The following discussion of critical accounting estimates, results of operations, and capital resources and liquidity should be read in conjunction with the financial statements and notes thereto included within "Part II, Item 8" of this report.
CRITICAL ACCOUNTING ESTIMATES Our financial statements reflect the selection and application of accounting policies that require management to make significant estimates and assumptions. We believe that the following are the most critical judgment areas in the application of accounting policies that currently affect our financial condition and results of operations. Regulatory Accounting We are regulated by the FERC. The Accounting Standards Codification Topic 980, Regulated Operations (Topic 980) provides that rate-regulated public utilities account for and report regulatory assets and liabilities consistent with the economic effect of the way in which regulators establish rates if the rates established are designed to recover the costs of providing the regulated service and if the competitive environment makes it probable that such rates can be charged and collected. Accounting for businesses that are regulated and apply the provisions of Topic 980 can differ from the accounting requirements for non-regulated businesses. Transactions that are recorded differently as a result of regulatory accounting requirements include the capitalization of an equity return component on regulated capital projects, capitalization of other project costs, retirements of general plant assets, employee related benefits, environmental costs, negative salvage, asset retirement obligations and other costs and taxes included in, or expected to be included in, future rates. As a rate-regulated entity, our management has determined that it is appropriate to apply the accounting prescribed by Topic 980 and, accordingly, the accompanying financial statements include the effects of the types of transactions described above that result from regulatory accounting requirements. Management's assessment of the probability of recovery or pass through of regulatory assets and liabilities requires judgment and interpretation of laws and regulatory commission orders. If, for any reason, we cease to meet the criteria for application of regulatory accounting treatment for all or part of our operations, the regulatory assets and liabilities related to those portions ceasing to meet such criteria would be eliminated from the Balance Sheet and included in the Statement of Comprehensive Income for the period in which the discontinuance of regulatory accounting treatment occurs, unless otherwise required to be recorded under other provisions of accounting principles 16
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generally accepted in
RESULTS OF OPERATIONS Analysis of Financial Results This analysis discusses financial results of our operations for the years 2013 and 2012. Variances due to changes in natural gas prices and transportation volumes have little impact on revenues, because under our rate design methodology, the majority of overall cost of service is recovered through firm capacity reservation charges in our transportation rates. Our operating revenues increased
$31.8 million, or 7 percent, as compared to 2012. This increase is primarily attributed to new rates, which became effective January 1, 2013. Our transportation service and gas storage service accounted for 98 percent and 2 percent, respectively, of our operating revenues for 2013, and 97 percent and 3 percent, respectively, of our operating revenues for 2012. Total operating expenses decreased $4.5 million, or 2 percent. This decrease is due primarily to i) lower labor costs of $3.8 million; ii) lower incentive compensation expense of $2.8 million; iii) lower contractual services of $2.5 million, primarily attributed to decreased expenditures on pipeline maintenance; and iv) lower group insurance expense of $2.1 million. These decreases were partially offset by i) lower capitalized labor and benefits of $2.8 million, attributed to lower capital spending; ii) higher depreciation of $2.7 million, attributed to property additions; and iii) higher charges from affiliates of $1.3 million. The increase in our net income is primarily due to the increase in operating revenues associated with our new rates. Effects of Inflation We generally have 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 operation and maintenance expenses. The cumulative impact of inflation over a number of years has resulted in increased costs for current replacement of productive facilities. The majority of our property, plant, and equipment and materials and supplies inventory is subject to ratemaking treatment, and under current FERC practices, recovery is limited to historical costs. We believe that we will be allowed to recover and earn a return based on increased actual costs incurred when existing facilities are replaced. Cost-based regulation along with competition and other market factors limit our ability to price services or products based upon inflation's effect on costs. CAPITAL RESOURCES AND LIQUIDITY Method of Financing We fund our working capital and capital requirements with cash flows from operating activities, equity contributions from WPZ, collection of advances made to WPZ, accessing capital markets, and, if required, borrowings under the credit facility and advances from WPZ. We may raise capital through private debt offerings, as well as offerings registered pursuant to offering-specific registration statements. Interest rates, market conditions, and industry conditions will affect future amounts raised, if any, in the capital markets. We anticipate that we will be able to access public and private debt markets on terms commensurate with our credit ratings to finance our capital requirements, when needed. In July 2013, WPZ amended its $2.4 billioncredit facility to increase the aggregate commitments to $2.5 billionand extend the maturity date to July 31, 2018. The amended credit facility may also, under certain conditions, be increased up to an additional $500 million. Total letter of credit capacity available to WPZ under the $2.5 billioncredit facility is $1.3 billion. At December 31, 2013, no letters of credit have been issued and no loans are outstanding under the credit facility. We may borrow up to $500 millionunder the amended credit facility to the extent not otherwise utilized by WPZand Transcontinental Gas Pipe Line Company, LLC. At December 31, 2013, the full $500 millionunder the credit facility was available to us. WPZ participates in a commercial paper program, and WPZ management considers amounts outstanding under this program to be a reduction of available capacity under the credit facility. The program allows a maximum outstanding amount at any time of $2 billionof unsecured commercial paper notes. At December 31, 2013, WPZ had $225 millionin outstanding commercial paper. 17
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Please see "Item 8. Financial Statements and Supplementary Data - Notes to Financial Statements: Note 4. Debt, Financing Arrangements, and Leases - Credit Facility and Note 7. Transactions with Major Customers and Affiliates - Related Party Transactions." Capital Expenditures We categorize our capital expenditures as either maintenance capital expenditures or expansion capital expenditures. Maintenance capital expenditures are those expenditures required to maintain the existing operating capacity and service capability of our assets, including replacement of system components and equipment that are worn, obsolete, completing their useful life, or necessary to remain in compliance with environmental laws and regulations. Expansion capital expenditures improve the service capability of the existing assets, increase transmission or storage capacities from existing levels or enhance revenues. We anticipate 2014 capital expenditures will be
$84 million. Of this total, $19 millionis considered nondiscretionary due to legal, regulatory, and/or contractual requirements. In 2014, we expect to fund our capital expenditures with cash from operations.