipated to be insignificant. Order 636 provides that pipelines should be allowed the opportunity to recover all prudently incurred transition costs. Transco does not believe that Order 636 transition costs to be incurred by Transco will have a material adverse effect on its financial position or results of operations. RATE AND REGULATORY REFUNDS As discussed in Note 3 of the Notes to Consolidated Financial Statements included in Item 8 herein, Transco has filed general rate cases (Docket Nos. RP95-197 and RP97-71) under which all issues have not been resolved. Transco has provided reserves which it believes are adequate for any refunds that may be required under Docket No. RP97-71 and believes no refunds will be required under Docket No. RP95-197. REGULATORY AND LEGAL PROCEEDINGS As discussed in Note 3 of the Notes to Consolidated Financial Statements included in Item 8 herein, Transco is involved in several pending regulatory and legal proceedings. Because of the complexities of the issues involved in these proceedings, Transco cannot predict the actual timing of resolution or the ultimate amounts which might have to be refunded or paid in connection with the resolution of these pending regulatory and legal proceedings. ENVIRONMENTAL MATTERS As discussed in Note 3 of the Notes to Consolidated Financial Statements included in Item 8 herein, Transco is subject to extensive federal, state and local environmental laws and regulations which affect Transco's operations related to the construction and operation of its pipeline facilities. Transco considers environmental assessment and remediation costs and costs associated with compliance with environmental standards to be recoverable through rates, as they are prudent costs incurred in the ordinary course of business. To date, Transco has been permitted recovery of environmental costs incurred, and it is Transco's intent to continue seeking recovery of such costs, as incurred, through rate filings. LONG-TERM GAS PURCHASE CONTRACTS Transco has long-term gas purchase contracts containing either fixed prices or variable prices that are at a significant premium to the estimated market price. However, due to contract expirations and estimated deliverability declines, Transco's estimated purchase commitments under such gas purchase contracts are not material to Transco's total gas purchases. YEAR 2000 COMPLIANCE Transco encountered only minor problems associated with the date change from 1999 to 2000, and experienced no business disruptions. The total cost incurred by Transco to prepare for the year 2000 date change was $6.7 million. Transco believes that limited and insignificant continued exposure to year 2000 complications remains. Williams and its wholly-owned subsidiaries, which includes Transco, initiated its enterprise-wide project in 1997 to address the year 2000 compliance issue for both traditional information technology areas and non-traditional areas, including embedded technology which is prevalent throughout the company. The project focused on all technology hardware and software, external interfaces with customers and suppliers, operations process control, automation and instrumentation systems, and facility items. The phases of the project were awareness, inventory and assessment, renovation and replacement, testing and validation, and contingency planning. During the inventory and assessment phase, all systems with possible year 2000 implications were inventoried and classified into five categories: 1) highest, business critical, 2) high, compliance necessary within a short period of time following January 1, 2000, 3) medium, compliance necessary within 30 days from January 1, 2000, 4) low, compliance desirable but not required, and 5) unnecessary. Categories 1 through 3 were designated as critical and were the major focus of this project. Transco initiated a formal communications process with other companies in 1998 to determine the extent to which those companies were addressing year 2000 compliance. Transco also worked directly with key business partners to reduce the risk of a break in service or supply and with noncompliant companies to mitigate any material adverse effect on Transco. Significant focus on the contingency planning phase of the project took place in 1999. Contingency plans were developed for critical business processes, critical business partners, suppliers and system replacements that experience significant delays. Renovation/replacement and testing/validation of critical systems was completed by December 31, 1999. Over the December 31, 1999 to January 4, 2000 period, an extensive system monitoring plan was in place with regular reporting of results. Transco utilized both internal resources (consisting of a core group of 121 people) and external contractors (at a cost of approximately $5.0 million) to complete the year 2000 compliance project. Costs incurred for new software and hardware purchases were capitalized and other costs were expensed as incurred. The $6.7 million total cost incurred by Transco, including any accelerated system replacements, was spent as follows: Prior to 1998 and during the first quarter of 1998, Transco conducted the project awareness and inventory/assessment phases of the project and incurred minimal costs. During the second quarter of 1998, $0.1 million was spent on the renovation/replacement and testing/validation phases and completion of the inventory/assessment phase. The third and fourth quarters of 1998 focused on the renovation/replacement and testing/validation phases, and $1.8 million was incurred. During the first quarter of 1999, renovation/replacement and testing/validation continued, contingency planning began, and $1.8 million was incurred. During the second quarter of 1999, the primary focus shifted to testing/validation and contingency planning, and $1.2 million was spent. The primary focus during the third quarter of 1999 was contingency planning and final testing, and $1.6 million was incurred. The fourth quarter of 1999 focused mainly on contingency planning and final testing, and $0.2 million was spent. The amount estimated to be spent during the first two quarters of 2000 for monitoring and problem resolution is considered minimal. Virtually all of the $6.7 million incurred to date has been expensed with a minimal amount capitalized. Any future costs for monitoring and problem resolution will be expensed. This estimate does not include Transco's potential share of year 2000 costs that were incurred by partnerships and joint ventures in which the company participates but is not the operator. The costs of previously planned system replacements are not considered to be year 2000 costs and are, therefore, excluded from the amounts discussed above. The preceding discussion contains forward-looking statements including, without limitation, statements relating to the company's expectations, intentions, and adequate resources, that are made pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. Readers are cautioned that such forward-looking statements contained in the year 2000 update are based on certain assumptions which may vary from actual results. Specifically, management's expectations about the final impact on the company and estimates of the total cost to the company of the year 2000 compliance issue are based upon the assumptions that there will not be a significant future impact from, for example, problems caused by customers or suppliers that have not yet been fully recognized, or problems with billing, payroll, or financial closing at the quarters or year end. However, there can be no guarantee that these assumptions are correct. CONCLUSION Although no assurances can be given, Transco currently believes that the aggregate of cash flows from operating activities, supplemented, when necessary, by repayments of funds advanced to Williams, advances or capital contributions from Williams and borrowings under the Credit Agreement will provide Transco with sufficient liquidity to meet its capital requirements. When necessary, Transco also expects to access public and private markets on reasonable terms to finance its capital requirements. ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK Transco's interest rate risk exposure results, in part, from its debt portfolio which is influenced by short-term rates, primarily London Interbank Offered Rate (LIBOR) -based borrowings from commercial banks, and long-term U.S. Treasury rates. To mitigate the impact of fluctuations in its interest rates, Transco maintains a significant portion of its debt portfolio in fixed rate debt. In addition, Transco's interest rate risk exposure results from demand notes between Transco and WGP which were first issued in 1999. Transco currently does not expect to receive payment for the principal of these notes prior to their termination in 2009. The interest rate on the demand notes is LIBOR plus a fixed rate of 0.275% per annum for January 1, 1999 to January 31, 1999 and 0.6875% per annum for February 1, 1999 to termination of the notes. The following tables provide information about Transco's long-term debt as of December 31, 1999 and 1998, and long-term advances to affiliates as of December 31, 1999, both of which are subject to interest rate risk. The tables present principal cash flows and weighted-average interest rates by expected maturity dates.
December 31, 1999 Expected Maturity Date - ---------------------- -------------------------------------------------------------- 2000 2001 2002 2003 ------------ ------------ ------------ ------------ (Dollars in millions) Long-term debt: Fixed rate........................ $ - $ 200 $ 125 $ - Interest rate................... 7.23% 7.25% 7.21% 6.77% Variable rate..................... $ - $ - $ 150 $ - Interest rate (5.30% for 1999) Long-term advances to affiliates: Variable rate..................... $ - $ - $ - $ - Interest rate (5.90% for 1999)..
December 31, 1999 Expected Maturity Date - ---------------------- -------------------------------------------------------------- 2004 Thereafter Total Fair Value ------------ ------------ ------------ ------------ (Dollars in millions) Long-term debt: Fixed rate........................ $ - $ 500 $ 825 $ 783 Interest rate................... 6.76% 7.21% Variable rate..................... $ - $ - $ 150 $ 150 Interest rate (5.30% for 1999) Long-term advances to affiliates: Variable rate..................... $ - $ 13,689 $ 13,689 $ 13,689 Interest rate (5.90% for 1999)..
December 31, 1998 Expected Maturity Date - ---------------------- -------------------------------------------------------------- 1999 2000 2001 2002 ------------ ------------ ------------ ------------ (Dollars in millions) Long-term debt: Fixed rate........................ $ - $ - $ 200 $ 125 Interest rate................... 7.23% 7.23% 7.25% 7.21% Variable rate..................... $ - $ - $ - $ 150 Interest rate (5.65% for 1998)
December 31, 1998 Expected Maturity Date - ---------------------- -------------------------------------------------------------- 2003 Thereafter Total Fair Value ------------ ------------ ------------ ------------ (Dollars in millions) Long-term debt: Fixed rate........................ $ - $ 500 $ 825 $ 841 Interest rate................... 6.77% 7.17% Variable rate..................... $ - $ - $ 150 $ 150 Interest rate (5.65% for 1998)
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page ----------------- Report of Independent Auditors .................... 28 Consolidated Balance Sheet .................... 29-30 Consolidated Statement of Income .................... 31 Consolidated Statement of Common Stockholder's Equity... 32 Consolidated Statement of Cash Flows ................... 33-34 Notes to Consolidated Financial Statements.............. 35-59 REPORT OF INDEPENDENT AUDITORS Transcontinental Gas Pipe Line Corporation The Board of Directors We have audited the accompanying consolidated balance sheet of Transcontinental Gas Pipe Line Corporation as of December 31, 1999 and 1998, and the related consolidated statements of income, common stockholder's equity, and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Transcontinental Gas Pipe Line Corporation at December 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. ERNST & YOUNG LLP Tulsa, Oklahoma February 17, 2000 TRANSCONTINENTAL GAS PIPE LINE CORPORATION CONSOLIDATED BALANCE SHEET THOUSANDS OF DOLLARS
December 31, -------------------------------------- 1999 1998 ----------------- ----------------- ASSETS Current Assets: Cash ................................................................. $ 843 $ 1,470 Receivables: Trade (Notes 4 and 7) .............................................. 31,843 13,889 Affiliates ......................................................... 14,761 10,892 Advances to affiliates ............................................. 481,707 416,164 State income taxes ................................................. 2,811 2,725 Other .............................................................. 11,740 5,075 Transportation and exchange gas receivables: Affiliates.......................................................... 354 1,370 Others.............................................................. 45,611 56,475 Inventories: Gas in storage, at LIFO ............................................ 41,599 35,720 Materials and supplies, at lower of average cost or market ......... 30,989 30,172 Gas available for customer nomination .............................. 4,612 13,895 Deferred income taxes (Note 6) ........................................ 68,081 99,598 Other ................................................................. 17,071 16,714 ----------------- ----------------- Total current assets ............................................... 752,022 704,159 ----------------- ----------------- Long-term advances to affiliates........................................... 13,689 - ----------------- ----------------- Investments, at cost plus equity in undistributed earnings ................ 58,093 8,915 ----------------- ----------------- Property, Plant and Equipment: Natural gas transmission plant ........................................ 4,452,101 4,259,502 Less - Accumulated depreciation and amortization ...................... 791,061 616,120 ----------------- ----------------- Total property, plant and equipment, net ........................... 3,661,040 3,643,382 ----------------- ----------------- Other Assets .............................................................. 174,336 175,501 ----------------- ----------------- $ 4,659,180 $ 4,531,957 ================= ================= The accompanying notes are an integral part of these consolidated financial statements.
TRANSCONTINENTAL GAS PIPE LINE CORPORATION CONSOLIDATED BALANCE SHEET THOUSANDS OF DOLLARS
December 31, -------------------------------------- 1999 1998 ----------------- ----------------- LIABILITIES AND STOCKHOLDER'S EQUITY Current Liabilities: Payables: Trade .............................................................. $ 87,580 $ 51,147 Affiliates ......................................................... 53,440 25,050 Other .............................................................. 14,954 21,138 Transportation and exchange gas payable: Affiliates ......................................................... 868 379 Others ............................................................. 7,569 8,354 Accrued liabilities: Federal income taxes payable to affiliate .......................... 21,866 26,076 Other taxes ........................................................ 12,967 16,467 Interest ........................................................... 21,191 20,885 Employee benefits .................................................. 56,494 51,616 Other .............................................................. 20,658 41,587 Reserve for rate refunds .............................................. 159,632 238,403 ----------------- ----------------- Total current liabilities .......................................... 457,219 501,102 ----------------- ----------------- Long-Term Debt (Note 4) ................................................... 975,330 975,768 ----------------- ----------------- Other Long-Term Liabilities: Deferred income taxes (Note 6)......................................... 879,506 846,306 Other ................................................................. 123,897 146,740 ----------------- ----------------- Total other long-term liabilities .................................. 1,003,403 993,046 ----------------- ----------------- Commitments and contingencies (Note 3) .................................... Cumulative Redeemable Preferred Stock, without par value: Authorized 10,000,000 shares: none issued or outstanding .............. - - ----------------- ----------------- Cumulative Redeemable Second Preferred Stock, without par value: Authorized 2,000,000 shares: none issued or outstanding ............... - - ----------------- ----------------- Common Stockholder's Equity: Common Stock $1.00 par value: 100 shares authorized, issued and outstanding ...................... - - Premium on capital stock and other paid-in capital .................... 1,652,430 1,652,430 Retained earnings ..................................................... 570,798 409,611 ----------------- ----------------- Total common stockholder's equity .................................. 2,223,228 2,062,041 ----------------- ----------------- $ 4,659,180 $ 4,531,957 ================= ================= The accompanying notes are an integral part of these consolidated financial statements.
TRANSCONTINENTAL GAS PIPE LINE CORPORATION CONSOLIDATED STATEMENT OF INCOME THOUSANDS OF DOLLARS
Years Ended December 31 ---------------------------------------------------------- 1999 1998 1997 ---------------- ---------------- ----------------- Operating Revenues: Natural gas sales.................................. $ 703,028 $ 524,822 $ 670,879 Natural gas transportation......................... 691,101 648,508 627,301 Natural gas storage................................ 137,050 143,275 141,108 Other ............................................. 12,277 8,531 4,011 ---------------- ---------------- ----------------- Total operating revenues........................ 1,543,456 1,325,136 1,443,299 ---------------- ---------------- ----------------- Operating Costs and Expenses Cost of natural gas sales.......................... 702,884 524,822 670,879 Cost of natural gas transportation................. 38,400 42,765 34,718 Operation and maintenance.......................... 172,912 172,769 185,175 Administrative and general......................... 130,027 120,632 124,145 Depreciation and amortization (Note 2)............. 161,480 151,387 157,883 Taxes - other than income taxes.................... 34,927 34,392 36,745 Other ............................................. 5,601 4,632 1,787 ---------------- ----------------- ---------------- Total operating costs and expenses.............. 1,246,231 1,051,399 1,211,332 ---------------- ---------------- ----------------- Operating Income....................................... 297,225 273,737 231,967 ---------------- ---------------- ----------------- Other (Income) and Other Deductions: Interest expense- affiliates..................... 243 45 2 - other.......................... 70,315 91,610 71,637 Interest income - affiliates..................... (25,770) (27,290) (9,213) - other.......................... (5) (92) (50) Allowance for equity and borrowed funds used during construction (AFUDC)...................... (5,542) (9,792) (7,771) Equity in earnings of unconsolidated affiliates.... (3,214) (239) (504) Miscellaneous other deductions, net................ 1,091 4,520 2,744 ---------------- ----------------- ----------------- Total other (income) and other deductions....... 37,118 58,762 56,845 ---------------- ---------------- ----------------- Income before Income Taxes and Extraordinary Item............................... 260,107 214,975 175,122 Provision for Income Taxes (Note 6)................ 98,920 79,281 66,594 ---------------- ---------------- ----------------- Income before Extraordinary Item................... 161,187 135,694 108,528 Extraordinary Item - Net Gain on Reacquired Debt .. - - 2,860 ---------------- ---------------- ----------------- Net Income......................................... $ 161,187 $ 135,694 $ 111,388 ================ ================ ================= The accompanying notes are an integral part of these consolidated financial statements.
TRANSCONTINENTAL GAS PIPE LINE CORPORATION CONSOLIDATED STATEMENT OF COMMON STOCKHOLDER'S EQUITY THOUSANDS OF DOLLARS
Years Ended December 31, ---------------------------------------------------------- 1999 1998 1997 ---------------- ---------------- ----------------- Common Stock: Balance at beginning and end of period............. $ - $ - $ - ---------------- ---------------- ----------------- Premium on Capital Stock and Other Paid-in Capital: Balance at beginning and end of period............. 1,652,430 1,652,430 1,652,430 ---------------- ---------------- ----------------- Retained Earnings: Balance at beginning of period..................... 409,611 273,917 166,784 Add (deduct): Net income...................................... 161,187 135,694 111,388 Cash dividends on common stock.................. - - (4,255) Non-cash dividends on common stock.............. - - - ---------------- ---------------- ----------------- Balance at end of period........................... 570,798 409,611 273,917 ---------------- ---------------- ----------------- Total Common Stockholder's Equity.................. $ 2,223,228 $ 2,062,041 $ 1,926,347 ================ ================ ================= The accompanying notes are an integral part of these consolidated financial statements.
TRANSCONTINENTAL GAS PIPE LINE CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS THOUSANDS OF DOLLARS
Years Ended December 31, ---------------------------------------------------------- 1999 1998 1997 ---------------- ---------------- ----------------- Cash flows from operating activities: Net income............................................. $ 161,187 $ 135,694 $ 111,388 Adjustments to reconcile net income to net cash provided by operating activities: Extraordinary item - net gain on reacquired debt.... - - (2,860) Depreciation and amortization (Note 2).............. 166,368 157,942 164,224 Deferred income taxes (Note 6)...................... 64,717 (5,729) (7,029) Allowance for equity funds used during construction (Equity AFUDC).................................... (3,853) (7,169) (5,377) Changes in operating assets and liabilities: Receivables...................................... (32,328) 7,634 27,487 Receivables sold................................. 4,900 (13,000) - Transportation and exchange gas receivable....... 11,880 32,547 4,619 Inventories...................................... 2,587 4,453 (14,779) Payables......................................... 57,658 (35,270) (18,481) Transportation and exchange gas payable.......... (296) (9,674) (8,833) Accrued liabilities.............................. (21,707) 26,363 28,047 Reserve for rate refunds......................... (78,771) 33,849 31,731 Other, net....................................... (28,581) (30,594) 5,657 ---------------- ---------------- ----------------- Net cash provided by operating activities..... 303,761 297,046 315,794 ---------------- ---------------- ----------------- Cash flows from financing activities: (Note 4) Additions to long-term debt............................ - 298,343 310,000 Retirement of long-term debt........................... - (160,000) (249,000) Debt issue costs....................................... - (2,060) (253) Dividends on common stock.............................. - - (4,255) ---------------- ---------------- ----------------- Net cash provided by financing activities..... - 136,283 56,492 ---------------- ---------------- -----------------
TRANSCONTINENTAL GAS PIPE LINE CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS THOUSANDS OF DOLLARS
Years Ended December 31, ---------------------------------------------------------- 1999 1998 1997 ---------------- ---------------- ----------------- Cash flows from investing activities: Property, plant and equipment: Additions, net of equity AFUDC...................... (186,297) (301,078) (242,202) Changes in accounts payable......................... 958 (2,629) (594) Sale of assets......................................... 2,503 - - Advances to affiliates, net............................ (79,232) (134,710) (132,958) Investments in affiliates, net......................... (45,940) (1,954) (703) Other, net............................................. 3,620 7,191 3,718 ---------------- ---------------- ----------------- Net cash used in investing activities......... (304,388) (433,180) (372,739) ---------------- ---------------- ----------------- Net increase (decrease) in cash........................ (627) 149 (453) Cash at beginning of period............................ 1,470 1,321 1,774 ================ ================ ================= Cash at end of period.................................. $ 843 $ 1,470 $ 1,321 ================ ================ ================= Supplemental disclosures of cash flow information: Cash paid during the year for: Interest (exclusive of amount capitalized)....... $ 83,539 $ 62,287 $ 69,657 Income taxes paid................................ 41,893 86,862 57,958 Income tax refunds received...................... (1,486) (77) (11,821) The accompanying notes are an integral part of these consolidated financial statements.
TRANSCONTINENTAL GAS PIPE LINE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Corporate Structure and Control................................... 35 2. Summary of Significant Accounting Policies........................ 35 3. Contingent Liabilities and Commitments............................ 39 4. Debt, Financing Arrangements and Leases........................... 50 5. Employee Benefit Plans............................................ 52 6. Income Taxes...................................................... 55 7. Financial Instruments............................................. 56 8. Transactions with Major Customers and Affiliates.................. 57 9. Quarterly Information (Unaudited)................................. 58 1. CORPORATE STRUCTURE AND CONTROL Transcontinental Gas Pipe Line Corporation (Transco) is a wholly-owned subsidiary of Williams Gas Pipeline Company (WGP). WGP is a wholly-owned subsidiary of The Williams Companies, Inc. (Williams). Prior to May 1, 1997, Transco was a wholly-owned subsidiary of Williams. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS Transco is an interstate natural gas transmission company which owns a natural gas pipeline system extending from Texas, Louisiana, Mississippi and the Gulf of Mexico through the states of Alabama, Georgia, South Carolina, North Carolina, Virginia, Maryland, Pennsylvania and New Jersey to the New York City metropolitan area. The system serves customers in Texas and the eleven southeast and Atlantic seaboard states mentioned above, including major metropolitan areas in Georgia, North Carolina, New York, New Jersey and Pennsylvania. Transco also holds a minority interest in an intrastate natural gas pipeline in North Carolina. BASIS OF PRESENTATION The acquisition of Transco Energy Company (TEC) and its subsidiaries, including Transco, by Williams in 1995 was accounted for using the purchase method of accounting. Accordingly, an allocation of the purchase price was assigned to the assets and liabilities of Transco based on their estimated fair values. The purchase price allocation to Transco primarily consisted of a $1.5 billion allocation to property, plant and equipment, which is being amortized on a straight-line basis, and adjustments to deferred taxes based upon the book basis of the net assets recorded as a result of the acquisition. Current Federal Energy Regulatory Commission (FERC) policy does not permit Transco to recover through rates amounts in excess of original cost. As a participant in Williams' cash management program, Transco and its subsidiaries have advances to and from Williams. These advances are represented by demand notes. Transco currently expects to receive payment of these advances within the next twelve months and has recorded such advances as current in the accompanying Consolidated Balance Sheet. Transco has also made advances to WGP. Transco currently does not expect to receive payment of these advances within the next twelve months and has recorded such advances as long-term advances to affiliates in the accompanying Consolidated Balance Sheet. The interest rate on intercompany demand notes is the London Interbank Offered Rate plus a rate ranging from 0.275% to 0.750% per annum. Through an agency agreement with Transco, Williams Energy Services Company (WESCO), an affiliate of Transco, manages Transco's jurisdictional merchant gas sales. The long-term purchase agreements managed by WESCO remain in Transco's name, as do the corresponding sales of such purchased gas. Therefore, Transco continues to record natural gas sales revenues and the related accounts receivable and cost of natural gas sales and the related accounts payable for the jurisdictional merchant sales that are managed by WESCO. Through the agency agreement, WESCO receives all margins associated with jurisdictional merchant gas sales business and, as Transco's agent, assumes all market and credit risk associated with Transco's jurisdictional merchant gas sales. Consequently, Transco's merchant gas sales service has no impact on its operating income or results of operations. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Transco and its majority-owned subsidiaries. Companies in which Transco and its subsidiaries own 20 percent to 50 percent of the voting common stock are accounted for under the equity method. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment is recorded at cost, adjusted in 1995 to reflect the allocation of the purchase price as discussed above. Gains or losses from the ordinary sale or retirement of property, plant and equipment are credited or charged to accumulated depreciation; other gains or losses are recorded in net income. Depreciation rates used for major regulated gas plant facilities at December 31, 1999, 1998, and 1997 were: Category of Property 1999 1998 1997 - ------------------------- ----------- ------------ ----------- Gathering facilities 2.60%-3.80% 2.60%-3.80% 2.60-3.80% Storage facilities 2.50% 2.50% 2.50% Onshore transmission facilities 2.35% 2.35% 2.35% Offshore transmission facilities 1.50% 1.50% 2.25% Depreciation of general plant is provided on a group basis at straight-line rates. Under the terms of a settlement in Transco's general rate case in Docket No. RP97-71, which was effective May 1, 1997, Transco agreed to reduce the depreciation rate for offshore transmission facilities. The reduction in the depreciation rate had no effect on operating or net income due to an offsetting reduction in operating revenues, but did result in lower cash flows from operations. The reduction in the rate was recorded in 1998, retroactive to May 1, 1997. ACCOUNTING FOR INCOME TAXES Williams and its wholly-owned subsidiaries, which includes Transco, file a consolidated federal income tax return. It is Williams' policy to charge or credit Transco with an amount equivalent to its federal income tax expense or benefit computed as if Transco had filed a separate return. Transco uses the liability method of accounting for deferred income taxes which requires, among other things, provisions for all temporary differences between the financial basis and the tax basis in Transco's assets and liabilities and adjustments to the existing deferred tax balances for changes in tax rates, whereby such balances will more closely approximate the actual taxes to be paid. REVENUE RECOGNITION Revenues for sales of products are recognized in the period of delivery and revenues from the transportation of gas are recognized based on contractual terms and the related transported volumes. Transco is subject to FERC regulations and, accordingly, certain revenues collected may be subject to possible refunds upon final orders in pending cases. Transco records rate refund liabilities considering Transco and other third party regulatory proceedings, advice of counsel and estimated total exposure, as discounted and risk weighted, as well as collection and other risks. ALLOWANCE FOR DOUBTFUL RECEIVABLES Due to its customer base, Transco has not historically experienced recurring credit losses in connection with its receivables. As a result, receivables determined to be uncollectible are reserved or written off in the period of such determination. At December 31, 1999 and 1998, Transco had no allowance for doubtful accounts. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION The allowance for funds used during construction (AFUDC) represents the cost of funds applicable to regulated natural gas transmission plant under construction as permitted by FERC regulatory practices. The allowance for borrowed funds used during construction was $1.7 million, $2.6 million and $2.4 million for 1999, 1998 and 1997, respectively. The allowance for equity funds was $3.9 million, $7.2 million and $5.4 million for 1999, 1998 and 1997, respectively. GAS IN STORAGE Transco utilizes the last-in, first-out (LIFO) method of accounting for inventory gas in storage. GAS IMBALANCES In the course of providing transportation services to customers, Transco may receive different quantities of gas from shippers than the quantities delivered on behalf of those shippers. Additionally, Transco transports gas on various pipeline systems which may deliver different quantities of gas on behalf of Transco than the quantities of gas received from Transco. These transactions result in gas transportation and exchange imbalance receivables and payables which are recovered or repaid in cash or through the receipt or delivery of gas in the future and are recorded in the accompanying Consolidated Balance Sheet. Settlement of imbalances requires agreement between the pipelines and shippers as to allocations of volumes to specific transportation contracts and timing of delivery of gas based on operational conditions. Transco's tariff includes a method whereby most transportation imbalances generated after August 1, 1991 are settled on a monthly basis. Imbalances predating August 1, 1991 are being recovered or repaid in cash or through the receipt or delivery of gas upon agreement of the parties as to the allocation of the gas volumes, and as permitted by pipeline operating conditions. These imbalances have been classified as current assets or current liabilities at December 31, 1999 and 1998. EMPLOYEE STOCK-BASED AWARDS Employee stock-based awards are accounted for under Accounting Principles Board Opinion (APBO) No. 25, "Accounting for Stock Issued to Employees" and related interpretations. Williams' fixed plan common stock options do not result in compensation expense, because the exercise price of the stock options equals the market price of the underlying stock on the date of grant. NEW ACCOUNTING STANDARDS The Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities". This standard, as amended by SFAS No. 137, will be effective for Transco beginning January 1, 2001. This standard requires that all derivatives be recognized as assets or liabilities in the balance sheet and that those instruments be measured at fair value. The effect of this standard on Transco's results of operations and financial position is being evaluated. The American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-5, "Reporting on the Costs of Start-Up Activities," effective January 1, 1999. The SOP requires that all start-up costs be expensed as incurred. The SOP did not have any significant effect on Transco's reported consolidated results of operations, financial position or cash flows. RECLASSIFICATIONS Certain reclassifications have been made in the 1998 and 1997 financial statements to conform to the 1999 presentation. 3. CONTINGENT LIABILITIES AND COMMITMENTS RATE AND REGULATORY MATTERS GENERAL RATE CASE (DOCKET NO. RP97-71) On November 1, 1996, Transco submitted to the FERC a general rate case filing principally designed to recover costs associated with increased capital expenditures. These increased capital expenditures primarily relate to system reliability, integrity and Clean Air Act compliance. When stated on a comparable basis, the rates Transco placed into effect on May 1, 1997, subject to refund, represented an annual cost of service increase of approximately $47 million over the cost of service underlying the rates contained in the settlement of Transco's last general rate filing (Docket No. RP95-197). The filing also included (1) a pro-forma proposal to roll-in the costs of Transco's Leidy Line and Southern expansion incremental projects and (2) a pro-forma proposal to make interruptible transportation (IT) backhaul rates equal to the IT forward haul rates. On November 29, 1996, the FERC issued an order accepting Transco's filing, suspending its effectiveness until May 2, 1997 (subsequently revised, on rehearing, to May 1, 1997) and establishing a hearing to examine the reasonableness of Transco's proposed rates. In addition, the order consolidated Transco's pro forma roll-in proposal with the Phase II hearing in Docket No. RP95-197. On January 20, 1998, Transco filed a Stipulation and Agreement for approval by the FERC, which resolves all cost of service, throughput and other issues in this proceeding, except rate of return, capital structure and certain minor cost allocation and rate design issues. On June 12, 1998, the FERC issued an order approving the settlement. On October 30, 1998, Transco issued refunds in connection with the settlement in the amount of $89.5 million, including interest, for which Transco had previously provided a reserve. The issues not resolved by the settlement were litigated by the parties before a FERC Administrative Law Judge (ALJ). On March 30, 1999, the ALJ issued her initial decision which is consistent with the rate of return and capital structure policies FERC announced in RP95-197 (see discussion below). Applying these policies, the ALJ recommended utilization of Transco's own capital structure, consisting of 60.2% equity, and a return on equity of 12.40%. The ALJ's decision is subject to FERC review. Based on developments in regulatory proceedings involving Transco, and on advice from counsel, in the fourth quarter of 1999, Transco adjusted its remaining reserve for rate refunds by $23.4 million to reflect its conclusion that the risk associated with one of the issues in this proceeding has been eliminated. Transco is continuing to accrue amounts to account for other issues that may ultimately affect Transco's rate of return in this proceeding. Transco believes the remaining reserve is adequate for any refunds that may be required. GENERAL RATE CASE (DOCKET NO. RP95-197) On March 1, 1995, Transco filed with the FERC a general rate case that proposed changes in the rates for Transco's transportation, sales and storage service rate schedules effective April 1, 1995. The changes in rates, if accepted as proposed, would have generated additional annual jurisdictional revenues of approximately $132 million over the pre-filed rates in effect, based, among other things, on an increase in Transco's cost of capital resulting from an increase in the equity component of the capital structure used (the filing was based on Transco's own capital structure) and in the cost of equity from the pre-filed rate of return on equity of 14.45% to the proposed rate of return on equity of 15.25%. On March 31, 1995, the FERC issued an order on Transco's filing which accepted and suspended the tariff sheets relating to Transco's rates, to be effective September 1, 1995, subject to refund, and established hearing procedures. On June 19, 1996, Transco filed with the FERC a Stipulation and Agreement which resolved cost of service (except capital structure and rate of return), throughput level and mix, and certain cost allocation and rate design issues. The agreement also reserved certain other issues for hearing, including the issue of rolled-in pricing for incremental Leidy Line services. With the exception of one party that filed comments opposing the settlement and one party that took no position on the merits of the settlement, all active parties and the FERC's staff either supported the settlement or did not oppose it. Transco began billing the settlement rates to non-contesting parties effective August 1, 1996. On October 9, 1996, Transco filed with the FERC a Stipulation and Agreement which, subject to the outcome of the litigation of the reserved issues in this proceeding, settled the issues of cost of service and throughput with the one party that opposed the resolution of those issues in the June 19, 1996 settlement. On November 1, 1996, the FERC issued an order approving the June 19 agreement, and on December 23, 1996, FERC approved the October 9, 1996 agreement. On February 3, 1997, the FERC denied rehearing of its November 1, 1996 order. As a result, Transco made refunds on May 30, 1997 of approximately $79.0 million, including interest, under Docket No. RP95-197 for which Transco had previously provided a reserve. Following a hearing before an ALJ, the ALJ's initial decision and an August 1, 1997, order from the FERC, the FERC issued a rehearing order on July 29, 1998, addressing Transco's capital structure and rate of return for ratemaking purposes. As to capital structure, the FERC affirmed the use of Transco's own capital structure, consisting of 57.58% equity, in developing Transco's rate of return in this proceeding. As discussed in greater detail below, the FERC also modified its previously used methodology for determining return on equity. Applying its revised methodology to Transco in this proceeding, the FERC established a rate of return on equity for Transco of 12.49%. A joint request for rehearing of the July 29, 1998 order was filed with the FERC and, on December 1, 1998, the FERC denied rehearing. On January 29, 1999, most of the same parties that were involved in the joint request for rehearing filed a notice of appeal with the United States Court of Appeals for the District of Columbia (D.C. Circuit Court). Transco made refunds on March 1, 1999 of approximately $96.0 million, including interest, under Docket No. RP95-197 for which Transco had previously provided a reserve. During the first half of 1999, Transco engaged in an analysis of the court appeal and, particularly, its likely results. Based on developments in regulatory proceedings in the second quarter of 1999 involving Transco and others, and advice received from counsel, Transco adjusted its remaining reserve for rate refunds ($28.1 million of principal and $5.9 million of interest) in the second quarter of 1999 to take into account the FERC's revised rate of return methodology as applied in the July 29, 1998, and December 1, 1998 orders. On February 7, 2000, the D.C. Circuit Court denied the appeal filed in January 1999. The hearing concerning the other cost allocation and rate design issues not resolved by the June 19, 1996 and October 9, 1996 agreements concluded in November 1996. A supplemental hearing to consider Transco's roll-in proposal filed in Docket No. RP97-71, as discussed above, was completed in June 1997. On March 24, 1998, the ALJ issued an initial decision on all of these issues. As to the main issue addressed in the decision, rolled-in pricing, the ALJ determined that the proponents of roll-in, including Transco, must satisfy the burden under Section 5 of the NGA and demonstrate that Transco's existing incremental rate treatment is unjust and unreasonable and that the proposed rolled-in rate treatment is just and reasonable. The ALJ ruled that neither Transco nor any of the other roll-in proponents had satisfied that burden and, therefore, that Transco's existing incremental rate treatment must remain in effect. On April 16, 1999, the FERC issued an order reversing the ALJ, concluding that Transco's proposal did not have to meet the Section 5 burden discussed above and that under the appropriate standard, Section 4, Transco had demonstrated that its proposal was just and reasonable. As a result, the FERC remanded to the ALJ issues regarding the implementation of Transco's roll-in proposal. Several parties have filed requests for rehearing of the FERC's April 16, 1999 order. RATE OF RETURN CALCULATION The FERC uses a methodology for calculating pipeline rates of return that incorporates a long-term growth rate component. The long-term growth rate component used by the FERC is a projection of U.S. gross domestic product growth rates. Generally, calculating rates of return utilizing a methodology which includes a long-term growth rate component results in rates of return that are lower than they would be if the long-term growth rate component were not included in the methodology. On January 30, 1998, the FERC convened a public conference to explore, among other things, possible modifications to the FERC's rate of return methodology. As discussed above, in its July 29, 1998 order, the FERC modified its rate of return methodology with regard to the weight to be given to the long-term growth component. Under its previous methodology, the FERC averaged the short and long-term growth projections, thereby giving them equal weight. In its July 29, 1998 order, the FERC changed its policy and will accord the short-term projection a two-thirds weighting and the long-term projection a one-third weighting. The FERC has determined that the short-term projection is more reliable and should be given more weight, but that the long-term projection should be given some weight in order to normalize any distortions that may be reflected in the short-term data. The revised weighting to be reflected in the FERC's methodology should lead to somewhat higher rates of return on equity than were obtained under the previous methodology. In addition, the FERC will now permit parties to argue that a pipeline's return on equity be established at any point within the range of returns developed under the two-stage methodology (rather than only at the high, mid or low point in the range) based on the pipeline's relative level of risk. In that regard, when assessing a pipeline's relative risk, the FERC determined that it will not lower a pipeline's return on equity if its lower risk is the result of the pipeline's own efficiency, but will focus on risks faced by the pipeline that are attributable to circumstances outside the control of the pipeline's management. PRODUCTION AREA RATE DESIGN (DOCKET NOS. RP92-137, RP93-136 AND RP98-381) Transco has expressed to the FERC concerns that inconsistent treatment under Order 636 of Transco and its competitor pipelines with regard to rate design and cost allocation issues in the production area may result in rates which could make Transco less competitive, both in terms of production-area and long-haul transportation. A hearing before an ALJ (Docket Nos. RP92-137 and RP93-136), dealing with, among other things, Transco's production-area rate design, concluded in June 1994. On July 19, 1995, the ALJ issued an initial decision finding that Transco's proposed production area rate design, and its existing use of a system wide cost of service and allocation of firm capacity in the production area are unjust and unreasonable. The ALJ therefore recommended that Transco divide its costs between its production area and market area, and permit its customers to renominate their firm entitlements. On July 3, 1996, the FERC issued an order on review of the ALJ's initial decision concerning, among other things, Transco's production area rate design. The FERC rejected the ALJ's recommendations that Transco divide its costs between its production area and market area, and permit its customers to renominate their firm entitlements. The FERC also concluded that Transco may offer firm service on its supply laterals through an open season and eliminate its IT feeder service in favor of an interruptible service option that does not afford shippers feeding firm transportation on Transco's production area mainline a priority over other interruptible transportation. On December 18, 1996, the FERC denied rehearing of its July 3, 1996 Order. Several parties, including Transco, filed petitions for review in the D.C. Circuit Court of the FERC's orders addressing production area rate design issues. Those appeals were held in abeyance pending the outcome of the proceedings in Transco's Docket No. RP98-381. In light of the FERC's orders rejecting Transco's proposal in Docket No. RP98-381, Transco withdrew its appeal and the remaining appeal was restored to the active docket. On August 31, 1998, Transco made a limited NGA Section 4 filing with the FERC to implement firm transportation service on Transco's production area supply laterals in accordance with the option authorized by the FERC's July 3 and December 18, 1996 orders. The filing (Docket No. RP98-381) was protested, and on September 30, 1998, the FERC accepted the filing and suspended its effectiveness until March 1, 1999, subject to further proceedings. On December 16, 1998, the FERC determined that the filing was not barred by prior Transco settlements, but on February 24, 1999, issued an order rejecting the filing, finding that Transco's proposal, as filed, conflicts with certain FERC policies. The FERC indicated that Transco could pursue implementation of firm service on Transco's production area supply laterals to the extent the service is structured in a way that conforms with those policies. Transco sought rehearing of the February 24, 1999 order and on July 29, 1999, the FERC issued an order denying all requests for rehearing in this proceeding. As a result, Transco's production area supply lateral service remains unchanged. GATHERING FACILITIES SPIN-DOWN ORDER (DOCKET NOS. CP96-206-000 AND CP96-207- 000) In February 1996, Transco filed an application with the FERC for an order authorizing the abandonment of certain facilities located onshore and offshore in Texas, Louisiana and Mississippi by conveyance to Williams Gas Processing - Gulf Coast Company (Gas Processing), an affiliate of Transco. The net book value recorded by Transco at December 31, 1999 of the facilities was approximately $475 million. Operating income recorded by Transco for the year ended December 31, 1999 associated with the facilities was approximately $11 million; however, such operating income may not be representative of the effects of the spin-down on Transco's future operating income due to various factors, including future regulatory actions. Concurrently, Gas Processing filed a petition for declaratory order requesting a determination that its gathering services and rates be exempt from FERC regulation under the NGA. On September 25, 1996, the FERC issued an order dismissing Transco's application and Gas Processing's petition for declaratory order. On October 25, 1996, Transco and Gas Processing filed a joint request for rehearing of the FERC's September 25 order, and in August 1997 filed a request that rehearing be expedited. On June 1, 1998, the FERC issued a Notice of Inquiry (NOI) into alternative methods for regulating natural gas pipeline facilities and services on the Outer Continental Shelf (OCS). The purpose of the NOI is to generate public comment that will assist the FERC in exploring possible alternatives to the FERC's current test used to determine whether offshore pipeline facilities and services should be subject to the FERC's NGA jurisdiction. On June 30, 1999, informed by the comments submitted in response to the NOI, the FERC issued a Notice of Proposed Rulemaking (NOPR), which proposes regulatory requirements under the Outer Continental Shelf Lands Act (OCSLA) to ensure that gas is transported on an open and nondiscriminatory basis through pipelines located on the OCS. The proposed regulations will apply both to NGA-jurisdictional and NGA-exempt offshore gas transportation service providers, and will require that those OCS gas transportation service providers, subject to certain exemptions, make available information regarding their affiliations and the conditions under which service is rendered. These proposed reporting requirements are intended by the FERC to assure that open access and nondiscriminatory conditions of service, including nondiscriminatory rates, exist for shippers using OCS facilities. The FERC is seeking comments from interested persons on the regulations proposed in the NOPR. Also on June 30, 1999, the FERC modified, in a case involving Sea Robin Pipeline Company, the test that the FERC will use to determine the jurisdictional status of OCS pipeline systems. In the Sea Robin case, the FERC determined that in assessing the jurisdictional status of offshore facilities, the location of gas processing plants will not be afforded greater significance than other factors used in the test. In addition, the FERC determined that the location of a collection facility, where gas is delivered by several relatively small diameter lines for aggregation and preparation for further delivery onshore through a single larger diameter pipeline, will be given considerable weight for determining the demarcation point between gathering and jurisdictional transportation on the OCS. The FERC stated that it will use this modified test, and any additional refinements that the FERC may develop to further adapt the test to the physical characteristics of moving gas across the OCS, to determine the jurisdictional status of the OCS pipeline systems. TILDEN/MCMULLEN FACILITIES SPIN-DOWN PROCEEDING (DOCKET NOS. CP98-236 AND 242) In February 1998, Transco filed an application with the FERC seeking authorization to abandon Transco's onshore Tilden/McMullen Gathering System located in Texas by conveyance to Gas Processing. Gas Processing filed a contemporaneous request that the FERC declare that the facilities sought to be abandoned would be considered nonjurisdictional gathering facilities upon transfer to Gas Processing. In May 1999, the FERC issued an order in which it determined that certain of the facilities would be gathering facilities upon transfer to Gas Processing, i.e., 1) those facilities upstream of and including the Tilden Plant, 2) the South McMullen and Goebel Laterals located downstream of the Tilden Plant, and 3) the small, short laterals which branch out from the McMullen Lateral downstream of the Tilden Plant at several points along its length. However, the FERC determined that the McMullen Lateral itself, as well as two compressor units, are jurisdictional facilities, but authorized their abandonment subject to Gas Processing obtaining a certificate to operate those facilities. The net book value at December 31, 1999 of the Tilden/McMullen facilities was approximately $62 million. Operating income for the year ended December 31, 1999 associated with those facilities is estimated to be less than $3 million; however, such operating income may not be representative of the effects of the spin-down on Transco's future operating income due to various factors, including future regulatory actions. Transco's abandonment authority is effective for one year from the date of issuance of the order. Transco must notify the FERC of the effective date of the abandonment within 10 days of the transfer. On June 3, 1999, Transco and Gas Processing filed for rehearing of the order with regard to the facilities classified by the FERC as jurisdictional facilities, and on October 5, 1999, the FERC denied the rehearing request. REGULATION OF SHORT TERM NATURAL GAS TRANSPORTATION SERVICE (DOCKET NO. RM98-10-000) AND REGULATION OF NATURAL GAS TRANSPORTATION SERVICES (DOCKET NO. RM98-12-000) On July 29, 1998, the FERC issued a Notice of Proposed Rulemaking (NOPR) and a Notice of Inquiry (NOI), proposing revisions to, and seeking comments on, its regulatory policies for interstate natural gas transportation service. In the NOPR (Docket No. RM98-10-000), the FERC proposed revisions to its regulations to reflect changes in the market for short-term transportation services on pipelines. The FERC proposes to eliminate cost-based regulation of short-term transportation services and implement regulatory policies that are intended to maximize competition in the short-term transportation market, mitigate the ability of firms to exercise residual monopoly power and provide opportunities for greater flexibility in the provision of pipeline services. Included among the proposed changes were initiatives to revise pipeline scheduling procedures, receipt and delivery point policies, and penalty policies, to require pipelines to auction short-term capacity, to revise the FERC's reporting requirements, to permit pipelines to negotiate rates and terms of service, and to revise certain rate and certificate policies. In the NOI (Docket No. RM98-12-000), the FERC sought comments on its pricing policies in the existing long-term market and pricing policies for new capacity. On April 22, 1999, Williams filed comments on the NOPR and NOI. In general, Williams comments were supportive of the FERC's initiatives, particularly to the extent that such initiatives would result in a more competitive, market-based environment. On February 9, 2000, the FERC issued a final rule, Order 637, in response to the comments received on the NOPR and NOI. The FERC adopts in Order 637 certain policies that it finds are necessary to adjust its current regulatory model to the needs of the evolving markets, but determines that any fundamental changes to its regulatory policy, which changes were raised and commented on in the NOPR and NOI, will be considered after further study and evaluation of the evolving marketplace. Most significantly, in Order 637, the FERC (i) revises its pricing policy to waive, for a two-year period, the maximum price ceilings for short-term releases of capacity of less than one year, and (ii) permits pipelines to file proposals to implement seasonal rates for short-term services and term-differentiated rates, subject to certain requirements including the requirement that a pipeline be limited to recovering its annual revenue requirement under those rates. STATEMENT OF POLICY ON CERTIFICATION OF NEW INTERSTATE NATURAL GAS PIPELINE FACILITIES (DOCKET NO. PL99-3-000) On September 15, 1999, the FERC issued a Policy Statement to provide guidance to the industry on how the FERC will evaluate proposals for the certification of new pipeline facility construction. The Policy Statement is the result, in part, of information received by the FERC in comments on the NOPR and NOI as well as a recent public conference on future demand for natural gas in the northeastern United States. The FERC's stated goals in issuing the Policy Statement are to foster competitive markets, protect captive customers, and avoid unnecessary environmental and community impacts while serving increasing demands for natural gas. The FERC also seeks to provide appropriate incentives for the optimal level of construction and efficient customer choices, and for applicants to structure their projects to avoid, or minimize, the potential impacts that could result from construction of a project. The Policy Statement sets forth several analytical steps that will be used by the FERC in evaluating applications for new facility construction. The threshold question for existing pipelines is whether the project can proceed without subsidies from the pipeline's existing customers, which usually, but not always, will mean that the project would be incrementally priced. The FERC will then determine whether the applicant has made efforts to eliminate or minimize any adverse effects the project might have on existing customers of the applicant pipeline, existing pipelines in the market and their captive customers, or landowners and communities affected by the route of the new pipeline. If adverse economic effects are found, the FERC will balance the public benefits of the project against the adverse effects, and will proceed to evaluate the application only if the benefits outweigh the adverse economic effects. If the proposed project will not have any adverse effects, no balancing of the benefits against adverse impacts will be necessary. The Policy Statement does not apply to new construction covered by blanket certificate authority and originally did not apply to new construction covered by optional certificate authority. The FERC has indicated that it will not apply the Policy Statement to applications received prior to July 29, 1998. Numerous parties filed comments on, or petitions for, rehearing of the Policy Statement, and on February 9, 2000 the FERC issued an order clarifying the Policy Statement to provide, among other things and most significantly, that the Policy Statement's balancing process can be used to rebut the presumption embodied in the optional certificate regulation that a project is required by the public convenience and necessity. The Policy Statement is not a rule, but will be used by the FERC to evaluate applications on a case-by-case basis. LEGAL PROCEEDINGS ROYALTY CLAIMS AND LITIGATION In connection with Transco's renegotiations with producers to resolve take-or-pay and other contract claims and to amend gas purchase contracts, Transco entered into certain settlements which may require the indemnification by Transco of certain claims for additional royalties which the producers may be required to pay as a result of such settlements. Transco has been made aware of demands on producers for additional royalties and such producers may receive other demands which could result in claims against Transco pursuant to the indemnification provisions in their respective settlements. Indemnification for royalties will depend on, among other things, the specific lease provisions between the producer and the lessor and the terms of the settlement between the producer and Transco. On March 15, 1994, a lawsuit was filed in the 189th Judicial District Court of Harris County, Texas (Texaco, Inc. vs. Transcontinental Gas Pipe Line Corporation). In this lawsuit, the plaintiff has claimed approximately $23 million, including interest and attorneys' fees for reimbursements of settlement amounts paid to royalty owners. On October 16, 1997, a jury verdict in this case found that Transco was required to pay Texaco damages of $14.5 million plus $3.75 million in attorney's fees. The trial judge initially deferred entering judgment and directed the parties to participate in mediation of this matter. Following mediation in 1998, which did not result in a resolution of this matter, the trial judge entered judgment consistent with the jury verdict and also awarded prejudgment interest of $5.0 million. Transco is appealing the verdict and continues to believe that it has meritorious defenses to Texaco's claims. In addition, Transco was notified by Freeport-McMoRan, Inc. (FMP) in February 1995, that pursuant to a settlement with the Mineral Management Service (MMS) of the MMS' claim for royalties due under gas contracts between Transco and FMP which had been modified pursuant to settlement agreements made in 1986 and 1989, FMP was asserting a claim for indemnification of approximately $6 million, including interest, under the excess royalty provisions of those settlement agreements. On or about March 30, 1995, FMP filed a petition for specific performance seeking recovery against Transco for the sums claimed under the settlement agreements. In May 1998, FMP filed a motion for summary judgement which Transco opposed. In September 1998, the court granted FMP's motion finding that at least a portion of FMP's payment to the MMS was subject to indemnification. Transco has appealed the court's ruling. In August 1996, a lawsuit was filed against Transco and certain Transco affiliates by a royalty owner in a gas producing field in Brooks County, Texas alleging a claim for incorrect computation of royalties. Transco is alleged to have purchased gas from the field. Transco has filed an answer denying liability for the claim. In 1998, the United States Department of Justice informed Williams that Jack Grynberg, an individual, had filed claims in the United States District Court for the District of Colorado under the False Claims Act against Williams and certain of its wholly- owned subsidiaries including Transco. Mr. Grynberg has also filed claims against approximately 300 other energy companies and alleges that the defendants violated the False Claims Act in connection with the measurement and purchase of hydrocarbons. The relief sought is an unspecified amount of royalties allegedly not paid to the federal government, treble damages, a civil penalty, attorneys' fees, and costs. On April 9, 1999, the United States Department of Justice announced that it was declining to intervene in any of the Grynberg qui tam cases; including the action filed against the Williams entities in the United States District Court for the District of Colorado. On October 21, 1999, the Panel on Multi-District Litigation transferred all of the Grynberg qui tam cases, including those filed against Williams, to the United States District Court for the District of Wyoming for pre-trial purposes. ENVIRONMENTAL MATTERS In July 1999, Transco received a letter stating that the U.S. Department of Justice (DOJ), at the request of the U.S. Environmental Protection Agency (EPA), intends to file a civil action against Transco arising from its waste management practices at Transco's compressor stations and metering stations located in eleven (11) states from Texas to New Jersey. DOJ stated in the letter that its complaint will seek civil penalties and injunctive relief under federal environmental laws. DOJ offered to discuss settlement of the claim and discussions began in September 1999. While no specific amount was proposed, DOJ stated that any settlement must include an appropriate civil penalty for the alleged violations. Transco cannot reasonably estimate the amount of its potential liability, if any, at this time. However, Transco believes it has substantially addressed environmental concerns on its system through ongoing voluntary remediation and management programs. Transco is subject to extensive federal, state and local environmental laws and regulations which affect Transco's operations related to the construction and operation of its pipeline facilities. Appropriate governmental authorities may enforce these laws and regulations with a variety of civil and criminal enforcement measures, including monetary penalties, assessment and remediation requirements and injunctions as to future compliance. Transco's use and disposal of hazardous materials are subject to the requirements of the federal Toxic Substances Control Act (TSCA), the federal Resource Conservation and Recovery Act (RCRA) and comparable state statutes. The Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), also known as "Superfund," imposes liability, without regard to fault or the legality of the original act, for release of a "hazardous substance" into the environment. Because these laws and regulations change from time to time, practices that have been acceptable to the industry and to the regulators have to be changed and assessment and monitoring have to be undertaken to determine whether those practices have damaged the environment and whether remediation is required. Since 1989, Transco has had studies underway to test certain of its facilities for the presence of toxic and hazardous substances to determine to what extent, if any, remediation may be necessary. On the basis of the findings to date, Transco estimates that environmental assessment and remediation costs that will be incurred over the next five years under TSCA, RCRA, CERCLA and comparable state statutes will total approximately $25 million to $30 million, measured on an undiscounted basis. This estimate depends upon a number of assumptions concerning the scope of remediation that will be required at certain locations and the cost of remedial measures to be undertaken. Transco is continuing to conduct environmental assessments and is implementing a variety of remedial measures that may result in increases or decreases in the total estimated costs. At December 31, 1999, Transco had a reserve of approximately $25 million for these estimated costs that has been recorded in current liabilities and other long-term liabilities in the accompanying Consolidated Balance Sheet. Transco considers environmental assessment and remediation costs and costs associated with compliance with environmental standards to be recoverable through rates, since they are prudent costs incurred in the ordinary course of business. To date, Transco has been permitted recovery of environmental costs incurred, and it is Transco's intent to continue seeking recovery of such costs, as incurred, through rate filings. Therefore, these estimated costs of environmental assessment and remediation have been recorded as regulatory assets in the accompanying Consolidated Balance Sheet. Transco has used lubricating oils containing polychlorinated biphenyls (PCBs) and, although the use of such oils was discontinued in the 1970s, has discovered residual PCB contamination in equipment and soils at certain gas compressor station sites. Transco has worked closely with the U. S. Environmental Protection Agency (EPA) and state regulatory authorities regarding PCB issues, and has a program to assess and remediate such conditions where they exist, the costs of which are included in the $25 million to $30 million range discussed above. Civil penalties have been assessed by the EPA against other major pipeline companies for the alleged improper use and disposal of PCBs. Transco has received and responded to information requests from the EPA. Although penalties have not presently been asserted except as indicated above in reference to the July, 1999 DOJ letter, no assurance can be given that the EPA will not seek such penalties in the future. Transco has been identified as a potentially responsible party (PRP) at various Superfund and state waste disposal sites. Based on present volumetric estimates and other factors, Transco's estimated aggregate exposure for remediation of these sites is less than $500,000. The estimated remediation costs for all such sites have been included in Transco's environmental reserve discussed above. Liability under CERCLA (and applicable state law) can be joint and several with other PRPs. Although volumetric allocation is a factor in assessing liability, it is not necessarily determinative; thus, the ultimate liability could be substantially greater than the amounts described above. Transco is also subject to the federal Clean Air Act and to the federal Clean Air Act Amendments of 1990 (1990 Amendments), which added significantly to the existing requirements established by the federal Clean Air Act. The 1990 Amendments required that the EPA issue new regulations, mainly related to mobile sources, air toxics, ozone non-attainment areas and acid rain. During the last few years Transco has been acquiring all necessary permits and installing new emission control devices required for new or modified facilities in areas designated as attainment by EPA and is continuing that process. Transco operates facilities in some areas of the country currently designated as non-attainment and it anticipates that by the end of the year 2000 the EPA may designate additional new non-attainment areas which might impact Transco's operations. Pursuant to non-attainment area requirements of the 1990 Amendments, and two recently promulgated EPA rules designed to mitigate the migration of ground-level ozone (NOx) in 22 eastern states, Transco is planning installation of new air pollution controls on existing sources at certain facilities in order to achieve attainment of air quality standards, including NOx emission reductions, in regions where they are not currently achieved, and anticipates that additional facilities may be subject to increased controls within five years. For many of these facilities, Transco is completing installation of more cost effective, innovative compressor engine control designs developed by the Company, and it is therefore not possible to precisely determine the control costs pending completion of performance testing and final state approval. The control additions described above, required to comply with current federal Clean Air Act requirements, the 1990 Amendments, and the individual State Implementation Plans (SIP) for NOx reductions, are estimated to cost in the range of $240 million to $285 million by May 2003 and will be recorded as additions to property, plant and equipment as the facilities are added. If the EPA designates additional new non-attainment areas in 2000 which impact Transco's operations, the cost of additions to property, plant and equipment is expected to increase, but Transco is unable at this time to estimate with any certainty the cost of additions that may be required although it is believed that some of those costs are included in the ranges discussed above. Additionally, the EPA is expected to promulgate new rules regarding Hazardous Air Pollutants (HAPs) by November 2000 which will impose controls in addition to the controls described above. Transco at this time cannot predict with any certainty the exact cost associated with the installation of those controls. The mandated compliance deadline for the HAP controls has been set for November 2003. Transco considers costs associated with compliance with the federal Clean Air Act and the 1990 Amendments to be prudent costs incurred in the ordinary course of business and, therefore, recoverable through its rates. SUMMARY While no assurances may be given, Transco does not believe that the ultimate resolution of the foregoing matters, taken as a whole and after consideration of amounts accrued, recovery from customers, insurance coverage or other indemnification arrangements, will have a materially adverse effect upon Transco's future financial position, results of operations or cash flow requirements. OTHER COMMITMENTS COMMITMENTS FOR CONSTRUCTION Transco has commitments for construction and acquisition of property, plant and equipment of approximately $62 million at December 31, 1999 of which the majority relates to construction materials for pipeline expansion projects. 4. DEBT, FINANCING ARRANGEMENTS AND LEASES LONG-TERM DEBT At December 31, 1999 and 1998, long-term debt issues were outstanding as follows (in thousands):
1999 1998 ------------------ ------------------ Debentures: 7.08% due 2026......................................... $ 200,000 $ 200,000 7.25% due 2026......................................... 200,000 200,000 ------------------ ------------------ Total debentures.................................... 400,000 400,000 ------------------ ------------------ Notes: 8-7/8% due 2002........................................ 125,000 125,000 Variable rate due 2002................................. 150,000 150,000 6-1/8% due 2005........................................ 200,000 200,000 6-1/4% due 2008........................................ 100,000 100,000 ------------------ ------------------ Total notes......................................... 575,000 575,000 ------------------ ------------------ Total long-term debt issues.................................. 975,000 975,000 Unamortized debt premium............................... 330 768 ------------------ ------------------ Total long-term debt......................................... $ 975,330 $ 975,768 ================== ==================
Sinking fund or prepayment requirements applicable to long-term debt outstanding at December 31, 1999 are as follows (in thousands): 2001: 7.08% Debentures................................... $ 200,000 ============== 2002: 8-7/8% Note........................................ $ 125,000 Variable rate note................................. 150,000 ============== Total........................................... $ 275,000 ============== There are no sinking fund requirements applicable to long-term debt outstanding for the years 2000, 2003, and 2004. No property is pledged as collateral under any of the long-term debt issues. The 7.08% Debentures mature on July 15, 2026, but are subject to redemption, at anytime after July 15, 2001, at Transco's option, in whole or part, at a specified redemption price, plus accrued and unpaid interest to the date of redemption. The holder of each 7.08% Debenture may elect between May 15, 2001 and June 15, 2001 to have such 7.08% Debenture repaid on July 15, 2001 at 100% of the principal amount. Because of this option available to the holder, the 7.08% Debentures have been included in the sinking fund or prepayment requirements for the year 2001 in the table above. The 7.08% Debentures have no sinking fund provisions. Williams and certain of its subsidiaries, including Transco, are parties to a $1 billion credit agreement (Credit Agreement), under which Transco can borrow up to $400 million if the funds available under the Credit Agreement have not been borrowed by Williams or other subsidiaries. Interest rates vary with current market conditions based on the base rate of Citibank N.A., three-month certificates of deposit of major United States money market banks, federal funds rate or the London Interbank Offered Rate. As of December 31, 1999, Transco had no outstanding borrowings under this agreement. In November 1997, Transco entered into interest-rate forward contracts to lock in underlying treasury rates on anticipated long-term debt issuances. The contracts were terminated in January 1998 and the settlement amount of $9.8 million was deferred in Other Assets in the accompanying Consolidated Balance Sheet and is being amortized as an adjustment to interest expense over the terms of the following described notes. On January 16, 1998, Transco issued $200 million of notes that mature on January 15, 2005, and $100 million of notes that mature on January 15, 2008, which pay interest at 6-1/8% and 6-1/4%, respectively, per annum on January 15 and July 15 of each year, beginning July 15, 1998. The effective interest rates for the new issues, including the effects of the forward contract settlements, are 6.225% and 6.323%, respectively. The Notes are not subject to redemption and have no sinking fund provisions. Proceeds from the Notes were used for general corporate purposes, including the repayment of $160 million borrowed under the Credit Agreement. SHORT-TERM DEBT Transco's short-term money market facility expired in 1999. During 1999 and 1998, Transco had no outstanding borrowings under this facility. RESTRICTIVE COVENANTS At December 31, 1999, none of Transco's debt instruments restrict the amount of dividends distributable. SALE OF RECEIVABLES Transco is a party to an agreement that expires on January 26, 2001 pursuant to which Transco can sell to an investor up to $100 million of undivided interest in certain of its trade receivables. At December 31, 1999 and 1998, interests in these receivables held by the investor were $92 million and $87 million, respectively. LEASE OBLIGATIONS Prior to December 23, 1998, Transco had a 20-year lease agreement with Transco Tower Limited for its headquarters building (Transco Tower) which expires in 2004 (Transco Tower lease). On December 23, 1998, Transco assigned and transferred to Laughton, L.L.C., (Laughton), an affiliate of Transco, all its right, title and interest in the Transco Tower lease and entered into an agreement to sublease the premises from Laughton through March 29, 2003 (Transco Tower sublease). All other terms of the Transco Tower lease are incorporated into the Transco Tower sublease, including sublease agreements between Transco and other parties that also expire in 2004. The future minimum lease payments under Transco's various operating leases, including the Transco Tower sublease, net of future minimum sublease receipts under Transco's existing sublease agreements through March 29, 2003, are as follows (in thousands):
Operating Leases ----------------------------------------------------------- Transco Tower Other Leases Total ----------------- ----------------- ----------------- 2000...................................... $ 22,831 $ 3,192 $ 26,023 2001...................................... 24,387 3,088 27,475 2002...................................... 24,318 3,088 27,406 2003...................................... 6,075 2,606 8,681 2004...................................... - 2,509 2,509 Thereafter................................ - 4,879 4,879 ----------------- ----------------- ----------------- Total net minimum obligations..... $ 77,611 $ 19,362 $ 96,973 ================= ================= =================
The allocation of the Williams purchase price to the assets and liabilities of Transco based on their estimated fair values resulted in the recording in 1995 of a liability of $53.0 million for the estimated unused space and the amount that Transco's Transco Tower lease obligation was in excess of fair value. The $53.0 million liability is being amortized over the term of the lease. Transco's lease expense was $19.3 million in 1999, $17.4 million in 1998 and $18.0 million in 1997. 5. EMPLOYEE BENEFIT PLANS PENSION PLAN Prior to January 1, 1999, Transco maintained a separate defined-benefit pension plan (Transco Plan) that provided benefits to Transco's officers and employees. Effective January 1, 1999, the Transco plan was merged with and into the Williams Pension Plan (Williams Plan), a non-contributory defined-benefit pension plan, and Transco began participation in the Williams Plan with Williams and its subsidiaries. Cash contributions related to Transco's participation in the Williams Plan totaled $7.6 million in 1999. The following table presents the changes in benefit obligations and plan assets for the Transco Plan for the year 1998. The table also presents a reconciliation of the funded status of the Transco Plan to the amount recognized in the Consolidated Balance Sheet as of December 31, 1998 (in thousands): 1998 ---------------- Change in benefit obligation: Benefit obligation at beginning of year.............. $ 237,086 Service cost......................................... 7,055 Interest cost........................................ 16,499 Amendments........................................... (35,014) Actuarial loss....................................... 35,521 Benefits paid........................................ (16,758) ---------------- Benefit obligation at end of year.................... 244,389 ---------------- Change in plan assets: Fair value of plan assets at beginning of year....... 209,396 Actual return on plan assets......................... 24,713 Employer contributions............................... 7,882 Benefits paid........................................ (16,758) ---------------- Fair value of plan assets at end of year............. 225,233 ---------------- Funded status............................................ (19,156) Unrecognized net actuarial loss.......................... 34,135 Unrecognized prior service credit........................ (36,576) ---------------- Accrued benefit cost..................................... $ (21,597) ================ The allocation of the purchase price to the assets and liabilities of Transco and TEC based on their estimated fair values resulted in the recording of an additional pension liability of $19.2 million, $17.3 million of which was recorded by Transco, representing the amount that the projected benefit obligation exceeded the plan assets. The amounts of pension costs deferred at December 31, 1999 and 1998 are $6.8 million and $6.9 million, respectively, and are expected to be recovered through future rates over the average remaining service period for active employees. The following table presents the net pension expense for the Transco Plan for the years ended December 31, 1998 and 1997 (in thousands):
1998 1997 ----------- ----------- Components of net periodic pension expense Service cost....................................... $ 7,055 $ 6,212 Interest cost...................................... 16,499 15,808 Expected return on plan assets..................... (18,991) (16,487) Amortization of prior service credit............... (2,839) (373) Recognized net actuarial loss...................... 1,790 77 Regulatory asset deferral.......................... (454) (47) ----------- ---------- Net periodic pension expense....................... $ 3,060 $ 5,190 =========== ===========
The weighted-average assumptions used to determine the projected benefit obligation for 1998 were a discount rate of 7 percent, an expected return on plan assets of 10 percent and a rate of compensation increase of 5 percent. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS Transco participates in a plan with Williams and its subsidiaries that provides certain health care and life insurance benefits for retired employees of Transco that were hired prior to January 1, 1996. The accounting for the plan anticipates future cost-sharing changes to the written plan that are consistent with Williams' expressed intent to increase the retiree contribution rate annually, generally in line with health care cost increases. Cash contributions totaled $11.1 million in 1999, $10.3 million in 1998 and $6.8 million in 1997. Although the actuarially determined cash contributions for each of the three years were comparable, the timing of the actual contributions caused a variance between years. The allocation of the purchase price to the assets and liabilities of Transco and TEC based on their estimated fair values resulted in the recording of a postretirement benefits liability of $86.9 million representing the amount that the accumulated postretirement benefit obligation exceeded the plan assets. The amounts of postretirement benefits costs deferred as a regulatory asset at December 31, 1999 and 1998 are $48.8 million and $54.7 million, respectively, and are expected to be recovered through future rates over the remaining amortization period of the unrecognized transition obligation. DEFINED-CONTRIBUTION PLAN Transco employees participate in a Williams defined-contribution plan. Compensation expense of $4.7 million, $4.6 million and $3.6 million was recognized by Transco in 1999, 1998 and 1997, respectively. EMPLOYEE STOCK-BASED AWARDS Williams has several plans providing for common stock-based awards to its employees and employees of its subsidiaries. The plans permit the granting of various types of awards including, but not limited to, stock options, stock appreciation rights, restricted stock and deferred stock. Awards may be granted for no consideration other than prior and future services or based on certain financial performance targets being achieved. The purchase price per share for stock options may not be less than the market price of the underlying stock on the date of grant. Stock options generally become exercisable after five years, subject to accelerated vesting if certain future stock prices are achieved. Stock options expire ten years after grant. SFAS No. 123, "Accounting for Stock-Based Compensation," requires that companies who continue to apply APBO No. 25 disclose pro forma net income assuming that the fair-value method in SFAS No. 123 had been applied in measuring compensation cost. Pro forma net income for Transco, beginning with 1997 employee stock-based awards was $157.7 million, $133.7 million and $109.4 million for 1999, 1998 and 1997, respectively. Reported net income was $161.2 million, $135.7 million and $111.4 million for 1999, 1998 and 1997, respectively. Pro forma amounts for 1999 reflect the remaining total compensation expense from the awards made in 1998, as these awards fully vested in 1999 as a result of the accelerated vesting provisions. Pro forma amounts for 1998 reflect the remaining total compensation expense from the awards made in 1997, as these awards fully vested in 1998 as a result of the accelerated vesting provisions. Since compensation expense from stock options is recognized over the future years' vesting period, and additional awards generally are made each year, pro forma amounts may not be representative of future years' amounts. The following table reflects stock options related to 1999, 1998 and 1997 (options in thousands):
1999 1998 1997 ------------- ------------- ------------- Options granted........................................... 426 284 546 Weighted-average grant date fair value.................... $ 11.90 $ 8.19 $ 5.98 Options outstanding - December 31......................... 2,301 2,055 1,987 Options exercisable - December 31......................... 2,176 1,772 1,465
The fair value of the stock options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions: expected life of the stock options of approximately five years; volatility of the expected market price of Williams common stock of 28 percent (25 percent in 1998 and 23 percent in 1997); risk-free interest rate of 5.6 percent (5.3 percent in 1998 and 6.1 percent in 1997); and a dividend yield of 1.5 percent (2.0 percent in 1998 and 2.4 percent in 1997). 6. INCOME TAXES Following is a summary of the provision for income taxes for 1999, 1998 and 1997 (in thousands):
1999 1998 1997 ------------- -------------- ------------- Federal: Current................................. $ 30,162 $ 75,422 $ 68,632 Deferred................................ 57,299 (5,056) (3,041) ------------- -------------- ------------- 87,461 70,366 65,591 ------------- -------------- ------------- State and municipal: Current................................. 4,041 9,588 4,991 Deferred................................ 7,418 (673) (3,988) ------------- -------------- ------------- 11,459 8,915 1,003 ------------- -------------- ------------- Provision for income taxes................... $ 98,920 $ 79,281 $ 66,594 ============= ============== =============
Following is a reconciliation of the provision for income taxes at the federal statutory rate to the provision for income taxes (in thousands):
1999 1998 1997 -------------- ------------- -------------- Taxes computed by applying the federal statutory rate. $ 91,037 $ 75,241 $ 61,293 Reclassification of state liability................... - - 3,761 State and municipal income taxes...................... 7,449 5,795 652 Other, net............................................ 434 (1,755) 888 -------------- ------------- -------------- Provision for income taxes............................ $ 98,920 $ 79,281 $ 66,594 ============== ============= ==============
Significant components of deferred income tax assets and liabilities as of December 31, 1999 and 1998 are as follows (in thousands):
1999 1998 ------------- ------------- Deferred tax liabilities - ------------------------- Property, plant and equipment.................................... $ 902,592 $ 883,706 Deferred charges................................................. 23,391 24,464 Other ........................................................... 14,099 5,422 ------------- ------------- Total deferred tax liabilities................................... 940,082 913,592 ------------- -------------
Deferred tax assets - --------------------- Estimated rate refund liability.................................. 64,876 91,260 Accrued payroll and benefits..................................... 13,803 13,457 Other accrued liabilities........................................ 4,995 7,375 Deferred state income taxes - noncurrent liabilities............. 34,766 33,435 Other noncurrent liabilities..................................... 5,562 14,275 Other ........................................................... 4,655 7,082 ------------- ------------- Total deferred tax assets........................................ 128,657 166,884 ------------- ------------- Net deferred tax liabilities..................................... $ 811,425 $ 746,708 ============= =============
7. FINANCIAL INSTRUMENTS FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount and estimated fair values of Transco's financial instruments as of December 31, 1999 and 1998 are as follows (in thousands):
Carrying Amount Fair Value ----------------------------- ----------------------------- 1999 1998 1999 1998 ------------ ------------ ------------ ------------ Financial assets: Cash and short-term financial assets. $ 482,550 $ 417,634 $ 482,550 $ 417,634 Long-term financial assets........... 13,689 - 13,689 - Financial liabilities: Long-term debt....................... 975,330 975,768 933,199 991,128
For cash and short-term financial assets (advances to affiliates), at variable interest rates, the carrying amount is a reasonable estimate of fair value due to the short maturity of those instruments. For long-term financial assets (advances to affiliates), the carrying amount is a reasonable estimate of fair value because the interest rate is a variable rate. For Transco's publicly traded long-term debt, estimated fair value is based on quoted market prices at year-end. For Transco's private debt, all at variable interest rates, estimated fair value is equivalent to the carrying amount. CREDIT AND MARKET RISK As of December 31, 1999 and 1998, Transco had trade receivables of $32 million and $14 million, respectively. These trade receivables primarily are due from local distribution companies and other pipeline companies predominantly located in the eastern United States. Transco's credit risk exposure in the event of nonperformance by the other parties is limited to the face value of the receivables. No collateral is required on these receivables. Transco has not historically experienced significant credit losses in connection with its trade receivables. Transco sells, with limited recourse, certain trade receivables. The aggregate limit under the receivables facilities was $100 million at December 31, 1999 and 1998. At December 31, 1999 and 1998, $92 million and $87 million, respectively, of such receivables had been sold. Based on amounts outstanding at December 31, 1999 and 1998 the maximum contractual credit loss under these arrangements is approximately $15 million and $13 million, respectively, but the likelihood of loss is considered to be remote. 8. TRANSACTIONS WITH MAJOR CUSTOMERS AND AFFILIATES MAJOR CUSTOMERS The sales, transportation and storage revenues received from Public Service Electric and Gas Company and Consolidated Edison Company of New York, Inc., the major customers of Transco, were $131.3 million and $117.2 million in 1999, $119.2 million and $113.9 million in 1998 and $139.3 million and $131.8 million in 1997, respectively. AFFILIATES Included in Transco's sales and transportation revenues for 1999, 1998, and 1997 are revenues applicable to sales and transportation for affiliates of $106.8 million, $81.9 million and $79.2 million, respectively. The rates charged to provide sales and transportation services to affiliates are the same as those that are charged to similarly-situated nonaffiliated customers. Through an agency agreement with Transco, WESCO manages Transco's jurisdictional merchant gas sales. For the years ended December 31, 1999, 1998 and 1997, included in Transco's cost of sales is $29.5 million, $31.0 million and $31.4 million, respectively, representing agency fees billed to Transco by WESCO under the agency agreement. Included in Transco's cost of sales for 1999, 1998 and 1997 is purchased gas cost from affiliates of $415.9 million, $317.0 million and $405.1 million, respectively. All gas purchases are made at market or contract prices. Transco has long-term gas purchase contracts containing either fixed prices or variable prices that are at a significant premium to the estimated market price. However, due to contract expirations and estimated deliverability declines, Transco's estimated purchase commitments under such gas purchase contracts are not material to Transco's total gas purchases. Furthermore, through the agency agreement with Transco, WESCO has assumed management of Transco's merchant sales service and, as Transco's agent, is at risk for any above-spot-market gas costs that it may incur. Also included in Transco's cost of transportation is transportation expense of $4.0 million in 1999, $4.1 million in 1998 and $4.3 million in 1997 applicable to the transportation of gas by Texas Gas Transmission Corporation (Texas Gas), an affiliate of Transco. Texas Gas is regulated by the FERC and its transportation rates charged to Transco are approved by the FERC. Williams has a policy of charging subsidiary companies for management services provided by the parent company and other affiliated companies. Included in Transco's administrative and general expenses for 1999, 1998 and 1997 were $18.0 million, $15.0 million and $14.7 million, respectively, for such corporate expenses charged by Williams. Management considers the cost of these services to be reasonable. Transco has an operating agreement with Williams Field Services (WFS) whereby WFS, as Transco's agent, assumed operational control of Transco's gas gathering facilities. Included in Transco's operation and maintenance expenses for 1999, 1998 and 1997, are $32.0 million, $31.4 million and $37.3 million, respectively, charged by WFS to operate Transco's gas gathering facilities. In December 1999, upon assignment of its 100% equity interest in the Buccaneer Gas Pipeline Company, L.L.C. (Buccaneer) to WGP, Transco billed WGP $13.1 million for costs incurred on behalf of Buccaneer. 9. QUARTERLY INFORMATION (UNAUDITED) The following summarizes selected quarterly financial data for 1999 and 1998 (in thousands):
First Second Third Fourth ------------- ------------- ------------- ------------- 1999 Operating revenues ............. $ 354,123 $ 389,701 $ 384,209 $ 415,423 Operating expenses.................. 284,296 302,734 325,367 333,834 ------------- ------------- ------------- ------------- Operating income ............... 69,827 86,967 58,842 81,589 Interest expense.................... 18,052 13,875 20,282 18,349 Other (income) and deductions, net (5,846) (6,536) (8,524) (12,534) ------------- ------------- ------------- ------------- Income before income taxes ......... 57,621 79,628 47,084 75,774 Provision for income taxes.......... 22,479 30,217 17,762 28,462 ------------- ------------- ------------- ------------- Net income.......................... $ 35,142 $ 49,411 $ 29,322 $ 47,312 ============= ============= ============= =============
Because of its rate structure and historic maintenance schedule, Transco typically experiences lower operating income in the second and third quarters as compared to the first and fourth quarters. Includes an adjustment to the reserve for rate refunds of $28.1 million of principal and $5.9 million of interest in connection with general rate case Docket No. RP95-197. Includes an adjustment to the reserve for rate refunds of $23.4 million of principal and $2.6 million of interest in connection with general rate case Docket No. RP97-71. Equity in earnings of unconsolidated affiliates was reclassified from operating revenues to other income and deductions, net, by $99 thousand, $614 thousand and $442 thousand in the first, second and third quarter, respectively.
First Second Third Fourth ------------- ------------- ------------ ------------- 1998 Operating revenues .............. $ 339,371 $ 334,246 $ 324,135 $ 327,384 Operating expenses.................. 267,416 263,981 263,541 256,461 ------------- ------------- ------------- ------------- Operating income ................ 71,955 70,265 60,594 70,923 Interest expense.................... 22,605 22,784 23,769 22,497 Other (income) and deductions, net (8,031) (9,580) (10,791) (4,491) ------------- ------------- ------------- ------------- Income before income taxes.......... 57,381 57,061 47,616 52,917 Provision for income taxes.......... 21,791 21,701 18,000 17,789 ------------- ------------- ------------- ------------- Net income.......................... $ 35,590 $ 35,360 $ 29,616 $ 35,128 ============= ============= ============= =============
Includes an adjustment of $11.8 million related to the settlement rates contained in the January 1998 Stipulation and Agreement in general rate case Docket No. RP97-71. Equity in earnings (losses) of unconsolidated affiliates was reclassified to other income and deductions, net, by ($4 thousand), $194 thousand and ($2 thousand) in the first, second and third quarter, respectively. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III Since Transco meets the conditions set forth in General Instruction (I)(1)(a) and (b) of Form 10-K, this information is omitted. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. PAGE REFERENCE TO 1999 10-K ------------ A. INDEX 1. FINANCIAL STATEMENTS: Report of Independent Auditors - Ernst & Young LLP 28 Consolidated Balance Sheet as of December 31, 1999 and 1998 29-30 Consolidated Statement of Income for the Years Ended December 31, 1999, 1998 and 1997 31 Consolidated Statement of Common Stockholder's Equity for the Years Ended December 31, 1999, 1998 and 1997 32 Consolidated Statement of Cash Flows for the Years Ended December 31, 1999, 1998 and 1997 33-34 Notes to Consolidated Financial Statements 35-59 2. FINANCIAL STATEMENT SCHEDULES: The following schedules are omitted because of the absence of the conditions under which they are required: I, II, III, IV, and V. 3. EXHIBITS: The following instruments are included as exhibits to this report. Those exhibits below incorporated by reference herein are indicated as such by the information supplied in the parenthetical thereafter. If no parenthetical appears after an exhibit, copies of the instrument have been included herewith. (2) PLAN OF ACQUISITION, REORGANIZATION ARRANGEMENT, LIQUIDATION OR SUCCESSION - Stock Option Agreement dated as of December 12, 1994 by and between The Williams Companies, Inc. and Transco Energy Company. (Exhibit 3 to Transco Energy Company Schedule 14D-9 Commission File Number 005-19963) (3) ARTICLES OF INCORPORATION AND BY-LAWS - 1 Second Restated Certificate of Incorporation, as amended, of Transco. (Exhibit 3.1 to Transco Form 8-K dated January 23, 1987 Commission File Number 1-7584) a) Certificate of Amendment, dated July 30, 1992, of the Second Restated Certificate of Incorporation (Exhibit (10)-17(a) to Transco Energy Company Form 10-K for 1993 Commission File Number 1-7513) b) Certificate of Amendment, dated December 22, 1986, of the Second Restated Certificate of Incorporation (Exhibit (10)-17(b) to Transco Energy Company Form 10-K for 1993 Commission File Number 1-7513) c) Certificate of Amendment, dated August 5, 1987, of the Second Restated Certificate of Incorporation (Exhibit (10)-17(c) to Transco Energy Company Form 10-K for 1993 Commission File Number 1-7513) - 2 By-Laws of Transco, as Amended and Restated May 2, 1995 (Exhibit (3)-2 to Transco Form 10-K for 1995 Commission File Number 1-7584) (4) INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES - 1 Indenture dated September 15, 1992 between Transco and the Bank of New York, as Trustee (Exhibit 4.2 to Transco Form 8-K dated September 17, 1992 Commission File Number 1-7584) - 2 Indenture dated July 15, 1996 between Transco and Citibank, N.A., as Trustee (Exhibit 4.1 to Transco Form S-3 dated April 2, 1996 Transco Registration Statement No. 333-2155) - 3 Indenture dated January 16, 1998 between Transco and Citibank, N.A., as Trustee (Exhibit 4.1 to Transco Form S-3 dated September 8, 1997 Transco Registration Statement No. 333-27311) - 4 Amendment dated January 26, 1999, to Second Amended and Restated Credit Agreement dated as of July 23, 1997 by and among Transco, The Williams Companies, Inc., Texas Gas Transmission Corporation, Northwest Pipeline Corporation, WilTel Communications, L.L.C., Williams Holdings of Delaware, Inc. and Citibank N.A. as agent and the Banks named therein (Exhibit 4(c) to The Williams Companies, Inc. Form 10-K for 1998 Commission File Number 1-4174) - 5 Second Amendment to Second Amended and Restated Credit Agreement, dated as of January 24, 2000 by and among Transco, The Williams Companies, Inc., Texas Gas Transmission Corporation, Northwest Pipeline Corporation and Citibank N.A. as agent and the Banks named therein (Exhibit 4(e) to the Williams Companies, Inc. Form 10-K for 1999 Commission File Number 1-4174) 10) MATERIAL CONTRACTS - 1 Transco Energy Company Tran$tock Employee Stock Ownership Plan (Transco Energy Company Registration Statement No. 33-11721) - 2 Lease Agreement, dated October 5, 1981, between Transco and Post Oak/Alabama, a Texas partnership. (Exhibit (10)-7 to Transco Energy Company Form 10-K for 1989 Commission File Number 1-7513) (21) SUBSIDIARIES OF THE REGISTRANT (23) CONSENT OF INDEPENDENT AUDITORS (24) POWER OF ATTORNEY WITH CERTIFIED RESOLUTION (27) FINANCIAL DATA SCHEDULE 4. REPORTS ON FORM 8-K: None. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, on this 29th day of March, 2000. TRANSCONTINENTAL GAS PIPE LINE CORPORATION (Registrant) By: /s/ JAMES C. BOURNE --------------------------------- James C. Bourne Controller Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on this 29th day of March, 2000, by the following persons on behalf of the registrant and in the capacities indicated. SIGNATURE TITLE --------- ----- /s/ KEITH E. BAILEY * Chairman of the Board - ------------------------------ Keith E. Bailey /s/ CUBA WADLINGTON, JR * Director, President and Chief Executive Officer - ------------------------------ Cuba Wadlington, Jr. (Principal Executive Officer) /s/ GARY D. LAUDERDALE* Director - ------------------------------ Gary D. Lauderdale /s/ NICK A. BACILE * Vice President (Principal Financial Officer) - ------------------------------ Nick A. Bacile /s/ JAMES C. BOURNE * Controller (Principal Accounting Officer) - ------------------------------ James C. Bourne * By /s/ JAMES C. BOURNE - --------------------------- James C. Bourne Attorney-in-fact EX-21 2 SUBSIDIARIES OF THE REGISTRANT Exhibit (21) TRANSCONTINENTAL GAS PIPE LINE CORPORATION SUBSIDIARIES % Owned State of Subsidiary Name By Parent Incorporation Cardinal Operating Company 100.00 Delaware Cross Bay Operating Company 100.00 Delaware Cumberland Operating Company 100.00 Delaware Independence Operating Company 100.00 Delaware Marsh Resources, Inc. 100.00 Delaware Pine Needle Operating Company 100.00 Delaware TGPL Enterprises, Inc. 100.00 Delaware Transco Cross Bay Company 100.00 Delaware TransCardinal Company 100.00 Delaware TransCarolina LNG Company 100.00 Delaware TransCumberland Pipeline Company 100.00 Delaware Transco Independence Pipeline Company 100.00 Delaware WGP Enterprises, Inc. 100.00 Delaware Williams Gas Processing - Gulf Coast Company, L.P. 99.00 Delaware EX-23 3 CONSENT OF INDEPENDENT AUDITORS Exhibit 23 Consent of Independent Auditors We consent to the incorporation by reference in the Registration Statement (Form S-3 No. 333-27311) of Transcontinental Gas Pipe Line Corporation and in the related Prospectus of our report dated February 17, 2000, with respect to the consolidated financial statements of Transcontinental Gas Pipe Line Corporation included in this Annual Report (Form 10-K) for the year ended December 31, 1999. /s/ ERNST & YOUNG LLP Tulsa, Oklahoma March 27, 2000 EX-24 4 POWER OF ATTORNEY WITH CERTIFIED RESOLUTION Exhibit (24) TRANSCONTINENTAL GAS PIPE LINE CORPORATION POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS that each of the undersigned individuals, in their capacity as a director or officer, or both, as hereinafter set forth below their signature, of TRANSCONTINENTAL GAS PIPE LINE CORPORATION, a Delaware corporation ("Transco"), does hereby constitute and appoint NICK A. BACILE AND JAMES C. BOURNE their true and lawful attorneys and each of them (with full power to act without the other) their true and lawful attorneys for them and in their name and in their capacity as a director or officer, or both, of Transco, as hereinafter set forth below their signature, to sign Transco's Annual Report to the Securities and Exchange Commission on Form 10-K for the fiscal year ended December 31, 1999, and any and all amendments thereto or all instruments necessary or incidental in connection therewith; and THAT the undersigned Transco does hereby constitute and appoint NICK A. BACILE AND JAMES C. BOURNE its true and lawful attorneys and each of them (with full power to act without the other) its true and lawful attorney for it and in its name and on its behalf to sign said Form 10-K and any and all amendments thereto and any and all instruments necessary or incidental in connection therewith. Each of said attorneys shall have full power of substitution and resubstitution, and said attorneys or any of them or any substitute appointed by any of them hereunder shall have full power and authority to do and perform in the name and on behalf of each of the undersigned, in any and all capacities, every act whatsoever requisite or necessary to be done in the premises, as fully to all intents and purposes as each of the undersigned might or could do in person, the undersigned hereby ratifying and approving the acts of said attorneys or any of them or of any such substitute pursuant hereto. IN WITNESS WHEREOF, the undersigned have executed this instrument, all as of the 18th day of February, 2000. /s/ Cuba Wadlington, Jr. /s/ Nick A. Bacile --------------------------- ---------------------------- Cuba Wadlington, Jr. Nick A. Bacile President, Chief Executive Vice President and Officer, and Director Chief Financial Officer (Principal Financial Officer) (Principal Executive Officer) /s/ James C. Bourne ----------------------- James C. Bourne Controller (Principal Accounting Officer) /s/ Keith E. Bailey /s/ Gary D. Lauderdale --------------------------- -------------------------- Keith E. Bailey Gary D. Lauderdale Director Director TRANSCONTINENTAL GAS PIPE LINE CORPORATION By /s/ Nick A. Bacile ------------------------- Nick A. Bacile Vice President and Chief Financial Officer ATTEST: /s/ Shawna L. Gehres -------------------------- Shawna L. Gehres Secretary TRANSCONTINENTAL GAS PIPE LINE CORPORATION I, the undersigned, Shawna L. Gehres, Secretary of TRANSCONTINENTAL GAS PIPE LINE CORPORATION, a Delaware company (hereinafter called the "Company"), do hereby certify that pursuant to Section 141(f) of the General Corporation Law of Delaware, the Board of Directors of this Corporation unanimously consented, as of February 18, 2000, to the following: RESOLVED that the Chairman of the Board, the President or any Vice President of the Company be, and each of them hereby is, authorized and empowered to execute a Power of Attorney for use in connection with the execution and filing, for and on behalf of the Company, under the Securities Exchange Act of 1934, of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000. I further certify that the foregoing resolution has not been modified, revoked or rescinded and is in full force and effect. IN WITNESS WHEROF, I have hereunto set my hand and affixed the corporate seal of TRANSCONTINENTAL GAS PIPE LINE CORPORATION this 18th day of February, 2000. /s/ Shawna L. Gehres ------------------------- Shawna L. Gehres Secretary [CORPORATE SEAL] EX-27 5 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONDENSED CONSOLIDATED BALANCE SHEET AND THE CONDENSED CONSOLIDATED STATEMENT OF INCOME FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1999, CONTAINED IN TRANSCONTINENTAL GAS PIPE LINE CORPORATION'S 1999 FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1999 DEC-31-1999 843 0 31,843 0 77,200 752,022 4,452,101 791,061 4,659,180 457,219 975,330 0 0 0 2,223,228 4,659,180 703,028 1,543,456 702,884 1,110,603 0 0 70,558 260,107 98,920 161,187 0 0 0 161,187 0 0
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