-----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, Tmi81DpEMCqW+4xsmtHfamSPnvQuwcyz2raRVXpfxldBj7kwSfJQWMCPnGQLhGGR /9EG4h9f63BVsZLA/ppshg== 0000099250-97-000001.txt : 19970328 0000099250-97-000001.hdr.sgml : 19970328 ACCESSION NUMBER: 0000099250-97-000001 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970327 SROS: NYSE 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: 1934 Act SEC FILE NUMBER: 001-07584 FILM NUMBER: 97564651 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 TGPL 1996 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, 1996 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, 1997 WAS 100. THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION (J)(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's principal business is the transportation of natural gas. The number of full time employees of Transco at December 31, 1996 was 1,502. Transco is a wholly-owned subsidiary of The Williams Companies, Inc. (Williams). Prior to May 1, 1995, Transco was an indirect wholly-owned subsidiary of Transco Energy Company (TEC). On December 12, 1994, TEC and Williams announced that they had entered into a merger agreement pursuant to which Williams acquired through a cash tender offer 24.6 million shares, or approximately 60%, of the outstanding shares of TEC's common stock for $430.5 million. The cash tender offer was then followed by a stock merger (Merger) in which shares of TEC common stock not purchased in the tender offer were exchanged for Williams' common stock valued at $334 million. On the May 1, 1995 effective date of the Merger, TEC declared and paid as dividends to Williams all of TEC's interest in Transco. For additional discussion and the accounting treatment of the Merger, see "Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 1. Corporate Structure and Control and 2. Summary of Significant Accounting Policies." At December 31, 1996, Transco's system had a mainline delivery capacity of approximately 3.6 Bcf(1) 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 6.5 Bcf of gas per day. - -------- (1) 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 and the term "TBtu" means trillion British Thermal Units. 1 The system is composed of approximately 10,500 miles of mainline and branch transmission pipelines, 37 compressor stations, five underground storage locations and four processing plants. Compression facilities at sea level rated capacity total approximately 1.2 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 and an additional liquefied natural gas (LNG) storage facility. The total storage capacity available to Transco and its customers in such storage fields and LNG facility is approximately 216 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. 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 role 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. For a discussion of Order 636 see "Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 3. Contingent Liabilities and Commitments - Rate and Regulatory Matters Order 636." After FERC approval in 1993, TEC realigned its gas marketing businesses under the common management of Transco Gas Marketing Company (TGMC), an affiliate of Transco, which, through an agency agreement, began to manage all jurisdictional merchant sales of Transco. In May 1995, Williams Energy Services Company (WESCO), an affiliate of Transco, became the successor to the TGMC agency agreement and began to manage Transco's jurisdictional merchant sales. 2 Also, 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 (WGP), a subsidiary of WFS. The net book value at December 31, 1996 of the facilities, including the purchase price allocation to Transco, was approximately $564 million. Concurrently, WGP 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. The filings are part of an ongoing comprehensive restructuring plan by Williams to separate all gathering facilities from Williams' jurisdictional interstate natural gas pipeline transmission companies. In September, 1996, the FERC issued an order dismissing Transco's application and WGP's petition for declaratory order. In October 1996, Transco and WGP filed a joint request for rehearing of the FERC's September order. 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, marketers and producers. Transco's largest customer in 1996 accounted for approximately 10 percent 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. 3 Transco's total system deliveries for the years 1996, 1995 and 1994 are shown below.
Transco System Deliveries (TBtu) 1996 1995 1994 - ----------------------------- ------- ------- ------- Market-area deliveries: Long-haul transportation....................... 948.9 858.4 805.1 Market-area transportation..................... 428.1 467.3 453.6 ............................................... _______ _______ _______ Total market-area deliveries................... 1,377.0 1,325.7 1,258.7 Production-area transportation..................... 210.0 165.9 185.9 ------- ------- ------- Total system deliveries............................ 1,587.0 1,491.6 1,444.6 ======= ======= ======= Average Daily Transportation Volumes (TBtu) 4.3 4.1 4.0 Average Daily Firm Reserved Capacity (TBtu) 5.2 5.2 4.9
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. As a result of the fundamental business changes resulting from FERC Order 636, especially the shifting of the responsibility for gas supply from the pipeline companies to local distribution companies (LDCs), maintaining committed proved gas reserves is no longer material to Transco's transportation business. PIPELINE PROJECTS SUNBELT EXPANSION PROJECT On December 2, 1996 the FERC issued a certificate authorizing the SunBelt Expansion Project to provide additional firm transportation capacity to growing markets in Georgia, South Carolina and North Carolina. The project will provide a total of 146 MMcf/d of firm transportation capacity to existing and new Transco customers by the 1997-1998 winter heating season. The firm capacity will extend from Transco's Station 65 in St. Helena Parish, Louisiana to Station 145 near the North and South Carolina state border. The project will include approximately 15 miles of pipeline looping and compression additions totaling 53,100 horsepower. Transco estimates the cost of the expansion to be approximately $85 million. Transco invested approximately $12 million in 1996 and expects to invest approximately $68 million in 1997. SOUTHEAST LOUISIANA GATHERING SYSTEM PROJECT On August 30, 1996, Transco filed an application with the FERC for authority to expand the offshore portion of its existing Southeast Louisiana Gathering System in two phases to provide a total of 660 MMcf/d of 4 additional firm transportation capacity. Transco estimates the cost of the expansion to be approximately $129 million and expects to invest approximately $95 million in 1997. MOBILE BAY LATERAL EXPANSION PROJECT On November 12, 1996, Transco filed an application with the FERC for approval to extend and expand its Mobile Bay lateral. The project will include expansion of Transco's existing 123-mile Mobile Bay lateral and construction of a new 77-mile offshore pipeline extension to an area near the outer continental shelf where substantial reserves have been discovered by several producers. The project, which was filed to increase capacity as much as 600 MMcf/d at an estimated cost of $171 million, is targeted to be in service by the 1998-99 winter heating season. In December, Transco received nominations for 300 MMcf/d of capacity in the project. PINE NEEDLE LNG COMPANY, LLC On November 27, 1996, the FERC issued its order authorizing Pine Needle LNG Company, LLC (Pine Needle), a North Carolina limited liability company, to develop a new LNG storage facility near Transco's mainline system in Guilford County, North Carolina. The project responds to strong market demand for winter peak heating service in the Southeast United States. The LNG facility will have a total storage capacity of 4 Bcf of gas and will be able to liquefy gas at a net rate of 20 MMcf/d into storage and vaporize and send out up to 400 MMcf/d. Transco will construct the necessary connections on its mainline system to enable it to deliver gas to and receive gas from the storage facility. Pine Needle estimates the total cost of the project to be $107 million. Pine Needle proposes a 50/50 debt to equity capital structure and will seek non-recourse project financing. Pine Needle plans to place the LNG facility into service on or about May 1, 1999. Pine Needle was formed in 1995 between a wholly owned subsidiary of Transco, three North Carolina local distribution companies (LDCs), a producer, and a Georgia gas authority. Transco's wholly owned subsidiary, TransCarolina LNG Company, holds a 35% ownership interest in Pine Needle and another wholly owned subsidiary of Transco, Pine Needle Operating Company, will serve as operator. Transco invested approximately $3 million in 1996 and expects to invest approximately $12 million in 1997. CARDINAL PIPELINE SYSTEM PROJECT On December 23, 1996, Cardinal Extension Company, LLC (Cardinal), a North Carolina limited liability company formed between a wholly owned subsidiary of Transco and three North Carolina LDCs, filed for authorization with the North Carolina Utilities Commission (NCUC) to (a) construct an approximately 67-mile extension of the existing Cardinal Pipeline system from Burlington to the area of Raleigh, North Carolina; (b) to provide an additional 140 MMcf/d of new firm transportation capacity to North Carolina markets, and (c) upon the satisfaction of certain conditions, to acquire the existing Cardinal Pipeline system (consisting of 37 miles of 24-inch pipeline extending from Transco's Station 160 to Burlington, North Carolina). The NCUC has scheduled a hearing on the proposed Cardinal project to commence on May 20, 1997. 5 Construction of the pipeline extension is planned to commence in early 1999 with a target in-service date of November 1, 1999. Cardinal Operating Company, a wholly owned subsidiary of Transco, will be responsible for constructing the pipeline extension and will serve as operator of the expanded pipeline system. Transco's wholly owned subsidiary, TransCardinal Company, will have a 45% ownership interest in Cardinal. The total costs for the acquisition and extension are expected to be $98 million. Cardinal proposes a 50/50 debt to equity capital structure and will seek non-recourse project financing. Transco expects to invest approximately $22 million in the project. SEABOARD EXPANSION PROJECT On November 18, 1996, the FERC made a preliminary determination that the SeaBoard Expansion Project is required by public convenience and necessity but denied Transco's request for rolled-in rate treatment. Transco has invested approximately $6 million in this project. As a result of the FERC action on rolled-in rate treatment, Transco has plans to significantly revise the project. PIEDMONT/MAIDEN LATERAL EXPANSION PROJECT On January 10, 1997, Transco filed an application with the FERC for authority to expand an existing delivery lateral to Piedmont Natural Gas Company, Inc. in Lincoln and Catawba Counties, North Carolina. The proposed facilities include 17.77 miles of 16-inch pipeline loop and an expansion of Transco's existing Lowesville Meter Station. The proposed in-service date for the expansion is November 1, 1997, and the estimated cost of the facilities is $14 million. Transco expects to invest approximately $12 million in 1997. 1998 CHEROKEE EXPANSION PROJECT In December 1996, Transco announced its 1998 Cherokee Expansion Project. The project is expected to provide approximately 87 MMcf/d of additional firm transportation capacity in Alabama and Georgia by the 1998- 1999 winter heating season at a cost of approximately $66 million. Transco plans to file in the spring of 1997 for FERC approval of the project. CUMBERLAND PIPELINE PROJECT In December 1996, Transco and AGL Resources Inc. announced the signing of a letter of intent to form a joint venture to be known as Cumberland Pipeline Company. Existing pipeline facilities owned by Transco and AGL Resources Inc. will be expanded northward into Tennessee to form the 135-mile pipeline that is expected to provide transportation capacity to markets in eastern Tennessee by the 2000-2001 winter heating season. The project is expected to be submitted for FERC approval in the fourth quarter of 1997. INDEPENDENCE PIPELINE PROJECT In February 1997, Transco and ANR Pipeline Company (ANR) announced the signing of a letter of intent to form a joint venture to be known as Independence Pipeline Company. The pipeline will consist of approximately 370 miles of 36-inch diameter pipe with an initial capacity of up to 900 MMcf/d. 6 It will extend from ANR's existing compressor station at Defiance, Ohio, to Transco's facilities at Leidy, Pa. Along the proposed route, interconnections with numerous other pipelines serving the Mid-Atlantic and Northeast regions are anticipated. Affiliates of ANR and Transco will each own 50 percent of the new project. The project is expected to be submitted for FERC approval in the second quarter of 1997 and is expected to be in service by the 1999-2000 winter heating season. 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 rates and (iii) allowed rate of return, including the equity component of a pipeline's capital structure. 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, 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, 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 minimizes 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." COMPETITION Competition for pipeline services continues to intensify, due primarily to changes in regulation. Although FERC Order 636, implemented in 1993, probably has contributed most to increased competition in pipeline services, other changes in federal and state regulation also promise to increase competition. Many states are mandating that distribution company LDC services be unbundled, thereby opening retail gas markets to competition. FERC Order 888 is requiring wholesale competition for electric power and many states are extending this to retail markets. States in the Mid Atlantic Census Region, 7 which contain important Transco markets, are particularly active in attempting to open retail gas and electric markets to competition. FERC Order 636 required that the natural gas, transportation, and other services formerly provided in bundled form by pipelines be unbundled, 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 gas and to increasingly competitive markets in natural gas services, including competitive secondary markets in pipeline capacity. Pipeline capacity is being used more efficiently, and peaking and storage services are increasingly effective substitutes for annual pipeline capacity. FERC Order 636 also changed rate design for pipelines. This change has reduced short term risk of cost recovery by pipelines with fully subscribed capacity but, together with slow growth in gas demand and more efficient use of pipeline capacity and increased availability of substitutes for it, increased the risk of contract non-renewal or capacity turnback. The pace and extent of LDC unbundling and electric power industry restructuring, and their impacts, remain uncertain at this time. Competition in retail gas markets should lead to more efficient use of pipeline capacity and greater preference for shorter term contracts. The potential impact of electric power industry restructuring is particularly uncertain because gas competes with electricity in residential, commercial, and industrial end uses, and with other fuels, especially coal, in electricity generation. Although the net impact of electric restructuring on gas demand is uncertain, especially in the short run, the long run impact is expected to be increased gas use for power generation relative to direct use in residential, commercial, and industrial applications. SALES SERVICE As discussed above, WESCO (and TGMC prior to the Merger) manages Transco's jurisdictional merchant 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. 8 Transco's gas sales volumes managed by WESCO and TGMC for the years 1996, 1995 and 1994 are shown below.
Gas Sales Volumes (TBtu) 1996 1995 1994 - ------------------------ ----- ----- ----- Long-term sales......................... 227.9 219.7 217.2 Short-term sales........................ 37.9 95.5 109.7 ----- ------- ----- Total gas sales.................... 265.8 315.2 326.9 ===== ===== =====
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 9. Transactions With Major Customers and Affiliates." REGULATION INTERSTATE GAS PIPELINE OPERATIONS Transco's transmission and storage activities are subject to regulation by the FERC under the Natural Gas Act of 1938 (Natural Gas Act) 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 Natural Gas Act. 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. 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, 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 this reason, management believes that compliance with applicable environmental requirements is not likely to have a material effect upon its earnings or competitive position. See "Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 3. Contingent Liabilities and Commitments - Environmental Matters." FORWARD-LOOKING INFORMATION Certain matters discussed in this report, excluding historical information, include forward-looking statements. Although Transco believes such forward-looking statements are based on reasonable assumptions, no assurance can be given that every objective will be reached. Such statements are made in reliance on the safe harbor protections provided under the Private Securities Litigation Reform Act of 1995. 9 As required by such Act, Transco hereby identifies the following 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 and conditions of the capital markets utilized by Transco 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; and (iii) risks and uncertainties related to the ability to develop expanded markets as well as maintaining existing markets. In addition, future utilization of pipeline capacity will depend on energy prices, competition from other pipelines and alternate fuels, the general level of natural gas demand 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. See "Item 8. Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 3. Contingent Liabilities and Commitments." RATE AND REGULATORY MATTERS ORDER 636 On February 27, 1997, the FERC issued an order in response to the D.C. Circuit Court's remand of Order 636. In that order, the FERC (i) reaffirmed its decision to allow pipelines to recover 100% of their GSR costs, (ii) allows the pipelines to propose an appropriate percentage of GSR costs to be recovered from IT customers, (iii) modified its right-of-first refusal policy to require firm capacity holders to match any term bid up to five years to keep their capacity, rather than the 20 year term adopted in Order 636, (iv) reaffirmed that SFV mitigation must be applied on a customer-by-customer basis, (v) requires prospectively that no-notice service be offered to all customers on a non-discriminatory basis, and (vi) reaffirmed that it will determine on a case-by-case basis the eligibility of a downstream pipeline's customers for the upstream pipeline's one-part, small customer rate. 10 ORDER 94-A COSTS (DOCKET NO. RP92-149) On February 28, 1997, the FERC issued an order denying rehearing of its January 29 order, but staying Columbia's refund obligation pending action by the Bankruptcy Court. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. Since Transco meets the conditions set forth in General Instruction (J)(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 a 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 (J)(1)(a) and (b) of Form 10-K, this information is omitted. 11 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. (THIS DISCUSSION SHOULD BE READ IN CONJUNCTION WITH ITEM 8, FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.) INTRODUCTION As discussed in Note 1, Corporate Structure and Control, of the Notes to Consolidated Financial Statements included in Item 8 herein, TEC and Williams announced that they had entered into a Merger Agreement pursuant to which Williams acquired on January 18, 1995, through a cash tender offer 24.6 million shares, or approximately 60%, of the outstanding shares of TEC's common stock for $430.5 million. The cash offer was then followed by a Merger in which shares of TEC common stock not purchased in the tender offer were exchanged for Williams' common stock valued at $334 million. On the May 1, 1995 effective date of the Merger, TEC declared and paid as dividends to Williams all of TEC's interests in Transco. 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 credit agreement and short-term money market facilities and, if required, by advances from Williams. In July 1996, Transco issued $200 million of 7.08% Debentures and, in December issued $200 million of 7.25% Debentures. Proceeds from the Debentures were used for general corporate purposes, including the refinancing of $275 million of Notes in 1996. In addition, Transco retired $99 million of Notes in January 1997. In 1997, Transco also plans to access capital markets to fund its expansion projects and other general corporate requirements. Transco believes any additional financing 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. Transco is a party to three short-term money market facilities, under which it can borrow up to an aggregate of $135 million. At December 31, 1996, there were no outstanding borrowings under the Credit Agreement or the short-term money market facilities. Advances due Transco by Williams totaled $148 million. CAPITAL EXPENDITURES As shown in the table below, Transco's capital expenditures for 1996 included $45 million for market-area projects, primarily for the Southeast Expansion Projects, compared 12 to $67 million in 1995, and $233 million for maintenance of existing facilities and other projects, compared to $170 million in 1995. Transco has budgeted approximately $415 million for 1997 capital expenditures related to expansion projects in the market and supply areas and the maintenance of existing facilities.
Budget Actual --------- ----------------------------------------- Capital Expenditures 1997 1996 1995 1994 - -------------------- -------- -------- -------- -------- (In millions) Market-Area Projects.................. $ 184.2 $ 44.5 $ 67.4 $ 20.4 Supply-Area Projects.................. 96.1 0.3 7.7 13.7 Maintenance of Existing Facilities and Other Projects....... 134.6 233.1 169.6 109.3 -------- ------- -------- ------- Total Capital Expenditure $ 414.9 $ 277.9 $ 244.7 $ 143.4 ======== ======= ======== =======
SOUTHEAST EXPANSION PROJECTS In November 1996, the final phase of the Southeast Expansion Projects was placed into service. Since late 1994, the Southeast Expansion Projects have added a total of 205 MMcf/d of firm transportation capacity to Transco's southeast customers in Alabama, Georgia, South and North Carolina and Virginia. The firm transportation capacity extends from Transco's Mobile Bay lateral interconnect, near Butler, Alabama, to delivery points upstream of Transco's Compressor Station 165, near Chatham, Virginia. The expansion projects include approximately 25 miles of pipeline replacement and looping and the installation of additional compression totaling approximately 70,000 horsepower. The 1994 Southeast Expansion Project was completed and placed into service in November 1994, and provides 35 MMcf/d of additional firm transportation capacity. Phase I of SE95/96 was completed and placed into service in December 1995, and provides 115 MMcf/d of additional firm transportation capacity. Phase II of SE95/96 added the remaining 55 MMcf/d for November 1996. The total cost of the expansion was approximately $106 million, of which approximately $22 million was invested in 1996. OTHER CAPITAL REQUIREMENTS AND CONTINGENCIES ORDER 636 TRANSITION COSTS As discussed in Note 3 of the Notes to Consolidated Financial Statements included in Item 8 herein, 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. 13 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. RP92-137 and RP95-197) under which all issues have not been resolved. Transco has provided reserves which it believes is adequate for any refunds that may be required under Docket Nos. RP92-137 and 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. 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 or short-term money market facilities will provide Transco with sufficient liquidity to meet its capital requirements. Transco also expects to access public and private markets on reasonable terms to finance its requirements. 14 RESULTS OF OPERATIONS As a result of the change in control of Transco on January 18, 1995 and the effects of the allocation of the purchase price, Transco's Consolidated Statement of Income for the year ended December 31, 1995 has been segregated into a pre-acquisition period ending January 17, 1995 and a post-acquisition period beginning January 18, 1995. For purposes of the discussion of variances the 1995 pre-acquisition and post-acquisition periods have been combined for a pro forma presentation of results of operations for the year 1995. 1996 COMPARED TO 1995 COMMON STOCK EQUITY IN NET INCOME AND OPERATING INCOME Transco's common stock equity in net income for 1996 was $95.5 million, compared with common stock equity in net income of $76.0 million for 1995. The 1995 results include an after-tax charge of $15.3 million to provide for executive severance and termination benefits, substantially all of which were not deductible for federal income tax purposes. Excluding this charge, Transco's common stock equity in net income for 1995 would have been $91.3 million. Operating income for 1996 was $208.6 million compared to operating income of $183.6 million ($199.6 million excluding the pre-tax charge of $16.0 million for executive severance and termination benefits) for 1995. Excluding the 1995 charge for executive severance and termination benefits, the higher common stock equity in net income of $4.2 million and higher operating income of $9.0 million for 1996 was primarily due to higher gas transportation revenues, net of the related cost of transportation and depreciation, and lower administrative and general expenses, partly offset by higher operation and maintenance expenses (excluding the effects of lower underground gas storage costs discussed below). In addition, common stock equity in net income in 1996 was impacted by higher fees of $2.0 million related to Transco's sale of receivables program, higher net interest expense of $1.4 million and lower dividends on preferred stock of $0.9 million compared to 1995. OPERATING COSTS AND EXPENSES Excluding the pre-tax effects of the 1995 charge for executive severance and termination benefits and the cost of sales and transportation of $884 million and $744 million for 1996 and 1995, respectively, Transco's operating expenses were $31 million lower in 1996 than in 1995. The decrease was due primarily to lower depreciation, operation and maintenance and administrative and general expenses. The lower depreciation expense of $23 million was primarily due to a reduction in depreciation rates in rate case RP95-197, partly offset by an increase of $5 million in the amortization of amounts allocated to Transco's property, plant and equipment from the Williams purchase price. The effects of the lower depreciation rates were substantially offset by a corresponding decrease in revenues collected in rate case RP95-197. Current FERC policy does not permit Transco to recover through rates the amortization of amounts 15 attributable to the Williams purchase price allocation. The lower operation and maintenance expense of $5 million was primarily attributable to lower underground storage costs ($10 million), labor costs ($3 million), rental costs ($2 million) and contract services ($1 million), partly offset by higher charges from others ($11 million) for the operation of certain Transco facilities. The lower administrative and general expense of $4 million was primarily due to lower information services and processing costs ($8 million), and lower office building rent ($1 million), partly offset by higher allocated corporate overhead costs from Williams ($3 million) and higher gas research costs ($2 million). Taxes - other than income taxes increased $1 million primarily due to higher state franchise taxes. TRANSPORTATION SERVICES Transco's operating revenues, excluding sales and storage services, decreased $56 million to $647 million for 1996, when compared to 1995. The lower transportation revenues were primarily due to lower gas transportation costs charged to Transco by others and lower depreciation costs that are recovered in Transco's rates, partly offset by the benefits of the two phases of the Southeast Expansion Projects placed in service in late 1995 and late 1996 and greater long-haul transportation deliveries. Other revenues increased $5 million due primarily to additional transportation of liquids and liquefiable hydrocarbons. Transco's market-area deliveries for 1996 were 51.3 TBtu, or 4%, higher than 1995. The increased deliveries were mainly due to the two phases of the Southeast Expansion Projects being placed into service in late 1995 and late 1996, greater volumes transported for injection into storage and prolonged cold weather in the market area during the first quarter of 1996. Transco's production-area deliveries for 1996 increased 44.1 TBtu, or 27%, when compared to 1995. The increased deliveries were primarily due to gas being transported for injection into storage and prolonged cold weather during the first quarter of 1996. As a result of a straight fixed-variable (SFV) rate design and the interruptible transportation revenue crediting, both in effect since September 1, 1992, increases or decreases in the system deliveries have had no significant impact on operating income. The revenue crediting requirement was eliminated on September 1, 1995 when Transco placed into effect the rates in its general rate case in Docket No. RP95-197. As a result, beginning September 1, 1995, increases or decreases in interruptible transportation volumes can have an impact on operating income. SALES SERVICES 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. 16 Through an agency agreement, WESCO manages all jurisdictional merchant gas sales of Transco, receives all margins associated with such 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. Transco's operating revenues related to its sales services increased $187 million to $807 million for 1996, when compared to 1995. The increase was primarily due to higher gas prices in Transco's jurisdictional merchant sales services, partly offset by 16% lower volumes of gas sales. However, this increase in revenues had no effect on Transco's operating or net income variances when compared to the prior year since the increase in revenues was offset by a corresponding increase in the cost of sales. STORAGE SERVICES Transco's operating revenues related to storage services decreased $14 million to $141 million in 1996, when compared to 1995. The decrease in revenues was primarily due to lower gas storage costs charged to Transco by others that are recovered in Transco's rates. This decrease in revenues was substantially offset by a corresponding decrease in underground storage costs included in operation and maintenance expenses. In addition, Transco's storage rates included in rate case RP95-197 are lower than those included in the prior rate case. 1995 COMPARED TO 1994 COMMON STOCK EQUITY IN NET INCOME AND OPERATING INCOME Transco's common stock equity in net income for 1995 was $28.8 million less than 1994. However, excluding the effects of selected items, the common stock equity in net income for 1995 was comparable to common stock equity in net income for 1994. Selected items that affected the results for 1995 included net after-tax charges of $31.6 million related to the Merger for the amortization of amounts allocated to Transco from the Williams purchase price and to provide for executive severance and termination benefits, substantially all of which were not deductible for federal income tax purposes. The selected item affecting the results for 1994 was an after-tax charge of $3.7 million related to a provision for refunds of certain FERC Order 94 production related costs. Operating income for 1995 was $183.6 million ($226.4 million excluding the selected items) compared to operating income of $223.4 million ($229.4 million excluding the selected item) for 1994. This $3.0 million decrease, excluding the selected items, was due to higher operating expenses (excluding the cost of sales and transportation) of $16.3 million, partly offset by higher revenues, net of the related cost of sales and transportation, of $13.3 million. OPERATING COSTS AND EXPENSES Excluding the pre-tax effects of the selected items and the cost of sales and transportation of $744 million and $871 million for 1995 and 1994, respectively, Transco's operating expenses were approximately $16 million higher in 1995 than 1994. The increase was due primarily to costs for underground storage facilities ($5 17 million), taxes other than income taxes ($4 million), corporate overhead expenses ($3 million) and depreciation and amortization expense ($3 million). TRANSPORTATION SERVICES Transco's operating revenues, excluding sales and storage services, increased $16 million to $703 million for 1995, when compared to 1994. Transportation revenues increased $22 million due primarily to additional revenues of $6 million from the Southeast Expansion Project which was placed into service in November 1994, lower credits to customers of $6 million related to refunds of previously over funded deferred federal income taxes and increased revenues related to certain increased costs included in Transco's rate filing effective September 1, 1995, subject to refund. Other revenues decreased $6 million due primarily to lower transportation of liquids and liquefiable hydrocarbons. SALES SERVICES Transco's operating revenues related to its sales services decreased $136 million to $619 million for 1995, when compared to 1994. Of this decrease, $84 million was related to lower prices, $22 million was related to lower volumes, $12 million was related to the lower demand charges beginning in April 1995 and $18 million was related to storage gas sold in 1994. However, the decrease in revenues had no effect on Transco's operating or net income since these revenue variances were offset by corresponding variances in the cost of sales when compared to the prior year. STORAGE SERVICES Transco's operating revenues related to storage services increased $7 million to $155 million in 1995, when compared to 1994. The increase reflects primarily an increase in Transco's storage rates effective in July 1994 due to higher storage rates charged to Transco by the operator of the Leidy and Wharton storage fields; however, this increase in revenues was substantially offset by a $5 million increase in underground storage costs included in operation and maintenance expenses. 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. 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 18 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. 19 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page ------ Report of Independent Auditors......................................... 21 Report of Independent Public Accountants............................... 22 Consolidated Balance Sheet............................................. 23-24 Consolidated Statement of Income....................................... 25 Consolidated Statement of Common Stockholder's Equity.................. 26 Consolidated Statement of Cash Flows................................... 27-28 Notes to Consolidated Financial Statements............................. 29-57 20 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, 1996 and 1995, and the related consolidated statements of income, common stockholder's equity, and cash flows for the year ended December 31, 1996 and the periods from January 1, 1995 to January 17, 1995, and from January 18, 1995 to December 31, 1995. 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. The consolidated statements of income, common stockholder's equity, and cash flows for the year ended December 31, 1994, were audited by other auditors whose report dated February 20, 1995, expressed an unqualified opinion on those statements. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Transcontinental Gas Pipe Line Corporation at December 31, 1996 and 1995, and the consolidated results of its operations and its cash flows for the year ended December 31, 1996 and the periods from January 1, 1995 to January 17, 1995, and from January 18, 1995 to December 31, 1995, in conformity with generally accepted accounting principles. ERNST & YOUNG LLP Tulsa, Oklahoma February 7, 1997 21 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Transcontinental Gas Pipe Line Corporation: We have audited the accompanying consolidated statements of income, common stockholder's equity and cash flows of Transcontinental Gas Pipe Line Corporation (a Delaware corporation) for the year ended December 31, 1994. 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 audit. We conducted our audit in accordance with generally accepted auditing standards. 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 audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Transcontinental Gas Pipe Line Corporation for the year ended December 31, 1994, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Houston, Texas February 20, 1995 22 TRANSCONTINENTAL GAS PIPE LINE CORPORATION CONSOLIDATED BALANCE SHEET THOUSANDS OF DOLLARS
December 31, December 31, 1996 1995 ------------ ------------ ASSETS Current Assets: Cash.............................................................. $ 1,774 $ 2,557 Receivables: Trade (Notes 4 and 8 ).......................................... 48,711 44,655 Affiliates...................................................... 1,761 2,848 Advances to affiliates.......................................... 148,496 104,499 Federal income tax benefits receivable from affiliate........... 3,076 - Other........................................................... 2,300 4,826 Transportation and exchange gas receivables: Affiliates...................................................... 22,111 28,309 Others.......................................................... 72,900 113,310 Inventories: Gas in storage, at LIFO......................................... 36,920 21,943 Materials and supplies, at lower of average cost or market...... 30,623 34,336 Gas available for customer nomination........................... 1,918 548 Deferred income tax asset (Note 7 )............................... 76,192 37,640 Other............................................................. 19,807 28,596 ------------ ------------ Total current assets............................................ 466,589 424,067 ------------ ------------ Investments, at cost plus equity in undistributed earnings........... 5,865 11,256 ------------ ------------ Property, Plant and Equipment: Natural gas transmission plant.................................... 3,738,550 3,455,154 Less - Accumulated depreciation and amortization.................. 318,234 170,417 ------------ ------------ Total property, plant and equipment, net........................ 3,420,316 3,284,737 ------------ ------------ Other Assets......................................................... 166,757 201,728 ------------ ------------ $ 4,059,527 $ 3,921,788 ============ ============ The accompanying notes are an integral part of these consolidated financial statements.
23 TRANSCONTINENTAL GAS PIPE LINE CORPORATION CONSOLIDATED BALANCE SHEET THOUSANDS OF DOLLARS
December 31, December 31, 1996 1995 ------------ ------------ LIABILITIES AND STOCKHOLDER'S EQUITY Current Liabilities: Current maturities of long-term debt (Note 4)......................... $ 99,000 $ 277,126 Payables: Trade.............................................................. 65,019 82,049 Affiliates......................................................... 70,283 84,590 Other.............................................................. 19,007 46,708 Transportation and exchange gas payable: Affiliates......................................................... 190 841 Others............................................................. 27,050 76,459 Accrued liabilities: Federal income taxes payable to affiliate.......................... - 55,868 State income and other taxes....................................... 17,846 9,135 Interest........................................................... 20,377 15,396 Employee benefits ................................................. 41,655 41,994 Other.............................................................. 24,411 31,934 Reserve for rate refunds.............................................. 172,823 55,123 ------------ ------------ Total current liabilities.......................................... 557,661 777,223 ------------ ------------ Long-Term Debt, less current maturities (Note 4)......................... 681,076 382,045 ------------ ------------ Other Long-Term Liabilities: Deferred income taxes (Note 7)........................................ 833,928 839,595 Other................................................................. 167,648 186,094 ------------ ------------ Total other long-term liabilities.................................. 1,001,576 1,025,689 ------------ ------------ Commitments and contingencies (Note 3)................................... Cumulative Redeemable Preferred Stock, without par value: (Note 5) Authorized 10,000,000 shares: none issued or outstanding.............. - - ------------ ------------ Cumulative Redeemable Second Preferred Stock, without par value: (Note 5) 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..................................................... 166,784 84,401 ------------ ------------ Total common stockholder's equity.................................. 1,819,214 1,736,831 ------------ ------------ $ 4,059,527 $ 3,921,788 ============ ============ The accompanying notes are an integral part of these consolidated financial statements.
24 The acquisition of Transco Energy Company and subsidiaries, including Transco, by The Williams Companies, Inc. was accounted for using the purchase method of accounting. Accordingly, the purchase price was "pushed-down" and recorded in the accompanying financial statements which affects the comparability of the post-acquisition and pre-acquisition financial position, results of operations and cash flows. TRANSCONTINENTAL GAS PIPE LINE CORPORATION CONSOLIDATED STATEMENT OF INCOME THOUSANDS OF DOLLARS
Post-Acquisition Pre-Acquisition ---------------------------------------- | ---------------------------------------- For the Year Ended For the Period | For the Period For the Year Ended December 31, January 18, 1995 | January 1, 1995 December 31, 1996 to December 31, 1995 | to January 17, 1995 1994 ------------------ -------------------- | -------------------- ------------------ | | Operating Revenues: | Natural gas sales.......................... $ 806,691 $ 587,568 | $ 31,701 $ 754,984 Natural gas transportation................. 640,096 667,601 | 32,775 678,561 Natural gas storage........................ 140,745 147,398 | 7,452 148,290 Other...................................... 7,297 2,584 | 133 9,127 -------------- ----------- | ------------- ------------ Total operating revenues................. 1,594,829 1,405,151 | 72,061 1,590,962 -------------- ----------- | ------------- ------------ | Operating Costs and Expenses: | Cost of natural gas sales.................. 806,690 586,878 | 31,691 752,495 Cost of natural gas transportation......... 77,369 119,455 | 6,279 118,865 Operation and maintenance.................. 197,953 194,441 | 8,722 190,501 Administrative and general................. 132,196 129,294 | 7,063 146,740 Provision for executive severance benefits. - - | 16,048 - Depreciation and amortization (Note 2)..... 134,199 151,711 | 5,560 120,797 Taxes - other than income taxes............ 36,471 33,818 | 1,558 31,061 Provision for regulatory issue (Note 3).... - - | - 6,000 Other...................................... 1,307 1,057 | 53 1,079 -------------- ----------- | ------------- ------------- Total operating costs and expenses....... 1,386,185 1,216,654 | 76,974 1,367,538 -------------- ----------- | ------------- ------------- | Operating Income (Loss)....................... 208,644 188,497 | (4,913) 223,424 | -------------- ----------- | ------------- ------------- | Other (Income) and Other Deductions: | Interest expense - affiliates ............. - 305 | 2 - - other................... 64,305 56,132 | 2,678 61,128 Interest income - affiliates.............. (5,895) (1,821) | (207) (6,122) - other................... (569) (630) | (12) (567) Allowance for equity and borrowed funds | used during construction (AFUDC)........ (6,800) (6,870) | (234) (4,184) Miscellaneous other deductions, net........ 3,447 315 | 213 4,710 -------------- ----------- | ------------- ------------- | | Total other (income) and other deductions 54,488 47,431 | 2,440 54,965 -------------- ----------- | ------------- ------------- | Income (Loss) before Income Taxes ......... 154,156 141,066 | (7,353) 168,459 Provision for Income Taxes (Note 7)........ 58,613 54,478 | 2,309 57,733 -------------- ----------- | ------------- ------------- Net Income (Loss).......................... 95,543 86,588 | (9,662) 110,726 Dividends on Preferred Stock............... - 722 | 194 5,944 -------------- ----------- | ------------- ------------- Common Stock Equity in Net Income (Loss)... $ 95,543 $ 85,866 | $ (9,856) $ 104,782 ============== =========== | ============= ============= The accompanying notes are an integral part of these consolidated financial statements.
25 The acquisition of Transco Energy Company and subsidiaries, including Transco, by The Williams Companies, Inc. was accounted for using the purchase method of accounting. Accordingly, the purchase price was "pushed-down" and recorded in the accompanying financial statements which affects the comparability of the post-acquisition and pre-acquisition financial position, results of operations and cash flows. TRANSCONTINENTAL GAS PIPE LINE CORPORATION CONSOLIDATED STATEMENT OF COMMON STOCKHOLDER'S EQUITY THOUSANDS OF DOLLARS
Post-Acquisition Pre-Acquisition --------------------------------------- | --------------------------------------- For the Year Ended For the Period | For the Period For the Year Ended December 31, January 18, 1995 | January 1, 1995 December 31, 1996 to December 31, 1995 | to January 17, 1995 1994 ------------------ -------------------- | ------------------- ------------------ | | Common Stock: | Balance at beginning and end of period... $ - $ - | $ - $ - ------------- ------------ | ------------- ------------- | Premium on Capital Stock and Other Paid-in | Capital: | Balance at beginning of period........... 1,652,430 285,792 | 285,792 283,037 Add (deduct): | TranStock contribution................. - - | - 2,901 Acquisition adjustment to eliminate | retained earnings..................... - 519,179 | - - Acquisition adjustment to record | assets and liabilities at fair value.. - 837,446 | - - Cash capital contribution ............. - 5,539 | - - Non-cash capital contribution ......... - 5,541 | - 37 Non-cash return of capital ............ - (698) | - - Loss on reacquired preferred stock..... - (369) | - (183) ------------- ------------ | ------------- ------------- | Balance at end of period................. 1,652,430 1,652,430 | 285,792 285,792 ------------- ------------ | ------------- ------------- | Retained Earnings: | Balance at beginning of period........... 84,401 519,179 | 529,035 424,253 Add (deduct): | Net income (loss)...................... 95,543 86,588 | (9,662) 110,726 Cash dividends on common stock......... (4,814) - | - - Non-cash dividends on common stock..... (8,346) (1,465) | - - Acquisition adjustment to eliminate | retained earnings..................... - (519,179) | - - Dividends on preferred stock........... - (722) | (194) (5,944) ------------- ------------ | ------------- ------------- | Balance at end of period................. 166,784 84,401 | 519,179 529,035 ------------- ------------ | ------------- ------------- | Total Common Stockholder's Equity........ $ 1,819,214 $ 1,736,831 | $ 804,971 $ 814,827 ============= ============ | ============= ============= The accompanying notes are an integral part of these consolidated financial statements.
26 The acquisition of Transco Energy Company and subsidiaries, including Transco, by The Williams Companies, Inc. was accounted for using the purchase method of accounting. Accordingly, the purchase price was "pushed-down" and recorded in the accompanying financial statements which affects the comparability of the post-acquisition and pre-acquisition financial position, results of operations and cash flows. TRANSCONTINENTAL GAS PIPE LINE CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS THOUSANDS OF DOLLARS
Post-Acquisition Pre-Acquisition -------------------- | --------------------------------------- For the Year Ended For the Period | For the Period For the Year Ended December 31, January 18, 1995 | January 1, 1995 December 31, 1996 to December 31, 1995 | to January 17, 1995 1994 ----------------- -------------------- | ------------------- ------------------ | | Cash flows from operating activities: | Net income (loss).............................. $ 95,543 $ 86,588 | $ (9,662) $ 110,726 Adjustments to reconcile net income (loss) | to net cash provided by (used in) | operating activities: | Depreciation and amortization (Note 2)...... 149,359 165,666 | 6,083 132,563 Deferred income taxes (Note 7).............. (44,219) (18,168) | 5,348 (24,466) Provision for (payment of) executive | severance benefits......................... (424) (14,849) | 16,048 - Allowance for equity funds used during | construction (Equity AFUDC).............. (4,670) (5,769) | (190) (3,410) Provision for regulatory issue (Note 3)..... - - | - 6,000 Changes in operating assets and liabilities: | Receivables............................... (3,519) 17,120 | (7,114) 32,067 Transportation and exchange gas receivable 46,608 (24,166) | (5,701) 35,363 Inventories............................... (12,357) (752) | (2,647) 17,131 Payables.................................. (67,253) 50,468 | (8,059) (30,836) Transportation and exchange gas payable... (50,060) 22,461 | 4,934 (27,798) Accrued liabilities....................... (40,122) 49,748 | (4,755) 7,527 Reserve for rate refunds.................. 117,188 (10,749) | (26,846) (68,041) Other, net................................ 15,298 (14,544) | 153 (25,031) ------------- ----------- | ------------- ------------ Net cash provided by (used in) | operating activities.................. 201,372 303,054 | (32,408) 161,795 ------------- ----------- | ------------- ------------ | Cash flows from financing activities: | (Notes 4 and 5) | Capital contribution by parent................. - 5,539 | - - Additions to long-term debt.................... 549,660 50,000 | - - Retirement of long-term debt................... (425,000) (50,000) | - - Debt issue costs .............................. (3,378) - | - - Retirement of preferred stock.................. - (49,744) | - (25,999) Advances from affiliates, net ................. - (8,195) | 8,195 - Dividends on preferred stock .................. - (1,647) | - (6,320) Dividends on common stock...................... (4,814) - | - - ------------- ----------- | ------------- ------------ Net cash provided by (used in) | financing activities..................... 116,468 (54,047) | 8,195 (32,319) ------------- ----------- | ------------- ------------
27 The acquisition of Transco Energy Company and subsidiaries, including Transco, by The Williams Companies, Inc. was accounted for using the purchase method of accounting. Accordingly, the purchase price was "pushed-down" and recorded in the accompanying financial statements which affects the comparability of the post-acquisition and pre-acquisition financial position, results of operations and cash flows. TRANSCONTINENTAL GAS PIPE LINE CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS THOUSANDS OF DOLLARS
Post-Acquisition Pre-Acquisition -------------------- | -------------------------------------- For the Year Ended For the Period | For the Period For the Year Ended December 31, January 18, 1995 | January 1, 1995 December 31, 1996 to December 31, 1995 | to January 17, 1995 1994 ----------------- -------------------- | ------------------- ------------------ | | Cash flows from investing activities: | Additions to property, plant and | equipment, net of equity AFUDC.............. (286,084) (240,102) | (3,797) (140,924) Changes in accounts payable and | accrued liabilities for additions | to property, plant and equipment............ 8,217 329 | (1,099) (2,516) Sale of assets............................... 2,561 8,154 | - - Advances to affiliates, net ................. (43,997) (52,124) | 63,599 17,331 Other, net................................... 680 1,199 | (24) (2,833) ------------- ----------- | ------------- ------------ Net cash provided by (used in) | investing activities................... (318,623) (282,544) | 58,679 (128,942) ------------- ----------- | -------------- ------------ | | Net increase (decrease) in cash ............. (783) (33,537) | 34,466 534 Cash at beginning of period.................. 2,557 36,094 | 1,628 1,094 ------------- ----------- | ------------- ------------ Cash at end of period........................ $ 1,774 $ 2,557 | $ 36,094 $ 1,628 ============= =========== | ============= ============ | | | Supplemental disclosures of cash flow | information: Cash paid during the year for: | Interest (exclusive of amount capitalized) $ 51,483 $ 52,450 | $ 5,552 $ 59,485 Income taxes paid......................... 175,001 28,576 | 19,427 60,663 Income tax refunds received............... (1,057) (22,454) | - (29,558) The accompanying notes are an integral part of these consolidated financial statements.
28 TRANSCONTINENTAL GAS PIPE LINE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Corporate Structure and Control....................................29 2. Summary of Significant Accounting Policies.........................30 3. Contingent Liabilities and Commitments.............................33 4. Debt, Financing Arrangements and Leases............................45 5. Preferred Stock....................................................47 6. Employee Benefit Plans.............................................48 7. Income Taxes.......................................................53 8. Financial Instruments..............................................54 9. Transactions with Major Customers and Affiliates...................55 10. Quarterly Information (Unaudited)..................................57 1. CORPORATE STRUCTURE AND CONTROL Prior to May 1, 1995, Transcontinental Gas Pipe Line Corporation (Transco) was a wholly-owned subsidiary of Transco Gas Company (TGC). TGC is a wholly-owned subsidiary of Transco Energy Company (TEC). On December 12, 1994, TEC and The Williams Companies, Inc. (Williams) announced that they had entered into a merger agreement (Merger Agreement) pursuant to which Williams acquired through a cash tender offer 24.6 million shares, or approximately 60%, of the outstanding shares of TEC's common stock for $430.5 million. The cash tender offer was then followed by a stock merger (Merger) in which shares of TEC common stock not purchased in the tender offer were exchanged for Williams' common stock valued at $334 million. The tender offer began on December 16, 1994 and expired on January 17, 1995. Approximately 35.2 million shares, or approximately 86.7%, of the outstanding shares of TEC's common stock were tendered to Williams for purchase. Pursuant to the Merger Agreement, on January 18, 1995, Williams accepted for payment 24.6 million shares of TEC's common stock for $17.50 per share as the first step in acquiring the entire equity interest of TEC. The exchange of the remainder of the outstanding shares of TEC's common stock for Williams' common stock was approved by a majority of TEC's stockholders on April 28, 1995 and occurred on the May 1, 1995 effective date of the Merger. On May 1, 1995, TEC declared and paid as a dividend to Williams all of TEC's interest in Transco. Transco's Board of Directors declared a non-cash common stock dividend equal to the net book value of the assets transferred to Williams of $8.3 million in 1996 and $1.5 29 million in 1995 and non-cash return of capital to Williams of $0.7 million in 1995. No common stock dividends were declared in 1994. 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. BASIS OF PRESENTATION The acquisition of TEC and its subsidiaries, including Transco, by Williams has been 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 accompanying post-acquisition consolidated financial statements reflect Transco's share of the purchase price. 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. Further, as a result of the change in control of Transco on January 18, 1995 and the effects of the allocation of the purchase price, Transco's Consolidated Statement of Income, Consolidated Statement of Common Stockholder's Equity and Consolidated Statement of Cash Flows for the twelve months ended December 31, 1995 have been segregated into a pre-acquisition period ending January 17, 1995 and a post-acquisition period beginning January 18, 1995. Prior to May 1, 1995 and as a subsidiary of TEC, Transco engaged in transactions with TEC and other TEC subsidiaries, characteristic of group operations. For consolidated cash management purposes, Transco made interest-bearing advances to TEC and received interest-bearing advances and capital contributions from TEC. These advances were represented by demand notes. As general TEC corporate policy, the interest rate on intercompany demand notes was 1-1/2% below the prime rate of Citibank, N.A. Effective May 1, 1995, Transco began participation in Williams' cash management program. On that date, the balance of the advances due to TEC were transferred by TEC to Williams. Subsequent to May 1, 1995, Transco repaid advances due Williams and made advances to Williams. These advances are represented by demand notes. Transco currently expects to receive payment of these advances within the next twelve months and 30 has recorded such advances as current in the accompanying Consolidated Balance Sheet. The interest rate on intercompany demand notes is the London Interbank Offered Rate on the first day of the month plus a spread ranging from 0.25% to 1.00%. Through an agency agreement, Williams Energy Services Company (WESCO), an affiliate of Transco, manages all jurisdictional merchant gas sales of Transco, receives all margins associated with such 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 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. Effective January 1, 1996, Transco adopted Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of." Adoption of the standard had no effect on Transco's financial position or results of operations. Depreciation rates used for major regulated gas plant facilities at year-end 1996, 1995 and 1994 were: Category of Property 1996 1995 1994 - -------------------- ----------- ----------- ----------- Gathering facilities....................... 2.60%-3.80% 6.22% 6.22% Storage facilities......................... 2.50% 2.50% 2.50% Onshore transmission facilities............ 2.35% 2.65% 2.65% Offshore transmission facilities........... 2.25% 3.75%-7.78% 3.75%-7.78% 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. RP95- 197, which was effective September 1, 1995, subject to refund, Transco agreed to reduce depreciation rates for certain categories of property. The reduction in depreciation rates 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 rates was recorded in 1996, retroactive to September 1, 1995. 31 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 each subsidiary with an amount equivalent to its federal income tax expense or benefit computed as if each subsidiary had filed a separate return. During 1994, TEC and its wholly-owned subsidiaries, which included Transco through its ownership by TGC, filed a consolidated federal income tax return. It was TEC's policy to charge or credit each subsidiary with an amount equivalent to its federal income tax expense or benefit computed as if each subsidiary filed a separate return, but including benefits from each subsidiary's losses and tax credits that may be utilized only on a consolidated basis. 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 Transco recognizes revenues for the sale of its commodities in the period of delivery and recognizes revenue for the transportation of gas in the period the service is provided based upon contractual terms. Transco is subject to FERC regulations and, accordingly, certain revenues are collected subject to possible refunds pending final FERC orders. Transco records rate refund accruals based on management's estimate of the expected outcome of these proceedings. ALLOWANCES 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, 1996 and 1995, 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 $2.1 million, $1.1 million and $0.8 million for 1996, 1995 and 1994, respectively. The allowance for equity funds was $4.7 million, $6.0 million and $3.4 million for 1996, 1995 and 1994, respectively. 32 GAS IN STORAGE Transco utilizes the last-in, first-out (LIFO) method of accounting for inventory gas in storage. The 1996 and 1995 inventory values approximated current replacement cost. 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 rate structure includes a method whereby most 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 in the future upon agreements of allocation and as permitted by operating conditions. These imbalances have been classified as current assets or current liabilities at December 31, 1996 and 1995. 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. 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 general rate filing proposes an annual cost of service increase of approximately $67 million over the cost of service underlying the rates contained in the settlement of Transco's last general rate filing. The rates, which were proposed to become effective, subject to refund, on May 1, 1997 (assuming a five-month suspension), are designed using the straight fixed-variable rate design method. The filing also includes (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 33 make IT backhaul rates equal to the forward haul rates. The pro-forma proposals would be made effective prospectively only after final FERC approval. On November 29, 1996, the FERC issued an order accepting Transco's filing, suspending its effectiveness until May 2, 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, and directed that the record in that proceeding be supplemented to the extent necessary. On February 3, 1997, the FERC issued an order on rehearing of its November 29, 1996 order which, among other things, revised the effective date for the proposed rates to May 1, 1997. On January 7, 1997, a prehearing conference was held during which a procedural schedule was adopted under which a hearing will commence on November 4, 1997. 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 generate additional annual jurisdictional revenues of approximately $132 million over the pre-filed rates in effect, based primarily on: (1) an increase in rate base resulting from additional plant and higher working capital requirements and a reduction in historical accumulated deferred income taxes; (2) an increase in operation and maintenance expenses; and (3) an increase in Transco's cost of capital resulting from an increase in the equity component of the capital structure used (the filing is based on Transco's own capital structure) and in the cost of equity from the prefiled rate of return on equity of 14.45% to the proposed rate of return on equity of 15.25%. Transco also proposed certain changes to the terms and conditions of its tariff, including the elimination of the interruptible transportation (IT) crediting mechanism. 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. The March 31 order also accepted, effective April 1, 1995, the tariff sheets changing Transco's terms and conditions of service, subject to the outcome of a technical conference. As to the elimination of the IT crediting mechanism, the FERC permitted Transco to eliminate the IT crediting mechanism subject to the outcome of a hearing to determine the reasonableness of Transco's test period throughput projections for interruptible services. At a prehearing conference on April 18, 1995, the presiding Administrative Law Judge (ALJ) adopted a procedural schedule establishing a phased hearing for the rate issues raised by Transco's filing. Phase I of the hearing was limited to the issues of the rate of return and capital structure. Phase II of the hearing was to address the remaining rate issues. 34 On August 31, 1995, Transco filed to place the rates filed on March 1, 1995 into effect on September 1, 1995, as adjusted to reflect certain changes subsequent to the March 1 filing. The FERC accepted Transco's filing, subject to the outcome of the hearing and technical conference established by the FERC's March 31 order. The September 1 rates were collected subject to refund from September 1, 1995 through July 31, 1996. Effective August 1, 1996, Transco began billing the rates contained in a settlement agreement, as discussed below. On October 4, 1995, the FERC issued an order on the tariff issues addressed at a technical conference held pursuant to the FERC's March 31 order. The FERC required that Transco make certain tariff changes consistent with the October 4 order (most of which were agreed to by Transco at the technical conference), and, as to other issues, directed Transco to continue discussions with its customers. The October 4 order directed that Transco modify its tariff concerning shipper access to secondary receipt points. On May 29, 1996, the FERC accepted Transco's filing effective June 1, 1996 to implement secondary receipt point access, but also required Transco to show cause why firm backhauls should not be required on Transco's system. Following a technical conference on the issue in Docket No. RP96-211, the FERC required Transco to offer a firm backhaul service which Transco implemented, subject to further FERC action, on January 1, 1997. The hearing before an ALJ in Phase I concluded in December 1995. On December 18, 1996, the ALJ issued his initial decision in Phase I, which, as to capital structure, found that TWC controlled Transco's financing and imputed TWC's capital structure to Transco, resulting in a capital structure consisting of 47.72% long term debt, 4.07% preferred equity, and 48.21% common equity, and found that Transco should use TWC's cost of long term debt (8.89%) and its cost of preferred equity (8.80%) as of June 30, 1995. As to rate of return, the ALJ recommended a rate of return on equity of 11.50%. Transco has taken exception to the ALJ's initial decision which will be reviewed by the FERC. On June 19, 1996, Transco filed a Stipulation and Agreement and settlement rates. The agreement resolves cost of service (subject to the outcome of capital structure and rate of return in the Phase I proceeding), throughput level and mix, and certain cost allocation and rate design issues. The agreement also reserves certain other issues for hearing in Phase II, 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. On November 1, 1996, the FERC issued an order approving the June 19 agreement, and on February 3, 1997 approved an order denying rehearing of its November 1, 1996 order. On July 15, 1996, Transco submitted a filing with the FERC in which Transco proposed to implement, for non-contesting parties, the settlement rates set forth in the 35 settlement. The July 15 filing was accepted effective August 1, 1996 and Transco began billing the settlement rates to non-contesting parties effective August 1, 1996. On October 9, 1996, Transco filed a Stipulation and Agreement with the ALJ, which, subject to the outcome of the litigation of the reserved issues in Phase I and Phase II in this proceeding, settles 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 19, 1996, the FERC approved the October 9, 1996 agreement. The hearing concerning the Phase II issues not resolved by the June 19, 1996 and October 9, 1996 agreements concluded in November 1996. A supplemental hearing is scheduled to commence in June 1997 to consider Transco's roll-in proposal filed in Docket No. RP97-71, as discussed above. GENERAL RATE CASE (DOCKET NO. RP92-137) On March 2, 1992, Transco filed with the FERC a general rate case that proposed an increase in transportation rates, based primarily on increases in operating and maintenance costs, including those associated with additional services provided to Transco's markets since its last general rate filing, and increased cost of capital. The filing also included a change to straight-fixed-variable (SFV) rate design and an increase in rate base resulting from additional plant and equipment costs and higher working capital requirements. On September 1, 1992, the increased rates went into effect, subject to refund. On May 3, 1993, Transco filed with the FERC a Settlement with regard to Docket No. RP92-137. On November 4, 1993, the FERC issued an order accepting the Settlement. The Settlement resolved all issues in Docket No. RP92-137 except (i) issues relating to Transco's rate of return (see discussion below), and (ii) the issue of the appropriate load factor for the design of Transco's interruptible rates, which the FERC referred to a hearing in Docket No. RP92-137, for prospective effect only. In addition, in the Settlement, Transco agreed to file a new general section 4 rate case to be effective no later than September 1, 1995 (see discussion above of Docket No. RP95-197). The Settlement became effective on April 1, 1994. One party appealed the FERC's orders related to the Settlement to the United States Court of Appeals for the D.C. Circuit (D.C. Circuit Court) on an issue not affecting Transco's cost recovery; however, that appeal was remanded by the D. C. Circuit to the FERC at the FERC's request. On January 23, 1997, the FERC issued an order on remand which is consistent with the settlement but which will require that Transco reallocate certain refunds among its customers. During 1995, Transco made refunds of approximately $62.2 million, including interest, under Docket No. RP92- 137 for which Transco had previously provided a reserve. On September 17, 1992, the FERC issued a decision addressing the single issue of the appropriate rate of return in Docket No. RP92-137. The FERC, using a hypothetical capital structure based on the average capital structure of a group of seven publicly-traded 36 companies with pipeline subsidiaries, determined Transco's appropriate rate of return on equity to be 14.45%. The FERC did not determine Transco's cost of debt and preferred stock, suggesting that this issue should be the subject of further proceedings in the context of the general rate case. Consequently, Transco's settlement rates in Docket No. RP92- 137 reflected a rate of return on equity of 14.45% but, consistent with the FERC order, the rates reflect the cost of debt and preferred stock originally filed in the general rate case. The issue of the appropriate rate of return for Transco was appealed to the D.C. Circuit Court. On December 23, 1994, the D.C. Circuit Court issued an opinion remanding to the FERC for further consideration the FERC's September 17, 1992 order. The D.C. Circuit Court determined that the FERC had failed to explain adequately its decisions to use a hypothetical capital structure for Transco, to select a rate of return on equity at the top range of reasonableness, and to use as a proxy group to develop Transco's hypothetical capital structure a group of publicly-traded parent companies with pipeline subsidiaries rather than a group of regulated pipelines. On April 10, 1996, the FERC issued its order on remand and adopted Transco's capital structure as the appropriate capital structure for ratemaking purposes, reversing its previous orders adopting a hypothetical capital structure. The FERC made no adjustment to Transco's rate of return on equity, adopting a 14.45% rate of return on equity. The FERC directed Transco to make refunds in accordance with the April 10, 1996 order. On July 23, 1996, the FERC denied rehearing of the April 10, 1996 order. On September 17, 1996, Transco made refunds required under the FERC order, for which Transco had previously provided a reserve. On September 20, 1996, certain parties filed a petition for review of the FERC's April 10, 1996 and July 23, 1996 orders in the D.C. Circuit Court. 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, 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 37 area mainline a priority over other interruptible transportation. On December 18, 1996, the FERC denied rehearing of its July 3, 1996 Order. One party has sought rehearing of that order, and Transco has sought clarification. ORDER 636 On November 1, 1993, Transco implemented Order 636. Prior to its implementation of Order 636, Transco received orders from the FERC which, among other things, (i) required Transco to revise its throughput projection for rate purposes to reflect a mix of throughput that includes a higher level of interruptible transportation, (ii) accepted Transco's proposal for rolled-in rate treatment of its Mobile Bay facilities and exempted Transco from having to reflect Mobile Bay transportation volumes and related revenues in a separate interruptible revenue crediting mechanism, (iii) approved a Stipulation and Agreement filed with the FERC by Transco and its sales customers resolving certain sales service issues and mooting potential issues regarding Transco's recovery of gas supply realignment (GSR) costs associated with Transco's firm sales service, and (iv) referred certain matters to the hearing in Docket No. RP92-137 (discussed above). Any changes in Transco's rates or services resulting from this hearing would have a prospective effect only. Transco and certain other parties have filed appeals of certain of the FERC's orders to the D.C. Circuit Court. Among the issues raised by the parties are whether the separately stated gathering rates charged by Transco should be subject to refund and issues related to Transco's storage tracker authority. On February 13, 1995, the D.C. Circuit Court issued an order holding all appeals of restructuring orders arising out of Order 636 in abeyance until the court rendered an opinion in the appeals of Order 636. On July 16, 1996, the D.C. Circuit Court issued a decision which in part affirmed and in part remanded Order 636. However, the court stated that Order 636 would remain in effect until the FERC issued a final order on remand after considering the remanded issues. With the issuance of this decision, the stay on the appeals of individual pipeline's restructuring cases has been lifted. Order 636 provides that pipelines should be allowed the opportunity to recover all prudently incurred transition costs. Transco does not expect to incur GSR costs associated with its firm sales service and Transco's non-GSR transition costs are anticipated to be insignificant. However, Transco expects that any Order 636 transition costs incurred should be recovered from its customers subject only to the costs and other risks associated with the difference between the time such costs are incurred and the time when those costs may be recovered from customers. GATHERING FACILITIES SPIN-DOWN ORDER (DOCKET NOS. CP96-206-000 AND CP96-207- 000) On October 26, 1994, the FERC issued a notice of a request for initiation of a complaint proceeding in Transco's Order 636 restructuring docket, stating that Fina Natural Gas Company (Fina) had filed a complaint requesting that the FERC initiate a 38 proceeding under section 5 of the Natural Gas Act of 1938 (NGA) to investigate the functionalization of Transco's production-area facilities. Fina asserted that some of Transco's production-area facilities have been misfunctionalized as transmission, and that under recent gathering orders, those facilities should properly be functionalized as gathering facilities. Transco filed an answer requesting that the FERC defer action on Fina's complaint until June 1, 1995, and advised the FERC that, in light of the FERC's evolving policies on gathering and production-area rate design, Transco is evaluating which, if any, of its Gulf Coast gathering facilities could be spun down into a nonjurisdictional subsidiary. On June 1, 1995, Transco advised the FERC that, in light of certain outstanding issues concerning the FERC's gathering policies, Transco had not yet determined the precise form that a gathering proposal to the FERC might take, or the ultimate timing of any such proposal. If the FERC elects to initiate a proceeding in response to Fina's complaint, any change in classification of the function of plant facilities between transmission and gathering would be prospective only. Subsequently, 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 (WGP), an affiliate of Transco. The net book value at December 31, 1996 of the facilities, including the purchase price allocation to Transco, was approximately $564 million. Concurrently, WGP 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. The filings are part of an ongoing comprehensive restructuring plan by Williams to separate all gathering facilities from Williams' jurisdictional interstate natural gas pipeline transmission companies. On September 25, 1996, the FERC issued an order dismissing Transco's application and WGP's petition for declaratory order. On October 25, 1996, Transco and WGP filed a joint request for rehearing of the FERC's September 25 order. ORDER 94-A COSTS (DOCKET NO. RP92-149) In 1983, the FERC issued Order 94-A, which permitted producers to collect certain production-related gas costs from pipelines on a retroactive basis. The FERC subsequently issued orders allowing several pipelines, including Transco, to direct bill their customers for such production-related costs through fixed monthly charges based on a customer's historical purchases. In 1990, the D.C. Circuit Court overturned the FERC's authorization for pipelines to direct bill production-related costs to customers based on gas purchased in prior periods and remanded the matter to the FERC to determine an appropriate recovery mechanism. Under the terms of a settlement, Transco's customers, with the exception of Columbia Gas Transmission Corporation (Columbia), agreed not to contest the Order 94-A payments previously made to Transco by them. Transco had billed to and recovered from Columbia approximately $7 million of Order 94-A costs. In October 1993, Transco and Columbia filed with the FERC for approval of a settlement agreement in which Transco agreed to 39 refund $1.4 million to Columbia, which amount was inclusive of principal and interest, in full and final settlement of all issues in this proceeding. On January 26, 1994, Columbia filed a letter with the FERC stating that, due to developments in other pipeline company proceedings involving settlements of the issue of recovery of Order 94-A costs from Columbia, Columbia could no longer support the settlement between Transco and Columbia. On February 13, 1995, the FERC issued an order rejecting the October 1993 settlement and requiring Transco to refund to Columbia the $7 million principal amount of Order 94-A costs collected from Columbia. Both Transco and Columbia requested rehearing of the February 13 order, and on May 1, 1995, the FERC issued an order denying both Transco's and Columbia's requests. On May 31, 1995, Transco made the required refund for which Transco had previously provided a reserve. Transco and Columbia each filed with the D.C. Circuit Court a petition for review of the FERC's order. On September 10, 1996, the D.C. Circuit Court issued an opinion, which vacated the FERC's February 13 order and directed the FERC to issue an order approving the October 1993 Transco-Columbia settlement. On January 29, 1997, the FERC issued an order approving the October 1993 settlement and directing Columbia to refund to Transco all amounts refunded to Columbia in excess of the amount required by the October 1993 settlement. On January 30, 1997 Columbia filed with the FERC a request for rehearing and a request that the FERC essentially stay Columbia's refund obligation pending action by the United States Bankruptcy Court. LEGAL PROCEEDINGS DAKOTA GASIFICATION LITIGATION In October 1990, Dakota Gasification Company (Dakota), the owner of the Great Plains Coal Gasification Plant (Plant), filed suit in the U.S. District Court in North Dakota against Transco and three other pipeline companies alleging that the pipeline companies had not complied with their respective obligations under certain gas purchase and gas transportation contracts. In September 1992, Dakota and the Department of Justice on behalf of the Department of Energy filed an amended complaint adding as defendants in the suit, Transco Energy Company, Transco Coal Gas Company and all of the other partners in the partnership that originally constructed the Plant and each of the parent companies of these entities. Dakota and the Department of Justice sought declaratory and injunctive relief and the recovery of damages, alleging that the four pipeline defendants underpaid for gas, collectively, as of June 30, 1992, by more than $232 million plus interest and for additional damages for transportation services and costs and expenses including attorneys' fees. By order dated December 18, 1996, the FERC approved a settlement of the litigation. No party to the FERC proceeding has sought review of this order. The final settlement terms went into effect February 1, 1997, which will allow Transco to recover its costs. 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 has entered into certain settlements which may require the 40 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 (Texaco)). In this lawsuit, the plaintiff has claimed approximately $23 million, including interest and attorneys' fees for reimbursements of settlement amounts paid to royalty owners. The trial of the lawsuit is scheduled for July 1997. Transco has denied liability in the litigation and believes that it has meritorious defenses to the claims which it intends to pursue vigorously. 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 3, 1995, Transco filed suit against FMP, FM Properties Operating Co. and FMP Operating Company in the 53rd Judicial District Court of Travis County, Texas, under the Texas Uniform Declaratory Judgements Act seeking a determination that Transco is not liable to defendants under the terms of the settlement agreements. On April 3, 1995, the defendants filed their answer and a plea in abatement. On or about March 30, 1995, FMP and FM Properties Operating Co. filed a petition for specific performance seeking recovery against Transco for the sums claimed under the settlement agreements. On May 4, 1995, Transco filed an answer denying any liability to plaintiffs. 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 not been formally served with the lawsuit but plans to file in the near future an answer denying liability for the claim. OTHER LITIGATION On July 18, 1996, an individual filed a lawsuit in the United States District Court for the District of Columbia against 70 natural gas pipelines and other gas purchasers or former gas purchasers. Transco is named as a defendant in the lawsuit. The plaintiff claims, on behalf of the United States under the False Claims Act, that the pipelines have incorrectly measured the heating value or volume of gas purchased by the defendants. The plaintiff claims that the United States has lost royalty payments as a result 41 of these practices. Transco intends to vigorously defend against these claims. On November 13, 1996, a group of 53 defendants, including Transco, filed a motion to dismiss the lawsuit. The court's decision is expected after oral argument on the motion, which is scheduled on March 12, 1997. In July 1996, Canadian Occidental of California (CXY) filed a lawsuit against Transco and certain Transco affiliates demanding an accounting relating to alleged take-or-pay deficiencies under seven gas purchase contracts for the years 1982 and 1983. Transco has answered the lawsuit asserting that the alleged deficiencies were settled in an agreement with CXY in 1986 or, alternatively, that the claims are barred by the statute of limitation, and has asked that the dispute be resolved by arbitration. The parties have agreed to delay discovery while engaging in settlement discussions. ENVIRONMENTAL MATTERS 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. 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, 1996, 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. 42 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 an information request from the EPA. Although penalties have not presently been asserted, no assurances 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 nonattainment and it anticipates that in 1997 the EPA may additionally designate new nonattainment areas which might impact Transco's operations. Pursuant to nonattainment area requirements of the 1990 Amendments, Transco is completing scheduled installation of new air pollution controls on existing sources at certain facilities in order to achieve attainment of air quality standards in regions where they are not currently achieved, and anticipates that additional facilities may be subject to increased controls within five years. 43 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 and the 1990 Amendments, are estimated to cost in the range of $20 million to $30 million over the next five years and will be recorded as additions to property, plant and equipment as the facilities are added. 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. In February 1995, three citizens filed suit against Transco in federal district court in Virginia for alleged violations of several provisions of both federal and state law. Since 1991, Transco has worked with the appropriate Virginia authorities to resolve certain emissions issues also raised by the citizens. In March 1995, Transco filed a motion to dismiss based on lack of subject matter jurisdiction and failure to state a claim. On October 13, 1995, the court dismissed all counts of plaintiffs' complaint provided that plaintiffs could amend their complaint to salvage the state law nuisance claim by inclusion of appropriate allegations establishing diversity of citizenship jurisdiction. Plaintiffs did so amend their complaint. In April 1996, an agreement was executed by all plaintiffs and Transco to settle and resolve this lawsuit. 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 and cash flow requirements. OTHER COMMITMENTS COMMITMENTS FOR CONSTRUCTION Transco has commitments for construction and acquisition of property, plant and equipment of approximately $38 million at December 31, 1996 of which the majority relates to construction materials for projects. 44 4. DEBT, FINANCING ARRANGEMENTS AND LEASES LONG-TERM DEBT At December 31, 1996 and 1995, long-term debt issues were outstanding as follows (in thousands):
1996 1995 --------------- --------- Debentures: 9-1/8% due 1998-2017 $ 150,000 $ 150,000 7.08% due 2026 200,000 - 7.25% due 2026 200,000 - -------------- ---------- Total debentures 550,000 150,000 -------------- ---------- Notes: 9% due 1996 - 150,000 8-1/8% due 1997 99,000 99,000 6.21% due 2000 - 125,000 8-7/8% due 2002 125,000 125,000 -------------- ---------- Total notes 224,000 499,000 -------------- ---------- Total long-term debt issues 774,000 649,000 Unamortized debt premium 6,076 10,171 Current maturities (99,000) (277,126) -------------- ---------- Total long-term debt, less current maturities $ 681,076 $ 382,045 ============== ==========
Sinking fund or prepayment requirements applicable to long-term debt outstanding at December 31, 1996 are as follows (in thousands): 1997: 8-1/8% Notes..................................... $ 99,000 ============ 1998: 9-1/8% Debentures................................ $ 7,500 ============ 1999: 9-1/8% Debentures................................ $ 7,500 ============ 2000: 9-1/8% Debentures................................ $ 7,500 ============ 2001: 9-1/8% Debentures................................ $ 7,500 7.08% Debentures................................. 200,000 ------------ Total........................................ $ 207,500 ============ No property is pledged as collateral under any of the long-term debt issues. On July 15, 1996, Transco issued $200 million of debentures (7.08% Debentures), which pay interest at 7.08% per annum on January 15 and July 15 of each year, beginning January 15, 1997. 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 has 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. On December 2, 1996, Transco issued $200 million of debentures (7.25% Debentures), which pay interest at 7.25% per annum on June 1 and December 1 of each year, beginning June 1, 1997. The 7.25% Debentures mature on December 1, 2026, but are subject to redemption, at anytime, at Transco's option, in whole or part, at a specified redemption price, plus accrued and unpaid interest to the date of redemption. The 7.25% Debentures have no sinking fund provisions. On January 15, 1997, Transco redeemed $99 million of its 8-1/8% Notes. 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. Interest rates vary with current market conditions. As of December 31, 1996, Transco had no outstanding borrowings under this agreement. SHORT-TERM DEBT Transco is a party to three short-term money market facilities, under which it can borrow up to an aggregate of $135 million. Interest rates vary with current market conditions. During 1996, Transco had no borrowings under these agreements. During 1995, the weighted average interest rate on short-term debt was 6.1%. RESTRICTIVE COVENANTS Certain of Transco's debt instruments restrict the amount of dividends distributable. As of December 31, 1996, approximately $515 million of Transco's common stockholder's equity of $1,819 million was restricted. SALE OF RECEIVABLES Transco is a party to an agreement that expires in February 1998 pursuant to which Transco can sell to an investor up to $100 million of undivided interests in certain of its trade receivables. At both December 31, 1996 and 1995, interests in $100 million of these receivables were held by the investor. 45 The Financial Accounting Standards Board issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," effective for transactions occurring after December 31, 1996. The adoption of this standard is not expected to impact Transco's consolidated results of operations, financial position or cash flows. LEASE OBLIGATIONS Transco has a 20-year lease agreement with Transco Tower Limited for its headquarters building (Transco Tower) which expires in 2004. Transco has an option to renew and extend the existing lease term under the same provisions for three successive renewal terms of five years each. During 1996 and 1995, Transco entered into sublease agreements that also expire in 2004. The future minimum lease payments under Transco's Transco Tower lease, net of future minimum sublease receipts under Transco's existing sublease agreements, are as follows (in thousands): 1997 ............................... $ 22,939 1998 ............................... 22,939 1999 ............................... 22,860 2000 ............................... 21,367 2001 ............................... 23,619 Thereafter.............................. 53,084 --------- Total net minimum obligations...... $ 166,808 ========= The allocation of the 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. Transco's lease expense was $17.0 million in 1996, $20.1 million in 1995 and $36.0 million in 1994. The reduced lease expense in 1996 and 1995 reflects the effects of the purchase price allocation discussed above and the lower 1996 expense also reflects income from subleasing space in the Transco Tower. 5. PREFERRED STOCK Transco has authorized 10,000,000 shares of cumulative first preferred stock without par value, of which none were outstanding at December 31, 1996 or 1995. Transco has authorized 2,000,000 shares of cumulative second preferred stock without par value. None of the second preferred had been issued at December 31, 1996. Transco redeemed all outstanding shares of its cumulative preferred stock series in March 1995 for $49.7 million, or $100 per share, plus accrued dividends of $0.6 million. 46 The changes in the total Transco preferred stock in each of the years 1995 and 1994 are (in thousands):
1995 1994 ----------------------------- ------------------------- Shares Amount Shares Amount -------------- ------------- -------------- ---------- Balance at beginning of year.... 497 $49,744 757 $75,743 Retirements...................... 497 49,744 260 25,999 -------------- ------------- -------------- ---------- Balance at end of year........... - $ - 497 $49,744 ============== ============= ============== ==========
6. EMPLOYEE BENEFIT PLANS RETIREMENT PLANS Prior to the Merger, Transco participated in a retirement plan (Retirement Plan) with TEC and certain of its subsidiaries that covered substantially all of Transco's officers and regular employees. Transco's officers and employees comprised a majority of the total officers and employees of TEC and its subsidiaries. Subsequent to the Merger, the Retirement Plan covers only Transco's officers and employees. The benefits under the Retirement Plan are determined by a formula based on the employee's years of service and average final compensation. The Retirement Plan provides for the vesting of employees after five years of credited service. Transco's funding policy is to contribute an amount at least equal to the minimum funding requirements actuarially determined by an independent actuary in accordance with the Employee Retirement Income Security Act of 1974. Plan assets consist primarily of commingled funds and assets held in a master trust. The master trust is comprised primarily of domestic and foreign common and preferred stocks, United States government securities, corporate bonds and commercial paper. The following table sets forth the funded status of the Retirement Plan at December 31, 1996 and 1995, and the amount of accrued pension liability for Transco and TEC as of December 31, 1996 and 1995 (in thousands): 1996 1995 --------- --------- Actuarial present value of accumulated benefit obligation, including vested benefits of $139,202 at December 31, 1996 and $128,783 at December 31, 1995................................. $ 147,514 $ 145,949 ========= ========= Actuarial present value of projected benefit obligation........................................... $ 197,787 $ 201,425 Plan assets at market value........................... 179,462 155,821 --------- --------- Projected benefit obligation in excess of plan assets.. 18,325 45,604 Unrecognized net gain (loss)........................... 7,284 ( 16,591) Unrecognized prior service cost........................ 4,774 5,147 --------- ---------- Accrued pension liability.............................. $ 30,383 $ 34,160 ========= ========== 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 47 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, 1996 and 1995 were $5.4 million and $6.5 million, respectively, and are expected to be recovered through future rates over the average remaining service period for active employees. The following table sets forth the components of the Retirement Plan's net pension cost for Transco for the year ended December 31, 1996 and Transco and TEC for the years ended December 31, 1995 and 1994 (in thousands):
1996 1995 1994 ---------- ---------- ---------- Service cost-benefits earned during the period... $ 5,847 $ 4,716 $ 7,361 Interest cost on projected benefit obligation.... 14,240 12,111 11,046 Actual return on plan assets..................... ( 32,978) ( 37,958) ( 3,228) Net amortization and deferral.................... 16,792 25,666 ( 10,250) ---------- ---------- ---------- Net pension cost................................. $ 3,901 $ 4,535 $ 4,929 ========== ========== ==========
Transco's share of the Retirement Plan's net pension costs for 1995 and 1994 was $4.2 million and $4.2 million, respectively. The projected unit credit method is used to determine the actuarial present value of the accumulated benefit obligation and the projected benefit obligation. The following table summarizes the various assumptions used to determine the projected benefit obligation for the Retirement Plan for the years 1996, 1995 and 1994(1): 1996 1995 1994 ------ ------ ------ Discount rate................................... 7.50% 7.25% 7.50% Rate of increase in future compensation levels.. 5.0% 5.0% 5.0% Expected long-term rate of return on assets..... 10% 10% 10% (1)Pension costs are determined using the assumptions as of the beginning of the year. The funded status is determined using the assumptions as of the end of the year. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS Prior to January 1, 1996, Transco participated in a plan with TEC and certain of its subsidiaries (TEC Plan) that provided certain health care and life insurance benefits for retired employees of Transco. Effective January 1, 1996, Transco began participation in a plan with Williams and its subsidiaries (Williams Plan) that provides similar benefits for retired employees of Transco that were hired prior to January 1, 1996. The plans provide benefits to retired Transco employees who worked full-time for five years, attained age 55 while in service and participated in Transco's Retirement Plan. The plans provide for retiree contributions and contain other cost-sharing features such as deductibles and coinsurance. The accounting for the plans anticipates future cost-sharing changes to the written plans that are consistent with Williams' expressed intent to increase the retiree contribution rate annually, generally in line with health care cost increases. 48 The benefits for all retired Transco employees are currently funded monthly to the extent recovery from customers can be achieved. Plan assets consist of assets held in two master trusts. One of the master trusts was previously described in the discussion of the retirement plan and the other consists primarily of domestic and foreign common stocks, government bonds and commercial paper held in a trust established under the provisions of section 501(c)(9) of the Internal Revenue Code. The following table sets forth the funded status of the plans at December 31, 1996 and 1995, reconciled with the accrued postretirement benefits for Transco at December 31, 1996 and Transco and TEC at December 31, 1995 (in thousands): 1996 1995 ---------- ---------- Accumulated postretirement benefit obligation: Retirees..................................... $ 77,249 $ 88,731 Fully eligible active plan participants...... 6,634 7,801 Other active plan participants............... 20,710 21,065 ---------- ---------- 104,593 117,597 Plan assets at market value...................... 65,320 51,776 ---------- ---------- Accumulated postretirement benefit obligation in excess of plan assets........................ 39,273 65,821 Unrecognized net gain............................ 23,248 10,107 Unrecognized prior service cost.................. 9,311 2,168 ---------- ---------- Accrued postretirement benefits.................. $ 71,832 $ 78,096 ========== ========== During the fourth quarter of 1996 the Williams Plan was amended, effective January 1, 1997, to increase the cost-sharing provisions. This amendment decreased the accumulated postretirement benefit obligation approximately $7.4 million. 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, 1996 and 1995 were $64.8 million and $71.7 million, respectively, and are expected to be recovered through future rates over the remaining amortization period of the unrecognized transition obligation. The following table sets forth the components of the plans' net periodic postretirement benefit cost for Transco for the year ended December 31, 1996 and Transco and TEC for the years ended December 31, 1995 and 1994 (in thousands):
1996 1995 1994 ---------- ---------- ---------- Service cost-benefits earned during the period...... $ 1,639 $ 2,619 $ 2,915 Interest cost on accumulated postretirement benefit obligation................................. 7,860 8,929 8,218 Actual return on plan assets........................ ( 6,868) ( 7,651) ( 895) Amortization of unrecognized transition obligation.. - - 5,314 Net amortization and deferral....................... 7,226 9,623 ( 516) ----------- ---------- ---------- Net periodic postretirement benefit cost............ $ 9,857 $ 13,520 $ 15,036 =========== ========== ==========
49 Transco's share of the TEC Plan's net periodic postretirement benefit cost for 1995 and 1994 was $12.7 million and $13.7 million, respectively. The annual rate of increase in the per capita cost of covered health care benefits for 1997 was assumed to be 9 to 10%. The rate was assumed to decrease gradually to 5% for the year 2004 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rate by one percent in each year would increase the accumulated postretirement benefit obligation for health care benefits as of December 31, 1996 by $7.6 million and the aggregate of the service and interest cost components of the net periodic postretirement health care benefit cost for 1996 by $1.2 million. The following table summarizes the various assumptions used to determine the accumulated postretirement benefit obligation for the plans for the years 1996, 1995 and 1994(1): 1996 1995 1994 ------ ------ ------ Discount rate................................ 7.50% 7.25% 7.75% After-tax expected long-term rate of return on assets.................................. 6% 6% 7% (1)Postretirement benefits costs are determined using the assumptions as of the beginning of the year. The funded status is determined using the assumptions as of the end of the year. In December 1992, the FERC issued a Statement of Policy which allows jurisdictional pipelines to recognize allowances for prudently incurred costs of postretirement benefits other than pensions on an accrual basis consistent with the accounting principles set forth in SFAS No. 106. Transco believes that all costs of providing postretirement benefits to its employees are necessary and prudent operating expenses and that such costs are recoverable in rates. TRAN$TOCK In January 1987, TEC's Board of Directors approved the establishment of an employee stock ownership plan called Tran$tock, which subsequently purchased 3,966,942 shares of newly issued TEC common stock at $45-3/8 per share. Compensation expense of $2.9 million related to Tran$tock was recognized by Transco in 1994. This expense represents the shares of TEC common stock allocated to employees of Transco for 1994. Transco recorded a capital contribution from TEC in the amount of the expense. The final allocation of shares was made to eligible participants in January 1995 applicable to the 1994 plan year; therefore, no compensation expense was recognized in 1995 and 1996. Effective January 1, 1996, the Tran$tock participants' share balances were merged with a Williams defined-contribution plan. THRIFT PLAN During 1995, Transco sponsored a defined-contribution plan (Thrift Plan) covering substantially all employees. Company contributions were based on 50 employees' compensation and, in part, matched employee contributions. Compensation expense of $3.3 million was recognized by Transco in 1995. Effective January 1, 1996, the Thrift Plan was merged with a Williams defined-contribution plan and Transco employees became eligible to participate in the Williams plan. Compensation expense of $4.4 million was recognized by Transco in 1996. 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. 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. Williams' employee stock-based awards are accounted for under 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. 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 1995 employee stock-based awards was $95.3 million and $74.4 million for 1996 and 1995, respectively. Reported net income was $95.5 million and $76.0 million for 1996 and 1995, respectively. Pro forma amounts for 1995 reflect total compensation expense from the awards made in 1995 as these awards fully vested as a result of the accelerated vesting provisions. Pro forma amounts for 1996 reflect compensation expense that may not be representative of future years amounts because the compensation expense from stock options is recognized over the future years vesting period, and additional awards generally are made each year. Stock options granted to employees of Transco in 1996 were 430,250 shares at a weighted average grant date fair value of $7.84. At December 31, 1996, stock options outstanding and options exercisable for employees of Transco were 856,818 shares and 473,849 shares, respectively. 51 7. INCOME TAXES Following is a summary of the provision for income taxes for 1996, 1995 and 1994 (in thousands):
Post-Acquisition Pre-Acquisition -------------------------------- | ------------------------ January 18, 1995 | January 1, 1995 to | to 1996 December 31, 1995 | January 17, 1995 1994 ---------- ----------------- | ---------------- ---------- | Federal: | Current.................... $ 88,927 $ 66,819 | $( 2,734) $ 72,364 Deferred................... ( 37,613) ( 17,404) | 4,577 ( 23,669) ---------- ------------- | ----------- ---------- 51,314 49,415 | 1,843 48,695 ---------- ------------- | ----------- ---------- State and municipal: | Current.................... 13,905 5,827 | ( 305) 9,835 Deferred................... ( 6,606) ( 764) | 771 ( 797) ---------- ------------- | ----------- ---------- 7,299 5,063 | 466 9,038 ---------- ------------- | ----------- ---------- | Provision for income taxes ... $ 58,613 $ 54,478 | $ 2,309 $ 57,733 ========== ============== | =========== ==========
Following is a reconciliation of the provision for income taxes at the federal statutory rate to the provision for income taxes (in thousands):
Post-Acquisition Pre-Acquisition --------------------------------- | ------------------------------ January 18, 1995 | January 1, 1995 to | to 1996 December 31, 1995 | January 17, 1995 1994 ---------- ----------------- | ---------------- ---------- | Taxes computed by applying | the federal statutory rate.. $ 53,955 $ 49,373 | $( 2,573) $ 58,961 Amortization of over funded | tax liabilities............. - - | - ( 7,675) Tran$tock compensation....... - - | - 1,015 Pre-acquisition executive | severance benefits.......... - - | 4,913 - State and municipal income | taxes....................... 4,744 3,291 | 303 5,874 Other, net................... (86) 1,814 | ( 334) ( 442) ---------- ----------- | --------------- ----------- | Provision for income taxes... $ 58,613 $ 54,478 | $ 2,309 $ 57,733 ========== ========== | ============== ===========
52 Significant components of deferred income tax assets and liabilities as of December 31, 1996 and 1995 are as follows (in thousands): 1996 1995 ---------- ---------- Deferred tax liabilities - ------------------------ Property, plant and equipment.................... $ 878,572 $ 881,906 Postretirement benefits.......................... 23,353 28,190 Other............................................ 10,621 42,941 --------- ---------- Total deferred tax liabilities................... 912,546 953,037 --------- ---------- Deferred tax assets Rate refunds..................................... 63,677 25,604 Accrued liabilities................ ............. 53,568 89,073 Deferred revenues................................ 6,020 2,246 State deferred taxes............................. 31,545 34,159 --------- --------- Total deferred tax assets........................ 154,810 151,082 --------- --------- Net deferred tax liabilities..................... $ 757,736 $ 801,955 ========= ========= 8. FINANCIAL INSTRUMENTS FAIR VALUE OF FINANCIAL INSTRUMENTS CARRYING AMOUNT AND FAIR VALUES The carrying amount and estimated fair values of Transco's financial instruments as of December 31, 1996 and 1995 are as follows (in thousands): Carrying Amount Fair Value --------------------- -------------------- 1996 1995 1996 1995 -------- -------- -------- -------- Financial assets: Cash and short-term financial assets............... $150,270 $107,056 $150,270 $107,056 Financial liabilities: Long-term debt ........ ........ 780,076 659,171 781,521 693,173 FAIR VALUE METHODS The following methods and assumptions were used in estimating fair values: For cash and short-term financial assets (advances to affiliates), the carrying amount is a reasonable estimate of fair value due to the short maturity of those instruments. Effectively, all of Transco's debt is publicly traded, therefore estimated fair value of long-term debt is based on quoted market prices at year end. 53 CREDIT AND MARKET RISK TRADE RECEIVABLES As of December 31, 1996 and 1995, Transco had trade receivables of $49 million and $45 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, 1996 and 1995. Transco received $21 million of proceeds in 1996, $108 million in 1995 and $80 million in 1994. At December 31, 1996 and 1995, $100 million of such receivables had been sold. Based on amounts outstanding at December 31, 1996 and 1995 the maximum contractual credit loss under these arrangements is approximately $15 million and $16 million, respectively, but the likelihood of loss is considered to be remote. 9. TRANSACTIONS WITH MAJOR CUSTOMERS AND AFFILIATES MAJOR CUSTOMER The sales, transportation and storage revenues received from Public Service Electric and Gas Company, the major customer of Transco, were $158.1 million in 1996, $166.7 million in 1995 and $180.5 million in 1994. The gas sales in 1996 were made to customers under executed Firm Sales Agreements with primary terms of not less than one year (1997) but not greater than five years (2001). AFFILIATES Included in Transco's sales and transportation revenues for 1996, 1995 and 1994 are revenues applicable to sales and transportation for affiliates of $124.3 million, $173.9 million and $209.4 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. The significant decrease in 1996 sales and transportation revenue reflects the impact of diminished gas supplies available for sale by Transco as Transco's gas purchase contracts expire or terminate. After FERC approval in January 1993, TEC realigned its gas marketing businesses under the common management of Transco Gas Marketing Company (TGMC), which, through an agency agreement, began to manage all jurisdictional merchant sales of Transco. In May 1995, WESCO became the successor to the TGMC agency agreement and began to manage Transco's jurisdictional merchant sales. For the years ended December 31, 1996, 1995 and 1994, included in Transco's cost of sales is $34.7 million, 54 $20.6 million and $24.4 million, respectively, representing agency fees billed to Transco by WESCO and TGMC under the agency agreement. Included in Transco's cost of sales and transportation for 1996, 1995 and 1994 is purchased gas cost from affiliates of $466.8 million, $131.5 million and $93.6 million, respectively. All gas purchases are made at market or contract prices. The significant increase in 1996 for purchased gas cost reflects the expiration or termination of third party gas purchase contracts during 1996 that resulted in a higher level of Transco's gas supply being purchased from affiliates. 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 $17.5 million in 1996, $36.4 million in 1995 and $36.3 million in 1994 applicable to the transportation of gas by Texas Gas Transmission Corporation (Texas Gas). The significant decrease in 1996 is mainly due to the conversion of certain Transco shippers from bundled service to unbundled service. Texas Gas is regulated by the FERC and its transportation rates charged to Transco are approved by the FERC. TEC had 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 January through April 1995 and the year 1994 was $10.9 million and $15.2 million, respectively, for management services charged by TEC. Effective May 1, 1995, Williams began charging corporate expenses to Transco for services similar to those previously provided by TEC or incurred directly by Transco. Included in Transco's administrative and general expenses for 1996 and 1995 were $14.5 million and $8.5 million, respectively, for such corporate expenses charged by Williams. Management considers the cost of these services reasonable. Transco entered into an operating agreement with Williams Field Services (WFS) effective May 1, 1995 whereby WFS, as Transco's agent, assumed operational control of Transco's gas gathering facilities. Included in Transco's operation and maintenance expenses for 1996 and 1995, are $35.6 million and $24.4 million, respectively, charged by WFS to operate Transco's gas gathering facilities. 55 10. QUARTERLY INFORMATION (UNAUDITED) The following summarizes selected quarterly financial data for 1996 and 1995 (in thousands):
Post-Acquisition ---------------------------------------------------- First Second Third Fourth ---------- ---------- ---------- ---------- 1996 Operating revenues................... $ 479,227 $ 391,576 $ 332,470 $ 391,556 Operating expenses................... 421,380 347,342 289,850 327,613 ---------- ---------- ---------- ---------- Operating income..................... 57,847 44,234 42,620 63,943 Interest expense..................... 13,146 16,510 17,759 16,890 Other (income) and deductions, net... (1,247) (1,829) (3,848) (2,893) ---------- ---------- ---------- ---------- Income before income taxes........... 45,948 29,553 28,709 49,946 Provision for income taxes........... 17,819 11,510 11,163 18,121 ---------- ---------- ---------- ---------- Common stock equity in net income.... $ 28,129 $ 18,043 $ 17,546 $ 31,825 ========== ========== ========== ==========
Pre-Acquisition Post-Acquisition ---------------- | -------------------------------------------------------- January 1, 1995 | January 18, 1995 to | to January 17, 1995 | March 31, 1995 Second Third Fourth ---------------- | ---------------- ---------- ---------- ---------- | 1995 | Operating revenues............. $ 72,061 | $ 295,659 $ 356,242 $ 340,351 $ 412,899 Operating expenses............. 76,974 | 249,655 305,905 301,946 359,148 ---------- | ------------- ---------- ---------- ---------- Operating income (loss)........ ( 4,913) | 46,004 50,337 38,405 53,751 Interest expense............... 2,680 | 12,849 14,247 14,303 15,038 Other (income) and | deductions, net ............. ( 240) | ( 1,088) ( 1,978) ( 1,507) ( 4,433) ---------- | ------------- ---------- ----------- --------- Income (loss) before | income taxes.................. ( 7,353) | 34,243 38,068 25,609 43,146 Provision for income taxes..... 2,309 | 13,236 14,171 9,076 17,995 ---------- | ------------- ---------- ----------- --------- Net income (loss).............. ( 9,662) | 21,007 23,897 16,533 25,151 Dividends on preferred stock... 194 | 722 - - - ---------- | ------------- ---------- ----------- --------- Common stock equity in net | income (loss)............... $( 9,856) | $ 20,285 $ 23,897 $ 16,533 $ 25,151 ========== | ============= ========== =========== ========= Includes a provision of $16,048 for executive severance benefits.
56 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 (J)(1)(a) and (b) of Form 10-K, this information is omitted. 57 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. PAGE REFERENCE TO 1996 10-K ------------ A. INDEX 1. FINANCIAL STATEMENTS: Report of Independent Auditors - Ernst & Young LLP 21 Report of Independent Public Accountants - Arthur Andersen LLP 22 Consolidated Balance Sheet as of December 31, 1996 and 1995 23-24 Consolidated Statement of Income for the Year Ended December 31, 1996, the Periods January 1, 1995 to January 17, 1995, and January 18, 1995 to December 31, 1995, and the Year Ended December 31, 1994 25 Consolidated Statement of Common Stockholder's Equity for the Year Ended December 31, 1996, the Periods January 1, 1995 to January 17, 1995, and January 18, 1995 to December 31, 1995, and the Year Ended December 31, 1994 26 Consolidated Statement of Cash Flows for the Year Ended December 31, 1996, the Periods January 1, 1995 to January 17, 1995, and January 18, 1995 to December 31, 1995, and the Year Ended December 31, 1994 27-28 Notes to Consolidated Financial Statements 29-57 58 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 - 1 Agreement and Plan of Merger dated as of December 12, 1994 by and among The Williams Companies, Inc., WC Acquisition Corp. and Transco Energy Company. (Exhibit 2 to Transco Energy Company Schedule 14D-9 Commission File Number 005-19963) - 2 Amendment to Agreement and Plan of Merger dated as of February 17, 1995 by and among The Williams Companies, Inc., WC Acquisition Corp. and Transco Energy Company. (Exhibit (2)-2 to Transco Energy Company Form 10-K for 1994 Commission File Number 1-7513) - 3 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) 59 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 as of June 1, 1983, between Transco and RepublicBank Houston, National Association, as Trustee. (Exhibit (4)-5 to Transco Form 10-K for 1989 Commission File Number 1-7584) a) First Supplemental Indenture, dated September 20, 1984, from Transco to RepublicBank Houston, National Association related to Indenture dated as of June 1, 1983. (Exhibit (4)-5a to Transco Form 10-K for 1989 Commission File Number 1-7584) b) Second Supplemental Indenture, dated as of May 31, 1985, from Transco to RepublicBank Houston, National Association related to Indenture dated as of June 1, 1983. (Exhibit (4)-5b to Transco Form 10-K for 1989 Commission File Number 1-7584) c) Third Supplemental Indenture, dated as of December 3, 1985, from Transco to RepublicBank Houston, National Association related to the Indenture dated as of June 1, 1983. (Exhibit (4)- 5c to Transco Form 10-K for 1989 Commission File Number 1-7584) d) Certified Resolutions of a Special Committee of the Board of Directors dated October 31, 1986. (Exhibit (4)-5d to Transco Form 10-K for 1989 Commission File Number 1-7584) e) Fourth Supplemental Indenture, dated as of November 7, 1986, from Transco to RepublicBank Houston, National Association related to Indenture dated as of June 1, 1983. (Exhibit (4)-5e Transco Form 10-K for 1989 Commission File Number 1-7584) f) Fifth Supplemental Indenture, dated as of January 15, 1987, from Transco to RepublicBank Houston, National Association 60 related to Indenture dated as of June 1, 1983. (Exhibit (4)-5f to Transco Form 10-K for 1989 Commission File Number 1-7584) g) Certified Resolutions of a Special Committee of the Board of Directors dated January 29, 1987. (Exhibit (4)-5g to Transco Form 10-K for 1989 Commission File Number 1-7584) h) Sixth Supplemental Indenture, dated as of September 15, 1987, from Transco to First RepublicBank Houston, National Association related to Indenture dated as of June 1, 1983. (Exhibit (4)-5h to Transco Form 10-K for 1989 Commission File Number 1-7584) - 2 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) - 3 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) - 4 Credit Agreement dated as of February 23, 1995 by and among Transco, Texas Gas Transmission Corporation, The Williams Companies, Inc., Northwest Pipeline Corporation, Williams Pipe Line Company and Citibank, N.A. as agent and the Banks named therein (Exhibit (4)-7 to Transco Energy Company Form 10-K for 1994 Commission File Number 1-7513) - 5 Amended and Restated Credit Agreement dated as of December 20, 1996 by and among Transco, The Williams Companies, Texas Gas Transmission Corporation, Northwest Pipeline Corporation, Williams Pipe Line Company, Williams Holdings of Delaware, Inc. and Citibank N.A. as agent and the Banks named therein (Exhibit 4(c) to The Williams Companies Form 10-K for 1996 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) 61 (21) SUBSIDIARIES OF THE REGISTRANT (24) POWER OF ATTORNEY WITH CERTIFIED RESOLUTION (27) FINANCIAL DATA SCHEDULE 4. REPORTS ON FORM 8-K: None. 62 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 26th day of March, 1997. TRANSCONTINENTAL GAS PIPE LINE CORPORATION Registrant By: /s/ NICK A. BACILE ----------------------------- Nick A. Bacile Vice President and Controller Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on this 26th day of March, 1997, below 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/ BRIAN E. O'NEILL * Director, President and Chief Executive Officer ----------------------- Brian E. O'Neill (Principal Executive Officer) /s/ CUBA WADLINGTON, Jr.* Director ---------------------------- Cuba Wadlington, Jr. /s/ NICK A. BACILE * Director, Vice President and Controller --------------------- Nick A. Bacile (Principal Accounting and Financial Officer) /s/ ROBERT S. BAHNICK * Director ------------------------- Robert S. Bahnick /s / FRANK J. FERAZZI * Director ------------------------- Frank J. Ferazzi /s/ LEWIS A. POSEKANY, Jr.* Director ---------------------------- Lewis A. Posekany /s/ THOMAS P. GRIFFIN * Director ------------------------- Thomas P. Griffin * By /s/ NICK BACILE -------------------------- Nick A. Bacile Attorney-in-fact 63 EX-21 2 SUBSIDIARIES OF THE REGISTRANT Exhibit (21) TRANSCONTINENTAL GAS PIPE LINE CORPORATION SUBSIDIARIES % Owned State of Subsidiary Name By Parent Incorporation Pine Needle Operating Company 100.00 Delaware TransCarolina LNG Company 100.00 Delaware Cardinal Operating Company 100.00 Delaware TransCardinal Company 100.00 Delaware WGP Enterprises, Inc. 100.00 Delaware EX-24 3 POWER OF ATTORNEY 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 ("TGPL"), does hereby constitute and appoint NICK A. BACILE, WILLIAM G. VON GLAHN and RANDALL R. CONKLIN their true and lawful attorneys and each of them (with full power to act without the others) their true and lawful attorneys for them and in their name and in their capacity as a director or officer, or both, of TGPL, as hereinafter set forth below their signature, to sign TGPL's Annual Report to the Securities and Exchange Commission on Form 10-K for the fiscal year ended December 31, 1996, and any and all amendments thereto or all instruments necessary or incidental in connection therewith; and THAT the undersigned TGPL does hereby constitute and appoint NICK A. BACILE, WILLIAM G. VON GLAHN and RANDALL R. CONKLIN its true and lawful attorneys and each of them (with full power to act without the others) 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 20th day of March, 1997. /s/ Brian E. O'Neill /s/ Nick A. Bacile - ----------------------------- -------------------------------- Brian E. O'Neill Nick A. Bacile President and Vice President, Chief Executive Officer Treasurer, Controller (Principal Executive Officer) & Assistant Secretary (Principal Financial & Accounting Officer) Page 2 /s/ Robert S. Bahnick /s/ Keith E. Bailey - ------------------------------- ------------------------------ Robert S. Bahnick Keith E. Bailey Director Director /s/ Frank J. Ferazzi /s/ Thomas P. Griffin - ------------------------------- ------------------------------- Frank J. Ferazzi Thomas P. Griffin Director Director /s/ Lewis A. Posekany, Jr. /s/ Cuba Wadlington, Jr. - ------------------------------- -------------------------------- Lewis A. Posekany, Jr. Cuba Wadlington, Jr. Director Director TRANSCONTINENTAL GAS PIPE LINE CORPORATION By /s/ Nick A. Bacile -------------------------- Nick A. Bacile ATTEST: Vice President /s/ David M. Higbee - ------------------------- David M. Higbee Secretary TRANSCONTINENTAL GAS PIPE LINE CORPORATION CERTIFICATION OF BOARD OF DIRECTORS RESOLUTION I, the undersigned, RANDALL R. CONKLIN, Assistant Secretary of TRANSCONTINENTAL GAS PIPE LINE CORPORATION, a Delaware corporation (hereinafter called the "Corporation"), 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 January 16, 1997, to the following: RESOLVED that the Chairman of the Board, the President or any Vice President of the Corporation 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 Corporation, under the Securities Exchange Act of 1934, of the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1996. I further certify that the foregoing resolution has not been modified, revoked or rescinded and is in full force and effect. IN WITNESS WHEREOF, I have hereunto set my hand and affixed the corporate seal of TRANSCONTINENTAL GAS PIPE LINE CORPORATION this 20th day of March, 1997. /s/ RANDALL R. CONKLIN ------------------------------- Randall R. Conklin Assistant Secretary (CORPORATE SEAL) EX-27 4 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, 1996, CONTAINED IN TRANSCONTINENTAL GAS PIPE LINE CORPORATION'S 1996 REPORT ON FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1000 12-MOS DEC-31-1996 DEC-31-1996 1,774 0 48,711 0 69,461 466,589 3,738,550 318,234 4,059,527 557,661 681,076 0 0 0 1,819,214 4,059,527 806,691 1,594,829 806,690 1,252,682 0 0 64,305 154,156 58,613 95,543 0 0 0 95,543 0 0
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