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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1997
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 1-6446
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K N ENERGY, INC.
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(Exact name of registrant as specified in its charter)
Kansas 48-0290000
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
370 Van Gordon Street
P.O. Box 281304, Lakewood, Colorado 80228-8304
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (303) 989-1740
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Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange on
Title of each class which registered
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Common stock, par value $5 per share New York Stock Exchange
Preferred share purchase rights New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
Preferred stock, Class A $5 cumulative series
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(Title of class)
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
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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. [ ]
State the aggregate market value of the voting stock held by nonaffiliates of
the registrant.
$1,693,628,233 as of February 20, 1998
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Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.
Common stock, $5 par value; authorized 50,000,000 shares; outstanding 32,140,425
shares as of February 20, 1998
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List hereunder documents incorporated by reference and the Part of the Form 10-K
into which the document is incorporated.
1998 Proxy Statement Part III
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K N ENERGY, INC. AND SUBSIDIARIES
Documents Incorporated by Reference and Index
Page Number
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1998 Proxy Included
Statement Herein
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PART I
ITEMS 1 & 2: BUSINESS AND PROPERTIES.................................................... 3-12
ITEM 3: LEGAL PROCEEDINGS ......................................................... 12-14
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders
during the last quarter of 1997.
EXECUTIVE OFFICERS OF THE REGISTRANT....................................... 15-16
PART II
ITEM 5: MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS................................................... 17
ITEM 6: SELECTED FINANCIAL DATA.................................................... 18
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..................................... 19-26
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Public Accountants ................................ 27
Consolidated Statements of Income for the Three
Years Ended December 31, 1997, 1996 and 1995 ........................ 28
Consolidated Balance Sheets as of December 31, 1997 and 1996............. 29
Consolidated Statements of Common Stockholders' Equity
for the Three Years Ended December 31, 1997, 1996 and 1995 30
Consolidated Statements of Cash Flows for the Three
Years Ended December 31, 1997, 1996 and 1995......................... 31
Notes to Consolidated Financial Statements............................... 32-51
Selected Quarterly Financial Data (Unaudited)......................... 52
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
There were no such matters during 1997.
PART III
ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT......................... 3-17*
ITEM 11: EXECUTIVE COMPENSATION..................................................... 9-17*
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............. 3-7*, 19*
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................. 7*
PART IV
ITEM 14: EXHIBITS AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
Reference is made to the listing of financial statements and
supplementary data under Item 8 in Part II of this index.
2. Financial Statement Schedules
None
3. Exhibits
Exhibit Index................................................... 58-60
List of Executive Compensation Plans and Arrangements........... 55-56
Exhibit 12 - Ratio of Earnings to Fixed Charges................. 61
Exhibit 13 - 1997 Annual Report to Shareholders**............... 62
Exhibit 21 - Subsidiaries of the Registrant..................... 63-65
Exhibit 23 - Consent of Independent Public Accountants.......... 66
Exhibit 27 - Financial Data Schedule***
Exhibit 99 - Consent of Independent Public Accountants.......... 67
(b) Reports on Form 8-K.................................................. 56
SIGNATURES ................................................................................ 57
Note: Individual financial statements of the parent Company are omitted
pursuant to the provisions of Accounting Series Release No. 302.
* Incorporated herein by reference.
** Such report is being furnished for the information of the Securities and
Exchange Commission ("SEC") only and is not to be deemed filed as a part of
this annual report on Form 10-K.
*** Included in SEC copy only.
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PART I
ITEMS 1 and 2: BUSINESS and PROPERTIES
As used in this report "the Company," "K N" and "K N Energy" refer to K N
Energy, Inc., together with its consolidated subsidiaries (excluding MidCon),
unless the context otherwise requires. "MidCon" refers to MidCon Corp., together
with its consolidated subsidiaries, unless the context otherwise requires. All
volumes of natural gas referred to herein are stated at a pressure base of 14.73
pounds per square inch absolute and at 60 degrees Fahrenheit and, in most
instances, are rounded to the nearest major multiple. The term "Mcf" means
thousand cubic feet, the term "MMcf" means million cubic feet, the term "Bcf"
means billion cubic feet and the term "Tcf" means trillion cubic feet. The term
"MMBtus" means million British thermal units ("Btus"). "NGLs" refers to natural
gas liquids, which consist of ethane, propane, butane, iso-butane and natural
gasoline. The term "Bbls" means barrels.
(A) General Description
K N Energy is an integrated energy services provider whose operations include
the gathering, processing, transportation and storage of natural gas, and the
marketing of natural gas and NGLs. As of December 31, 1997, the Company operated
over 12,300 miles of interstate and intrastate pipelines and over 8,800 miles of
gathering and processing pipeline that connect major supply areas with major
consuming areas in the Western and Mid-Continent United States. The Company also
owned or operated at such date 19 natural gas processing plants with total
processing capacity of approximately 1.7 Bcf per day, including the Bushton
complex in the Hugoton Basin, one of the largest natural gas extraction
facilities in the United States, and 7 storage facilities with 827 MMcf per day
of withdrawal capacity. As of December 31, 1997, the Company's regulated retail
natural gas business served over 210,000 customers in Colorado, Nebraska and
Wyoming (excluding customers served by the Company's Kansas natural gas
distribution assets which are the subject of a definitive sale agreement,
expected to be closed in the first half of 1998). The Company also markets
innovative products and services, such as the Simple Choicesm ("Simple Choice")
menu of products and call center services designed for residential consumers,
utilities and small businesses through its 50% owned ENOable, LLC ("ENOable")
affiliate.
The Company's executive offices are located at 370 Van Gordon Street, P.O. Box
281304, Lakewood, Colorado 80228-8304 and its telephone number is (303)
989-1740. K N was incorporated in the State of Kansas on May 18, 1927. The
Company employed 2,134 people at December 31, 1997.
On January 30, 1998, pursuant to a definitive stock purchase agreement (the
"Agreement"), K N Energy paid approximately $2.1 billion in cash and issued a
note in an aggregate principal amount of approximately $1.39 billion (the
"Substitute Note") to Occidental Petroleum Corporation ("Occidental") to acquire
the outstanding shares of capital stock of MidCon (the "MidCon Shares") and a
note in a like aggregate principal amount (the "ESOP Note") issued to Occidental
by MidCon's employee stock ownership plan (the "Acquisition"). As a result of
the Acquisition, MidCon became a wholly owned subsidiary of K N Energy. In
connection with the planned termination of MidCon's employee stock ownership
plan following the Acquisition, the ESOP Note was cancelled. The Substitute Note
is required to be paid in full on January 4, 1999 and bears interest at 5.798%.
The Company is required to collateralize the Substitute Note plus an amount
equal to 105 days of accrued interest with U.S. government securities or one or
more letters of credit, or a combination thereof. Such amounts were initially
collateralized with letters of credit which the Company intends to replace with
U.S. government securities purchased utilizing all or a portion of the proceeds
of certain future securities offerings, see Capital Resources.
The Agreement contains representations and warranties of each of Occidental and
the Company, which survive the closing for one year (except as to certain tax
matters, which survive for two years), and customary
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covenants. In connection with its acquisition of the MidCon Shares, the Company
became obligated with respect to MidCon's liabilities, including, without
limitation, liabilities with respect to environmental matters, liabilities under
MidCon's benefit plans for active and retired employees and the obligations of
Occidental's insurance subsidiary with respect to insurance policies previously
issued to MidCon. Each party has agreed to indemnify the other party for certain
losses or liabilities incurred as a result of a breach of representation or
warranty or covenant and, in the case of Occidental, to indemnify the Company
for certain losses or liabilities arising out of MidCon's employee stock
ownership plan.
As a result of various regulatory requirements, prior to the consummation of the
Acquisition, MidCon dividended all of the issued and outstanding capital stock
of MidCon Power Services Corp. ("MidCon Power"), a wholly owned subsidiary of
MidCon, to Occidental. K N and Occidental have entered into a separate stock
transfer agreement for the acquisition of all the issued and outstanding capital
stock of MidCon Power by K N. The acquisition of the MidCon Power capital stock
by K N was contingent on the Federal Energy Regulatory Commission ("FERC")
approving the transaction, which approved was received on March 2, 1998. The
closing of the MidCon Power acquisition is expected to occur by mid-March 1998.
MidCon is engaged in the purchase, gathering, processing, transmission, storage
and sale of natural gas to utilities, municipalities and industrial and
commercial users. MidCon operates over 14,000 miles of natural gas pipelines
which are located in the center of the North American pipeline grid. These
pipeline assets include two major interconnected transmission pipelines
terminating in the Chicago area: one originating in West Texas and the other in
the Gulf Coast areas of Texas and Louisiana, as well as a major intrastate
pipeline located in Texas. MidCon also purchases electricity from electric
utilities and other electric power producers and marketers and resells the
electricity to wholesale and end-use customers.
(B) Narrative Description of Business
Overview
K N Energy is an integrated energy services provider with operations that
include the gathering, processing, transportation and storage of natural gas and
the marketing of natural gas and NGLs. The Company's operations currently are
organized into three segments: (i) gathering, processing and marketing services
(including intrastate transmission and storage in Texas), (ii) interstate
transportation and storage, and (iii) retail natural gas services, although the
Company currently expects that its future reporting of business unit results may
change as a result of the implementation of statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and Related
Information". As discussed below, certain of the Company's operations are
regulated by various federal and state entities. For the year ended December 31,
1997, approximately 48% of the Company's operating income was derived from
regulated assets, although such percentage has increased as a result of the
acquisition of MidCon as described preceding.
(1) Gathering, Processing, and Marketing Services
The Company provides natural gas gathering, processing, storage, transportation,
marketing, field services and supply services, to a variety of customers. Within
this business segment, the Company owns and operates approximately 12,900 miles
of pipeline in nine states and operates 19 gas processing plants in five states
and natural gas storage facilities in West Texas and on the Gulf Coast. For the
year ended December 31, 1997, this business segment accounted for approximately
52% of consolidated operating income.
Revenues from the Company's gathering, processing, storage, transportation,
marketing and supply activities are generated in four different ways. First, the
Company performs a merchant function whereby the Company
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purchases gas at the wellhead, combines such gas with other supplies of gas, and
markets the aggregated gas to consumers. Second, the Company gathers, transports
and/or processes gas for producers or other third parties who retain title to
the gas. Third, the Company processes gas into NGLs and markets NGLs. Fourth,
the Company provides gas marketing and supply services, including certain
storage services, to producers, various natural gas resellers and end users. The
Company also arranges the purchase and transportation of producers' excess or
uncommitted gas to end users, acts as shipper or agent for the end users,
administers nominations and provides balancing assistance when needed.
In conjunction with its merchant function, the Company engages in price risk
management activities in the energy financial instruments market to hedge its
price and basis risk exposure. The Company buys and sells gas and crude oil
futures positions on the New York Mercantile Exchange and Kansas City Board of
Trade and uses over-the-counter energy swaps and options for the purpose of
reducing adverse price exposure to gas supply costs or specific market margins.
Pursuant to guidelines approved by its Board of Directors, the Company engages
in these activities only as a hedging mechanism against price volatility
associated with pre-existing or anticipated physical gas and condensate sales,
gas purchases, system use and storage in order to protect profit margins, and is
prohibited from engaging in speculative trading.
Gas Gathering and Processing
The Company's gathering and processing subsidiaries operate pipeline systems in
seven Mid-Continent and Rocky Mountains states. These subsidiaries perform
various services for customers including, among others, gathering gas at the
wellhead or other field aggregation points, transporting gas on an intrastate
basis at negotiated rates, processing gas to extract NGLs, and marketing natural
gas and NGLs. Based on average throughput, the Company's largest gathering
operation is its Hugoton Basin system in Kansas which gathers approximately 530
MMcf per day, making K N the largest gatherer in this basin. The Hugoton Basin
system interconnects with several gas processing plants in the area including
K N's Bushton plant. The Company's Wattenberg System in northeastern Colorado,
which includes gathering and transmission lines, has current throughput of
approximately 150 MMcf per day. K N's West Texas System is located primarily in
western Texas and the Texas Panhandle. This system, which includes gathering,
intrastate transmission and storage pipelines, six gas processing plants, and
one storage facility, has gathering throughput of approximately 140 MMcf per
day. The Company also owns gathering facilities in the Powder River and Wind
River Basins of Wyoming and the Piceance and Uinta Basins of western Colorado
and eastern Utah with combined throughput of approximately 130 MMcf per day.
In addition to the above systems, K N recently acquired two gathering systems in
the Rocky Mountains which gather in aggregate approximately 460 MMcf per day. In
December 1997, K N purchased an equity interest in the Red Cedar Gathering
System in the San Juan Basin of New Mexico. The Red Cedar system gathers
approximately 440 MMcf per day of natural gas and is connected to the Company's
jointly owned Coyote Gulch processing plant and to the TransColorado pipeline.
Also in December 1997, K N acquired Interenergy Corporation, a closely held
provider of natural gas services in the Rocky Mountain area. The Interenergy
assets include pipelines which gather approximately 20 MMcf per day, a gas
processing plant in Wyoming and an interest in a gas processing plant in North
Dakota.
In 1996, Wildhorse Energy Partners, LLC ("Wildhorse"), a joint venture between
K N and Tom Brown, Inc. ("TBI"), purchased gathering and processing assets of
Williams Field Services in western Colorado and eastern Utah. The acquisition of
these assets provided Wildhorse access to existing TBI production, to
approximately 240,000 acres of undeveloped leaseholds held by TBI in the
Piceance Basin and to undeveloped third-party acreage throughout the Piceance
and Uinta basins. The assets acquired included approximately 950 miles of
natural gas gathering lines, two processing plants, a carbon dioxide treatment
plant and a dew point control
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plant. During the year ended December 31, 1997, these facilities processed and
treated approximately 70 MMcf of natural gas per day.
At December 31, 1997, the Company's gathering, processing and marketing segment
operated 19 natural gas processing plants, including the Bushton complex, one of
the largest NGLs extraction facilities in the United States. On a daily basis,
these plants process approximately 1.4 Bcf of natural gas (and have capacity to
process 1.7 Bcf of natural gas per day) and produce approximately 2.4 million
gallons] of NGLs. NGLs are sold by the Company on a contractual basis to various
NGL pipelines, end users and marketers at index-based prices.
Marketing
In 1997, the Company's natural gas marketing customers included local
distribution companies, industrial, commercial and agricultural end users,
electric utilities, Company affiliates, and other marketers located both on and
off K N's pipeline systems. Natural gas is purchased by K N's gathering,
processing and marketing business from various sources, including gas producers,
gas processing plants and pipeline interconnections. For the year ended December
31, 1997, the Company's gathering, processing and marketing operations sold an
average of approximately 1.6 Bcf of natural gas per day before intersegment
eliminations.
As is customary in the industry, most of the Company's gas purchase agreements
are for periods of one year or less, and many are for periods of 60 days or
less. Various agreements permit the purchaser or the supplier to renegotiate the
purchase price or discontinue the purchase under certain circumstances. Purchase
volume obligations under many of the agreements utilized by this business
segment are generally "best efforts" and do not have traditional take-or-pay
provisions. However, certain agreements require the Company to prepay for, or to
receive, minimum quantities of natural gas.
The Company owns a storage facility located in Gaines County, Texas, which had a
working storage capacity of 16.4 Bcf of natural gas at December 31, 1997 and
withdrawal capacity of 525 MMcf per day. This facility has traditionally been
used to meet peak day requirements of the West Texas system. K N also has lease
rights in the Stratton Ridge facility located in Brazoria County, Texas,
including a peak day natural gas withdrawal capacity of 150 MMcf per day at
December 31, 1997.
K N Field Services
K N Field Services, Inc. ("KNFS") provides field operations services to gas and
oil industry customers who own production, gathering, processing and
transportation assets. To the extent possible, KNFS uses the existing
infrastructure and labor force employed in the Company's own systems to serve
its clients. Among the services KNFS provides are well tending, site services,
corrosion monitoring, compression operations and maintenance, safety training,
gathering and pipeline operations and maintenance, measurement, pressure and
flow monitoring, water hauling and line locating.
(2) Interstate Transportation and Storage Services
The Company's interstate pipeline system provides transportation and storage
services to affiliates, third-party natural gas distribution utilities, and
other shippers. For the year ended December 31, 1997, this business segment
accounted for approximately 25% of consolidated operating income. As of December
31, 1997, the Company's interstate pipeline system consisted of approximately
6,900 miles of transmission lines and one storage field.
The Company provides both firm and interruptible transportation and no-notice
services to its customers. Under no-notice service, customers are able to meet
their peak day requirements without making specific nominations
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as required by firm and interruptible transportation service tariffs. The local
distribution companies and other shippers may release their unused firm
transportation capacity rights to other shippers. It is the Company's experience
that this released capacity has, to a large extent, replaced interruptible
transportation on the Company's interstate pipeline system. Firm transportation
customers pay a monthly reservation charge plus a commodity charge based on
actual volumes transported. Interruptible transportation is billed on the basis
of volumes shipped.
In 1996, K N purchased a crude oil pipeline (renamed the Pony Express Pipeline)
running from Lost Cabin in central Wyoming to Freeman, Missouri near Kansas
City, and converted it to natural gas transport service. The line became
operational in August 1997 and, under its current configuration, has a maximum
capacity of 255 MMcf per day. The Pony Express Pipeline provides access to
significant natural gas reserves principally from the Denver-Julesburg, Wind
River and Powder River Basins and is a catalyst for the development of the
market hub at Rockport, Colorado. As a complement to this pipeline, in November
1996 the Company acquired one 20-year contract and one 19-year contract to
provide firm transportation capacity of 230 MMcf of natural gas per day to the
Kansas City metropolitan area. This project reflects the Company's ongoing
strategy to balance regulated pipeline projects with the corresponding potential
for greater returns from other nonregulated business segments.
The Company is a one-half joint venture partner in the TransColorado Gas
Transmission Company ("TransColorado"). TransColorado's pipeline is expected to
provide increased flexibility in accessing multiple natural gas basins in the
Rocky Mountain region. Though only a portion of the pipeline is currently
operational, when completed, the TransColorado Pipeline will extend 290 miles,
from the Piceance Basin of Colorado to Blanco, New Mexico, and will have an
initial capacity of 300 MMcf per day. The TransColorado Pipeline will operate as
an interstate pipeline regulated by the FERC.
The Company's interstate pipeline system provides storage services to its
customers through its Huntsman Storage Field in Cheyenne County, Nebraska. The
facility had a peak natural gas withdrawal capacity of 100 MMcf per day at
December 31, 1997.
(3) Retail Natural Gas Services
The Company provides retail natural gas services to residential, commercial,
agricultural and industrial customers for space heating, crop irrigation,
drying, and processing of agricultural products. The Company's en*able joint
venture also has a 24-hour Customer Service Center in Scottsbluff, Nebraska,
which centralizes customer service calls, service start-up and billing calls,
service dispatch and remittance operations for the three-state region. For the
year ended December 31, 1997, this business segment accounted for approximately
23% of consolidated operating income.
Regulated Retail Services
The Company's retail natural gas business operated approximately 1,500 miles of
intrastate natural gas transmission, gathering and storage facilities as of
December 31, 1997. These intrastate pipeline systems serve industrial customers
and much of the Company's retail natural gas business in Colorado and Wyoming.
As of December 31, 1997, the Company's retail natural gas business served over
210,000 customers in Colorado, Nebraska and Wyoming through approximately 7,200
miles of distribution pipelines (excluding the Company's Kansas natural gas
distribution assets which the Company entered into an agreement to sell in
December 1997, and which sale is expected to be consummated in the first half of
1998, following receipt of regulatory approval).
The Company's underground storage facilities are used to provide natural gas for
load balancing and peak system demand. Storage services for the Company's retail
natural gas services segment are provided by three facilities
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owned in Wyoming, one facility in Colorado owned and operated by Wildhorse and a
storage facility located in Nebraska and owned by the Company's interstate
pipeline system. The peak day natural gas withdrawal capacity available for this
segment at December 31, 1997 was 103 MMcf per day.
The Company's retail operations in Nebraska, Wyoming and northeastern Colorado
serve areas that are primarily rural and agriculturally based. In much of
Nebraska, the winter heating load is balanced by irrigation requirements in
summer months and grain drying in the fall. The economy in the western Colorado
service territory continues to grow as a result of growth in mountain resort
communities and development of retirement communities.
Gas Purchases and Supply
The Company's retail natural gas business relies on the Company's interstate
pipeline system, the intrastate pipeline systems it operates, and third-party
pipelines for transportation and storage services required to serve its markets.
Its gas supply requirements are being met through a combination of purchases
from wholly owned marketing subsidiaries and third-party suppliers.
The gas supply for the retail natural gas business segment comes primarily from
basins in Kansas, Montana, Wyoming, Colorado, New Mexico and western Nebraska
which include under-developed basins that represent significant proved reserves.
The Company's gas supplies are strategically located with respect to existing
and planned pipeline capacity, giving the Company access to gas for its retail
customer base.
Certain gas purchase contracts contain take-or-pay clauses which require that a
certain purchase level be attained each contract year, or the Company must make
a payment which is generally equal to the contract price multiplied by the
deficient volume. All such payments are fully recoupable under the terms of the
gas purchase contracts and the existing regulatory rules. To date, no buy-out or
buy-down payments relating to take-or-pay contracts have been made by this
business segment. See "--Gathering, Processing and Marketing
Services--Marketing."
Unregulated Retail Services
In September 1996, the Company, through its subsidiary K N Services, Inc.
("KNS"), began marketing its Simple Choice package of products and services. In
addition to natural gas service, under Simple Choice, customers can order
satellite TV, appliance protection, long-distance telephone service, wireless
Internet access and other products and services with one call, paid for with one
monthly payment and backed by one service guarantee. Simple Choice was launched
in Scottsbluff, Nebraska, where the Company also opened its first Simple Choice
General Store.
In early 1997, K N and PacifiCorp jointly formed en*able to market the Simple
Choice brand to K N's approximately 200,000 and PacifiCorp's approximately 1.5
million customers as well as to other utilities. en*able is engaged in efforts
to create Simple Choice partnerships and licensing agreements with other
utilities. An integral part of the Simple Choice package is outsourced billing
and customer service for third-party utilities. To enhance this capability,
early in 1997 KNS and PacifiCorp's subsidiary, PacifiCorp Holdings, Inc.,
acquired OrCom Systems, Inc., the software development company that designed the
billing system which supports the Simple Choice brand of products and services.
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(4) General
(a) Federal and State Regulation
Gathering, Processing and Marketing Services
Under the Natural Gas Act, facilities used for and operations involving the
production and gathering of natural gas are exempt from FERC's jurisdiction,
while facilities used for and operations involving interstate transmission are
not exempt. However, the FERC's determination of what constitutes exempt
gathering facilities as opposed to jurisdictional transmission facilities has
evolved over time. Under current law, facilities which otherwise are classified
as gathering may be subject to ancillary FERC rate and service jurisdiction when
owned by an interstate pipeline company and used in connection with interstate
transportation or jurisdictional sales.
The FERC has historically distinguished between facilities owned by
noninterstate pipeline companies, such as the Company's gathering facilities, on
a fact-specific basis.
The issue of state jurisdiction over gathering activities has previously been
raised before the Colorado Public Utilities Commission, Kansas Corporation
Commission, New Mexico Public Service Commission, Texas Railroad Commission and
Wyoming Public Service Commission, as well as before state legislative bodies.
The Company is closely monitoring developments in this area.
As part of its corporate reorganization, the Company requested, was granted
authority and in 1994 transferred substantially all of its gathering facilities
to a wholly owned subsidiary. The FERC determined that after the transfer the
gathering facilities would be nonjurisdictional, but the FERC reserved the right
to reassert jurisdiction if the Company was found to be operating the facilities
in an anti-competitive manner or contrary to open access principles.
The operations of the Company's intrastate pipeline and marketing subsidiaries
located primarily in Texas are affected by FERC rules and regulations issued
pursuant to the Natural Gas Act and the Natural Gas Policy Act. Of particular
importance are regulations which allow increased access to interstate
transportation services, without the necessity of obtaining prior FERC
authorization for each transaction. The most important element of the program is
nondiscriminatory access, under which a regulated pipeline must agree, under
certain conditions, to transport gas for any party requesting such service.
The interstate gas marketing activities of the Company's various marketing and
pipeline subsidiaries are conducted either as unregulated first sales or
pursuant to blanket certificate authority granted by the FERC under the Natural
Gas Act.
Certain of the Company's intrastate pipeline services and assets are subject to
regulation by the Texas Railroad Commission.
Interstate Transportation and Storage Services
Facilities for the transportation of natural gas in interstate commerce and for
storage services in interstate commerce are subject to regulation by the FERC
under the Natural Gas Act and the Natural Gas Policy Act. The acquisition of
MidCon's interstate natural gas pipeline system results in a significant
increase in the percentage of the Company's assets subject to regulation by the
FERC. The Company is also subject to the requirements of FERC Order Nos. 497, et
seq. and 566, et. seq., the Marketing Affiliate Rules, which prohibit
preferential treatment by an interstate pipeline of its marketing affiliates and
govern in particular the provision of information by an interstate pipeline to
its marketing affiliates.
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In January 1998, the Company's subsidiary, K N Interstate Gas Transmission Co.
("KNI") filed a rate case requesting an increase in its rates which would result
in additional annual revenues of $30.2 million. The FERC, by an order dated
February 26, 1998, accepted the filing and suspended its effective date for the
full five-month period permitted by the Natural Gas Act thus permitting the
rates to go into effect subject to refund August 1, 1998. Various parties
intervened in the proceedings. There will be additional proceedings before the
FERC to resolve differences.
Retail Natural Gas Services
Certain of the Company's intrastate pipelines, storage, distribution and/or
retail sales in Colorado, Kansas, Texas and Wyoming are under the regulatory
authority of each state's utility commission. In Nebraska, retail gas sales
rates for residential and small commercial customers within a municipality are
regulated by each municipality served.
In certain of the incorporated communities in which the Company provides natural
gas services at retail, the Company operates under franchises granted by the
applicable municipal authorities. The duration of franchises varies. In
unincorporated areas, the Company's natural gas utility services are not subject
to municipal franchise. The Company has been issued various certificates of
public convenience and necessity by the regulatory commissions in Colorado,
Kansas and Wyoming authorizing it to provide natural gas utility services within
certain incorporated and unincorporated areas of those states.
Continuing regulatory change will provide energy consumers with increasing
choices among their suppliers. The Company emerged as a leader in providing for
customer choice by filing an application with the Wyoming Public Service
Commission in 1995 to allow 10,500 residential and commercial customers to
choose to purchase the gas from a qualified list of suppliers. The proposal
provided that the Company would continue to provide all other utility services.
In early 1996, the Wyoming Public Service Commission issued an order allowing
the Company to bring competition to these 10,500 residential and commercial
customers beginning in mid 1996. Choosing from a menu of three competing
suppliers, approximately 80% of the Company's customers chose to remain with the
Company. The experience gave the Company early and valuable experience in
competing in an unbundled environment and led to the development of new products
and services that add value to the natural gas commodity. The innovative program
was one of the first in the nation that allowed essentially all customers the
opportunity to exercise energy choice for natural gas. Similarly, the Company
has made voluntary filings with municipal authorities in Nebraska to provide its
retail customers with an opportunity to purchase gas from competing suppliers on
an unregulated basis. The Company will continue to provide all other gas utility
services. If municipal approvals are received, the program will be implemented
in 1998.
(b) Environmental Regulation
The Company's operations and properties are subject to extensive and evolving
Federal, state and local laws and regulations governing the release or discharge
of regulated materials into the environment or otherwise relating to
environmental protection. Numerous governmental departments issue rules and
regulations to implement and enforce such laws which are often difficult and
costly to comply with and which carry substantial penalties for failure to
comply. Moreover, the Company believes recent trends toward stricter standards
in environmental legislation and regulation are likely to continue.
The United States Oil Pollution Act of 1990 and regulations promulgated
thereunder by the Minerals Management Service impose a variety of requirements
on persons who are or may be responsible for oil spills in waters of the United
States. The term "waters of the United States" has been broadly defined to
include inland waterbodies, such as wetlands, playa lakes and intermittent
streams. The Company has a limited number of facilities that could affect
"waters of the United States." The Federal Water Pollution Control Act, also
known as the Clean Water Act, and
10
11
regulations promulgated thereunder, require containment of potential discharges
of oil or hazardous substances and preparation of oil spill contingency plans.
The Company has implemented programs that address containment of potential
discharges and spill contingency planning. The failure to comply with ongoing
environmental regulatory requirements or inadequate cooperation during a spill
event may subject a responsible party to civil or criminal enforcement actions.
The Comprehensive Environmental Response, Compensation and Liability Act, as
amended ("Superfund"), imposes liability on certain classes of persons who are
considered to have contributed to the release of a "hazardous substance" into
the environment without regard to fault or the legality of the original conduct.
Under Superfund, such persons may be subject to joint and several liability for
the costs of cleaning up the hazardous substances that have been released into
the environment and for damages to natural resources. Furthermore, neighboring
landowners and other third parties have the right to file claims for personal
injury and property damage allegedly caused by the hazardous substances released
into the environment.
Federal and state regulations implementing the 1990 Amendments to the Clean Air
Act affect the Company's operations in several ways. Natural gas compressors for
both gathering and transmission activity are now required to meet stricter air
emission standards. Additionally, states in which the Company operates are
adopting regulations under the authority of the "Operating Permit Program" under
Title V of these 1990 Amendments. This Operating Permit Program requires
operators of certain facilities to obtain individual site-specific air permits
containing stricter operational and technological standards of operation in
order to achieve compliance with this section of the 1990 Clean Air Act
Amendments and associated state air regulations.
The Toxic Substances Control Act, as amended ("TSCA"), imposes certain
operational and technical standards on persons who manufacture, process,
distribute, use or dispose of TSCA-related substances, including such things as
polychlorinated biphenyls ("PCBs"), asbestos, and lead-based paints. The Company
has facilities which contain such TSCA-related substances.
In connection with the Acquisition of MidCon, Occidental indemnified the Company
against certain liabilities, including litigation and the failure of MidCon to
be in compliance with applicable laws, in each case which would have a material
adverse effect on MidCon, for one year following the closing date. To the extent
that an environmental liability of MidCon is not covered by Occidental's
indemnity obligation or, to the extent that matters arise following the
termination of Occidental's indemnification obligation, the Company will be
responsible for MidCon's environmental liabilities. The Company does not expect
that such costs will have a material adverse impact on its business, financial
position or results of operations.
Based on current information and taking into account reserves established for
environmental matters, the Company does not believe that compliance with
Federal, state and local environmental laws and regulations will have a material
adverse effect on the Company's business, financial position or results of
operations. In addition, the clean-up programs in which the Company is engaged
are not expected to interrupt or diminish the Company's operational ability to
gather or transport natural gas. However, there can be no assurances that future
events, such as changes in existing laws, the promulgation of new laws, or the
development of new facts or conditions will not cause the Company to incur
significant costs.
(c) Safety Regulation
The operations of certain of the Company's gas pipelines are subject to
regulation by the United States Department of Transportation (the "DOT") under
the Natural Gas Pipeline Safety Act of 1968, as amended (the "NGPSA"). The NGPSA
establishes safety standards with respect to the design, installation, testing,
construction, operation and management of natural gas pipelines, and requires
entities that own or operate pipeline facilities to comply with the applicable
safety standards, to establish and maintain inspection and maintenance plans,
and to comply with such plans.
11
12
The NGPSA was amended by the Pipeline Safety Act of 1992 to require the DOT's
Office of Pipeline Safety to consider, among other things, protection of the
environment when developing minimum pipeline safety regulations. Management
believes the Company's operations, to the extent they may be subject to the
NGPSA, comply in all material respects with the NGPSA.
The Company is also subject to state and federal laws and regulations concerning
occupational health and safety.
(d) Other
Amounts spent by the Company during 1997, 1996 and 1995 on research and
development activities were not material.
(C) Financial Information About Foreign and Domestic Operations and Export
Sales
Substantially all of the Company's operations are in the contiguous 48 states.
ITEM 3: LEGAL PROCEEDINGS
The Company was named as one of four potentially responsible parties ("PRPs") at
a U.S. Environmental Protection Agency ("EPA") Superfund site known as the
Mystery Bridge Road/U.S. Highway 20 site located near Casper, Wyoming (the
"Brookhurst Subdivision") in 1989. A majority of the Company's groundwater, soil
and free phase petroleum cleanup occurred between 1990 and 1996. Groundwater
remediation standards were recently achieved at the Company's operable unit, and
the EPA has allowed the Company to go into a post-remedial action monitoring
phase. The total remaining estimated cost is not expected to exceed $150,000.
(United States of America v. Dow Chemical Company, Dowell Schlumberger, Inc.,
and K N Energy, Inc., Civil Action No. 91CV1042, United States District Court
for the District of Wyoming; formerly reported as Administrative Orders for
Removal Action on Consent, October 15, 1987, and Amendment to Administrative
Order for Removal Order on Consent, October 10, 1989, Docket No. CERCLA
VII-88-01, United States Environmental Protection Agency; Judicial Entry of
Consent Decree, United States v. Dow Chemical Company, et al. (D. Wyo)
USDC-WY-91CV1042B, Superfund Site Number 8T83, Natrona County, Wyoming; EPA
Docket Number CERCLA-VIII).
In 1994, a mercury sampling program was initiated on the Company's systems in
central and western portions of Kansas. The Company is working with the Kansas
Department of Health and Environment pursuant to a voluntary agreement. The
assessment program is being completed, and the Company in 1998 will commence a
phased remediation program for those sites where concentrations are above
regulatory thresholds, at an expected cost of $200,000 in 1998. The program will
take place over a period of years, and the costs are not expected to have a
material adverse impact on the Company's business, financial position or results
of operations.
The Company performed environmental audits in Colorado, Kansas and Nebraska,
which revealed that certain grease and lubricating oils used at various pipeline
and facilities locations contained PCBs. The Company is working with the
appropriate regulatory agencies to manage the cleanup and remediation of the
pipelines and facilities. The Company filed suit against Rockwell International
Corporation ("Rockwell"), manufacturer of the PCB-containing grease used in
certain of the Company's pipelines and facilities, and two other related
defendants for expenses and losses incurred by the Company for cleanup or
mitigation. The Company settled with Rockwell in March 1994. (K N Energy, Inc.
and Rocky Mountain Natural Gas Company v. Rockwell International Corp et al.,
United States District Court for the District of Colorado, Case No. 93-711). To
date since 1991, the Company has incurred approximately $500,000 in costs
associated with the remediation and management of this issue, including
preparation and implementation of a workplan. In 1998, the Company may spend up
to approximately $470,000. A substantial portion of these costs are recoverable
under the settlement entered into with Rockwell. The total potential remediation
and cleanup costs at
12
13
currently identified locations is not expected to have a material adverse impact
on the Company's financial position or results of operations. The cleanup
programs are not expected to interrupt or diminish the Company's operational
ability to gather or transport natural gas.
Pursuant to certain acquisition agreements involving Cabot Corporation
("Cabot"), the Company's largest stockholder, Cabot indemnified the Company for
certain environmental liabilities. Issues have arisen concerning Cabot's
indemnification obligations. The Company and Cabot have agreed to enter into
binding arbitration to resolve all issues in dispute. The Company is unable to
estimate its potential exposure for such liabilities at this time, but does not
expect them to have a material adverse impact on the Company's financial
position or results of operations.
The Company acquired certain gathering and processing assets from Parker &
Parsley Gas Processing Co. and its affiliates in October 1995. In connection
with that acquisition, and for a reduction in the purchase price that included
the estimated costs of remediation of $3.9 million, the Company agreed to accept
all responsibility and liability for environmental matters associated with such
properties. Also, in March 1997, the Company acquired the Bushton processing
complex and Hugoton Basin gathering assets from Enron Corporation and certain of
its affiliates. In connection with that acquisition, the Company established
reserves to fund previously-identified environmental/operational issues; the
Company will also be reimbursed on a shared basis for costs and expenses
associated with any environmental deficiencies identified at the facility in the
next five years up to a maximum of $10 million, although the Company does not
anticipate costs will reach that amount. After consideration of reserves
established and the agreements entered into in connection with these various
acquisitions, costs and expenses related to environmental matters are not
expected to have a material adverse effect on the business, financial position
or results of operations of the Company.
In May 1997, the Nebraska Department of Environmental Quality ("NDEQ") issued a
violation notice to KNI regarding historical Prevention of Significant
Deterioration permitting issues related to certain engines at the Big Springs,
Nebraska, facility. KNI is in the process of obtaining the proper permits at
this time, and is also engaged in discussions with NDEQ regarding settlement of
the violation notice and a $500,000 fine currently proposed by the NDEQ. The
costs associated with this matter are not expected to have a material adverse
effect on the Company's business, financial position or results of operations.
On October 9, 1992, Jack J. Grynberg filed suit in the United States District
Court for the District of Colorado against the Company, Rocky Mountain Natural
Gas Company ("RMNG') and GASCO, Inc. (the "K N Entities") alleging that the KN
Entities as well as K N Production Company and K N Gas Gathering, Inc., have
violated federal and state antitrust laws. In essence, Grynberg asserts that the
defendant companies have engaged in an illegal exercise of monopoly power, have
illegally denied him economically feasible access to essential facilities to
transport and distribute gas produced from fewer than 20 wells located in
northwest Colorado, and have illegally attempted to monopolize or to enhance or
maintain an existing monopoly. Grynberg also asserts certain causes of action
relating to a gas purchase contract. The Company's potential liability for
monetary damages and the amount of such damages, if any, are subject to dispute
between the parties; however, the Company believes it has a meritorious position
in these matters and does not expect this lawsuit to have a material adverse
effect on the Company's financial position or results of operations. In July
1996, the U. S. District Court, District of Colorado lifted its stay and allowed
discovery for a period of time. Currently, this case is still pending. Discovery
is now complete, but no trial date has yet been set. (Grynberg v. K N, et al.,
Civil Action No. 92-2000, United States District Court for the District of
Colorado).
On July 26, 1996, K N and RMNG along with over 70 other natural gas pipeline
companies, were served by Jack J. Grynberg, acting on behalf of the Government
of the United States, with a Civil False Claims Act lawsuit alleging
mismeasurement of the heating content and volume of natural gas resulting in
underpayment of royalties to the federal government. The government,
particularly officials from the Departments of Justice and Interior, reviewed
the complaint and the evidence presented by Mr. Grynberg and declined to
intervene in the action, allowing Mr. Grynberg to proceed on his own. No
specific claims were made against K N or RMNG, and no specific monetary damages
were
13
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claimed. K N and the other named companies filed a motion to dismiss the
lawsuit on grounds of improper joinder and lack of jurisdiction. The motion to
dismiss was granted in 1997, and K N is no longer required to respond to this
action. However, the court did give Mr. Grynberg leave to refile and pursue this
action in a court with proper jurisdiction. The Company believes it has a
meritorious position in this matter, and does not expect this lawsuit to have a
material adverse effect on the Company's financial position or results of
operations. (United States of America ex rel. Jack J. Grynberg v. Alaska
Pipeline Company, et al., Civil Action No. 95-725-TF#, United States District
Court for the District of Columbia).
The Company believes it has meritorious defenses to all lawsuits and legal
proceedings in which it is a defendant and will vigorously defend against them.
Based on its evaluation of the above matters, and after consideration of
reserves established, the Company believes that the resolution of such matters
will not have a material adverse effect on the Company's financial position or
results of operations.
14
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EXECUTIVE OFFICERS OF THE REGISTRANT
(A) Identification and Business Experience of Executive Officers
Name Age Position and Business Experience
- ------------------------------------------------- --- ------------------------------------------------------------
Morton C. Aaronson............................... 39 Chief Marketing Officer since April 1996. Vice President
since January 1996. Vice President, MCI/ NewsCorp. Business
Development from May 1995 to January 1996. Vice President,
Market Management, MCI Communications Corporation from
August 1994 to May 1995. Vice President, Large Accounts and
Global Markets, MCI Communications Corporation, from July
1993 to August 1994. Director, Major Accounts Marketing, MCI
Communications Corporation from July 1992 to July 1993.
John N. DiNardo.................................. 50 Vice President and General Manager since April 1996. Vice
President - Gas Gathering and Processing from March 1994 to
April 1996. General Manager, K N Gas Gathering, Inc. and K N
Front Range Gathering Company from May 1993 to March 1994.
Director of Project Development, K N Gas Gathering, Inc.
from August 1991 to May 1993.
Jack W. Ellis II................................. 44 Vice President and Controller since December 1997. Vice
President and Controller, NorAm Energy Co. from December
1989 to August 1997.
William S. Garner, Jr............................ 48 Vice President since April 1997. Vice President and General
Counsel from January 1991 to April 1997 and Secretary from
April 1992 to April 1996.
Larry D. Hall.................................... 55 Chairman of the Board since April 1996. President and Chief
Executive Officer since July 1994. President and Chief
Operating Officer from May 1988 to July 1994. Director since
1984.
S. Wesley Haun................................... 50 Vice President, Strategic Business Development Since April
1997. Vice President since April 1996. Vice President,
Marketing and Supply from May 1993 to April 1996. Vice
President, Gas Supply from March 1990 to May 1993.
E. Wayne Lundhagen............................... 60 Vice President and Treasurer since March 1995. Vice
President, Finance and Accounting from May 1988 to March
1995.
Clyde E. McKenzie................................ 50 Vice President and Chief Financial Officer since April 1996.
Vice President and Treasurer, Apache Corporation from 1988
to 1996.
John L. Pelletier............................... 49 Vice President, Administration since February 1998. Vice
President, Administration of MidCon Corp. from 1992 to
January 1998.
15
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John F. Riordan................................. 62 Vice Chairman of the Board and Director since February 1998.
President and Chief Executive Officer of MidCon Corp. from
1990 to January 1998. Executive Vice President and
Director of Occidental Petroleum Corporation from 1991 to
January 1998.
Murray R. Smith................................. 43 Vice President - Corporate Communications since August 1996.
Senior Vice President, K N Services, Inc. from April to
August 1996. Director of Field Communications, Training and
Sales Programs, MCI Communications Corporation from October
1995 to April 1996. Director of Field Marketing and
Communications, WorldWide Sales, MCI Communications
Corporation from October 1994 to October 1995. Director of
Field Marketing - Business Services, MCI Communications
Corporation from June 1992 to October 1994. Director of
Marketing, Southern Division, MCI Communications Corporation
from November 1990 to June 1992.
H. Rickey Wells................................. 41 Vice President - Business Operations since April 1996. Vice
President, Operations from June 1988 to April 1996.
Martha B. Wyrsch................................ 40 Vice President, General Counsel and Secretary since August
1997. Vice President, Deputy General Counsel and Secretary
from April 1996 to August 1997. Deputy General Counsel from
November 1995 to April 1996. Assistant General Counsel from
June 1995 to November 1995. Senior Counsel from June 1993 to
June 1995.
These officers generally serve until April of each year.
(B) Involvement in Certain Legal Proceedings
None.
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PART II
ITEM 5: MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's common stock is listed for trading on the New York Stock Exchange
under the symbol KNE. Dividends paid and the price range of the Company's common
stock by quarter for the last two years are provided below.
1997 1996
---- ----
Market Price Data
(Low-High-Close)
Quarter Ended:
March 31 $36.125 - $41.75 - $39.50 $27.00 - $31.75 - $31.125
June 30 $36.875 - $43.125 - $42.125 $30.625 - $34.375 - $33.50
September 30 $39.00 - $47.938 - $45.75 $31.75 - $36.625 - $35.25
December 31 $41.00 - $54.00 - $54.00 $35.00 - $41.25 - $39.25
Dividends
Quarter Ended:
March 31 $0.27 $0.26
June 30 $0.27 $0.26
September 30 $0.27 $0.26
December 31 $0.28 $0.27
Common Stockholders
Year-end 10,090 9,794
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ITEM 6: SELECTED FINANCIAL DATA
FIVE-YEAR REVIEW
K N ENERGY, INC. AND SUBSIDIARIES
Selected Financial Data (In Thousands, Except Per Share Amounts)
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
OPERATING REVENUES:
Gathering, Processing and
Marketing Services $ 1,866,327 $ 1,191,292 $ 854,462 $ 838,474 $ 730,895
Interstate Transportation and
Storage Services 23,757 25,352 22,217 21,044 99,838
Retail Natural Gas Services 255,034 223,838 227,282 220,431 212,905
Gas and Oil Production -- -- 7,437 11,328 5,321
----------- ----------- ----------- ----------- -----------
Total Operating Revenues $ 2,145,118 $ 1,440,482 $ 1,111,398 $ 1,091,277 $ 1,048,959
=========== =========== =========== =========== ===========
OPERATING INCOME $ 142,249 $ 134,801 $ 115,362 $ 54,879 $ 80,874
Other Income and (Deductions) (29,091) (35,085) (33,790) (30,058) (31,406)
----------- ----------- ----------- ----------- -----------
INCOME BEFORE INCOME TAXES 113,158 99,716 81,572 24,821 49,468
Income Taxes 35,661 35,897 29,050 9,500 18,599
----------- ----------- ----------- ----------- -----------
NET INCOME 77,497 63,819 52,522 15,321 30,869
Less - Preferred Stock Dividends 350 398 492 630 853
----------- ----------- ----------- ----------- -----------
EARNINGS AVAILABLE FOR
COMMON STOCK $ 77,147 $ 63,421 $ 52,030 $ 14,691 $ 30,016
=========== =========== =========== =========== ===========
DILUTED EARNINGS PER
COMMON SHARE $ 2.45 $ 2.14 $ 1.83 $ 0.52 $ 1.09
=========== =========== =========== =========== ===========
DIVIDENDS PER COMMON SHARE $ 1.09 $ 1.05 $ 1.01 $ 0.76 $ 0.51
=========== =========== =========== =========== ===========
NUMBER OF SHARES USED IN
COMPUTING DILUTED EARNINGS
PER COMMON SHARE 31,538 29,624 28,360 28,044 27,424
=========== =========== =========== =========== ===========
TOTAL ASSETS $ 2,305,805 $ 1,629,720 $ 1,257,457 $ 1,172,384 $ 1,169,275
=========== =========== =========== =========== ===========
CAPITAL EXPENDITURES $ 311,093 $ 119,987 $ 79,313 $ 70,511 $ 100,780
=========== =========== =========== =========== ===========
ACQUISITIONS $ 153,756 $ 155,909 $ 35,897 $ 31,363 $ 65,172
=========== =========== =========== =========== ===========
CAPITALIZATION:
Common Stockholders' Equity $ 606,132 48% $ 519,794 55% $ 426,760 57% $ 393,686 54% $ 391,462 53%
Preferred Stock 7,000 -- 7,000 1% 7,000 1% 7,000 1% 7,000 1%
Preferred Stock Subject to
Mandatory Redemption -- -- -- -- 572 -- 1,715 -- 2,858 --
Preferred Capital Trust
Securities 100,000 8% -- -- -- -- -- -- -- --
Long-Term Debt 553,816 44% 423,676 44% 315,564 42% 334,644 45% 335,190 46%
----------- --- ----------- --- ----------- --- ----------- --- ----------- ---
Total Capitalization $ 1,266,948 100% $ 950,470 100% $ 749,896 100% $ 737,045 100% $ 736,510 100%
=========== === =========== === =========== === =========== === =========== ===
BOOK VALUE PER COMMON SHARE $ 18.93 $ 17.16 $ 15.19 $ 14.25 $ 14.39
=========== =========== =========== =========== ===========
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ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
On January 30, 1998, K N acquired all the outstanding capital stock of MidCon
Corp. for approximately $2.1 billion in cash and a $1.39 billion short-term
note. See K N - MidCon Combination in the Outlook/Forward-Looking Information
section of this report and Note 2 of Notes to Consolidated Financial Statements.
CONSOLIDATED EARNINGS
Consolidated net income, diluted earnings per common share and return on average
common equity for the three years ended December 31, 1997 were:
1997 1996 1995
---- ---- ----
Net Income (In Millions) $77.5 $63.8 $52.5
Earnings per Common Share $2.45 $2.14 $1.83
Return on Average Common Equity 13.7% 13.4% 12.7%
Net income and diluted earnings per share for 1997 represent increases of 21
percent and 14 percent, respectively, from 1996. This improvement resulted
principally from (1) the earnings contribution of the Bushton assets acquired in
April 1997, (2) the August 1997 startup of the Pony Express Pipeline, (3)
earnings from the Company's equity investments in the TransColorado Pipeline and
the Coyote Gulch Gas Treating Plant, (4) income related to the sale of a 50
percent interest in en*able, and (5) a lower 1997 income tax provision. To
achieve its double-digit earnings growth in 1997, the Company overcame several
challenges, including losses in certain power marketing transactions, lower
natural gas liquids ("NGLs") prices, record low demand for wholesale irrigation
load in the Texas intrastate market area and a delay in reaching full throughput
capacity on the Pony Express Pipeline (which impacted operating results for both
the gathering, processing and marketing, and the interstate pipeline segments).
These negative factors were mitigated by the Company's decision to take
advantage of favorable market conditions to effect certain transactions as
discussed following.
The 17 percent increase in 1996 diluted earnings per share from 1995 was
primarily attributable to business growth on the interstate pipeline and
gathering and processing systems, higher prices for NGLs, expense savings from
the 1995 corporate restructuring, and incremental sales of storage gas.
Operating results for 1996 were adversely impacted by low demand for retail
irrigation sales and transportation services due to abnormally heavy rainfall
during the summer.
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RESULTS OF OPERATIONS
Comparative operating results by business segment, consolidated other income and
(deductions) and income taxes are presented below. Segment operating revenues,
costs and expenses and volumetric data cited below are before intersegment
eliminations; dollar amounts are in millions.
GATHERING, PROCESSING AND MARKETING SERVICES 1997 1996 1995
---- ---- ----
Operating Revenues -
Gas Sales $1,443.9 $ 983.4 $706.8
Natural Gas Liquids Sales 275.9 189.9 117.0
Gathering, Transportation and Other 210.6 83.2 66.7
-------- -------- ------
1,930.4 1,256.5 890.5
-------- -------- ------
Operating Costs and Expenses -
Gas Purchases and Other Costs of Sales 1,691.5 1,050.1 704.3
Operations and Maintenance 115.1 89.1 85.1
Depreciation and Amortization 34.8 31.7 26.5
Taxes, Other Than Income Taxes 14.6 11.1 10.0
-------- -------- ------
1,856.0 1,182.0 825.9
-------- -------- ------
Operating Income $ 74.4 $ 74.5 $ 64.6
======== ======== ======
Systems Throughput (Trillion Btus) -
Gas Sales 573.7 430.1 407.8
Gathering and Transportation 423.0 313.1 306.0
-------- -------- ------
996.7 743.2 713.8
======== ======== ======
Natural Gas Liquids Sales (Million Gallons) -
Company-Owned and Processed 549.7 405.9 375.6
Third-Party Marketed 167.7 63.9 12.5
-------- -------- ------
717.4 469.8 388.1
======== ======== ======
The significant increases in 1997 operating revenues, costs and expenses and
volumetric data largely reflect the acquisition of the Bushton gathering and
processing assets effective April 1, 1997. Other operating revenues and other
costs of sales also reflect a significant increase in 1997 power marketing
activity which, as discussed below, was suspended in the third quarter. The
Bushton acquisition contributed incremental 1997 operating revenues of $114.8
million and operating income of $15.4 million. This segment's 1997 operating
income was level with the prior year's results, as 1997 operations were
adversely impacted by losses from certain power marketing transactions, lower
NGLs prices, reduced wholesale irrigation demand (5.9 trillion Btus below 1996
deliveries due to abundant rainfall in the Texas intrastate market area) and
$1.4 million of expenses incurred to centralize the Company's marketing
activities in Houston.
During 1997, losses of approximately $4.0 million were incurred in connection
with certain power marketing transactions which were not in compliance with the
Company's risk management policies. Subsequently, power marketing activities
were suspended in the third quarter.
Excluding the Bushton facility, average NGLs prices in 1997 were $0.03 per
gallon lower than 1996, creating a negative impact on 1997 operating income of
approximately $7.5 million. Irrigation-related gas marketing and transportation
and storage margins were adversely impacted by approximately $5.4 million due to
the abnormally wet 1997 summer. Additionally, the delay until January 1998 in
reaching full throughput capability on the Pony Express Pipeline limited growth
in gathering and processing volumes at the Company's expanded Douglas plant and
marketing opportunities into the Kansas City area, as upstream business
expansion opportunities off the Pony Express Pipeline were expected to offset
on-going declines in certain producing areas. The cumulative unfavorable
earnings impact of these 1997 events was substantially mitigated by increased
sales of storage gas and the sale of certain non-strategic gas supply, NGLs
marketing and storage-related contracts. These transactions, aggregating $15.9
million of net margin increases over similar transactions in 1996,
20
21
essentially offset the losses and negative market circumstances enumerated
above. The Company currently expects that future margins from storage sales will
be less.
The 15 percent increase in 1996 operating income over 1995 largely resulted from
three factors: (1) growth in volumes (principally due to acquisitions, the
Wildhorse joint venture with Tom Brown, Inc., and sales of storage gas), (2)
higher NGLs prices and (3) expense savings accruing from the 1995 corporate
restructuring. This segment did experience compression of margins during 1996 in
all three of its principal activities (gas sales, NGLs sales and transportation
and gathering services) due to competitive factors and significantly higher gas
costs influenced by colder weather nationwide. Average 1996 NGLs sales prices
exceeded those realized in 1995 by $0.10 per gallon. However, the impact of
higher NGLs prices was partially offset by the effect of higher gas prices on
shrink and fuel payments to producers under "keep whole" processing agreements.
INTERSTATE TRANSPORTATION AND STORAGE SERVICES 1997 1996 1995
---- ---- ----
Operating Revenues -
Transportation and Storage $ 73.8 $ 63.4 $ 58.6
Other 6.0 8.4 5.8
-------- -------- --------
79.8 71.8 64.4
-------- -------- --------
Operating Costs and Expenses -
Gas Purchases and Other Costs of Sales 6.0 7.3 7.7
Operations and Maintenance 26.1 24.3 27.5
Depreciation and Amortization 9.0 8.0 7.8
Taxes, Other Than Income Taxes 3.7 2.8 3.4
-------- -------- --------
44.8 42.4 46.4
-------- -------- --------
Operating Income $ 35.0 $ 29.4 $ 18.0
======== ======== ========
Systems Throughput (Trillion Btus) 177.4 156.8 155.6
======== ======== ========
The Pony Express Pipeline accounted for the majority of the 1997 improvement in
the interstate pipeline's operating income, despite regulatory delays in
commencing the project and operational delays in reaching its design capability.
Additionally, 1997 operating results were positively impacted by increased 1997
gas supply requirements in the Company's retail natural gas services segment
resulting from colder weather and higher irrigation demand. Effective August 31,
1997, the Casper processing plant was transferred to an unregulated subsidiary
included in the gathering, processing and marketing segment. The reduction in
1997 other operating revenues and gas purchases and other costs of sales is
primarily due to this transfer.
21
22
This segment's 1996 results showed substantial improvement over 1995 as
throughput and demand revenues increased due to mid-year 1996 system expansions
in Wyoming. Throughput in 1996 was adversely affected by below normal irrigation
load on the Company's retail segment served by the interstate pipeline. Lower
1996 operations and maintenance and payroll taxes resulted from expense savings
due to the 1995 corporate restructuring.
1997 1996 1995
---- ---- ----
RETAIL NATURAL GAS SERVICES
Operating Revenues -
Gas Sales $ 219.4 $ 190.0 $ 204.0
Transportation and Other 37.4 35.4 28.3
-------- -------- --------
256.8 225.4 232.3
-------- -------- --------
Operating Costs and Expenses -
Gas Purchases and Other Costs of Sales 148.3 115.3 122.4
Operations and Maintenance 57.9 62.3 60.3
Depreciation and Amortization 12.2 11.5 11.0
Taxes, Other Than Income Taxes 5.6 5.4 5.6
-------- -------- --------
224.0 194.5 199.3
-------- -------- --------
Operating Income $ 32.8 $ 30.9 $ 33.0
======== ======== ========
Systems Throughput (Trillion Btus) -
Gas Sales 38.6 34.7 39.0
Transportation 34.9 32.9 27.4
-------- -------- --------
73.5 67.6 66.4
======== ======== ========
Operating income in 1997 as compared to 1996 was positively affected by
increased demand for space-heating and irrigation due to colder weather and less
rainfall during the summer. Although approximately 13 percent below a normal
year, irrigation deliveries of 10.9 trillion Btus in 1997 exceeded 1996
requirements by 1.4 trillion Btus. The impact of 1997 company-wide expense
controls on operations and maintenance costs is most apparent in this segment,
as this segment has not experienced significant acquisitions or expansion
projects this year.
Operating results for 1996 were adversely impacted by low demand for irrigation
requirements due to abnormally heavy rainfall during the summer. Irrigation
sales and transportation volumes in 1996 were 3.8 trillion Btus below the 1995
season. Deliveries to irrigators of 12.6 trillion Btus in 1995 were more
indicative of a normal year's load. This negative impact on 1996 earnings was
partially mitigated by increased customer requirements for grain drying and
growth in transportation volumes on the Rocky Mountain intrastate pipeline due
to the fourth quarter 1996 acquisition of interconnected gathering and
processing facilities. Operations and maintenance expenses were 3.3 percent
higher than in 1995, as costs incurred in the development of new marketing
initiatives exceeded savings realized from the 1995 corporate restructuring.
OTHER INCOME AND (DEDUCTIONS) 1997 1996 1995
---- ---- ----
Interest Expense $ (43.5) $ (35.9) $ (34.2)
------- ------- -------
Minority Interests and Other, Net 14.4 0.8 0.4
------- ------- -------
$ (29.1) $ (35.1) $ (33.8)
======= ======= =======
Increases in the most recent two years' interest expense result from the
issuance of long-term debt in 1997 and 1996 and higher levels of short-term
borrowings incurred principally to fund capital expenditures. In 1997 and 1996,
the Company capitalized $7.8 million and $1.8 million, respectively, of interest
costs primarily related to the construction of the Pony Express Pipeline.
Minority Interests and Other, Net for 1997 includes $5.7 million of earnings
from the Company's equity investments in the TransColorado Pipeline and the
Coyote Gulch Gas Treating Plant, and $7.0 million of income related to the sale
of a 50 percent interest in en*able, with no corresponding amounts in 1996. Net
gains totaling $ 3.7 million on the sale of several non-strategic gathering
systems and, in accordance with regulatory guidelines, the capitalization of
equity financing costs of $4.5 million
22
23
related to the Pony Express Pipeline, more than offset the $5.8 million of
financing costs (included in Minority Interests) associated with the 8.56%
Preferred Capital Trust Securities issued in April 1997.
INCOME TAXES 1997 1996 1995
---- ---- ----
Provisions $ 35.7 $ 35.9 $ 29.1
======= ======= =======
Effective Tax Rate 31.5% 36.0% 35.6%
======= ======= =======
The reduced 1997 provision for income taxes and the resulting reduction in the
effective tax rate are due to the successful resolution of certain issues from
prior years' income tax filings. Refer to Note 7 of Notes to Consolidated
Financial Statements for a reconciliation of the statutory rate to yearly
effective rates.
LIQUIDITY AND CAPITAL RESOURCES
During 1997 the primary sources of cash were from internally generated cash
flows, the public offerings of long-term debt and preferred capital trust
securities and short-term borrowings. Cash outflows funded capital expenditures
and acquisitions, debt service and dividend payments.
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash flows from operating activities for 1997 totaled $97.5 million,
compared with $75.6 million and $132.2 million for 1996 and 1995, respectively.
The improvement in 1997's net operating cash flows was largely attributable to
the same factors resulting in the reported increase in earnings. Net operating
cash flows in 1996 were primarily negatively impacted by disbursements to buyout
above-market gas purchase contracts and increases in storage gas inventories.
CAPITAL EXPENDITURES AND COMMITMENTS
Capital expenditures of $311.1 million in 1997 were significantly higher than
expenditures of $120.0 million in 1996 and $79.3 million in 1995. The large
increase in 1997 capital expenditures resulted from the completion of the Pony
Express Pipeline, construction of transmission laterals into the Kansas City
metropolitan area, and capital investment related to the Bushton acquisition,
including initial expenditures to reduce field pressures in the Hugoton Basin.
The 1998 capital expenditures budget totals $149.5 million (before adjustment to
reflect the consolidation with MidCon). Budgeted maintenance, safety and
environmental expenditures approximate $56.4 million and budgeted business
growth or expansion expenditures approximate $93.1 million.
Principal acquisitions or investments made during 1997 included the Bushton gas
gathering and processing assets effective in April, Interenergy effective in
December (primarily a gathering and marketing entity) and an interest in the Red
Cedar Gathering Company acquired at year-end. See Notes 3(A), 3(C) and 3(B) of
Notes to Consolidated Financial Statements.
23
24
CAPITAL RESOURCES
At December 31, 1997, the Company had a credit agreement with 11 banks (the
"Pre-Acquisition Facility") pursuant to which the Company could borrow or
provide support for commercial paper issuance up to a total of $350 million.
Borrowings under the Pre-Acquisition Facility were $329.2 million and $129.3
million at December 31, 1997 and 1996, respectively. The Pre-Acquisition
Facility was terminated in January 1998 and replaced with new credit lines and
an acquisition facility in conjunction with the acquisition of MidCon. See Note
8(A) of Notes to Consolidated Financial Statements.
In January 1998, following a review of the K N - MidCon combination, Fitch
Investors Service ("Fitch"), Moody's Investors Service ("Moody's") and Standard
& Poor's ("S&P") lowered their ratings of the Company's senior unsecured debt.
Fitch lowered its rating from A- to BBB, Moody's lowered its rating from A3 to
Baa2 and S&P lowered its rating from BBB+ to BBB-. The Company intends to
strengthen its balance sheet during 1998 by public equity offerings, limiting
capital expenditures (for both MidCon and the historical K N companies) and
increasing internally generated cash flows.
In recent years, the Company's capitalization has averaged approximately 45
percent debt to 55 percent equity. As a result of the acquisition of MidCon on
January 30, 1998, the Company's leverage has increased significantly through the
utilization of an acquisition debt facility and new revolving credit facilities.
See Note 8(A) of Notes to Consolidated Financial Statements. The Company
currently has in place a shelf registration statement with the Securities and
Exchange Commission in a total amount of $4.0 billion, pursuant to which, as of
March 4, 1997, the Company had agreed to the pricing for public sale of $2.35
billion principal amount of debt securities of varying maturities and 10 million
shares of common stock (up to 11.5 million shares if the underwriters'
over-allotment option is fully exercised). The proceeds of these offerings are
expected to be used to (1) repay the acquisition debt associated with the
purchase of MidCon and (2) purchase U.S. government securities to serve as a
portion of the collateral required for the note issued to the seller in the
MidCon acquisition. The Company's future financing plans include the public
issuance of other securities, including trust securities which are mandatorily
redeemable or convertible. The Company currently expects that, even if it is
successful in completing both the offerings currently in progress and its
planned offerings, its degree of leverage in the near-term will remain
significantly above historical levels.
REGULATION
In 1997, approximately 48 percent of the Company's operating income was derived
from assets which are rate-regulated at either the federal, state or local
level. At least in the near-term, a significantly higher percentage of the
Company's operating income is expected to be derived from rate-regulated
operations as a result of the acquisition of MidCon. In substantially all
regulatory jurisdictions, rates are currently determined using cost-based
regulation and, at this time, the Company does not expect a significant change
in the manner in which rates are set. Thus far, the primary impact of
competition on the Company's regulated businesses has been the conversion of
services from the "bundled" merchant and transportation function (including the
pass-through of actual gas costs expended) to transportation services only. The
Company anticipates that this conversion to transportation service will continue
and become more prevalent at the retail level. During 1998, K N will continue to
implement its Choice Gas Program in Nebraska, pursuant to which approximately
100,000 retail customers will be able to choose their gas supplier. See Note
4(B) of Notes to Consolidated Financial Statements.
RISK MANAGEMENT
To minimize the risk of price changes in the natural gas and NGLs markets, the
Company uses certain financial instruments for hedging purposes. These
instruments include energy products traded on the New York Mercantile Exchange,
the Kansas City Board of Trade and over-the-counter markets, including futures
and options contracts and fixed-price swaps.
Pursuant to guidelines approved by its Board of Directors, the Company is to
engage in these activities only as a hedging mechanism against price volatility
associated with pre-existing or anticipated physical gas and
24
25
condensate sales, gas purchases, system use and storage in order to protect
profit margins, and is not to engage in speculative trading. See "Results of
Operations - Gathering, Processing and Marketing Services." Commodity-related
activities of the risk management group are monitored by the Company's Risk
Management Committee, which is charged with the review and enforcement of the
Board of Directors' risk management guidelines. The Risk Management Committee
reviews the types of hedging instruments used, contract limits and approval
levels and may review the pricing and hedging of any or all commodity
transactions. All energy futures, swaps and options are recorded at fair value.
Gains and losses on hedging positions are deferred and recognized as gas
purchases expense in the periods in which the underlying physical transactions
occur.
The Company's Treasury Department manages the Company's interest rate exposure,
utilizing interest rate swaps, caps or similar derivatives within
Board-established guidelines. None of these interest rate derivatives are
leveraged.
OUTLOOK/FORWARD-LOOKING INFORMATION
GENERAL
The statements contained in this section, Outlook/Forward-Looking Information,
include forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
Although the Company believes that these statements are based upon reasonable
assumptions, it can give no assurance that its goals will be achieved. Important
factors that could cause actual results to differ materially from those in the
forward-looking statements contained herein include, among other factors, the
pace of deregulation of retail natural gas and electricity markets in the United
States, federal and state regulatory developments, the timing and extent of
changes in commodity prices for oil, gas, NGLs, electricity, certain
agricultural products and interest rates, the extent of success in acquiring
natural gas facilities, the timing and success of efforts to develop power,
pipeline and other projects, political developments in foreign countries, and
conditions of the capital markets and equity markets during the periods covered
by the forward-looking statements.
K N - MIDCON COMBINATION
On December 18, 1997, K N entered into a definitive agreement to acquire all of
the outstanding capital stock of MidCon from Occidental Petroleum Corporation
for $3.49 billion, consisting of $2.1 billion in cash and the assumption of
$1.39 billion of short-term debt. The acquisition closed on January 30, 1998, at
which time MidCon became a wholly owned subsidiary of the Company.
MidCon is engaged in the purchase, gathering, processing, transmission, storage
and sale of natural gas to utilities, municipalities and industrial and
commercial users. MidCon operates over 14,000 miles of natural gas pipelines
which are located in the center of the North American pipeline grid. These
pipeline assets include two major interconnected transmission pipelines
terminating in the Chicago area: one originating in West Texas and the other in
the Gulf Coast areas of Texas and Louisiana, as well as a major intrastate
pipeline located in Texas. MidCon also purchases electricity from electric
utilities and other electric power producers and marketers and resells the
electricity to wholesale and end-use customers.
As a result of the acquisition, K N will be one of the largest integrated
natural gas companies in the United States. The Company will own and/or operate
approximately 26,000 miles of interstate, intrastate and offshore natural gas
transmission pipeline, approximately 11,000 miles of gathering pipeline,
approximately 7,000 miles of local distribution pipeline, and 16 storage
facilities with storage capacity of more than 250 Bcf of working gas. The
Company will also be one of the largest transporters and marketers of natural
gas in the United States with average sales volumes of 3.7 Bcf and average
transportation volumes of 5.1 Bcf of natural gas per day. On a pro forma basis
including only adjustments directly attributable to the acquisition of MidCon,
as of and for the year ended December 31, 1997, the Company had approximately
$8.2 billion in assets, operating revenues of
25
26
approximately $5.2 billion, operating income of approximately $358.6 million and
net income of approximately $83.0 million.
In addition to significantly increasing the Company's size and scope of
operations, as well as its geographic presence, management believes the
acquisition will also provide K N with a strong platform for future growth. The
Company will have assets in 16 states and access to several of the largest
natural gas markets in the United States, including Chicago, Houston, Kansas
City and Denver. The combined company will have access to natural gas supplies
in the major natural gas supply basins in the United States, including those in
the Mid-Continent, West Texas, Rocky Mountain and Gulf Coast regions. The
Company will also be one of the nation's largest owners and operators of natural
gas storage assets in both supply and market areas. Management believes these
assets are strategically located and will allow the Company to become a major
supplier of storage service, particularly in the Chicago market, and that the
acquisition will also significantly broaden the Company's retail presence in
both the residential and small business market segments.
LITIGATION AND ENVIRONMENTAL
The Company's anticipated environmental capital costs and expenses for 1998,
including expected costs and expenses for voluntary remediation efforts, are
approximately $7.7 million, exclusive of anticipated costs and expenses
associated with the recently acquired MidCon assets. A substantial portion of
the Company's environmental costs are either recoverable through insurance and
indemnification provisions, have reserves associated with them or have been
previously expensed as part of ongoing business operations.
Refer to Notes 2 and 5 of Notes to Consolidated Financial Statements for
additional information on the Company's pending litigation and environmental
matters. The Company's management believes it has established reserves such that
the resolution of pending litigation and environmental matters will not have a
material adverse impact on the Company's financial position or results of
operations.
SIGNIFICANT OPERATING VARIABLES
The Company's principal exposure to price variability is with NGLs prices. The
Company attempts to mitigate this exposure by an appropriate mix of "percent of
proceeds" and "keep whole" processing agreements and by the use of financial
hedging instruments. See Risk Management elsewhere herein. Under current
agreements with producers, excluding MidCon processing facilities, a one cent
change in average per gallon prices impacts pre-tax operating income by
approximately $5.5 million.
READINESS FOR YEAR 2000
The Company has completed a high-level assessment of its systems and
infrastructure to determine the extent of the work needed to ensure Year 2000
compliance. A plan has been developed and is being implemented to test and
verify Year 2000 compliance, including making necessary modifications, for all
systems and processes. K N will continue to evaluate the estimated costs
associated with these efforts based on the results of this work. While these
efforts involve additional costs, the Company believes, based on available
information, that these costs will not be material to its results of operations.
26
27
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To K N Energy, Inc.:
We have audited the accompanying consolidated balance sheets of K N Energy, Inc.
(a Kansas corporation) and subsidiaries as of December 31, 1997 and 1996, and
the related consolidated statements of income, common stockholders' equity and
cash flows for each of the three years in the period ended December 31, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with 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 financial position of K N Energy, Inc. and
subsidiaries as of December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Denver, Colorado
February 3, 1998
27
28
CONSOLIDATED STATEMENTS OF INCOME
K N ENERGY, INC. AND SUBSIDIARIES
YEARS ENDED DECEMBER 31
-----------------------
1997 1996 1995
---- ---- ----
(In Thousands, Except Per Share Amounts)
OPERATING REVENUES:
Gathering, Processing and Marketing Services $ 1,866,327 $ 1,191,292 $ 854,462
Interstate Transportation and Storage Services 23,757 25,352 22,217
Retail Natural Gas Services 255,034 223,838 227,282
Gas and Oil Production -- -- 7,437
----------- ----------- -----------
Total Operating Revenues 2,145,118 1,440,482 1,111,398
----------- ----------- -----------
OPERATING COSTS AND EXPENSES:
Gas Purchases and Other Costs of Sales 1,724,671 1,060,374 753,022
Operations and Maintenance 198,274 174,774 173,288
Depreciation, Depletion and Amortization 55,994 51,212 49,891
Taxes, Other Than Income Taxes 23,930 19,321 19,835
----------- ----------- -----------
Total Operating Costs and Expenses 2,002,869 1,305,681 996,036
----------- ----------- -----------
OPERATING INCOME 142,249 134,801 115,362
----------- ----------- -----------
OTHER INCOME AND (DEDUCTIONS):
Interest Expense (43,495) (35,933) (34,211)
Minority Interests (8,706) (2,946) (905)
Other, Net 23,110 3,794 1,326
----------- ----------- -----------
Total Other Income and (Deductions) (29,091) (35,085) (33,790)
----------- ----------- -----------
INCOME BEFORE INCOME TAXES 113,158 99,716 81,572
Income Taxes 35,661 35,897 29,050
----------- ----------- -----------
NET INCOME 77,497 63,819 52,522
Less - Preferred Stock Dividends 350 398 492
----------- ----------- -----------
EARNINGS AVAILABLE FOR COMMON STOCK $ 77,147 $ 63,421 $ 52,030
=========== =========== ===========
BASIC EARNINGS PER COMMON SHARE $ 2.48 $ 2.18 $ 1.87
=========== =========== ===========
DILUTED EARNINGS PER COMMON SHARE $ 2.45 $ 2.14 $ 1.83
=========== =========== ===========
The accompanying notes are an integral part of these statements.
28
29
CONSOLIDATED BALANCE SHEETS
K N ENERGY, INC. AND SUBSIDIARIES
DECEMBER 31
-----------
1997 1996
---- ----
(In Thousands)
ASSETS:
CURRENT ASSETS:
Cash and Cash Equivalents $ 22,471 $ 10,339
Restricted Deposits 11,339 6,666
Accounts Receivable 409,937 304,942
Materials and Supplies 13,476 6,092
Gas in Underground Storage 33,558 43,511
Prepaid Gas 5,507 12,001
Other Prepaid Expenses 16,687 12,824
Gas Imbalances and Other 63,555 65,319
---------- ----------
576,530 461,694
---------- ----------
INVESTMENTS 149,869 50,538
---------- ----------
PROPERTY, PLANT AND EQUIPMENT, NET 1,420,975 1,022,301
---------- ----------
DEFERRED CHARGES AND OTHER ASSETS 158,431 95,187
---------- ----------
TOTAL ASSETS $2,305,805 $1,629,720
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY:
CURRENT LIABILITIES:
Current Maturities of Long-Term Debt $ 30,751 $ 26,971
Notes Payable 329,200 129,300
Accounts Payable 334,418 241,187
Accrued Expenses 37,264 34,696
Accrued Taxes 7,445 16,045
Gas Imbalances and Other 57,733 50,417
---------- ----------
796,811 498,616
---------- ----------
DEFERRED LIABILITIES, CREDITS AND RESERVES:
Deferred Income Taxes 168,583 122,371
Other 26,160 31,930
---------- ----------
194,743 154,301
---------- ----------
LONG-TERM DEBT 553,816 423,676
---------- ----------
K N-OBLIGATED MANDATORILY REDEEMABLE PREFERRED CAPITAL TRUST SECURITIES OF
SUBSIDIARY TRUST HOLDING SOLELY DEBENTURES OF K N 100,000 -
---------- ----------
MINORITY INTERESTS IN EQUITY OF SUBSIDIARIES 47,303 26,333
---------- ----------
COMMITMENTS AND CONTINGENT LIABILITIES (NOTES 2, 3(A), 5 AND 13)
STOCKHOLDERS' EQUITY:
Preferred Stock 7,000 7,000
---------- ----------
Common Stock-
Authorized - 50,000,000 Shares, Par Value $5 Per Share
Outstanding - 32,024,557 and 30,295,792 Shares, Respectively 160,123 151,479
Additional Paid-in Capital 270,678 228,902
Retained Earnings 185,658 142,578
Deferred Compensation (9,203) (2,908)
Treasury Stock, at Cost - 28,482 and 7,216 Shares, Respectively (1,124) (257)
---------- ----------
Total Common Stockholders' Equity 606,132 519,794
---------- ----------
Total Stockholders' Equity 613,132 526,794
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $2,305,805 $1,629,720
========== ==========
The accompanying notes are an integral part of these statements.
29
30
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
K N ENERGY, INC. AND SUBSIDIARIES
YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
COMMON STOCK ADDITIONAL DEFERRED TREASURY STOCK
------------ PAID-IN RETAINED COMPEN- --------------
SHARES AMOUNT CAPITAL EARNINGS SATION SHARES AMOUNT
------ ------ ------- -------- ------ ------ ------
(Dollars In Thousands)
BALANCE, DECEMBER 31, 1994 27,617,531 $ 138,088 $ 170,932 $ 86,032 $ (378) (44,417) $ (988)
Net Income 52,522
Cash Dividends -
Common, $1.01 Per Share (28,167)
Preferred (492)
Treasury Stock Acquired (72,500) (1,959)
Employee Stock Options 354,901 1,774 4,006
Employee Benefit Plans 20,738 104 394 80 2
Dividend Reinvestment and
Stock Purchase Plans 97,979 490 1,444 106,098 2,633
Issuance of Common Shares as
Executive Compensation 6,600 33 134
Amortization of Deferred
Compensation 156
---------- ----------- ----------- ----------- ----------- -------