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PNG > SEC Filings for PNG > Form 10-Q on 8-May-2013All Recent SEC Filings

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Form 10-Q for PAA NATURAL GAS STORAGE LP


8-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion is intended to provide investors with an understanding of our financial condition and results of our operations and should be read in conjunction with our historical consolidated financial statements and accompanying notes and Management's Discussion and Analysis of Financial Condition and Results of Operations as presented in our 2012 Annual Report on Form 10-K. For more detailed information regarding the basis of presentation for the following financial information, see the condensed consolidated financial statements and related notes that are contained in Part I, Item 1 of this Quarterly Report on Form 10-Q.

Overview of Operating Results, Capital Spending and Significant Activities

Adjusted EBITDA for the three months ended March 31, 2013 was approximately $31.6 million, a 13% increase over adjusted EBITDA of approximately $27.8 million for the three months ended March 31, 2012. This increase was primarily the result of incremental revenues attributable to working gas storage capacity expansions of approximately 17 Bcf in the aggregate at our Pine Prairie and Southern Pines facilities during 2012, sales of crude oil associated with liquids removal activities at our Bluewater facility and results of PNG Marketing, LLC (our commercial optimization company). See "- Results of Operations" for further discussion and analysis of our operating results. Expansion capital expenditures for the three months ended March 31, 2013 were approximately $9.6 million.


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Results of Operations



The tables below summarize our results of operations for the periods indicated
(in thousands, except working capacity and monthly operating metrics data):



                                          Three Months Ended          Favorable/(Unfavorable)
                                              March 31,                     Variance(1)
                                          2013          2012              $                %
Revenues
Firm storage services                  $    36,461    $  33,807    $          2,654            8 %
Hub services and merchant
storage(2)                                  90,344       73,756              16,588           22 %
Other                                        2,128        1,159                 969           84 %
Total revenues                             128,933      108,722              20,211           19 %

Storage-related costs - Hub
services and merchant storage(3)           (86,614 )    (70,079 )           (16,535 )        (24 )%
Storage-related costs - Firm
storage services(4)                         (3,197 )     (3,776 )               579           15 %
Field operating costs                       (3,390 )     (3,047 )              (343 )        (11 )%
General and administrative expenses         (5,720 )     (5,047 )              (673 )        (13 )%
Other income/(expense), net                     (6 )        (11 )
Equity compensation expense                  1,359        1,039
Mark-to-market of open derivative
positions                                      188           14
Adjusted EBITDA                        $    31,553    $  27,815    $          3,738           13 %

Reconciliation to net income
Adjusted EBITDA                        $    31,553    $  27,815    $          3,738           13 %
Depreciation, depletion and
amortization                                (9,639 )     (9,076 )              (563 )         (6 )%
Interest expense, net of
capitalized interest                        (2,398 )     (1,668 )              (730 )        (44 )%
Equity compensation expense                 (1,359 )     (1,039 )
Mark-to-market of open derivative
positions                                     (188 )        (14 )
Net income                             $    17,969    $  16,018    $          1,951           12 %

Operating Data:
Net revenue margin(5)                  $    39,310    $  34,881    $          4,429           13 %
Field operating costs/ G&A/ Other           (7,757 )     (7,066 )              (691 )        (10 )%
Adjusted EBITDA                        $    31,553    $  27,815    $          3,738           13 %

Average working storage capacity
(Bcf)                                           93           76                  17           22 %

Monthly Operating Metrics ($/Mcf)
Net revenue margin(5)                  $      0.14    $    0.15    $          (0.01 )         (7 )%
Field operating costs/ G&A /Other            (0.03 )      (0.03 )                 -            -
Adjusted EBITDA                        $      0.11    $    0.12    $          (0.01 )         (8 )%




--------------------------------------------------------------------------------
(1)            Certain variance amounts and/or percentages were intentionally
omitted.

(2)            Includes revenues associated with sales of natural gas through

commercial marketing activities.

(3) Includes costs associated with natural gas sold through commercial marketing activities and storage-related costs (including fuel expense) attributable to hub services and merchant storage revenues.

(4) Includes storage-related costs (including fuel expense) attributable to firm storage services revenues.

(5) Net revenue margin equals total revenues less storage-related costs and excludes the impact, if any, of mark-to-market adjustments (unrealized gains and losses) on open derivative positions.

Non-GAAP and Segment Financial Measures

To supplement our financial information presented in accordance with GAAP, management uses adjusted EBITDA and distributable cash flow in its evaluation of past performance and prospects for the future. Management believes that the presentation of


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such additional financial measures provides useful information to investors regarding our financial condition and results of operations because these measures, when used in conjunction with related GAAP financial measures, (i) provide additional information about our core operations and ability to generate and distribute cash flow, (ii) provide investors with the financial analytical framework upon which management bases financial, operational, compensation and planning decisions and (iii) present measurements that investors, rating agencies and debt holders have indicated are useful in assessing us and our results of operations. Adjusted EBITDA and/or distributable cash flow may exclude, for example, the impact of unique and infrequent items, items outside of management's control and/or items that are not indicative of our core operating results and business outlook, which we have defined hereinafter as "selected items impacting comparability." These additional financial measures are reconciled to net income, the most directly comparable measure as reported in accordance with GAAP, in the following table and should be viewed in addition to, and not in lieu of, our condensed consolidated financial statements and footnotes.

We define adjusted EBITDA as earnings before interest expense, taxes, depreciation, depletion and amortization, equity compensation plan charges, unrealized gains and losses from derivative activities and applicable "selected items impacting comparability."

Distributable cash flow, as determined by our general partner, is defined as:
(i) net income; plus or minus, as applicable, (ii) any amounts necessary to offset the impact of any items included in net income that do not impact the amount of available cash; plus (iii) any acquisition-related expenses deducted from net income and associated with (a) successful acquisitions or (b) any other potential acquisitions that have not been abandoned; minus (iv) any acquisition-related expenses covered by clause (iii)(b) immediately preceding that relate to (a) potential acquisitions that have since been abandoned or (b) potential acquisitions that have not been consummated within one year following the date such expense was incurred (except that if the potential acquisition is the subject of a pending purchase and sale agreement as of such one-year date, such one-year period of time shall be extended until the first to occur of the termination of such purchase and sale agreement or the first day following the closing of the acquisition contemplated by such purchase and sale agreement); and minus (v) maintenance capital expenditures. The types of items covered by clause (ii) above include (a) depreciation, depletion and amortization expense,
(b) any gain or loss from the sale of assets not in the ordinary course of business, (c) any gain or loss as a result of a change in accounting principle,
(d) any non-cash gains or items of income and any non-cash losses or expenses, including asset impairments, amortization of debt discounts, premiums or issue costs, mark-to-market activity associated with hedging and with non-cash revaluation and/or fair valuation of assets or liabilities and (e) earnings or losses from unconsolidated subsidiaries except to the extent of actual cash distributions received. Distributable cash flow does not reflect actual cash on hand that is available for distribution to our unitholders.

The following table reconciles Non-GAAP and segment financial measures to the most directly comparable measures as reported in accordance with GAAP (in thousands):

                                                      Three Months Ended
                                                          March 31,
                                                       2013         2012
Adjusted EBITDA reconciliation
Net income                                          $    17,969   $ 16,018
Interest expense, net of capitalized interest             2,398      1,668
Depreciation, depletion and amortization                  9,639      9,076
Selected items impacting adjusted EBITDA
Equity compensation expense(1)                            1,359      1,039
Mark-to-market of open derivative positions                 188         14
Adjusted EBITDA                                     $    31,553   $ 27,815

Distributable cash flow reconciliation
Net income                                          $    17,969   $ 16,018
Depreciation, depletion and amortization                  9,639      9,076
Maintenance capital expenditures                           (150 )     (182 )
Other non cash items:
Equity compensation expense, net of cash payments         1,498        947
Mark-to-market of open derivative positions                 188         14
Distributable cash flow                             $    29,144   $ 25,873



(1) Excludes equity compensation expense attributable to certain awards which will be settled in cash upon vesting.


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Three Months Ended March 31, 2013 as Compared to the Three Months Ended March 31, 2012

Revenues, Volumes and Related Costs. As noted in the table above, our total revenues net of storage-related costs increased during the three months ended March 31, 2013 (the "2013 period") when compared to the three months ended March 31, 2012 (the "2012 period"). The primary reasons for such increase are incremental revenues attributable to the expansion of our working gas capacity at our Pine Prairie and Southern Pines facilities, the results of PNG Marketing, LLC (our commercial optimization company) and an increase in crude oil sales associated with liquids removal activities at our Bluewater facility. These and other significant variances related to these periods are discussed in more detail below:

Firm storage services - Firm storage services revenues increased in the 2013 period as compared to the 2012 period. Incremental revenues attributable to the expansion of our working gas capacity at our Pine Prairie and Southern Pines facilities were offset by decreased storage rates on contracts executed to replace expiring contracts on existing capacity. Also, additional working gas storage capacity was retained for use by our commercial optimization company in the 2013 period as compared to the 2012 period. Revenues generated through the use of storage capacity by our commercial optimization company are reflected as merchant storage revenues when natural gas we own is withdrawn from storage and sold.

Hub services and merchant storage - Hub services and merchant storage revenues (which include revenues from sales of natural gas by our commercial optimization company) increased in the 2013 period as compared to the 2012 period. The primary reason for the increase in the 2013 period as compared to the 2012 period is due to an increase in volumes sold and a slight increase in price of natural gas sold by our commercial optimization company. The volume and timing of natural gas sales by our commercial optimization company are largely driven by market opportunities.

Other - Other revenues increased in the 2013 period as compared to the 2012 period. The primary reason for the increase in the 2013 period as compared to the 2012 period was due to an increase in crude oil sales associated with liquids removal activities at our Bluewater facility.

Storage-related costs - Hub services and merchant storage - Hub services and merchant storage-related costs (which includes costs associated with natural gas sold by our commercial optimization company) increased in the 2013 period as compared to the 2012 period. The primary reason for the increase in the 2013 period as compared to the 2012 period is due to the increase in volumes of natural gas sold by our commercial optimization company.

Storage-related costs - Firm storage services - Firm storage services related costs decreased in the 2013 period as compared to the 2012 period. The decrease in the 2013 period as compared to the 2012 period is primarily due to a reduction in storage and transportation capacity leased from third parties.

Other Costs and Expenses. The significant variances are discussed further below:

Field operating costs - Field operating costs increased in the 2013 period as compared to the 2012 period. The primary reason for such an increase in the 2013 period as compared to the 2012 period is attributable to an increase in insurance costs and growth in personnel costs, including equity compensation costs.

General and administrative expenses - General and administrative expenses increased in the 2013 period as compared to the 2012 period. The 2013 period reflects an increase in costs associated with the continued expansion of our business and growth in personnel costs, including equity compensation costs. Additionally, we recognized approximately $0.3 million and $0.5 million of equity compensation expense associated with equity compensation awards granted by PAA during the 2013 and 2012 periods, respectively. Although we will not bear the economic burden of these awards, we benefit from the services underlying these awards.

Depreciation, depletion and amortization - Depreciation, depletion and amortization expense increased in the 2013 period as compared to the 2012 period. The increase resulted primarily from an increased amount of depreciable assets resulting from capacity expansions at our Pine Prairie and Southern Pines facilities.

Interest expense, net of capitalized interest - Interest expense, net of capitalized interest, increased in the 2013 period when compared to the 2012 period. Interest expense, on a gross basis, decreased to approximately $3.7 million in the 2013 period as compared to approximately $4.1 million in the 2012 period due to lower average interest rates in the 2013 period as compared to the 2012 period and was partially offset by higher average debt balances in the 2013 period as compared to the 2012 period. Capitalized interest decreased from approximately $2.4 million in the 2012 period to approximately $1.3 million in the 2013 period. The decrease was primarily the result of lower average interest rates and an increase in assets in-service.


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Outlook

Overall market conditions during the quarter ended March 31, 2013 for both hub services and firm storage services were more challenging than those during the quarter ended March 31, 2012. During the quarter ended March 31, 2013, current rolling seasonal spreads (October to January), which are a proxy for the current intrinsic value of storage, ranged from $0.28 to $0.45, compared to $0.52 to $0.77 for the quarter ended March 31, 2012. Over the past ten years, seasonal spreads ranged from $0.19-$4.74. Seasonal spreads for 2014-2015 and 2015-2016, which influence the rates at which we will be able to contract firm storage capacity in future years, have ranged from $0.31 to $0.39. Volatility levels, which impact the value we are able to realize on a short-term basis from our hub service and merchant storage activities, decreased during the quarter ended March 31, 2013 from the quarter ended March 31, 2012. In general, our outlook presumes that these market conditions will continue for the next two to three years.

Although we can provide no assurance regarding the amount of our future cash flows, we believe our asset base, contract profile, financial position and economically attractive expansion projects will enable us to substantially maintain our cash flows during such two to three year period if current market conditions persist. Also, we are reasonably well positioned to develop low cost organic expansions and to acquire other assets if favorable market conditions exist. However, if gas storage market conditions decline further, in addition to adversely affecting hub services activities, they may also adversely impact the lease rates our customers are willing to pay for firm storage services with respect to new capacity under construction, as well as renewals of existing capacity upon expirations of existing term leases, many of which are at rates above current market levels. Although a significant portion of our existing capacity is underpinned by multi-year firm storage contracts, we can provide no assurance that our operating and financial results will not be adversely impacted by adverse overall market conditions. In addition, we can provide no assurances that our organic growth and acquisition efforts will be successful.

Liquidity and Capital Resources

Overview

Our primary cash requirements include, but are not limited to (i) ordinary course of business uses, such as the payment of amounts related to storage costs incurred, natural gas purchases and other operating and general and administrative expenses, interest payments on our outstanding debt and distributions to our owners, (ii) maintenance and expansion capital expenditures, including purchases of base gas, (iii) acquisitions of assets or businesses and (iv) repayment of principal on our short-term and long-term debt. We generally expect to fund our short-term cash requirements through our primary sources of liquidity, which consist of our cash flow generated from operations as well as borrowings under our credit facility. In addition, we generally expect to fund our long-term needs, such as those resulting from expansion activities or acquisitions, through a variety of sources (either separately or in combination), which may include operating cash flows, borrowings under our credit agreement, and/or proceeds from the issuance of additional equity or debt securities.

Credit Agreement

Our senior unsecured credit agreement, which was most recently amended in June 2012, provides for (i) $350 million under a revolving credit facility, which may be increased at our option to $550 million (subject to receipt of additional or increased lender commitments) and (ii) two $100 million term loan facilities (the "GO Bond Term Loans") pursuant to the purchase, at par, of the GO Bonds we acquired in conjunction with the Southern Pines Acquisition. The revolving credit facility expires in August 2016, unless extended. The purchasers of the two GO Bond Term Loans have the right to put, at par, to PNG the GO Bond Term Loans in August 2016, unless extended. The GO Bonds mature by their terms in May 2032 and August 2035, respectively.

Our credit agreement contains covenants and events of default. Our credit agreement restricts, among other things, our ability to make distributions of available cash to unitholders if any default or event of default, as defined in the credit agreement, exists or would result therefrom. In addition, the credit agreement contains restrictive covenants, including those that restrict our ability to grant liens, incur additional indebtedness, engage in certain transactions with affiliates, engage in substantially unrelated businesses, sell substantially all of our assets or enter into a merger or consolidation, and enter into certain burdensome agreements. In addition, the credit agreement contains certain financial covenants which, among other things, require us to maintain a debt-to-EBITDA coverage ratio that will not be greater than 5.00 to 1.00 on outstanding debt (5.50 to 1.00 during an acquisition period) and also require that we maintain an EBITDA-to-interest coverage ratio that will not be less than 3.00 to 1.00, as such terms are defined in the credit agreement.

At March 31, 2013, borrowings of approximately $408.6 million were outstanding under our credit agreement, which includes approximately $208.6 million under the revolving credit facility. Additionally, we had approximately $10.2 million of outstanding letters of credit under our revolving credit facility. As of March 31, 2013, we were in compliance with the covenants, including the financial ratios, contained in our credit agreement. Based on the most restrictive covenant, at March 31, 2013 our incremental


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borrowing ability under our credit agreement was limited to approximately $131.2 million. Notably, the restriction on debt incurrence does not limit our ability to incur hedged inventory debt. Also, the formula for determining EBITDA in the context of the financial ratios allows for inclusion of pro forma EBITDA arising from certain capital investments, including for acquisitions and certain capital expenditures related to our Pine Prairie and Southern Pines expansions. We believe our credit facility and available debt capacity is adequate to fund our current capital program.

PAA Financial Support

PAA may elect, but is not obligated, to provide financial support to us under certain circumstances, such as in connection with an acquisition or expansion capital project. Our partnership agreement contains provisions designed to facilitate PAA's ability to provide us with financial support while reducing concerns regarding conflicts of interest by defining certain potential financing transactions between PAA and us as fair to our unitholders. As further defined in our partnership agreement, potential PAA financial support can include, but is not limited to, our issuance of common units to PAA, our borrowing of funds from PAA or guarantees or trade credit support to support the ongoing operations of us or our subsidiaries. We have no obligation to seek financing or support from PAA or to accept such financing or support if offered to us. As of March 31, 2013, outstanding parental guarantees issued by PAA to third parties on behalf of PNG Marketing were approximately $15 million. No amounts were due to PAA as of March 31, 2013 under such guarantees and no payments were made to PAA under such guarantees during the three months ended March 31, 2013.

Sources of Liquidity

Our current sources of liquidity include:

cash generated from operations;

borrowings under our credit agreement;

issuances of additional partnership units; and

debt offerings.

We believe that cash generated from these sources will be sufficient to meet our short-term working capital requirements, long-term capital expenditure requirements, and quarterly cash distributions to unitholders.

We have filed with the SEC a universal shelf registration statement that, subject to effectiveness at the time of use, allows us to issue up to an aggregate of $1.0 billion of debt or equity securities ("Traditional Shelf"). We have not issued any securities under the Traditional Shelf. All issuances of equity securities associated with our continuous offering program, as discussed further below, have been issued pursuant to the Traditional Shelf. At March 31, 2013, we had approximately $999 million of unsold securities available under the PNG Shelf.

On March 18, 2013, we entered into an equity distribution agreement with a financial institution pursuant to which we may offer and sell, through this financial institution as our sales agent, common units representing limited partner interests having an aggregate offering price of up to $75 million. Sales of such common units will be made by means of ordinary brokers' transactions on the NYSE at market prices, in block transactions or as otherwise agreed upon by our sales agent and us. Under the terms of the agreement, we have the option to sell common units to any of our sales agent as principal for its own account at a price to be agreed upon at the time of the sale. For any such sales, we will enter into a separate terms agreement with the sales agent. During the first quarter of 2013, we issued an aggregate of 56,800 common units under this agreement, generating net proceeds of approximately $1.2 million, including our general partner's proportionate capital contribution. In April 2013, we issued an additional 1.2 million common units under this agreement.

To maintain our targeted credit profile, we generally intend to fund approximately 60% of the capital required for future expansion projects (beyond the projects currently under development) with a combination of additional equity and retained cash flow in excess of distributions.

For a discussion of the impact that the price of natural gas might have on our operations and liquidity and capital resources, see Item 3. "Quantitative and Qualitative Disclosures about Market Risk."


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Working Capital

Working capital, defined as the amount by which current assets exceed current liabilities, is an indication of our liquidity and potential need for short-term funding. Our working capital requirements are driven primarily by changes in accounts receivable and accounts payable, natural gas inventory balances and short-term debt. These changes are primarily affected by factors such as credit extended to, and the timing of collections from, our customers, timing differences between the acquisition and sale of natural gas inventory (including cash settlement and margin requirements on related derivative instruments) and our level of spending for maintenance and expansion activity. As of March 31, 2013 we had a working capital deficit of approximately $13.4 million.

Historical Cash Flow Information



The following table presents a summary of our cash flows for the three months
ended March 31, 2013 and 2012 (in thousands):



                                    Three Months Ended
                                        March 31,
. . .
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