<PAGE> 1
Filed Pursuant to Rule 424(b)(3)
Registration Nos. 333-44421 & 333-44421-01
INFORMATION CONTAINED IN THIS PRELIMINARY PROSPECTUS SUPPLEMENT IS SUBJECT TO
COMPLETION OR AMENDMENT AND PROSPECTIVE PURCHASERS ARE REFERRED TO THE RELATED
FINAL PROSPECTUS SUPPLEMENT FOR DEFINITIVE INFORMATION ON ANY MATTER CONTAINED
HEREIN. NEITHER THIS PRELIMINARY PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING
PROSPECTUS SHALL CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO
BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY JURISDICTION IN WHICH
SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO REGISTRATION OR
QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH JURISDICTION.
PROSPECTUS SUPPLEMENT (Subject to Completion, Dated February 10, 1998)
(To Prospectus dated January 30, 1998)
$
K N Energy, Inc. LOGO
$ % SENIOR NOTES DUE 2003
$ % SENIOR NOTES DUE 2005
$ % SENIOR NOTES DUE 2008
$ % SENIOR DEBENTURES DUE 2028
$ % SENIOR DEBENTURES DUE 2098
$ % RESET PUT SECURITIES (REPS(SM)) DUE 20 *
------------------------
THE 2003 SENIOR NOTES, THE 2005 SENIOR NOTES, THE 2008 NOTES, THE 2028 SENIOR
DEBENTURES, THE 2098 SENIOR DEBENTURES (COLLECTIVELY, THE "SENIOR NOTES") AND
THE 20 REPS (COLLECTIVELY, WITH THE SENIOR NOTES, THE "OFFERED SECURITIES")
WILL MATURE ON MARCH , 2003, MARCH , 2005, MARCH , 2008, MARCH , 2028,
MARCH , 2098 AND MARCH , 20 , RESPECTIVELY. THE OFFERED SECURITIES WILL BE
REDEEMABLE AS SET FORTH HEREIN UNDER "DESCRIPTION OF OFFERED SECURITIES." EACH
SERIES OF OFFERED SECURITIES WILL BE REPRESENTED BY ONE OR MORE GLOBAL DEBT
SECURITIES REGISTERED IN THE NAME OF THE DEPOSITORY TRUST COMPANY (THE
"DEPOSITARY") OR ITS NOMINEE. BENEFICIAL INTERESTS IN THE GLOBAL DEBT SECURITIES
WILL BE SHOWN ON, AND TRANSFERS THEREOF WILL BE EFFECTED THROUGH, RECORDS
MAINTAINED BY THE DEPOSITARY OR ITS PARTICIPANTS. EXCEPT AS DESCRIBED HEREIN,
OFFERED SECURITIES IN DEFINITIVE FORM WILL NOT BE ISSUED. SEE "DESCRIPTION OF
THE OFFERED SECURITIES -- BOOK ENTRY SYSTEM" HEREIN AND "DESCRIPTION OF THE DEBT
SECURITIES -- PROVISIONS APPLICABLE TO BOTH SENIOR AND SUBORDINATED DEBT
SECURITIES -- GLOBAL DEBT SECURITIES" IN THE ACCOMPANYING PROSPECTUS.
CONCURRENTLY WITH THESE OFFERINGS (THE "DEBT OFFERINGS"), THE COMPANY IS
OFFERING 10,000,000 SHARES OF COMMON STOCK (THE "EQUITY OFFERING" AND, TOGETHER
WITH THE DEBT OFFERINGS, THE "OFFERINGS"). THE CLOSINGS OF THE EQUITY OFFERING
AND THE DEBT OFFERINGS ARE NOT CONDITIONED UPON EACH OTHER.
------------------------
SEE "RISK FACTORS" BEGINNING ON PAGE S-12 FOR CERTAIN INFORMATION RELEVANT TO AN
INVESTMENT IN THE SECURITIES.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS
SUPPLEMENT OR THE PROSPECTUS TO WHICH IT RELATES. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
------------------------
<TABLE>
<CAPTION>
PRICE UNDERWRITING
TO DISCOUNTS AND PROCEEDS TO
PUBLIC(1) COMMISSIONS(2) COMPANY(1)(3)(4)
----------- -------------- -----------------
<S> <C> <C> <C>
Per 2003 Senior Note........................ % % %
Per 2005 Senior Note........................ % % %
Per 2008 Senior Note........................ % % %
Per 2028 Senior Debenture................... % % %
Per 2098 Senior Debenture................... % % %
Per 20 REPS................................ % % %
Total............................. $ $ $
</TABLE>
- ------------
(1) Plus accrued interest, if any, from March , 1998.
(2) The Company has agreed to indemnify the several Underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as
amended. See "Underwriters."
(3) Before deducting expenses payable by the Company estimated at $ .
(4) Represents consideration for the 20 REPS, which includes consideration for
the Call Option.
------------------------
* REPS is a service mark of Morgan Stanley, Dean Witter, Discover & Co.
------------------------
The Offered Securities are offered, subject to prior sale, when, as and if
accepted by the Underwriters and subject to approval of certain legal matters by
Davis Polk & Wardwell, counsel for the Underwriters. It is expected that
delivery of the Offered Securities will be made in book-entry form through the
book-entry facilities of The Depository Trust Company on or about
, 1998, against payment therefor in immediately available
funds.
------------------------
MORGAN STANLEY DEAN WITTER
BANCAMERICA ROBERTSON STEPHENS
CHASE SECURITIES INC.
LEHMAN BROTHERS
J.P. MORGAN & CO.
NATIONSBANC MONTGOMERY SECURITIES
, 1998
<PAGE> 2
CERTAIN PERSONS PARTICIPATING IN THE DEBT OFFERINGS MAY ENGAGE IN
TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICES OF THE
OFFERED SECURITIES. SPECIFICALLY, THE UNDERWRITERS MAY OVER-ALLOT IN CONNECTION
WITH THE DEBT OFFERINGS, AND MAY BID FOR, AND PURCHASE THE OFFERED SECURITIES IN
THE OPEN MARKET. FOR A DISCUSSION OF THESE ACTIVITIES, SEE "UNDERWRITERS."
<PAGE> 3
NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED IN CONNECTION
WITH ANY OFFERING MADE HEREBY TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATION NOT CONTAINED OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS
SUPPLEMENT OR THE ACCOMPANYING PROSPECTUS, AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR ANY UNDERWRITER, AGENT OR DEALER. THIS PROSPECTUS SUPPLEMENT
AND THE ACCOMPANYING PROSPECTUS DO NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY SECURITY OTHER THAN THE OFFERED SECURITIES
OFFERED HEREBY, NOR DO THEY CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY TO ANY PERSON IN ANY
JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION TO
SUCH PERSON. NEITHER THE DELIVERY OF THIS PROSPECTUS SUPPLEMENT WITH THE
ACCOMPANYING PROSPECTUS NOR ANY OFFER OR SALE MADE HEREBY SHALL UNDER ANY
CIRCUMSTANCES CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN OR
THEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF OR THEREOF OR
THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE
HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PROSPECTUS SUPPLEMENT
Prospectus Supplement Summary......................................................... S-4
Risk Factors.......................................................................... S-12
Use of Proceeds....................................................................... S-16
The Acquisition and the Financing Plan................................................ S-17
Capitalization........................................................................ S-20
Unaudited Pro Forma Consolidated Financial Statements................................. S-22
Selected Historical Financial Information for K N Energy.............................. S-29
Selected Historical Financial Information for MidCon.................................. S-31
The Combined Company.................................................................. S-33
K N Energy, Inc....................................................................... S-37
MidCon Corp........................................................................... S-41
Regulation............................................................................ S-45
Description of Offered Securities..................................................... S-50
Certain United States Federal Income Tax Considerations............................... S-55
Underwriters.......................................................................... S-59
Experts............................................................................... S-60
Legal Matters......................................................................... S-60
Index to Financial Statements......................................................... F-1
PROSPECTUS
Available Information................................................................. 3
Incorporation of Certain Documents by Reference....................................... 4
K N Energy, Inc. ..................................................................... 4
The Trust............................................................................. 4
Use of Proceeds....................................................................... 6
Ratios of Earnings to Fixed Charges................................................... 6
Description of the Preferred Securities............................................... 7
Description of the Trust Debentures................................................... 7
Description of the Guarantee.......................................................... 13
Relationship Among the Preferred Securities, the Trust Debentures and the Guarantee... 15
Description of the Debt Securities.................................................... 16
Description of Capital Stock.......................................................... 28
Description of Stock Purchase Contracts and Stock Purchase Units...................... 31
Book-Entry Issuance................................................................... 32
Plan of Distribution.................................................................. 33
Legal Matters......................................................................... 35
Experts............................................................................... 35
</TABLE>
S-3
<PAGE> 4
PROSPECTUS SUPPLEMENT SUMMARY
The following information does not purport to be complete and is qualified
in its entirety by the detailed information appearing elsewhere in this
Prospectus Supplement and the accompanying Prospectus or incorporated by
reference herein or therein. As used in this Prospectus Supplement and the
accompanying Prospectus "the Company," "K N" and "K N Energy" refer to K N
Energy, Inc., together with its consolidated subsidiaries (including MidCon),
unless the context otherwise requires. As used in this Prospectus Supplement,
"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.
Prospective investors should carefully consider the matters discussed under the
caption "Risk Factors."
INTRODUCTION
On January 30, 1998, K N Energy acquired all of the outstanding capital
stock of MidCon from Occidental Petroleum Corporation ("Occidental") (the
"Acquisition") for $2.1 billion in cash and a short-term note in the aggregate
principal amount of $1.39 billion (the "Substitute Note"), which was
collateralized at the closing by letters of credit issued under a $4.5 billion
Bank Facility (as defined herein). As a result of the Acquisition, MidCon became
a wholly-owned subsidiary of K N Energy. The total amount of funds required by K
N to complete the Acquisition, pay related fees and expenses and to repay
borrowings under the Company's existing credit facility was approximately $2,499
million and was financed with borrowings made under the Bank Facility. The
Company will use the net proceeds from these offerings of senior notes of
varying maturities in an aggregate principal amount of up to $2.35 billion and
the Equity Offering to refinance borrowings under the Bank Facility in
connection with the Acquisition and to purchase U.S. government securities to
replace a portion of the letters of credit that collateralize the Substitute
Note. The Company intends to purchase additional U.S. government securities to
replace completely the letters of credit and to further refinance borrowings
under the Bank Facility in the first half of 1998 through the sale of preferred
capital securities and mandatorily convertible preferred capital trust
securities of subsidiary trusts (the "Additional Offerings," and together with
the Offerings and the Company's borrowings under the Bank Facility in connection
with the Acquisition, the "Financing Plan"). The closings of the Debt Offerings
and the Equity Offering are not conditioned upon each other.
THE COMPANIES
K N ENERGY
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 September 30, 1997, the Company
operated over 12,300 miles of interstate and intrastate pipelines and over 8,600
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 18 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 September 30, 1997, the Company's regulated retail
natural gas business served over 200,000 customers in Colorado, Nebraska and
Wyoming (excluding customers served by the Company's Kansas natural gas
distribution assets). The Company also markets innovative products and services,
such as the Simple Choice(sm) ("Simple Choice") menu of products and call center
services designed for residential consumers, utilities, and small businesses
through its 50% owned EN-able(sm), LLC ("EN-able") affiliate.
S-4
<PAGE> 5
The Company's principal offices are located at 370 Van Gordon Street,
Lakewood, CO 80228, and its telephone number is (303) 989-1740.
MIDCON CORP.
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 13,000 miles of natural gas pipelines
which are strategically 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. In 1996, MidCon delivered an average of
over 6.2 Bcf per day of natural gas. MidCon is one of the largest and lowest
cost transporters of natural gas to the Chicago market and in 1996 delivered an
average of 2.2 Bcf per day of natural gas to the Chicago metropolitan area,
representing 60% of the total natural gas delivered to that market during the
same period. MidCon is also one of the nation's largest storage operators with
approximately 600 Bcf of total natural gas storage capacity near its major
markets, over 200 Bcf of working gas and up to 4.4 Bcf per day of peak
deliverability from its facilities as of September 30, 1997. MidCon also
purchases electricity from electric utilities, and other electric power
producers and marketers and resells the electricity to wholesale and end-use
customers.
THE COMBINED COMPANY
As a result of the Acquisition, K N Energy is one of the largest integrated
natural gas companies in the United States. On a pro forma basis as of September
30, 1997, the Company owned and/or operated approximately 25,800 miles of
interstate, intrastate and offshore natural gas transmission pipeline,
approximately 11,100 miles of gathering pipeline, approximately 7,100 miles of
local distribution pipeline (excluding K N's Kansas natural gas distribution
assets) and 16 storage facilities with storage capacity of more than 230 Bcf of
working gas. On a pro forma basis, the Company also is one of the largest
transporters and marketers of natural gas in the United States with average
sales volumes of approximately 3.7 Bcf of natural gas per day and average
transportation volumes of approximately 5.1 Bcf of natural gas per day. On a pro
forma basis as of September 30, 1997, the Company had $8.2 billion in assets,
and pro forma for the year ended December 31, 1996, the Company had operating
revenues of $4.0 billion, operating income of $399.5 million and net income of
$71.0 million.
In addition to significantly increasing the Company's size and scope of
operations as well as its geographic presence, management believes the
Acquisition also provides K N with a strong platform for future growth. The
Company now has pipeline assets in 15 states and access to several of the
largest natural gas markets in the United States, including Chicago, Houston,
Kansas City and Denver. In addition, the Company has 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.
As a result of the Acquisition, the Company is also 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. Management believes that the Acquisition also significantly
broadens the Company's retail presence in both the residential and small
business market segments.
BUSINESS STRATEGY
The Company's objective is to enhance its assets and operations along all
segments of the natural gas "value stream" by increasing access to supplies of
natural gas for the Company's upstream gathering and processing facilities,
delivering that supply through K N's midstream transmission pipelines and
marketing that supply to a broad range of downstream end users, including
utility, residential, commercial, agricultural and industrial customers. The
Company believes that it has developed several competitive strengths that will
enable it to continue to successfully implement this strategy, including: (i)
extensive natural gas infrastructure from the wellhead to the burner tip, (ii)
access to natural gas supplies in several of the largest domestic natural gas
producing areas, (iii) access to natural gas markets in some of the largest
natural gas consuming
S-5
<PAGE> 6
areas in the Midwest, Texas and the Rocky Mountains, (iv) a management team
which combines an entrepreneurial spirit with significant experience in the
natural gas industry, (v) a strong track record of quickly and successfully
integrating acquisitions and (vi) a commitment to providing superior customer
service. Management believes the Acquisition is consistent with the Company's
strategy. The key elements of the Company's strategy include the following:
Optimize operation of the Company's assets. Over the past several years, K
N has been able to generate significant value through the improved operation of
its assets. With the Acquisition, the Company has identified several
opportunities for the optimization of operations through the integration and
consolidation of MidCon's assets with those of K N. By connecting pipelines to
proximate gathering facilities, relocating processing facilities and
reconfiguring certain operations, the Company believes it can increase
throughputs, lower costs and thereby significantly improve the operating results
of these assets. Specifically, K N plans to integrate and consolidate its
gathering, processing and intrastate pipelines in West Texas with MidCon's
assets in the region. K N also plans to build an interconnect between the
Amarillo Line of MidCon's Natural Gas Pipeline Company of America ("NGPL")
pipeline and K N's Bushton natural gas processing plant. In addition, the
Company believes that the combination of K N's supply area storage with MidCon's
market area storage provides additional opportunities for the Company to
arbitrage regional and seasonal natural gas price differentials.
Aggressively pursue new markets. K N will continue to pursue opportunities
to gain additional market share along the MidCon and K N pipeline systems. K N
is currently executing this strategy by expanding its marketing presence in the
Denver metropolitan area through construction of the Front Runner Pipeline, and
in Kansas City through the construction of an additional lateral pipeline. Both
of these cities represent markets that the Company believes have been
historically underserved by gas pipelines and that are easily reached through
extensions of K N's current pipelines. The Company believes that, given MidCon's
pipeline system and its low-cost position, the Acquisition also provides
significant additional opportunities to continue to access new markets and
significantly increase the Company's market share.
Leverage regulated assets by developing complementary unregulated
businesses. K N seeks to build or acquire unregulated businesses that
complement its core regulated assets. A key component of K N's growth has been
its ability to evolve from a 99% regulated entity in 1990 to a 45% regulated
entity at September 30, 1997 based on operating income. As an example of this
strategy, K N has successfully taken advantage of several unregulated gathering,
processing and marketing opportunities in the Rocky Mountains and Midwest in
conjunction with the development and operation of its regulated Pony Express
Pipeline. Management believes that MidCon's assets, which are largely regulated,
present additional opportunities for K N to continue to pursue this strategy.
For the year ended December 31, 1996, approximately 70% of the Company's pro
forma operating income was derived from regulated assets, compared with
approximately 45% for K N's historical business on a stand-alone basis. The
Company's goal is to increase the operating income derived from unregulated
assets to approximately 50% over time. The Company also believes it can improve
the profitability of certain of MidCon's gathering assets through a spin-down of
such assets from a regulated affiliate to unregulated affiliates. By
transferring these assets to unregulated affiliates, the Company believes it
will be able to achieve increased operational flexibility, lower costs and take
advantage of opportunities to increase system throughput.
Pursue strategic acquisitions, alliances, joint ventures and
partnerships. K N will continue to pursue acquisitions and strategic alliances
that create new business opportunities and enhance its existing operations. The
Company maintains a highly disciplined approach to acquisitions in order to
identify investments that logically expand K N's business into contiguous
markets, help increase economies of scale and provide opportunities to leverage
regulated businesses by developing complementary unregulated businesses. The
Company has established a number of strategic alliances, joint ventures and
partnerships to reach its goals. For example, the Wildhorse Energy Partners, LLC
("Wildhorse") gathering and marketing joint venture with Tom Brown, Inc.
("TBI"), pursuant to which TBI has dedicated all of its uncommitted Rocky
Mountain gas production, has enhanced the Company's access to gas supply. The
Company also formed a partnership to develop the TransColorado pipeline and
provide increased market access for isolated Rocky Mountain gas. In 1997, the
Company and PacifiCorp Holdings, Inc. formed EN-able, a joint venture to exploit
retail
S-6
<PAGE> 7
opportunities presented by deregulation of the retail electric and gas utility
industries. The Company believes that the Acquisition provides not only a
significant platform from which to pursue additional complementary acquisitions,
but also greatly enhances the value of K N as a potential partner.
Maintain and enhance the Company's position as a low-cost provider. The
Company is a low-cost provider of natural gas gathering, processing and
transportation services and is constantly seeking opportunities to reduce costs
further without compromising safety or sacrificing customer service. Recent
operational changes consistent with this strategy include re-routing gas from
high cost plants into the more efficient Bushton system and the exchange of
underperforming assets in Texas for transmission assets needed to transport new
gathering volumes and which enhanced the performance of other K N assets. NGPL
is currently one of the lowest cost transporters of gas in the Mid-Continent
region and as a result, management believes that the Company is now in an even
stronger position to preserve or increase market share than its higher-cost
competitors, particularly in the event that additional gas comes into the
Chicago market from Canada. In addition, the increased access to additional
supply sources from MidCon's pipelines should support K N's low-cost position.
The Company also expects to realize annual operating and administrative savings
beginning in 1998 primarily due to the consolidation of operations and
activities that are duplicative with those of MidCon and improved utilization of
assets.
Expand the Company's retail presence. In order to take advantage of the
rapidly changing competitive landscape in the utility industry, the Company has
developed value-added products and services to offer to its customers beyond the
traditional energy commodity. As part of this strategy, K N developed Simple
Choice which offers consumers, through their local utilities, a bundled package
of energy, communications and entertainment products serviced through one call
and itemized on one bill. The Simple Choice package of services is marketed to
other utilities through the Company's EN-able joint venture with PacifiCorp
Holdings, Inc. By licensing Simple Choice to other gas, electric and water
utilities, EN-able creates partnerships that allow utility partners to play a
broader role in providing a range of products and services to the home, and
allows EN-able to build a larger retail presence in the marketplace more quickly
than it could on its own. EN-able also provides back-office support to its
utility partners, including infrastructure support for customer care and billing
functions and marketing channels. Management believes MidCon's retail marketing
operations, which are conducted through mc(2) Inc. ("mc(2)") and which market
gas and electricity principally to commercial and industrial customers,
complement the operations of EN-able.
RECENT DEVELOPMENTS
K N Energy. On February 4, 1998, K N Energy announced that, for the year
ended December 31, 1997, it had consolidated net income of $77.5 million, or
$2.45 per share of Common Stock on a diluted basis, on operating revenues of
$2.15 billion. This compares with net income of $63.8 million, or $2.14 per
share on a diluted basis, on operating revenues of $1.44 billion for the year
ended December 31, 1996.
MidCon. For the year ended December 31, 1997, MidCon reported a consolidated
net loss of $4.5 million on operating revenues of $3.05 billion, compared to
consolidated net income of $116.5 million on operating revenues of $2.57 billion
for the year ended December 31, 1996. Results for 1997 were negatively impacted
by interest expense of $110.5 million related to a note for $1.39 billion issued
to Occidental by MidCon's employee stock ownership plan and $126.4 million of
interest expense related to a $1.6 billion dividend note payable to Occidental.
See "The Acquisition and the Financing Plan."
S-7
<PAGE> 8
THE DEBT OFFERINGS
Offered Securities......... $ million principal amount of % Senior
Notes due 2003
$ million principal amount of % Senior
Notes due 2005
$ million principal amount of % Senior
Notes due 2008
$ million principal amount of % Senior
Debentures due 2028
$ million principal amount of % Senior
Debentures due 2098
$ million principal amount of % REPS due
20
Maturity Dates............. 2003 Senior Notes -- March , 2003
2005 Senior Notes -- March , 2005
2008 Senior Notes -- March , 2008
2028 Senior Debentures -- March , 2028
2098 Senior Debentures -- March , 2098
20 REPS -- March , 20
Interest Payment Dates..... March and September of each year, commencing
September , 1998.
Ranking.................... The Offered Securities will be senior unsecured
obligations of the Company and will rank pari
passu in right of payment with the Company's
obligations under all its existing and future
senior unsecured indebtedness.
Redemption................. The Senior Notes will be redeemable in whole or in
part, at the option of the Company at any time,
at redemption prices as set forth herein under
"Description of Offered Securities -- The Senior
Notes -- Redemption."
The 20 REPS will be subject to mandatory
redemption from the then existing holders on
March , 20 either (i) through the exercise of
the Call Option (as defined herein) by Morgan
Stanley & Co. International Limited (the
"Callholder"), or (ii) in the event the
Callholder does not exercise the Call Option, the
automatic exercise of the Mandatory Put (as
defined herein) by First Trust National
Association (the "Debt Trustee") on behalf of the
holders. If the Callholder elects to purchase the
20 REPS, the 20 REPS will be acquired by the
Callholder from the holders on March , 20 (the
"Coupon Reset Date") at 100% of the principal
amount thereof. If the Callholder for any reason
does not elect to purchase the 20 REPS on the
Coupon Reset Date, the Company will be required
to repurchase the 20 REPS from the holders on
March , 20 at 100% of the principal amount
thereof. See "Description of Offered
Securities -- The 20 REPS -- Call Option;
Mandatory Put."
Interest Rates............. Each series of Senior Notes will bear interest at
the annual rate contained in its title.
The 20 REPS will bear interest at the rate of %
until the Coupon Reset Date. If the Callholder
has elected to exercise the Call Option, the
interest rate on the 20 REPS will be reset by
the Calculation Agent (as defined herein)
effective on the Coupon Reset Date pursuant to
the Coupon Reset Process. See "Description of
Offered Securities -- The 20 REPS -- Coupon
Reset Process if the Notes are Called."
S-8
<PAGE> 9
Certain Covenants.......... The Senior Debt Indenture governing the Offered
Securities contains certain covenants that, among
other things, limit the ability of the Company
and its subsidiaries to create liens, enter into
sale and lease-back transactions, and engage in
mergers and consolidations or transfer
substantially all of the Company's assets. See
"Description of the Debt Securities" in the
accompanying Prospectus.
Use of Proceeds............ The net proceeds from the Debt Offerings will be
used to refinance borrowings under the Bank
Facility and to purchase U.S. government
securities to collateralize the Substitute Note
and replace a portion of the letters of credit
currently collateralizing the Substitute Note.
See "The Acquisition and Financing Plan" and "Use
of Proceeds."
Equity Offering............ The Company is concurrently offering to the public
10,000,000 shares of common stock. The closings
of the Debt Offerings and the Equity Offering are
not conditioned upon each other.
S-9
<PAGE> 10
SUMMARY HISTORICAL AND PRO FORMA FINANCIAL INFORMATION
The following table presents summary historical statement of operations
data for each of K N Energy and MidCon for the year ended December 31, 1996 and
for the nine month period ended September 30, 1997 and pro forma summary
financial information for K N Energy for the year ended December 31, 1996 and
the nine month period ended September 30, 1997 assuming that the Acquisition and
the Offerings occurred at the beginning of each such period. The historical
information for both K N and MidCon for the year ended December 31, 1996 has
been derived from audited financial statements. Additionally, the historical
income statement information for the nine months ended September 30, 1997 and
the historical balance sheet data as of September 30, 1997 have been derived
from unaudited financial statements of K N Energy and MidCon. The unaudited pro
forma balance sheet information for September 30, 1997 is presented as if the
Acquisition and the Offerings had occurred on that date. The unaudited pro forma
statement of operations data are not necessarily indicative of the financial
results that would have occurred had the Acquisition and the Offerings been
consummated on the dates indicated, nor are they necessarily indicative of
future financial results. The information set forth below should be read in
conjunction with the historical financial statements of each of K N Energy and
MidCon and the notes thereto and the "Unaudited Pro Forma Consolidated Financial
Statements" included elsewhere in this Prospectus Supplement.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, 1996 SEPTEMBER 30, 1997
--------------------------------------- -----------------------------------------
HISTORICAL HISTORICAL
------------------------ --------------------------
K N MIDCON PRO FORMA K N MIDCON PRO FORMA
---------- ---------- ----------- ----------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Operating revenues.......... $1,443,174 $2,574,211 $4,017,385 $ 1,362,457 $2,063,058 $3,425,515
Operating costs and
expenses.................. 1,308,373 2,313,319 3,617,931 1,266,238 1,896,844 3,162,049
---------- ---------- ---------- ---------- ---------- ----------
Operating income............ 134,801 260,892 399,454 96,219 166,214 263,466
Other income and
(deductions):
Interest expense.......... (35,933) (79,626) (318,856) (30,991) (181,601) (217,756)
Minority interests........ (2,946) -- (2,946) (5,681) -- (5,681)
Other, net................ 3,794 11,903 42,291 14,979 18,555 55,569
---------- ---------- ---------- ---------- ---------- ----------
Income before income
taxes..................... 99,716 193,169 119,943 74,526 3,168 95,598
Income taxes................ 35,897 76,684 48,968 25,488 87 32,608
---------- ---------- ---------- ---------- ---------- ----------
Net income.................. 63,819 116,485 70,975 49,038 3,081 62,990
Preferred stock dividends... 398 -- 398 263 -- 263
---------- ---------- ---------- ---------- ---------- ----------
Earnings available for
common shares............. $ 63,421 $ 116,485 $ 70,577 $ 48,775 $ 3,081 $ 62,727
========== ========== ========== ========== ========== ==========
Earnings per common share... $ 2.14 -- $ 1.78 $ 1.55 -- $ 1.52
Number of shares used in
computing earnings per
common share.............. 29,624 -- 39,624 31,397 -- 41,397
Dividends per common
share..................... $ 1.05 -- $ 1.05 $ 0.81 -- $ 0.81
OTHER FINANCIAL DATA:
EBITDA(1)................... $ 186,861 $ 450,306 $ 663,761 $ 146,618 $ 295,693 $ 467,009
Capital expenditures and
acquisitions.............. 273,994 146,883 316,238 56,578
Depreciation and
amortization.............. 51,212 177,511 224,962 41,101 110,924 153,655
</TABLE>
S-10
<PAGE> 11
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1997
---------------------------------------
HISTORICAL
-------------------------
K N MIDCON PRO FORMA
---------- ----------- ----------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.............. $ 18,819 $ 6,278 $ 18,819
Investment in U.S. government
securities........................... -- -- 319,804(2)
Current assets......................... 351,998 969,042 1,331,114
Total assets........................... 1,852,457 6,510,513 8,180,076
Current liabilities.................... 580,795 887,361 2,238,030
ESOP debt.............................. -- 1,386,026 --
Total long-term debt................... 410,498 1,600,000 2,760,498
K N-obligated mandatorily redeemable
preferred capital trust securities of
subsidiary trust holding solely
debentures of K N.................... 100,000 -- 100,000
Minority interests in equity of
subsidiaries......................... 31,160 7,456 38,616
Preferred stock........................ 7,000 -- 7,000
Common stockholders' equity............ 564,809 700,884 1,044,809
</TABLE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1997
---------------------------------------
K N MIDCON(3) COMBINED
---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Miles of pipeline
Interstate........................... 6,970 10,049 17,019
Intrastate........................... 5,418 2,617 8,035
Offshore............................. -- 702 702
Gathering and processing............. 8,691 2,379 11,070
Distribution(4)...................... 8,665 -- 8,665
Gas processing plants
Number of plants..................... 18 4 22
Total processing capacity (MMcf per
day)............................... 1,675 750 2,425
Natural gas storage facilities
Number of storage facilities......... 7 9 16
Total withdrawal capacity (MMcf per
day)............................... 827 4,400 5,227
</TABLE>
- ---------------
(1) EBITDA represents net income plus income taxes, interest expense,
depreciation, and amortization expense. EBITDA is not presented as an
indicator of the Company's operating performance, an indicator of cash
available for discretionary spending or as a measure of liquidity. EBITDA
may not be comparable to other similarly titled measures of other companies.
(2) Represents the purchase of U.S. government securities which, combined with
the letters of credit issued under the Bank Facility, will satisfy K N's
obligation to collateralize the Substitute Note.
(3) Does not include 2,600 miles of leased pipelines from MidCon Texas.
(4) Includes K N's Kansas natural gas distribution assets which will be sold
upon receipt of regulatory approval.
S-11
<PAGE> 12
RISK FACTORS
Prospective purchasers of the Offered Securities should carefully review
the information contained elsewhere in this Prospectus Supplement or in the
accompanying Prospectus or incorporated by reference herein or therein and
should particularly consider the following matters.
ACQUISITION OF MIDCON; INTEGRATION OF BUSINESSES OF K N ENERGY AND MIDCON
The Acquisition has significantly increased the size of K N's operations.
This significant increase in size substantially increases the demands placed
upon the Company's management, including demands resulting from the need to
integrate operations of MidCon with those of K N. The Company believes that a
key benefit to be realized from the Acquisition will be the integration of its
and MidCon's assets. There can be no assurance, however, that K N Energy will
not encounter difficulties in integrating MidCon's operations with its own or
that the expected benefits will be realized from such integration. The
difficulties of such integration may be increased by the necessity of
coordinating geographically separated organizations; integrating different
strategies and integrating personnel with disparate business backgrounds and
corporate cultures. There can be no assurance that K N Energy and MidCon will be
able to integrate effectively or in a timely manner. Nor can there be any
assurance that, even if integrated, the Company's product and service offerings
will be successful. Among the factors considered by K N Energy in connection
with the Acquisition were the opportunities for synergies expected to be
achieved from the Acquisition. However, there can be no assurance that K N
Energy will achieve the desired levels of synergies and related revenue growth
and cost savings when anticipated or at all. Failure to achieve the desired
levels of synergies could have a material adverse effect on the business,
results of operations, liquidity and financial condition of K N Energy.
In connection with the Acquisition, the Company became obligated with
respect to MidCon's liabilities including, without limitation, liabilities with
respect to environmental matters, liabilities (including liabilities with
respect to retiree welfare benefits) under MidCon's employee benefits plans and
the obligations of Occidental's insurance subsidiary with respect to insurance
policies previously issued to MidCon. Pursuant to the stock purchase agreement
for the Acquisition (the "Agreement"), Occidental has indemnified the Company
with respect to some of these liabilities, including all liabilities with
respect to MidCon's employee stock ownership plan. However, there can be no
assurance that any of the liabilities will not adversely affect the Company's
results of operations or financial condition. The representations and warranties
contained in the Agreement generally survive the closing of the Acquisition for
one year. There can be no assurance that liabilities will not arise that are not
covered by Occidental's indemnity of K N or that such liabilities may not arise
following such one-year period. See "The Acquisition and the Financing Plan."
EFFECT OF SUBSTANTIAL LEVERAGE
K N Energy incurred substantial additional indebtedness in connection with
the Acquisition. After giving effect to the Acquisition and the Offerings, as of
September 30, 1997, K N Energy would have had total debt of $4,261 million and
stockholders' equity (including the 8.56% Series B Capital Trust Securities of K
N Capital Trust I) of $1,152 million, resulting in a total debt to total capital
ratio of 78.7% (77.4% net of government securities held as collateral). In
addition, depending on prevailing financial, economic and market conditions K N
Energy may be unable to consummate the Additional Offerings necessary to replace
the letters of credit and refinance the remainder of the borrowings under the
Bank Facility in accordance with the Financing Plan. Accordingly, the amount of
outstanding indebtedness may be greater than contemplated under the Financing
Plan and stockholders' equity may be lower than contemplated under the Financing
Plan. Failure to refinance substantially all of the borrowings and extensions of
credit under the Bank Facility within 364 days of the closing of the Acquisition
will result in an event of default under the Bank Facility and could result in
acceleration of the indebtedness under the Bank Facility. See "Capitalization"
and "The Acquisition and the Financing Plan -- The Financing Plan." K N Energy
may also incur additional indebtedness in the future, including in connection
with other acquisitions, although its ability to do so will be restricted by the
Bank Facility. See "The Acquisition and the Financing Plan -- Description of
Bank Facility."
S-12
<PAGE> 13
K N Energy's leverage may have important consequences to holders of the
Offered Securities, including: (i) limiting K N Energy's ability to obtain
additional financing to fund future working capital requirements, capital
expenditures, debt service requirements, acquisitions or other general corporate
requirements; (ii) requiring a substantial portion of K N Energy's cash flow
from operations to be dedicated to payment of principal and interest on its
indebtedness, thereby reducing the funds available for operations and future
business opportunities; (iii) placing K N Energy at a competitive disadvantage
to companies with which it competes that may be less leveraged; and (iv)
increasing K N Energy's vulnerability to adverse economic and industry
conditions. In addition, since certain of K N Energy's borrowings may be at
variable rates of interest, K N Energy will be vulnerable to increases in
interest rates, which could have a material adverse effect on K N Energy's
results of operations, liquidity and financial condition. K N Energy's ability
to make scheduled payments of the principal of, to pay interest on or to
refinance its indebtedness depends on its future performance, which to a certain
extent is subject to economic, financial, competitive and other factors beyond
its control. There can be no assurance that K N Energy's business will continue
to generate cash flow from operations in the future sufficient to service its
debt and make necessary capital expenditures. If unable to generate such cash
flow, K N Energy may be required to adopt one or more alternatives, such as
selling assets, restructuring debt or obtaining additional equity capital. There
can be no assurance that any of these strategies could be effected on
satisfactory terms or without substantial additional expense to K N Energy.
These and other factors could have a material adverse effect on the results of
operations, liquidity and financial condition of K N Energy.
The Bank Facility imposes financial and other restrictions on K N Energy
and also requires K N Energy to make payments in respect of the
collateralization of the Substitute Note, interest and outstanding principal,
including from the proceeds of certain issuances of capital stock or
indebtedness. See "The Acquisition and the Financing Plan -- Description of Bank
Facility." Covenants contained in the Bank Facility and relating to certain
other indebtedness of K N limit, among other things, the incurrence of funded
indebtedness by K N and its subsidiaries and, in the event of a downgrade in the
ratings of K N's long-term senior unsecured debt, impose minimum EBITDA/interest
and net worth requirements. There can be no assurance that the requirements of
the Bank Facility or such other indebtedness will be met in the future. Failure
to comply with such covenants may result in a default with respect to the
related debt under the Bank Facility or such other indebtedness and could lead
to acceleration of such debt or any instruments evidencing indebtedness that
contain cross-acceleration or cross-default provisions. In such a case, there
can be no assurance that K N Energy would be able to refinance or otherwise
repay such indebtedness.
RISKS RELATING TO ACQUISITION STRATEGY
A substantial portion of the Company's growth over the last several years
has been attributable to acquisitions. A principal component of the Company's
strategy is to continue to acquire assets or businesses that are logical
extensions of its existing assets or businesses in order to increase the
efficiency of its existing assets. See "The Combined Company -- Business
Strategy." The Company's ability to achieve its goals will be dependent upon a
number of factors, including the Company's ability to identify acceptable
acquisition candidates, consummate acquisitions on favorable terms, successfully
integrate acquired businesses, increase its gas throughput into new markets and
obtain financing to support its growth. There can be no assurance that the
Company will be successful in implementing its acquisition strategy or that such
strategy will improve operating results.
COMPETITION
The Company competes with other pipeline companies, marketers and brokers
of varying size, resources and experience as well as with producers who are able
to market gas directly to wholesale and end-use markets. Factors influencing the
competitive environment include (i) regulatory changes that provide greater
access to markets by gas producers and marketers, (ii) the ability of certain
markets to switch to alternative fuels at favorable prices, and (iii) increased
pipeline and gas storage capacity in the United States. In addition, natural gas
competes with fuel oil, coal, propane and electricity as an energy source in the
areas served by the Company's interstate pipeline system and retail natural gas
business. The Company expects that such
S-13
<PAGE> 14
competition will increase as a result of the continued implementation of FERC
Order 636 and state retail unbundling initiatives. In addition, the Company's
gas gathering, processing and marketing operations depend in large part on the
ability of the Company to assess and respond to changing market conditions in
negotiating gas purchase and sale agreements and to obtain satisfactory margins
between the purchase price of its natural gas supply and the sales price for
such residual gas volumes and the NGLs processed.
As FERC Order 636 continues to be implemented, increased competition for
market share has led to the announcement of new pipeline projects for increased
capacity. Given the major supplies of gas in the Rocky Mountains, San Juan Basin
and Western Canada, and the relatively high natural gas prices in the Midwest
and Northeast, the major projects have focused on constructing new pipelines
which transport gas from Western Canada to the Midwest (including Northern
Border, Alliance and Transvoyageur), and new pipelines which redirect gas from
the Midwest to the Northeast and Eastern Canada (including Independence/Market
Link (in which MidCon has an interest), Millenium, Eastern Express,
Spectrum/Excelsior, Tristate and Vector). While proposals for the projects
mentioned above have been announced or filed with regulatory authorities, it is
unlikely that all of them will ultimately be completed. Nevertheless, given its
strategic location at the center of the North American pipeline grid, Chicago is
likely to develop into a major natural gas trading hub for the rapidly growing
demand markets in the Midwest and Northeast. To the extent additional pipeline
capacity into Chicago is constructed, the Company's financial position and
results of operations could be adversely affected. The Company intends to try to
mitigate any negative impact over time with additional market growth and
expansion of capacity to move volumes east of Chicago to the heavily populated
northeastern corridor of the United States.
FLUCTUATING COMMODITY PRICES
The products of K N's natural gas processing operations, including NGLs,
residue gas and related by-products, are commodities. As such, their prices are
often subject to material changes in response to relatively minor changes in
supply and demand, general economic conditions and other market conditions over
which K N has no control. Other market conditions affecting the Company's
natural gas processing business include the availability and prices of
alternative energy and feedstock sources, government regulation, industry-wide
inventory levels, the seasons, the weather and the impact of energy conservation
efforts.
A decrease in the difference between NGL and natural gas prices results in
lower unit margins on natural gas volumes processed, and may result in lower
volumes processed, or lower recoveries of certain NGLs (primarily ethane) at
certain plants. Generally, the prices contained in natural gas processing supply
contracts are tied to a current or index price and, therefore, adjust with
changes in overall market conditions. In addition, K N is contractually able to
mitigate the effect of contracting processing margins by reducing recoveries
until the margin between NGL and natural gas prices improves. A prolonged
contraction of the margin between NGLs and natural gas could materially
adversely affect the financial condition and results of K N's natural gas
processing operations.
REGULATION; PENDING REGULATORY PROCEEDINGS
K N Energy and MidCon are both regulated by the Federal Energy Regulatory
Commission (the "FERC") in accordance with the Natural Gas Act of 1938, as
amended (the "Natural Gas Act") and the Natural Gas Policy Act of 1978, as
amended (the "Natural Gas Policy Act"). The FERC regulates the interstate
transportation of natural gas, including, among other things, rates and charges
allowed natural gas companies, construction, extensions and abandonments of
facilities and service, rates of depreciation and amortization and accounting
systems. As a result of the Acquisition, approximately 70% of the operating
income of K N will be derived from regulated assets. Although the Company has in
the past successfully converted to unregulated status certain existing gathering
and processing assets and intends to take similar action with respect to certain
assets of MidCon, there can be no assurance that the Company will receive the
requisite approvals to "spin down" such assets, or once converted to unregulated
status, that the FERC will not attempt to reassert jurisdiction over such
assets. See "Regulation -- Federal and State Regulation."
S-14
<PAGE> 15
In addition, K N Energy and MidCon are currently parties to various
regulatory and rate proceedings relating to the establishment of rates for
service, terms and conditions of service, authorizations to own and construct
new facilities as well as complaints from customers relating to the
implementation of each company's tariff governing authorized services. There
have also been proceedings from time to time relating to cost recovery issues
arising out of contract expirations, gas supply realignment and other transition
issues. Both companies regularly attempt to reach comprehensive settlements with
the parties in pending cases which would resolve the issues in a given matter.
Both companies to date have been successful in resolving major rate and
certificate cases arising out of significant restructuring of the regulated
industries. It is contemplated that each company will continue to pursue a
business strategy which will pursue settlement of regulatory proceedings where
settlement is prudent. While negotiated settlement of such disputes is
encouraged by the FERC and state regulatory bodies, such settlements remain
subject to the FERC or state regulatory review and approval. Whether the FERC or
state regulators will approve such settlements in the form filed or whether a
particular regulatory proceeding will be otherwise resolved in a manner
satisfactory to the Company cannot be predicted with certainty, and the business
of the Company could be adversely affected thereby. For a description of certain
regulatory proceedings in which K N Energy and MidCon are currently involved,
see "Regulation -- Federal and State Regulation."
The Company's operations and properties, including those of MidCon acquired
in the Acquisition, are also 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 or safety
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. These laws and
regulations can also impose liability for remedial costs on the owner or
operator of properties or the generators of waste materials, regardless of
fault. Moreover, the trends toward stricter standards in environmental
legislation and regulation are expected to continue. The Company expects to
incur certain costs to comply with environmental laws and regulations. See
"Regulation -- Environmental Regulation."
While the Company is not aware of any environmental liabilities or
conditions that would have a material adverse effect on the business, results of
operations or financial condition of the Company, there is an inherent risk of
the incurrence of environmental or safety costs and liabilities in the business
of the Company due to its handling of natural gas and other regulated substances
and 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.
FORWARD-LOOKING STATEMENTS
Certain of the matters discussed under the captions "Prospectus Supplement
Summary," "Risk Factors," "Unaudited Pro Forma Consolidated Financial
Statements," "The Combined Company," "K N Energy, Inc.," "MidCon Corp." and
elsewhere in this Prospectus Supplement include forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended (the
"Securities Act") and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). 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, other federal and state regulatory
developments, the timing and extent of changes in commodity prices for oil, gas,
NGLs, electricity and interest rates, the extent of the Company's success in
acquiring natural gas facilities, the ability of the Company to successfully
integrate MidCon and other acquisition candidates into its operations, 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.
S-15
<PAGE> 16
USE OF PROCEEDS
The net proceeds of the Debt Offerings are estimated to be approximately
$ billion. K N intends to use such net proceeds to refinance a portion of
the indebtedness incurred under the Bank Facility in connection with the
Acquisition and to purchase U.S. government securities to collateralize the
Substitute Note and replace a portion of the letters of credit issued under the
Bank Facility currently collateralizing the Substitute Note. As of February 1,
1998 the Acquisition borrowings bore interest at 6.14%. All of the borrowings
and extensions of credit under the Bank Facility mature on January 29, 1999
other than borrowings under the $400 Million Facility (as defined herein) which
matures on January 30, 2003. See "The Acquisition and the Financing Plan."
S-16
<PAGE> 17
THE ACQUISITION AND THE FINANCING PLAN
THE ACQUISITION
Pursuant to the Agreement, on January 30, 1998, the Company paid
approximately $2.1 billion in cash and issued the Substitute Note in an
aggregate principal amount of approximately $1.39 billion to Occidental to
acquire the outstanding shares of capital stock of MidCon (the "MidCon Shares")
and a note in a like aggregate principal amount issued to Occidental by MidCon's
employee stock ownership plan (the "ESOP Note"). 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 a rate equal to 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 with the proceeds of the Offerings and the Additional
Offerings. See "Use of Proceeds" and "-- The Financing Plan."
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 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 is contingent upon the FERC approving the transaction.
THE FINANCING PLAN
The total amount of funds required by K N Energy to complete the
Acquisition, including payment of related transaction costs, was approximately
$2,499 million, which was financed through borrowings under Credit Agreements,
dated as of January 30, 1998 (the "Bank Facility"), among the Company, Morgan
Guaranty Trust Company of New York ("Morgan Guaranty"), an affiliate of J.P.
Morgan Securities Inc., and a syndicate of other lenders. The Bank Facility
replaced the Company's Amended and Restated Credit Agreement, dated as of March
7, 1997, among the Company, Morgan Guaranty and a syndicate of other lenders
(the "1997 Credit Agreement"). In addition, the Company issued the Substitute
Note which, pursuant to the Agreement, was collateralized by letters of credit
issued under the Bank Facility. The Company intends to refinance borrowings
under the Bank Facility and purchase U.S. government securities to replace a
portion of the letters of credit issued under the Bank Facility through the
Offerings. The Company intends to purchase additional U.S. government securities
to collateralize the Substitute Note and replace the letters of credit and
further refinance borrowings under the Bank Facility through the issuance of
approximately $400 million of mandatorily convertible preferred capital trust
securities of a subsidiary trust and approximately $300 million of preferred
capital trust securities of another subsidiary trust during the first half of
1998. The Company is required to refinance $4.1 billion of borrowings and the
extension of credit under several letters of credit under the Bank Facility
within 364 days following the consummation of the Acquisition.
S-17
<PAGE> 18
At the closing of the Acquisition, the financing was provided as follows:
<TABLE>
<CAPTION>
AMOUNT
-------------
(IN MILLIONS)
<S> <C>
SOURCES OF FUNDS:
Borrowings under the Bank Facility............................. $ 2,492.7
Cash on hand at MidCon......................................... 6.3
------
Total sources of funds................................. $ 2,499.0
======
USES OF FUNDS:
Cash consideration to Occidental............................... $ 2,104.0
Repay borrowings under 1997 Credit Agreement................... 285.0
Estimated transaction costs.................................... 60.0
Working capital adjustment..................................... 50.0
------
Total uses of funds.................................... $ 2,499.0
======
</TABLE>
The Company intends to refinance indebtedness incurred under the Bank
Facility in connection with the Acquisition and to purchase government
securities to replace the letters of credit under the Bank Facility
collateralizing the Substitute Note prior to maturity with the proceeds of the
Offerings and the following Additional Offerings and other borrowings. There can
be no assurance that the Company will be able to complete any or all of the
Equity Offering or the Additional Offerings. See "Risk Factors -- Effect of
Substantial Leverage."
<TABLE>
<CAPTION>
AMOUNT
-------------
(IN MILLIONS)
<S> <C>
SOURCES OF FUNDS:
Proceeds from the Equity Offering.............................. $ 500.0
Proceeds from the Debt Offerings............................... 2,350.0
Additional Offerings
Proceeds from capital securities............................ 300.0
Proceeds from mandatorily convertible preferred capital
trust securities.......................................... 400.0
--------
Total sources of funds................................. $ 3,550.0
========
USES OF FUNDS:
Repayment of borrowings under Bank Facility.................... $ 2,016.0
Purchase of U.S. government securities as collateral for the
Substitute Note............................................. 1,481.5
Estimated fees and expenses.................................... 52.5
--------
Total uses of funds.................................... $ 3,550.0
========
</TABLE>
DESCRIPTION OF BANK FACILITY
The description set forth below does not purport to be complete and is
qualified in its entirety by reference to certain agreements setting forth the
principal terms of the Bank Facility.
The Bank Facility provides for indebtedness in an aggregate principal
amount not to exceed $4.5 billion, which consists of the following credit
facilities: (a) an approximately $1.39 billion letter of credit facility
providing for the issuance of letters of credit for the benefit of Occidental to
support the Substitute Note (the "L/C Facility"); (b) a $2.1 billion revolving
credit facility providing for revolving loans to the Company in an aggregate
principal amount not to exceed $2.1 billion (the "$2.1 Billion Facility"); (c) a
$400 million revolving credit facility providing for revolving loans to the
Company and the issuance of letters of credit for the account of the Company in
an aggregate principal amount at any time not to exceed $400 million (of which
not more than $100 million may be represented by letters of credit) (the "$400
Million Facility"); and
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<PAGE> 19
(d) a $600 million revolving credit facility providing for revolving loans to
the Company in an aggregate principal amount at any time not to exceed $600
million (the "$600 Million Facility"). The L/C Facility and the $2.1 Billion
Facility may be used solely in connection with the Acquisition. The $400 Million
Facility and the $600 Million Facility may be used for general corporate
purposes and replace the 1997 Credit Agreement.
The L/C Facility, the $2.1 Billion Facility and the $600 Million Facility
have maturities of 364 days. The $400 Million Facility has a maturity of five
years. The $2.1 Billion Facility has been drawn in its entirety and all monies
borrowed thereunder were used to finance a portion of the Acquisition. The
Company intends to refinance indebtedness incurred and extensions of credit
under the Bank Facility in connection with the Acquisition through the Offerings
and the Additional Offerings. See "-- The Financing Plan" and "Capitalization."
At the Company's option, revolving credit commitments may be permanently
reduced, in whole or in part, at any time in minimum amounts of $10 million or
any larger multiples of $1 million. At the Company's option, the interest rates
per annum applicable to the Bank Facility will be either LIBOR, Adjusted CD or
Base Rate and, in the case of both the $400 Million Facility and the $600
Million Facility, Money Market Absolute and Money Market LIBOR (each as defined
in the Bank Facility) plus, in the case of LIBOR and Adjusted CD, an agreed upon
margin based on credit ratings assigned to the long-term senior unsecured debt
of the Company by Moody's Investors Service, Inc. ("Moody's") and Standard and
Poor's Ratings Services ("S&P") and, in the case of Money Market LIBOR, a margin
over or under LIBOR determined for the applicable interest period. As used
herein, the term "Base Rate" means the higher of Morgan Guaranty's prime rate or
the federal funds rate plus 0.50%.
Letter of credit fees are based on the credit ratings described in the
immediately preceding paragraph. The Company is also required to pay a per annum
utilization fee equal to 12.5 basis points on all borrowings if 50% or more of
such facility is outstanding at the time of such borrowing.
The Bank Facility covenants include, without limitation, a limit on total
consolidated subsidiary debt to 10% of the Company's total consolidated debt, a
limitation on total consolidated debt to 87% percent of total capitalization at
the closing of the Acquisition (67% after the consummation of the Offerings and
the Additional Offerings), a limitation on consolidated debt of any material
subsidiary to 65% of the consolidated total capitalization of such material
subsidiary, a restriction on liens on the assets of the Company or its
subsidiaries and a minimum EBITDA to interest requirement.
S-19
<PAGE> 20
CAPITALIZATION
The following table sets forth the unaudited consolidated capitalization of
K N at September 30, 1997(i) on a historical basis, (ii) as adjusted for (a) the
Offerings and application of the proceeds therefrom and (b) the acquisition of
MidCon, including the incurrence of borrowings under the Bank Facility in
connection with the Acquisition and (iii) as adjusted for the completion of K
N's plans for refinancing the indebtedness under the Bank Facility through the
Additional Offerings. See "The Acquisition and the Financing Plan." The
adjustments made for the implementation of K N's Financing Plan assume the
ability to complete the Offerings and the Additional Offerings under the terms
and pricing as described below, which K N believes to be reasonable in light of
its knowledge of current market conditions and its expected credit profile at
the anticipated dates of the Offerings and the Additional Offerings. There can
be no assurance that the Company will be able to complete any or all of the
Offerings and the Additional Offerings, or that the proceeds from the Offerings
and the Additional Offerings will be as currently contemplated. The closings of
the Debt Offerings and the Equity Offering are not conditioned upon each other.
This table should be read in conjunction with the consolidated financial
statements of K N and MidCon and the "Unaudited Pro Forma Consolidated Financial
Statements" and the notes thereto included elsewhere herein.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997
(UNAUDITED)
------------------------------------------------------------------------------
ADJUSTMENTS AS ADJUSTED
FOR THE FOR THE ADJUSTMENTS AS ADJUSTED
OFFERINGS OFFERINGS FOR THE FOR THE
K N AND THE AND THE ADDITIONAL ADDITIONAL
HISTORICAL ACQUISITION ACQUISITION OFFERINGS OFFERINGS
------------- ----------- ------------ ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Securities held as collateral for
Substitute Note.......................... -- $ 319,804 (1) $ 319,804 $1,161,663 (5) $1,481,467
========== ==========
Short-term debt:
Current maturities of long-term debt..... $ 19,055 $ 19,055 $ 19,055
Borrowings under 1997 Credit Agreement... 285,000 (285,000) (2) -- --
Borrowings under Bank Facility........... -- 2,207,696 (2) -- 476,663 (5) 476,663
285,000 (2)
(2,012,696) (1)
(480,000) (3)
Substitute Note due January 1, 1999...... -- 1,481,467 (4) 1,481,467 1,481,467
---------- ---------- ----------
Total short-term debt.............. $ 304,055 $1,500,522 $1,977,185
========== ========== ==========
Long-term debt............................. $ 410,498 2,350,000 (1) $2,760,498 $2,760,498
K N-obligated mandatorily redeemable
preferred capital trust securities of
subsidiary trusts holding solely
debentures of K N(6)..................... 100,000 100,000 300,000 (5) 400,000
K N-obligated mandatorily convertible
preferred capital trust securities of
subsidiary trust holding solely
debentures of K N(6)..................... -- -- 388,000 (5) 388,000
Stockholders' equity.......................
Preferred stock (200,000 Class A shares
authorized, 70,000 outstanding and
2,000,000 Class B shares authorized,
none outstanding)...................... 7,000 7,000 7,000
Common stock (50,000,000 shares
authorized, 31,446,326
outstanding)(7)........................ 157,232 50,000 (3) 207,232 207,232
Additional paid-in capital............... 252,030 430,000 (3) 682,030 682,030
Retained earnings........................ 166,099 166,099 166,099
Deferred compensation.................... (9,667) (9,667) (9,667)
Treasury stock........................... (885) (885) (885)
---------- ---------- ----------
Total stockholders' equity............. 571,809 1,051,809 1,051,809
---------- ---------- ----------
Total capitalization............... $ 1,082,307 $3,912,307 $4,600,307
========== ========== ==========
</TABLE>
- ---------------
(1) Gives effect to the issuance of $2.35 billion of long-term debt securities
and application of the net proceeds of $2.3325 billion to (i) retire
acquisition debt of $2.013 billion and (ii) purchase $319.8 million of U.S.
government securities to be held as collateral for the Substitute Note,
reducing the use of the L/C Facility in a like amount.
(2) Gives effect to acquisition debt totalling approximately $2.5 billion,
including $285 million which was used to repay amounts borrowed under the
1997 Credit Agreement.
S-20
<PAGE> 21
(3) Gives effect to the issuance of the 10,000,000 shares of Common Stock
offered pursuant to the Equity Offering at an assumed public offering price
of $50 per share and the application of the net proceeds of $480 million to
the reduction of acquisition debt.
(4) Pursuant to the Agreement, the Company issued the Substitute Note to
Occidental for the total principal amount due on the ESOP Note of $1,399
million plus accrued interest to the date of closing. The accrued interest
totalled approximately $8.8 million at the closing of the Acquisition and
approximately $83 million at September 30, 1997. The Substitute Note matures
on January 1, 1999
and has been initially collateralized by letters of credit issued under the
L/C Facility. It is currently the Company's intention to collateralize the
Substitute Note with U.S. government securities. See Notes (1) and (5).
(5) Gives effect to the issuance of $300 million of mandatorily redeemable
preferred capital trust securities and $400 million of mandatorily
convertible preferred capital trust securities and application of the net
proceeds of $297 million and $388 million, respectively, together with
$476.7 million of incremental borrowings under the Bank Facility to purchase
$1.162 billion of U.S. government securities as collateral for the
Substitute Note.
(6) The sole assets of the trusts are or will be debentures of K N. Upon
prepayment of such debentures, the related capital securities will be
mandatorily redeemable.
(7) In February 1998, K N Energy's board of directors approved an increase in
the number of authorized shares of Common Stock to 150,000,000. Such
increase is subject to shareholder approval.
S-21
<PAGE> 22
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
The following unaudited pro forma financial statements give effect to the
Acquisition and to the Offerings. There can be no assurance that the Offerings
will be completed as anticipated or that the net proceeds will be the amount
assumed in the accompanying unaudited pro forma financial statements. The
unaudited pro forma condensed balance sheet as of September 30, 1997 is
presented as if the Acquisition and the Offerings had occurred on that date. The
unaudited pro forma condensed statements of income for the year ended December
31, 1996 and the nine months ended September 30, 1997 assume that the
Acquisition and the Offerings occurred at the beginning of each such period. The
Acquisition will be recorded as a purchase for accounting purposes and,
accordingly, the assets acquired and liabilities assumed will be recorded at
their estimated respective fair market values.
The unaudited pro forma financial statements and accompanying notes should
be read in conjunction with the historical financial statements of K N and
MidCon included elsewhere herein and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" of K N incorporated herein by
reference. See Consolidated Financial Statements included elsewhere herein and
"Incorporation of Certain Documents by Reference" in the accompanying
Prospectus. The unaudited pro forma condensed statements of income are not
necessarily indicative of the financial results that would have occurred had the
Acquisition been consummated on the dates indicated, nor are they necessarily
indicative of future financial results. Results for the interim periods are not
necessarily indicative of results to be expected for a full year.
The pro forma adjustments are based on preliminary assumptions and
estimates made by K N's management and do not reflect adjustments for
anticipated operating efficiencies and cost savings which K N expects to achieve
as a result of the Acquisition. The actual allocation of the consideration paid
by K N for MidCon may differ from that reflected in the unaudited pro forma
combined condensed financial statements after a more extensive review of the
fair market values of the assets acquired and liabilities assumed has been
completed. Amounts allocated will be based upon the estimated fair values at the
closing date of the Acquisition, which amounts could vary significantly from the
amounts at September 30, 1997.
S-22
<PAGE> 23
UNAUDITED PRO FORMA CONDENSED BALANCE SHEET
SEPTEMBER 30, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
ASSETS
HISTORICAL PRO FORMA
------------------------- ----------------------------
K N ENERGY MIDCON ADJUSTMENTS COMBINED
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Current Assets:
Cash and Cash Equivalents.................................. $ 18,819 $ 6,278 $ (6,278) (a) $ 18,819
Investment in U.S. Government Securities................... -- -- 319,804 (b) 319,804
Restricted Deposits........................................ 6,448 30,678 37,126
Accounts Receivable........................................ 192,523 448,916 641,439
Materials and Supplies..................................... 14,998 11,320 26,318
Gas in Underground Storage................................. 23,660 73,312 96,972
Prepaid Gas................................................ 9,572 -- 9,572
Other Prepaid Expenses..................................... 14,983 3,771 18,754
Net Properties to Be Dividended, Net of Tax................ -- 303,452 (303,452) (c) --
Gas Imbalances and Other................................... 70,995 91,315 162,310
---------- ----------- ----------- -----------
351,998 969,042 10,074 1,331,114
Investments.................................................. 75,197 53,498 128,695
Property, Plant and Equipment, at Cost....................... 1,861,679 7,049,437 (179,078) (d) 8,732,038
Accumulated Depreciation and Amortization.................... (542,905) (1,617,826) (2,160,731)
---------- ----------- ----------- -----------
Net Property, Plant and Equipment............................ 1,318,774 5,431,611 (179,078) 6,571,307
Long-Term Receivable -- Occidental Petroleum................. -- 31,390 (31,390) (e) --
Deferred Charges and Other Assets............................ 106,488 24,972 17,500 (b) 148,960
---------- ----------- ----------- -----------
Total Assets......................................... $1,852,457 $ 6,510,513 $ (182,894) $ 8,180,076
========== ========== =========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current Maturities of Long-Term Debt....................... $ 19,055 -- -- $ 19,055
Notes Payable.............................................. 285,000 -- $2,207,696 (a) --
(2,012,696) (b)
(480,000) (g)
(285,000) (h)
285,000 (h)
Substitute Note............................................ -- -- 1,481,467 (f) 1,481,467
Accounts Payable........................................... 173,070 $ 290,660 463,730
Accrued Expenses........................................... 25,952 -- 10,000 (d) 35,952
Accrued Taxes.............................................. 26,673 -- 26,673
Dividend Payable........................................... -- 303,452 (303,452) (c) --
Current portion of ESOP Debt............................... -- 12,574 (12,574) (i) --
Gas Imbalances and Other................................... 51,045 197,808 (37,700) (j) 211,153
Interest Payable to Affiliates............................. -- 82,867 (82,867) (f) --
---------- ----------- ----------- -----------
580,795 887,361 769,874 2,238,030
Deferred Liabilities, Credits and Reserves:
Deferred Income Taxes...................................... 131,567 1,690,440 (64,468) (d) 1,726,149
(31,390) (e)
Other...................................................... 26,628 238,346 264,974
---------- ----------- ----------- -----------
158,195 1,928,786 (95,858) 1,991,123
ESOP Debt.................................................... -- 1,386,026 (1,386,026) (i)
Long-Term Debt............................................... 410,498 1,600,000 (1,600,000) (k) 2,760,498
2,350,000 (b)
K N-Obligated Mandatorily Redeemable Preferred Capital
Trust Securities of Subsidiary Trust Holding Solely
Debentures of K N.......................................... 100,000 -- 100,000
Minority Interests in Equity of Subsidiaries................. 31,160 7,456 38,616
Stockholders' Equity:
Preferred Stock............................................ 7,000 -- 7,000
Common Stock............................................... 157,232 14 (14) (l) 207,232
50,000 (g)
Additional Paid-in Capital................................. 252,030 1,970,375 (1,970,375) (l) 682,030
430,000 (g)
Retained Earnings.......................................... 166,099 89,497 (89,497) (l) 166,099
Unearned ESOP Shares....................................... -- (1,359,002) 1,359,002 (l) --
Deferred Compensation...................................... (9,667) -- (9,667)
Treasury Stock............................................. (885) -- (885)
---------- ----------- ----------- -----------
Total Common Stockholders' Equity...................... 564,809 700,884 (220,884) 1,044,809
---------- ----------- ----------- -----------
Total Stockholders' Equity............................. 571,809 700,884 (220,884) 1,051,809
---------- ----------- ----------- -----------
Total Liabilities and Stockholders' Equity........... $1,852,457 $ 6,510,513 $ (182,894) $ 8,180,076
========== ========== =========== ==========
</TABLE>
See Notes to Unaudited Pro Forma Combined Condensed Financial Statements
S-23
<PAGE> 24
UNAUDITED PRO FORMA CONDENSED STATEMENT OF INCOME
YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
------------------------- --------------------------
K N ENERGY MIDCON ADJUSTMENTS COMBINED
---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Operating Revenues......................... $1,443,174 $2,574,211 $4,017,385
---------- ---------- ----------
Operating Costs and Expenses:
Gas Purchases and Other Costs of Sales... 1,062,062 1,981,235 3,043,297
Operations and Maintenance............... 175,778 108,347 284,125
Depreciation and Amortization............ 51,212 177,511 $ (3,761)(m) 224,962
Taxes, Other Than Income Taxes........... 19,321 46,226 65,547
---------- ---------- ----------- ----------
Total Operating Costs and
Expenses....................... 1,308,373 2,313,319 (3,761) 3,617,931
---------- ---------- ----------- ----------
Operating Income........................... 134,801 260,892 3,761 399,454
---------- ---------- ----------- ----------
Other Income and (Deductions):
Interest Expense......................... (35,933) (79,626) (203,297)(n) (318,856)
Minority Interests....................... (2,946) -- (2,946)
Other, Net............................... 3,794 11,903 10,387(o) 42,291
16,207(b)
---------- ---------- ----------- ----------
Total Other Income and
(Deductions)................... (35,085) (67,723) (176,703) (279,511)
---------- ---------- ----------- ----------
Income Before Income Taxes................. 99,716 193,169 (172,942) 119,943
Income Taxes............................... 35,897 76,684 (63,613)(p) 48,968
---------- ---------- ----------- ----------
Net Income................................. 63,819 116,485 (109,329) 70,975
Less -- Preferred Stock Dividends.......... 398 -- 398
---------- ---------- ----------- ----------
Earnings Available For Common Stock........ $ 63,421 $ 116,485 $(109,329) $ 70,577
========= ========= ========= =========
Earnings Per Common Share.................. $ 2.14 $ 1.78
Number of Shares Used in Computing Earnings
Per Common Share......................... 29,624 10,000(g) 39,624
Dividends Per Common Share................. $ 1.05 $ 1.05*
</TABLE>
- ---------------
* Represents K N's historical dividends per common share.
See Notes to Unaudited Pro Forma Combined Condensed Financial Statements
S-24
<PAGE> 25
UNAUDITED PRO FORMA CONDENSED STATEMENT OF INCOME
NINE MONTHS ENDED SEPTEMBER 30, 1997
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
HISTORICAL PRO FORMA
------------------------- --------------------------
K N ENERGY MIDCON ADJUSTMENTS COMBINED
---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Operating Revenues......................... $1,362,457 $2,063,058 $3,425,515
---------- ---------- ----------
Operating Costs and Expenses:
Gas Purchases and Other Costs of Sales... 1,060,884 1,684,980 2,745,864
Operations and Maintenance............... 146,109 77,853 $ (2,663)(i) 221,299
Depreciation and Amortization............ 41,101 110,924 1,630(m) 153,655
Taxes, Other Than Income Taxes........... 18,144 23,087 41,231
---------- ---------- ----------- ----------
Total Operating Costs and
Expenses....................... 1,266,238 1,896,844 (1,033) 3,162,049
---------- ---------- ----------- ----------
Operating Income........................... 96,219 166,214 1,033 263,466
---------- ---------- ----------- ----------
Other Income and (Deductions):
Interest Expense......................... (30,991) (181,601) 4,716(n) (217,756)
(9,880)(o)
Minority Interests....................... (5,681) -- (5,681)
Other, Net............................... 14,979 18,555 9,881(o) 55,569
12,154(b)
---------- ---------- ----------- ----------
Total Other Income and
(Deductions)................... (21,693) (163,046) 16,871 (167,868)
---------- ---------- ----------- ----------
Income Before Income Taxes................. 74,526 3,168 17,904 95,598
Income Taxes............................... 25,488 87 7,033(p) 32,608
---------- ---------- ----------- ----------
Net Income................................. 49,038 3,081 10,871 62,990
Less -- Preferred Stock Dividends.......... 263 -- 263
---------- ---------- ----------- ----------
Earnings Available For Common Stock........ $ 48,775 $ 3,081 $ 10,871 $ 62,727
========= ========= ========= =========
Earnings Per Common Share.................. $ 1.55 $ 1.52
Number of Shares Used in Computing Earnings
Per Common Share......................... 31,397 10,000(g) 41,397
Dividends Per Common Share................. $ 0.81 $ 0.81*
</TABLE>
- ---------------
* Represents K N's historical dividends per common share.
See Notes to Unaudited Pro Forma Combined Condensed Financial Statements
S-25
<PAGE> 26
NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED
FINANCIAL STATEMENTS
(a) Acquisition debt is calculated based on the following assumptions:
<TABLE>
<CAPTION>
(THOUSANDS)
----------
<S> <C>
Cash Consideration Paid at Closing.................................... $2,103,974
Transaction Costs..................................................... 60,000
Working Capital Adjustment (estimated)................................ 50,000
Less:
MidCon Cash Balance at September 30, 1997............................. (6,278)
----------
Total Acquisition Debt........................................ $2,207,696
=========
</TABLE>
The acquisition debt, which will mature 364 days after draw-down, is shown
as a current liability in the accompanying unaudited Pro Forma Condensed
Balance Sheet, although it is currently K N's intention to refinance a
significant portion of the acquisition debt through the issuance of debt
and equity securities, see "The Acquisition and the Financing Plan."
(b) To record the Debt Offerings and application of the net proceeds of
$2,332.5 million to (i) reduce short-term borrowings, including both
borrowings under the Bank Facility utilized to effect the Acquisition and
borrowings under the 1997 Credit Agreement, by $2,012.7 million and (ii)
purchase $319.8 million of U.S. government securities to be held in partial
satisfaction of K N's requirement to collateralize the Substitute Note,
reducing utilization of the L/C Facility by a similar amount. See Notes (f)
and (n). The Debt Offerings are expected to include notes with
approximately 6 separate maturities with varying terms and, for purposes of
preparing these pro forma financial statements, the weighted average
interest rate for the entire issuance is expected to be approximately 7%. K
N believes that the interest rate assumed is appropriate under current
market conditions for a BBB- rated senior debt obligation, although it may
differ from the rate actually obtained at the time the debt securities are
sold. A change of 1% in the assumed interest rate would change pro forma
interest expense for the year ended December 31, 1996 and the nine months
ended September 30, 1997 by approximately $23.5 million and $17.6 million,
respectively. The U.S. government securities held as collateral for the
Substitute Note as provided in the Agreement, are assumed to earn interest
at the rate of 5.25%.
(c) Gives pro forma effect to the January 1, 1998 dividend by MidCon to a
subsidiary of Occidental Petroleum Corporation of MidCon's 49% interest in
a limited partnership which owns MidCon Texas Pipeline Corp.
(d) The following preliminary allocation of purchase price to assets acquired
and liabilities assumed reflects the assumption that current assets and
current liabilities are carried at historical amounts which approximate
their fair market value. The fair market value of property, plant and
equipment includes a gas plant acquisition adjustment of approximately $3.8
billion which represents the excess of the estimated fair market value of
MidCon's interstate pipeline assets over their recorded historical cost for
regulatory purposes, which will be amortized over 35 years (approximately
the estimated remaining life of MidCon's interstate pipeline assets).
<TABLE>
<CAPTION>
(THOUSANDS)
-----------
<S> <C>
CALCULATION OF PURCHASE PRICE:
Cash Consideration Paid at Closing................................... $ 2,103,974
Substitute Note Payable to Occidental................................ 1,481,467
Transaction Costs.................................................... 60,000
Working Capital Adjustment (estimated)............................... 50,000
-----------
Total........................................................ $ 3,695,441
==========
PRELIMINARY ALLOCATION OF PURCHASE PRICE
Cash and Cash Equivalents............................................ $ 6,278
Restricted Deposits.................................................. 30,678
Accounts Receivable.................................................. 448,916
Materials and Supplies............................................... 11,320
Gas in Underground Storage........................................... 73,312
Other Prepaid Expenses............................................... 3,771
Gas Imbalances and Other............................................. 91,315
Investments.......................................................... 53,498
</TABLE>
S-26
<PAGE> 27
NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED
FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
(THOUSANDS)
-----------
<S> <C>
Deferred Charges and Other Assets.................................... 24,972
Property, Plant and Equipment, Net(*)................................ 5,252,533
Accounts Payable..................................................... (290,660)
Gas Imbalances and Other............................................. (160,108)
Deferred Income Taxes(**)............................................ (1,594,582)
Other Non-Current Liabilities........................................ (238,346)
Accrued Expenses..................................................... (10,000)
Minority Interest in Unconsolidated Subsidiaries..................... (7,456)
-----------
Total........................................................ $ 3,695,441
==========
</TABLE>
(*) The fair market value assigned by K N, inclusive of the gas
plant acquisition adjustment, is less than MidCon's
historical book value (which included a gas
plant acquisition adjustment of approximately $3.9 billion)
by approximately $179.1 million.
(**) The accumulated deferred income taxes associated with the
assets being acquired and the liabilities being assumed
(after K N's allocation of purchase price) are less than
MidCon's historical accumulated deferred income taxes by
approximately $64.5 million.
(e) To eliminate the receivable and corresponding deferred taxes associated
with deferred intercompany gains which will be settled at closing.
(f) In accordance with the terms of the Agreement, K N issued the Substitute
Note to Occidental for the total of the principal due on the ESOP Note
($1,398,600,000) plus interest accrued to date of closing on the ESOP Note
($82,867,000 as of September 30, 1997), totaling $1,481,467,000, bearing
interest at 5.80% and maturing on January 4, 1999. K N collateralized the
Substitute Note with letters of credit under the Bank Facility at the
closing of the Acquisition. It is currently K N's intention to purchase
government securities to replace the L/C Facility with the proceeds of the
Debt Offerings and the Additional Offerings. See Note(b).
(g) Gives effect to issuance of the 10 million shares of Common Stock at an
assumed public offering price of $50 per share and application of the net
proceeds therefrom to the reduction of short-term borrowings.
(h) Reflects the utilization of additional borrowings under the Bank Facility
to repay the borrowings outstanding under the 1997 Credit Agreement.
(i) Gives pro forma effect to the termination of MidCon's Employee Stock
Ownership Plan instituted in November 1996, including cancellation of the
related debt and removal of the associated administrative expenses.
(j) Represents the elimination of the deferred net gain recorded in
conjunction with MidCon's postretirement benefit plan.
(k) Gives pro forma effect to the elimination of MidCon's long-term payable to
Occidental recorded in conjunction with a November 30, 1996 dividend
declaration of $1.6 billion.
(l) Represents the elimination of the historical equity balances of MidCon.
S-27
<PAGE> 28
NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED
FINANCIAL STATEMENTS -- (CONTINUED)
(m) The pro forma adjustments to depreciation and amortization consist of the
following:
<TABLE>
<CAPTION>
(THOUSANDS)
-----------
<S> <C>
Year Ended December 31, 1996
Elimination of MidCon's historical depreciation and amortization,
exclusive of depreciation on MidCon Texas Pipeline Corp., see Note
(c)................................................................. $ (153,833)
K N's recomputed depreciation and amortization, see Note (d)........... 150,072
-----------
Total.......................................................... $ (3,761)
=========
Nine Months Ended September 30, 1997
Elimination of MidCon's historical depreciation and amortization....... $ (110,924)
K N's recomputed depreciation and amortization, see Note (d)........... 112,554
-----------
Total.......................................................... $ 1,630
=========
</TABLE>
(n) The pro forma adjustments to interest expense consist of the following:
<TABLE>
<CAPTION>
(THOUSANDS)
-----------
<S> <C>
Year Ended December 31, 1996
Elimination of MidCon's historical interest expense on its ESOP Note... $ (12,584)
Elimination of MidCon's historical interest expense on its $1.6 billion
payable to Occidental............................................... (16,502)
Interest Expense on the Debt Offerings at 7.0%, see Note (b)........... 164,500
Interest Expense at 5.80% on the Substitute Note, see Note (f)......... 81,091
Interest savings associated with the repayment of $285 million
outstanding under the 1997 Credit Agreement......................... (19,950)
Fee for letters of credit at 0.625% used to collateralize the
Substitute Note, see Note (f)....................................... 6,742
-----------
Total.......................................................... $ 203,297
=========
Nine Months Ended September 30, 1997
Elimination of MidCon's historical interest expense on its ESOP Note... $ (82,867)
Elimination of MidCon's historical interest expense on its $1.6 billion
payable to Occidental............................................... (96,117)
Interest Expense on the Debt Offerings at 7.0%, see Note (b)........... 123,375
Interest Expense at 5.8% on the Substitute Note, see Note (f).......... 60,818
Interest Expense on ESOP Administration................................ (19)
Interest savings associated with the repayment of $285 million
outstanding under the 1997 Credit Agreement......................... (14,963)
Fee for letters of credit at 0.625% used to collateralize the
Substitute Note, see Note (f)....................................... 5,057
-----------
Total.......................................................... $ (4,716)
=========
</TABLE>
(o) To eliminate facility fees (and, in the nine months ended September 30,
1997, interest income) associated with MidCon's participation in a sale of
receivables facility, which participation terminated with closing of the
Acquisition.
(p) Represents the tax effect at the effective rate (equal to (i) the statutory
federal income tax rate plus (ii) the statutory state income tax rate, net
of federal income tax benefit) for all pre-tax pro forma adjustments not
representing permanent book/tax differences.
S-28
<PAGE> 29
SELECTED HISTORICAL FINANCIAL INFORMATION FOR K N ENERGY
The following table sets forth selected financial data for K N for each of
the five fiscal years in the period ended December 31, 1996 and the nine months
ended September 30, 1996 and 1997. This data should be read in conjunction with
the historical financial statements and related notes of K N included elsewhere
herein. Selected unaudited financial data of the nine months ended September 30,
1996 and 1997 include all adjustments (consisting only of normal recurring
accruals, except as otherwise explicitly described) that K N considers necessary
for a fair presentation of consolidated operating results for such interim
periods. Results for the interim periods are not necessarily indicative of
results for the full year.
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------------------------------------- ----------------------
1992 1993 1994 1995 1996 1996 1997
-------- ---------- ---------- ---------- ---------- -------- ----------
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Operating revenues
Gathering, processing and
marketing services.............. $507,756 $ 730,895 $ 838,474 $ 854,462 $1,193,984 $788,719 $1,175,320
Interstate transportation and
storage services................ 127,611 99,838 21,044 22,217 25,352 17,619 17,648
Retail natural gas services....... 196,025 212,905 220,431 227,282 223,838 158,882 169,489
Gas and oil production............ 4,710 5,321 11,328 7,437 -- -- --
------- --------- --------- --------- --------- ------- ---------
Total operating revenues.... 836,102 1,048,959 1,091,277 1,111,398 1,443,174 965,220 1,362,457
Operating costs and expenses........ 752,141 968,085 1,036,398 996,036 1,308,373 877,203 1,266,238
------- --------- --------- --------- --------- ------- ---------
Operating income.................... 83,961 80,874 54,879 115,362 134,801 88,017 96,219
Other income and (deductions):
Interest expense.................. (27,012) (30,513) (31,605) (34,211) (35,933) (26,209) (30,991)
Minority interests................ (1,559) 292 (659) (905) (2,946) (2,246) (5,681)
Other, net........................ 1,020 (1,185) 2,206 1,326 3,794 3,012 14,979
------- --------- --------- --------- --------- ------- ---------
Income before income taxes.......... 56,410 49,468 24,821 81,572 99,716 62,574 74,526
Income taxes........................ 20,068 18,599 9,500 29,050 35,897 22,526 25,488
------- --------- --------- --------- --------- ------- ---------
Net income.......................... 36,342 30,869 15,321 52,522 63,819 40,048 49,038
Preferred stock dividends........... 2,976 853 630 492 398 298 263
------- --------- --------- --------- --------- ------- ---------
Earnings available for common
stock............................. $ 33,366 $ 30,016 $ 14,691 $ 52,030 $ 63,421 $ 39,750 $ 48,775
======= ========= ========= ========= ========= ======= =========
Number of shares used in computing
earnings per common share......... 24,828 27,424 28,044 28,360 29,624 29,216 31,397
Earnings per common share........... $ 1.34 $ 1.09 $ 0.52 $ 1.83 $ 2.14 $ 1.36 $ 1.55
Dividends per common share.......... 0.51 0.51 0.76 1.01 1.05 0.78 0.81
OTHER FINANCIAL DATA:
Net cash flows from operating
activities........................ $ 51,021 $ 67,943 $ 91,212 $ 129,580 $ 80,829 $ 70,180 $ 102,399
EBITDA(1)........................... 122,775 124,625 106,704 165,674 186,861 127,215 146,618
Capital expenditures and
acquisitions...................... 96,255 148,301 101,742 111,258 273,994 137,836 316,238
Depreciation, depletion and
amortization...................... 39,353 44,644 50,278 49,891 51,212 38,432 41,101
Ratio of earnings to fixed
charges(2)........................ 2.61x 2.41x 1.69x 3.07x 3.21x 2.88x 2.40x
</TABLE>
S-29
<PAGE> 30
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF
------------------------------------------------------------------ SEPTEMBER 30,
1992 1993 1994 1995 1996 -------------
---------- ---------- ---------- ---------- ---------- 1997
-------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.................. $ 23,554 $ 14,353 $ 20,613 $ 14,254 $ 10,339 $ 18,819
Current assets............................. 250,880 312,856 279,314 306,799 454,824 351,998
Total assets............................... 1,007,411 1,169,275 1,172,384 1,257,457 1,629,720 1,852,457
Current liabilities........................ 204,723 263,331 255,770 329,838 498,616 580,795
Long-term debt............................. 303,224 335,190 334,644 315,564 423,676 410,498
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............................. 13,540 13,775 13,231 14,277 26,333 31,160
Preferred stock............................ 26,310 7,000 7,000 7,000 7,000 7,000
Common stockholders' equity................ 347,738 391,462 393,686 426,760 519,794 564,809
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------------------------- --------------
1992 1993 1994 1995 1996 1996 1997
----- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Interstate natural gas transportation volumes (Bcf)................ 126 131 135 156 159 122 127
Gathering, processing and marketing services
Gas sales volumes (Bcf).......................................... 225 290 353 408 430 313 364
Gathered volumes (Bcf)........................................... 137 222 287 306 326 243 290
Natural gas liquid sales (MM Gal)................................ 171 241 375 388 470 346 526
Retail natural gas services
Gas sales volumes (Bcf).......................................... 41 42 41 39 35 25 29
Transportation volumes (Bcf)..................................... 12 15 19 27 35 25 26
</TABLE>
<TABLE>
<CAPTION>
AS OF
SEPTEMBER 30,
1997
------------------
<S> <C> <C> <C>
Miles of pipeline
Interstate........................................................................ 6,970
Intrastate........................................................................ 5,418
Gathering and processing.......................................................... 8,691
Distribution(3)................................................................... 8,665
Gas processing plants
Number of plants.................................................................. 18
Total processing capacity (MMcf per day).......................................... 1,675
Natural gas storage facilities
Number of storage facilities...................................................... 7
Total withdrawal capacity (Bcf per day)........................................... 0.8
</TABLE>
- ---------------
(1) EBITDA represents net income plus income taxes, interest expense,
depreciation, and amortization expense. EBITDA is not presented as an
indicator of the Company's operating performance, an indicator of cash
available for discretionary spending or as a measure of liquidity. EBITDA
may not be comparable to other similarly titled measures of other companies.
(2) Respecting the computation of the ratio of earnings to fixed charges see
"Ratios of Earnings to Fixed Charges" in the accompanying Prospectus.
(3) Including K N's Kansas natural gas distribution assets the sale of which
will close upon receipt of regulatory approval.
S-30
<PAGE> 31
SELECTED HISTORICAL FINANCIAL INFORMATION FOR MIDCON
The following table sets forth selected financial data for MidCon for each
of the five fiscal years in the period ended December 31, 1996 and the nine
months ended September 30, 1996 and 1997. This data should be read in
conjunction with the historical financial statements and related notes of MidCon
included elsewhere herein. Selected unaudited financial data for the nine months
ended September 30, 1996 and 1997 include all adjustments (consisting only of
normal recurring accruals, except as otherwise explicitly described) that MidCon
considers necessary for a fair presentation of consolidated operating results
for such interim periods. Results for the interim periods are not necessarily
indicative of results for the full year.
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
-------------------------------------------------------------- -----------------------
1992 1993 1994 1995 1996 1996 1997
---------- ---------- ---------- ---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues
Gas sales, transportation, storage
and other operating revenues..... $2,365,267 $2,403,185 $2,109,834 $2,038,444 $2,574,211 $1,776,703 $2,063,058
Interest and other income.......... 350,400 261,598 24,486 11,686 1,187 7,721 9,595
Earnings of pipeline ventures...... 14,165 10,760 13,100 18,155 12,716 9,899 9,965
--------- --------- --------- --------- --------- --------- ---------
Total operating revenues..... 2,729,832 2,675,543 2,147,420 2,068,285 2,588,114 1,794,323 2,082,618
Costs and other deductions
Cost of sales...................... 1,746,380 1,787,552 1,561,331 1,473,370 1,981,235 1,338,188 1,684,980
Selling, general, administrative
and other operating expenses..... 146,376 103,883 109,556 167,235 108,347 83,959 77,853
Depreciation....................... 273,448 274,551 191,672 193,112 177,511 131,676 110,924
Taxes other than income taxes...... 36,200 45,470 45,585 42,357 46,226 36,341 23,087
Interest expense................... -- 2,103 8,101 23,286 79,626 43,379 181,601
Other.............................. (2,394) 1,414 1,802 1,646 2,000 1,439 1,005
--------- --------- --------- --------- --------- --------- ---------
Income before income taxes........... $ 529,822 $ 460,570 $ 229,373 $ 167,279 $ 193,169 $ 159,341 $ 3,168
========= ========= ========= ========= ========= ========= =========
OTHER FINANCIAL DATA:
Net cash provided by operating
activities......................... $ 282,319 $ 306,205 $ 454,383 $ 167,305 $ 267,073 $ 372,756 $ 132,178
EBITDA(1)............................ 803,270 737,224 429,146 383,677 450,306 334,396 295,693
Capital expenditures................. 117,027 64,831 92,656 150,229 146,883 102,031 56,578
Depreciation......................... 273,448 274,551 191,672 193,112 177,511 131,676 110,924
</TABLE>
S-31
<PAGE> 32
<TABLE>
<CAPTION>
AS OF
AS OF DECEMBER 31, SEPTEMBER 30,
-------------------------------------------------------------- -------------
1992 1993 1994 1995 1996 1997
---------- ---------- ---------- ---------- ---------- -------------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.................... $ 6,970 $ 4,600 $ 8,098 $ 10,414 $ 4,258 $ 6,278
Current assets............................... 1,160,630 597,471 730,683 561,748 1,033,007 969,042
Total assets................................. 7,963,108 7,276,792 7,330,820 7,095,494 6,652,362 6,510,513
Current liabilities.......................... 649,657 581,902 533,622 513,620 961,614 887,361
ESOP debt.................................... -- -- -- -- 1,386,026 1,386,026
Long-term debt............................... 684,483 83,462 32,802 874,899 1,632,696 1,600,000
Minority interests in equity of
subsidiaries............................... -- 12,985 5,870 5,349 8,076 7,456
Common stockholder's equity.................. 3,981,540 4,228,001 4,372,210 3,328,038 692,641 700,884
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------- -------------
1992 1993 1994 1995 1996 1996 1997
----- ----- ----- ----- ----- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
NGPL
Transportation volumes (Bcf)...................................... 1,364 1,408 1,318 1,318 1,284 935 788
MidCon Texas
Sales volumes (Bcf)............................................... 244 211 198 238 239 183 201
Transportation volumes (Bcf)...................................... 238 201 215 215 271 201 229
MidCon Gas Services
Sales volumes (Bcf)............................................... 224 211 351 410 460 312 374
MidCon Gas Products
Natural gas liquids sales volumes (MM Gal)........................ 215 179 124 160 174 135 109
</TABLE>
<TABLE>
<CAPTION>
AS OF
SEPTEMBER 30,
1997
------------------
<S> <C> <C> <C>
Miles of pipeline(2)
Interstate.................................................................. 10,049
Intrastate.................................................................. 2,617
Offshore.................................................................... 702
Gathering and processing.................................................... 2,379
Gas processing plants
Number of plants............................................................ 4
Total processing capacity (MMcf per day).................................... 750
Natural gas storage facilities
Number of storage facilities................................................ 9
Total withdrawal capacity (Bcf per day)..................................... 4.4
</TABLE>
- ---------------
(1) EBITDA represents net income plus income taxes, interest expense and
depletion, depreciation, and amortization expense. EBITDA is not presented
as an indicator of MidCon's operating performance, an indicator of cash
available for discretionary spending or as a measure of liquidity. EBITDA
may not be comparable to other similarly titled measures of other companies.
(2) Does not include 2,600 miles of leased pipelines from MidCon Texas.
S-32
<PAGE> 33
THE COMBINED COMPANY
As a result of the Acquisition, K N Energy is one of the largest integrated
natural gas companies in the United States. On a pro forma basis as of September
30, 1997, the Company owned and/or operated approximately 25,800 miles of
interstate, intrastate and offshore natural gas transmission pipeline,
approximately 11,100 miles of gathering pipeline, approximately 7,100 miles of
local distribution pipeline (excluding K N's Kansas natural gas distribution
assets) and 16 storage facilities with storage capacity of more than 230 Bcf of
working gas. On a pro forma basis, the Company is also one of the largest
transporters and marketers of natural gas in the United States with average
sales volumes of approximately 3.7 Bcf of natural gas per day and average
transportation volumes of approximately 5.1 Bcf of natural gas per day. On a pro
forma basis as of September 30, 1997, the Company had $8.2 billion in assets,
and pro forma for the year ended December 31, 1996, the Company had operating
revenues of $4.0 billion, operating income of $399.5 million and net income of
$71.0 million.
In addition to significantly increasing the Company's size and scope of
operations as well as its geographic presence, management believes the
Acquisition also provides K N with a strong platform for future growth. On a pro
forma basis, the Company now has pipeline assets in 15 states and access to
several of the largest natural gas markets in the United States, including
Chicago, Houston, Kansas City and Denver. In addition, the combined company has
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. As a result of the Acquisition, the Company is 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. Management believes the
Acquisition also significantly broadens the Company's retail presence in both
the residential and small business market segments.
BUSINESS STRATEGY
The Company's strategy is to enhance its assets and operations along all
segments of the natural gas "value stream" by increasing access to supplies of
natural gas for the Company's upstream gathering and processing facilities,
delivering that supply through K N's midstream transmission pipelines and
marketing that supply to a broad range of downstream end users, including
utility, residential, commercial, agricultural and industrial customers. The
Company believes that it has developed several competitive strengths that will
enable it to continue to successfully implement this strategy, including: (i)
extensive natural gas infrastructure from the wellhead to the burner tip, (ii)
access to natural gas supplies in several of the largest domestic natural gas
producing areas, (iii) access to natural gas markets in some of the largest
natural gas consuming areas in the Midwest, Texas and the Rocky Mountains, (iv)
a management team which combines an entrepreneurial spirit with significant
experience in the natural gas industry, (v) a strong track record of quickly and
successfully integrating acquisitions and (vi) a commitment to provide superior
customer service. Management believes the Acquisition is consistent with the
Company's strategy. The key elements of the Company's strategy include the
following:
Optimize operation of the Company's assets
Over the past several years, K N has been able to generate significant
value through the improved operation of its assets. With the Acquisition, the
Company has identified several opportunities for the optimization of operations
through the integration and consolidation of MidCon's assets with those of K N.
By connecting pipelines to proximate gathering facilities, relocating processing
facilities and reconfiguring certain operations, the Company believes it can
increase throughput, lower costs and thereby significantly improve operating
results of these assets. Specifically, K N plans to integrate and consolidate
its gathering, processing and intrastate pipelines in West Texas with MidCon's
assets in the region. K N also plans to build an interconnect between the
Amarillo Line of MidCon's NGPL pipeline and K N's Bushton natural gas processing
plant. In addition, the Company believes that the combination of K N's supply
area storage with MidCon's market area storage provides additional opportunities
for the Company to arbitrage regional and seasonal natural gas price
differentials.
S-33
<PAGE> 34
Aggressively pursue new markets
K N will continue to pursue opportunities to gain additional market share
along the MidCon and K N pipeline systems. K N is currently executing this
strategy by expanding its marketing presence in the Denver metropolitan area
through construction of the Front Runner Pipeline, and in Kansas City through
the construction of an additional lateral pipeline. Both of these cities
represent markets that the Company believes have been historically underserved
by gas pipelines and that are easily reached through extensions of K N's current
pipelines. The Company believes that, given MidCon's pipeline system and its
low-cost position, the Acquisition also provides significant additional
opportunities to continue to access new markets and significantly increases the
Company's market share.
Leverage regulated assets by developing complementary unregulated businesses
K N seeks to build or acquire unregulated businesses that complement its
core regulated assets. A key component of K N's growth has been its ability to
evolve from a 99% regulated entity in 1990 to a 45% regulated entity at
September 30, 1997, based on operating income. As an example of this strategy, K
N has successfully taken advantage of several unregulated gathering, processing
and marketing opportunities in the Rocky Mountains and Midwest in conjunction
with the development and operation of its regulated Pony Express Pipeline.
Management believes that MidCon's assets, which are largely regulated, present
additional opportunities for K N to continue to pursue this strategy. For the
year ended December 31, 1996, approximately 70% of the Company's pro forma
operating income was derived from regulated assets, compared with approximately
45% for K N's historical business on a stand-alone basis. The Company's goal is
to increase the operating income derived from unregulated assets to
approximately 50% over time. The Company also believes it can improve the
profitability of certain of MidCon's gathering assets through a spin-down of
such assets from a regulated affiliate to unregulated affiliates. By
transferring these assets to unregulated affiliates, the Company believes it
will be able to increase operational flexibility, lower costs, and take
advantage of opportunities to increase system throughput.
Pursue strategic acquisitions, alliances, joint ventures and partnerships
K N will continue to pursue acquisitions and strategic alliances that
create new business opportunities and enhance its existing operations. The
Company maintains a highly disciplined approach to acquisitions in order to
identify investments that logically expand K N's business into contiguous
markets, help increase economies of scale or provide opportunities to leverage
regulated businesses by developing complementary unregulated businesses. The
Company has established a number of strategic alliances, joint ventures and
partnerships to reach its goals. For example, the Wildhorse gathering and
marketing joint venture with TBI, pursuant to which TBI has dedicated all of its
uncommitted Rocky Mountain gas production, has enhanced the Company's access to
gas supply. The Company also formed a partnership to develop the TransColorado
pipeline and provide increased market access for isolated Rocky Mountain gas. In
1997, the Company and PacifiCorp Holdings, Inc. formed EN-able, a joint venture
to exploit retail opportunities presented by deregulation of the retail electric
and gas utility industries. The Company believes that the Acquisition provides
not only a significant platform from which to pursue additional complementary
acquisitions, but also greatly enhances the value of K N as a potential partner.
Maintain and enhance the Company's position as a low-cost provider
The Company is a low-cost provider of natural gas gathering, processing and
transportation services and is constantly seeking opportunities to further
reduce costs without compromising safety or sacrificing customer service. Recent
operational changes consistent with this strategy include re-routing gas from
high cost plants into the more efficient Bushton complex and the exchange of
underperforming assets in Texas for transmission assets needed to transport new
gathering volumes and which enhanced the performance of other K N assets. NGPL
is currently one of the lowest cost transporters of gas in the Mid-Continent
region and, as a result, management believes that the Company is now in an even
stronger position to preserve or increase market share than its higher-cost
competitors, particularly in the event that additional gas comes into the
Chicago market from Canada. In addition, the increased access to additional
supply sources from MidCon's pipelines
S-34
<PAGE> 35
should support K N's low-cost position. The Company expects to realize annual
operating and administrative savings beginning in 1998 due primarily to the
consolidation of operations and activities that are duplicative with those of
MidCon and improved utilization of assets.
Expand the Company's retail presence
In order to take advantage of the rapidly changing competitive landscape in
the utility industry, the Company has developed value-added products and
services to offer to customers beyond the traditional energy commodity. As part
of this strategy, K N developed Simple Choice which offers consumers, through
their local utilities, a bundled package of energy, communications and
entertainment products serviced through one call and itemized on one bill. The
Simple Choice package of services is marketed to other utilities through the
Company's EN-able joint venture with PacifiCorp Holdings, Inc. By licensing
Simple Choice to other gas, electric and water utilities, EN-able creates
partnerships that allow utility partners to play a broader role in providing a
range of products and services to the home, and allows EN-able to build a larger
retail presence in the marketplace more quickly than it could on its own.
EN-able also provides back-office support to its utility partners, including
infrastructure support for customer care and billing functions and marketing
channels. Management believes MidCon's retail marketing operations, which are
conducted through mc(2) and which market gas and electricity principally to
commercial and industrial customers, complement the operations of EN-able.
INDUSTRY OVERVIEW
Evolution of the Natural Gas Business
Participants in the natural gas industry in the United States generally
fall into three principal categories: production, transmission and distribution
companies. Production companies explore for and develop natural gas reserves.
Gathering, processing and transmission companies gather and process natural gas
from the field and transport the gathered and processed gas to wholesale
customers, including local distribution companies ("LDCs") and large industrial
users, around the country through interstate and intrastate pipelines. LDCs
purchase, transport, distribute and resell natural gas to end users, including
residential, commercial or industrial gas customers.
Beginning in the mid-1980's, the FERC exercised its broad regulatory
authority and undertook the process of deregulating the natural gas industry.
Traditionally, a pipeline company's numerous gas services to utilities and other
end users, such as sales, local transportation and storage, had been tied
together and offered to customers as a single "bundled" product at one price.
The final deregulation order, FERC Order 636, which became effective at the end
of 1993, required natural gas companies to "unbundle" these services and
separately price each component, thus introducing market-driven competition
within the natural gas transmission industry and allowing large volume customers
to choose a natural gas supplier. See "Regulation." As a result of deregulation,
natural gas companies have focused their efforts on increasing the quality and
scope of their products and services in order to attract and retain customers as
well as take advantage of higher margin business activities. In addition, there
has been significant consolidation in the industry involving gas gathering,
processing, transmission and marketing assets as companies have sought to
increase the size and scope of their operations to achieve economies of scale
and gain market share.
While FERC Order 636 has primarily impacted large commercial and industrial
customers, the process of deregulation has now turned toward the LDCs with state
regulators beginning to require LDCs to also unbundle charges for their various
services. In a fully deregulated environment, large and small customers will no
longer be forced to buy their natural gas products and services from a utility
and instead will be free to choose from a variety of energy suppliers based on,
among other things, service, price and variety of other product offerings. In
addition, access to wholesale and retail markets, economies of scale and product
innovation will be critical factors for success.
S-35
<PAGE> 36
Natural Gas Supply and Demand Dynamics
Since 1986, the market share for natural gas in the United States has
steadily increased as its image as an economical, reliable and clean-burning
fuel has improved. In addition, technological innovations such as 3-D seismic
imaging, improved directional drilling equipment and techniques, and new
deepwater production technologies have served to lower the cost of discovering
and developing new reserves. Based on Energy Information Administration (the
"EIA") statistics, between 1991 and 1996, consumption of natural gas in the
United States increased from 19.0 Tcf to 22.0 Tcf, representing a compound
annual growth rate of 3.0%. The EIA projects that the demand for natural gas
will increase to 24.7 Tcf by the year 2000 and to 25.5 Tcf by the year 2002.
In the United States, there are four major market sectors for the
consumption of natural gas -- residential, commercial, industrial and electric
utilities. Of these four sectors, based on EIA statistics, the industrial market
is the single largest in terms of gas consumption accounting for approximately
40% of all U.S. gas consumption in 1996 followed by the residential, commercial
and electric utility sectors with 24%, 14% and 12%, respectively, for the same
period. It is generally expected that the industrial market will continue to
remain the largest market. However, this expectation could change as a result of
the outcome of electric utility deregulation which, if it drives the
construction of additional gas-fired generating facilities, could significantly
increase the demand for natural gas. While the overall demand for natural gas is
expected to increase, given that space heating is the single largest use for gas
across all market sectors, winter weather patterns will continue to be a key
determinant of the changes in natural gas demand from year-to-year and the
market will always be subject to some degree of volatility.
Based on EIA statistics, in terms of regional demand, the Midwest and South
Central regions are the highest consuming regions accounting for an annual
average of 25.3% and 29.6%, respectively, of total annual consumption in the
country. Since 1991, however, the Northeast and Southeast have been the fastest
growing regional markets with compound annual growth rates of 4.9% and 4.5%,
respectively. Within these regions, the industrial segment in the Northeast and
the electric utility segment in the Southeast have the highest compound annual
growth rates at 10.3% and 5.8%, respectively, during this time period. These
growth rates have largely been driven by the construction of new cogeneration
facilities in the Northeast and the increased gas and electric utility load
resulting from population migration in the Southeast.
In response to the growing demand for natural gas, activities related to
the production of natural gas have also increased. Historically, the majority of
the supply of natural gas in the United States has been sourced from the Gulf
Coast, Mid-Continent, San Juan Basin and the Permian Basin and, to a lesser
extent, Western Canada. In the next few years, it is expected that the increase
in demand for natural gas will be met primarily by an increase in production
from the Rocky Mountains, Western Canada and the deepwater Gulf of Mexico.
S-36
<PAGE> 37
K N ENERGY, INC.
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 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. As described further below,
certain of the Company's operations are regulated by various federal and state
entities. For the nine months ended September 30, 1997, approximately 45% of the
Company's operating income was derived from regulated assets.
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 12,700 miles of pipeline in seven states and operates 18 gas
processing plants in five states and natural gas storage facilities in West
Texas and on the Gulf Coast. For the nine months ended September 30, 1997, this
business segment accounted for approximately 55% 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 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 its Board of Directors' approved guidelines, the Company engages in
these activities only as a hedging mechanism against 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 540 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 180 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 100 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.
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In addition to the above systems, K N recently acquired two gathering
systems in the Rocky Mountains which gather in aggregate approximately 360 MMcf
per day. In December 1997, K N purchased a 60% interest in the Red Cedar
Gathering System in the San Juan Basin of New Mexico. The Red Cedar system
gathers approximated 340 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, a joint venture between K N and 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 leasehold
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 plant. During the nine
months ending September 30, 1997, these facilities processed and treated more
than 75 MMcf of natural gas per day.
At September 30, 1997, the Company's gathering, processing and marketing
segment operated 18 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 more than 2
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 nine months ended
September 30, 1997, the Company's gathering, processing and marketing operations
sold an average of approximately 1.3 Bcf of natural gas per day before
intersegment eliminations. In addition, the recently-acquired Interenergy assets
included a marketing operation which sold 342 MMcf of natural gas per day to
approximately 650 customers in 1997.
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 September 30, 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
September 30, 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.
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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 nine months ended September 30, 1997, this business
segment accounted for approximately 22% of consolidated operating income. As of
September 30, 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 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 Pipeline Co. ("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
September 30, 1997.
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 nine months ended September 30, 1997, this business segment accounted
for approximately 22% 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 September 30, 1997. These intrastate pipeline systems serve industrial
customers and much of the Company's retail natural gas business in Colorado and
Wyoming. As of September 30, 1997, the Company's retail natural gas business
served over 200,000 customers in Colorado, Nebraska and Wyoming through
approximately 7,100 miles of distribution pipelines (excluding the Company's
Kansas natural gas distribution assets which the Company entered into an
agreement to sell in
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December 1997, and which sale is expected to be consummated in the second
quarter 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
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 September 30, 1997 was 107 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. The Company plans to open additional stores in 1998 and is
engaged in efforts to create Simple Choice partnerships and licensing agreements
with other utilities.
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. 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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MIDCON CORP.
OVERVIEW
MidCon is engaged in the purchase, gathering, processing, transmission,
storage and sale of natural gas to utilities, municipalities and industrial and
commercial users. MidCon also purchases electricity from electric utilities, and
other electric power producers and marketers and resells the electricity to
wholesale and end-use customers.
MidCon's operations are conducted through its principal subsidiaries: NGPL,
which owns and operates a major interstate pipeline transmission system and
related assets; MidCon Texas Pipeline Operator, Inc. ("MidCon Texas"), which
operates an intrastate pipeline system in Texas; MidCon Gas Services Corp.
("MidCon Gas"), which purchases and sells natural gas and arranges for the
transportation and storage of such gas; MidCon Power Services Corp. ("MidCon
Power"), which purchases electricity from electric utilities and other electric
power producers and marketers, resells electricity to wholesale customers and
arranges for the transmission of such power; mc(2) Inc. ("mc(2)"), which markets
natural gas and electricity at the retail level; and MidCon Gas Products Corp.
("MidCon Gas Products"), which gathers and processes natural gas. In addition,
MidCon also has equity investments in several other natural gas pipelines.
INTERSTATE AND INTRASTATE TRANSPORTATION SERVICES
MidCon's pipeline subsidiaries operate over 13,000 miles of natural gas
pipelines which are strategically located in the center of the North American
pipeline grid. This pipeline network provides access not only to the major
supply areas in the Gulf of Mexico, the Gulf Coast, the Permian Basin, the
Mid-Continent, the Rocky Mountains and Western Canada, but also to the major
consuming markets in the Midwest and along the Gulf Coast.
Transportation and Sales
NGPL owns and operates over 10,000 miles of pipeline, consisting of two
major interconnected transmission pipelines terminating in the Chicago
metropolitan area. One pipeline -- known as the "Amarillo Line" -- originates in
the West Texas and New Mexico producing areas and is comprised of approximately
5,500 miles of mainline and various small-diameter pipelines. The other
pipeline -- known as the "Gulf Coast Line" -- originates in the Gulf Coast areas
of Texas and Louisiana and consists of approximately 4,900 miles of mainline and
various small-diameter pipelines. These two main pipelines are connected at
points in Texas and Oklahoma by NGPL's 240-mile Amarillo/Gulf Coast ("A/G")
pipeline. In addition, a 105-mile pipeline runs from the Arkoma Basin gas
producing area of eastern Oklahoma to the A/G pipeline. NGPL also owns a
pipeline which extends from the Gulf Coast Line in Texas into southwestern
Louisiana. The system is powered by 61 compressor stations in mainline and
storage service having an aggregate of approximately 1.0 million horsepower.
NGPL's system has over 1,700 points of interconnection with 31 interstate
pipelines, 24 intrastate pipelines and 54 LDCs and end-users, thereby providing
significant flexibility in the receipt and delivery of gas.
MidCon Texas operates an intrastate pipeline system, located primarily in
the Texas Gulf Coast area, which it leases from an Occidental affiliate under a
30-year lease which commenced on December 31, 1996. The system includes
approximately 2,600 miles of pipelines, supply lines, sales laterals and related
facilities and has 22 interconnects with other pipelines. A subsidiary of MidCon
Gas owns a separate Texas intrastate pipeline system (the "Palo Duro System")
that includes approximately 400 miles of pipeline and related facilities. The
Palo Duro System is leased to a nonaffiliate.
Pursuant to transportation agreements and FERC tariff provisions, NGPL
offers both firm transportation service and interruptible transportation
service. Under NGPL's tariff, firm transportation customers pay reservation
charges each month, irrespective of volumes actually transported. Interruptible
transportation customers pay a commodity charge based upon actual volumes
transported. Reservation and commodity charges are both based upon geographical
location, time of year and distance of the transportation service provided.
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NGPL's principal delivery market area encompasses the states of Illinois,
Indiana and Iowa and portions of Wisconsin, Nebraska, Kansas, Missouri and
Arkansas. NGPL is one of the largest transporters of natural gas to the Chicago
market, and its cost of service is one of the lowest in the region. In 1996,
NGPL delivered an average of 2.2 Bcf per day of natural gas, representing 60% of
the total natural gas delivered to the Chicago metropolitan area during the same
period. Given its strategic location at the center of the North American
pipeline grid, Chicago is likely to continue to be a major natural gas trading
hub for the rapidly growing demand markets in the Midwest and Northeast.
Approximately 100% of NGPL's pipeline capacity to Chicago is committed under
firm transportation services. As of November 1, 1997, approximately 22% of the
total volume committed to be transported under NGPL's firm transportation
contracts had remaining terms in excess of 3 years.
In January 1997, NGPL and a subsidiary of NIPSCO Industries, Inc.
("NIPSCO") completed construction of a 100 MMcf per day pipeline interconnection
in the Chicago metropolitan area between their respective pipeline systems, thus
providing NGPL with additional access to markets east of Chicago.
Unlike NGPL, MidCon Texas acts as a merchant provider of natural gas as
well as a transporter. Texas is the largest producer of and the largest
consuming market for natural gas in the United States. Principal customers of
MidCon Texas include the electric and natural gas utilities that serve the
Houston area and industrial customers located along the Houston Ship Channel and
in the Beaumont/Port Arthur area. For 1997, MidCon Texas delivered an average of
1.6 Bcf per day of natural gas, representing approximately 16% of the total
natural gas deliveries in Texas and about 35% of the total deliveries in the
Houston market.
Deliveries of gas by MidCon's pipelines include both volumes sold by the
pipelines and their marketing affiliates and volumes owned by others which are
transported. The following table sets forth the gas volumes sold to, or
transported for, nonaffiliates by NGPL, MidCon Texas and MidCon Gas for each of
the periods indicated:
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED DECEMBER 31, ENDED
-------------------------- SEPTEMBER 30,
1994 1995 1996 1997
------ ------ ------ -------------
(IN BCF)
<S> <C> <C> <C> <C>
NGPL
Transportation...................... 1,318 1,318 1,284 788
MidCon Texas
Sales............................... 198 238 239 201
Transportation...................... 215 215 271 229
MidCon Gas Services
Sales............................... 351 410 460 374
</TABLE>
Sales volumes shown in the foregoing table for MidCon Texas include sales
deliveries by a marketing affiliate to nonaffiliates. The table does not include
gas transported by NGPL for affiliates for sale to nonaffiliates of
approximately 220 Bcf, 221 Bcf, 220 Bcf and 183 Bcf for the years ended December
31, 1994, 1995 and 1996 and the nine months ended September 30, 1997,
respectively. The table also does not show volumes of gas that have been
auctioned by NGPL following the termination of its traditional gas sales service
on December 1, 1993.
NGPL also furnishes transportation service for others to and from many
other locations on its pipeline system and, in recent years, has increased
transportation deliveries to markets outside the Chicago metropolitan area.
Competition for such service may be provided by one or more other pipelines,
depending upon the nature of the transportation service required. Transportation
rates, service options and available pipeline capacity and, in some cases, the
availability of, and rates for, storage services are the key factors in
determining NGPL's ability to compete for particular transportation business.
In 1996, Trailblazer Pipeline Company ("Trailblazer"), a regulated natural
gas transmission business funded by a general partnership in which a subsidiary
of NGPL owns a one-third interest, signed 10-year agreements with six shippers
for additional firm transportation service. To accommodate these additional
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service requirements, Trailblazer installed compression to increase pipeline
capacity by approximately 75 MMcf per day. The new compression facilities went
into service during the summer of 1997. Trailblazer's system runs from eastern
Colorado to eastern Nebraska and transports gas produced in the Rocky Mountains.
NGPL is the operator of the pipeline. Trailblazer moved approximately 194 Bcf of
gas in 1996.
Subsidiaries of MidCon also own interests in several regulated natural gas
pipeline systems which are accounted for as equity investments. In the Gulf
Coast area, these subsidiaries own 20% to 50% of three pipeline ventures that
operate approximately 550 miles of pipeline in the Gulf of Mexico and NGPL owns
interests, of varying percentages, in approximately 250 miles of jointly-owned
supply laterals that also operate in the Gulf of Mexico. The joint ventures
transport gas onshore from producers in the offshore Louisiana and Texas areas
for various customers. Onshore, NGPL subsidiaries own interests of 18 and
33 1/3%, in Overthrust Pipeline Company and Trailblazer, respectively, that
operate approximately 520 miles of pipelines in Wyoming, Colorado and Nebraska.
Storage
NGPL is one of the nation's largest storage operators with approximately
600 Bcf of total natural gas storage capacity, over 200 Bcf of working gas, and
up to 4.4 Bcf per day of peak deliverability from its facilities which are
strategically located near the markets MidCon services. NGPL owns and operates
nine underground storage fields in four states to provide services to NGPL's
customers and to support pipeline deliveries during the winter when demand for
natural gas is higher.
NGPL provides firm and interruptible gas storage service pursuant to
storage agreements and FERC-approved tariffs. Firm storage customers pay a
monthly demand charge irrespective of actual volumes stored. Interruptible
storage customers pay a monthly commodity charge based upon actual volumes of
gas stored.
MidCon Texas also developed a salt dome storage facility located near
Markham, Texas with a subsidiary of NIPSCO. The facility has two salt dome
caverns and an estimated 8.3 Bcf of total capacity, 5.7 Bcf of working storage
capacity and 500 MMcf per day of withdrawal capacity. The storage facility is
leased by a partnership in which subsidiaries of MidCon and NIPSCO are equal
partners. MidCon Texas has executed a 20-year sublease with the partnership
under which it has rights to 50% of the facility's working gas capacity, 85% of
its withdrawal capacity and approximately 70% of its injection capacity.
These storage assets further complement the pipeline facilities and allow
MidCon to optimize deliveries on its pipelines and meet peak delivery
requirements in its principal markets.
GATHERING, PROCESSING AND MARKETING SERVICES
MidCon, through its subsidiaries, is engaged in the gathering and
processing of natural gas. These subsidiaries process natural gas in four
facilities and own and operate four gathering systems located in Texas and New
Mexico. During 1997, MidCon subsidiaries produced approximately 8.8 MBbls per
day of natural gas liquids and gathered 160 MMcf per day of natural gas.
MidCon Texas purchases its gas supplies from producers and, to a lesser
extent, from other pipeline companies or their subsidiaries. MidCon Gas
purchases gas supplies primarily from producers and other gas marketers. MidCon
Gas maintains inventories of gas supplies in storage facilities of its
affiliates and other pipeline companies. MidCon Gas uses futures contracts,
options and swaps to hedge the impact of natural gas price fluctuations.
MidCon Power was formed in 1995 to provide marketing services to the
electric power industry and to prepare for anticipated opportunities as the
electric power market begins to unbundle. MidCon Power began trading wholesale
power in late 1995. In 1997, MidCon Power traded over 4.3 million megawatt
hours.
RETAIL NATURAL GAS SERVICES
MidCon formed mc(2) in February 1997 to extend its skills in marketing
natural gas and electricity to retail customers including small industrial,
commercial and, as regulation ultimately allows, residential end-users.
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These customer groups constitute over one-half of the natural gas and two-thirds
of the electricity consumed in the United States annually and MidCon believes
that substantial opportunities exist for selling natural gas supply products
that are simple, reliable and cost-competitive. In providing energy services,
mc(2) works in a coordinated effort with MidCon Gas and MidCon Power, with these
two entities acting as exclusive energy providers to mc(2).
In February 1997 mc(2) initiated its service in the market area surrounding
Chicago, an area where MidCon has a strong competitive position, and the New
York City metropolitan market, an area where unbundling efforts and utility
tariffs provide opportunities for profit. Mc(2) currently serves over 10,000
commercial natural gas customers in Illinois, Pennsylvania, New York and New
Jersey and has begun marketing in Ohio. Several thousand customers were added in
August 1997 when mc(2) acquired certain assets of Norstar Energy Limited
Partnership ("Norstar"). The former Norstar customers account for annual sales
of about 8 Bcf of natural gas.
In September 1997, mc(2) began offering electric service to commercial
customers by participating in Pennsylvania's statewide pilot program, one of the
first of its kind in the nation. The plan allows up to 5% of each customer class
at each utility to self-nominate a supplier other than the local electric
utility. By aggressively focusing on two key markets during a two-week
nomination window, mc(2) signed up over 400 businesses served by three utilities
in Pittsburgh and Philadelphia.
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REGULATION
FEDERAL AND STATE REGULATION
Both the performance of interstate transportation and storage services by
natural gas companies, including interstate pipeline companies, and the rates
charged for such services, are regulated by the FERC under the Natural Gas Act,
and, to a lesser extent, the Natural Gas Policy Act.
Legislative and regulatory changes began in 1978 with the passage of the
Natural Gas Policy Act, pursuant to which the process of deregulation of gas
sold at the wellhead was commenced. The restructuring of the natural gas
industry continued with the adoption of (i) Order 380 in 1984, which eliminated
purchasers' minimum bill obligations to the pipelines, thus making gas purchased
from third parties, particularly on the spot market, more economically
attractive relative to gas purchased from pipelines and (ii) Order 436 in 1985,
which provided that interstate transportation of gas under blanket or
self-implementing authority must be provided on an open-access,
non-discriminatory basis. After Order 436 was partially overturned in federal
court, the FERC issued Order 500 in August 1987 as an interim rule intended to
readopt the basic thrust of the regulations promulgated by Order 436. Order 500
was amended by Orders 500 A through L. The FERC's stated purpose in issuing
Orders 436 and 500, as amended, was to create a more competitive environment in
the natural gas marketplace. This purpose continued with Order 497, issued in
June 1988, which set forth new standards and guidelines imposing certain
constraints on the interaction of interstate pipelines and their marketing
affiliates and imposing certain disclosure requirements regarding that
interaction.
Order 636, issued in April 1992, as amended, was a continuation of the
FERC's efforts to improve the competitive structure of the pipeline industry and
maximize the consumer benefits of a competitive structure of the pipeline
industry and a competitive wellhead gas market. In Order 636, the FERC required
interstate pipelines that perform open access transportation under blanket
certificates to "unbundle" or separate their traditional merchant sales services
from their transportation and storage services and to provide comparable
transportation and storage services with respect to all gas supplies whether
purchased from the pipeline or from other merchants such as marketers or
producers. The pipelines must now separately state the applicable rates for each
unbundled service (i.e., for the gas commodity, transportation and storage).
Specifically, Order 636 contains the following procedures to increase
competition in the industry: (i) requiring the unbundling of sales services from
other services, meaning that only a separately identified merchant division of
the pipeline could sell gas at points of entry into the pipeline system; (ii)
permitting holders of firm capacity to release all or a part of their capacity
for resale by the pipeline either to the highest bidder or, under short-term or
maximum rate releases, to shippers in a prepackaged release, with revenues in
both instances credited to the releasing shipper; (iii) allowing shippers to use
other receipt points and delivery points on the system, subject to the rights of
other shippers to use those points as their primary receipt and delivery points;
(iv) the issuance of blanket sales certificates to interstate pipelines for
unbundled services; (v) the continuation of pregranted abandonment of previously
committed pipeline sales and transportation services, subject to certain rights
of first refusal, which should make unused pipeline capacity available to other
shippers and clear the way for excess transportation services to be reallocated
to the marketplace; (vi) requiring that firm and interruptible transportation
services be provided by the pipelines to all parties on a comparable basis; and
(vii) generally requiring that pipelines derive transportation rates using a
straight-fixed-variable rate method which places all fixed costs in a fixed
reservation fee that is payable without regard to usage, as opposed to the
previously used modified fixed-variable method that allocated a part of the
pipelines' fixed costs to the usage fee. The FERC's stated position is that the
straight-fixed-variable method promotes the goal of a competitive national gas
market by increasing the cost of unnecessarily holding firm capacity rather than
releasing it, and is consistent with its directive to unbundle the pipelines'
traditional merchant sales services. Order 636 has been affirmed in all material
respects upon judicial review and the Company's own FERC order approving its
unbundling plan is final and not subject to any pending judicial review.
NGPL has been a party to a number of contracts that required NGPL to
purchase natural gas at prices in excess of the prevailing market price. As a
result of Order 636 prohibiting interstate pipelines from using their gas
transportation and storage facilities to market gas to sales customers, NGPL no
longer had a sales market for the gas it is required to purchase under these
contracts. Order 636 went into effect on NGPL's system on December 1, 1993. NGPL
has agreed to pay substantial transition costs to reform these contracts with
gas
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suppliers. Under settlement agreements reached by NGPL and its former sales
customers, NGPL recovered from those customers over a four year period beginning
December 1, 1993, a significant amount of the gas supply realignment (GSR)
costs. The FERC has also permitted NGPL to implement a tariff mechanism to
recover additional portions of its GSR costs in rates charged to transportation
customers that were not party to the settlements. In July 1996, a Federal
appellate court remanded Order 636 to the FERC for further explanation of
aspects of its decision regarding recovery of GSR costs by interstate pipelines.
Because of the settlements and FERC orders authorizing NGPL's GSR cost recovery
mechanism, the remand is not expected to have any significant impact on NGPL.
The FERC has allowed GSR rates to go into effect on December 1, 1997, subject to
refund, to recover any shortfall in recoveries of GSR costs allocated to
interruptible transportation. However, the FERC rejected NGPL's filing for
rehearing that NGPL be allowed to recoup a portion of any shortfall on title
transfers and interruptible transportation to pooling points.
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 Company
plans to transfer MidCon's gathering facilities to a wholly owned subsidiary in
order to make such facilities nonjurisdictional. See "The Combined
Company -- Business Strategy."
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 (including MidCon Texas') 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. See "The Combined Company -- Business Strategy." The Company is also
subject to the requirements of FERC Order Nos. 497, et seq. and
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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.
On December 1, 1992, NGPL filed with the FERC for a general rate increase
to recover higher operating costs. The FERC permitted NGPL to put the new rates
into effect on June 1, 1993, subject to refund. In November 1994, NGPL filed a
proposed settlement of the rate case with the FERC. The settlement was approved
by the FERC in January 1995. This settlement resulted in refunds being made to
customers of approximately $128 million in 1995.
On June 1, 1995, NGPL filed a general rate case with the FERC to establish
new rates as well as new or revised services. The FERC permitted NGPL to place
new rates into effect, subject to refund, on December 1, 1995. This date
corresponded to the effective date of new transportation and storage agreements
between NGPL and its principal local distribution customers. Major issues in the
rate case included the terms and conditions of new services, throughput levels
used in the design of rates, discounting adjustments, levels of depreciation
rates and return on investment, and the levels used in the design of fuel rates.
In May 1996, NGPL filed with the FERC an offer of settlement to resolve the
remaining issues in the proceeding. On November 3, 1997, the FERC approved a
settlement of this rate case substantially consistent with what NGPL proposed.
This settlement of the rate case has had a favorable impact of approximately $9
million on operating margin for the ten months ended October 31, 1997. The
FERC's order approving the settlement is final and not subject to rehearing or
judicial review.
In January 1997, Amoco Production Company and Amoco Energy Trading
Corporation ("Amoco") filed a complaint against NGPL before the FERC contending
that NGPL had improperly provided its affiliate, MidCon Gas, transportation
service on preferential terms, seeking termination of currently effective
contracts and the imposition of civil penalties. A subsequent FERC staff audit
made proposed findings that NGPL has favored MidCon Gas, which NGPL has
challenged. In July, Amoco and NGPL agreed to a settlement of this proceeding.
Amoco has filed to withdraw its complaint subject to the FERC's procedures.
Several intervenors have opposed the withdrawal of the complaint and NGPL has
filed an answer to that opposition. By orders issued January 16, 1998, the FERC
ruled that NGPL had violated certain of the FERC's regulations regarding its
business relationships with its affiliate, MidCon Gas. Relying upon its
authority under the Natural Gas Policy Act, the FERC provided notice to NGPL
that, in addition to other remedial action, it proposes to assess civil
penalties of $8,840,000. Such orders also required NGPL to take certain other
actions, including making a new tariff filing, and imposed certain restrictions
on the sharing of employees by NGPL and MidCon Gas. The FERC is proposing to
suspend one-half of the penalty provided that for two years following the date
of the order NGPL does not violate specified sections of the FERC's regulations.
Pursuant to the provisions of the Natural Gas Policy Act and Natural Gas Act,
NGPL has thirty days to seek rehearing of the order and its findings as well as
provide the FERC with any factual or legal arguments that it believes may
justify reduction or remission by the FERC of the amount of penalty proposed in
the order. The Company is reviewing the orders and is considering whether, and
to what extent, to avail itself of its rights to further contest the provisions.
In addition, other parties to the proceeding may seek rehearing. The Company
does not believe the ultimate resolution of these issues will have a material
adverse affect on its operations and results.
In January 1998, the Company's subsidiary, K N Interstate Pipeline Co. ("K
N Interstate") filed a rate case requesting an increase in its rates which would
result in additional annual revenues of $32.4 million. The Company anticipates
that the FERC will accept the filing and suspend 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. The Company also anticipates
that there will be interventions by interested parties including its customers
and that there will be additional proceedings before the FERC to resolve
differences. As indicated under "Risk Factors -- Regulation; Pending Regulatory
Proceedings," the Company will pursue a negotiated resolution of any differences
but the Company cannot predict with certainty whether the regulatory proceedings
will be resolved through a negotiated settlement or through administrative
litigation. The Company's interstate pipeline business could be adversely
affected by an unsatisfactory outcome.
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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.
ENVIRONMENTAL REGULATION
The Company's operations and properties, including those of MidCon, 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 or human health and safety.
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. These laws and regulations
can also impose liability for remedial costs on the owner or operator of
properties or the generators of waste materials, regardless of fault. Moreover,
the recent trends toward stricter standards in environmental legislation and
regulation are likely to continue.
In May 1997, the Nebraska Department of Environmental Quality ("NDEQ")
issued a violation notice to K N Interstate Gas Transmission Company ("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 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.
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.
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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. A discussion of the environmental matters involving K N
Energy can be found in the Annual Report on Form 10-K for the year ended
December 31, 1996, as amended by Amendment No. 1 thereto, and K N Energy's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1997. See
"Incorporation of Certain Documents by Reference" in the accompanying
Prospectus.
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DESCRIPTION OF OFFERED SECURITIES
The following description of the particular terms of the Offered Securities
offered hereby supplements and, to the extent inconsistent therewith, replaces
the description of the general terms and provisions of the Offered Securities
set forth in the accompanying Prospectus under the caption "Description of the
Debt Securities," to which description reference is hereby made. The following
summary is qualified in its entirety by reference to the Senior Debt Indenture
referred to in the accompanying Prospectus. Capitalized terms defined in the
Prospectus have the same meanings when used herein.
GENERAL
The Senior Notes and the 20 REPS offered hereby constitute six separate
series of senior debt securities, limited to (i) $ million aggregate
principal amount, with respect to the 2003 Senior Note series, (ii) $
million aggregate principal amount, with respect to the 2005 Senior Note series,
(iii) $ million aggregate principal amount, with respect to the 2008
Senior Notes series, (iv) $ million aggregate principal amount, with
respect to the 2028 Senior Debentures, (v) $ million aggregate
principal amount with respect to the 2098 Senior Debentures and (vi) $
million aggregate principal amount with respect to the 20 REPS. Upon issuance,
each series of the Offered Securities will be represented by one or more
registered Global Debt Securities that will be deposited with, or on behalf of,
the Depositary and will be registered in the name of the Depositary or its
nominee. For so long as the Offered Securities are registered in the name of the
Depositary, or its nominee, the principal and interest due on the Offered
Securities will be payable by the Company or its agent to the Depositary for
payment to its participants for subsequent disbursement to the beneficial
owners. See "--Book-Entry System" below and "Description of the Debt
Securities--Provisions Applicable to Both Senior and Subordinated Debt
Securities--Global Debt Securities" in the accompanying Prospectus.
The defeasance and covenant defeasance provisions of the Senior Debt
Indenture described under the caption "Description of the Debt
Securities--Provisions Applicable to Both Senior and Subordinated Debt
Securities--Defeasance and Discharge" and "--Covenant Defeasance" in the
accompanying Prospectus will apply to the Offered Securities.
THE SENIOR NOTES
The 2003 Senior Notes will mature on March , 2003, the 2005 Senior Notes
will mature on March , 2005, the 2008 Senior Notes will mature on March ,
2008, the 2028 Senior Debentures will mature on March , 2028, and the 2098
Senior Debentures will mature on March , 2098. Each series of the Senior Notes
will bear interest from March , 1998 at the rate shown in the title of such
series as shown on the cover page hereof, payable semiannually (to holders of
record at the close of business on the fifteenth calendar day (whether or not a
Business Day (as defined herein)) immediately preceeding the relevant interest
payment date) on March and September of each year beginning September , 1998.
Redemption
Each series of Senior Notes will be redeemable as a whole or in part, at
the option of the Company at any time, at a redemption price equal to the
greater of (i) 100% of their principal amount or (ii) the sum of the present
values of the remaining scheduled payments of principal and interest thereon
discounted to the date of redemption on a semiannual basis (assuming a 360-day
year consisting of twelve 30-day months) at the Treasury Rate plus
( ) basis points for the 2003 Senior Notes, ( )
basis points for the 2005 Senior Notes, ( ) basis points for
the 2008 Senior Notes, ( ) basis points for the 2028 Senior
Debentures and ( ) basis points for the 2098 Senior
Debentures, plus in the case of each of clause (i) and (ii) accrued interest to
the date of redemption.
"Comparable Treasury Issue" means the United States Treasury security
selected by an Independent Investment Banker as having a maturity comparable to
the remaining term ("Remaining Life") of the series of Senior Notes to be
redeemed that would be utilized, at the time of selection and in accordance with
customary financial practice in pricing new issues of corporate debt securities
of comparable maturity to the remaining term of such Senior Notes.
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"Independent Investment Banker" means Morgan Stanley & Co. Incorporated or,
if such firm is unwilling or unable to select the Comparable Treasury Issue, an
independent investment banking institution of national standing appointed by the
Debt Trustee.
"Comparable Treasury Price" means (A) the average of four Reference
Treasury Dealer Quotations for such redemption date, after excluding the highest
and lowest Reference Treasury Dealer Quotations, or (B) if the Independent
Investment Banker obtains fewer than five such Reference Treasury Dealer
Quotations, the average of all such quotations.
"Reference Treasury Dealer" means Morgan Stanley & Co. Incorporated,
BancAmerica Robertson Stephens, Chase Securities Inc., Lehman Brothers Inc.,
J.P. Morgan Securities Inc. and NationsBanc Montgomery Securities LLC and their
respective successors, provided, however, that if any of the foregoing shall
cease to be a primary U.S. Government securities dealer in New York City (a
"Primary Treasury Dealer"), the Company shall substitute therefor another
Primary Treasury Dealer.
"Reference Treasury Dealer Quotations" means, with respect to each
Reference Treasury Dealer and any redemption date, the average, as determined by
the Independent Investment Banker, of the bid and asked prices for the
Comparable Treasury Issue (expressed in each case as a percentage of its
principal amount) quoted in writing to the Independent Investment Banker at 5:00
p.m., New York City time, on the third Business Day preceding such redemption
date.
"Treasury Rate" means, with respect to any redemption date, (i) the yield,
under the heading which represents the average for the immediately preceding
week, appearing in the most recently published statistical release designated
"H.15(519)" or any successor publication which is published weekly by the
Federal Reserve and which establishes yields on actively traded United States
Treasury securities adjusted to constant maturity under the caption "Treasury
Constant Maturities," for the maturity corresponding to the Comparable Treasury
Issue (if no maturity is within three months before or after the Remaining Life,
yields for the two published maturities most closely corresponding to the
Comparable Treasury Issue shall be determined and the Treasury Rate shall be
interpolated or extrapolated from such yields on a straight line basis, rounding
to the nearest month) or (ii) if such release (or any successor release) is not
published during the week preceding the calculation date or does not contain
such yields, the rate per annum equal to the semi-annual equivalent yield to
maturity of the Comparable Treasury Issue, calculated using a price for the
Comparable Treasury Issue (expressed as a percentage of its principal amount)
equal to the Comparable Treasury Price for such redemption date. The Treasury
Rate shall be calculated on the third Business Day preceding the redemption
date.
Holders of Senior Notes to be redeemed will receive notice thereof by
first-class mail at least 30 and not more than 45 days prior to the date fixed
for redemption.
THE 20 REPS
The 20 REPS will bear interest at the rate of % from March , 1998
to but excluding March , 20 (the "Coupon Reset Date"). Interest on the 20
REPS is payable semi-annually on March and September of each year,
commencing September , 1998 (each an "Interest Payment Date"). Interest will
be calculated based on a 360-day year consisting of twelve 30-day months. On
each Interest Payment Date, interest shall be payable to the persons in whose
name the 20 REPS are registered on the fifteenth calendar day (whether or not a
Business Day) immediately preceding the related Interest Payment Date (each, a
"Record Date"). "Business Day" means any day other than a Saturday, Sunday or a
day on which banking institutions in The City of New York are authorized or
obligated by law, executive order or governmental decree to be closed. If Morgan
Stanley & Co. International Limited as Callholder (the "Callholder") elects to
purchase the 20 REPS pursuant to the Call Option (as defined below) the
Calculation Agent (as defined below) will reset the interest rate effective on
the Coupon Reset Date, pursuant to the Coupon Reset Process described below. In
such circumstance, (i) the 20 REPS will be purchased from the holders by the
Callholder, in whole but not in part, at 100% of the principal amount thereof on
the Coupon Reset Date, on the terms and subject to the conditions described
herein (interest accrued to the Coupon Reset Date will be paid by the Company on
such date to holders on the immediately preceding Record Date), and (ii) on and
after the Coupon Reset Date, the 20 REPS will bear interest at the rate
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determined by the Calculation Agent in accordance with the procedures set forth
under "--Coupon Reset Process if the Notes are Called" below.
Final Maturity Date
The 20 REPS will mature on March , 20 (the "Final Maturity Date"). On
March , 20 , however, holders of the 20 REPS will be entitled to receive
100% of the principal amount thereof (i) from the Callholder if it purchases the
20 REPS pursuant to the Call Option or (ii) in the event the Callholder does
not exercise the Call Option or fails for any reason to pay the Call Price (as
defined below) to the Debt Trustee when required from the Company following the
exercise by the Debt Trustee for and on behalf of the holders of the 20 REPS of
the Mandatory Put (as defined below). The Debt Trustee will exercise the
Mandatory Put without the consent of, or notice to, the holders of the 20 REPS.
Call Option; Mandatory Put
(i) Call Option. The initial Callholder will be Morgan Stanley & Co.
International Limited. Pursuant to the terms of the 20 REPS, the Callholder has
the right to purchase the 20 REPS, in whole but not in part, on the Coupon
Reset Date (the "Call Option"), at a price equal to 100% of the principal amount
thereof (the "Call Price"), by giving notice to the Debt Trustee (the "Call
Notice"). If the Callholder exercises the Call Option, the Debt Trustee will
send a copy of the Call Notice to the holders as required by the terms of the
20 REPS. The Callholder will be required to give the Call Notice to the Debt
Trustee, in writing, prior to 4:00 p.m., New York City time, no later than
fifteen calendar days prior to the Coupon Reset Date. If the Callholder
exercises the Call Option, (i) not later than 2:00 p.m., New York City time on
the Business Day prior to the Coupon Reset Date, the Callholder shall pay the
amount of the Call Price in immediately available funds to the Debt Trustee for
payment of the Call Price to the holders of the 20 REPS on the Coupon Reset
Date and (ii) the holders of the 20 REPS will be required to deliver the 20
REPS against payment therefor on the Coupon Reset Date through the facilities of
DTC. The Callholder is not required to exercise the Call Option, and no holder
of the 20 REPS or any interest therein shall have any right or claim against
the Callholder as a result of the Callholder not purchasing the 20 REPS.
The Call Option provides for certain circumstances under which such Call
Option may be terminated. If the Call Option terminates or if the Callholder
fails to pay the Call Price to the Debt Trustee at or prior to the required
time, the Debt Trustee shall exercise the Mandatory Put described below. The
Debt Trustee shall notify the holders that it is exercising the Mandatory Put as
required by the terms of the Senior Debt Indenture, as supplemented.
(ii) Mandatory Put. If the Callholder fails for any reason to purchase the
20 REPS on the Coupon Reset Date, the Debt Trustee will be obligated to
exercise on behalf of the holders the right to require the Company to purchase
the 20 REPS, in whole but not in part (the "Mandatory Put"), on the Coupon
Reset Date at a price equal to 100% of the principal amount thereof (the "Put
Price"). By its purchase of the 20 REPS, each holder irrevocably agrees that
the Debt Trustee shall exercise the Mandatory Put for or on behalf of the holder
of the 20 REPS as provided herein. If the Debt Trustee exercises the Mandatory
Put then the Company shall deliver the Put Price in immediately available funds
to the Debt Trustee by no later than 12:00 noon, New York City time, on the
Coupon Reset Date and the holders will be required to deliver the 20 REPS to
the Company against payment therefor on the Coupon Reset Date through the
facilities of DTC. No holder of the 20 REPS or any interest therein has the
right to consent or object to the exercise of the Debt Trustee's duties under
the Mandatory Put.
Coupon Reset Process if the Notes are Called
Pursuant to the terms of a calculation agent agreement, Morgan Stanley &
Co. Incorporated has been appointed the calculation agent for the 20 REPS (in
its capacity as calculation agent for the 20 REPS, the "Calculation Agent"). If
the Callholder exercises the Call Option as set forth above, then the following
steps (the "Coupon Reset Process") shall be taken in order to determine the
interest rate to be paid on the 20 REPS from and including such Coupon Reset
Date to the Final Maturity Date (the "Coupon Reset Rate"). The Company and the
Calculation Agent shall use reasonable efforts to cause the actions contemplated
below to be completed in as timely a manner as possible.
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(a) The Company shall provide the Calculation Agent with a list (the
"Dealer List"), no later than five Business Days prior to the Coupon Reset
Date, containing the names and addresses of three dealers, one of which
shall be Morgan Stanley & Co. Incorporated, from which it desires the
Calculation Agent to obtain the Bids (as defined below) for the purchase of
the 20 REPS.
(b) Within one Business Day following receipt by the Calculation Agent
of the Dealer List, the Calculation Agent shall provide to each dealer
("Dealer") on the Dealer List (i) a copy of this Prospectus Supplement and
the accompanying Prospectus, (ii) a copy of the form of the 20 REPS and
(iii) a written request that each such Dealer submit a Bid to the
Calculation Agent at 12:00 noon, New York City time, on the third Business
Day prior to the Coupon Reset Date (a "Bid Date"). The time on the Bid Date
upon which Bids will be requested may be changed by the Calculation Agent.
"Bid" shall mean an irrevocable written offer given by a Dealer for the
purchase of the 20 REPS, settling on the Coupon Reset Date, and shall be
quoted by such Dealer as a stated yield to maturity on the 20 REPS ("Yield
to Maturity"). Each Dealer shall be provided with (i) the name of the
Company, (ii) an estimate of the Purchase Price (which shall be stated as a
U.S. dollar amount and be calculated by the Calculation Agent in accordance
with clause (c) below), (iii) the principal amount and maturity of the 20
REPS and (iv) the method by which interest will be calculated on the 20
REPS.
(c) The purchase price to be paid by any Dealer for the 20 REPS (the
"Purchase Price") shall be equal to (i) the principal amount of the
20 REPS plus (ii) a premium (the "Notes Premium") which shall be equal to
the excess, if any, of (A) the discounted present value to the Coupon Reset
Date of a bond with a maturity of March , 20 , which has an interest
rate of %, semiannual interest payments on each March and September
commencing September , 20 , and a principal amount of
$ , and assuming a discount rate equal to the Treasury Rate
over (B)$ . "Treasury Rate" for the 20 REPS means the per annum rate
equal to the offer side yield to maturity of the current on-the-run
year United States Treasury Security per Telerate page 500 (or any
successor or substitute page as may replace such page on such service) at
11:00 a.m., New York time on the applicable Bid Date (or such other date or
time that may be agreed upon by the Company and the Calculation Agent) or,
if such rate does not appear on Telerate page 500 (or any successor or
substitute page as may replace such page on such service) at such time, the
rates on GovPx End-of-Day Pricing at 3:00 p.m. on the applicable Bid Date.
(d) The Calculation Agent shall immediately notify the Company of (i)
the names of each of the Dealers from whom the Calculation Agent received
Bids on the Bid Date, (ii) the Bid submitted by each such Dealer and (iii)
the Purchase Price as determined pursuant to paragraph (c) hereof. Unless
the Call Option has terminated, the Calculation Agent shall thereafter
select from the Bids received the Bid with the lowest Yield to Maturity
(the "Selected Bid") and set the Coupon Reset Rate equal to the interest
rate which would amortize the Notes Premium fully over the term of the 20
REPS at the Yield to Maturity indicated by the Selected Bid, provided,
however, that if the Calculation Agent has not received a timely Bid from a
Dealer, the Selected Bid shall be the lowest of all Bids received by such
time and provided, further that if any two or more of the lowest Bids
submitted are equivalent, the Company shall in its sole discretion select
any of such equivalent Bids (and such selected Bid shall be the Selected
Bid). In all cases, Morgan Stanley & Co. Incorporated, in its capacity as a
dealer has the right to match the Bid with the lowest Yield to Maturity,
whereby Morgan Stanley & Co. Incorporated's Bid becomes the Selected Bid.
(e) Immediately after calculating the Coupon Reset Rate, the
Calculation Agent shall provide written notice to the Company and the Debt
Trustee, setting forth the Coupon Reset Rate. The Company shall thereafter
establish the Coupon Reset Rate as the new interest rate on the 20 REPS,
effective from and including the Coupon Reset Date by delivery to the Debt
Trustee on or before the Coupon Reset Date of an officers' certificate.
(f) The Callholder shall sell the 20 REPS to the Dealer that made the
Selected Bid at the Purchase Price, such sale to be settled on the Coupon
Reset Date in immediately available funds.
If the Calculation Agent determines that (i) since the Call Notice, an
Event of Default has occurred under Sections 501 (1),(2),(3),(4), (5) or (7) of
the Senior Debt Indenture (in such event, termination is at the Callholders'
option) or under Section 501 (6) of the Senior Debt Indenture (in such event,
termination is
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automatic), (ii) a Market Disruption Event (as defined below) has occurred
following the exercise of the Call Option or (iii) two or more of the Dealers
have failed to provide Bids in a timely manner substantially as provided above,
such Call Option will be automatically revoked, and the Debt Trustee will
exercise the Mandatory Put on behalf of the holders. "Market Disruption Event"
shall mean any of the following: (i) a suspension or material limitation in
trading in securities generally on the New York Stock Exchange, Inc. (the
"NYSE") or the establishment of minimum prices on such exchange; (ii) a general
moratorium on commercial banking activities declared by either federal or New
York State authorities; (iii) any material adverse change in the existing
financial, political or economic conditions in the United States of America;
(iv) an outbreak or escalation of major hostilities involving the United States
of America or the declaration of a national emergency or war by the United
States; or (v) any material disruption of the U.S. government securities market,
U.S. corporate bond market or U.S. federal wire system.
The calculation agent agreement provides that the Calculation Agent may
resign at any time, such resignation to be effective ten business days after the
delivery to the Company and the Debt Trustee of notice of such resignation. In
such case, the Company may appoint a successor Calculation Agent.
The Calculation Agent, in its individual capacity, may buy, sell, hold and
deal in the 20 REPS and may exercise any vote or join in any action which any
holder of the 20 REPS may be entitled to exercise or take as if it were not the
Calculation Agent. The Calculation Agent, in its individual capacity, may also
engage in any transaction with the Company and any of its affiliates as if it
were not the Calculation Agent.
BOOK-ENTRY SYSTEM
Each series of the Offered Securities will be represented by one or more
Global Debt Securities registered in the name of Cede & Co., the nominee of the
Depositary. The Depositary is a limited-purpose trust company organized under
the New York Banking Law, a "banking organization" within the meaning of the New
York Banking Law, a member of the Federal Reserve System, a "clearing
corporation" within the meaning of the New York Uniform Commercial Code, and a
"clearing agency" registered pursuant to the provisions of Section 17A of the
Exchange Act. The Depositary holds securities that its participants (the "Direct
Participants") deposit with the Depositary. The Depositary also facilities the
settlement among Direct Participants of securities transactions, such as
transfers and pledges, in deposited securities through electronic computerized
book-entry changes in Direct Participants' accounts, thereby eliminating the
need for physical movement of securities certificates. Direct Participants
include securities brokers and dealers, banks, trust companies, clearing
corporations and certain other organizations. The Depositary is owned by a
number of its Direct Participants and by the NYSE, the American Stock Exchange,
Inc., and the National Association of Securities Dealers, Inc. Access to the
Depositary's system is also available to others such as securities brokers and
dealers, banks and trust companies that clear through or maintain a custodial
relationship with a Direct Participant, either directly or indirectly (the
"Indirect Participants," and together with the Direct Participants, the
"Participants"). The rules applicable to the Depositary and its Participants are
on file with the Securities and Exchange Commission.
Purchases of the Offered Securities within the Depositary's system must be
made by or through Direct Participants, which will receive a credit for the
Offered Securities on the Depositary's records. The ownership interest of each
actual purchaser of each Offered Security (a "Beneficial Owner") is in turn to
be recorded on the Direct and Indirect Participants' respective records.
Beneficial Owners will not receive written confirmation from the Depositary of
their purchase, but Beneficial Owners are expected to receive written
confirmations providing details of the transaction, as well as periodic
statements of their holdings, from the Direct or Indirect Participant through
which the Beneficial Owner entered into the transaction. Transfers of ownership
interests in the Offered Securities are to be accomplished by entries made on
the books of Participants acting on behalf of Beneficial Owners. Beneficial
Owners will not receive certificates representing their ownership interests in
Offered Securities except in the event that use of the book-entry system for the
Offered Securities is discontinued.
To facilitate subsequent transfers, all Offered Securities deposited by
Direct Participants with the Depositary will be registered in the name of Cede &
Co. The deposit of the Offered Securities with the Depositary and their
registration in the name of Cede & Co. effect no change in beneficial ownership.
The Depositary has no knowledge of the actual Beneficial Owners of the Offered
Securities; the Depositary's
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<PAGE> 55
records reflect only the identity of the Direct Participants to whose accounts
such Offered Securities are credited, which may or may not be the Beneficial
Owners. The Participants will remain responsible for keeping account of their
holdings on behalf of their customers.
Conveyance of notices and other communications by the Depositary to Direct
Participants, by Direct Participants to Indirect Participants, and by Direct
Participants and Indirect Participants to Beneficial Owners will be governed by
arrangements among them, subject to any statutory or regulatory requirements as
may be in effect from time to time.
Redemption notices shall be sent to Cede & Co. If less than all of the
Offered Securities of an issue are being redeemed, the Depositary's practice is
to determine by lot the amount of the interest of each Direct Participant in
such series to be redeemed.
Neither the Depositary nor Cede & Co. will consent or vote with respect to
the Offered Securities. Under its usual procedures, the Depositary mails an
omnibus proxy (an "Omnibus Proxy") to the Participants as soon as possible after
the record date. The Omnibus Proxy assigns Cede & Co.'s consenting or voting
rights to those Direct Participants to whose accounts the Offered Securities are
credited on the record date (identified in a listing attached to the Omnibus
Proxy).
Principal, redemption premium, if any, and interest payments on the Offered
Securities will be made to the Depositary. The Depositary's practice is to
credit Direct Participants' accounts on the relevant payment date in accordance
with their respective holdings shown on the Depositary's records unless the
Depositary has reason to believe that it will not receive payment on such
payment date. Payments by Participants to Beneficial Owners will be governed by
standing instructions and customary practices, as is the case with securities
for the accounts of customers in bearer form or registered in "street-name," and
will be the responsibility of such Participant and not of the Depositary, the
Underwriters, or the Company, subject to any statutory or regulatory
requirements as may be in effect from time to time. Payment of principal,
redemption premium, if any, and interest to the Depositary is the responsibility
of the Company or the Paying Agent. Disbursement of such payments to Direct
Participants is the responsibility of the Depositary, and disbursement of such
payments to the Beneficial Owners is the responsibility of Direct and Indirect
Participants. Global Debt Securities will settle in immediately available funds
in the secondary trading market. No assurance can be given as to the effect, if
any, of settlement in immediately available funds on trading activity in the
Offered Securities.
The Depositary may discontinue providing its services as securities
depository with respect to the Offered Securities at any time by giving
reasonable notice to the Company. Under such circumstances and in the event that
a successor securities depository is not obtained, Offered Securities
certificates are required to be printed and delivered. In addition, the Company
may decide to discontinue use of the system of book-entry transfers through the
Depositary (or a successor securities depository). In that event, Offered
Securities certificates will be printed and delivered.
The Company will not have any responsibility or obligation to Participants
or the persons for whom they act as nominees with respect to the accuracy of the
records of the Depositary, its nominee or any Direct or Indirect Participant
with respect to any ownership interest in the Offered Securities, or with
respect to payments to or providing of notice for the Direct Participants, the
Indirect Participants or the Beneficial Owners.
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following summary of certain United States federal income tax
consequences of the purchase, ownership and disposition of the Offered
Securities is based upon laws, regulations, rulings and decisions now in effect,
all of which are subject to change (including changes in effective dates) or
possible differing interpretations. Unless otherwise stated, this summary deals
only with United States Holders (defined below) who are initial purchasers who
hold the Offered Securities as capital assets and does not purport to deal with
persons in special tax situations, such as financial institutions, insurance
companies, regulated investment companies, dealers in securities or currencies,
persons holding the Offered Securities as a hedge against currency risk or as a
position in a "straddle" for tax purposes, or persons whose functional currency
is not the United States dollar. In addition, this discussion only addresses the
federal income tax consequences of the 20 REPS until the Coupon Reset Date.
PERSONS CONSIDERING THE PURCHASE OF OFFERED SECURITIES SHOULD
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CONSULT THEIR OWN TAX ADVISORS CONCERNING THE APPLICATION OF UNITED STATES
FEDERAL INCOME TAX LAWS TO THEIR PARTICULAR SITUATIONS AS WELL AS ANY
CONSEQUENCES OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF THE OFFERED
SECURITIES ARISING UNDER THE LAWS OF ANY OTHER TAXING JURISDICTION.
As used herein, the term "United States Holder" means a beneficial owner of
Offered Securities that is for United States federal income tax purposes (i) a
citizen or resident of the United States, (ii) a corporation, partnership or
other entity created or organized in or under the laws of the United States or
of any political subdivision thereof (other than a partnership that is not
treated as a United States person under any applicable Treasury regulations),
(iii) an estate whose income is subject to United States federal income tax
regardless of its source, (iv) a trust if a court within the United States is
able to exercise primary supervision over the administration of the trust and
one or more United States persons have the authority to control all substantial
decisions of the trust, or (v) any other person whose income or gain in respect
of the Offered Securities is effectively connected with the conduct of a United
States trade or business. As used herein, the term "Non-United States Holder"
means a beneficial owner of Offered Securities that is not a United States
Holder.
Except as discussed below, interest on the Offered Securities will
generally be taxable to a United States Holder as ordinary income at the time it
is paid or accrued in accordance with the United States Holder's method of
accounting for tax purposes.
2098 SENIOR DEBENTURES
The Company believes that the 2098 Senior Debentures should constitute
indebtedness for United States federal income tax purposes and intends to treat
them as such. Such treatment is not binding on the Internal Revenue Service
("IRS") which, because of the long maturity of the 2098 Senior Debentures, may
seek to treat them as equity. Except where indicated, the following discussion
assumes that the 2098 Senior Debentures will be classified as indebtedness for
such purposes. As a result, interest on the 2098 Senior Debentures also will
generally be taxable to a United States Holder as ordinary income at the time it
is paid or accrued in accordance with the United States Holder's method of
accounting for tax purposes.
20 REPS
The United States federal income tax treatment of debt obligations such as
the 20 REPS is not entirely certain. Because the 20 REPS are subject to a
mandatory put or call on the Coupon Reset Date, the Company intends to treat the
20 REPS as maturing on the Coupon Reset Date for United States federal income
tax purposes and as being reissued on the Coupon Reset Date should the
Callholder sell the 20 REPS pursuant to the Coupon Reset Process. Based on such
treatment, stated interest on the 20 REPS generally will be taxable to a United
States Holder as ordinary income at the time such interest is accrued or
received (in accordance with the United States Holder's regular method of tax
accounting).
There can be no assurance, however, that the IRS will agree with the
Company's treatment of the 20 REPS and it is possible that the IRS could assert
another treatment. For instance, it is possible that the IRS could seek to treat
the 20 REPS as maturing on the Final Maturity Date and to treat the issue price
of the 20 REPS as including the value of the Call Option. Because of the Coupon
Reset Process, if the 20 REPS were treated as maturing on the Final Maturity
Date, Treasury regulations relating to contingent payment debt obligations would
appear to be applicable. The effect of such Treasury regulations would be to (i)
require United States Holders, regardless of their usual method of tax
accounting, to use an accrual method with respect to the 20 REPS; (ii) result
in the possibility that United States Holders would be required to accrue income
in excess of actual cash payments received; and (iii) generally result in
ordinary rather than capital treatment of any gain or loss on the sale, exchange
or retirement of the 20 REPS.
SALE OR OTHER DISPOSITION OF OFFERED SECURITIES
Under the foregoing treatment, upon the sale, exchange or retirement of the
Offered Securities, a United States Holder generally will recognize taxable gain
or loss equal to the difference between the amount realized by such United
States Holder on the sale, exchange or retirement of the Offered Securities
(except to the extent that such amount realized represents accrued and unpaid
interest that such United States Holder has not included in gross income
previously) and such United States Holder's adjusted tax basis in the Offered
Securities. Such gain or loss will generally be long-term capital gain or loss
if the Offered Securities were held for more than one year. Capital gains of
individuals derived with respect to capital assets held for more than
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one year are eligible for reduced rates of taxation depending upon the holding
period of such capital assets. United States Holders should consult their own
tax advisors regarding the capital gains rate applicable to them. The
deductibility of capital losses is subject to limitations.
NON-UNITED STATES HOLDERS
Under present United States federal income and estate tax law, and subject
to the discussion below concerning backup withholding:
(a) no withholding of United States federal income tax will be
required with respect to the payment by the Company or any paying agent of
principal or interest (which for purposes of this discussion includes any
original issue discount ("OID")) on an Offered Security owned by a
Non-United States Holder, provided (i) that the beneficial owner does not
actually or constructively own 10% or more of the total combined voting
power of all classes of stock of the Company entitled to vote within the
meaning of section 871(h)(3) of the Code and the regulations thereunder,
(ii) the beneficial owner is not a controlled foreign corporation that is
related to the Company through stock ownership, (iii) the beneficial owner
is not a bank whose receipt of interest on an Offered Security is described
in section 881(c)(3)(A) of the Code and (iv) the beneficial owner satisfies
the statement requirement (described generally below) set forth in section
871(h) and section 881(c) of the Code and the regulations thereunder;
(b) no withholding of United States federal income tax will be
required with respect to any gain or income realized by a Non-United States
Holder upon the sale, exchange or retirement of an Offered Security; and
(c) an Offered Security beneficially owned by an individual who at the
time of death is a Non-United States Holder will not be subject to United
States federal estate tax as a result of such individual's death, provided
that such individual does not actually or constructively own 10% or more of
the total combined voting power of all classes of stock of the Company
entitled to vote within the meaning of section 871(h)(3) of the Code and
provided that the interest payments with respect to such Offered Security
would not have been, if received at the time of such individual's death,
effectively connected with the conduct of a United States trade or business
by such individual.
To satisfy the requirement referred to in (a)(iv) above, the beneficial
owner of such Offered Securities or a financial institution holding the Offered
Securities on behalf of such owner, must provide, in accordance with specified
procedures, a paying agent of the Company with a statement to the effect that
the beneficial owner is not a United States person. Currently, these
requirements will be met if (1) the beneficial owner provides his name and
address, and certifies, under penalties of perjury, that he is not a United
States person (which certification may be made on an IRS Form W-8 (or successor
form)) or (2) a financial institution holding the Offered Securities on behalf
of the beneficial owner certifies, under penalties of perjury, that such
statement has been received by it and furnishes a paying agent with a copy
thereof. Under recently finalized Treasury regulations (the "Final
Regulations"), the statement requirement referred to in (a)(iv) above may also
be satisfied with other documentary evidence for interest paid after December
31, 1998 with respect to an offshore account or through certain foreign
intermediaries.
If a Non-United States Holder cannot satisfy the requirements of the
"portfolio interest" exception described in (a) above, payments of premium, if
any, and interest made to such Non-United States Holder will be subject to a 30%
withholding tax unless the beneficial owner of the Offered Securities provides
the Company or its paying agent, as the case may be, with a properly executed
(1) IRS Form 1001 (or successor form) claiming an exemption from withholding
under the benefit of a tax treaty or (2) IRS Form 4224 (or successor form)
stating that interest paid on the Offered Securities is not subject to
withholding tax because it is effectively connected with the beneficial owner's
conduct of a trade or business in the United States. Under the Final
Regulations, Non-United States Holders will generally be required to provide IRS
Form W-8 in lieu of IRS Form 1001 and IRS Form 4224, although alternative
documentation may be applicable in certain situations.
If a Non-United States Holder is engaged in a trade or business in the
United States and premium, if any, or interest on the Offered Securities is
effectively connected with the conduct of such trade or business, the Non-United
States Holder, although exempt from the withholding tax discussed above, will be
subject to
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United States federal income tax on such interest on a net income basis in the
same manner as if it were a United States Holder. In addition, if such holder is
a foreign corporation, it may be subject to a branch profits tax equal to 30% of
its effectively connected earnings and profits for the taxable year, subject to
adjustments. For this purpose, such premium, if any, and interest on the Offered
Securities will be included in such foreign corporation's earnings and profits.
Any gain or income realized upon the sale, exchange or retirement of an
Offered Security generally will not be subject to United States federal income
tax unless (i) such gain or income is effectively connected with a trade or
business in the United States of the Non-United States Holder, or (ii) in the
case of a Non-United States Holder who is an individual, such individual is
present in the United States for 183 days or more in the taxable year of such
sale, exchange or retirement, and certain other conditions are met.
As discussed above, the Company believes that the 2098 Senior Debentures
should constitute indebtedness for United States federal income tax purposes and
intends to treat them as such. If, however, the 2098 Senior Debentures were to
be recharacterized as equity, the interest thereon generally would be subject to
30% withholding tax when paid to a Non-United States Holder and under certain
circumstances, gain, if any, on the disposition of the 2098 Senior Debentures
could be subject to United States federal income tax under the rules relating to
"United States real property holding corporations". As a result, Non-United
States Holders should consult with their tax advisors prior to purchasing the
2098 Senior Debentures.
INFORMATION REPORTING AND BACKUP WITHHOLDING
In general, information reporting requirements will apply to certain
payments of principal, interest and premium paid on Offered Securities and to
the proceeds of sale of an Offered Security made to United States Holders other
than certain exempt recipients (such as corporations). A 31 percent backup
withholding tax will apply to such payments if the United States Holder fails to
provide a taxpayer identification number or certification of foreign or other
exempt status or fails to report in full dividend and interest income.
No information reporting or backup withholding will be required with
respect to payments made by the Company or any paying agent to Non-United States
Holders if a statement described above in (a)(iv) has been received and the
payor does not have actual knowledge that the beneficial owner is a United
States person.
In addition, backup withholding and information reporting will not apply if
payments of the principal, interest or premium on an Offered Security are paid
or collected by a foreign office of a custodian, nominee or other foreign agent
on behalf of the beneficial owner of such Offered Security, or if a foreign
office of a broker (as defined in applicable Treasury regulations) pays the
proceeds of the sale of an Offered Security to the owner thereof. If, however,
such nominee, custodian, agent or broker is, for United States federal income
tax purposes, a United States person, a controlled foreign corporation or a
foreign person that derives 50% or more of its gross income for certain periods
from the conduct of a trade or business in the United States, or, after December
31, 1998, if such nominee, custodian, agent or broker is a foreign partnership,
in which one or more United States persons, in the aggregate, own more than 50%
of the income or capital interests in the partnership or if the partnership is
engaged in a trade or business in the United States, such payments will not be
subject to backup withholding but will be subject to information reporting,
unless (1) such custodian, nominee, agent or broker has documentary evidence in
its records that the beneficial owner is not a United States person and certain
other conditions are met or (2) the beneficial owner otherwise establishes an
exemption.
Payments of principal, interest and premium on an Offered Security paid to
the beneficial owner of a Offered Security by a Untied States office of a
custodian, nominee or agent, or the payment by the United States office of a
broker of the proceeds of sale of an Offered Security, will be subject to both
backup withholding and information reporting unless the beneficial owner
provides the statement referred to in (a)(iv) above and the payor does not have
actual knowledge that the beneficial owner is a United States person or
otherwise establishes an exemption.
Any amounts withheld under the backup withholding rules will be allowed as
a refund or a credit against such holder's United States federal income tax
liability provided the required information is furnished to the IRS.
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<PAGE> 59
UNDERWRITERS
Under the terms and subject to the conditions contained in an Underwriting
Agreement, dated the date hereof, the Underwriters named below have severally
agreed to purchase, and the Company has agreed to sell to them, severally, the
respective principal amounts of the Offered Securities set forth opposite their
respective names below:
<TABLE>
<CAPTION>
PRINCIPAL PRINCIPAL
PRINCIPAL PRINCIPAL PRINCIPAL AMOUNT AMOUNT
AMOUNT AMOUNT AMOUNT OF 2028 OF 2098 PRINCIPAL
OF 2003 OF 2005 OF 2008 SENIOR SENIOR AMOUNT
NAME SENIOR NOTES SENIOR NOTES SENIOR NOTES DEBENTURES DEBENTURES OF 20 REPS
- ------------------------- ------------ ------------ ------------ ---------- ---------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Morgan Stanley & Co.
Incorporated........... $ $ $ $ $ $
BancAmerica Robertson
Stephens...............
Chase Securities Inc.....
Lehman Brothers Inc......
J.P. Morgan Securities
Inc....................
NationsBanc Montgomery
Securities LLC.........
------------ ------------ ------------ ---------- ---------- ----------------
Total.................. $ $ $ $ $ $
========= ========= ========= ======== ======== ============
</TABLE>
The Underwriting Agreement provides that the obligation of the several
Underwriters to pay for and accept delivery of the Offered Securities is subject
to the approval of certain legal matters by their counsel and to certain other
conditions. The Underwriters are obligated to take and pay for all of the
Offered Securities if any are taken.
The Underwriters initially propose to offer part of the Offered Securities
directly to the public at the public offering prices set forth on the cover page
hereof and part to certain dealers at prices that represent a concession not to
exceed % of the principal amount in the case of the 2003 Senior Notes, % of
the principal amount in the case of the 2005 Senior Notes, % of the principal
amount in the case of the 2008 Senior Notes, % of the principal amount in the
case of the 2028 Senior Debentures, % of the principal amount in the case of
the 2098 Senior Debentures and % of the principal amount in the case of the
20 REPS. Any Underwriter may allow, and any such dealers may reallow, a
concession to certain other dealers not to exceed % of the principal amount in
the case of the 2003 Senior Notes, % of the principal amount in the case of
the 2005 Senior Notes, % of the principal amount in the case of the 2008
Senior Notes, % of the principal amount in the case of the 2028 Senior
Debentures, % of the principal amount in the case of the 2098 Senior
Debentures and % of the principal amount in the case of the 20 REPS. After
the initial offering of the Offered Securities, the respective offering prices
and other selling terms may from time to time be varied by the Underwriters.
The Company has agreed to indemnify the several Underwriters against
certain liabilities, including liabilities under the Securities Act of 1933, as
amended.
The Company does not intend to apply for listing of any of the Offered
Securities on a national securities exchange, but has been advised by the
Underwriters that they presently intend to make a market in the Offered
Securities, as permitted by applicable laws and regulations. The Underwriters
are not obligated, however, to make a market in the Offered Securities and any
such market-making may be discontinued at any time at the sole discretion of the
Underwriters. Accordingly, no assurance can be given as to the liquidity of or
trading markets for, the Offered Securities.
In order to facilitate the offering of the Offered Securities, the
Underwriters may engage in transactions that stabilize, maintain or otherwise
affect the prices of the Offered Securities. Specifically, the Underwriters may
overallot in connection with the offering, creating a short position in the
Offered Securities for their own
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account. In addition, to cover overallotments or to stabilize the price of the
Offered Securities, the Underwriters may bid for, and purchase, the Offered
Securities in the open market. Finally, the underwriting syndicate may reclaim
selling concessions allowed to an underwriter or a dealer for distributing the
Offered Securities in the offering, if the syndicate repurchases previously
distributed Offered Securities in transactions to cover syndicate short
positions, in stabilization transactions or otherwise. Any of these activities
may stabilize or maintain the market prices of the Offered Securities above
independent market levels. The Underwriters are not required to engage in these
activities, and may end any of these activities at any time.
The Underwriters or their affiliates have performed various investment or
commercial banking services for the Company in the past and may do so from time
to time in the future. Morgan Stanley & Co. Incorporated advised K N Energy with
regard to the Acquisition for which it received customary compensation. Morgan
Stanley & Co. Incorporated is also participating as an underwriter in the Equity
Offering. Morgan Guaranty, an affiliate of J.P. Morgan Securities Inc., is the
administrative agent and a lender under the Bank Facility. J.P. Morgan
Securities Inc. served as an underwriter of the Company's public offering of
debentures in October 1997 and received customary compensation therefor. Each of
Bank of America NT & SA, an affiliate of BancAmerica Robertson Stephens, The
Chase Manhattan Bank, an affiliate of Chase Securities Inc. and NationsBank,
N.A., an affiliate of NationsBanc Montgomery Securities LLC, is a lender under
the Bank Facility. BancAmerica Robertson Stephens, Chase Securities Inc., J.P.
Morgan Securities Inc. and NationsBanc Montgomery Securities LLC each will act
as a syndication agent under the Bank Facility. Also, the Company intends to use
the net proceeds of this Offering to refinance or otherwise repay a portion of
the indebtedness incurred under the Bank Facility. Because more than 10% of the
net proceeds of this Offering will be paid to affiliates of members of the
National Association of Securities Dealers (the "NASD"), the offering is being
made pursuant to Rule 2710(c)(8) of the Conduct Rules of the NASD.
EXPERTS
The consolidated financial statements of K N Energy, Inc. and subsidiaries
as of December 31, 1996 and 1995, and for each of the three years in the period
ended December 31, 1996, included in this Prospectus Supplement, have been
audited by Arthur Andersen LLP, independent public accountants, as stated in
their report with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in accounting and auditing in giving said
report.
The consolidated financial statements of MidCon Corp. and subsidiaries as
of December 31, 1996 and 1995, and for each of the three years in the period
ended December 31, 1996, included in this Prospectus Supplement, have been
audited by Arthur Andersen LLP, independent public accountants, as stated in
their report with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in accounting and auditing in giving said
report.
LEGAL MATTERS
Certain legal matters with respect to the Offered Securities will be passed
upon for K N Energy by Simpson Thacher & Bartlett (a partnership which includes
professional corporations), New York, New York and Polsinelli, White, Vardeman &
Shalton, Kansas City, Missouri. Certain legal matters will be passed upon for
the Underwriters by Davis Polk & Wardwell, New York, New York. Simpson Thacher &
Bartlett and Davis Polk & Wardwell will rely on Polsinelli, White, Vardeman &
Shalton as to matters of Kansas law.
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<PAGE> 61
INDEX TO FINANCIAL STATEMENTS
K N ENERGY, INC.
AND SUBSIDIARIES
<TABLE>
<S> <C>
INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Statements of Income for the Nine Months Ended September 30, 1997
and 1996........................................................................ F-2
Consolidated Balance Sheets as of September 30, 1997 and December 31, 1996....... F-3
Consolidated Statements of Cash Flows for the Nine Months Ended September 30,
1997 and 1996................................................................... F-5
Notes to Consolidated Financial Statements....................................... F-7
CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1996,
1995 AND 1994
Report of Independent Public Accountants -- Arthur Andersen LLP.................. F-10
Consolidated Statements of Income for the Years Ended December 31, 1996, 1995 and
1994............................................................................ F-11
Consolidated Balance Sheets as of December 31, 1996 and 1995..................... F-12
Consolidated Statements of Common Stockholders' Equity for the Years Ended
December 31, 1996, 1995 and 1994................................................ F-13
Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995
and 1994........................................................................ F-14
Notes to Consolidated Financial Statements....................................... F-15
</TABLE>
MIDCON CORP.
AND SUBSIDIARIES
<TABLE>
<S> <C>
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Statements of Operations for the Nine Months Ended September 30,
1997 and 1996................................................................... F-37
Consolidated Balance Sheet as of September 30, 1997 and December 31, 1996........ F-38
Statements of Consolidated Cash Flows for the Nine Months Ended September 30,
1997 and 1996................................................................... F-39
Consolidated Statements of Stockholder's Equity for the Years Ended December 31,
1995 and 1996 and the Nine Months Ended September 30, 1997...................... F-40
Notes to Consolidated Financial Statements....................................... F-41
CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEARS ENDED DECEMBER 31, 1996,
1995 AND 1994
Report of Independent Public Accountants -- Arthur Andersen LLP.................. F-49
Consolidated Statements of Operations for the Years Ended December 31, 1996, 1995
and 1994........................................................................ F-50
Consolidated Balance Sheets as of December 31, 1996 and 1995..................... F-51
Statements of Common Stockholder's Equity for the Years Ended December 31, 1996,
1995 and 1994................................................................... F-52
Consolidated Statements of Cash Flows for the Years Ended December 31, 1996, 1995
and 1994........................................................................ F-53
Notes to Consolidated Financial Statements for the Years Ended December 31, 1996,
1995 and 1994................................................................... F-54
</TABLE>
F-1
<PAGE> 62
K N ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30
-----------------------
1997 1996
---------- --------
<S> <C> <C>
Operating Revenues:
Gathering, Processing and Marketing Services......................... $1,175,320 $788,719
Interstate Transportation and Storage Services....................... 17,648 17,619
Retail Natural Gas Services.......................................... 169,489 158,882
------- ------
Total Operating Revenues............................................. 1,362,457 965,220
------- ------
Operating Costs and Expenses:
Gas Purchases and Other Costs of Sales............................... 1,060,884 693,006
Operations and Maintenance........................................... 146,109 130,316
Depreciation and Amortization........................................ 41,101 38,432
Taxes, Other Than Income Taxes....................................... 18,144 15,449
------- ------
Total Operating Costs and Expenses................................... 1,266,238 877,203
------- ------
Operating Income..................................................... 96,219 88,017
------- ------
Other Income and (Deductions):
Interest Expense..................................................... (30,991) (26,209)
Minority Interests................................................... (5,681) (2,246)
Other, Net........................................................... 14,979 3,012
------- ------
Total Other Income and (Deductions).................................. (21,693) (25,443)
------- ------
Income Before Income Taxes........................................... 74,526 62,574
Income Taxes......................................................... 25,488 22,526
------- ------
Net Income........................................................... 49,038 40,048
Less -- Preferred Stock Dividends.................................... 263 298
------- ------
Earnings Available For Common Stock.................................. $ 48,775 $ 39,750
======= ======
Number of Shares Used in Computing Earnings Per Common Share......... 31,397 29,216
======= ======
Earnings Per Common Share............................................ $ 1.55 $ 1.36
======= ======
Dividends Per Common Share........................................... $ 0.81 $ 0.78
======= ======
</TABLE>
The accompanying notes are an integral part of these statements.
F-2
<PAGE> 63
K N ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31
1997 1996
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash and Cash Equivalents.......................................... $ 25,267 $ 17,005
Accounts Receivable................................................ 192,523 304,942
Materials and Supplies............................................. 14,998 6,092
Gas in Underground Storage......................................... 23,660 43,511
Prepaid Gas........................................................ 9,572 12,001
Other Prepaid Expenses............................................. 14,983 12,824
Gas Imbalances and Other........................................... 70,995 65,319
---------- ----------
351,998 461,694
---------- ----------
Investments........................................................ 75,197 50,538
---------- ----------
Property, Plant and Equipment, at Cost:
Gathering, Processing and Marketing Services....................... 856,637 683,569
Interstate Transportation and Storage Services..................... 583,475 447,557
Retail Natural Gas Services........................................ 421,567 409,626
---------- ----------
1,861,679 1,540,752
Less Accumulated Depreciation and Amortization..................... 542,905 518,451
---------- ----------
1,318,774 1,022,301
---------- ----------
Deferred Charges and Other Assets.................................. 106,488 95,187
---------- ----------
Total Assets............................................. $ 1,852,457 $1,629,720
========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE> 64
K N ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
1996
SEPTEMBER 30, ------------
1997
-------------
(UNAUDITED)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current Maturities of Long-Term Debt............................... $ 19,055 $ 26,971
Notes Payable...................................................... 285,000 129,300
Accounts Payable................................................... 173,070 241,187
Accrued Expenses................................................... 25,952 34,696
Accrued Taxes...................................................... 26,673 16,045
Gas Imbalances and Other........................................... 51,045 50,417
---------- ----------
580,795 498,616
---------- ----------
Deferred Liabilities, Credits and Reserves:
Deferred Income Taxes.............................................. 131,567 122,371
Other.............................................................. 26,628 31,930
---------- ----------
158,195 154,301
---------- ----------
Long-Term Debt..................................................... 410,498 423,676
---------- ----------
K N-Obligated Mandatorily Redeemable Preferred Capital Trust
Securities of Subsidiary Trust Holding Solely Dentures of K N.... 100,000 --
---------- ----------
Minority Interests in Equity of Subsidiaries....................... 31,160 26,333
---------- ----------
Stockholders' Equity:
Preferred Stock -- Authorized -- Class A, 200,000 Shares: Class B,
2,000,000 Shares, Without Par Value Redeemable Solely at Option
of Company at $105 Per Share -- Class A, $5.00 Cumulative Series;
70,000 Shares.................................................... 7,000 7,000
---------- ----------
Common Stock -- Authorized -- 50,000,000 Shares, Par Value $5 Per
Share Outstanding -- 31,446,326 and 30,295,792 Shares,
Respectively..................................................... 157,232 151,479
Additional Paid-in Capital......................................... 252,030 228,902
Retained Earnings.................................................. 166,099 142,578
Deferred Compensation.............................................. (9,667) (2,908)
Treasury Stock, at Cost -- 24,942 and 7,216 Shares, Respectively... (885) (257)
---------- ----------
Total Common Stockholders' Equity.................................. 564,809 519,794
---------- ----------
Total Stockholders' Equity......................................... 571,809 526,794
---------- ----------
Total Liabilities and Stockholders' Equity............... $ 1,852,457 $1,629,720
========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE> 65
K N ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30
---------------------
1997 1996
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income............................................................. $ 49,038 $ 40,048
Adjustments to Reconcile Net Income to Net Cash Flows From Operating
Activities:
Depreciation and Amortization........................................ 41,101 38,432
Deferred Income Taxes................................................ 8,781 7,823
Deferred Purchased Gas Costs......................................... (14,736) 1,939
Provisions for Losses on Accounts Receivable......................... 808 284
Changes in Gas in Underground Storage................................ 5,409 (3,359)
Changes in Other Working Capital Items............................... 30,418 15,591
Changes in Deferred Revenues......................................... (11,699) (16,898)
Other, Net........................................................... (6,721) (13,680)
-------- --------
NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES........................ 102,399 70,180
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital Expenditures................................................... (213,320) (73,602)
Acquisitions........................................................... (102,918) (64,234)
Investments............................................................ (10,796) (3,320)
Proceeds From Sales of Assets.......................................... 9,938 5,016
-------- --------
NET CASH FLOWS USED IN INVESTING ACTIVITIES............................ (317,096) (136,140)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-Term Debt (Net).................................................. 155,700 (73,000)
Long-Term Debt Issued.................................................. -- 125,000
Long-Term Debt Retired................................................. (21,136) (13,935)
Capital Trust Pass-through Securities Issued........................... 100,000 --
Common Stock Issued.................................................... 15,802 52,685
Treasury Stock Issued.................................................. 974 4,858
Treasury Stock Acquired................................................ (1,602) (5,997)
Cash Dividends -- Common............................................... (25,254) (22,594)
-- Preferred.......................................... (263) (298)
Minority Interests Contributions....................................... -- 21
Minority Interests Distributions....................................... -- (2,339)
Securities Issuance Costs.............................................. (1,262) (938)
-------- --------
NET CASH FLOWS PROVIDED BY FINANCING ACTIVITIES........................ 222,959 63,463
-------- --------
Net Increase (Decrease) in Cash and Cash Equivalents................... 8,262 (2,497)
Cash and Cash Equivalents at Beginning of Year......................... 17,005 22,571
-------- --------
Cash and Cash Equivalents at End of Period............................. $ 25,267 $ 20,074
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE> 66
K N ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30
---------------------
1997 1996
-------- --------
<S> <C> <C>
CHANGES IN OTHER WORKING CAPITAL ITEMS SUMMARY (Net of Effects from
Acquisitions):
Accounts Receivable.................................................... $113,822 $ 55,219
Materials and Supplies................................................. (3,331) 2,533
Other Current Assets................................................... (5,406) (26,980)
Accounts Payable....................................................... (68,117) (42,978)
Other Current Liabilities.............................................. (6,550) 27,797
-------- --------
$ 30,418 $ 15,591
======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash Paid During the Year for:
Interest (Net of Amount Capitalized)................................. $ 35,050 $ 25,939
======== ========
Income Taxes......................................................... $ 15,496 $ 8,955
======== ========
</TABLE>
F-6
<PAGE> 67
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. GENERAL
In the opinion of management, all adjustments necessary for a fair
statement of the results for the unaudited interim periods have been made. These
adjustments consist only of normal recurring accruals.
Certain prior year amounts have been reclassified to conform with the 1997
presentation.
2. ACQUISITIONS
(A) Bushton
In March 1997, K N completed its purchase of several Enron Corporation
subsidiaries that owned or operated the Bushton natural gas processing facility
located in Ellsworth County, Kansas, and other Hugoton Basin gathering assets
located in Kansas and Oklahoma. The Bushton facility processes approximately 825
MMcf of natural gas and produces approximately 1.2 million gallons of natural
gas liquids ("NGLs") and approximately 1.7 MMcf of crude helium per day. The
gathering assets gather approximately 475 MMcf per day of natural gas through
approximately 2,200 miles of pipeline. The Company assumed operation of these
facilities effective April 1, 1997.
A wholly owned subsidiary of K N leases the processing facilities at
Bushton under operating leases requiring semiannual payments averaging $23.1
million per annum for the remaining term of the leases. Under the terms of these
leases, the lessee has the option of terminating the leases and/or buying the
assets at any time after November 2003, and extending the leases beyond May
2012, the scheduled termination date. In addition, the lessee may purchase the
processing facilities upon termination of the leases.
(B) Interenergy
On August 25, 1997, K N signed a binding agreement to acquire Interenergy
Corporation ("Interenergy"), a diversified energy company involved with natural
gas gathering, processing and marketing in the Rocky Mountain and mid-continent
states. K N will exchange K N common stock and assume Interenergy's debt in a
transaction to be accounted for as a purchase. Interenergy's assets to be
acquired include approximately 615 miles of natural gas gathering pipeline and
two natural gas liquids processing facilities -- one in Wyoming and one 50
percent jointly owned in North Dakota. Interenergy's gathering capacity is 53
million cubic feet of natural gas per day, with plant capacity totaling 35
million cubic feet per day. Interenergy has its headquarters in Denver and
employs 65 people.
3. SALE OF KANSAS DISTRIBUTION PROPERTIES
On October 1, 1997, K N entered into a letter of intent to sell its retail
natural gas distribution properties in Kansas to Midwest Energy, Inc., a
customer-owned cooperative based in Hays, Kansas. K N will sell its natural gas
distribution systems in 58 Kansas communities, serving approximately 30,000
residential, commercial and industrial customers. The transaction, expected to
close by year end, is subject to final approval by both companies, in addition
to all applicable state and federal regulatory authorities.
4. PONY EXPRESS PIPELINE
In 1996, K N purchased a 900-mile crude oil pipeline owned by Amoco
Pipeline Company for conversion to natural gas service. In May 1996, one of K
N's regulated interstate pipeline subsidiaries, K N Interstate Gas Transmission
Co. ("KNI"), filed with the Federal Energy Regulatory Commission ("FERC")
requesting authority to purchase from K N the portion of the line, renamed the
Pony Express Pipeline, from Lost Cabin, Wyoming in central Wyoming to Freeman,
Missouri near Kansas City. KNI also requested authority to convert the pipeline
to natural gas service, install compression and construct additional pipeline
facilities. On May 30, 1997, the FERC issued an order granting KNI's requested
authority to proceed with the project. The
F-7
<PAGE> 68
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
pipeline began free flow operations in August 1997, and full service at its
designated capacity of 255 MMcf per day is expected by early December 1997.
5. FINANCING
On October 27, 1997, the Company sold $150 million of 6.67% debentures
maturing on November 1, 2027. The debentures are callable by the Company any
time after November 1, 2004 and are redeemable at the option of the registered
holders on November 1, 2004. The Company used the net proceeds from the sale to
reduce short-term indebtedness.
On April 24, 1997, the Company sold $100 million of 8.56% Capital Trust
Pass-through Securities (the "Capital Securities") maturing on April 15, 2027.
The sale was effected through a wholly owned business trust named K N Capital
Trust I (the "Trust"). The Company used the net proceeds from the sale to reduce
short-term indebtedness. The financial statements of the Trust are consolidated
into the Company's consolidated financial statements, with the Capital
Securities treated as a minority interest and shown in the Company's
consolidated balance sheet as "K N-Obligated Mandatorily Redeemable Capital
Trust Pass-through Securities of Subsidiary Trust."
6. COMMON STOCK ISSUANCE
On June 11, 1997, Cabot Corporation exercised warrants held by it and
purchased, in an unregistered offering, 642,232 shares of K N's Common Stock
which were issued to Cabot Specialty Chemicals, Inc., in exchange for Cabot's
payment of $11.3 million.
7. JOINT VENTURE
In January 1997, K N and PacifiCorp formed a joint venture named en-able,
L.L.C. ("en-able") that provides a broad portfolio of branded products and
services that local utilities can offer to their customers under the Simple
Choice(SM) brand. All Simple Choice(SM) products and services are supported
through a customer service center in Scottsbluff, Nebraska owned and operated by
en-able. Subsidiaries of K N and PacifiCorp each own 50 percent of en-able.
8. ACCOUNTING PRONOUNCEMENTS ISSUED BUT NOT YET EFFECTIVE
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 128, Earnings Per Share. This new
statement is effective December 15, 1997; early adoption is not permitted. SFAS
128 provides computation, presentation and disclosure requirements for earnings
per share. When adopted, the Company will restate reported earnings per share
for all prior periods presented. Had this standard been effective for the
periods presented herein, the following earnings per share would have been
reported:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30
---------------
1997 1996
----- -----
<S> <C> <C>
Basic Earnings Per Share........................................... $1.58 $1.38
Diluted Earnings Per Share......................................... $1.55 $1.36
</TABLE>
9. RISK MANAGEMENT
The Company uses two types of risk management instruments -- energy
financial instruments and interest rate swaps -- which are discussed below. The
Company is exposed to credit-related losses in the event
F-8
<PAGE> 69
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
of nonperformance by counterparties to these financial instruments, but does not
expect any counterparties to fail to meet their obligations given their existing
credit ratings.
The fair value of these risk management instruments reflects the estimated
amounts that the Company would receive or pay to terminate the contracts at the
reporting date, thereby taking into account the current unrealized gains or
losses on open contracts. Market quotes are available for substantially all
instruments used by the Company.
(A) Energy Financial Instruments
The Company uses energy financial instruments to minimize its risk of price
changes in the spot and fixed price natural gas and NGLs markets. Energy risk
management products include commodity futures and options contracts, fixed price
swaps and basis swaps. Pursuant to its Board of Directors' approved guidelines,
the Company is to engage in these activities only as a hedging mechanism against
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. The 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. All energy futures, swaps and options are recorded at fair value.
Gains and losses on hedging positions are deferred and recognized as gas
purchases expenses in the periods the underlying physical transactions occur.
The differences between the current market value and the original physical
contracts' value, associated with hedging activities, are reflected, depending
on maturity, as deferred charges or credits and other current assets or
liabilities in the accompanying consolidated balance sheets. These deferrals
will be offset by the corresponding underlying physical transactions.
In the event energy financial instruments do not meet the criteria for
hedge accounting, the deferred gains or losses associated with the corresponding
financial instruments would be included in the results of operations in the
current period.
In the event energy financial instruments are terminated prior to the
period of physical delivery of the items being hedged, the gains or losses on
the energy financial instruments at the time of termination remain deferred
until the period of physical delivery unless both the energy financial
instruments and the items being hedged result in a loss. If this occurs, the
loss is recorded immediately.
(B) Interest Rate Swaps
The Company has entered into various interest rate swap and cap agreements
for the purpose of managing interest rate exposure. Settlement amounts payable
or receivable under these agreements are recorded as interest expense or income
in the accounting period they are incurred.
F-9
<PAGE> 70
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, 1996 and 1995,
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,
1996. 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, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Denver, Colorado
February 4, 1997
F-10
<PAGE> 71
K N ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
----------------------------------------
1996 1995 1994
---------- ---------- ----------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C>
OPERATING REVENUES:
Gathering, Processing and Marketing Services........... $1,193,984 $ 854,462 $ 838,474
Interstate Transportation and Storage Services......... 25,352 22,217 21,044
Retail Natural Gas Services............................ 223,838 227,282 220,431
Gas and Oil Production................................. -- 7,437 11,328
------- ------- -------
Total Operating Revenues............................... 1,443,174 1,111,398 1,091,277
------- ------- -------
OPERATING COSTS AND EXPENSES:
Gas Purchases and Other Costs of Sales................. 1,062,062 752,129 777,634
Operations and Maintenance............................. 175,778 174,181 165,516
Depreciation, Depletion and Amortization............... 51,212 49,891 50,278
Taxes, Other Than Income Taxes......................... 19,321 19,835 17,025
Merger and Restructuring Costs......................... -- -- 25,945
------- ------- -------
Total Operating Costs and Expenses..................... 1,308,373 996,036 1,036,398
------- ------- -------
OPERATING INCOME....................................... 134,801 115,362 54,879
------- ------- -------
OTHER INCOME AND (DEDUCTIONS):
Interest Expense....................................... (35,933) (34,211) (31,605)
Minority Interests..................................... (2,946) (905) (659)
Other, Net............................................. 3,794 1,326 2,206
------- ------- -------
Total Other Income and (Deductions).................... (35,085) (33,790) (30,058)
------- ------- -------
INCOME BEFORE INCOME TAXES............................. 99,716 81,572 24,821
Income Taxes........................................... 35,897 29,050 9,500
------- ------- -------
NET INCOME............................................. 63,819 52,522 15,321
Less -- Preferred Stock Dividends...................... 398 492 630
------- ------- -------
EARNINGS AVAILABLE FOR COMMON STOCK.................... $ 63,421 $ 52,030 $ 14,691
======= ======= =======
EARNINGS PER COMMON SHARE.............................. $ 2.14 $ 1.83 $ 0.52
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these statements.
F-11
<PAGE> 72
K N ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31
-------------------------
1996 1995
---------- ----------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and Cash Equivalents................................................... $ 17,005 $ 22,571
Accounts Receivable......................................................... 298,072 214,963
Materials and Supplies...................................................... 6,092 10,515
Gas in Underground Storage.................................................. 43,511 13,534
Prepaid Gas................................................................. 12,001 7,800
Other Prepaid Expenses...................................................... 12,824 13,536
Gas Imbalances and Other.................................................... 65,319 23,880
---------- ----------
454,824 306,799
---------- ----------
INVESTMENTS:
Investment in Tom Brown, Inc................................................ 44,331 --
Investment in Gas and Oil Properties, Net................................... -- 36,451
Other....................................................................... 6,207 15,784
---------- ----------
50,538 52,235
---------- ----------
PROPERTY, PLANT AND EQUIPMENT, NET............................................ 1,029,171 859,203
---------- ----------
DEFERRED CHARGES AND OTHER ASSETS............................................. 95,187 39,220
---------- ----------
TOTAL ASSETS.................................................................. $1,629,720 $1,257,457
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current Maturities of Long-Term Debt........................................ $ 26,971 $ 28,197
Notes Payable............................................................... 129,300 88,000
Accounts Payable............................................................ 241,187 157,340
Accrued Taxes............................................................... 16,045 5,423
Gas Imbalances and Other.................................................... 85,113 50,878
---------- ----------
498,616 329,838
---------- ----------
DEFERRED LIABILITIES, CREDITS AND RESERVES:
Deferred Income Taxes....................................................... 122,371 112,267
Deferred Revenues........................................................... 6,940 20,823
Other....................................................................... 24,990 30,356
---------- ----------
154,301 163,446
---------- ----------
LONG-TERM DEBT................................................................ 423,676 315,564
---------- ----------
MINORITY INTERESTS IN EQUITY OF SUBSIDIARIES.................................. 26,333 14,277
---------- ----------
COMMITMENTS AND CONTINGENT LIABILITIES (NOTES 1, 5 AND 14) PREFERRED STOCK
SUBJECT TO MANDATORY REDEMPTION............................................. -- 572
---------- ----------
STOCKHOLDERS' EQUITY:
Preferred Stock............................................................. 7,000 7,000
---------- ----------
Common Stock:
Authorized -- 50,000,000 Shares, Par Value $5 Per Share
Outstanding -- 30,295,792 and 28,097,749 Shares, Respectively............. 151,479 140,489
Additional Paid-in Capital.................................................. 228,902 176,910
Retained Earnings........................................................... 142,578 109,895
Deferred Compensation....................................................... (2,908) (222)
Treasury Stock, at Cost -- 7,216 and 10,739 Shares, Respectively............ (257) (312)
---------- ----------
Total Common Stockholders' Equity........................................... 519,794 426,760
---------- ----------
Total Stockholders' Equity.................................................. 526,794 433,760
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.................................... $1,629,720 $1,257,457
========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
F-12
<PAGE> 73
K N ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL DEFERRED TREASURY STOCK
---------------------- PAID-IN RETAINED COMPEN- ------------------
SHARES AMOUNT CAPITAL EARNINGS SATION SHARES AMOUNT
----------- -------- ---------- -------- ------- -------- ------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1993......... 27,200,967 $136,005 $164,427 $ 92,187 $(1,157) -- $ --
Net Income......................... 15,321
Cash Dividends --
Common, $0.76 Per Share.......... (20,846)
Preferred........................ (630)
Treasury Stock Acquired............ (91,601) (2,065)
Employee Stock Options............. 59,492 298 466
Employee Benefit Plans............. 136,922 685 2,858 27,805 633
Dividend Reinvestment and Stock
Purchase Plans................... 181,069 905 2,676 19,379 444
Exercise of Common Stock
Warrants......................... 19,081 95 111
Issuance of Common Shares as
Executive Compensation........... 20,000 100 394 (322)
Amortization of
Deferred Compensation............ 1,101
---------- -------- -------- -------- ------- -------- -------
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
---------- -------- -------- -------- ------- -------- -------
BALANCE, DECEMBER 31, 1995......... 28,097,749 140,489 176,910 109,895 (222) (10,739) (312)
Net Income......................... 63,819
Cash Dividends --
Common, $1.05 Per Share.......... (30,738)
Preferred........................ (398)
Sale of Common Stock, Net.......... 1,715,000 8,575 44,591
Redemption and Cancellation of
Common Stock Warrants............ (7,420)
Unrealized Holding Gains on
Available-for-Sale Securities.... 5,735
Treasury Stock Acquired............ (220,178) (7,069)
Acquisition of Businesses.......... 1,648 33,765 1,183
Employee Stock Options............. 292,421 1,462 2,981 517 16
Dividend Reinvestment and Stock
Purchase Plans................... 95,572 478 1,438 189,419 5,925
Issuance of Common Shares as
Executive Compensation........... 95,050 475 3,019 (3,494)
Amortization of
Deferred Compensation............ 808
---------- -------- -------- -------- ------- -------- -------
BALANCE, DECEMBER 31, 1996......... 30,295,792 $151,479 $228,902 $142,578 $(2,908) (7,216) $ (257)
========== ======== ======== ======== ======= ======== =======
</TABLE>
The accompanying notes are an integral part of these statements.
F-13
<PAGE> 74
K N ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31
------------------------------------
1996 1995 1994
--------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income............................................... $ 63,819 $ 52,522 $ 15,321
Adjustments to Reconcile Net Income to Net Cash Flows
From Operating Activities:
Depreciation, Depletion and Amortization............... 51,212 49,891 50,278
Deferred Income Taxes.................................. 16,443 15,975 7,302
Deferred Purchased Gas Costs........................... (8,109) (1,458) 1,601
Provision for Losses on Accounts Receivable............ 307 949 627
Loss (Gain) on Sale of Facilities...................... 491 -- (1,458)
Asset Write-off Associated with Merger................. -- -- 2,500
Changes in Other Working Capital Items................. (27,561) 19,297 16,523
Changes in Deferred Revenues........................... (13,883) (21,267) (1,602)
Other, Net............................................. (1,890) 13,671 120
-------- -------- -------
NET CASH FLOWS FROM OPERATING ACTIVITIES................. 80,829 129,580 91,212
-------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital Expenditures................................... (119,987) (79,313) (70,511)
Acquisitions........................................... (154,007) (31,945) (31,231)
Investments............................................ (2,142) (6,598) (3,906)
Proceeds from Sale of Facilities....................... 11,922 2,706 22,305
Collections (Payments) Under Basket Agreement.......... 6 1,491 (306)
-------- -------- -------
NET CASH FLOWS USED IN INVESTING ACTIVITIES.............. (264,208) (113,659) (83,649)
-------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-Term Debt, Net................................... 41,300 28,000 13,000
Long-Term Debt -- Issued............................... 125,000 -- 83,100
-- Retired.......................... (18,170) (21,322) (79,078)
Preferred Stock Redemption............................. (572) (1,143) (1,643)
Common Stock Issued.................................... 61,668 8,379 8,093
Redemption and Cancellation of Common Stock Warrants... (7,420) -- --
Common Stock Issuance Costs............................ (2,143) -- --
Treasury Stock -- Issued............................... 5,941 2,635 1,077
-- Acquired........................... (7,069) (1,959) (2,065)
Cash Dividends -- Common............................... (30,738) (28,167) (20,846)
-- Preferred.......................... (398) (492) (630)
Minority Interests -- Contributions.................... 13,586 2,906 1,163
-- Distributions................... (2,182) (2,765) (2,183)
Premium on Debt Re-acquisition and Issuance Costs...... (990) (35) (1,291)
-------- -------- -------
NET CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES....... 177,813 (13,963) (1,303)
-------- -------- -------
Net Increase (Decrease) in Cash and Cash Equivalents... (5,566) 1,958 6,260
Cash and Cash Equivalents at Beginning of Year......... 22,571 20,613 14,353
-------- -------- -------
Cash and Cash Equivalents at End of Year............... $ 17,005 $ 22,571 $ 20,613
======== ======== =======
</TABLE>
The accompanying notes are an integral part of these statements.
F-14
<PAGE> 75
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(A) Nature of Operations
K N Energy, Inc. ("K N") is an energy services provider and has operations
in nine states in the Rocky Mountain and Mid-Continent regions. Natural gas
services include gathering, processing, storing, transporting and marketing
natural gas, providing retail natural gas distribution services, providing field
services to natural gas producers and marketing natural gas liquids. A branded
package of consumer services and customer billing and call center services are
also offered. The Company's operations are divided between regulated and
nonregulated sectors.
(B) Basis of Presentation
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions. These estimates and assumptions affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities, and
the reported amounts of revenues and expenses. Actual results could differ from
these estimates.
The consolidated financial statements include the accounts of K N and its
majority-owned subsidiaries (the "Company"). Investments in jointly owned
operations in which the Company has 20 to 50 percent ownership are accounted for
under the equity method. All material intercompany items and transactions have
been eliminated.
(C) Accounting for Regulatory Activities
The Company's regulated public utilities are accounted for in accordance
with the provisions of Statement of Financial Accounting Standards ("SFAS") No.
71, Accounting for the Effects of Certain Types of Regulation, which prescribes
the circumstances in which the application of generally accepted accounting
principles is affected by the economic effect of regulation.
Regulatory assets and liabilities represent probable future revenues or
expenses to the Company associated with certain charges and credits which will
be recovered from or refunded to customers through the ratemaking process. The
following regulatory assets and liabilities are reflected in the accompanying
consolidated financial statements (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1995
------- -------
<S> <C> <C>
REGULATORY ASSETS:
Employee Benefit Costs................................. $ 1,084 $ 923
Debt Refinancing Costs................................. 3,100 3,514
Deferred Income Taxes.................................. 706 755
Purchased Gas Costs.................................... 28,814 15,254
Plant Acquisition Adjustments.......................... 454 454
Rate Regulation and Application Costs.................. 830 1,401
------- -------
Total Regulatory Assets.................................. 34,988 22,301
------- -------
REGULATORY LIABILITIES:
Deferred Income Taxes.................................. 4,218 4,621
Purchased Gas Costs.................................... 6,529 10,640
------- -------
Total Regulatory Liabilities............................. 10,747 15,261
------- -------
NET REGULATORY ASSETS.................................... $24,241 $ 7,040
======= =======
</TABLE>
F-15
<PAGE> 76
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As of December 31, 1996, $32.5 million of the Company's regulated assets
and $9.9 million of the Company's regulated liabilities were being recovered
from or refunded to customers through rates over periods ranging from one to 17
years.
(D) Earnings Per Share
Primary earnings per share are computed based on the monthly weighted
average number of common shares outstanding during the periods and the assumed
exercise of dilutive common stock equivalents (stock options and warrants) using
the treasury stock method. The number of common shares used in computing
earnings per share was 29,624,000 in 1996, 28,360,000 in 1995 and 28,044,000 in
1994.
(E) Gas in Underground Storage
K N's regulated retail distribution business and Northern Gas Company
account for gas in underground storage using the last-in, first-out ("LIFO")
method. K N Gas Supply Services, Inc., K N Marketing, Inc., and K N Natural Gas,
Inc., wholly owned subsidiaries of K N, value gas in underground storage at
average cost. AOG Gas Transmission Company, L.P., K N Marketing, L.P., Rocky
Mountain Natural Gas Company and Westar Transmission Company, wholly owned
subsidiaries of K N, use the first-in, first-out ("FIFO") method.
The Company also maintains gas in its underground storage facilities on
behalf of certain third parties. The Company receives a fee for its storage
services but does not reflect the value of third party gas in the accompanying
consolidated financial statements.
(F) Prepaid Gas
Prepaid gas represents payments made in lieu of taking delivery of (and
purchasing) natural gas under the take-or-pay provisions of certain of the
Company's gas purchase contracts, net of any subsequent recoupments in kind from
producers. Funds paid by the Company for take-or-pay are fully recoupable from
future production and are recorded as an asset (Prepaid Gas). When recoupment is
made in kind in a subsequent contract year, natural gas purchase expense is
recorded and the asset is reduced.
(G) Property, Plant and Equipment
Property, plant and equipment is stated at historical cost which, for
constructed plant, includes indirect costs such as payroll taxes, fringe
benefits, and administrative and general costs. Expenditures which increase
capacities or extend useful lives are capitalized. Routine maintenance, repairs
and renewal costs are expensed as incurred.
Gains or losses are recognized upon retirement of non utility property,
plant and equipment. The cost of depreciable utility property, plant and
equipment retired, plus the cost of removal less salvage, is deducted from
accumulated depreciation with no effect on current period earnings.
(H) Depreciation, Depletion and Amortization
Depreciation is computed based on the straight-line method over estimated
useful lives ranging from 3 to 40 years for most property, plant and equipment.
(I) Deferred Revenues
In conjunction with the Federal Energy Regulatory Commission ("FERC") Order
No. 636 ("Order 636") restructuring activities, the Company negotiated new gas
sales agreements with its former wholesale customers. As a result, the Company
is now responsible for performance under, or to otherwise dispose of,
F-16
<PAGE> 77
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
certain pre-Order 636 gas purchase contracts. These gas sales agreements provide
for such customers to pay fixed demand charges over the agreement term, and to
purchase gas from a subsidiary of the Company at negotiated commodity rates. The
demand portion of the gas sales agreements was recorded as deferred revenues in
1993. Commodity charges are recorded as deferred revenues as gas is delivered
under these agreements. Gas purchase, gathering, transportation and contract
administration costs are recorded as a reduction to the related revenues. In
addition, margins on sales of excess gas supplies under the previously described
contracts to affiliates at market clearing or contracted rates are recorded in
deferred revenues. Subsequent margins earned on these sales by the affiliates
are recognized as income when the gas is delivered. Company management believes
that the revenues being collected and deferred under these agreements will be
sufficient to offset future costs associated with the gas purchase contracts,
and will not have a material adverse effect on the Company's financial position
or results of operations.
In January 1994, contract demand receivables with a face amount of $41
million were sold to a financial institution. No gain or loss was recorded on
the sale.
(J) Accounting Pronouncements Issued But Not Yet Effective
Effective January 1, 1997, the Company will adopt the provisions of
Statement of Position ("SOP") No. 96-1, Environmental Remediation Liabilities.
This Statement provides authoritative guidance for recognition, measurement,
display, and disclosure of environmental remediation liabilities in financial
statements. The Company has recorded environmental remediation liabilities of
$2.9 million at December 31, 1996. SOP 96-1 is not expected to have a material
impact on the Company's financial position or results of operations upon
adoption.
(K) Reclassification of Prior Year Amounts
Certain prior year amounts have been reclassified to conform with the 1996
presentation.
(L) Cash Flow Information
The Company considers all highly-liquid investments purchased with an
original maturity of three months or less to be cash equivalents.
F-17
<PAGE> 78
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Changes in Other Working Capital Items Summary and Supplemental Disclosures
of Cash Flow Information are as follows (in thousands):
CHANGES IN OTHER WORKING CAPITAL ITEMS SUMMARY
(NET OF ACQUISITION EFFECTS)
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- -------
<S> <C> <C> <C>
Accounts Receivable......................................... $(82,903) $(67,364) $24,685
Contract Demand Receivables................................. -- -- 38,732
Materials and Supplies...................................... 4,761 2,172 (1,083)
Gas in Underground Storage.................................. (29,977) 17,950 (10,842)
Other Current Assets........................................ (45,498) 16,981 (16,329)
Accounts Payable, Accrued Taxes and Other Current
Liabilities............................................... 126,056 49,558 (18,640)
-------- ------- -------
$(27,561) $ 19,297 $16,523
======== ======= =======
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION CASH PAID
DURING THE YEAR FOR:
Interest (Net of Amount Capitalized)........................ $ 31,748 $ 34,503 $28,721
======== ======= =======
Income Taxes................................................ $ 14,156 $ 9,774 $12,763
======== ======= =======
</TABLE>
2. AOG MERGER
On July 13, 1994, pursuant to the Agreement of Merger dated March 24, 1994,
American Oil & Gas Corporation ("AOG") was merged into the Company. As a result
of the merger, each outstanding share of common stock of AOG was converted into
0.47 of a share of common stock of K N. In connection with the merger, all the
outstanding shares of AOG common stock were converted into approximately 12.2
million shares of K N stock, and the authorized number of shares of K N common
stock was increased to 50 million shares. The merger was accounted for as a
pooling of interests. The Company recorded merger and restructuring costs
totaling $25.9 million in 1994 relating to the merger and the formal
restructuring plan of the Company's retail distribution operations. The
restructuring plan was completed during 1995. Total cash expenditures related to
these charges were $23.4 million.
3. MERGER AND ACQUISITIONS
(A) Pony Express Pipeline
In 1996, K N purchased a 900-mile crude oil pipeline owned by Amoco
Pipeline Company for conversion to natural gas service. In May, one of K N's
regulated interstate pipeline subsidiaries, K N Interstate Gas Transmission Co.
("KNI"), filed with the FERC requesting authority to purchase from K N the
portion of the line, renamed the Pony Express Pipeline, from Lost Cabin, Wyoming
in central Wyoming to Freeman, Missouri near Kansas City. KNI also requested
authority to convert the pipeline to natural gas service, install compression
and construct additional pipeline facilities. The pipeline is expected to begin
limited operations late in the second quarter of 1997; the actual timing depends
upon the date FERC approval is received.
On November 27, 1996, KNI took assignment of two contracts to provide firm
transportation capacity of 230 MMcf per day to the Kansas City metropolitan area
part of which will be transported through the Pony Express Pipeline. KNI will
also construct approximately 36 miles of lateral facilities to connect the new
markets with the Pony Express Pipeline and a third-party pipeline. These
facilities are expected to be in service by September 1997.
F-18
<PAGE> 79
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(B) Gas and Oil Properties
On January 31, 1996, K N and Tom Brown, Inc. ("TBI") closed a transaction
pursuant to which K N transferred its stock in K N Production Company ("KNPC"),
a wholly owned subsidiary of K N, to TBI in exchange for common and convertible
preferred stock of TBI. The transaction represents a non-monetary exchange
(valued at $38.6 million) of oil and gas assets for accounting purposes. The
common shares are considered available-for-sale securities and, as a result,
unrealized holding gains totaling $5.7 million are included in additional
paid-in capital in the consolidated Balance Sheet at December 31, 1996.
In conjunction with this transaction, K N and TBI formed Wildhorse Energy
Partners, LLC, owned 55 percent by K N and 45 percent by TBI, which performs
certain gathering, processing, field, marketing and storage services in a
defined area of mutual interest.
(C) Gathering Assets
In September 1996, Wildhorse Energy Partners, LLC executed a definitive
agreement to purchase Williams Field Services' gathering and processing assets
in western Colorado and eastern Utah. The assets acquired include 955 miles of
gathering lines and related facilities and two natural gas processing plants.
(D) Transmission and Storage Systems
In February 1995, the Company acquired certain natural gas transmission
pipeline and storage assets in Texas. The assets include two West Texas pipeline
systems, comprised of 347 miles of pipeline and related facilities, which are
connected to K N's core pipeline system. In addition, surface facilities, lease
rights and approximately 10.3 Bcf of natural gas in storage in a leased, Gulf
Coast storage field were acquired. K N also acquired the remaining 50 percent
interest it did not previously own in a 90-mile joint venture pipeline near
Midland, Texas. The total purchase price was $79 million. The Company utilized
an operating lease and short-term debt financing arrangements to fund the
acquisition.
(E) TransColorado Project
During 1996, an agreement was executed providing for the construction and
operation of a new unregulated gas treating plant in southwestern Colorado owned
by affiliates of K N and El Paso Natural Gas Company. The treating plant is
connected to Phase I (New Mexico pre-build) of the TransColorado pipeline. On
September 30, 1996, the FERC approved TransColorado Gas Transmission Company's
application to construct Phase I of the project which consists of 22.5 miles of
24-inch pipeline and 2.5 miles of 16-inch lateral pipeline. Both the pipeline
and plant, which have a combined capital cost of approximately $30 million and a
design capacity to handle up to 120,000 MMBtu per day, were placed in service in
December 1996.
(F) Processing Assets
On December 13, 1996, K N signed a letter of intent to purchase several
Enron Corp. subsidiaries that own the Bushton natural gas processing facility
located in Ellsworth County, Kansas, and other Hugoton Basin gathering assets
located in Kansas and Oklahoma. The Bushton facility processes approximately 825
MMcf of natural gas and produces approximately 1.2 million gallons of natural
gas liquids and approximately 1.7 MMcf of crude helium per day. The gathering
assets gather approximately 475 MMcf per day of natural gas through
approximately 2,200 miles of pipeline.
The closing of the transaction is subject to execution of acceptable
definitive agreements and receipt of appropriate regulatory approvals.
F-19
<PAGE> 80
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. REGULATORY MATTERS
On February 16, 1996, the Wyoming Public Service Commission issued an order
authorizing K N to implement a program to allow approximately 10,500 residential
and commercial customers to choose their energy provider from a qualified list
of suppliers. This new service commenced on June 1, 1996. K N continues to
provide all other utility services and manages the gas supplies for customers in
the program.
KNI made a rate filing with the FERC in December 1993 which became
effective July 1, 1994, subject to refund. The Stipulation and Agreement
approved by the FERC in January 1995 provides for an $8.7 million annual
increase in revenues. Revenues collected above the settlement rates were
refunded to customers in early 1995.
In January 1995, as a result of an agreement reached with its customers,
the Company filed an application with the FERC to transfer three storage fields,
including approximately 45 Bcf of cushion gas held by KNI, to a newly created
affiliate, K N Natural Gas, Inc. ("KNNG"). On May 2, 1995, the FERC issued an
order approving the storage reorganization filing. With the approval of this
transfer, KNI owns only the Huntsman, Nebraska storage facilities, which remain
as jurisdictional facilities and continue to provide storage services.
Jurisdictional rates were restated to reflect this transfer. KNNG began selling
gas at market rates from the three storage facilities which were transferred,
effective June 1, 1995.
In December 1994, KNI sought authority from the FERC to install pipeline
and compressor facilities in the vicinity of Casper, Wyoming which would
increase KNI's mainline capacity by 47.5 MMBtus per day. By an order dated
January 18, 1996, the FERC granted the requested authority. KNI has constructed
$8.7 million of facilities which increase westend system capacity by 35 MMBtus
per day and is holding in abeyance construction of the rest of the authorized
facilities pending action by the FERC on its Pony Express Pipeline application.
K N's retail natural gas services business segment received rate increases
from the Colorado Public Utilities Commission during 1994 as summarized below:
<TABLE>
<CAPTION>
APPROVED
ANNUALIZED
EFFECTIVE DATE REVENUE
ENTITY REQUESTING INCREASE OF NEW RATES INCREASE
------------------------------------------------ ------------------- --------------
(IN MILLIONS)
<S> <C> <C>
RMNGD*.......................................... $ 1.5 4-2-94
RMNGD*.......................................... 0.5 9-1-94
</TABLE>
- ---------------
*Rocky Mountain Natural Gas Division of K N
5. LEGAL MATTERS
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. The total
remaining estimated cost is not expected to exceed $150,000.
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 five-year assessment
program; active remediation will begin in the summer of 1997. The costs are not
expected to have any material adverse impact on the Company's financial position
or results of operations. The cleanup program is not expected to interrupt or
diminish the Company's operational ability to gather or transport natural gas.
F-20
<PAGE> 81
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 polychlorinated biphenyls ("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. At
PCB sites with approved workplans, the Company estimates that the future cost of
remediation, which will occur over a period of years, will be approximately $1.3
million, a substantial portion of which is recoverable under the Rockwell
settlement. Approximately $1.4 million for PCB remediation has been expended as
of December 31, 1996. The total potential remediation and cleanup costs at
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 in 1989 and 1992, The Maple Gas
Corporation and Cabot Corporation ("Cabot"), the Company's largest stockholder,
indemnified the Company for certain environmental liabilities. Issues have
arisen concerning Cabot's indemnification obligations; however, in conjunction
with the AOG merger, the Company and Cabot entered into a standstill agreement
pertaining to these and other matters, which will expire on March 31, 1997. The
Company believes it will be able to reach agreement with Cabot, and 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 a 32 MMBtu per day cryogenic NGLs processing plant and
approximately 900 miles of gathering pipeline located in the Texas Panhandle
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,
which 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. After consideration of reserves established,
such costs are not expected to have a material adverse impact on the Company's
financial position or results of operations. The cleanup program, which will
occur over a number of years, is not expected to interrupt or diminish the
Company's operational ability to gather, process or transport natural gas.
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 and GASCO, Inc. (the "K N Entities") alleging that the K N
Entities as well as KNPC 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 of this proceeding, and discovery is
ongoing. This case is still pending, but no trial date has yet been set. On July
26, 1996, K N and Rocky Mountain Natural Gas Company ("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 have been made against K N or RMNG, and no specific monetary
damages have been claimed. No trial date has been set. The Company
F-21
<PAGE> 82
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
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.
6. PROPERTY, PLANT AND EQUIPMENT
Investment in property, plant and equipment, at cost, and accumulated
depreciation and amortization ("Accumulated D&A"), detailed by business segment,
are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1996
----------------------------------------------
PROPERTY, PLANT ACCUMULATED
AND EQUIPMENT D&A NET
--------------- ----------- ----------
<S> <C> <C> <C>
Gathering, Processing and Marketing
Services................................... $ 683,569 $ 212,926 $ 470,643
Interstate Transportation and Storage
Services................................... 454,427 156,358 298,069
Retail Natural Gas Services.................. 409,626 149,167 260,459
---------- -------- ----------
$ 1,547,622 $ 518,451 $1,029,171
========== ======== ==========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1995
-----------------------------------------------
PROPERTY, PLANT ACCUMULATED
AND EQUIPMENT D&A NET
--------------- ----------- -----------
<S> <C> <C> <C>
Gathering, Processing and Marketing
Services................................... $ 663,754 $ 205,702 $458,052
Interstate Transportation and Storage
Services................................... 315,686 149,267 166,419
Retail Natural Gas Services.................. 369,576 134,844 234,732
---------- -------- ----------
$ 1,349,016 $ 489,813 $859,203
========== ======== ==========
</TABLE>
Effective January 1, 1996, the Company adopted SFAS No. 121, Accounting for
the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of.
This statement imposes a stricter criterion for both nonregulated and regulated
long-lived assets by requiring that such assets be probable of future recovery
at each balance sheet date. Based on the current regulatory structure in which
the Company operates, this conclusion may change in the future as competitive
factors influence wholesale and retail pricing in the industry. Adoption of this
standard had no impact on the Company's financial position or results of
operations.
7. INCOME TAXES
Deferred income tax assets and liabilities are recognized based on enacted
tax laws for all temporary differences between financial reporting and tax bases
of assets and liabilities. Deferred tax assets are reduced by a valuation
allowance for the amount of any tax benefit that is not expected to be realized.
F-22
<PAGE> 83
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Components of the income tax provision applicable to federal and state
income taxes are as follows
(in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
TAXES CURRENTLY PAYABLE:
Federal..................................... $17,685 $11,069 $ 5,992
State....................................... 1,769 2,006 (3,794)
------- ------- -------
Total............................... 19,454 13,075 2,198
------- ------- -------
TAXES DEFERRED:
Federal..................................... 15,601 15,672 4,081
State....................................... 842 303 3,221
------- ------- -------
Total............................... 16,443 15,975 7,302
------- ------- -------
TOTAL TAX PROVISION........................... $35,897 $29,050 $ 9,500
======= ======= =======
EFFECTIVE TAX RATE............................ 36.0% 35.6% 38.3%
======= ======= =======
</TABLE>
The difference between the statutory federal income tax rate and the
Company's effective income tax rate is summarized as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
FEDERAL INCOME TAX RATE................................ 35.0% 35.0% 35.0%
INCREASE (DECREASE) AS A RESULT OF:
State Income Tax, Net of Federal Benefit............. 1.7% 1.8% (1.5%)
Nonconventional Fuels Credit......................... -- (1.0%) (3.0%)
Nondeductible Merger Costs........................... -- -- 7.8%
Other................................................ (0.7%) (0.2%) --
---- ---- ----
EFFECTIVE TAX RATE..................................... 36.0% 35.6% 38.3%
==== ==== ====
</TABLE>
F-23
<PAGE> 84
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company has recorded deferred regulatory assets of $0.7 million and
$0.8 million, and deferred regulatory liabilities of $4.2 million and $4.6
million at December 31, 1996 and 1995, respectively, which are expected to
result in cost-of-service adjustments. These amounts reflect the "gross of tax"
presentation required under SFAS No. 109, Accounting for Income Taxes. The
deferred tax assets and liabilities and deferred regulatory assets and
liabilities for rate-regulated entities computed according to SFAS 109 result
from the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31
---------------------
1996 1995
-------- --------
<S> <C> <C>
DEFERRED TAX ASSETS:
Unbilled Revenue..................................... $ 925 $ 2,113
Vacation Accrual..................................... 1,599 1,577
State Taxes.......................................... 4,438 4,358
Capitalized Overhead Adjustment...................... 1,858 2,069
Operating Reserves................................... 1,155 772
Stock Investments.................................... -- 1,425
Deferred Revenues.................................... -- 1,525
Alternative Minimum Tax Credits...................... 10,164 10,011
Other................................................ 4,339 5,327
-------- --------
TOTAL DEFERRED TAX ASSETS.............................. 24,478 29,177
-------- --------
DEFERRED TAX LIABILITIES:
Liberalized Depreciation............................. 131,192 129,048
Rate Matters......................................... 6,757 4,574
Prepaid Pension...................................... 2,735 3,988
Stock Investments.................................... 3,457 --
Other................................................ 2,708 3,834
-------- --------
TOTAL DEFERRED TAX LIABILITIES......................... 146,849 141,444
-------- --------
NET DEFERRED TAX LIABILITIES........................... $122,371 $112,267
======== ========
DEFERRED ACCOUNTS FOR RATE REGULATED ENTITIES:
Assets............................................... $ 706 $ 755
======== ========
Liabilities.......................................... $ 4,218 $ 4,621
======== ========
</TABLE>
8. FINANCING
(A) Notes Payable
At December 31, 1996, K N had a revolving credit agreement with seven banks
to borrow for general corporate purposes, including commercial paper support, up
to a total of $200 million. On March 7, 1997, this agreement was amended to
include a total of 11 banks and to increase the amount of the credit facility to
$350 million. Borrowings are made at rates negotiated on the borrowing date and
for a term of no more than 360 days. Under the credit agreement, K N agrees to
pay a facility fee based on the total commitment, at rates which vary based on
the financial rating of K N's long-term debt. Facility fees paid in both 1996
and 1995 were $0.2 million. The amended credit agreement expires March 7, 2002.
At December 31, 1996, $40 million was outstanding under this credit agreement,
compared with $10 million at December 31, 1995 under other agreements that were
not renewed during 1996.
F-24
<PAGE> 85
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Commercial paper issued by K N represents unsecured short-term notes with
maturities not to exceed 270 days from the date of issue. During 1996, all
commercial paper was redeemed within 63 days, with interest rates ranging from
5.15 to 6.63 percent. Commercial paper outstanding at December 31, 1996 and
1995, respectively, were $89.3 and $78.0 million. The weighted average interest
rates on short-term borrowings outstanding at December 31, 1996 and 1995,
respectively, were 6.93 percent and 6.01 percent.
Average short-term borrowings outstanding during 1996 and 1995 were $60.8
million and $47.8 million, respectively. During 1996 and 1995, the weighted
average interest rates on short-term borrowings outstanding were 5.62 percent
and 6.01 percent, respectively.
(B) Long-Term Debt
<TABLE>
<CAPTION>
DECEMBER 31
---------------------
1996 1995
-------- --------
(IN THOUSANDS)
<S> <C> <C>
DEBENTURES:
6.5% Series, Due 2013........................................ $ 50,000 $ 50,000
7.85% Series, Due 2022....................................... 27,545 28,434
8.75% Series, Due 2024....................................... 75,000 75,000
7.35% Series, Due 2026....................................... 125,000 --
SINKING FUND DEBENTURES:
9.95% Series, Due 2020....................................... 20,000 20,000
9.625% Series, Due 2021...................................... 45,000 45,000
8.35% Series, Due 2022....................................... 35,000 35,000
Unamortized Debt Discount...................................... (1,013) (1,069)
SENIOR NOTES:
7.27%, Due 1997-2002......................................... 30,000 32,500
11.846% (AOG), Due 1997-1999................................. 18,661 25,446
Medium-Term Notes, 10.07% Average Rate, Due 1997-1999.......... 8,000 12,500
$25 Million Subordinated Revolving Credit Note (AOG) with Cabot
Corporation, Interest at the London Interbank Offered Rate
("LIBOR") Plus 0.925% at December 31, 1996 and 1995, (6.425%
and 6.8625%, Respectively), Due 1997......................... 10,916 11,142
8.5% Note Payable of Red River Pipeline, L.P., Due 1997-1998... 6,538 9,808
Current Maturities of Long-Term Debt........................... (26,971) (28,197)
-------- --------
Total Long-Term Debt........................................... $423,676 $315,564
======== ========
</TABLE>
Maturities of long-term debt for the five years ending December 31, 2001,
are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR AMOUNT
----------------------------------------------- -------
<S> <C>
1997........................................... $26,971
1998........................................... 19,055
1999........................................... 13,089
2000........................................... 5,000
2001........................................... 6,000
</TABLE>
On May 23, 1996, K N filed a universal shelf registration statement with
the Securities and Exchange Commission ("SEC") for common stock and unsecured
debt securities up to an aggregate initial offering of $300 million.
On July 26, 1996, K N sold publicly $125 million of 30-year 7.35%
debentures at an all-in cost to the Company of 7.40 percent. This debt was
issued from the $200 million shelf registration filed with the SEC in
F-25
<PAGE> 86
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
November 1993. Net proceeds from this financing were used to reduce short-term
indebtedness and fund capital expenditures, including costs of acquiring the
Pony Express Pipeline (See Note 3(A)).
At December 31, 1996 and 1995, the carrying amount of the Company's
long-term debt was $451.7 million and $344.8 million, respectively, and the
estimated fair value was $471.6 million and $383.2 million, respectively. The
fair value of the Company's long-term debt is estimated based on the quoted
market prices for the same or similar issues, or on the current rates offered to
the Company for debt of the same remaining maturity.
(C) Common Stock
On August 6, 1996, K N sold publicly 1,715,000 million shares of its common
stock at $32.25 per share, less offering expenses. The stock was sold from the
$300 million shelf registration filed with the SEC in May 1996. K N applied
approximately $7.4 million of the net proceeds from the offering to redeem and
cancel outstanding warrants to purchase a total of 545,200 shares of K N's
common stock. The balance of the net proceeds from the offering were used in the
same manner as the net proceeds from the debt financing described above in Note
9(B).
In connection with the sale of K N common stock described above, Cabot
Corporation sold 1,850,000 shares of K N common stock. K N did not receive any
of the proceeds from the sale of K N common stock by Cabot Corporation. After
the sale, Cabot Corporation owned 2,990,186 shares, or 9.9 percent of the common
stock of K N, including 642,232 shares of common stock underlying warrants
expiring on September 30, 1999.
9. PREFERRED STOCK
<TABLE>
<CAPTION>
DECEMBER 31
-----------------
1996 1995
------ ------
(IN THOUSANDS)
<S> <C> <C>
Authorized -- Class A, 200,000 Shares; Class B, 2,000,000 Shares,
All Without Par Value -- Redeemable Solely at Option of
Company -- Class A, $5.00 Cumulative Series, 70,000 Shares....... $7,000 $7,000
====== ======
Subject to Mandatory Redemption at $100 Per Share -- Class B, $8.30
Cumulative Series, 5,720 Shares at December 31, 1995............. $ - $ 572
====== ======
</TABLE>
(A) Class A $5.00 Preferred Stock
The Class A $5.00 Preferred Stock is redeemable, in whole or in part, at
the option of the Company at any time on 30 days' notice at $105 per share plus
accrued dividends. This series has no sinking fund requirements.
(B) Class B $8.30 Preferred Stock
The remaining 5,720 shares of K N Class B $8.30 Preferred Stock subject to
mandatory redemption were redeemed by the Company in 1996. In each of the years
1995 and 1994, the Company redeemed 5,714 shares subject to mandatory
redemption, and an additional 5,714 shares at $100 per share.
(C) Rights of Preferred Shareholders
All outstanding series of preferred stock have voting rights. If, for any
class of preferred stock, the Company (i) is in arrears on dividends, (ii) has
failed to pay or set aside any amounts required to be paid or set aside for all
sinking funds, or (iii) is in default on any of its redemption obligations, then
no dividends shall
F-26
<PAGE> 87
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
be paid or declared on any junior stock nor shall any junior stock be purchased
or redeemed by the Company. Also, if dividends on any class of preferred stock
are sufficiently in arrears, the holders of that stock may elect one-third of
the Company's Board of Directors.
(D) Fair Value
The Company redeemed all shares of preferred stock subject to mandatory
redemption during 1996. The carrying amount and estimated fair value of the
Company's outstanding preferred stock subject to mandatory redemption at
December 31, 1995 was $0.6 million. The fair value of the Company's preferred
stock was estimated based on an evaluation made by an independent security
analyst.
10. RISK MANAGEMENT
The Company uses two types of risk management instruments -- energy
financial instruments and interest rate swaps -- which are discussed below. The
Company is exposed to credit-related losses in the event of nonperformance by
counterparties to these financial instruments, but does not expect any
counterparties to fail to meet their obligations given their existing credit
ratings.
The fair value of these risk management instruments reflects the estimated
amounts that the Company would receive or pay to terminate the contracts at the
reporting date, thereby taking into account the current unrealized gains or
losses on open contracts. Market quotes are available for substantially all
instruments used by the Company.
(A) Energy Financial Instruments
The Company uses energy financial instruments to minimize its risk of price
changes in the spot and fixed price natural gas and NGLs markets. Energy risk
management products include commodity futures and options contracts, fixed price
swaps and basis swaps. Pursuant to its Board of Directors' approved guidelines,
the Company is to engage in these activities only as a hedging mechanism against
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. The 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. All energy futures, swaps and options are recorded at fair value.
Gains and losses on hedging positions are deferred and recognized as gas
purchases expenses in the periods the underlying physical transactions occur.
All 1996 and 1995 transactions were recorded as hedges.
As of December 31, 1996 the Company had deferred net gains of $1.8 million,
representing the difference between the current market value and the original
physical contracts' value, associated with hedging activities, of which $1.6
million of losses relate to commodity contracts and $3.4 million of gains relate
to over-the-counter swaps and options. The deferrals will be offset by the
corresponding underlying physical transactions and are reflected as net deferred
charges in the accompanying consolidated financial statements. At December 31,
1996 the Company held notional long volumetric positions of 21.4 Bcf of gas, of
which 1.7 were held in gas commodity positions and 19.7 were held in
over-the-counter swaps and options. Of the 21.4 notional total, associated
physical transactions of 17.2 Bcf are expected to occur in 1997 and 4.2 Bcf in
1998. A change of plus or minus 10 percent of the fair market prices of the
above financial instruments would have the approximate effect of reducing or
increasing the deferrals by $4.3 million, which would be offset by corresponding
increases or decreases in the value of the underlying physical transactions.
F-27
<PAGE> 88
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(B) Interest Rate Swaps
The Company has entered into various interest rate swap and cap agreements
for the purpose of managing interest rate exposure. Settlement amounts payable
or receivable under these agreements are recorded as interest expense or income
in the accounting period they are incurred.
In February 1993, AOG entered into a three-year interest rate swap
agreement covering $25 million of notional principal whereby it pays LIBOR,
which is reset every six months in arrears, in exchange for a fixed rate of 5.07
percent. This agreement terminated in March 1996. In September 1993, AOG entered
into a second three-year interest rate swap agreement covering $10 million of
notional principal at a LIBOR rate, which is reset every 12 months in arrears,
in exchange for a fixed rate of 5.27 percent. In August 1994, the counterparty
to this second agreement exercised its rights to extend this agreement by one
additional year, with the agreement now terminating in September 1997.
In 1994, the Company entered into four interest rate cap agreements which
effectively cap the LIBOR rate to be paid by the Company under these swap
agreements at 7.5 percent for the terms of the original swap agreements.
11. EMPLOYEE BENEFITS
(A) Retirement Plans
The Company has defined benefit pension plans covering substantially all
full-time employees. These plans provide pension benefits that are based on the
employees' compensation during the period of employment. These plans are tax
qualified subject to the minimum funding requirements of the Employee Retirement
Income Security Act. The Company's funding policy is to contribute annually the
recommended contribution using the actuarial cost method and assumptions used
for determining annual funding requirements. Plan assets consist primarily of
pooled fixed income, equity, bond and money market funds.
Net pension cost includes the following components (in thousands):
<TABLE>
<CAPTION>
1996 1995 1994
-------- -------- -------
<S> <C> <C> <C>
Service Cost -- Benefits Earned During the Period... $ 3,289 $ 3,332 $ 2,721
Interest Cost on Projected Benefit Obligation....... 6,756 6,372 5,986
Actual Return on Assets............................. (18,243) (17,569) 565
Net Amortization and Deferral....................... 8,896 8,415 (9,166)
-------- -------- -------
Net Periodic Pension Cost........................... $ 698 $ 550 $ 106
======== ======== =======
</TABLE>
As a result of restructuring activities, curtailment gains of $.07 million
are reflected in the net amortization and deferral component of net periodic
pension cost for 1995.
F-28
<PAGE> 89
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table sets forth the plans' funded status and amounts
recognized in the Company's consolidated financial statements at December 31,
1996 and 1995 (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31
---------------------
1996 1995
-------- --------
<S> <C> <C>
Actuarial Present Value of Benefit Obligations:
Vested Benefit Obligation.................................... $(84,861) $(77,490)
======== ========
Accumulated Benefit Obligation............................... $(90,779) $(82,937)
======== ========
Projected Benefit Obligation................................. $(97,182) $(90,046)
Plan Assets at Fair Value...................................... 123,736 111,084
-------- --------
Plan Assets in Excess of Projected Benefit Obligation.......... 26,554 21,038
Unrecognized Net Gain.......................................... (16,023) (9,678)
Prior Service Cost Not Yet Recognized in Net Periodic Pension
Costs........................................................ 155 171
Unrecognized Net Asset at January 1............................ (1,282) (1,429)
-------- --------
Prepaid Pension Cost........................................... $ 9,404 $ 10,102
======== ========
</TABLE>
The rate of increase in future compensation and the expected long-term rate
of return on assets were 3.5 and 8.5 percent, respectively, for both 1996 and
1995. The weighted average discount rate used in determining the actuarial
present value of the projected benefit obligation was 7.5 percent for both 1996
and 1995.
In 1996, a maximum of 10 percent of eligible employee compensation was
contributed to the Employees Retirement Fund Trust Profit Sharing Plan (the
"Profit Sharing Plan"), a defined contribution plan. The Company's contribution
was determined by comparing actual 1996 results to a predetermined graduated
scale of annual operating income goals. Prior to 1996 the Company contributed
the lesser of 10 percent of the Company's net income or 10 percent of eligible
employee compensation to the Profit Sharing Plan. Contributions by the Company
were $6.6 million, $5.6 million and $2.3 million for 1996, 1995 and 1994,
respectively.
(B) Other Postretirement Employee Benefits
The Company has a defined benefit postretirement plan providing medical
care benefits upon retirement for all eligible employees with at least five
years of credited service as of January 1, 1993, and their eligible dependents.
Retired employees are required to contribute monthly amounts which depend upon
the retired employee's age, years of service upon retirement and date of
retirement.
This plan also provides life insurance benefits upon retirement for all
employees with at least 10 years of credited service who are age 55 or older
when they retire. The Company pays for a portion of the life insurance benefit;
employees may, at their option, increase the benefit by making contributions
from age 55 until age 65 or retirement, whichever is earlier. The Company funds
the future expected postretirement benefit costs under the plan by making
payments to Voluntary Employee Benefit Association trusts. The Company's funding
policy is to contribute amounts within the deductible limits imposed on Internal
Revenue Code Sec. 501(c)(9) trusts. Plan assets consist primarily of pooled
fixed income funds.
F-29
<PAGE> 90
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Net postretirement benefit cost includes the following components (in
thousands):
<TABLE>
<CAPTION>
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Service Cost -- Benefits Earned During the Period........ $ 324 $ 378 $ 321
Interest Cost on APBO.................................... 1,392 1,381 1,307
Actual Return on Assets.................................. (114) (156) 7
Net Amortization and Deferral............................ 894 884 805
------ ------ ------
Net Periodic Postretirement Benefit Cost................. $2,496 $2,487 $2,440
====== ====== ======
</TABLE>
The following table sets forth the plan's funded status and the amounts
recognized in the Company's consolidated financial statements as follows (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31
---------------------
1996 1995
-------- --------
<S> <C> <C>
Accumulated Postretirement Benefit Obligation:
Retirees..................................................... $(15,578) $(13,138)
Eligible Active Plan Participants............................ (1,549) (3,524)
Ineligible Active Plan Participants.......................... (2,294) (2,751)
-------- --------
Total APBO..................................................... (19,421) (19,413)
Plan Assets at Fair Value...................................... 3,192 2,623
-------- --------
Accumulated Postretirement Benefit Obligation in Excess of Plan
Assets....................................................... (16,229) (16,790)
Unrecognized Net Gain.......................................... (1,179) (649)
Prior Service Cost Not Yet Recognized in Net Periodic
Postretirement Benefit Cost.................................. -- --
Unrecognized Transition Obligation............................. 14,865 15,794
-------- --------
Accrued Postretirement Benefit Cost............................ $ (2,543) $ (1,645)
======== ========
</TABLE>
The weighted average discount rate used in determining the actuarial
present value of the APBO was 7.5 percent for both 1996 and 1995. The assumed
health care cost trend rate was seven percent for 1996 and beyond. A
one-percentage-point increase in the assumed health care cost trend rate for
each future year would have increased the aggregate of the service and interest
cost components of the 1996 net periodic postretirement benefit cost by
approximately $16,000 and would have increased the APBO as of December 31, 1996,
by approximately $204,000.
K N's retail distribution business in Kansas, Nebraska and Wyoming has
received regulatory approval to include in the cost-of-service component of its
rates the cost of postretirement benefits as measured by application of SFAS No.
106, Employers' Accounting for Postretirement Benefits Other Than Pensions. In
addition, KNI has received approval from the FERC for similar regulatory
treatment. At both December 31, 1996 and 1995, no SFAS 106 costs were deferred
as regulatory assets.
(C) Other Postemployment Benefits
On January 1, 1994, the Company adopted SFAS No. 112, Employers' Accounting
for Postemployment Benefits, which establishes standards of financial accounting
and reporting for the estimated cost of benefits provided by an employer to
former or inactive employees after employment but before retirement.
Implementation of SFAS 112 had no material effect on the Company's financial
position or results of operations. SFAS 112 costs deferred as regulatory assets
were $1.1 million and $0.9 million at December 31, 1996 and 1995, respectively.
F-30
<PAGE> 91
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
12. COMMON STOCK OPTION AND PURCHASE PLANS
The Company has the following stock option plans: The 1982 Incentive Stock
Option Plan ("the 1982 Plan"), the 1982 Stock Option Plan for Non-Employee
Directors ("the 1982 Directors' Plan"), the 1986 Incentive Option Plan ("the
1986 Plan"), the 1988 Incentive Stock Option Plan ("the 1988 Plan"), the 1992
Stock Option Plan for Non-Employee Directors ("the 1992 Directors' Plan"), the
1994 K N Energy, Inc. Long-Term Incentive Plan ("the LTIP Plan") and the
American Oil and Gas Corporation Stock Incentive Plan ("the AOG Plan"). The
Company also has an employee stock purchase plan ("the ESP Plan").
During 1993, AOG issued to its chief executive officer 50,000 shares of
restricted AOG common stock (23,500 shares of K N common stock) which vest 50
percent per year. AOG also sold 150,000 shares of AOG common stock (70,500
shares of K N common stock) to its president and chief operating officer for
$0.04 per share of AOG common stock ($0.0851 per share of K N common stock).
One-half of these shares was fully vested and nonforfeitable upon issuance, and
the remainder became fully vested upon consummation of the merger described in
Note 2. The market value of these AOG shares issued was approximately $2.3
million based on the average market price per share of AOG common stock on the
date of issuance. The market value of the restricted shares was reflected as
deferred compensation and was amortized over the vesting period.
The Company accounts for its plans under Accounting Principles Board
Opinion ("APB") No. 25, Accounting for Stock Issued to Employees. The Company
recorded compensation expense totaling $0.8 million, $0.2 million and $1.3
million for 1996, 1995 and 1994, respectively, relating to restricted stock
grants awarded under the plans.
Had compensation cost for these plans been determined consistent with SFAS
No. 123, Accounting for Stock-Based Compensation, the Company's net income and
earnings per share would have been reduced to the following pro forma amounts
(in thousands except per share amounts):
<TABLE>
<CAPTION>
1996 1995
------- -------
<S> <C> <C>
NET INCOME:
As Reported............................................ $63,819 $52,522
======= =======
Pro Forma.............................................. $62,497 $52,101
======= =======
EARNINGS PER SHARE:
As Reported............................................ $ 2.14 $ 1.83
======= =======
Pro Forma.............................................. $ 2.10 $ 1.82
======= =======
</TABLE>
Because the SFAS 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years. Additionally, the
pro forma amounts include $0.4 million and $0.3 million related to the purchase
discount offered under the ESP Plan for 1996 and 1995, respectively.
The Company may sell up to 600,000 shares of stock to its eligible
employees under the ESP Plan. Employees purchased 87,615 shares and 95,572
shares in 1996 and 1995, respectively, and have purchased 484,599 shares through
December 31, 1996. Employees purchase shares through voluntary payroll
deductions at a 15 percent discount from the market value of the common stock,
as defined in the plan. The fair value per share of shares purchased in 1996 and
1995 was $6.45 and $5.35, respectively.
F-31
<PAGE> 92
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
OPTION SHARES
GRANTED
SHARES SUBJECT THROUGH EXPIRATION
PLAN NAME TO THE PLAN DECEMBER 31, 1996 VESTING PERIOD PERIOD
- ----------------------------------------- -------------- ----------------- -------------- ----------
<S> <C> <C> <C> <C>
1982 Plan................................ 888,525 888,525 Immediate 10 years
1982 Directors' Plan..................... 124,393 124,393 Three years 10 years
1986 Plan................................ 412,500 412,500 Immediate 10 years
1988 Plan................................ 412,500 408,665 Immediate 10 years
1992 Directors' Plan..................... 350,000 83,250 Immediate 10 years
LTIP Plan................................ 2,200,000 1,425,800 0-5 years 5-10 years
AOG Plan................................. 517,000 517,000 Three years 10 years
</TABLE>
Under all plans, except the LTIP Plan and the AOG Plan, options are granted
at not less than 100 percent of the market value of the stock at the date of
grant. Under the LTIP Plan options may be granted at less than 100 percent of
the market value of the stock at the date of grant.
At December 31, 1996, 135 employees, officers and directors of the Company
held options under the plans. A summary of the status of the Company's stock
option plans at December 31, 1996 and 1995, and changes during the years then
ended is presented in the table and narrative below:
<TABLE>
<CAPTION>
1996 1995
-------------------- --------------------
WTD AVG WTD AVG
EXERCISE EXERCISE
SHARES PRICE SHARES PRICE
--------- -------- --------- --------
<S> <C> <C> <C> <C>
OUTSTANDING AT BEGINNING OF YEAR................ 1,164,510 $21.25 1,214,024 $18.49
Granted......................................... 925,126 $31.61 348,200 $25.87
Exercised....................................... (329,574) $15.88 (373,423) $16.54
Forfeited....................................... (33,575) $23.69 (24,291) $21.80
--------- ------ --------- ------
OUTSTANDING AT END OF YEAR...................... 1,726,487 $27.78 1,164,510 $21.25
========= ====== ========= ======
EXERCISABLE AT END OF YEAR...................... 604,962 $24.52 584,902 $18.16
========= ====== ========= ======
WEIGHTED AVERAGE FAIR VALUE OF OPTIONS
GRANTED....................................... $ 9.53 $ 4.71
========= =========
</TABLE>
200,626 of the 1,726,487 options outstanding December 31, 1996 have
exercise prices between $0 and $16.79 with a weighted average exercise price of
$7.70 and a weighted average remaining contractual life of 6.22 years. 104,076
of these options are exercisable; their weighted average exercise price is
$14.85. 797,944 options have exercise prices between $21.68 and $31.75 with a
weighted average exercise price of $25.36 and a weighted average remaining
contractual life of 7.55 years. 424,644 of these options are exercisable; their
weighted average exercise price is $24.87. The remaining 727,917 options have
exercise prices between $32.13 and $38.50 with a weighted average exercise price
of $35.96 and a weighted average remaining contractual life of 9.63 years. Of
these options 76,242 are exercisable; their weighted average exercise price is
$35.81.
The fair value of each option grant is estimated on the date of grant using
the Black Scholes option pricing model with the following assumptions: risk-free
interest rates of 5.5 percent, expected weighted average lives of 4 years and
expected volatility of 20 percent for grants in both 1996 and 1995; and expected
dividend yields of 2.5 and 3.5 percent for grants in 1996 and 1995,
respectively.
Option balances and option price ranges per share for 1994 under APB 25
were as follows: beginning balance of 983,628 shares at $8.96 to $28.99, options
granted of 309,500 shares at $0.00 to $24.00, options exercised of 67,093 shares
at $0.00 to $23.04 and options forfeited of 12,011 shares at $15.08 to $23.01.
F-32
<PAGE> 93
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. COMMON STOCK WARRANTS
At December 31, 1996 and 1995, warrants to purchase 642,232 and 1,187,432
shares of the Company's common stock were outstanding, respectively. The
warrants are exercisable at $17.55 per warrant and expire on September 30, 1999.
In August 1996, warrants for 545,200 shares were redeemed and cancelled at a
total cost of $7.4 million.
14. COMMITMENTS AND CONTINGENT LIABILITIES
(A) Leases
On February 16, 1995, AOG Gas Transmission Company, L.P., a wholly owned
subsidiary of K N, acquired natural gas transmission pipeline and storage assets
in Texas. (See Note 3(D).) A portion of these assets has been funded through
10-year operating leases. These operating leases contain purchase options at the
end of their lease terms. The Company also leases certain office space,
properties and equipment under operating leases.
Payments made under operating leases were $22.3 million in 1996, $16.2
million in 1995 and $9.6 million in 1994.
Future minimum commitments under major operating leases are as follows (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31 AMOUNT
-------------------------------------------------- --------
<S> <C>
1997.............................................. $ 17,126
1998.............................................. 13,400
1999.............................................. 12,707
2000.............................................. 12,042
2001.............................................. 11,103
Thereafter........................................ 98,594
--------
Total Commitments................................. $164,972
========
</TABLE>
(B) Basket Agreement
Under terms of an agreement (the "Basket Agreement") entered into with
Cabot as part of AOG's acquisition of Cabot's natural gas pipeline business, AOG
and Cabot equally share net payments made in settlement of certain liabilities
related to operations of the acquired business prior to the acquisition date. At
December 31, 1996 and 1995, the Company's estimated net liability was $5.5
million and $5.6 million, respectively. The Company had made net payments of
$10.9 million as of December 31, 1996 and 1995. The difference between net
payments made by the Company and its estimated liability is reflected in current
assets and consists of (i) the present value of Cabot's share of net payments
and (ii) future recoveries from customers. The Basket Agreement is expected to
be settled in 1997.
(C) Guarantees of Unconsolidated Subsidiaries' Debt
The Company executed guarantees of two unconsolidated subsidiaries'
revolving credit agreements with Credit Lyonnais, effective July 19, 1996. One
guarantee is for TransColorado Gas Transmission Company ("TransColorado") for a
maximum of $7.5 million due by December 31, 1999 and another guarantee is for
Coyote Gas Treating, LLC ("Coyote") for a maximum of $10 million due by December
31, 1999. As of December 31, 1996, $3.1 and $7.2 million, respectively,
represent the guaranteed amounts by the Company borrowed against the
TransColorado and Coyote agreements.
F-33
<PAGE> 94
K N ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(D) Capital Expenditure Budget
The consolidated capital expenditure budget for 1997 is approximately $185
million, excluding acquisitions. Approximately $9.4 million had been committed
for the purchase of plant and equipment at December 31, 1996.
15. MAJOR CUSTOMER
Atmos Energy Corporation and affiliates comprised 10 percent of
consolidated revenues in 1995 and 11 percent in 1994.
16. BUSINESS SEGMENT INFORMATION
The Company is a natural gas energy products and services provider engaged
in the following activities:
- gathering, processing, marketing, storing and transporting natural gas;
providing field services to natural gas producers; and marketing natural
gas liquids (Gathering, Processing and Marketing Services);
- interstate storing and transporting natural gas (Interstate
Transportation and Storage Services);
- providing retail natural gas sales and transportation services (Retail
Natural Gas Services).
The Company was involved in developing and producing natural gas and crude
oil in 1995 and 1994 (Gas and Oil Production).
F-34
<PAGE> 95
BUSINESS SEGMENT INFORMATION
(BEFORE INTERSEGMENT ELIMINATIONS)
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
OPERATING REVENUES:
Gathering, Processing and Marketing Services........... $1,259,171 $ 899,581 $ 885,949
Interstate Transportation and Storage Services......... 71,769 64,405 60,562
Retail Natural Gas Services............................ 225,432 232,317 225,960
Gas and Oil Production................................. -- 10,721 14,128
Intersegment Eliminations.............................. (113,198) (95,626) (95,322)
------- ------- -------
$1,443,174 $1,111,398 $1,091,277
======= ======= =======
OPERATING INCOME:
Gathering, Processing and Marketing Services........... $ 74,460 $ 64,623 $ 21,716
Interstate Transportation and Storage Services......... 29,460 17,933 16,503
Retail Natural Gas Services............................ 30,881 32,995 13,752
Gas and Oil Production................................. -- (189) 2,908
------- ------- -------
OPERATING INCOME....................................... 134,801 115,362 54,879
Other Income and (Deductions).......................... (35,085) (33,790) (30,058)
------- ------- -------
INCOME BEFORE INCOME TAXES............................. $ 99,716 $ 81,572 $ 24,821
======= ======= =======
IDENTIFIABLE ASSETS:
Gathering, Processing and Marketing Services........... $ 869,141 $ 685,023 $ 574,280
Interstate Transportation and Storage Services......... 315,503 178,882 216,753
Retail Natural Gas Services............................ 419,415 328,166 304,065
Gas and Oil Production................................. -- 36,451 43,932
Corporate *............................................ 25,661 28,935 33,354
------- ------- -------
$1,629,720 $1,257,457 $1,172,384
======= ======= =======
DEPRECIATION, DEPLETION AND AMORTIZATION EXPENSE:
Gathering, Processing and Marketing Services........... $ 31,654 $ 26,510 $ 26,933
Interstate Transportation and Storage Services......... 8,078 7,767 8,628
Retail Natural Gas Services............................ 11,480 11,006 10,718
Gas and Oil Production................................. -- 4,608 3,999
------- ------- -------
$ 51,212 $ 49,891 $ 50,278
======= ======= =======
CAPITAL EXPENDITURES AND ACQUISITIONS:
Gathering, Processing and Marketing Services........... $ 96,486 $ 67,774 $ 26,521
Interstate Transportation and Storage Services......... 157,510 11,200 16,424
Retail Natural Gas Services............................ 28,770 30,080 23,673
Gas and Oil Production................................. -- 6,156 35,256
------- ------- -------
$ 282,766 $ 115,210 $ 101,874
======= ======= =======
</TABLE>
- ---------------
* Principally cash and investments
F-35
<PAGE> 96
QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
K N ENERGY, INC. AND SUBSIDIARIES
QUARTERLY OPERATING RESULTS FOR 1996 AND 1995
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1996
-----------------------------------------------
FIRST SECOND THIRD FOURTH
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Operating Revenues.............................. $385,851 $277,148 $304,317 $475,858
Operating Income................................ 35,776 22,084 30,157 46,784
Net Income...................................... 17,507 8,848 13,693 23,771
Preferred Dividends............................. 100 99 99 100
Earnings Available for Common Stock............. $ 17,407 $ 8,749 $ 13,594 $ 23,671
======== ======== ======== ========
Number of Common Shares Used In Computing
Earnings Per Share............................ 28,945 29,181 30,046 30,875
======== ======== ======== ========
Earnings Per Common Share....................... $ 0.60 $ 0.30 $ 0.46 $ 0.78
======== ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
1995
-----------------------------------------------
FIRST SECOND THIRD FOURTH
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Operating Revenues.............................. $294,058 $238,105 $248,976 $330,259
Operating Income................................ 31,781 19,266 25,973 38,342
Net Income...................................... 14,518 6,922 11,829 19,253
Preferred Dividends............................. 123 123 123 123
Earnings Available for Common Stock............. $ 14,395 $ 6,799 $ 11,706 $ 19,130
======== ======== ======== ========
Number of Common Shares Used In Computing
Earnings Per Share............................ 28,144 28,353 28,472 28,649
======== ======== ======== ========
Earnings Per Common Share....................... $ 0.51 $ 0.24 $ 0.41 $ 0.67
======== ======== ======== ========
</TABLE>
F-36
<PAGE> 97
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDING SEPTEMBER 30, 1997 AND 1996
(THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDING ENDING
SEPTEMBER 30, SEPTEMBER 30,
1997 1996
------------- -------------
<S> <C> <C>
REVENUES:
Gas sales, transportation, storage and other operating
revenues..................................................... $ 2,063,058 $ 1,776,703
Interest and other income....................................... 9,595 7,721
Earnings of pipeline ventures................................... 9,965 9,899
----------- -----------
2,082,618 1,794,323
----------- -----------
COSTS AND OTHER DEDUCTIONS:
Cost of sales................................................... 1,684,980 1,338,188
Selling, general and administrative and other operating
expenses..................................................... 77,853 83,959
Depreciation.................................................... 110,924 131,676
Taxes other than income taxes................................... 23,087 36,341
Interest expense................................................ 181,601 43,379
Other........................................................... 1,005 1,439
----------- -----------
2,079,450 1,634,982
----------- -----------
INCOME BEFORE INCOME TAXES........................................ 3,168 159,341
PROVISIONS FOR AND CHARGE-IN-LIEU OF INCOME TAXES................. 87 59,276
----------- -----------
NET INCOME........................................................ $ 3,081 $ 100,065
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-37
<PAGE> 98
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AT SEPTEMBER 30, 1997 AND DECEMBER 31, 1996
(THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................................................ $ 6,278 $ 4,258
Restricted deposits...................................................................... 30,678 38,623
Receivables
Affiliated companies................................................................... 268,947 415,643
Customers.............................................................................. 14,592 9,363
Other.................................................................................. 17,858 26,324
Interest-bearing receivables, net-affiliated companies................................... 147,519 25,361
Gas transportation imbalances............................................................ 44,438 56,106
Materials and supplies................................................................... 11,320 11,718
Net properties to be dividended, net of tax.............................................. 303,451 308,804
Gas stored underground................................................................... 73,312 39,343
Prepayments.............................................................................. 3,771 20,187
Deferred income taxes.................................................................... 46,878 77,277
------------ ------------
Total Current Assets............................................................... 969,042 1,033,007
------------ ------------
PROPERTY, PLANT AND EQUIPMENT.............................................................. 6,648,818 6,876,061
Accumulated depreciation................................................................. (1,617,826) (1,785,257)
------------ ------------
Net Property, Plant and Equipment...................................................... 5,030,992 5,090,804
------------ ------------
LONG-TERM INTERCOMPANY RECEIVABLE.......................................................... 31,390 33,197
GAS STORED UNDERGROUND -- NONCURRENT....................................................... 400,619 413,334
INVESTMENTS IN PIPELINE VENTURES........................................................... 53,498 53,141
DEFERRED CHARGES AND OTHER ASSETS.......................................................... 24,972 28,879
------------ ------------
TOTAL ASSETS............................................................................... $ 6,510,513 $ 6,652,362
============ ============
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES:
Payables --
Affiliated companies................................................................... $ 3,576 $ 2,857
Trade.................................................................................. 194,818 301,569
Contract impairment.................................................................... 605 1,126
Other.................................................................................. 91,661 115,943
Dividend payable, affiliates............................................................. 303,452 308,804
Accrued interest payable, affiliates..................................................... 82,867 --
Rate refund provision.................................................................... 13,756 15,218
Gas transportation imbalances............................................................ 80,990 83,310
Current portion of long-term ESOP debt................................................... 12,574 12,574
Other.................................................................................... 103,062 120,213
------------ ------------
Total Current Liabilities.......................................................... 887,361 961,614
------------ ------------
OTHER LIABILITIES AND DEFERRED CREDITS:
Reserve for contract impairment.......................................................... 13,773 43,775
Intercompany liability................................................................... -- 32,696
Interest-bearing notes, affiliated companies............................................. 1,600,000 1,600,000
Long-term ESOP debt...................................................................... 1,386,026 1,386,026
Postretirement benefits other than pensions.............................................. 90,889 89,780
Other.................................................................................... 133,684 157,400
------------ ------------
Total Other Liabilities and Deferred Credits....................................... 3,224,372 3,309,677
------------ ------------
DEFERRED INCOME TAXES...................................................................... 1,690,440 1,680,354
------------ ------------
CONTINGENT LIABILITIES AND COMMITMENTS
MINORITY EQUITY IN SUBSIDIARIES AND PARTNERSHIPS........................................... 7,456 8,076
------------ ------------
STOCKHOLDER'S EQUITY:
Common Stock, $.01 par value, authorized 2,000,000 shares, outstanding 1,400,000......... 14 14
Unearned ESOP shares..................................................................... (1,359,002) (1,393,849)
Additional paid-in capital............................................................... 1,970,375 2,000,060
Retained earnings........................................................................ 89,497 86,416
------------ ------------
Total Stockholder's Equity......................................................... 700,884 692,641
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY................................................. $ 6,510,513 $ 6,652,362
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-38
<PAGE> 99
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDING SEPTEMBER 30, 1997 AND 1996
(THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1996
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income...................................................... $ 3,081 $ 100,065
Income adjustments --
Depreciation................................................. 110,924 131,676
Deferred income tax provision (benefit)...................... 38,531 6,424
Other noncash (credits) charges to income, net............... (23,416) 43,831
Distributions from (to) pipeline ventures, net of earnings... (307) 1,851
Compensation expense......................................... 1,148 --
Changes in operating assets and liabilities:
Decrease in accounts receivable.............................. 35,770 39,671
Decrease in accounts receivable from affiliates.............. 153,836 13,233
(Increase) decrease in inventories........................... (35,307) 19,757
Decrease (increase) in prepaid and other assets.............. 2,654 (42,176)
Change in gas transportation imbalances, net................. 9,708 (8,845)
(Decrease) increase in accounts payable and accrued
liabilities................................................. (165,633) 64,579
Increase (decrease) in accounts payable to affiliates........ 719 (256)
Decrease in income taxes..................................... (7,597) (1,532)
Other operating, net............................................ 8,067 4,478
--------- ---------
Net cash provided by operating activities.................... 132,178 372,756
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures............................................ (56,578) (102,031)
Acquisition of cushion gas...................................... -- (90,409)
Proceeds (costs) from disposal of property, plant and equipment,
net.......................................................... 8,738 (6,399)
Other investing, net............................................ (5,565) (2,953)
--------- ---------
Net cash used by investing activities........................ (53,405) (201,792)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments debt......................................... -- (7,500)
Amounts paid to minority interest............................... (1,941) --
Net change in interest-bearing receivables/payables with
affiliated companies and intercompany liability.............. (74,812) (162,920)
--------- ---------
Net cash used by financing activities........................ (76,753) (170,420)
--------- ---------
Increase (decrease) in cash and cash equivalents.................. 2,020 544
--------- ---------
Cash and cash equivalents at beginning of period.................. 4,258 10,414
--------- ---------
Cash and cash equivalents at end of period........................ $ 6,278 $ 10,958
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-39
<PAGE> 100
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
UNEARNED ADDITIONAL RETAINED
COMMON ESOP PAID-IN EARNINGS
STOCK SHARES CAPITAL (DEFICIT)
------ ----------- ----------- ---------
<S> <C> <C> <C> <C>
Balance, December 31, 1994................. $ -- $ -- $ 4,280,577 $ 91,633
Net income............................... -- -- -- 106,626
Dividend of intercompany receivable to
Parent (Note 3.c)..................... -- -- (922,470) (228,328)
------ ----------- ----------- ---------
Balance, December 31, 1995................. -- -- 3,358,107 (30,069)
Net income............................... -- -- -- 116,485
Dividend of subsidiaries and properties
(Note 2.c)............................ -- -- (672,407) --
Contribution of intercompany debt (Note
2.b).................................. -- -- 914,703 --
Non-cash dividend (Note 2.b)............. -- -- (1,600,000) --
Stock split (Note 2.b)................... 14 -- (14) --
Unearned ESOP shares (Note 9)............ -- (1,400,000) -- --
Dividends on unearned ESOP shares (Note
2.a).................................. -- -- 3,348 --
Release of ESOP shares, net of tax effect
(Note 9).............................. -- 6,151 (3,677) --
------ ----------- ----------- ---------
Balance, December 31, 1996................. 14 (1,393,849) 2,000,060 86,416
Net income............................... -- -- -- 3,081
Release of ESOP shares, net of tax
effect................................ -- 34,847 (31,275) --
Noncash dividend of properties........... -- -- (3,764) --
Adjustment to dividend of subsidiaries
and properties........................ -- -- 5,354 --
------ ----------- ----------- ---------
Balance, September 30, 1997................ $ 14 $(1,359,002) $ 1,970,375 $ 89,497
====== ========== ========== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-40
<PAGE> 101
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) DESCRIPTION OF COMPANY
The accompanying unaudited consolidated condensed financial statements have
been prepared by MidCon Corp. pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and disclosures normally
included in consolidated financial statements have been condensed or omitted
pursuant to such rules and regulations, but resultant disclosures are in
accordance with generally accepted accounting principles as they apply to
interim reporting. The consolidated condensed financial statements should be
read in conjunction with MidCon Corp.'s audited consolidated financial
statements for the year ended December 31, 1996 ("1996 financial statements").
In the opinion of MidCon Corp.'s management, the accompanying consolidated
condensed financial statements contain all adjustments (consisting only of
normal recurring adjustments) necessary to present fairly MidCon Corp.'s
consolidated financial position as of September 30, 1997, and the consolidated
results of operations and consolidated cash flows for the nine months then
ended. The results of operations and cash flows for the nine month periods ended
September 30, 1997 and 1996 are not necessarily indicative of the results of
operations and cash flows to be expected for the full year.
MidCon Corp. ("MidCon" and, together with its subsidiaries, "Company") is a
wholly-owned subsidiary of Occidental Petroleum Corporation ("Occidental"). On
December 18, 1997, Occidental announced that it had signed a definitive
agreement to sell the Company for $3.49 billion in consideration, subject to
certain supplemental adjustments. The transaction is expected to close in the
first quarter 1998.
(2) MIDCON RECAPITALIZATION
(a) ESOP
In November 1996, Occidental established the MidCon Corp. Employee Stock
Ownership Plan ("ESOP") (see Note 9) for the benefit of the eligible employees
of the Company.
Also, in November 1996, Occidental sold $1.4 billion of Occidental's
Cumulative MidCon-Indexed Convertible Preferred Stock ("CMIC Preferred Stock")
to the MidCon Corp. ESOP Trust (the "Trust"). The CMIC Preferred Stock is
convertible into Occidental common stock based on the value of the Company. The
Trust paid for the CMIC Preferred Stock with $1.4 million cash and a $1.3986
billion 30-year promissory note ("ESOP note"), bearing interest at 7.9 percent
per annum, guaranteed by MidCon.
Principal and interest payments on the ESOP note are due on December 31 in
annual installments of approximately $123 million, commencing December 31, 1997,
and continuing through December 31, 2026, upon which date all principal and
interest remaining unpaid shall be immediately due and payable. Dividends on the
CMIC Preferred Stock are payable at an annual rate of $21 per share, when and as
declared by Occidental's Board of Directors. It is anticipated that MidCon will
make discretionary annual contributions to the MidCon ESOP which, together with
the annual dividends, will be used to repay the ESOP note. Dividends of $3.3
million on unearned shares and a cash contribution of $9.2 million were used for
debt service on the ESOP note in 1996.
Results for the nine month period ended September 30, 1997 include interest
expense of $82.9 million on the ESOP note and compensation expense of $1.1
million as discussed in Note 9.
(b) Other Capital Transactions
Concurrent with the establishment of the ESOP, several transactions were
recorded. MidCon had a 1,400,000-for-one split of the outstanding shares of its
common stock, while the par value of such stock was changed from $1.00 per share
to $.01 per share. Occidental contributed to the capital of MidCon $741 million
of promissory notes previously issued by MidCon and $154 million of non-interest
bearing intercorporate advances made by Occidental to MidCon that were
outstanding as of November 30, 1996. In addition,
F-41
<PAGE> 102
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MidCon declared a dividend, payable in the form of a $1.6 billion note payable
to Occidental. The principal amount of this note is due and payable on December
31, 2026 and bears interest at an annual rate of 7.9 percent payable monthly
through December 31, 2001. Thereafter, the rate changes to the London Interbank
Offered Rate ("LIBOR") plus 1.25 percent.
Results for the nine month period ended September 30, 1997 include interest
expense of $96.1 million on the $1.6 billion note.
(c) Dividend of Subsidiaries and Properties
During 1996, MidCon dividended all the outstanding shares of common stock
of its subsidiaries, Occidental Energy Ventures Corp. and MC Panhandle, Inc., to
Occidental. Properties from other Company subsidiaries comprising certain oil
and gas properties and well compressor properties were dividended to Occidental
effective on December 31, 1996. The net income from these operations was $7.8
million for the nine months ended September 30, 1996.
Also, effective December 31, 1996, MidCon dividended 51 percent of its
interest in an intrastate pipeline limited liability partnership to Occidental
(see Note 2.d).
A summary of the 1996 adjustments showing the effect of the above
transactions on certain balance sheet accounts is presented below (in millions):
<TABLE>
<CAPTION>
INCREASE
(DECREASE)
----------
<S> <C>
Property, Plant and Equipment..................................... $ (1,339)
Accumulated Depreciation.......................................... $ (345)
Deferred Income Taxes............................................. $ (322)
Additional Paid-in Capital........................................ $ (672)
</TABLE>
(d) Lease of Intrastate Pipeline Assets
In December 1996, MidCon merged its subsidiary MidCon Texas Pipeline Corp.
("MidCon Texas") into a limited partnership, which then owned its Texas
intrastate pipeline and related facilities. On December 31, 1996, fifty-one
percent of the Company's ownership in the partnership was dividended to a
subsidiary of Occidental with a dividend of the remaining 49 percent to be paid
on January 1, 1998. This 49 percent interest is reflected in the accompanying
consolidated balance sheets as "Net properties to be dividended, net of tax."
MidCon formed a new subsidiary, MidCon Texas Pipeline Operator, Inc. ("MTPO"),
which assumed certain of the contracts and obligations of MidCon Texas before
the merger. In addition, MTPO entered into an agreement with the limited
partnership to lease the intrastate pipeline system owned by the limited
partnership over a 30 year period commencing on January 1, 1997. The Company
accounts for this lease as an operating lease. The initial annual lease fee is
$30 million in 1997. The lease fee changes to $20 million for the years 1998
through 2001, $40 million for the years 2002 through 2005 and $30 million during
the remaining lease term. Lease expense of $30 million will be recognized
annually. The lease agreement requires MTPO to pay for taxes, insurance and
maintenance expenses and contains restrictions concerning additions,
dispositions and modifications to the leased property.
(3) SIGNIFICANT ACCOUNTING POLICIES
Reference is made to Note 3 in MidCon's 1996 financial statements for a
summary of significant accounting policies.
F-42
<PAGE> 103
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(a) Cash and Cash Equivalents and Interest-Bearing Receivables/Payables,
Net-Affiliated Companies
Cash equivalents consist of interest bearing commercial paper and other
bank deposits with initial maturities of three months or less. Cash equivalents
totaled approximately $3.4 million and $1.5 million at September 30, 1997 and
December 31, 1996, respectively.
Occidental and its subsidiaries utilize a cash-management system designed
to minimize cash balances and external borrowing. In November 1996, MidCon
entered into a new intercompany cash management agreement with Occidental. This
agreement, which was effective January 1, 1997, engages Occidental to continue
to provide the Company with certain financing and cash management services.
Amounts due from or to affiliates under this program are reflected as current
assets and liabilities in the accompanying financial statements. Interest income
and expense is allocated to the participating companies on the basis of the
principal contributed or borrowed, respectively. Under the former cash
management system, MidCon has periodically dividended, to its parent company,
its interest bearing receivables from Occidental.
(b) Accounting Changes
In June 1996, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities." The statement provides consistent standards for
distinguishing transfers of financial assets that are sales from transfers that
are secured borrowings. The Company's adoption of SFAS No. 125, effective
January 1, 1997, did not have an impact on the Company's financial position or
results of operations.
In October 1996, the American Institute of Certified Public Accountants
("AICPA") issued Statement of Position No. 96-1, "Environmental Remediation
Liabilities" ("SOP 96-1"), which provides authoritative guidance on specific
accounting issues that are present in the recognition, measurement, display and
disclosure of environmental remediation liabilities. The Company's adoption of
SOP 96-1, effective January 1, 1997, did not have an impact on the Company's
financial position or results of operations.
The FASB has issued SFAS No. 129, "Disclosure of Information about Capital
Structure" to be effective for periods ending after December 15, 1997. SFAS No.
129 establishes standards for disclosing information about an entity's capital
structure. The Company does not believe that the application of the new standard
will have a material effect on the Company's financial position or results of
operations.
The FASB has issued SFAS No. 130, "Reporting Comprehensive Income" to be
effective for periods beginning after December 15, 1997. SFAS No. 130
establishes standards for reporting and display of comprehensive income and its
components in a full set of general purpose financial statements. The Company
does not believe that the application of the new standard will have a material
effect on the Company's financial position or results of operations.
The FASB has issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" to be effective for periods beginning after
December 15, 1997. SFAS No. 131 establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. The Company does not believe that the
application of the new standard will have a material effect on the Company's
financial position or results of operations.
(c) Property, Plant and Equipment and Related Depreciation
Reference is made to the 1996 financial statements and Note 3(f) thereto
for a description of investments in property, plant and equipment.
F-43
<PAGE> 104
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(d) Restricted Deposits
The Company engages in hedging to decrease or modify its exposure to
natural gas price risk. In accordance with New York Mercantile Exchange rules,
$30.7 million and $38.6 million of monies on deposit with brokers was restricted
at September 30, 1997 and December 31, 1996, respectively, to meet trading
requirements.
(e) Supplemental Cash Flow Information
Cash payments during the nine months ended September 30, 1997 and 1996
included income taxes of approximately $3.4 million and $4.0 million,
respectively. Interest paid for the same periods, net of amounts capitalized,
was $95.9 million and $0.
(f) Hedging Activities
The Company uses commodity futures contracts, options and swaps to hedge
the impact of natural gas price fluctuations related to its business activities.
Gains and losses on hedge contracts are deferred and recognized as an adjustment
to sales revenue or purchase costs when the related transaction being hedged is
finalized.
(g) Liabilities
"Accrued liabilities current" and "Other noncurrent liabilities" include
reserves relating to a reorganization of the Company's operations initiated in
1995. The Company recorded a reserve of $37 million during the fourth quarter of
1995. The current and noncurrent portion of the reserve totaled approximately $7
million and $4 million, respectively at September 30, 1997 and $9 million and
$12 million, respectively, at December 31, 1996.
(4) LITIGATION
There are various lawsuits and proceedings pending against the Company. It
is impossible at this time to determine the ultimate legal liabilities that may
arise therefrom. However, in management's opinion, after taking into account
reserves, the pending lawsuits and proceedings and claims should not have a
material adverse effect upon the consolidated financial position or results of
operations of the Company.
(5) REGULATORY MATTERS
On November 3, 1997, the FERC approved a settlement of the general rate
case of the Natural Gas Pipeline Company of America ("Natural") filed on June 1,
1995, substantially consistent with what Natural proposed. This settlement of
the rate case has had a favorable impact of approximately $9 million on
operating margin for the nine months ended September 30, 1997.
In January 1997, Amoco Production Company and Amoco Energy Trading
Corporation ("Amoco") filed a complaint against Natural before the FERC
contending that Natural had improperly provided its affiliate, MidCon Gas,
transportation service on preferential terms, seeking termination of currently
effective contracts and the imposition of civil penalties. A subsequent FERC
staff audit made proposed findings that Natural has favored MidCon Gas, which
Natural has challenged. In July, Amoco and Natural agreed to a settlement of
this proceeding. Amoco has filed to withdraw its complaint subject to the FERC's
procedures. Several intervenors have opposed the withdrawal of the complaint and
Natural has filed an answer to that opposition. The matter is pending before the
FERC.
F-44
<PAGE> 105
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) CONTINGENT LIABILITIES AND COMMITMENTS
The FERC has allowed certain rates for gas supply realignment ("GSR") costs
to go into effect on December 1, 1997, subject to refund, to recover any
shortfall in recoveries of GSR costs allocated to interruptible transportation
(see Note 5 to the 1996 financial statements). However, the FERC rejected
Natural's filing for rehearing that Natural be allowed to recoup a portion of
any shortfall on title transfers and interruptible transportation to pooling
points.
The Company has certain other commitments and contingent liabilities under
contracts, guarantees and joint ventures.
In management's opinion, after taking into account reserves, none of such
commitments and contingencies discussed above should have a material adverse
effect upon the consolidated financial position or results of operations of the
Company.
(7) INCOME TAXES
The Company is included in Occidental's consolidated federal tax return and
unitary state tax returns. The consolidated provisions for these income taxes
are allocated to the Company on the basis of a tax sharing agreement with
Occidental. Under the agreement, the amount of consolidated current and deferred
tax provisions is determined as if the Company were a corporation that was not
owned by Occidental and filed a separate consolidated income tax return. In
addition, state income taxes are provided for all states in which the Company is
included in a state return with Occidental, notwithstanding that the Company may
not have been subject to tax in that jurisdiction but for its affiliation with
Occidental.
The provision for taxes based on income for the 1997 and 1996 interim
periods was computed in accordance with Interpretation No. 18 of APB Opinion No.
28 on reporting taxes for interim periods and was based on projections of total
year pretax income.
Taxable gains were recorded by the Company resulting from dividends and
asset transfers to Occidental during 1996 (see Note 2.c). Since the Company is
included in the consolidated federal income tax return with Occidental, these
taxable gains are deferred until the Company is transferred outside the
consolidated group. Under the Company's tax sharing agreement, so long as the
Company is part of the consolidated group, the tax payments associated with the
gains will be reimbursed to the Company over the remaining tax lives of the
transferred assets. An intercompany receivable from Occidental has been recorded
on the consolidated balance sheet to reflect these reimbursements.
Taxable gains were recorded by the Company resulting from asset transfers
unrelated to the dividends and asset transfers to Occidental during 1996 (see
Note 2.c), and the tax associated therewith will not be reimbursed by Occidental
under the Company's tax sharing agreement.
(8) RETIREMENT AND POSTRETIREMENT BENEFITS
Reference is made to Note 8 to MidCon's 1996 financial statements for a
description of the retirement plans and Postretirement benefits.
(9) RETIREMENT PLANS AND ESOP
All employees are participants in a defined contribution retirement plan
and are eligible to participate in a defined contribution savings plan.
Effective January 1, 1997, the Company established the MidCon Corp. Retirement
Plan ("MRA") and the MidCon Corp. Savings Plan ("MSA"). Related plan assets from
Occidental Petroleum Corporation Retirement Plan and the Occidental Petroleum
Corporation Savings Plan were transferred to the MRA and MSA, respectively. The
plans provide for periodic contributions based on
F-45
<PAGE> 106
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the salary and age level of employees and/or employee contributions. Beginning
January 1, 1997, the Company's contribution under the MRA is being reduced over
time pursuant to the terms of the plan.
Effective November 20, 1996, Occidental established the ESOP for all
eligible employees of the Company. Generally, the shares of the CMIC Preferred
Stock held by the ESOP are released and allocated to participant accounts based
on the proportion of the payment on the ESOP note for the respective period
compared to the total remaining payments due on the note. Dividends on the CMIC
Preferred Stock are payable at an annual rate of $21 per share, when and as
declared by Occidental's Board of Directors. It is anticipated that MidCon will
make discretionary annual contributions to the MidCon ESOP which, together with
the annual dividends, will be used to repay the ESOP note. The Company accounts
for its ESOP in accordance with AICPA Statement of Position 93-6, "Employers'
Accounting for Employee Stock Ownership Plans" which requires that compensation
expense be measured based on the fair value of shares committed to be released.
The ESOP loan guarantee is recorded as an intercompany liability and the
shares of CMIC Preferred Stock pledged as collateral are reported as unearned
ESOP shares in the consolidated balance sheet. The Company reports compensation
expense equal to the estimated current market price of the shares. Dividends on
allocated ESOP shares result in a reduction to additional paid-in capital.
Dividends on ESOP shares have been used to satisfy debt service. ESOP
compensation expense was $1.1 million and $0 for the nine months ended September
30, 1997 and 1996, respectively. The ESOP has 40,998 and 6,151 allocated shares
and 1,359,002 and 1,393,849 unreleased shares outstanding at September 30, 1997
and December 31, 1996, respectively.
(10) TRANSACTIONS WITH AFFILIATES
Excess funds are invested with Occidental through its centralized
cash-management system. All intercompany loans are evidenced by a cash
management agreement. Interest earned or charged is calculated at prevailing
market rates.
Occidental provides and directly bills the Company for various services
including information technology services, administrative services for payroll,
and employee benefits for which the Company was allocated approximately $4.0
million and $3.8 million for the nine month periods ended September 30, 1997 and
1996, respectively. In addition, Occidental charges the Company for expense
incurred on its behalf such as insurance. All these charges, which were part of
the noninterest-bearing long-term intercompany liability at September 30, 1997
and December 31, 1996, approximate the amounts management believes would be
incurred if the Company were to independently secure these services. The charges
for these services are not reflected in the table on the following page.
Effective January 1, 1997, MidCon entered into a 10-year service agreement
with Occidental. This agreement provides for the continuation of various
services performed on the Company's behalf by Occidental. The initial annual fee
for these services will be $13 million through December 31, 2001, after which
time the fee will be renegotiated. The services provided will include, among
others, insurance administration, internal audit, legal and investor relations.
In addition, the agreement provides for the allocation of certain out-of-pocket
expenses incurred on the Company's behalf and for separate fees to be billed to
the Company by Occidental for such services as tax, regulatory compliance,
payroll and benefits and information technology. The fees charged are reflected
for the nine months ended September 30, 1997, as "Charges for Occidental's
general and administrative costs" indicated in the table below.
F-46
<PAGE> 107
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Principal transactions with affiliated companies, except as disclosed
elsewhere in these financial statements, were as follows for the nine month
periods indicated (in millions):
<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------
1997 1996
------- ------
<S> <C> <C>
Affiliated company transactions:
Transfer of trade receivables................................... $ 258.9 $200.9
Fees and expenses on trade receivables transferred.............. $ 9.9 $ 8.0
Sales, transportation and storage of natural gas and other
revenues..................................................... $ 1.4 $ 2.1
Purchases and transportation of natural gas..................... $ 24.5 $ 0.3
Charge for Occidental's general and administrative costs........ $ 9.8 $ 13.7
Net interest income (expense)................................... $(164.8) $(32.5)
Pipeline venture transactions:
Cash distributions.............................................. $ 9.7 $ 11.8
Transportation of natural gas charged to operation expense...... $ 7.6 $ 6.2
</TABLE>
(11) GAS STORED UNDERGROUND
At September 30, 1997 and December 31, 1996, Natural's current top gas
storage inventory, which is accounted for on the LIFO method, was $2.6 million
and $5.0 million, respectively. Noncurrent top gas inventory is stated on the
LIFO method. The current value of the noncurrent top gas inventory exceeded the
LIFO valuation by $236.9 million and $413.7 million at September 30, 1997 and
December 31, 1996, respectively. Noncurrent cushion gas inventory is stated at
average cost.
(12) PIPELINE VENTURES
Investments in active companies in which the Company has a voting interest
of not more than 50 percent are accounted for on the equity method. At September
30, 1997, the Company's equity investments consisted primarily of:
<TABLE>
<CAPTION>
OWNERSHIP
INVESTEE INTEREST
------------------------------------------------------------------ ---------
<S> <C>
West Cameron Dehydration Company.................................. 50%
Stingray Pipeline Company......................................... 50%
Gulf Processing................................................... 50%
U-T Offshore System............................................... 33 1/3%
Trailblazer Pipeline Company...................................... 33 1/3%
High Island Offshore System....................................... 20%
Overthrust Pipeline Company....................................... 18%
</TABLE>
Summarized financial information of these ventures is set forth below (in
millions):
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
1997 1996
------- ------
<S> <C> <C>
Operating revenues.......................................... $ 100.0 $ 87.6
Costs and expenses.......................................... 64.4 48.7
------- ------
Net income.................................................. $ 35.6 $ 38.9
====== =====
</TABLE>
F-47
<PAGE> 108
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
<S> <C> <C>
Current assets..................................... $ 48.4 $ 79.2
Noncurrent assets.................................. $ 280.1 $290.9
Current liabilities................................ $ 47.3 $ 69.1
Noncurrent liabilities............................. $ 132.3 $145.2
Stockholders' equity............................... $ 148.8 $155.8
</TABLE>
In accordance with project financing arrangements of certain of these
ventures and under tariffs approved by the FERC, Natural is required to pay
demand charges to certain of these ventures for contracted transportation
services. The demand charges for the nine month periods ended September 30, 1997
and 1996 were approximately $7.5 million and $6.1 million, respectively.
(13) YEAR 2000 COMPLIANCE
The Company has completed an assessment of its information systems to
determine what modifications, if any, are necessary for proper functioning of
these systems in the year 2000. Cost related to maintenance or modification of
these systems will be expensed as incurred. The Company does not anticipate the
related costs to have a material impact on its results of operations.
F-48
<PAGE> 109
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Midcon Corp.:
We have audited the accompanying consolidated balance sheets of MIDCON
CORP. (a Delaware corporation and a wholly-owned subsidiary of Occidental
Petroleum Corporation) and subsidiaries as of December 31, 1996 and 1995, and
the related consolidated statements of operations, stockholder's equity and cash
flows for each of the three years in the period ended December 31, 1996. 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 financial statements referred to above present fairly,
in all material respects, the financial position of MidCon Corp. and
subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois
January 31, 1997
F-49
<PAGE> 110
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
(THOUSANDS)
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
REVENUES:
Gas sales, transportation, storage and other
operating revenues............................... $2,574,211 $2,038,444 $2,109,834
Interest and other income (Note 3.h)................ 1,187 11,686 24,486
Earnings of pipeline ventures (Note 16)............. 12,716 18,155 13,100
---------- ---------- ----------
2,588,114 2,068,285 2,147,420
---------- ---------- ----------
COSTS AND OTHER DEDUCTIONS:
Cost of sales....................................... 1,981,235 1,473,370 1,561,331
Selling, general and administrative and other
operating expenses (Note 3.n).................... 108,347 167,235 109,556
Depreciation (Note 3.f)............................. 177,511 193,112 191,672
Taxes other than income taxes....................... 46,226 42,357 45,585
Interest expense (Note 2.a)......................... 79,626 23,286 8,101
Other............................................... 2,000 1,646 1,802
---------- ---------- ----------
2,394,945 1,901,006 1,918,047
---------- ---------- ----------
INCOME BEFORE INCOME TAXES............................ 193,169 167,279 229,373
PROVISIONS FOR AND CHARGE-IN-LIEU OF INCOME TAXES
(Note 7)............................................ 76,684 60,653 85,164
---------- ---------- ----------
NET INCOME............................................ $ 116,485 $ 106,626 $ 144,209
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-50
<PAGE> 111
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AT DECEMBER 31,
(THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents (Note 3.c).................................................. $ 4,258 $ 10,414
Restricted deposits (Note 3.g)........................................................ 38,623 24,645
Receivables
Affiliated companies (Note 3.d)..................................................... 415,643 222,979
Customers........................................................................... 9,363 3,362
Other............................................................................... 26,324 26,781
Interest-bearing receivables, net -- affiliated companies (Note 3.c and 14)........... 25,361 --
Gas transportation imbalances (Note 3.i).............................................. 56,106 77,131
Materials and supplies (Note 3.e)..................................................... 11,718 16,821
Net properties to be dividended, net of tax (Note 2.d)................................ 308,804 --
Gas stored underground (Note 15)...................................................... 39,343 66,732
Prepayments........................................................................... 20,187 12,535
Deferred income taxes (Note 7)........................................................ 77,277 100,348
----------- -----------
Total Current Assets............................................................ 1,033,007 561,748
----------- -----------
PROPERTY, PLANT AND EQUIPMENT (Note 2.c and 3.f)........................................ 6,876,061 8,069,359
Accumulated depreciation (Note 2.c)................................................... (1,785,257) (2,005,399)
----------- -----------
Net Property, Plant and Equipment (Note 3.m).................................... 5,090,804 6,063,960
----------- -----------
LONG-TERM INTERCOMPANY RECEIVABLE (Note 7).............................................. 33,197 --
GAS STORED UNDERGROUND -- NONCURRENT (Note 15).......................................... 413,334 378,508
INVESTMENTS IN PIPELINE VENTURES (Note 16).............................................. 53,141 54,184
DEFERRED CHARGES AND OTHER ASSETS....................................................... 28,879 37,094
----------- -----------
TOTAL ASSETS.................................................................... $ 6,652,362 $ 7,095,494
========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES:
Payables --
Affiliated companies (Note 3.d)..................................................... $ 2,857 $ 6,886
Trade............................................................................... 301,569 108,027
Contract impairment (Note 3.h)...................................................... 1,126 19,708
Other............................................................................... 115,943 121,948
Interest-bearing payables, net -- affiliated companies (Note 3.c and 14).............. -- 87,310
Dividend payable, affiliates (Note 2.d)............................................... 308,804 --
Rate refund provision (Note 5)........................................................ 15,218 3,073
Gas transportation imbalances (Note 3.i).............................................. 83,310 95,841
Current portion of long-term ESOP debt (Note 2.a)..................................... 12,574 --
Other................................................................................. 120,213 70,827
----------- -----------
Total Current Liabilities....................................................... 961,614 513,620
----------- -----------
OTHER LIABILITIES AND DEFERRED CREDITS:
Reserve for contract impairment (Note 3.h)............................................ 43,775 61,464
Intercompany liability (Note 14)...................................................... 32,696 134,316
Interest-bearing notes, affiliated companies (Notes 2.b and 3.c)...................... 1,600,000 740,583
Long-term ESOP debt (Note 2.a)........................................................ 1,386,026 --
Postretirement benefits other than pensions (Note 8).................................. 89,780 97,200
Other................................................................................. 157,400 227,634
----------- -----------
Total Other Liabilities and Deferred Credits.................................... 3,309,677 1,261,197
----------- -----------
DEFERRED INCOME TAXES (Note 2.c and 7).................................................. 1,680,354 1,987,290
----------- -----------
CONTINGENT LIABILITIES AND COMMITMENTS (Notes 4, 5, 6 and 12)
MINORITY EQUITY IN SUBSIDIARIES AND PARTNERSHIPS (Note 1)............................... 8,076 5,349
----------- -----------
STOCKHOLDER'S EQUITY:
Common Stock, $.01 par value, authorized 2,000,000 shares, outstanding 1,400,000
shares in 1996; $1 par value, authorized 1,000 shares, outstanding 1 share in 1995
(Note 2.b).......................................................................... 14 --
Unearned ESOP shares (Note 9)......................................................... (1,393,849) --
Additional paid-in capital............................................................ 2,000,060 3,358,107
Retained earnings (deficit)........................................................... 86,416 (30,069)
----------- -----------
Total Stockholder's Equity...................................................... 692,641 3,328,038
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY...................................... $ 6,652,362 $ 7,095,494
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-51
<PAGE> 112
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(THOUSANDS)
<TABLE>
<CAPTION>
UNEARNED ADDITIONAL RETAINED
COMMON ESOP PAID-IN EARNINGS
STOCK SHARES CAPITAL (DEFICIT)
------------ ----------- ---------- ---------
<S> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1993............ $ -- $ -- $4,280,577 $ (52,576)
Net income............................ -- -- -- 144,209
---- ----------- ---------- --------
BALANCE, DECEMBER 31, 1994............ -- -- 4,280,577 91,633
Net income............................ -- -- -- 106,626
Dividend of intercompany receivable to
Parent (Note 3.c)................... -- -- (922,470) (228,328)
---- ----------- ---------- --------
BALANCE, DECEMBER 31, 1995............ -- -- 3,358,107 (30,069)
Net income............................ -- -- -- 116,485
Dividend of subsidiaries and
properties (Note 2.c)............... -- -- (672,407) --
Contribution of intercompany debt
(Note 2.b).......................... -- -- 914,703 --
Non-cash dividend (Note 2.b).......... -- -- (1,600,000) --
Stock split (Note 2.b) 14 -- (14) --
Unearned ESOP shares (Note 9)......... -- (1,400,000) -- --
Dividends on unearned ESOP shares..... -- -- 3,348 --
Release of ESOP shares, net of tax
effect (Note 9)..................... -- 6,151 (3,677) --
---- ----------- ---------- --------
BALANCE, DECEMBER 31, 1996............ $ 14 $(1,393,849) $2,000,060 $ 86,416
==== =========== ========== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-52
<PAGE> 113
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
(THOUSANDS)
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income............................................... $ 116,485 $ 106,626 $ 144,209
Income adjustments --
Depreciation.......................................... 177,511 193,112 191,672
Deferred income tax benefit........................... (1,909) (65,710) (372)
Other noncash charges (credits) to income, net (Note
3.h and 3.n)........................................ 28,966 43,382 (15,030)
Distributions from (to) pipeline ventures, net of
earnings............................................ 1,385 (3,439) 5,567
Compensation expense (Note 9)......................... 217 -- --
Changes in operating assets and liabilities:
Decrease in accounts receivable....................... 1,248 2,166 17,320
Decrease (increase) in accounts receivable from
affiliates.......................................... (190,120) 17,405 15,425
Decrease in inventories............................... 32,492 16,448 9,193
Decrease (increase) in prepaid and other assets....... (26,384) (7,959) 39,304
Change in gas transportation imbalances, net.......... 8,494 (4,513) 11,463
Increase (decrease) in accounts payable and accrued
liabilities (Note 5)................................ 150,089 (160,088) 88,447
Decrease in accounts payable to affiliates............ (4,029) (752) (23,882)
Increase (decrease) in income taxes................... (2,805) 4,319 2,979
Other operating, net..................................... (24,567) 26,308 (31,912)
--------- --------- ---------
Net cash provided by operating activities........ 267,073 167,305 454,383
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures..................................... (146,883) (150,229) (92,656)
Acquisition of cushion gas............................... (91,212) -- --
Proceeds (costs) from disposal of property, plant and
equipment, net........................................ 4,111 (2,682) (1,572)
Other investing, net..................................... (1,008) 267 (1,651)
--------- --------- ---------
Net cash used by investing activities............ (234,992) (152,644) (95,879)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Retirement of debt....................................... (7,500) (500) (500)
Amounts paid to minority interest........................ (2,583) (3,745) (1,936)
Net change in interest-bearing receivables/payables with
affiliated companies and intercompany liability....... (28,154) (8,100) (352,570)
--------- --------- ---------
Net cash used in financing activities............ (38,237) (12,345) (355,006)
--------- --------- ---------
Increase (decrease) in cash and cash equivalents........... (6,156) 2,316 3,498
--------- --------- ---------
Cash and cash equivalents at beginning of year............. 10,414 8,098 4,600
--------- --------- ---------
Cash and cash equivalents at end of year................... $ 4,258 $ 10,414 $ 8,098
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-53
<PAGE> 114
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) DESCRIPTION OF COMPANY
MidCon Corp. (Company) is a wholly-owned subsidiary of Occidental Petroleum
Corporation (Occidental). The Company through its subsidiaries engages in
interstate and intrastate natural gas transmission and marketing as well as
electric power marketing. The Company's subsidiaries purchase, transport, store
and process gas and sell gas to utilities, municipalities and industrial and
commercial users. Another subsidiary purchases electricity from electric
utilities and other electric power producers and marketers and resells
electricity to wholesale customers.
The principal subsidiaries of the Company are Natural Gas Pipeline Company
of America (Natural), which operates a major interstate pipeline transmission
system along with several storage facilities; MidCon Texas Pipeline Operator,
Inc., (MTPO), which operates an intrastate pipeline system in Texas (see Note
2.c and 2.d); MidCon Gas Services Corp., which together with its subsidiaries,
(MidCon Gas), engages in the purchase and sale of gas and arranges for the
transportation and storage of natural gas; and MidCon Power Services Corp.
(MidCon Power), which engages in the purchase and sale at wholesale of electric
power and arranges for the transmission of such power. Other subsidiaries of the
Company own interests in several gas pipeline joint ventures (see Note 16).
Natural's interstate pipeline and storage operations are subject to
extensive regulation by the Federal Energy Regulatory Commission (the "FERC").
The FERC regulates, among other things, rates and charges for storage and
transportation of gas in interstate commerce, the construction and operation of
interstate pipeline facilities and the accounts and records of interstate
pipelines. Certain of MidCon Texas Pipeline Corp.'s (MidCon Texas) and MTPO's
rates and other aspects of its business are subject to regulation by the Texas
Railroad Commission.
(2) MIDCON RECAPITALIZATION
(a) ESOP
In November 1996, Occidental established the MidCon Corp. Employee Stock
Ownership Plan (ESOP) (see Note 9) for the benefit of the employees of the
Company and its subsidiaries.
Also, in November 1996, Occidental sold $1.4 billion of Occidental's
Cumulative MidCon-Indexed Convertible Preferred Stock (CMIC Preferred Stock) to
the MidCon Corp. ESOP Trust (the Trust). The CMIC Preferred Stock is convertible
into Occidental common stock based on the value of the Company. The Trust paid
for the CMIC Preferred Stock with a $1.4 billion 30-year promissory note (ESOP
note), bearing interest at 7.9 percent per annum, guaranteed by the Company.
Principal and interest payments on the ESOP note are due on December 31 in
annual installments of approximately $123 million, commencing December 31, 1997,
and continuing up to and excluding December 31, 2026, upon which date all
principal and interest remaining unpaid shall be immediately due and payable.
Dividends on the CMIC Preferred Stock are payable at an annual rate of $21 per
share, when and as declared by Occidental's Board of Directors. It is
anticipated that the Company will make discretionary annual contributions to the
MidCon ESOP which, together with the annual dividends, will be used to repay the
ESOP note. Dividends of $3.3 million on unearned shares and cash payments of
$9.2 million were used for debt service on the ESOP note in 1996.
Future earnings will be reduced by interest expense on the $1.4 billion
ESOP note and compensation expense as discussed in Note 9.
(b) Other Capital Transactions
Concurrent with the establishment of the ESOP, several transactions were
recorded. The Company had a 1,400,000-for-one split of the outstanding shares of
its common stock while the par value of such stock was
F-54
<PAGE> 115
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
changed from $1.00 per share to $.01 per share. Occidental contributed to the
capital of the Company $741 million of promissory notes previously issued by the
Company and $154 million of non-interest bearing intercorporate advances made by
Occidental to the Company that were outstanding as of November 30, 1996. In
addition, the Company declared a dividend, payable in the form of a $1.6 billion
note payable to Occidental. The principal amount of this note is due and payable
on December 31, 2026 and bears interest at an annual rate of 7.9 percent payable
monthly through December 31, 2001. Thereafter, the rate changes to the London
Interbank Offered Rate (LIBOR) plus 1.25 percent.
Future earnings will be reduced by interest expense on the $1.6 billion
note payable.
(c) Dividend of Subsidiaries and Properties
During 1996, the Company dividended all the outstanding shares of common
stock of its subsidiaries, Occidental Energy Ventures Corp. (OEVC) and MC
Panhandle, Inc., to Occidental. Properties from other Company subsidiaries
comprising certain oil and gas properties and well compressor properties were
dividended to Occidental effective on December 31, 1996. The net income from
these operations was $15 million, $9 million and $10 million for the twelve
months ended December 31, 1996, 1995 and 1994, respectively.
Also, effective December 31, 1996, the Company dividended 51 percent of its
interest in an intrastate pipeline limited liability partnership to Occidental
(see Note 2.d).
A summary of the 1996 adjustments showing the effect of the above
transactions on certain balance sheet accounts is presented below (in millions):
<TABLE>
<CAPTION>
INCREASE
(DECREASE)
----------
<S> <C>
Property, Plant and Equipment..................................... $ (1,339)
Accumulated Depreciation.......................................... $ (345)
Deferred Income Taxes............................................. $ (322)
Additional Paid-in Capital........................................ $ (672)
</TABLE>
(d) Lease of Intrastate Pipeline Assets
In December 1996, the Company merged its subsidiary MidCon Texas into a
limited partnership which then owned its Texas intrastate pipeline and related
facilities. On December 31, 1996, fifty-one percent of the Company's ownership
in the partnership was dividended to a subsidiary of Occidental with a dividend
of the remaining 49 percent to be paid on January 1, 1998. This 49 percent
interest is reflected in the accompanying consolidated balance sheets as "Net
properties to be dividended, net of tax." The Company formed a new subsidiary,
MTPO, which assumed certain of the contracts and obligations of MidCon Texas
before the merger. In addition, MTPO entered into an agreement with the limited
partnership to lease the intrastate pipeline system owned by the limited
partnership over a 30 year period commencing on January 1, 1997. The Company
accounts for this lease as an operating lease. The initial annual lease fee is
$30 million in 1997. The lease fee changes to $20 million for the years 1998
through 2001, $40 million for the years 2002 through 2005 and $30 million during
the remaining lease term. Lease expense of $30 million will be recognized
annually. The lease agreement requires MTPO to pay for taxes, insurance and
maintenance expense and contains restrictions concerning additions, dispositions
and modifications to the leased property. The annual lease fee approximates
MidCon Texas' 1996 depreciation expense and any difference is not expected to
have a material impact on future years' net income.
F-55
<PAGE> 116
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(3) SIGNIFICANT ACCOUNTING POLICIES
(a) Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its majority-owned subsidiaries. The consolidated balance sheet at December
31, 1996, reflects the transactions discussed in Note 2. The consolidated income
statement presented for 1996 includes the results of operations for the assets
dividended for the entire twelve months with the exception of OEVC, which is
included for nine months. All material intercompany transactions have been
eliminated. The equity method of accounting is used for investments in pipeline
ventures in which 50 percent or less of the voting interest is owned. The
Company's financial statements reflect adjustments needed to present
transactions with Occidental on a stand-alone basis.
Certain reclassifications have been made to the prior years' financial
statements to conform to the 1996 presentation.
(b) Accounting Changes
The Company's adoption of Statement of Financial Accounting Standards
(SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets To Be Disposed Of", effective January 1, 1996, which assumed
that the Company will continue to operate, maintain and, where appropriate,
expand its business, did not have an impact on the Company's consolidated
financial position or results of operations. The provisions require the Company
to review long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If it is determined that an impairment loss has occurred based on
expected future cash flows, then a loss will be recognized in the income
statement using a fair-value based model.
(c) Cash and Cash Equivalents and Interest-Bearing Receivables/Payables,
Net -- Affiliated Companies
Cash equivalents consist of interest bearing commercial paper and other
bank deposits with initial maturities of three months or less. Cash equivalents
totaled approximately $1.5 million and $1.7 million at December 31, 1996 and
1995, respectively.
Occidental and its subsidiaries utilize a cash-management system designed
to minimize cash balances and external borrowing. Amounts due from or to
affiliates under this program are reflected as current assets and liabilities in
the accompanying financial statements. Interest income and expense is allocated
to the participating companies on the basis of the principal contributed or
borrowed, respectively. The Company has periodically dividended, to its parent
company, its interest bearing receivables from Occidental under the former cash
management system.
In November 1996, the Company entered into a new intercompany cash
management agreement with Occidental. This agreement, which is effective January
1, 1997, engages Occidental to continue to provide the Company with certain
financing and cash management services.
During 1995, the Company declared a dividend to Occidental of an
intercompany receivable due from a then wholly-owned subsidiary. The balance of
the intercompany receivable, which prior to the dividend was eliminated in the
Company's, consolidation, is shown on the December 31, 1995 consolidated balance
sheet as a noncurrent interest-bearing payable to affiliated companies
representing an amount due Occidental (see Note 2.b).
(d) Receivables/Payables with Affiliated Companies
Receivable and payable balances with affiliates arise from transactions
between the Company's subsidiaries and Occidental's other subsidiaries. These
transactions occur in the normal course of business at prices which approximate
market.
F-56
<PAGE> 117
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company transfers to an Occidental special purpose affiliate certain
trade receivables under a revolving sales program with limited recourse, in
connection with the ultimate sale for cash of such receivables. The Company
retains the collection responsibility with respect to the receivables sold. An
interest in new receivables is transferred monthly, representing the net
difference between newly created receivables and collections made from
customers. Fees and expenses related to the sales of receivables under this
program are included in Selling, general and administrative and other operating
expenses.
(e) Inventories
Inventories are stated at the lower of cost or market. Inventories of
natural gas are determined using the average-cost method by MidCon Gas and the
last-in, first-out (LIFO) method by Natural (see Note 15). The cost of materials
and supplies inventories is determined using the average-cost method.
(f) Property, Plant and Equipment and Related Depreciation
Property additions and major renewals and improvements are capitalized at
cost. Interest costs incurred in connection with capital expenditures are
capitalized and amortized over the lives of the related assets. Depreciation of
natural gas transmission facilities is provided using primarily the
straight-line method.
Prior to the dividend of its oil and gas properties to Occidental, the
Company accounted for these properties using the successful-efforts method.
Costs of acquiring nonproducing acreage, costs of drilling successful
explorations wells and development costs were capitalized (see Note 2.c).
Depreciation of oil and gas producing properties was determined by the
units-of-production method and was based on estimated recoverable reserves.
Effective January 1, 1996, MidCon Texas revised the estimated average
useful lives used to compute depreciation to a remaining useful life of 38
years. This revision was made to more properly reflect the current economic
lives of the assets based on anticipated industry conditions. The aggregate
effect of this change was an increase in net income for the year ended December
31, 1996 of $14.9 million.
Property, plant and equipment includes purchase price adjustments related
to the acquisition of the Company by Occidental in 1986. For Natural's rate
making purposes, recovery is limited to the original cost of property, plant and
equipment which includes an allowance for funds used during construction. The
allocated purchase price, less subsequent accumulated depreciation, exceeded the
amount subject to recovery through the rate-regulatory process by $4.1 billion
and $4.2 billion at December 31, 1996 and 1995, respectively. This excess amount
as of December 31, 1996 is being depreciated over a remaining period of 37
years.
(g) Restricted Deposits
The Company engages in hedging to decrease its exposure to natural gas
price risk. In accordance with New York Mercantile Exchange rules, $38.6 million
and $24.6 million of monies on deposit with brokers was restricted at December
31, 1996 and 1995, respectively, to meet trading requirements (see Notes 3.1 and
11).
(h) Reserve for Contract Impairment
The contract impairment reserve recognizes the disadvantageous aspects of
certain gas-purchase and sales contracts resulting from economic and regulatory
conditions. Nearly all of these contracts or the disadvantageous aspects of
these contracts have now been resolved.
The contract impairment reserve includes reserves for the cost of the
resolution of these gas purchase and sales contracts, including "take-or-pay"
obligations. The noncurrent portion of the reserve was reduced by $52 million
and $66 million in 1996 and 1995, respectively, with no impact on net income,
primarily to reflect the settlement of an impaired contract, partial payment
thereon and the payment of above market costs.
F-57
<PAGE> 118
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The noncurrent portion of the reserve was reduced by $20 million in 1994 to
reflect a decrease in the net exposure under disadvantageous gas purchase
contracts, the elimination of certain potential claims, the successful
resolution of litigation, settlements or other changes in the expected outcome
of matters covered by the reserve.
(i) Gas Transportation Imbalances
Gas transportation imbalances receivable and payable reflect gas volumes
owed to Natural, MTPO and MidCon Gas or to their customers. For MTPO and MidCon
Gas, imbalances are valued primarily at the weighted average cost of purchased
gas.
Natural's current imbalances are being settled on a monthly basis through
established cashout procedures. These imbalances are valued at the applicable
percentage of an average monthly index price determined in the month the
imbalance occurred. The remaining imbalances not under the cashout procedure are
valued primarily at the current market price.
(j) Supplemental Cash Flow Information
Cash payments during the years 1996, 1995 and 1994 included income taxes of
approximately $5.0 million, $6.4 million and $4.7 million, respectively.
Interest paid for the same period, net of amounts capitalized, was $74.3
million, $.3 million and $2.9 million.
(k) Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments" requires the disclosure of the fair value
of off- and on-balance sheet financial instruments. The Company has no material
off-balance sheet financial instruments. All balances reflected in the
consolidated balance sheets for financial instruments approximate market value.
(l) Hedging Activities
The Company uses commodity futures contracts, options and swaps to hedge
the impact of natural gas price fluctuations related to its business activities.
Gains and losses on hedge contracts are deferred and recognized as an adjustment
to sales revenue or purchase costs when the related transaction being hedged is
finalized (see Note 11).
(m) Risks and Uncertainties
The process of preparing consolidated financial statements in conformity
with generally accepted accounting principles (GAAP) requires the use of
estimates and assumptions regarding certain types of assets, liabilities,
revenues and expenses. Such estimates primarily relate to unsettled transactions
and events as of the date of the consolidated financial statements. Accordingly,
upon settlement, actual results may differ from estimated amounts, generally not
by material amounts. Management believes that these estimates and assumptions
provide a reasonable basis for the fair presentation of the Company's financial
position and results of operations.
Included in the accompanying balance sheet is net property, plant and
equipment at a carrying value of $5.1 billion as of December 31, 1996. These
carrying values are based on the Company's plans and intentions to continue to
operate, maintain and, where it is economically desirable, to expand its
businesses. If future economic conditions result in changes in management's
plans or intentions, the carrying values of the affected assets will be reviewed
again and any appropriate adjustments made.
F-58
<PAGE> 119
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(n) Liabilities
Accrued liabilities current and other noncurrent liabilities include
reserves relating to a reorganization of the Company's operations initiated in
1995 which were initially recorded as selling, general and administrative and
other operating expenses for $37 million during the fourth quarter of 1995. The
current and noncurrent portion of the reserve totaled approximately $9 million
and $12 million, respectively, at December 31, 1996 and $16 million and $21
million, respectively, at December 31, 1995.
(4) LITIGATION
There are various lawsuits and proceedings pending against the Company and
its subsidiaries. It is impossible at this time to determine the ultimate legal
liabilities that may arise therefrom. However, in management's opinion, after
taking into account reserves, the pending lawsuits and proceedings and claims
should not have a material adverse effect upon the consolidated financial
position or results of operations of the Company.
(5) REGULATORY MATTERS
On December 1, 1992, Natural filed with the FERC for a general rate
increase to recover higher operating costs. The FERC permitted Natural to put
the new rates into effect on June 1, 1993, subject to refund. In November 1994,
Natural filed a proposed settlement of the rate case with the FERC. The
settlement was approved by the FERC in January 1995. This settlement resulted in
refunds being made to customers of approximately $128 million in 1995.
On June 1, 1995, Natural filed a general rate case with the FERC to
establish new rates as well as new or revised services. The FERC permitted
Natural to place new rates and services into effect, subject to refund, on
December 1, 1995. This date corresponded to the effective date of new
transportation and storage agreements between Natural and its principal local
distribution customers. Major issues in the rate case include throughput levels
used in the design of rates, discounting adjustments, levels of depreciation
rates and return on investment, and the level and design of fuel rates. In May
1996, Natural filed with the FERC an offer of settlement to resolve the
remaining issues in this proceeding. Natural is currently negotiating with
intervenors to reach accommodations to allow the settlement to be certified as
unopposed.
In 1994, a federal appellate court remanded to the FERC two orders
determining that Great Lakes Gas Transmission Limited Partnership ("Great
Lakes") should implement incremental rates rather than rolled in rates to
recover the costs of certain expansions to its pipeline system. Under those
orders, the customers of Great Lakes for which the expansion facilities had been
built paid an incremental rate to cover the cost of the facilities while rates
to other shippers, such as Natural, were unaffected. In June 1995, the FERC
issued an order reversing its prior incremental rate decisions with retroactive
effect to November 1991. As a result of the 1995 order, Natural has paid Great
Lakes an additional $13.5 million for the period from November 1, 1991 through
November 1, 1995, the date Natural's contract with Great Lakes terminated.
Natural's request for rehearing of the FERC's June 1995 order was denied and
Natural has sought judicial review of this FERC decision. Natural has also filed
a mechanism for recovery of the additional amounts paid to Great Lakes as a
result of the June 1995 order. The FERC issued an order that would permit
Natural to recover from its customers any allocated and approved costs from
Great Lakes for post-December 1, 1993 service. In January 1997, the FERC
approved a settlement filed by Natural that resolves all issues related to
Natural's recovery from customers of a portion of the additional payment made to
Great Lakes.
In January 1997, Amoco Production Company and Amoco Energy Trading
Corporation ("Amoco") filed a complaint against Natural before the FERC
contending that Natural had improperly provided its affiliate, MidCon Gas
Services Corp. ("MidCon Gas"), transportation service on preferential terms.
Amoco has requested, among other things, that the FERC require Natural to
terminate the transportation services it
F-59
<PAGE> 120
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
provides to MidCon Gas. Natural believes it has treated all shippers, including
Amoco, fairly and it will vigorously defend its actions.
(6) CONTINGENT LIABILITIES AND COMMITMENTS
Natural has been a party to a number of contracts that required Natural to
purchase natural gas at prices in excess of the prevailing market price. As a
result of a FERC order (Order 636) prohibiting interstate pipelines from using
their gas transportation and storage facilities to market gas to sales
customers, Natural no longer had a sales market for the gas it is required to
purchase under these contracts. Order 636 went into effect on Natural's system
on December 1, 1993. Natural has agreed to pay substantial transition costs to
reform these contracts with gas suppliers. Settlement agreements reached by
Natural and its former sales customers, under which Natural is recovering from
those customers over a four year period beginning December 1, 1993, a
significant amount of the gas supply realignment (GSR) costs it incurs, have
been approved by the FERC. The FERC has also permitted Natural to implement a
tariff mechanism to recover additional portions of its GSR costs in rates
charged to transportation customers that were not party to the settlements. In
July 1996, a Federal appellate court remanded Order 636 to the FERC for further
explanation of aspects of its decision regarding recovery of GSR costs by
interstate pipelines.
The Company has certain other commitments and contingent liabilities under
contracts, guarantees and joint ventures.
In management's opinion, after taking into account reserves, none of such
commitments and contingencies discussed above should have a material adverse
effect upon the consolidated financial position or results of operations of the
Company.
(7) INCOME TAXES
The Company and its subsidiaries are included in Occidental's consolidated
federal tax return and unitary state tax returns. The consolidated provisions
for these income taxes are allocated to the Company on the basis of a tax
sharing agreement with Occidental. Under the agreement, the amount of
consolidated current and deferred tax provisions is determined as if the Company
were a corporation that was not owned by Occidental and filed a separate
consolidated income tax return. In addition, state income taxes are provided in
all states in which the Company is included in a state return with Occidental,
notwithstanding that the Company may not have been subject to tax in that
jurisdiction but for its affiliation with Occidental.
Taxable gains were recorded by the Company resulting from dividends and
asset transfers to Occidental during 1996 (see Note 2.c). Since the Company is
included in the consolidated federal income tax return with Occidental, these
taxable gains are deferred until the Company is transferred outside the
consolidated group. Under the Company's tax sharing agreement, the tax payments
associated with the gains will be reimbursed to the Company over the remaining
tax lives of the transferred assets. A long-term intercompany receivable from
Occidental has been recorded on the consolidated balance sheet to reflect these
reimbursements.
F-60
<PAGE> 121
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The provisions (credits) for income taxes for the years ended December 31
were as follows (in millions):
<TABLE>
<CAPTION>
ALLOCATED
CONSOLIDATED
TAXES STATE TOTAL
------------ ----- ------
<S> <C> <C> <C>
1996
Current........................................... $ 68.0 $10.6 $ 78.6
Deferred.......................................... (2.0) .1 (1.9)
------ ----- -----
$ 66.0 $10.7 $ 76.7
====== ===== =====
1995
Current........................................... $115.6 $10.8 $126.4
Deferred.......................................... (60.4) (5.3) (65.7)
------ ----- -----
$ 55.2 $ 5.5 $ 60.7
====== ===== =====
1994
Current........................................... $ 79.0 $ 6.5 $ 85.5
Deferred.......................................... 1.0 (1.4) (.4)
------ ----- -----
$ 80.0 $ 5.1 $ 85.1
====== ===== =====
</TABLE>
The following is a reconciliation, stated as a percentage of pretax income,
of the U.S. statutory federal income tax rate to the Company's effective
allocated consolidated tax rate on income:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER
31,
------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
U.S. federal statutory tax rate......................... 35% 35% 35%
State taxes, net of federal benefit..................... 5 3 2
Income tax reserve no longer required................... -- (2) --
--- --- ---
Allocated consolidated tax rate......................... 40% 36% 37%
=== === ===
</TABLE>
Tax effects of temporary differences at December 31, 1996 and 1995 were as
follows (in millions):
<TABLE>
<CAPTION>
1996 1995
-------------------------- --------------------------
DEFERRED DEFERRED DEFERRED DEFERRED
ITEMS RESULTING IN TEMPORARY TAX TAX TAX TAX
DIFFERENCES ASSETS LIABILITIES ASSETS LIABILITIES
--------------------------------------- -------- ----------- -------- -----------
<S> <C> <C> <C> <C>
Property, plant and equipment, net..... $ -- $ 1,866 $ -- $ 2,182
Contract impairment reserves........... 49 -- 74 --
Postretirement benefit accruals........ 47 -- 47 --
State income taxes..................... 91 28 99 23
Regulatory liabilities................. 39 -- 32 --
Investment in partnerships............. 8 23 9 25
All other.............................. 107 27 92 10
---- ------ ---- ------
Total deferred taxes......... $341 $ 1,944 $353 $ 2,240
==== ====== ==== ======
</TABLE>
(8) RETIREMENT AND POSTRETIREMENT BENEFITS
The Company's retirement and postretirement defined benefit plans are
accrued based on various assumptions and discount rates, as described below. The
actuarial assumptions used could change in the near term as a result of changes
in expected future trends and other factors which, depending on the nature of
the changes, could cause increases or decreases in the liabilities accrued.
F-61
<PAGE> 122
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pension costs for the Company's defined benefit pension plan, determined by
independent actuarial valuations, are funded by payments to trust funds, which
are administered by independent trustees. The components of the net pension cost
for 1996, 1995 and 1994 were as follows (in millions):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER
31,
-----------------------------
1996 1995 1994
----- ----- -----
<S> <C> <C> <C>
Service cost -- benefits earned during the period....... $ 1.4 $ 1.4 $ 1.4
Interest cost on projected benefit obligation........... 0.7 0.5 0.5
Actual return on plan assets............................ (0.7) (0.7) (0.1)
Net amortization and deferral........................... -- 0.1 (0.4)
----- ----- -----
Net pension cost........................................ $ 1.4 $ 1.3 $ 1.4
===== ===== =====
</TABLE>
The following table sets forth the plan's funded status and amounts
recognized in the Company's consolidated balance sheets at December 31, 1996 and
1995 (in millions):
<TABLE>
<CAPTION>
BALANCE AT DECEMBER 31,
-------------------------------
1996 1995
------------- -------------
ACCUMULATED ACCUMULATED
BENEFITS BENEFITS
EXCEED ASSETS EXCEED ASSETS
------------- -------------
<S> <C> <C>
Present value of the estimated pension benefits to be
paid in the future:
Total projected benefit obligations.................... $10.6 $ 8.8
Estimated fair value of plan assets.................... 9.4 7.7
----- -----
Projected benefit obligations in excess of plan
assets.............................................. $ 1.2 $ 1.1
===== =====
Projected benefit obligations in excess of plan
assets.............................................. $ 1.2 $ 1.1
Unrecognized prior service benefit..................... 0.1 0.2
Unrecognized net loss.................................. (0.7) (0.5)
----- -----
Pension liability...................................... $ 0.6 $ 0.8
===== =====
</TABLE>
The discount rate used in determining the actuarial present value of the
projected benefit obligations was 7.5 percent in 1996 and 1995. The rate of
increase in future compensation levels used in determining the actuarial present
value of the projected benefit obligations was 5.5 percent in 1996 and 1995. The
expected long-term rate of return on assets was 8 percent in 1996 and 1995.
The Company provides medical, dental and life insurance for certain active,
retired and disabled employees and their eligible dependents. Beginning in 1993,
participants pay for all medical cost increases in excess of increases in the
Consumer Price Index (CPI). The benefits generally are funded by the Company as
the benefits are paid during the year. The cost of providing these benefits is
based on claims filed and insurance premiums paid for the period. The total
benefits costs were approximately $14.6 million, $15.5 million and $16.3 million
in 1996, 1995 and 1994, respectively. The 1996, 1995 and 1994 costs included
$5.7 million, $6.6 million and $7.5 million, respectively, for postretirement
costs, as discussed below.
The postretirement benefit obligation at December 31, 1996 and 1995 was
determined by application of the terms of medical, dental, and life insurance
plans, including the effect of established maximums on covered costs, together
with relevant actuarial assumptions and health-care cost trend rates projected
at a CPI increase of 3.0 percent and 4.0 percent in 1996 and 1995, respectively.
The weighted average discount rate used in determining the accumulated
postretirement benefit obligation was 7.5 percent as of December 31, 1996 and
1995. The Company's funding policy generally is to pay claims as they come due
with the exception
F-62
<PAGE> 123
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of Natural which began funding for its obligation effective June 1, 1993. A FERC
policy statement allows collection of these costs currently in rates as the
appropriate funds are placed in an irrevocable trust. The trust was established
during 1993 and assets are invested in a variety of instruments, such as bonds,
money market accounts and equity investments.
The following table sets forth the postretirement plan's status, reconciled
with the amounts included in the consolidated balance sheets at December 31,
1996 and 1995 (in millions):
<TABLE>
<CAPTION>
BALANCE AT DECEMBER
31,
--------------------
1996 1995
----- ------
<S> <C> <C>
Accumulated postretirement benefit obligation
Retirees...................................................... $63.4 $ 75.7
Fully eligible actives........................................ 14.3 8.1
Other actives................................................. 12.4 17.2
----- ------
Total accumulated postretirement benefit obligation............. 90.1 101.0
Plan assets at fair value....................................... 34.2 26.4
----- ------
Unfunded status................................................. 55.9 74.6
Unrecognized net gain........................................... 37.9 26.4
----- ------
Accrued postretirement benefit cost............................. $93.8 $101.0
===== ======
</TABLE>
The benefit obligation decreased due primarily to the effect of the
decrease in the CPI discussed above, as well as favorable retiree claims
experience.
Net periodic postretirement benefit cost for 1996, 1995 and 1994 included
the following components (in millions):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER
31,
-----------------------------
1996 1995 1994
----- ----- -----
<S> <C> <C> <C>
Service cost -- benefits attributed to service during
the period............................................ $ 1.1 $ 1.1 $ 1.0
Interest cost on accumulated postretirement benefit
obligation............................................ 7.2 7.2 7.7
Actual return on plan assets............................ (1.3) (0.7) (0.6)
Net amortization and deferral........................... (1.1) (1.0) (0.6)
Other................................................... (0.2) -- --
----- ----- -----
Net periodic postretirement benefit cost................ $ 5.7 $ 6.6 $ 7.5
===== ===== =====
</TABLE>
(9) RETIREMENT PLANS AND ESOP
All employees are participants in defined contribution retirement and
savings plans. The plans provide for periodic contributions based on the salary
and age level of employees and/or employee contributions. The Company's expense
under the provisions of the plans was $12.5 million, $13.2 million and $12
million for 1996, 1995 and 1994, respectively. Beginning January 1, 1997, the
Company's contribution under the salaried retirement plan, totaling $7.6
million, $7.7 million and $7.4 million for 1996, 1995 and 1994, respectively,
will be reduced over time pursuant to the terms of the plan.
Effective November 20, 1996, Occidental established the ESOP for all
eligible employees of the Company. Generally, the shares of the CMIC Preferred
Stock held by the ESOP are released and allocated to participant accounts based
on the proportion of the payment on the note for the respective period compared
to the total remaining payments due on the note. Dividends on the CMIC Preferred
Stock are payable at an annual rate of $21 per share, when and as declared by
Occidental's Board of Directors. It is anticipated that the Company will make
discretionary annual contributions to the MidCon ESOP which, together with the
annual dividends, will be used to repay the ESOP note. The Company accounts for
its ESOP in accordance
F-63
<PAGE> 124
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
with Statement of Position 93-6, "Employers' Accounting for Employee Stock
Ownership Plans" which requires that compensation expense be measured based on
the fair value of shares committed to be released.
The ESOP loan guarantee is recorded as a long-term intercompany liability
and the shares of CMIC Preferred Stock pledged as collateral are reported as
unearned ESOP shares in the consolidated balance sheet. As shares are released
from collateral, the Company reports compensation expense equal to the estimated
current market price of the shares. Dividends on allocated ESOP shares result in
a reduction to additional paid-in capital. Dividends on unallocated ESOP shares
will be used to satisfy debt service. ESOP compensation expense was $217,000 for
1996. The ESOP has 6,151 allocated shares and 1,393,849 unreleased shares
outstanding at December 31, 1996.
(10) STOCK BASED COMPENSATION PLANS
Certain Company executives participate in various Occidental incentive
stock plans. These plans include options with vesting terms of 3 years and
maximum terms of 10 years and one month. Under these plans, 168,000 and 143,332
options were granted for the years ended December 31, 1996 and 1995,
respectively. In addition, 4,589 and 10,909 of Occidental's $.20 par value
restricted stock were granted during the years ended December 31, 1996 and 1995,
respectively. These grants vest after 4 years (5 years for awards issued prior
to December 1995) or earlier under certain conditions.
The Company accounts for these plans under Accounting Principles Board
Opinion No. 25. The difference in compensation expense for these plans
determined in accordance with SFAS No. 123, "Accounting for Stock Based
Compensation" is not significant.
(11) HEDGING ACTIVITIES
The Company uses commodity futures contracts, options and swaps to hedge
the impact of natural gas price fluctuations related to two major categories of
business: purchases for and sales from storage and fixed-price sales and
purchase contracts.
STORAGE
Storage activities consist of purchasing and injecting natural gas into
storage during low-price, low-demand periods (typically the months of April
through October) and withdrawing that gas for sale during high-price,
high-demand periods (typically the period from November through March). These
periods may vary depending primarily on weather conditions and competing fuel
prices in the market areas. The Company uses derivatives (mainly futures
contracts) to hedge the sales and purchase prices related to its storage
program. The hedging contracts used have terms of less than 18 months. Gains and
losses on these hedging contracts are deferred and recognized in income when the
transactions being hedged are finalized. A small number of options were sold
against inventory capacity or physical inventory with results included in
periodic income.
FIXED-PRICE SALES AND PURCHASES
Fixed-price gas sales and purchase contracts vary by agreement. Hedges are
placed nearly simultaneously with the consummation of many of the sales-purchase
agreements. All agreements are for less than 18 months.
Gains and losses on these hedging contracts are deferred and recognized in
income when the transactions being hedged are finalized. New York Mercantile
Exchange (NYMEX), Kansas City Board of Trade (KCBT), (collectively, the
Exchanges) and over-the-counter (OTC) hedge instruments are utilized.
F-64
<PAGE> 125
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
All hedging activity is matched to physical natural gas buying and selling
activity and is done with natural gas futures or derivative instruments. There
is essentially no discrepancy with regard to timing, i.e., hedges are placed for
the same month in which the price risk for the underlying physical movement is
anticipated to occur, based on analysis of sales and purchase contracts and
historical data. Hedges are removed upon consummation of the underlying physical
activity. All deferred gains or losses are then recognized. Because the
commodity covered by the Exchanges' natural gas futures contracts is
substantially the same commodity that the Company buys and sells in the physical
market, no special correlation studies, other than monitoring the degree of
convergence between the futures and the cash markets, are deemed necessary.
Geographic basis risk (the difference in value of gas at the Exchanges' delivery
points versus the points of the Company's transaction) is monitored and where
appropriate, hedged using OTC instruments. Exchange-traded futures and options
are valued using settlement prices published by the Exchanges. OTC options are
valued using a standard option pricing model that requires published exchange
prices, market volatility per broker quotes, and the time value of money. Swaps
are valued by comparing current broker quotes for price or basis with the
corresponding price or basis in the related swap agreement and then discounting
the result to present value.
Although futures and options traded on the Exchanges are included in the
table below, they are not financial instruments as defined in GAAP, since
physical delivery of natural gas may be, and occasionally is, made pursuant to
these contracts. However, they are a major part of the Company's commodity risk
management program.
The following table summarizes the types of hedges used and the related
financial information as of December 31, 1996 and 1995:
<TABLE>
<CAPTION>
OVER-THE-
EXCHANGES (a) COUNTER(b) TOTAL
------------- ------------- -------------
NOTIONAL VOLUMES IN BCF HEDGES OF 1996 1995 1996 1995 1996 1995
- ------------------------------------ ------------ ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Price Hedge:
Futures........................... Purchases 32 62 -- -- 32 62
Swaps............................. Purchases -- -- -- 8 -- 8
Sales -- -- 1 -- 1 --
Options........................... Purchases -- -- 2 -- 2 --
Basis Hedge:
Basis Swaps(c).................... Purchases -- -- 33 9 33 9
Sales -- -- 34 7 34 7
</TABLE>
<TABLE>
<CAPTION>
OVER-THE-
EXCHANGES COUNTER BOOK VALUE FAIR VALUE
----------- ----------- ----------- -----------
DOLLARS IN MILLIONS 1996 1995 1996 1995 1996 1995 1996 1995
- ------------------------------------------------- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Deferred net gains (losses):
Firm commitment/forecast transactions.......... $(3) $14 $ -- $ --
Assets:
Basis swaps.................................... $ -- $-- $ 1 $--
Liabilities:
Price swaps.................................... $ -- $ 2 $-- $ 6
Basis swaps.................................... $ -- $ 1 $-- $ 2
</TABLE>
- ---------------
(a) Not financial instruments as defined in GAAP, but included as they are a
major part of the program.
(b) Excluding the nine-year swap agreement, the average weighted term is less
than twelve months. Ninety percent of the notional volumes are hedged with
counterparties with a BBB or better credit rating.
(c) Basis swaps are utilized to hedge the geographic price differentials due
primarily to transportation cost and local supply-demand factors.
F-65
<PAGE> 126
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(12) LEASES
Rent expense under primarily operating leases was $14.6 million in 1996 and
$13.9 million in 1995 and 1994.
At December 31, 1996, future minimum rental commitments under
noncancellable operating leases, including the MTPO lease agreement (see Note
2.d), were as follows (in millions):
<TABLE>
<CAPTION>
CALENDAR YEAR
-----------------------------------------------------------
<S> <C>
1997.................................................... $ 42.1
1998.................................................... 32.5
1999.................................................... 33.7
2000.................................................... 33.8
2001.................................................... 32.8
Remaining years......................................... 854.0
--------
Total............................................ $1,028.9
========
</TABLE>
(13) MAJOR CUSTOMERS
Revenues realized from major customers, which are defined as those
providing in excess of ten percent of total operating revenues, were as follows
for the years ended December 31, (in millions):
<TABLE>
<CAPTION>
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Northern Illinois Gas Company............................ $114.5 $267.0 $332.3
The Peoples Gas Light and Coke Company................... $114.3 $214.7 $285.7
</TABLE>
(14) TRANSACTIONS WITH AFFILIATES
Excess funds are invested with Occidental through its centralized
cash-management system. All intercompany loans are evidenced by a cash
management agreement. Interest earned or charged is calculated at prevailing
market rates.
Occidental provides and directly bills the Company's subsidiaries for
various services including information technology services, administrative
services for payroll, and employee benefits for which the Company was allocated
for 1996 and 1995 approximately $5.2 million and $5.4 million, respectively. In
addition, Occidental charges the Company for expense incurred on its behalf such
as insurance. All these charges, which were part of the noninterest-bearing
long-term intercompany liability at December 31, 1996 and 1995, approximate the
amounts management believes would be incurred if the Company were to
independently secure these services. The charges for these services are not
reflected in the table on the following page.
On November 20, 1996, the Company entered into a 10 year service agreement
with Occidental. This agreement, which is effective January 1, 1997, provides
for the continuation of various services performed on the Company's behalf by
Occidental. The initial annual fee for these current services will be $13
million through December 31, 2001, after which time the fee will be
renegotiated. The services provided will include, among others, insurance,
internal audit, legal and investor relations. In addition, the agreement
provides for the allocation of certain out-of-pocket expenses incurred on the
Company's behalf and for separate fees to be billed to the Company by Occidental
for such services as tax, regulatory compliance, payroll and benefits and
information technology. The fees charged will generally replace the "Charges for
Occidental's general and administrative costs" indicated in the table below.
F-66
<PAGE> 127
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Principal transactions with affiliated companies, except as disclosed
elsewhere in these financial statements were as follows (in millions):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER
31,
----------------------------
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Affiliated company transactions:
Transfer of trade receivables........................ $410.6 $219.8 $226.4
Fees and expenses on trade receivables transferred... $ 10.4 $ 8.4 $ 8.4
Sales, transportation and storage of natural gas and
other revenues.................................... $ 3.7 $ 2.8 $ --
Purchases and transportation of natural gas.......... $ 2.1 $ 0.9 $ 1.8
Charge for Occidental's general and administrative
costs............................................. $ 18.3 $ 21.1 $ 19.0
Net interest income (expense)................ $(66.1) $(11.6) $ 8.6
Pipeline venture transactions:
Cash distributions................................... $ 14.1 $ 16.8 $ 18.7
Transportation of natural gas charged to operation
expense........................................... $ 8.3 $ 9.8 $ 20.2
</TABLE>
(15) GAS STORED UNDERGROUND
At December 31, 1996 and 1995, Natural's current gas storage inventory
which is accounted for on the LIFO method was $5 million and $1.8 million,
respectively. The remaining current gas storage inventory is accounted for under
the average cost method. Noncurrent gas inventory is stated primarily at the
allocated purchase cost.
During 1994, inventory quantities were reduced at Natural resulting in a
liquidation of LIFO inventory quantities carried at lower costs that prevailed
in prior years. The effect of this liquidation was to reduce cost of sales by
$13.6 million.
(16) PIPELINE VENTURES
Investments in active companies in which the Company has a voting interest
of not more than 50 percent are accounted for on the equity method. At December
31, 1996, the Company's equity investments consisted primarily of:
<TABLE>
<CAPTION>
INVESTEE OWNERSHIP INTEREST
--------------------------------------------------------------------- ------------------
<S> <C>
West Cameron Dehydration Company..................................... 50%
Stingray Pipeline Company............................................ 50%
Gulf Processing...................................................... 50%
U-T Offshore System.................................................. 33 1/3%
Trailblazer Pipeline Company......................................... 33 1/3%
High Island Offshore System.......................................... 20%
Overthrust Pipeline Company.......................................... 18%
</TABLE>
Summarized financial information of these ventures is set forth below (in
millions):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER
31,
----------------------------
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Operating revenues....................................... $116.3 $138.1 $121.9
Costs and expenses....................................... 65.9 72.2 83.0
------ ------ ------
Net income..................................... $ 50.4 $ 65.9 $ 38.9
====== ====== ======
</TABLE>
F-67
<PAGE> 128
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
BALANCE AT DECEMBER
31,
---------------------
1996 1995
------ ------
<S> <C> <C>
Current assets................................................. $ 79.2 $ 95.3
Noncurrent assets.............................................. $290.9 $314.8
Current liabilities............................................ $ 69.1 $ 77.9
Noncurrent liabilities......................................... $145.2 $175.4
Shareholders' equity........................................... $155.8 $156.8
</TABLE>
In accordance with project financing arrangements of certain of these
ventures and under tariffs approved by the FERC, Natural is required to pay
demand charges to certain of these ventures for contracted transportation
services. The demand charges for the years 1996, 1995 and 1994 were
approximately $10.7 million, $9.2 million, and $20.7 million, respectively.
(17) CONCENTRATION OF CREDIT RISK
The Company and its subsidiaries sell and transport natural gas in
interstate and intrastate commerce primarily in the central and Gulf regions of
the United States, respectively. Although affected by the economic climate for
natural gas, the end-use market of these companies' customers is diversified
among residential, commercial and industrial users. These companies mitigate
credit risk by requiring collateral or financial guarantees and letters of
credit from customers with specific credit concerns.
F-68
<PAGE> 129
PROSPECTUS
$4,000,000,000
K N Energy, Inc.
STOCK PURCHASE CONTRACTS
STOCK PURCHASE UNITS
TRUST DEBENTURES
DEBT SECURITIES
COMMON STOCK
K N Capital Trust III
PREFERRED SECURITIES
Guaranteed as set forth herein by
K N Energy, Inc.
------------------------
K N Energy, Inc. ("K N", "K N Energy" or the "Company") may offer and sell
from time to time, together or separately: (i) Stock Purchase Contracts ("Stock
Purchase Contracts") to purchase shares of common stock, par value $5.00 per
share ("Common Stock"), of the Company; (ii) Stock Purchase Units ("Stock
Purchase Units"), each representing ownership of a Stock Purchase Contract and
Preferred Securities (as defined below) or debt obligations of third parties,
including U.S. Treasury securities, securing the holder's obligation to purchase
Common Stock under the Stock Purchase Contracts; (iii) its debentures (the
"Trust Debentures") to be purchased with the proceeds from the sale of preferred
securities representing undivided beneficial ownership interests in the assets
of K N Capital Trust III ("Preferred Securities"), a statutory business trust
created under the laws of the State of Delaware (the "Trust"); (iv) in addition
to the Trust Debentures, its debentures, notes and other debt securities in one
or more series, which may be either senior debt securities or subordinated debt
securities ("Debt Securities"); and (v) Common Stock. In addition the Trust may
offer its Preferred Securities. The aggregate initial offering price of all of
the Securities (as defined below) which may be sold pursuant to this Prospectus
will not exceed $4,000,000,000 or, if applicable, the equivalent thereof in any
other currency or currency unit. The Securities will be offered in amounts, at
prices and on terms to be determined in light of market conditions at the time
of sale and set forth in a supplement to this Prospectus (a "Prospectus
Supplement"). The Stock Purchase Contracts, Stock Purchase Units, Trust
Debentures, Debt Securities, Common Stock and Preferred Securities are
collectively called the "Securities."
(continued on next page)
------------------------
The Securities may be sold directly by the Company, or in the case of the
Preferred Securities, the Trust, to investors, through agents designated from
time to time or to or through underwriters or dealers. See "Plan of
Distribution." If any agents of the Company or, in the case of the Preferred
Securities, the Trust, or any underwriters are involved in the sale of any
Securities in respect of which this Prospectus is being delivered, the names of
such agents or underwriters and any applicable commissions or discounts will be
set forth in a Prospectus Supplement. The net proceeds to the Company from such
sale also will be set forth in a Prospectus Supplement. See "Use of Proceeds."
------------------------
The Common Stock is traded on the New York Stock Exchange (the "NYSE")
under the symbol "KNE." Any Common Stock sold pursuant to a Prospectus
Supplement will be listed on such exchange, subject to official notice of
issuance. The Prospectus Supplement will state whether any Securities offered
thereby will be listed on any national securities exchange. If such Securities
are not listed on any national securities exchange, there can be no assurance
that there will be a secondary market for any such Securities.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------------
THIS PROSPECTUS MAY NOT BE USED TO CONSUMMATE SALES OF THE SECURITIES UNLESS
ACCOMPANIED BY A PROSPECTUS SUPPLEMENT.
------------------------
January 30, 1998
<PAGE> 130
(continued from previous page)
Certain specific terms of the particular Securities in respect of which
this Prospectus is being delivered will be set forth in an applicable Prospectus
Supplement, including, where applicable, (i) in the case of Stock Purchase
Contracts, the number of shares of Common Stock issuable thereunder, the
purchase price of the Common Stock, the date or dates on which the Common Stock
is required to be purchased by the holders of the Stock Purchase Contracts, any
periodic payments required to be made by the Company to the holders of the Stock
Purchase Contracts or vice versa, and the terms of the offering and sale
thereof, (ii) in the case of Stock Purchase Units, the specific terms of the
Stock Purchase Contracts and any Preferred Securities or debt obligations of
third parties securing the holder's obligation to purchase the Common Stock
under the Stock Purchase Contracts, and the terms of the offering and sale
thereof, (iii) in the case of Trust Debentures or Debt Securities, the specific
designation, aggregate principal amount, authorized denominations, ranking as
senior or subordinated, maturity, interest payment dates, interest rate (which
may be fixed or variable) or method of calculating interest, if any, applicable
Extension Period (as defined below) or interest deferral terms, if any, place or
places where principal, premium, if any, and interest, if any, will be payable,
any terms for mandatory or optional redemption, any sinking fund provisions,
terms for any conversion or exchange into other securities, initial offering or
purchase price, methods of distribution and any other special terms, and (iv) in
the case of Preferred Securities, the specific title, aggregate amount, stated
liquidation preference, number of securities, the rate of payment of periodic
cash distributions ("distributions" or "Distributions") or method of calculating
such rate, applicable Extension Period or distribution deferral terms, if any,
place or places where distributions will be payable, any terms of redemption,
initial offering or purchase price, methods of distribution and any other
special terms. If so specified in the applicable Prospectus Supplement, the
Securities offered thereby may be issued in whole or in part in the form of one
or more temporary or permanent global securities ("Global Securities").
Unless otherwise set forth in the applicable Prospectus Supplement, the
Trust Debentures will be senior unsecured obligations of the Company and will
rank pari passu in right of payment with all of the Company's other senior
unsecured obligations. If provided in an accompanying Prospectus Supplement, the
Company will have the right to defer payments of interest on the Trust
Debentures by extending the interest payment period thereon at any applicable
time or from time to time for such number of consecutive interest payment
periods (which shall not extend beyond the stated maturity (the "Stated
Maturity") of the Trust Debentures) with respect to each deferral period as may
be specified in such Prospectus Supplement (each, an "Extension Period"). See
"Description of the Trust Debentures -- Option to Extend Interest Payment
Period."
The Company will be the owner of the common securities (the "Common
Securities," and, together with the Preferred Securities, the "Trust
Securities") of the Trust. The payment of distributions with respect to the
Preferred Securities and payments on liquidation or redemption with respect to
the Preferred Securities, in each case out of funds held by the Trust, will be
irrevocably guaranteed by the Company to the extent described herein (the
"Guarantee"). Certain payments in respect of the Common Securities may also be
guaranteed by the Company. See "Description of the Guarantee." Unless otherwise
set forth in the applicable Prospectus Supplement, the obligations of the
Company under the Guarantee will be senior unsecured obligations of the Company
and will rank pari passu with all of the Company's other senior unsecured
obligations. Concurrently with the issuance by the Trust of the Preferred
Securities, the Trust will invest the proceeds thereof and any contributions
made in respect of the Common Securities in the Trust Debentures, which will
have terms corresponding to the terms of the Preferred Securities. The Trust
2
<PAGE> 131
(continued from previous page)
Debentures will be the sole assets of the Trust, and payments under the Trust
Debentures and those made by the Company in respect of fees and expenses
incurred by the Trust will be the only revenue of the Trust. Upon the occurrence
of certain events as are described herein and in the accompanying Prospectus
Supplement, the Company may redeem the Trust Debentures and cause the redemption
of the Trust Securities. In addition, if provided in the applicable Prospectus
Supplement, the Company may dissolve the Trust at any time and, after
satisfaction of the liabilities to creditors of the Trust as provided by
applicable law, cause the Trust Debentures to be distributed to the holders of
the Trust Securities in liquidation of their interest in the Trust.
Taken together, the Company's obligations under the Trust Debentures, the
Debenture Indenture (as defined herein), the Declaration (as defined herein) and
the Guarantee, in the aggregate, have the effect of providing a full,
irrevocable and unconditional guarantee of payments of distributions and other
amounts due on the Preferred Securities. See "Relationship Among the Preferred
Securities, the Trust Debentures and the Guarantee."
------------------------
AVAILABLE INFORMATION
The Company is subject to the information requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance
therewith files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements, and other information filed by the Company with the Commission can
be inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549 and at the following Regional Offices of the Commission: Chicago
Regional Office, Citicorp Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661; and New York Regional Office, Seven World Trade Center, 13th
Floor, New York, New York 10048. Copies of such material can be obtained from
the Public Reference Section of the Commission, Washington, D.C. 20549 at
prescribed rates. The Commission maintains a Website that contains reports,
proxy and information statements and other materials that are filed through the
Commission's Electronic Data Gathering Analysis and Retrieval System. The
Website can be accessed at http://www.sec.gov. In addition, reports, proxy
statements and other information concerning the Company can be inspected at the
NYSE, 20 Broad Street, New York, New York 10005, on which exchange the Common
Stock is listed.
This Prospectus constitutes a part of three Registration Statements on Form
S-3 (together with all amendments and exhibits thereto, the "Registration
Statement") filed by the Company and the Trust with the Commission under the
Securities Act of 1933, as amended (the "Securities Act"). This Prospectus omits
certain of the information contained in the Registration Statement, and
reference is hereby made to the Registration Statement for further information
with respect to the Company and the securities offered hereby. Any statements
contained herein concerning the provisions of any document filed as an exhibit
to the Registration Statement or otherwise filed with the Commission are not
necessarily complete, and in each instance reference is made to the copy of such
document so filed. Each such statement is qualified in its entirety by such
reference.
No separate financial statements of the Trust have been included herein.
The Company and the Trust do not consider that such financial statements would
be material to holders of the Preferred Securities because the Trust is a newly
formed special purpose entity, has no operating history or independent
operations and is not engaged in and does not propose to engage in any activity
other than its holding as trust assets the Trust Debentures and the issuance of
the Trust Securities. See "The Trust," "Description of the Trust Debentures,"
"Description of the Preferred Securities" and "Description of the Guarantee."
The Trust is currently not subject to the information reporting
requirements of the Exchange Act.
3
<PAGE> 132
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents filed by the Company with the Commission (File No.
1-6446) pursuant to the Exchange Act are incorporated by reference and made a
part hereof:
(a) the Company's Annual Report on Form 10-K for the year ended
December 31, 1996, as amended by Amendment No. 1 thereto;
(b) the Company's Quarterly Reports on Form 10-Q for the quarters
ended March 31, June 30, and September 30, 1997;
(c) the Company's Current Reports on Form 8-K dated January 28 and 29
and October 27, 1997 and January 5 and 16, 1998; and
(d) the description of the Preferred Share Purchase Rights and the
Common Stock contained in the Company's Registration Statements on Form
8-A.
All documents subsequently filed by the Company pursuant to Section 13(a),
13(c), 14 or 15(d) of the Exchange Act, after the date of this Prospectus and
prior to the termination of the offering of the Securities pursuant hereto,
shall be deemed to be incorporated by reference herein and to be a part hereof
from the date of filing of such document. Any statement contained herein or in a
document incorporated or deemed to be incorporated by reference herein shall be
deemed to be modified or superseded for purposes of this Prospectus to the
extent that a statement contained herein or in any other subsequently filed
document which also is or is deemed to be incorporated by reference herein
modifies or supersedes such statement. Any such statement so modified or
superseded shall not be deemed, except as so modified or superseded, to
constitute a part of this Prospectus.
The Company will provide without charge to any person, including any
beneficial owner of Securities, to whom this Prospectus is delivered, upon
written or oral request of such person, a copy of any and all of the documents
referred to above which have been incorporated by reference in this Prospectus
(other than exhibits to such documents, unless such exhibits are specifically
incorporated by reference into such documents). Such requests should be directed
to the office of the Vice President and Treasurer, K N Energy, Inc., 370 Van
Gordon Street, P.O. Box 281304, Lakewood, Colorado 80228-8304, telephone number
(303) 989-1740.
K N ENERGY, INC.
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 natural gas liquids. The Company also markets
innovative products and services, such as the Simple Choice(sm) menu of products
and call center services designed for residential consumers, utilities, and
small businesses through its 50% owned en-able(sm), LLC affiliate.
K N was incorporated under the laws of the State of Kansas in 1927. The
address of its principal executive offices is 370 Van Gordon Street, P. O. Box
281304, Lakewood, Colorado 80228-8304 and its telephone number is (303)
989-1740.
Additional information concerning the Company and its subsidiaries is
included in the Company reports and other documents incorporated by reference in
this Prospectus. See "Available Information" and "Incorporation of Certain
Documents by Reference."
THE TRUST
The Trust is a statutory business trust created under Delaware law pursuant
to (i) a declaration of trust, dated as of January 15, 1998, and entered into by
the Company, as sponsor (the "Sponsor") and the trustee named herein and (ii)
the filing of a certificate of trust with the Secretary of State of the State of
Delaware on January 15, 1998. The declaration will be amended and restated in
its entirety (as so amended and restated,
4
<PAGE> 133
the "Declaration"), substantially in the form filed as an exhibit to the
Registration Statement of which this Prospectus forms a part, as of the date the
Preferred Securities of such Trust are initially issued. The Declaration will be
qualified under the Trust Indenture Act of 1939, as amended (the "Trust
Indenture Act"). Upon issuance of the Preferred Securities, the purchasers
thereof will own all of the Preferred Securities. K N Energy will directly or
indirectly acquire all of the Common Securities, which will have an aggregate
liquidation amount equal to 3% of the total capital of the Trust. The Preferred
Securities rank pari passu, and payments will be made thereon on a pro rata
basis, with the Common Securities, except that upon the occurrence and during
the continuance of a Declaration Event of Default, the rights of the holders of
the Common Securities to receive payments of periodic distributions and payments
upon liquidation, redemption and otherwise will be subordinated to the rights of
the holders of the Preferred Securities. The Trust exists for the exclusive
purposes of (i) issuing the Trust Securities representing undivided beneficial
interests in the assets of the Trust, (ii) investing the gross proceeds of the
Trust Securities in the Trust Debentures and (iii) engaging in only those other
activities necessary or incidental thereto.
The Trust's business and affairs will be conducted by the K N Trustees (as
defined below) and the administrators ("Administrators"), as set forth in the
Declaration. Pursuant to the Declaration, the number of K N Trustees will
initially be two. One trustee will be a financial institution that maintains its
principal place of business in the State of Delaware (the "Delaware Trustee").
The other trustee (the "Institutional Trustee" and, together with the Delaware
Trustee, the "K N Trustees") will be a financial institution that is
unaffiliated with K N Energy and will serve as institutional trustee under the
Declaration and as indenture trustee for the purposes of compliance with the
provisions of the Trust Indenture Act. Initially, Wilmington Trust Company, a
Delaware banking corporation, will be both the Delaware Trustee and the
Institutional Trustee until removed or replaced by the holder of the Common
Securities (or in certain circumstances the holders of a majority in liquidation
amount of the Preferred Securities). Wilmington Trust Company will act as
trustee (the "Guarantee Trustee") under the Guarantee and as Debenture Trustee
(as defined herein) under the Debenture Indenture (as defined herein). The
Administrators will be three individuals who are employees or officers of or
affiliated with K N Energy and will act as administrators with respect to the
Trust. The Administrators will be selected by the holders of a majority in
liquidation amount of the Common Securities. The Administrators will have only
those ministerial duties set forth in the Declaration with respect to
accomplishing the purposes of the Trust and are not intended to be trustees or
fiduciaries with respect to the Trust or the holders of Preferred Securities.
The Institutional Trustee will hold title to the Trust Debentures for the
benefit of the holders of the Trust Securities, and the Institutional Trustee
will have the power to exercise all rights, powers and privileges under the
Debenture Indenture as the holder of the Trust Debentures. In addition, the
Institutional Trustee will maintain exclusive control of a segregated
non-interest bearing bank account (the "Property Account") to hold all payments
made in respect of the Trust Debentures for the benefit of the holders of the
Trust Securities. The Institutional Trustee will make payments of distributions
and payments on liquidation, redemption and otherwise to the holders of the
Trust Securities out of funds from the Property Account. The Guarantee Trustee
will hold the Guarantee for the benefit of the holders of the Preferred
Securities. K N Energy, as the direct or indirect holder of all the Common
Securities, will have the right to appoint, remove or replace any Administrator
and to increase or decrease the number of Administrators. Holders of the Common
Securities will have the right to replace the Institutional Trustee (or, upon
the occurrence and continuance of an event of default under the Declaration, the
holders of a majority in liquidation amount of the Preferred Securities),
provided that the successor Institutional Trustee shall be a corporation with
trust powers organized under the laws of the United States or any State thereof
with a combined capital and surplus of at least $50 million. Pursuant to the
Debenture Indenture, K N Energy, as borrower, will pay all fees and expenses
related to the Trust and the offering of the Trust Securities. See "Description
of the Trust Debentures -- Miscellaneous."
The rights of the holders of the Preferred Securities, including economic
rights, rights to information and voting rights, are set forth in the
Declaration and the Delaware Business Trust Act (the "Trust Act"). The principal
place of business of the Trust is c/o K N Energy, Inc., 370 Van Gordon Street,
P.O. Box 281304, Lakewood, Colorado 80228-8304, and its telephone number is
(303) 989-1740.
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USE OF PROCEEDS
Except as may otherwise be described in the Prospectus Supplement relating
to an offering of Securities, the net proceeds from the sale of the Securities
(including Trust Debentures issued to the Trust in connection with the
investment by the Trust of all of the proceeds from the sale of the Preferred
Securities) offered pursuant to this Prospectus and such Prospectus Supplement
(the "Offered Securities") will be used by the Company to refinance indebtedness
incurred in connection with the acquisition of MidCon Corp. from Occidental
Petroleum Corporation. The remainder of the net proceeds will be used for
general corporate purposes. Any specific allocation of the net proceeds of an
offering of Securities by the Company to a specific purpose will be determined
at the time of such offering and will be described in the related Prospectus
Supplement.
RATIOS OF EARNINGS TO FIXED CHARGES
The following table sets forth the Company's consolidated ratios of
earnings to fixed charges for the periods shown.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
NINE MONTHS ----------------------------------------
ENDED SEPTEMBER 30, 1997 1996 1995 1994 1993 1992
- ------------------------ ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
2.40 3.21 3.07 1.69 2.41 2.61
</TABLE>
The ratios of earnings to fixed charges were computed by dividing earnings
by fixed charges. For this purpose, earnings are the sum of net income, taxes
and fixed charges. Fixed charges are interest, amortization of debt discount,
premium and expense, preferred stock dividends of a subsidiary, and the
estimated interest portion of rental charges. The allowance for borrowed funds
used during construction recognized for gas utility operations has been added to
fixed charges and is included in earnings.
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<PAGE> 135
DESCRIPTION OF THE PREFERRED SECURITIES
The Trust may issue only one series of Preferred Securities having terms
described in the Prospectus Supplement relating thereto. The Declaration
authorizes the Administrators of the Trust to issue on behalf of the Trust one
series of Preferred Securities. The Declaration will be qualified as an
indenture under the Trust Indenture Act. The Preferred Securities will have such
terms, including distributions, redemption, voting, liquidation rights and such
other preferred, deferred or other special rights or such restrictions as shall
be set forth in the Declaration or made part of the Declaration by the Trust
Indenture Act or the Trust Act. Reference is made to any Prospectus Supplement
relating to the Preferred Securities of the Trust for specific terms, including
(i) the specific designation of the Preferred Securities, (ii) the number of
Preferred Securities, (iii) the annual distribution rate (or method of
calculation thereof) for Preferred Securities, the date or dates upon which such
distributions shall be payable and the record date or dates for the payment of
such distributions, (iv) whether distributions of Preferred Securities shall be
cumulative, and, in the case of Preferred Securities having such cumulative
distribution rights, the date or dates or method of determining the date or
dates from which distributions of Preferred Securities shall be cumulative, (v)
the amount or amounts which shall be paid out of the assets of the Trust to the
holders of Preferred Securities upon voluntary or involuntary dissolution,
winding-up or termination of the Trust, (vi) the obligation or right, if any, of
the Trust to purchase or redeem Preferred Securities and the price or prices at
which, the period or periods within which and the terms and conditions upon
which Preferred Securities shall or may be purchased or redeemed, in whole or in
part, pursuant to such obligation or right, (vii) the voting rights, if any, of
Preferred Securities in addition to those required by law, including the number
of votes per Preferred Security and any requirement for the approval by the
holders of Preferred Securities, as a condition to specified actions or
amendments to the Declaration, (viii) the terms and conditions, if any, upon
which Preferred Securities issued by the Trust may be converted into Common
Stock of the Company, including the conversion price per share and the
circumstances, if any, under which such conversion right will expire, (ix) the
terms and conditions, if any, upon which the Trust Debentures may be distributed
to holders of Trust Securities, (x) if applicable, any securities exchange upon
which the Preferred Securities shall be listed, and (xi) any other relevant
rights, preferences, privileges, limitations or restrictions of Preferred
Securities issued by the Trust consistent with the Declaration or with
applicable law. All Preferred Securities offered hereby will be guaranteed by
the Company as and to the extent set forth below under "Description of the
Guarantee." Certain United States federal income tax considerations applicable
to the offering of the Preferred Securities will be described in the Prospectus
Supplement relating thereto.
In connection with the issuance of the Preferred Securities, the Trust will
issue Common Securities. The Declaration authorizes the Administrators of the
Trust to issue on behalf of the Trust the Common Securities having such terms
including distributions, redemption, voting, liquidation rights or such
restrictions as shall be set forth therein. The terms of the Common Securities
issued by the Trust will be substantially identical to the terms of the
Preferred Securities issued by the Trust and the Common Securities will rank
pari passu, and payments will be made thereon on a pro rata basis with the
Preferred Securities except that if an event of default under the Declaration (a
"Declaration Event of Default") occurs and is continuing, the rights of the
holders of the Common Securities to payments in respect of distributions and
payments upon liquidation, redemption and maturity will be subordinated to the
rights of the holders of the Preferred Securities. A Declaration Event of
Default will occur upon a Debenture Indenture Event of Default (as defined
below). Except in certain limited circumstances, the Common Securities issued by
the Trust will also carry the right to vote and to appoint, remove or replace
any of the K N Trustees of the Trust. All of the Common Securities of the Trust
will be directly or indirectly owned by the Company.
DESCRIPTION OF THE TRUST DEBENTURES
The Trust Debentures are to be issued under an indenture, as supplemented
or amended from time to time (as so supplemented or amended, the "Debenture
Indenture"), between the Company and Wilmington Trust Company, as trustee (the
"Debenture Trustee"). This summary of certain terms and provisions of the Trust
Debentures and the Debenture Indenture is not necessarily complete, and
reference is hereby made to the copy of the form of the Debenture Indenture
which is filed as an exhibit to the Registration Statement of which this
Prospectus forms a part, and to the Trust Indenture Act. Whenever particular
defined terms of the
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<PAGE> 136
Debenture Indenture are referred to in this Section or in a Prospectus
Supplement, such defined terms are incorporated herein or therein by reference.
The Company's Debt Securities are separately described in this Prospectus
under the caption "Description of the Debt Securities."
GENERAL
Unless otherwise specified in the applicable Prospectus Supplement, the
Trust Debentures will be issued as unsecured debt under the Debenture Indenture
and will rank pari passu in right of payment with all of the Company's other
senior unsecured obligations. Except as otherwise provided in the applicable
Prospectus Supplement, the Debenture Indenture does not limit the incurrence or
issuance of other secured or unsecured debt of the Company, whether under the
Debenture Indenture, any other indenture that the Company may enter into in the
future or otherwise.
The Trust Debentures will be issuable in one series pursuant to an
indenture supplemental to the Debenture Indenture or a resolution of the
Company's Board of Directors or a committee thereof.
The obligations of K N Energy under the Trust Debentures are senior to its
8.56% Series B Junior Subordinated Deferrable Interest Trust Debentures due
April 15, 2027 (the "1997 Subordinated Trust Debentures"), which were issued in
October 1997 in the aggregate principal amount of $103,100,000. The obligations
of K N Energy under the Guarantee are senior to its guarantee (the "1997
Guarantee") in relation to the 8.56% Series B Capital Trust Pass-through
Securities of K N Capital Trust I (the "1997 Capital Securities"), which were
issued in October 1997 in the aggregate liquidation amount of $100,000,000.
The Trust Debentures may be distributed pro rata to the holders of such
Trust Securities in connection with the dissolution of the Trust upon the
occurrence of certain events described herein or in the Prospectus Supplement
relating to the Trust Securities. Only one series of Trust Debentures will be
issued to the Trust or a K N Trustee of such Trust in connection with the
issuance of Trust Securities by the Trust.
The applicable Prospectus Supplement will describe the following terms of
the Trust Debentures: (i) the title of the Trust Debentures; (ii) any limit upon
the aggregate principal amount of the Trust Debentures; (iii) the date on which
the principal of the Trust Debentures is payable or the method of determination
thereof; or the right, if any, of the Company to defer payment of principal;
(iv) the rate, if any, at which the Trust Debentures shall bear interest
(including reset rates, if any, and the method by which any such rate will be
determined), the Interest Payment Dates on which any such interest shall be
payable, the right, if any, of the Company to defer or extend an Interest
Payment Date and the Regular Record Date for any interest payable on any
Interest Payment Date or the method by which any of the foregoing shall be
determined; (v) the place where the principal of and premium, if any, and
interest, if any, on the Trust Debentures will be payable and where, subject to
the terms of the Debenture Indenture as described below under "-- Denominations,
Registration and Transfer," the Trust Debentures may be presented for
registration of transfer or exchange and the place or places where notices and
demands to or upon the Company in respect of the Trust Debentures and the
Debenture Indenture may be made ("Place of Payment"); (vi) any period or periods
within, or date or dates on which, the price or prices at which and the terms
and conditions upon which Trust Debentures may be redeemed, in whole or in part,
at the option of the Company or a holder thereof; (vii) the obligation or the
right, if any, of the Company or a holder thereof to redeem, purchase or repay
the Trust Debentures and the period or periods within which, the price or prices
at which, the currency or currencies (including currency unit or units) in which
and the other terms and conditions upon which the Trust Debentures shall be
redeemed, repaid or purchased, in whole or in part, pursuant to such obligation;
(viii) the denominations in which any Trust Debentures shall be issuable if
other than denominations of $1,000 and any integral multiple thereof; (ix) if
other than in U.S. Dollars, the currency or currencies (including currency unit
or units) in which the principal of (and premium, if any) and interest, if any,
on the Trust Debentures shall be payable, or in which the Trust Debentures shall
be denominated; (x) any additions, modifications or deletions in the Events of
Default or covenants of the Company specified in the Debenture Indenture with
respect to the Trust Debentures; (xi) if other than the principal amount
thereof, the portion of the principal amount of Trust Debentures that shall be
payable upon declaration of acceleration of the maturity thereof;
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<PAGE> 137
(xii) any additions or changes to the Debenture Indenture with respect to a
series of Trust Debentures as shall be necessary to permit or facilitate the
issuance of such series in bearer form, registrable or not registrable as to
principal, and with or without interest coupons; (xiii) any index or indices
used to determine the amount of payments of principal of and premium, if any, on
the Trust Debentures and the manner in which such amounts will be determined;
(xiv) the terms and conditions relating to the issuance of a temporary Global
Security representing all of the Trust Debentures of such series and exchange of
such temporary Global Security for definitive Trust Debentures of such series;
(xv) whether the Trust Debentures of the series shall be issued in whole or in
part in the form of one or more Global Securities and, in such case, the
depositary for such Global Securities; (xvi) the appointment of any trustee,
registrar, paying agent or agents; (xvii) the terms and conditions of any
obligation or right of the Company or a holder to convert or exchange Trust
Debentures into Preferred Securities or other securities; (xviii) the relative
degree, if any, to which such Trust Debentures of the series shall be senior to
or be subordinated to other series of such Trust Debentures or other
indebtedness of the Company in right of payment, whether such other series of
Trust Debentures or other indebtedness are outstanding or not; and (xix) any
other terms of the Trust Debentures not inconsistent with the provisions of the
Debenture Indenture. (Section 2.1) Unless otherwise indicated in the applicable
Prospectus Supplement, the Trust Debentures will not be subject to any sinking
fund.
Trust Debentures may be sold at a substantial discount below their stated
principal amount, bearing no interest or interest at a rate which at the time of
issuance is below market rates. Certain material United States federal income
tax consequences and special considerations applicable to any such Trust
Debentures will be described in the applicable Prospectus Supplement.
If the purchase price of any of the Trust Debentures is payable in one or
more foreign currencies or currency units or if any Trust Debentures are
denominated in one or more foreign currencies or currency units or if the
principal of, premium, if any, or interest, if any, on any Trust Debentures is
payable in one or more foreign currencies or currency units, the restrictions,
elections, certain material United States federal income tax considerations,
specific terms and other information with respect to such issue of Trust
Debentures and such foreign currency or currency units will be set forth in the
applicable Prospectus Supplement.
If any index is used to determine the amount of payments of principal,
premium, if any, or interest on any series of Trust Debentures, certain material
United States federal income tax, accounting and other considerations applicable
thereto will be described in the applicable Prospectus Supplement.
DENOMINATIONS, REGISTRATION AND TRANSFER
Unless otherwise specified in the applicable Prospectus Supplement, the
Trust Debentures will be issuable only in registered form without coupons in
denominations of $1,000 and any integral multiple thereof. (Section 2.3) Trust
Debentures will be exchangeable for other Trust Debentures of the same issue, of
any authorized denominations of a like aggregate principal amount, the same
original issue date ("Original Issue Date"), the same Stated Maturity and
bearing the same interest rate. (Section 2.5)
Trust Debentures may be presented for exchange as provided above, and may
be presented for registration of transfer (with the form of transfer endorsed
thereon, or a satisfactory written instrument of transfer, duly executed), at
the office of the appropriate Securities Registrar or at the office of any
transfer agent designated by the Company for such purpose with respect to any
series of Trust Debentures and referred to in the applicable Prospectus
Supplement, without service charge and upon payment of any taxes and other
governmental charges as described in the Debenture Indenture. The Company will
appoint the Debenture Trustee as Securities Registrar under the Debenture
Indenture. Such transfer or exchange will be effected upon the Security
Registrar or such transfer agent, as the case may be, being satisfied with the
documents of title and the identity of the person making the request. (Section
2.5) If the applicable Prospectus Supplement refers to any transfer agents (in
addition to the Securities Registrar) initially designated by the Company with
respect to the Trust Debentures, the Company may at any time rescind the
designation of any such transfer agent or approve a change in the location
through which any such transfer agent acts, provided that the Company maintains
a transfer agent in each Place of Payment for the Trust Debentures. The Company
may at any time designate additional transfer agents with respect to the Trust
Debentures.
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In the event of any redemption, neither the Company nor the Debenture
Trustee shall be required to (i) issue, register the transfer of or exchange of
the Trust Debentures during a period beginning at the opening of business 15
days before the day of selection for redemption of the Trust Debentures, and
ending at the close of business on the day of mailing of the relevant notice of
redemption or (ii) transfer or exchange any Trust Debentures so selected for
redemption, except, in the case of any Trust Debentures being redeemed in part,
any portion thereof not to be redeemed. (Section 2.5)
OPTION TO EXTEND INTEREST PAYMENT PERIOD
If provided in the applicable Prospectus Supplement, the Company shall have
the right, at any time and from time to time during the term of the Trust
Debentures, to defer the payment of interest for such number of consecutive
interest payment periods as may be specified in the applicable Prospectus
Supplement, subject to the terms, conditions and covenants, if any, specified in
such Prospectus Supplement, provided that such Extension Period may not extend
beyond the Stated Maturity of the final installment of principal of the Trust
Debentures. Certain material United States federal income tax consequences and
special considerations applicable to the Trust Debentures will be described in
the applicable Prospectus Supplement.
CERTAIN COVENANTS
The Debenture Indenture contains certain covenants regarding, among other
matters, corporate existence, payment of taxes and reports to holders of the
Trust Debentures. If and to the extent indicated in the applicable Prospectus
Supplement, these covenants may be removed or additional covenants added with
respect to the Trust Debentures. (Article 9)
DEBENTURE INDENTURE EVENTS OF DEFAULT
The Debenture Indenture provides that any one or more of the following
described events, which has occurred and is continuing, constitutes a "Debenture
Indenture Event of Default" with respect to the Trust Debentures: (i) failure
for 30 days to pay interest on the Trust Debentures, including any compound
interest, in respect thereof or, any additional interest, if any, when due;
provided that a valid extension of an interest payment period will not
constitute a default in the payment of interest for this purpose; (ii) failure
to pay principal of or premium, if any, on the Trust Debentures when due whether
at maturity, upon redemption, by declaration or otherwise; (iii) failure to
observe or perform any other covenant contained in the Debenture Indenture for
90 days after notice to K N Energy by the Debenture Trustee or by the holders of
not less than 25% in aggregate outstanding principal amount of the Trust
Debentures; (iv) the dissolution, winding up or termination of the Trust, except
in connection with the distribution of Trust Debentures to the holders of
Preferred Securities in liquidation of the Trust upon the redemption of all
outstanding Preferred Securities or in connection with certain mergers,
consolidations or amalgamations permitted by the Declaration; or (v) certain
events in bankruptcy, insolvency or reorganization of K N Energy. (Section 4.1)
If any Debenture Indenture Event of Default shall occur and be continuing,
the Debenture Trustee or the holders of not less than 25% in aggregate principal
amount of the outstanding Trust Debentures may declare the principal of and
interest on the Trust Debentures due and payable immediately; provided, that,
after such acceleration, but before a judgment or decree based on acceleration,
the holders of a majority in aggregate principal amount of outstanding Trust
Debentures may, under certain circumstances, rescind and annul such acceleration
if all Debenture Indenture Events of Default, other than the nonpayment of
accelerated principal, have been cured or waived as provided in the Debenture
Indenture. (Section 4.2)
A default under any other indebtedness of K N Energy would not constitute a
Debenture Indenture Event of Default under the Trust Debentures.
Subject to the provisions of the Debenture Indenture relating to the duties
of the Debenture Trustee in case a Debenture Indenture Event of Default occurs
and is continuing, the Debenture Trustee will be under no obligation to exercise
any of its rights or powers under the Debenture Indenture at the request or
direction of any holders of Trust Debentures, unless such holders shall have
offered to the Debenture Trustee reasonable indemnity. Subject to such
provisions for the indemnification of the Debenture Trustee, the holders of a
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majority in aggregate principal amount of the outstanding Trust Debentures will
have the right to direct the time, method and place of conducting any proceeding
for any remedy available to the Debenture Trustee, or exercising any trust or
power conferred on the Debenture Trustee. (Section 4.12)
No holder of any Trust Debentures will have any right to institute any
proceeding with respect to the Debenture Indenture or for any remedy thereunder,
unless such holder shall have previously given to the Debenture Trustee written
notice of a continuing Debenture Indenture Event of Default and, if the
Institutional Trustee is not the sole holder of Trust Debentures, unless the
holders of at least 25% in aggregate principal amount of the outstanding Trust
Debentures shall also have made written request, and offered reasonable
indemnity, to the Debenture Trustee to institute such proceeding as Debenture
Trustee, and the Debenture Trustee shall not have received from the holders of a
majority in aggregate principal amount of the outstanding Trust Debentures a
direction inconsistent with such request. (Section 4.7) However, such
limitations do not apply to a suit instituted by a holder of a Trust Debenture
for enforcement of payment of the principal of or interest on such Trust
Debenture on or after the respective due dates expressed in such Trust
Debenture.
The Debenture Indenture contains provisions permitting the holders of a
majority in aggregate principal amount of the Trust Debentures, on behalf of all
of the holders of the Trust Debentures, to waive any past default in the
performance of any of the covenants contained in the Debenture Indenture, except
a default in the payment of principal or interest on any of the Trust
Debentures. (Section 4.13)
MODIFICATIONS AND AMENDMENTS OF THE DEBENTURE INDENTURE
The Debenture Indenture contains provisions permitting K N Energy and the
Debenture Trustee, with the consent of the holders of not less than a majority
in aggregate principal amount of the outstanding Trust Debentures, to modify the
Debenture Indenture or the rights of the holders of Trust Debentures; provided,
however, that no such modification may, without the consent of the holder of
each outstanding Trust Debenture affected thereby, (i) extend the Stated
Maturity of the Trust Debentures or reduce the principal amount thereof, or
reduce the rate or extend the time for payment of interest thereon, or reduce
any premium payable upon the redemption thereof, or (ii) reduce the percentage
in aggregate principal amount of outstanding Trust Debentures, the holders of
which are required to consent to any such supplemental indenture. (Section 8.2)
In addition, K N Energy and the Debenture Trustee may execute, without the
consent of any holder of Trust Debentures, any supplemental indenture (i) to
cure any ambiguities, (ii) to comply with the Trust Indenture Act and (iii) for
certain other customary purposes. (Section 8.1)
SATISFACTION AND DISCHARGE; DEFEASANCE
Unless otherwise specified in the applicable Prospectus Supplement, when,
among other things, all Trust Debentures not previously delivered to the
Debenture Trustee for cancellation (i) have become due and payable or (ii) will
become due and payable at their Stated Maturity within one year, and the Company
deposits or causes to be deposited with the Debenture Trustee, as trust funds in
trust for the purpose, an amount in the currency or currencies in which the
Trust Debentures are payable sufficient to pay and discharge the entire
indebtedness on the Trust Debentures not previously delivered to the Debenture
Trustee for cancellation, for the principal (and premium, if any) and interest
to the date of the deposit or to the Stated Maturity, as the case may be, then
the Debenture Indenture will cease to be of further effect (except as to the
Company's obligations to pay all other sums due pursuant to the Debenture
Indenture and to provide the officers' certificates and opinions of counsel
described therein), and the Company will be deemed to have satisfied and
discharged the Debenture Indenture. (Section 3.1)
Unless otherwise specified in the applicable Prospectus Supplement, the
Company may elect either (a) to terminate (and be deemed to have satisfied) all
its obligations with respect to any series of Trust Debentures (except for the
obligations to register the transfer or exchange of such Trust Debentures, to
replace mutilated, destroyed, lost or stolen Trust Debentures, to maintain an
office or agency in respect of the Trust Debentures, to compensate and indemnify
the Debenture Trustee ("defeasance")) or (b) to be released
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from its obligations with respect to certain covenants, ("covenant defeasance"),
upon the deposit with the Debenture Trustee, in trust for such purpose, of money
and/or U.S. Government Obligations (as defined in the Debenture Indenture) which
through the payment of principal and interest in accordance with their terms
will provide money, in an amount sufficient (in the opinion of a nationally
recognized firm of independent public accountants) to pay principal of, interest
on and any other amounts payable in respect of the outstanding Trust Debentures.
(Sections 3.3, 3.4 and 3.5) Such a trust may be established only if, among other
things, the Company has delivered to the Debenture Trustee an opinion of counsel
(as specified in the Debenture Indenture) with regard to certain matters,
including an opinion to the effect that the holders of such Trust Debentures
will not recognize income, gain or loss for United States federal income tax
purposes as a result of such deposit and discharge and will be subject to United
States federal income tax on the same amounts and in the same manner and at the
same times as would have been the case if such deposit and defeasance or
covenant defeasance, as the case may be, had not occurred. (Section 3.6)
INFORMATION CONCERNING THE DEBENTURE TRUSTEE
The Debenture Trustee, prior to default, undertakes to perform only such
duties as are specifically set forth in the Debenture Indenture and, after
default, shall exercise the same degree of care as a prudent individual would
exercise in the conduct of his or her own affairs. Subject to such provision,
the Debenture Trustee is under no obligation to exercise any of the powers
vested in it by the Debenture Indenture at the request of any holder of Trust
Debentures, unless offered reasonable indemnity by such holder against the
costs, expenses and liabilities that might be incurred thereby. The Debenture
Trustee is not required to expend or risk its own funds or otherwise incur
personal financial liability in the performance of its duties if the Debenture
Trustee reasonably believes that repayment or adequate indemnity is not
reasonably assured to it. (Section 5.1)
The Debenture Indenture also contains limitations on the right of the
Debenture Trustee, as a creditor of K N Energy, to obtain payment of claims in
certain cases or to realize on certain property received in respect of any such
claim as security or otherwise. (Section 5.6) In addition, the Debenture Trustee
may be deemed to have a conflicting interest and may be required to resign as
Debenture Trustee if at the time of a default under the Debenture Indenture it
is a creditor of K N Energy. (Section 5.9) K N Energy may from time to time
maintain deposit accounts and conduct its banking transactions with the
Debenture Trustee in the ordinary course of business.
Wilmington Trust Company is also the trustee under the indenture relating
to the 1997 Subordinated Trust Debentures. Pursuant to the Trust Indenture Act,
should a default occur with respect to either the 1997 Subordinated Trust
Debentures or the Trust Debentures, then Wilmington Trust Company would be
required to resign as trustee under one of the indentures within 90 days of such
default, unless such default were cured, duly waived or otherwise eliminated.
GOVERNING LAW
The Debenture Indenture and the Trust Debentures will be governed by, and
construed in accordance with, the laws of the State of New York. (Section 1.13)
MISCELLANEOUS
K N Energy will have the right at all times to assign any of its respective
rights or obligations under the Debenture Indenture to a direct or indirect
wholly-owned subsidiary of K N Energy; provided, that, in the event of any such
assignment, K N Energy will remain liable for all of their respective
obligations. Subject to the foregoing, the Debenture Indenture will be binding
upon and inure to the benefit of the parties thereto and their respective
successors and assigns. The Debenture Indenture provides that it may not
otherwise be assigned by the parties thereto. (Section 1.10)
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DESCRIPTION OF THE GUARANTEE
Set forth below is a summary of information concerning the Guarantee, which
will be executed and delivered by K N Energy for the benefit of the holders from
time to time of Preferred Securities. The Guarantee will be qualified under the
Trust Indenture Act. Wilmington Trust Company, as the Guarantee Trustee, will
hold the Guarantee for the benefit of the holders of the Preferred Securities.
The following summary is not necessarily complete, and reference is hereby made
to the copy of the form of the Guarantee (including the definitions therein of
certain terms), which is filed as an exhibit to the Registration Statement of
which this Prospectus forms a part, and to the Trust Indenture Act. Whenever
particular defined terms of the Guarantee are referred to in this Prospectus,
such defined terms are incorporated herein by reference.
GENERAL
Pursuant to and to the extent set forth in the Guarantee, unless otherwise
specified in the applicable Prospectus Supplement, K N Energy will agree to pay
in full to the holders of the Preferred Securities (except to the extent paid by
the Trust), as and when due, regardless of any defense, right of set off or
counterclaim that the Trust may have or assert, the following payments (the
"Guarantee Payments"), without duplication: (i) any accumulated and unpaid
distributions that are required to be paid on the Preferred Securities to the
extent the Trust has funds available therefor, (ii) the Redemption Price, plus
accumulated and unpaid distributions, with respect to any Preferred Securities
called for redemption by the Trust, to the extent the Trust has funds available
therefor and (iii) upon a voluntary or involuntary liquidation, dissolution,
winding-up or termination of the Trust (other than in connection with the
distribution of Trust Debentures to the holders of Trust Securities or the
redemption of all the Preferred Securities), the lesser of (a) the aggregate of
the liquidation amount and all accumulated and unpaid distributions on the
Preferred Securities to the date of payment to the extent the Trust has funds
available therefor and (b) the amount of assets of the Trust remaining available
for distribution to holders of Preferred Securities upon the liquidation of the
Trust. The holders of a majority in liquidation amount of the Preferred
Securities have the right to direct the time, method and place of conducting any
proceeding for any remedy available to the Guarantee Trustee or to direct the
exercise of any trust or power conferred upon the Guarantee Trustee under the
Guarantee. If the Guarantee Trustee fails to enforce the Guarantee, any holder
of Preferred Securities may directly institute a legal proceeding against K N
Energy to enforce the obligations of K N Energy under the Guarantee without
first instituting a legal proceeding against the Trust, the Guarantee Trustee or
any other person or entity. If K N Energy were to default on its obligation to
pay amounts payable on the Trust Debentures, the Trust would lack available
funds for the payment of distributions or amounts payable on redemption of the
Preferred Securities or otherwise, and in such event holders of the Preferred
Securities would not be able to rely upon the Guarantee for payment of such
amounts. Instead, a holder of the Preferred Securities would be required to rely
on the enforcement (1) by the Institutional Trustee of its rights, as registered
holder of the Trust Debentures, against K N Energy pursuant to the terms of the
Trust Debentures or (2) by such holder of Preferred Securities of its right
against K N Energy to enforce payment on the Trust Debentures. See "Description
of the Trust Debentures." The Declaration provides that each holder of Preferred
Securities, by acceptance thereof, if any, agrees to the provisions of the
Guarantee, including the subordination provisions thereof, if any, and the
Debenture Indenture.
The Guarantee will not apply to any payment of distributions or Redemption
Price, or to payments upon the dissolution, winding-up or termination of the
Trust, except to the extent the Trust shall have funds available therefor. If K
N Energy does not make interest payments on the Trust Debentures, the Trust will
not pay distributions on the Preferred Securities and will not have funds
available therefor. See "Description of the Trust Debentures." Unless otherwise
set forth in the applicable Prospectus Supplement, the Guarantee, when taken
together with K N Energy's obligations under the Trust Debentures, the Debenture
Indenture and the Declaration, including its obligations under the Debenture
Indenture to pay costs, expenses, debts and liabilities of the Trust (other than
with respect to the Trust Securities) will provide a full and unconditional
guarantee on a senior unsecured basis by K N Energy of payments due on the
Preferred Securities.
K N Energy has also agreed separately to irrevocably and unconditionally
guarantee the obligations of the Trust with respect to the Common Securities
(the "Common Securities Guarantee") to the same extent as
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the Guarantee, except that upon the occurrence and during the continuation of a
Declaration Event of Default, holders of Preferred Securities shall have
priority over holders of Common Securities with respect to distributions and
payments on liquidation, redemption or otherwise.
CERTAIN COVENANTS OF K N ENERGY
The Guarantee contains certain covenants regarding among other matters,
reports to Holders of the Preferred Securities and the Guarantee Trustee, and,
upon the occurrence of certain events, restrictions on the payment of dividends,
interest on debt securities and guarantee payments on other Company guarantees.
If and to the extent indicated in the applicable Prospectus Supplement, these
covenants may be removed or additional covenants added with respect to the
Guarantee.
AMENDMENTS AND ASSIGNMENT
Except with respect to any changes that do not materially adversely affect
the rights of holders of Preferred Securities (in which case no vote will be
required) the Guarantee may be amended only with the prior approval of the
holders of at least a majority in liquidation amount of all the outstanding
Preferred Securities. The manner of obtaining any such approval of holders of
the Preferred Securities will be as set forth in the applicable Prospectus
Supplement. All guarantees and agreements contained in the Guarantee shall bind
the successors, assigns, receivers, trustees and representatives of K N Energy
and shall inure to the benefit of the holders of the Preferred Securities then
outstanding. Except in certain circumstances, K N Energy may not assign its
rights or delegate its obligations under the Guarantee without the prior
approval of the holders of at least a majority in liquidation amount of the
Preferred Securities then outstanding.
TERMINATION OF THE GUARANTEE
The Guarantee will terminate as to each holder of Preferred Securities upon
(i) full payment of the Redemption Price and accumulated and unpaid
distributions with respect to all Preferred Securities, (ii) upon distribution
of the Trust Debentures held by the Trust to the holders of the Preferred
Securities or (iii) upon liquidation of the Trust and will terminate completely
upon full payment of the amounts payable in accordance with the Declaration.
EVENTS OF DEFAULT
An event of default under the Guarantee will occur upon the failure of K N
Energy to perform any of its payment or other obligations thereunder.
The holders of a majority in liquidation amount of Preferred Securities
relating to the Guarantee have the right to direct the time, method and place of
conducting any proceeding for any remedy available to the Guarantee Trustee in
respect of the Guarantee or to direct the exercise of any trust or power
conferred upon the Guarantee Trustee under the Preferred Securities. If the
Guarantee Trustee fails to enforce the Guarantee, any holder of Preferred
Securities relating to such Guarantee may institute a legal proceeding directly
against K N Energy to enforce the Guarantee Trustee's rights under the
Guarantee, without first instituting a legal proceeding against the Trust, the
Guarantee Trustee or any other person or entity. Notwithstanding the foregoing,
if K N Energy has failed to make a guarantee payment, a holder of Preferred
Securities may directly institute a proceeding against K N Energy for
enforcement of the Guarantee for such payment. K N Energy waives any right or
remedy to require that any action be brought first against the Trust or any
other person or entity before proceeding directly against K N Energy.
STATUS OF THE GUARANTEE
Unless otherwise set forth in the applicable Prospectus Supplement, the
Guarantee will constitute an unsecured obligation of K N Energy and will rank
pari passu in right of payment to all other senior unsecured obligations of K N
Energy. The terms of the Preferred Securities provide that each holder of
Preferred Securities issued by the Trust by acceptance thereof agrees to the
other terms of the Guarantee relating thereto.
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The Guarantee will constitute a guarantee of payment and not of collection
(that is, the guaranteed party may institute a legal proceeding directly against
the guarantor to enforce its rights under the guarantee without instituting a
legal proceeding against any other person or entity).
INFORMATION CONCERNING THE GUARANTEE TRUSTEE
The Guarantee Trustee, prior to the occurrence of a default with respect to
the Guarantee, undertakes to perform only such duties as are specifically set
forth in the Guarantee and, after default with respect to the Guarantee, shall
exercise the same degree of care as a prudent man would exercise in the conduct
of his own affairs. Subject to such provision, the Guarantee Trustee is under no
obligation to exercise any of the powers vested in it by the Guarantee at the
request of any holder of Preferred Securities unless it is offered reasonable
indemnity against the costs, expenses and liabilities that might be incurred
thereby.
Wilmington Trust Company is also the trustee under the 1997 Guarantee.
Pursuant to the Trust Indenture Act, should a default occur with respect to
either the 1997 Guarantee or the Guarantee, then Wilmington Trust Company would
be required to resign as trustee under one of the guarantees within 90 days of
such default, unless such default were cured, duly waived or otherwise
eliminated.
GOVERNING LAW
The Guarantee will be governed by, and construed in accordance with, the
laws of the State of New York.
RELATIONSHIP AMONG THE PREFERRED SECURITIES,
THE TRUST DEBENTURES AND THE GUARANTEE
As set forth in the Declaration, the sole purpose of the Trust is to issue
the Trust Securities evidencing undivided beneficial ownership interests in the
assets of the Trust, and to invest the proceeds from such issuance and sale in
the Trust Debentures.
As long as payments of interest and other payments are made when due on the
Trust Debentures, such payments will be sufficient to cover distributions and
payments due on the Trust Securities because of the following factors: (i) the
aggregate principal amount of Trust Debentures will be equal to the sum of the
aggregate stated liquidation amount of the Trust Securities; (ii) the interest
rate and the interest and other payment dates on the Trust Debentures will match
the distribution rate and distribution and other payment dates for the Preferred
Securities; (iii) pursuant to the Debenture Indenture, K N Energy, as borrower,
shall pay, and the Trust shall not be obligated to pay, directly or indirectly,
all costs, expenses, debts and obligations of the Trust (other than with respect
to the Trust Securities); and (iv) the Declaration further provides that the K N
Trustees shall not take or cause or permit the Trust to, among other things,
engage in any activity that is not consistent with the purposes of the Trust.
Payments of distributions (to the extent funds therefor are available) and
other payments due on the Preferred Securities (to the extent funds therefor are
available) are guaranteed by K N Energy as and to the extent set forth under
"Description of the Guarantee." If K N Energy does not make interest payments on
the Trust Debentures purchased by the Trust, it is expected that the Trust will
not have sufficient funds to pay distributions on the Preferred Securities. The
Guarantee is a full guarantee on a senior basis with respect to the Preferred
Securities issued by the Trust from the time of its issuance but does not apply
to any payment of distributions unless and until the Trust has sufficient funds
for the payment of such distributions. The Guarantee covers the payment of
distributions and other payments on the Preferred Securities only if and to the
extent that K N Energy has made a payment of interest or principal on the Trust
Debentures held by the Trust as its sole asset. The Guarantee, when taken
together with K N Energy's obligations under the Trust Debentures, the Debenture
Indenture and the Declaration, including its obligations to pay costs, expenses,
debts and liabilities of the Trust (other than with respect to the Trust
Securities), provides a full and unconditional guarantee on a senior basis of
amounts payable on the Preferred Securities.
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Notwithstanding anything to the contrary in the Debenture Indenture, the
Company has the right to set-off any payment it is otherwise required to make
thereunder with and to the extent the Company has theretofore made, or is
concurrently on the date of such payment making, a payment under the Guarantee.
If the Guarantee Trustee fails to enforce the Guarantee, a holder of any
Preferred Security may institute a legal proceeding directly against the Company
to enforce its rights under the Guarantee without first instituting a legal
proceeding against the Guarantee Trustee, the Trust or any other person or
entity.
The Trust's Preferred Securities evidence undivided beneficial ownership
interests in the assets of the Trust, and the Trust exists for the sole purpose
of issuing the Preferred Securities and Common Securities and investing the
proceeds thereof in Trust Debentures. A principal difference between the rights
of a holder of a Preferred Security and a holder of a Trust Debenture is that a
holder of a Trust Debenture will accrue, and (subject to the permissible
extension of the interest period) is entitled to receive, interest on the
principal amount of Trust Debentures held, while a holder of Preferred
Securities is only entitled to receive distributions if and to the extent the
Trust has funds available for the payment of such distributions.
Upon any voluntary or involuntary dissolution of the Trust involving the
liquidation of the Trust Debentures, the holders of Preferred Securities of the
Trust will be entitled to receive, out of assets held by the Trust, the
Liquidation Distribution in cash. See "Description of the Preferred Securities."
Upon any voluntary or involuntary liquidation or bankruptcy of the Company, the
Institutional Trustee as holder of the Trust Debentures would be entitled to
receive payment in full of principal and interest, before any stockholders of
the Company receive payments or distributions.
DESCRIPTION OF THE DEBT SECURITIES
The Debt Securities will constitute either senior or subordinated debt of
the Company and will be issued, in the case of Debt Securities that will be
senior debt ("Senior Debt Securities"), under an Indenture dated as of November
20, 1993 (the "Senior Debt Indenture"), between the Company and First Trust
National Association, as successor trustee, and, in the case of Debt Securities
that will be subordinated debt ("Subordinated Debt Securities"), under a
Subordinated Indenture dated as of May 15, 1996 (the "Subordinated Debt
Indenture"), between the Company and First Trust National Association, as
trustee. The Senior Debt Indenture and the Subordinated Debt Indenture are
sometimes hereinafter referred to individually as the "Debt Indenture" and
collectively as the "Debt Indentures." First Trust National Association (and any
successor thereto as trustee under the Debt Indentures) is hereinafter referred
to as the "Debt Trustee." The Debt Indentures are incorporated by reference in
the Registration Statement. The following summaries of certain provisions of the
Debt Indentures and the Debt Securities do not purport to be complete and such
summaries are subject to the detailed provisions of the applicable Debt
Indenture to which reference is hereby made for a full description of such
provisions, including the definition of certain terms used herein. Section
references in parentheses below are to sections in both Debt Indentures unless
otherwise indicated. Wherever particular sections or defined terms of the
applicable Debt Indenture are referred to, such sections or defined terms are
incorporated herein by reference as part of the statement made, and the
statement is qualified in its entirety by such reference. The Debt Indentures
are substantially identical, except for certain covenants of the Company and
provisions relating to subordination and conversion.
The Debt Securities may be issued from time to time in one or more series.
The following description of the Debt Securities sets forth certain general
terms and provisions of the Debt Securities of all series. The particular terms
of each series of Debt Securities offered by any Prospectus Supplement (the
"Offered Debt Securities") will be described therein.
The Company's Trust Debentures are separately described in this Prospectus
under the caption "Description of the Trust Debentures."
PROVISIONS APPLICABLE TO BOTH SENIOR AND SUBORDINATED DEBT SECURITIES
General. The Debt Securities will be unsecured senior or subordinated
obligations of the Company and may be issued from time to time in one or more
series. The Debt Indentures do not limit the amount of Debt
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Securities, debentures, notes or other types of indebtedness that may be issued
by the Company or any of its subsidiaries nor do they restrict transactions
between the Company and its affiliates or the payment of dividends or other
distributions by the Company to its stockholders. The rights of the Company's
creditors, including holders of Debt Securities, will be limited to the assets
of the Company and will not be an obligation of any of its Subsidiaries. In
addition, other than as may be set forth in any Prospectus Supplement, the Debt
Indentures do not and the Debt Securities will not contain any covenants or
other provisions that are intended to afford holders of the Debt Securities
special protection in the event of either a change of control of the Company or
a highly leveraged transaction by the Company.
Reference is made to the Prospectus Supplement for the following terms of
and information relating to the Offered Debt Securities (to the extent such
terms are applicable to such Offered Debt Securities): (i) the title of the
Offered Debt Securities; (ii) classification as either Senior Debt Securities or
Subordinated Debt Securities; (iii) whether the Offered Debt Securities that
constitute Subordinated Debt Securities are convertible into Common Stock and,
if so, the terms and conditions upon which such conversion will be effected
including the initial conversion price or conversion rate and any adjustments
thereto in addition to or different from those described herein, the conversion
period and other conversion provisions in addition to or in lieu of those
described herein; (iv) any limit on the aggregate principal amount of the
Offered Debt Securities; (v) whether the Offered Debt Securities are to be
issuable as Registered Securities or Bearer Securities or both, whether any of
the Offered Debt Securities are to be issuable initially in temporary global
form and whether any of the Offered Debt Securities are to be in permanent
global form; (vi) the price or prices (expressed as a percentage of the
aggregate principal amount thereof) at which the Offered Debt Securities will be
issued; (vii) the date or dates on which the Offered Debt Securities will
mature; (viii) the rate or rates per annum (or the method by which such will be
determined) at which the Offered Debt Securities will bear interest, if any, and
the date from which any such interest will accrue; (ix) the Interest Payment
Dates on which any such interest on the Offered Debt Securities will be payable,
the Regular Record Date for any interest payable on any Offered Debt Securities
which are Registered Securities on any Interest Payment Date and the extent to
which, or the manner in which, any interest payable on a temporary global
Offered Debt Security on an Interest Payment Date will be paid; (x) any
mandatory or optional sinking fund or analogous provisions; (xi) each office or
agency where, subject to the terms of the Debt Indentures as described below
under "Payment and Paying Agents", the principal of and any premium and interest
on the Offered Debt Securities will be payable and each office or agency where,
subject to the terms of the Debt Indentures as described below under "-- Form,
Exchange, Registration and Transfer", the Offered Debt Securities may be
presented for registration of transfer or exchange; (xii) the right of the
Company to redeem the Offered Debt Securities at its option and the period or
periods, if any, within which and the price or prices at which the Offered Debt
Securities may, pursuant to any optional or mandatory redemption provisions, be
redeemed, in whole or in part, and the other detailed terms and provisions of
any such optional or mandatory redemption; (xiii) the denominations in which any
Offered Debt Securities which are Registered Securities will be issuable, if
other than denominations of $1,000 and any integral multiple thereof, and the
denomination or denominations in which any Offered Debt Securities which are
Bearer Securities will be issuable, if other than the denomination of $5,000;
(xiv) the currency or currencies (including composite currencies) in which
payment of principal of and any premium and interest on the Offered Debt
Securities is payable; (xv) any index used to determine the amount of payments
of principal of and any premium and interest on the Offered Debt Securities;
(xvi) information with respect to book-entry procedures, if any; (xvii) any
applicable United States federal income tax consequences; and (xviii) any other
terms of the Offered Debt Securities not inconsistent with the provisions of the
Debt Indentures. (Section 301) Any such Prospectus Supplement will also describe
any special provisions for the payment of additional amounts with respect to the
Offered Debt Securities.
Debt Securities may be issued as Original Issue Discount Securities. An
Original Issue Discount Security is a Debt Security, including any Zero-Coupon
Security, which is issued at a price lower than the amount payable upon the
Stated Maturity thereof and which provides that upon redemption or acceleration
of the maturity thereof an amount less than the amount payable upon the Stated
Maturity thereof and determined in accordance with the terms of such Debt
Security shall become due and payable. Special United States federal income tax
considerations applicable to Debt Securities issued at an original issue
discount, including Original
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Issue Discount Securities, and special United States tax considerations and
other terms and restrictions applicable to any Debt Securities which are issued
in bearer form, offered exclusively to United States Aliens or denominated in
other than United States dollars, will be set forth in a Prospectus Supplement
relating thereto.
Form, Exchange, Registration and Transfer. Debt Securities of a series may
be issuable in definitive form solely as Registered Securities, solely as Bearer
Securities or as both Registered Securities and Bearer Securities. Unless
otherwise indicated in an applicable Prospectus Supplement, Bearer Securities
will have interest coupons attached. (Section 201) The Debt Indentures also
provide that Debt Securities of a series may be issuable in temporary or
permanent global form. (Section 201)
Registered Securities of any series will be exchangeable for other
Registered Securities of the same series of any authorized denominations and of
a like aggregate principal amount and tenor. In addition, if Debt Securities of
any series are issuable as both Registered Securities and Bearer Securities, at
the option of the Holder, and subject to the terms of the applicable Debt
Indenture, Bearer Securities (with all unmatured coupons, except as provided
below, and all matured coupons in default) of such series will be exchangeable
for Registered Securities of the same series of any authorized denominations and
of a like aggregate principal amount and tenor. Bearer Securities surrendered in
exchange for Registered Securities between a Regular Record Date or a Special
Record Date and the relevant date for payment of interest shall be surrendered
without the coupon relating to such date for payment of interest, and interest
accrued as of such date will not be payable in respect of the Registered
Security issued in exchange for such Bearer Security, but will be payable only
to the Holder of such coupon when due in accordance with the terms of the
applicable Debt Indenture. Bearer Securities will not be issued in exchange for
Registered Securities. (Section 305)
Debt Securities may be presented for exchange as provided above, and
Registered Securities may be presented for registration of transfer (with the
form of transfer endorsed thereon duly executed), at the office of the Security
Registrar or at the office of any transfer agent designated by the Company for
such purpose with respect to any series of Debt Securities and referred to in an
applicable Prospectus Supplement, without service charge and upon payment of any
taxes and other governmental charges as described in the Debt Indentures. Such
transfer or exchange will be effected upon the Security Registrar or such
transfer agent, as the case may be, being satisfied with the documents of title
and identity of the person making the request. The Debt Trustee will serve
initially as Security Registrar. (Section 305) If a Prospectus Supplement refers
to any transfer agents (in addition to the Security Registrar) initially
designated by the Company with respect to any series of Debt Securities, the
Company may at any time rescind the designation of any such transfer agent or
approve a change in the location through which any such transfer agent acts,
except that, if Debt Securities of a series are issuable solely as Registered
Securities, the Company will be required to maintain a transfer agent in each
Place of Payment for such series and, if Debt Securities of a series are also
issuable as Bearer Securities, the Company will be required to maintain (in
addition to the Security Registrar) a transfer agent in a Place of Payment for
such series located outside the United States. The Company may at any time
designate additional transfer agents with respect to any series of Debt
Securities. (Section 1002)
In the event of any redemption in part, the Company shall not be required
to (i) issue, register the transfer of or exchange Debt Securities of any series
during a period beginning at the opening of business 15 days prior to the
selection of Debt Securities of that series for redemption and ending on the
close of business on (A) if Debt Securities of the series are issuable only as
Registered Securities, the day of mailing of the relevant notice of redemption
and (B) if Debt Securities of the series are issuable as Bearer Securities, the
date of the first publication of the relevant notice of redemption or, if
Securities of the series are also issuable as Registered Securities and there is
no publication, the mailing of the relevant notice of redemption; (ii) register
the transfer of or exchange any Registered Security, or portion thereof, called
for redemption, except the unredeemed portion of any Registered Security being
redeemed in part; or (iii) exchange any Bearer Security called for redemption,
except to exchange such Bearer Security for a Registered Security of that series
and like tenor which is immediately surrendered for redemption. (Section 305)
Payment and Paying Agents. Unless otherwise indicated in an applicable
Prospectus Supplement, payment of principal of and any premium and interest on
Bearer Securities will be payable, subject to any
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applicable laws and regulations, at the offices of such Paying Agents outside
the United States as the Company may designate from time to time, in the manner
indicated in such Prospectus Supplement. (Section 1002) Unless otherwise
indicated in an applicable Prospectus Supplement, payment of interest on Bearer
Securities on any Interest Payment Date will be made only against surrender to
the Paying Agent of the coupon relating to such Interest Payment Date. (Section
1001) No payment with respect to any Bearer Security will be made at any office
or agency of the Company in the United States or by check mailed to any address
in the United States or by transfer to any account maintained with a bank
located in the United States. Notwithstanding the foregoing, payments of
principal of and any premium and interest on Bearer Securities denominated and
payable in U.S. dollars will be made at the office of the Company's Paying Agent
in the Borough of Manhattan, The City of New York, if (but only if) payment of
the full amount thereof in U.S. dollars at all offices or agencies outside the
United States is illegal or effectively precluded by exchange controls or other
similar restrictions. (Section 1002)
Unless otherwise indicated in an applicable Prospectus Supplement, payment
of principal of and any premium and interest on Registered Securities will be
made at the office of such Paying Agent or Paying Agents as the Company may
designate from time to time, except that at the option of the Company payment of
any interest may be made by check mailed on or before the due date to the
address of the Person entitled thereto as such address shall appear in the
Security Register. (Sections 307, 1002) Unless otherwise indicated in an
applicable Prospectus Supplement, payment of any installment of interest on
Registered Securities will be made to the Person in whose name such Registered
Security is registered at the close of business on the Regular Record Date for
such interest. (Section 307)
Unless otherwise indicated in an applicable Prospectus Supplement, the Debt
Trustee, at its corporate trust office in Chicago, Illinois, will act as Paying
Agent for payments with respect to Debt Securities which are issuable solely as
Registered Securities and the Company will maintain a Paying Agent outside the
United States for payments with respect to Debt Securities (subject to
limitations described above in the case of Bearer Securities) which are issuable
solely as Bearer Securities or as both Registered Securities and Bearer
Securities. Any Paying Agents outside the United States and any other Paying
Agents in the United States initially designated by Company for the Debt
Securities will be named in an applicable Prospectus Supplement. The Company may
at any time designate additional Paying Agents or rescind the designation of any
Paying Agent or approve a change in the office through which any Paying Agent
acts, except that, if Debt Securities of a series are issuable solely as
Registered Securities, the Company will be required to maintain a Paying Agent
in each Place of Payment for such series and, if Debt Securities of a series are
issuable as Bearer Securities, the Company will be required to maintain (i) a
Paying Agent in the Borough of Manhattan, The City of New York for principal
payments with respect to any Registered Securities of the series (and for
payments with respect to Bearer Securities of the series in the circumstances
described above, but not otherwise), and (ii) a Paying Agent in a Place of
Payment located outside the United States where Debt Securities of such series
and any coupons appertaining thereto may be presented and surrendered for
payment. (Section 1002)
All monies paid by the Company to a Paying Agent for the payment of
principal of and any premium or interest on any Debt Security which remain
unclaimed at the end of two years after such principal, premium or interest
shall have become due and payable will (subject to applicable escheat laws) be
repaid to the Company, and the Holder of such Debt Security or any coupon will
thereafter look only to the Company for payment thereof. (Section 1003)
Global Debt Securities. Debt Securities of a series may be issued in whole
or in part in the form of one or more global Debt Securities that will be
deposited with, or on behalf of, a depository identified in the Prospectus
Supplement relating to such series. Global Debt Securities may be issued in
either registered or bearer form and in either temporary or permanent form.
(Section 203) Unless and until it is exchanged in whole or in part for the
individual Debt Securities represented thereby, a global Debt Security may not
be transferred except as a whole by the depository for such global Debt Security
to a nominee of such depository or by a nominee of such depository to such
depository or another nominee of such depository or by the depository or any
nominee to a successor depository or any nominee of such successor.
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The specific terms of the depository arrangement with respect to a series
of Debt Securities and certain limitations and restrictions relating to a series
of Bearer Securities in the form of one or more global Debt Securities will be
described in the Prospectus Supplement relating to such series.
Events of Default. Any one of the following events constitutes an Event of
Default under each Debt Indenture with respect to Debt Securities of any series:
(a) failure to pay any interest on any Debt Security of that series when due,
continued for 30 days; (b) failure to pay principal of or any premium on any
Debt Security of that series when due; (c) failure to deposit any sinking fund
payment, when due, in respect of any Debt Security of that series; (d) failure
to perform any other covenant of the Company in such Debt Indenture (other than
a covenant included in such Debt Indenture solely for the benefit of series of
any Debt Securities other than that series), continued for 90 days after written
notice as provided in such Debt Indenture; (e) certain events in bankruptcy,
insolvency or reorganization involving the Company; and (f) any other Event of
Default provided with respect to Debt Securities of that series. (Section 501)
If an Event of Default with respect to Debt Securities of any series at the
time Outstanding occurs and is continuing, either the Debt Trustee or the
Holders of at least 25% in aggregate principal amount of the Outstanding
Securities of that series by notice as provided in the applicable Debt Indenture
may declare the principal amount (or, if the Debt Securities of that series are
Original Issue Discount Securities, such portion of the principal amount as may
be specified in the terms of that series) of all the Debt Securities of that
series to be due and payable immediately. At any time after a declaration of
acceleration with respect to Debt Securities of any series has been made, but
before a judgment or decree for payment of money has been obtained by the Debt
Trustee, the Holders of a majority in aggregate principal amount of the
Outstanding Securities of that series may, under certain circumstances, rescind
and annul such acceleration. (Section 502)
Each Debt Indenture provides that, subject to the duty of the Debt Trustee
during default to act with the required standard of care, the Debt Trustee is
under no obligation to exercise any of its rights or powers under such Debt
Indenture at the request or direction of any of the Holders, unless such Holders
shall have offered to the Debt Trustee reasonable indemnity. (Sections 601, 603)
Subject to such provisions for the indemnification of the Debt Trustee, the
Holders of a majority in aggregate principal amount of the Outstanding
Securities of any series have the right to direct the time, method and place of
conducting any proceeding for any remedy available to the Debt Trustee, or
exercising any trust or power conferred on the Debt Trustee, with respect to the
Debt Securities of that series; provided, however, that the Debt Trustee is not
obligated to take any action unduly prejudicial to Holders not joining in such
direction or involving the Debt Trustee in personal liability. (Section 512)
The Company is required to furnish to the Debt Trustee annually a statement
as to the performance by the Company of its obligations under each Debt
Indenture and as to any default in such performance. (Section 1007)
Defeasance. If so specified with respect to any particular series of Debt
Securities issued under an Debt Indenture, the Company may discharge its
indebtedness and its obligations or certain of its obligations under such Debt
Indenture with respect to such series by depositing funds or obligations issued
or guaranteed by the United States of America with the Debt Trustee. (Sections
1301-1303)
Defeasance and Discharge. Each Debt Indenture provides that, if so
specified with respect to the Debt Securities of any series issued under such
Debt Indenture (other than convertible Subordinated Debt Securities), the
Company will be discharged from any and all obligations in respect of the Debt
Securities of such series (except for certain obligations relating to temporary
Debt Securities and exchange of Debt Securities, registration of transfer or
exchange of Debt Securities of such series, replacement of stolen, lost or
mutilated Debt Securities of such series, maintenance of paying agencies to hold
moneys for payment in trust and payment of additional amounts, if any, required
in consequence of United States withholding taxes imposed on payments to
non-United States persons) upon the deposit with the Trustee, in trust, of money
and/or U.S. Government Obligations which through the payment of interest and
principal in respect thereof in accordance with their terms will provide money
in an amount sufficient to pay the principal of (and premium, if any), and each
installment of interest on, the Debt Securities of such series on the Stated
Maturity of such payments in accordance with the terms of such Debt Indenture
and the Debt Securities of such series.
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(Sections 1302, 1304) Such a trust may only be established if, among other
things, the Company has delivered to the Debt Trustee an Opinion of Counsel to
the effect that (i) the Company has received from, or there has been published
by, the Internal Revenue Service a ruling, or (ii) since the date of such Debt
Indenture there has been a change in applicable federal income tax law, in
either case to the effect that, and based thereon such Opinion of Counsel shall
confirm that, the Holders of such series will not recognize income, gain or loss
for United States federal income tax purposes as a result of such deposit,
defeasance and discharge, and will be subject to United States federal income
tax on the same amounts and in the same manner and at the same times as would
have been the case if such deposit, defeasance and discharge had not occurred.
(Section 1304) In the event of any such defeasance and discharge of Debt
Securities of such series, Holders of such series would be entitled to look only
to such trust fund for payment of principal of and any premium and any interest
on their Debt Securities until Maturity.
Covenant Defeasance. Each Debt Indenture also provides that, if so
specified with respect to the Debt Securities of any series issued thereunder,
the Company may omit to comply with certain restrictive covenants, including (in
the case of the Senior Debt Indenture) the covenant described under "Limitation
on Liens" below, but excluding (in the case of the Subordinated Debt Indenture)
any applicable obligation of the Company respecting the conversion of Debt
Securities of such series into Common Stock, and any such omission shall not be
an Event of Default with respect to the Debt Securities of such series, upon the
deposit with the Debt Trustee, in trust, of money and/or U.S. Government
Obligations which through the payment of interest and principal in respect
thereof in accordance with their terms will provide money in an amount
sufficient to pay the principal of (and premium, if any), and each installment
of interest on, the Debt Securities of such series on the Stated Maturity of
such payments in accordance with the terms of such Debt Indenture and the Debt
Securities of such series. The obligations of the Company under such Debt
Indenture and the Debt Securities of such series other than with respect to such
covenants shall remain in full force and effect. (Section 1303) Such a trust may
be established only if, among other things, the Company has delivered to the
Debt Trustee an Opinion of Counsel to the effect that the Holders of such series
will not recognize income, gain or loss for United States federal income tax
purposes as a result of such deposit and defeasance of certain obligations and
will be subject to United States federal income tax on the same amounts and in
the same manner and at the same time as would have been the case if such deposit
and defeasance had not occurred. (Section 1304)
Although the amount of money and U.S. Government Obligations on deposit
with the Debt Trustee would be intended to be sufficient to pay amounts due on
the Debt Securities of such series at the time of their Stated Maturity, in the
event the Company exercises its option to omit compliance with the covenants
defeased with respect to the Debt Securities of any series as described above,
and the Debt Securities of such series are declared due and payable because of
the occurrence of any Event of Default, such amount may not be sufficient to pay
amounts due on the Debt Securities of such series at the time of the
acceleration resulting from such Event of Default. The Company shall in any
event remain liable for such payments as provided in the applicable Debt
Indenture.
Federal Income Tax Consequences Relating to Defeasance. Under current
United States federal income tax law, defeasance and discharge would likely be
treated as a taxable exchange of Debt Securities to be defeased for an interest
in the defeasance trust. As a consequence, a holder would recognize gain or loss
equal to the difference between the holder's cost or other tax basis for such
Debt Securities and the value of the holder's interest in the defeasance trust,
and thereafter would be required to include in income the holder's share of the
income, gain or loss of the defeasance trust. Under current United States
federal income tax law, covenant defeasance would ordinarily not be treated as a
taxable exchange of such Debt Securities.
Meetings, Modification and Waiver. Modifications and amendments of either
Debt Indenture may be made by the Company and the Debt Trustee with the consent
of the Holders of a majority in aggregate principal amount of the Outstanding
Securities of each series affected by such modification or amendment; provided,
however, that no such modification or amendment may, without consent of the
Holder of each Outstanding Security affected thereby, (a) change the Stated
Maturity of the principal of, or any installment of principal of or interest on,
any Debt Security, (b) change the Redemption Date with respect to any Debt
Security, (c) reduce the principal amount of, or premium or interest on, any
Debt Security, (d) change any
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obligation of the Company to pay additional amounts, (e) reduce the amount of
principal of an Original Issue Discount Security payable upon acceleration of
the Maturity thereof, (f) change the coin or currency in which any Debt Security
or any premium or interest thereon is payable, (g) change the redemption right
of any Holder, (h) impair the right to institute suit for the enforcement of any
payment on or with respect to any Debt Security or any conversion right with
respect thereto, (i) reduce the percentage in principal amount of Outstanding
Securities of any series, the consent of whose Holders is required for
modification or amendment of such Debt Indenture or for waiver of compliance
with certain provisions of such Debt Indenture or for waiver of certain
defaults, (j) reduce the requirements contained in such Debt Indenture for
quorum or voting, (k) change any obligation of the Company to maintain an office
or agency in the places and for the purposes required by such Debt Indenture,
(l) adversely affect the right to convert Subordinated Debt Securities, if
applicable, or (m) modify any of the above provisions. (Section 902)
The Subordinated Debt Indenture may not be amended to alter the
subordination of any outstanding Subordinated Debt Securities without the
consent of each holder of Senior Indebtedness (as defined below under
"-- Provisions Applicable Solely to Subordinated Debt Securities") then
outstanding that would be adversely affected thereby. (Section 907 of the
Subordinated Debt Indenture)
The Holders of a majority in aggregate principal amount of the Outstanding
Securities of each series may, on behalf of all Holders of that series, waive,
insofar as that series is concerned, compliance by the Company with certain
restrictive provisions of the Debt Indenture under which such series has been
issued. (Section 1008) The Holders of a majority in aggregate principal amount
of the Outstanding Securities of each series may, on behalf of all Holders of
that series, waive any past default under the applicable Debt Indenture with
respect to any Debt Securities of that series, except a default (a) in the
payment of principal of, or premium, if any, or any interest on any Debt
Security of such series or (b) in respect of a covenant or provision of such
Debt Indenture which cannot be modified or amended without the consent of the
Holder of each Outstanding Security of such series affected. (Section 513)
Each Debt Indenture provides that in determining whether the Holders of the
requisite principal amount of the Outstanding Securities have given any request,
demand, authorization, direction, notice, consent or waiver thereunder or are
present at a meeting of the Holders for quorum purposes, (i) the principal
amount of an Original Issue Discount Security that is deemed to be Outstanding
will be the amount of the principal that would be due and payable as of the date
of such determination upon acceleration of the Maturity thereof, and (ii) the
principal amount of a Debt Security denominated in a foreign currency or
currency units will be the U.S. dollar equivalent, determined on the date of
original issuance of such Debt Security, of the principal amount of such Debt
Security or, in the case of an Original Issue Discount Security, the U.S. dollar
equivalent, determined on the date of original issuance of such Security, of the
amount determined as provided in (i) above. (Section 101)
Each Debt Indenture contains provisions for convening meetings of the
Holders of a series if Debt Securities of that series are issuable as Bearer
Securities. (Section 1401) A meeting may be called at any time by the Trustee,
and also, upon request, by the Company or the Holders of at least 10% in
aggregate principal amount of the Outstanding Securities of such series, in any
such case upon notice given in accordance with "-- Notices" below. (Section
1402) Except for any consent which must be given by the Holder of each
Outstanding Security affected thereby, as described above, any resolution
presented at a meeting (or adjourned meeting at which a quorum is present) may
be adopted by the affirmative vote of the Holders of a majority in aggregate
principal amount of the Outstanding Securities of that series; provided,
however, that any resolution with respect to any request, demand, authorization,
direction, notice, consent, waiver or other action which may be made, given or
taken by the Holders of a specified percentage, which is less than a majority,
in aggregate principal amount of the Outstanding Securities of a series may be
adopted at a meeting (or adjourned meeting duly reconvened at which a quorum is
present) by the affirmative vote of the Holders of such specified percentage in
aggregate principal amount of the Outstanding Securities of that series. Any
resolution passed or decision taken at any meeting of Holders of any series duly
held in accordance with the applicable Debt Indenture will be binding on all
Holders of that series and related coupons. The quorum at any meeting, and at
any reconvened meeting, will be Persons holding or representing a majority in
aggregate principal amount of the Outstanding Securities of a series. (Section
1404)
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Consolidation, Merger and Sale of Assets. The Company, without the consent
of the Holders of any of the outstanding Debt Securities under either Debt
Indenture, may consolidate with or merge into, or convey, transfer or lease its
assets substantially as an entirety to, any Person which is a corporation,
partnership or trust organized and validly existing under the laws of any
domestic jurisdiction, provided that any successor Person assumes the Company's
obligations on the Securities and under such Debt Indenture, that after giving
effect to the transaction no Event of Default, and no event which, after notice
or lapse of time, would become an Event of Default, shall have occurred and be
continuing, and that certain other conditions are met. (Section 801)
Notices. Except as otherwise provided in the Debt Indentures, notices to
Holders of Bearer Securities will be given by publication at least twice in a
daily newspaper in The City of New York and in such other city or cities as may
be specified in such Bearer Securities. Notices to Holders of Registered
Securities will be given by mail to the addresses of such Holders as they appear
in the Security Register. (Section 106)
Title. Title to any Bearer Securities (including Bearer Securities in
permanent global form) and any coupons appertaining thereto will pass by
delivery. The Company, the Debt Trustee and any agent of the Company or the
Trustee may treat the bearer of any Bearer Security and the bearer of any coupon
and the registered owner of any Registered Security as the owner thereof
(whether or not such Debt Security or coupon shall be overdue and
notwithstanding any notice to the contrary) for the purpose of making payment
and for all other purposes. (Section 308)
Replacement of Securities and Coupons. Any mutilated Debt Security or a
Debt Security with a mutilated coupon appertaining thereto will be replaced by
the Company at the expense of the Holder upon surrender of such Debt Security to
the Debt Trustee. Debt Securities or coupons that became destroyed, stolen or
lost will be replaced by the Company at the expense of the Holder upon delivery
to the Debt Trustee of the Debt Security and coupons or evidence of destruction,
loss or theft thereof satisfactory to the Company and the Debt Trustee; in the
case of any coupon which becomes destroyed, stolen or lost, such coupon will be
replaced by issuance of a new Debt Security in exchange for the Debt Security to
which such coupon appertains. In the case of a destroyed, lost or stolen Debt
Security or coupon, an indemnity satisfactory to the Debt Trustee and the
Company may be required at the expense of the Holder of such Debt Security or
coupon before a replacement Debt Security will be issued. (Section 306)
Governing Law. The Debt Indentures, the Debt Securities and coupons will
be governed by, and construed in accordance with, the laws of the State of New
York. (Section 113)
Regarding the Trustee. First Trust National Association, the Debt Trustee
under each Debt Indenture, is also trustee under another indenture under which
several issues of the Company's debt securities are outstanding.
Each Debt Indenture contains certain limitations on the right of the Debt
Trustee, should it become a creditor of the Company, to obtain payment of claims
in certain cases, or to realize for its own account on certain property received
in respect of any such claim as security or otherwise. (Section 613) The Debt
Trustee is permitted to engage in certain other transactions; however, if it
acquires any conflicting interest (as described in the Debt Indentures), it must
eliminate such conflict or resign. (Section 608)
Pursuant to the Trust Indenture Act, should a default occur with respect to
either the Senior Debt Securities or the Subordinated Debt Securities, First
Trust National Association would be required to resign as Debt Trustee under one
of the Debt Indentures within 90 days of such default unless such default were
cured, duly waived or otherwise eliminated.
PROVISIONS APPLICABLE SOLELY TO SENIOR DEBT SECURITIES
General. Senior Debt Securities will be issued under the Senior Debt
Indenture, and each series will rank pari passu as to the right of payment of
principal and any premium and interest with each other series issued thereunder
and will rank senior to all series of Subordinated Debt Securities that may be
issued.
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Certain Definitions. For purposes of the following discussion, the
following definitions are applicable (Section 101 of the Senior Debt Indenture):
"Net Tangible Assets" means the total amount of assets appearing on a
consolidated balance sheet of the Company and its Subsidiaries less, without
duplication: (a) all current liabilities (excluding any thereof which are
extendible or renewable by their terms or replaceable or refundable pursuant to
enforceable commitments at the option of the obligor thereon without requiring
the consent of the obligee to a time more than 12 months after the time as of
which the amount thereof is being computed and excluding current maturities of
long-term debt and preferred stock); (b) all reserves for depreciation and other
asset valuation reserves but excluding reserves for deferred federal income
taxes arising from accelerated depreciation or otherwise; (c) all goodwill,
trademarks, trade names, patents and unamortized debt discount and expense and
other like intangible assets carried as an asset and (d) all appropriate
adjustments on account of minority interests of other Persons holding common
stock in any Subsidiary.
"Person" means any individual, corporation, partnership, joint venture,
trust, unincorporated organization or government or any agency or political
subdivision thereof.
"Principal Property" means any natural gas pipeline, natural gas
distribution system, natural gas gathering system or natural gas storage
facility located in the United States, except any such property that in the
opinion of the Board of Directors is not of material importance to the business
conducted by the Company and its consolidated Subsidiaries taken as a whole.
"Principal Subsidiary" means any Subsidiary which owns a Principal
Property.
"Subsidiary" means a corporation more than 50% of the outstanding stock of
which is owned, directly or indirectly, by the Company or by one or more
Subsidiaries, or by the Company and one or more other Subsidiaries. For the
purposes of this definition, "voting stock" means stock which ordinarily has
voting power for the election of directors, whether at all times or only so long
as no senior class of stock has such voting power by reason of any contingency.
Limitation on Liens. The Company covenants in the Senior Debt Indenture
that it will not, nor will it permit any Subsidiary to, issue, assume or
guarantee any debt for money borrowed ("Debt") if such Debt is secured by a
mortgage, pledge, security interest or lien (a "mortgage" or "mortgages") upon
any Principal Property of the Company or any Principal Subsidiary or upon any
shares of stock or indebtedness of any Principal Subsidiary (whether such
Principal Property, shares or indebtedness was owned on the date of the Senior
Debt Indenture or thereafter acquired) without in any such case effectively
providing that the Senior Debt Securities shall be secured equally and ratably
with (or prior to) such Debt, except that the foregoing restrictions shall not
apply to: (a) mortgages on any property acquired, constructed or improved by the
Company or any Principal Subsidiary after the date of the Senior Debt Indenture
which are created within 180 days after such acquisition (or in the case of
property constructed or improved, after the completion and commencement of
commercial operation of such property, whichever is later) to secure or provide
for the payment of the purchase price or cost thereof, provided that in the case
of such construction or improvement the mortgages shall not apply to any
property theretofore owned by the Company or any Subsidiary other than
theretofore unimproved real property; (b) existing mortgages on property
acquired (including mortgages on any property acquired from a Person which is
consolidated with or merged with or into the Company or a Subsidiary) or
mortgages outstanding at the time any corporation becomes a Subsidiary; (c)
mortgages in favor of domestic or foreign governmental bodies to secure advances
or other payments pursuant to any contract or statute or to secure indebtedness
incurred to finance the purchase price or cost of constructing or improving the
property subject to such mortgages, including mortgages to secure Debt of the
pollution control or industrial revenue bond type; (d) mortgages in favor of the
Company or any Principal Subsidiary; or (e) any extension, renewal or
replacement (or successive extensions, renewals or replacements), in whole or in
part, of any mortgage referred to in any of the foregoing clauses (a)-(d).
(Section 1006 of the Senior Debt Indenture)
Notwithstanding the foregoing, the Company and any Subsidiary may, without
securing the Senior Debt Securities, issue, assume or guarantee secured Debt
(which would otherwise be subject to the foregoing
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restrictions) in an aggregate amount which, together with all other such Debt,
does not exceed 10% of the Net Tangible Assets, as shown on a consolidated
balance sheet as of a date not more than 90 days prior to the proposed
transaction prepared by the Company in accordance with generally accepted
accounting principles. (Section 1006 of the Senior Debt Indenture)
PROVISIONS APPLICABLE SOLELY TO SUBORDINATED DEBT SECURITIES
Subordination. The Subordinated Debt Securities will be subordinate and
junior in right of payment, to the extent set forth in the Subordinated Debt
Indenture, to all Senior Indebtedness (as defined below) of the Company. If the
Company should default in the payment of any principal of or premium or interest
on any Senior Indebtedness when the same becomes due and payable, whether at
Stated Maturity or a date fixed for prepayment or by declaration of acceleration
or otherwise, then, upon written notice of such default to the Company by the
holders of such Senior Indebtedness or any trustee therefor and subject to
certain rights of the Company to dispute such default and subject to proper
notification of the Trustee, unless and until such default has been cured or
waived or ceases to exist, no direct or indirect payment (in cash, property,
securities, by set-off or otherwise) will be made or agreed to be made for
principal of, premium, if any, or interest, if any, on the Subordinated Debt
Securities, or in respect of any redemption, retirement, purchase or other
acquisition of the Subordinated Debt Securities other than those made in capital
stock of the Company (or cash in lieu of fractional shares thereof) pursuant to
any conversion right of the Subordinated Debt Securities or otherwise made in
capital stock of the Company. (Sections 1601, 1604 and 1605 of the Subordinated
Debt Indenture)
"Senior Indebtedness" is defined in Section 101 of the Subordinated Debt
Indenture as Indebtedness (as defined below) of the Company outstanding at any
time except (a) any Indebtedness as to which, by the terms of the instrument
creating or evidencing the same, it is provided that such Indebtedness is not
senior in right of payment to the Subordinated Debt Securities, (b) the
Subordinated Debt Securities, (c) any Indebtedness of the Company to a
wholly-owned Subsidiary of the Company, (d) interest accruing after the filing
of a petition initiating certain bankruptcy or insolvency proceedings unless
such interest is an allowed claim enforceable against the Company in a
proceeding under federal or state bankruptcy laws and (e) trade accounts
payable. "Indebtedness" is defined in Section 101 of the Subordinated Debt
Indenture as, with respect to any Person, (a) (i) the principal of and premium
and interest, if any, on indebtedness for money borrowed of such Person
evidenced by bonds, notes, debentures or similar obligations, including any
guaranty by such Person of any indebtedness for money borrowed of any other
Person, whether any such indebtedness or guaranty is outstanding on the date of
the Subordinated Debt Indenture or is thereafter created, assumed or incurred,
(ii) the principal of and premium and interest, if any, on indebtedness for
money borrowed, incurred, assumed or guaranteed by such Person in connection
with the acquisition by it or any of its subsidiaries of any other business,
properties or other assets and (iii) lease obligations which such Person
capitalizes in accordance with Statement of Financial Accounting Standards No.
13 promulgated by the Financial Accounting Standards Board or such other
generally accepted accounting principles as may be from time to time in effect,
(b) any other indebtedness of such Person, including any indebtedness
representing the balance deferred and unpaid of the purchase price of any
property or interest therein, including any such balance that constitutes a
trade account payable, and any guaranty, endorsement or other contingent
obligation of such Person in respect of any indebtedness of another, which is
outstanding on the date of the Subordinated Debt Indenture or is thereafter
created, assumed or incurred by such Person and (c) any amendments,
modifications, refundings, renewals or extensions of any indebtedness or
obligation described as Indebtedness in clause (a) or (b) above.
If (i) without the consent of the Company a court shall enter (A) an order
for relief with respect to the Company under the United States federal
bankruptcy laws, (B) a judgment, order or decree adjudging the Company a
bankrupt or insolvent, or (C) an order for relief for reorganization,
arrangement, adjustment or composition of or in respect of the Company under the
United States federal bankruptcy laws or state insolvency laws or (ii) the
Company shall institute proceedings for the entry of an order for relief with
respect to the Company under the United States federal bankruptcy laws or for an
adjudication of insolvency, or shall consent to the institution of bankruptcy or
insolvency proceedings against it, or shall file a petition seeking, or
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seek or consent to reorganization, arrangement, composition or similar relief
under any applicable law, or shall consent to the filing of such petition or to
the appointment of a receiver, custodian, liquidator, assignee, trustee,
sequestrator or similar official in respect of the Company or of substantially
all of its property, or the Company shall make a general assignment for the
benefit of creditors, then all Senior Indebtedness (including any interest
thereon accruing after the commencement of any such proceedings) will first be
paid in full before any payment or distribution, whether in cash, securities or
other property, is made on account of the principal of, premium, if any, or
interest, if any, on the Subordinated Debt Securities. In such event, any
payment or distribution on account of the principal of, premium, if any, or
interest, if any, on the Subordinated Debt Securities, whether in cash,
securities or other property (other than securities of the Company or any other
corporation provided for by a plan of reorganization or readjustment the payment
of which is subordinate, at least to the extent provided in the subordination
provisions with respect to the Subordinated Debt Securities, to the payment of
all Senior Indebtedness then outstanding and to any securities issued in respect
thereof under any such plan of reorganization or readjustment), which would
otherwise (but for the subordination provisions) be payable or deliverable in
respect of the Subordinated Debt Securities will be paid or delivered directly
to the holders of Senior Indebtedness in accordance with the priorities then
existing among such holders until all Senior Indebtedness (including any
interest thereon accruing after the commencement of any such proceedings) has
been paid in full. If any payment or distribution on account of the principal
of, premium, if any, or interest, if any, on the Subordinated Debt Securities of
any character, whether in cash, securities or other property (other than
securities of the Company or any other corporation provided for by a plan of
reorganization or readjustment the payment of which is subordinate, at least to
the extent provided in the subordination provisions with respect to the
Subordinated Debt Securities, to the payment of all Senior Indebtedness then
outstanding and to any securities issued in respect thereof under any such plan
of reorganization or readjustment), shall be received by the Debt Trustee or any
Holder of any Subordinated Debt Securities in contravention of any of the terms
of the Subordinated Debt Indenture, such payment or distribution will be
received in trust for the benefit of, and will be paid over or delivered and
transferred to, the holders of the Senior Indebtedness then outstanding in
accordance with the priorities then existing among such holders for application
to the payment of all Senior Indebtedness remaining unpaid, to the extent
necessary to pay all such Senior Indebtedness in full. In the event of any such
proceeding, after payment in full of all sums owing with respect to Senior
Indebtedness, the Holders of Subordinated Debt Securities, together with the
holders of any other obligations of the Company ranking on a parity with the
Subordinated Debt Securities, will be entitled to be repaid from the remaining
assets of the Company the amounts at that time due and owing on account of
unpaid principal of or any premium or interest on the Subordinated Debt
Securities and such other obligations before any payment or other distribution,
whether in cash, property or otherwise, shall be made on account of any capital
stock or obligations of the Company ranking junior to the Subordinated Debt
Securities and such other obligations. (Section 1601 of the Subordinated Debt
Indenture)
The Prospectus Supplement respecting any series of Subordinated Debt
Securities will set forth any subordination provisions applicable to such series
in addition to or different from those described above.
By reason of such subordination, in the event of the insolvency of the
Company, Holders of Senior Indebtedness and holders of other obligations of the
Company that are not subordinated to Senior Indebtedness may receive more,
ratably, than Holders of the Subordinated Debt Securities. Such subordination
will not prevent the occurrence of an Event of Default or limit the right of
acceleration in respect of the Subordinated Debt Securities.
Conversion. The Subordinated Debt Indenture may provide for a right of
conversion of Subordinated Debt Securities into Common Stock (or cash in lieu
thereof). (Sections 301 and 1501 of the Subordinated Debt Indenture) The
following provisions will apply to Debt Securities that are convertible
Subordinated Debt Securities unless otherwise provided in the Prospectus
Supplement for such Debt Securities.
The Holder of any convertible Subordinated Debt Securities will have the
right exercisable at any time set forth in the Prospectus Supplement, unless
previously redeemed or otherwise purchased by the Company, to convert such
Subordinated Debt Securities into shares of Common Stock at the conversion price
or conversion rate set forth in the Prospectus Supplement, subject to
adjustment. (Section 1502 of the Subordinated Debt Indenture) The holder of
convertible Subordinated Debt Securities may convert any
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portion thereof which is $1,000 in principal amount or any integral multiple
thereof. (Section 1502 of the Subordinated Debt Indenture)
In certain events, the conversion price or conversion rate will be subject
to adjustment as set forth in the Subordinated Debt Indenture. Such events
include the issuance of shares of Common Stock of the Company as a dividend or
distribution on the Common Stock; subdivisions, combinations and
reclassifications of the Common Stock; the issuance to all holders of Common
Stock of rights or warrants entitling the holders thereof (for a period not
exceeding 45 days) to subscribe for or purchase shares of Common Stock at a
price per share less than the then current market price per share of Common
Stock (as determined pursuant to the Subordinated Debt Indenture); and the
distribution to substantially all holders of Common Stock of evidences of
indebtedness, equity securities (including equity interests in the Company's
Subsidiaries) other than Common Stock, or other assets (excluding cash dividends
paid from surplus) or subscription rights or warrants (other than those referred
to above). No adjustment of the conversion price or conversion rate will be
required unless an adjustment would require a cumulative increase or decrease of
at least 1% in such price or rate. (Section 1504 of the Subordinated Debt
Indenture) Certain adjustments in the conversion price or conversion rate in
accordance with the foregoing provisions may result in constructive
distributions to either holders of the Subordinated Debt Securities or holders
of Common Stock which would be taxable pursuant to Treasury Regulations issued
under section 305 of the Internal Revenue Code of 1986, as amended. The amount
of any such taxable constructive distribution would be the fair market value of
the Common Stock which is treated as having been constructively received, such
value being determined as of the time the adjustment resulting in the
constructive distribution is made.
Fractional shares of Common Stock will not be issued upon conversion, but,
in lieu thereof, the Company will pay a cash adjustment based on the then
current market price for the Common Stock. (Section 1503 of the Subordinated
Debt Indenture) Upon conversion, no adjustments will be made for accrued
interest or dividends, and therefore convertible Subordinated Debt Securities
surrendered for conversion between the record date for an interest payment and
the Interest Payment Date (except convertible Subordinated Debt Securities
called for redemption on a redemption date during such period) must be
accompanied by payment of an amount equal to the interest thereon which the
registered holder is to receive. (Sections 1504 and 1502 of the Subordinated
Debt Indenture)
In the case of any consolidation or merger of the Company (with certain
exceptions) or any conveyance, transfer or lease of the properties and assets of
the Company substantially as an entirety to any Person, each Holder of
convertible Subordinated Debt Securities, after the consolidation, merger,
conveyance, transfer or lease, will have the right to convert such convertible
Subordinated Debt Securities only into the kind and amount of securities, cash
and other property which the Holder would have been entitled to receive upon or
in connection with such consolidation, merger, conveyance, transfer or lease, if
the Holder had held the Common Stock issuable upon conversion of such
convertible Subordinated Debt Securities immediately prior to such
consolidation, merger, conveyance, transfer or lease. (Section 1505 of the
Subordinated Debt Indenture)
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DESCRIPTION OF CAPITAL STOCK
GENERAL
K N is currently authorized by its Restated Articles of Incorporation, as
amended (the "K N Charter") to issue 50,000,000 shares of Common Stock, of which
32,024,557 were outstanding on December 31, 1997; 200,000 shares of Class A
Preferred Stock, no par value ("Class A Preferred Stock"), of which 70,000
shares were outstanding as Class A $5.00 Cumulative Preferred Stock on such
date; and 2,000,000 shares of Class B Preferred Stock, no par value ("Class B
Preferred Stock"), none of which were outstanding on such date.
The Board of Directors of K N is authorized by the K N Charter to provide,
without further stockholder action, for the issuance of one or more series of
Class A Preferred Stock and Class B Preferred Stock. The Board of Directors has
the power to fix various terms with respect to each such series, including
voting power, designations, preferences, dividend rates, conversion and exchange
provisions, redemption provisions and, in the case of the Class B Preferred
Stock, the amounts which holders are entitled to receive upon any liquidation,
dissolution or winding up of K N. Class A Preferred Stock and Class B Preferred
Stock will rank prior to the Common Stock with respect to both dividends and
distribution of assets on liquidation, dissolution or winding up of K N.
In the event of any liquidation, dissolution or winding up of K N, whether
voluntary or involuntary, the holders of shares of Class A Preferred Stock of
each series shall be entitled to receive in full out of the assets of K N the
sum of $100 per share of Class A Preferred Stock, plus any arrearages in
dividends thereon to the date fixed for the payment in liquidation, before any
distribution shall be made to the holders of shares of any stock junior to the
Class A Preferred Stock. K N may, at the option of the Board of Directors,
redeem the whole or any part of the Class A Preferred Stock, or of any series
thereof at any time or from time to time within the period during which such
stock is, according to the K N Charter, or the resolutions of the Board of
Directors providing for the issue thereof, redeemable, by paying the redemption
price thereof, including any arrearages in dividends thereon to the date fixed
for redemption. The Class A $5.00 Cumulative Preferred Stock is redeemable, in
whole or in part, at the option of K N at any time, or from time to time, at the
price of $105 per share plus accrued and unpaid dividends. This series has no
sinking fund requirements. Holders of shares of Class A $5.00 Cumulative
Preferred Stock are entitled to receive, when and as declared by the Board of
Directors of K N, cumulative preferential cash dividends at the annual rate of
$5.00 per share prior to the payment of any dividends or other distributions on
(or purchase or redemption of) the Class B Preferred Stock or the Common Stock.
In the event of any liquidation, dissolution or winding up of K N, whether
voluntary or involuntary, the holders of shares of Class B Preferred Stock of
each series shall be entitled to receive, subject to the prior rights of the
holders of shares of Class A Preferred Stock, the full preferential amount fixed
by the K N Charter, or by the resolutions of the Board of Directors providing
for the issue thereof, including any arrearages in dividends thereon to the date
fixed for the payment in liquidation, before any distribution shall be made to
the holders of shares of any stock junior to the Class B Preferred Stock.
Dividends may not be declared or paid or set apart for payment on any series of
Class B Preferred Stock, unless there shall be no arrearages in dividends on any
series of Class A Preferred Stock entitled to cumulative dividends for any past
dividend period and dividends in full for the current dividend period have been
paid or declared or set aside for payment on all Class A Preferred Stock.
In addition, the holders of the Class A Preferred Stock then outstanding
have the right to vote separately as a class with respect to (i) certain
amendments to the K N Charter or the By-Laws of K N which adversely affect the
voting powers, rights or preferences of the holders of shares of Class A
Preferred Stock, (ii) the creation of any class of stock or any security
convertible into or exchangeable for or evidencing the right to purchase any
stock ranking prior to or on a parity with, either as to dividends or upon
liquidation, the Class A Preferred Stock, or (iii) certain mergers or
consolidations of K N with or into any other corporation. For such actions to be
taken by K N, including increasing the authorized amount of any class of stock
ranking prior to the Class A Preferred Stock, the affirmative vote of the
holders of at least 50% of the shares of the Class A Preferred Stock then
outstanding would be required. The affirmative vote of at least 50% of the
shares of any
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series of Class A Preferred Stock then outstanding is required for K N to amend
the K N Charter or resolutions of the Board of Directors of K N providing for
the issue of such series of Class A Preferred Stock so as to affect adversely
the powers, preferences or rights of holders of Class A Preferred Stock of such
series. The holders of Class B Preferred Stock then outstanding also have the
right to a separate vote regarding (a) the events described in the first
sentence of this paragraph with regard to such Class B Preferred Stock,
requiring the affirmative vote of at least 50% of the shares of Class B
Preferred Stock then outstanding, and (b) amendments to the K N Charter, or to
resolutions of K N's Board of Directors providing for the issue of any series of
Class B Preferred Stock so as to affect adversely the powers, preferences or
rights of the holders of such series, requiring the affirmative vote of at least
50% of the shares of such series then outstanding.
If dividends are in arrears on the shares of any series of Class A
Preferred Stock to which the following provisions are made applicable pursuant
to the K N Charter or resolutions of K N's Board of Directors providing for the
issue of any such series (i) in an aggregate amount equal to three but less than
six full quarterly dividends, then the holders of the shares of all such series
of Class A Preferred Stock have the exclusive right, voting separately as a
class and without regard to series, to elect directors constituting one-third of
K N's Board of Directors or (ii) in an aggregate amount equal to six full
quarterly dividends, then such holders have the exclusive right, voting
separately as a class and without regard to series, to elect directors
constituting one-half of K N's Board of Directors plus one additional director,
in each case until all arrearages in dividends and dividends in full for the
current quarterly period have been paid on or declared and set aside for payment
on the shares of such series. These provisions are applicable to the Class A
$5.00 Cumulative Preferred Stock. The holders of any outstanding Class B
Preferred Stock would have the right to elect directors of K N similar to the
Class A $5.00 Cumulative Preferred Stock in the event of nondeclaration of
dividends, for the periods described above, on the Class B Preferred Stock if
the holders of the Class A $5.00 Cumulative Preferred Stock are not then
entitled to elect directors as described above.
All outstanding shares of Common Stock are, and any shares of Common Stock
newly issued under any Prospectus Supplement will be, validly issued, fully paid
and nonassessable. Holders of K N Common Stock and Class A $5.00 Cumulative
Preferred Stock are entitled to one vote for each share on all matters voted on
by stockholders. Holders of Common Stock, Class A Preferred Stock and Class B
Preferred Stock have no preemptive rights to subscribe for or purchase any
additional securities issued by K N. Subject to the preferential rights of the
holders of the Class A Preferred Stock and Class B Preferred Stock, the holders
of Common Stock are entitled to receive any dividends which may be declared by
the Board of Directors out of funds legally available therefor and to share pro
rata in the net assets of K N upon liquidation, dissolution or winding up.
Shares of Common Stock have no cumulative voting rights or redemption, sinking
fund or conversion privileges.
ANTI-TAKEOVER MATTERS
Charter and Bylaws. Certain provisions of the K N Charter and the By-Laws
of K N could have the effect of preventing a change in control of K N in certain
situations. These provisions generally provide for (a) the classification of the
Board of Directors of K N into three classes of as nearly an equal number as
possible, having staggered terms of three years each; (b) the removal of
directors only for cause or by unanimous vote of the remaining members of the
Board of Directors; (c) the filling of any vacancy on the Board of Directors by
the remaining directors then in office; (d) the limitation of the number of
directors to a minimum of nine and a maximum of 15, with the exact number to be
determined by the Board of Directors; (e) increasing the stockholder vote
required to amend, repeal or adopt any provision inconsistent with the foregoing
provisions under (a), (b) and (d) above to two-thirds of the outstanding voting
securities of K N; (f) the requirement that certain business combinations or
transactions involving K N and any beneficial owner of more than 5% of the
outstanding voting securities of K N be approved by holders of at least
twothirds of the outstanding voting securities of K N, including those held by
such beneficial owner, unless the business combination or transaction is (I)
approved by the Board of Directors before such beneficial owner became a holder
of more than 5% of K N's outstanding voting securities or (II) approved by
sufficient members of the Board of Directors to constitute a majority of the
members of the full Board of Directors in office prior to the time such
beneficial owner became a holder of more than 5% of K N's voting securities, or
(III) with an entity
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of which a majority of the outstanding shares of voting securities is owned by K
N and its subsidiaries; (g) increasing the stockholder vote required to amend,
repeal or adopt any provision inconsistent with the foregoing provision under
(f) above to two-thirds or more of the then outstanding shares of voting
securities of K N; (h) the requirement that certain business combinations or
transactions involving K N and any beneficial owner of 10% or more of the
outstanding voting securities of K N be approved by holders of at least 80% of
the outstanding voting securities of K N, including those held by such
beneficial owner, unless (I) the business combination or transaction is approved
by three-fourths of the Board of Directors then in office who are not associated
with or related to anyone who beneficially owns, and do not themselves own, 10%
or more of K N's voting securities or (II) certain conditions relating generally
to the fairness of the price to be received by stockholders of K N in such
business combination or transaction are satisfied; (i) increasing the
stockholder vote required to amend, repeal or adopt any provision inconsistent
with the foregoing provision under (h) above to 80% or more of the outstanding
voting securities of K N unless approved by an affirmative vote of three-fourths
of the Board of Directors then in office who are not associated with or related
to anyone who beneficially owns, and do not themselves own, 10% or more of K N's
voting securities; (j) certain procedural requirements for stockholder
nominations to the Board of Directors; and (k) the requirement that special
meetings of stockholders may only be called by stockholders owning 51% or more
of the outstanding voting securities of K N, by a majority of the Board of
Directors, the Chairman of the Board of Directors or the President of K N.
Shareholder Rights Plan. On August 17, 1995, the Board of Directors of K N
declared a dividend of one preferred share purchase right (a "Right") with
respect to each outstanding share of Common Stock held of record on September
15, 1995 or issued thereafter and prior to the date the Rights become
exercisable. Until the Rights become exercisable, they will be evidenced by
certificates for shares of Common Stock and will automatically trade with the
Common Stock. If and when the Rights become exercisable, Rights certificates
will be distributed and the Rights will become separately tradable. The full
terms of the Rights are set forth in the Rights Agreement, dated as of August
21, 1995 (the "Rights Agreement"), between the Company and The Bank of New York,
as Rights Agent. A copy of the Rights Agreement is filed as an exhibit to the
Registration Statement.
Each Right entitles the holder thereof to purchase from the Company one
one-thousandth of a share of Class B Junior Participating Series Preferred
Stock, without par value (the "Preferred Shares"), for a price of $80 per one
onethousandth of a Preferred Share (the "Purchase Price"), subject to
adjustment. The Rights become exercisable upon the earlier of (i) ten business
days following a public announcement that a person or group of affiliated or
associated persons has acquired beneficial ownership of 20% or more of the
outstanding voting shares of the Company or (ii) ten business days following the
commencement or announcement of an intention to commence a tender or exchange
offer the consummation of which would result in the beneficial ownership by a
person or group of 20% or more of the outstanding voting shares of the Company.
The Rights will expire on the later of September 15, 2005 or the third
anniversary of the date on which the Rights became exercisable (the "Final
Expiration Date"), unless the Final Expiration Date is extended or the Rights
are earlier redeemed or exchanged by the Company as described below.
If a person or group were to acquire 20% or more of the voting shares of
the Company, each Right then outstanding (other than Rights beneficially owned
by the acquiring person, which would become null and void) would become a right
to buy that number of shares of Common Stock (or, under certain circumstances,
the equivalent number of one onethousandths of a Preferred Share) that at the
time of such acquisition would have a market value of two times the Purchase
Price of the Right. If the Company were acquired in a merger or other business
combination transaction or more than 50% of its consolidated assets or earning
power were sold, proper provision will be made so that holder of a Right will
thereafter have the right to receive, upon the exercise thereof at the then
current Purchase Price of the Right, that number of shares of common stock of
the acquiring company which at the time of such transaction would have a market
value of two times the Purchase Price of the Right.
At any time after the acquisition by a person or group of beneficial
ownership of 20% or more of the outstanding voting shares of the Company and
before the acquisition by a person or group of 50% or more of the outstanding
voting shares of the Company, the Board of Directors may, at its option, issue
shares of
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Common Stock (or Preferred Shares) in mandatory redemption of, and in exchange
for, all or part of the then outstanding and exercisable Rights (other than
Rights owned by such person or group, which would become null and void) at an
exchange ratio of one share of Common Stock (or one one-thousandth of a
Preferred Share) for each Right, subject to adjustment. In addition, the Company
is entitled to redeem all of the outstanding Rights at a price of $0.01 per
Right at any time prior to the first public announcement that a person or group
has become the beneficial owner of 20% or more of the outstanding voting shares
of the Company.
Until a Right is exercised, the holder thereof, as such, has no rights as a
stockholder of the Company, including, without limitation, the right to vote or
to receive dividends.
KANSAS BUSINESS COMBINATION ACT
K N is subject to Sections 17-12,100 et seq. of the Kansas Statutes
Annotated (the "K.S.A."), which imposes a three-year moratorium on business
combinations between a Kansas corporation and an "interested stockholder" (in
general, a stockholder owning 15% or more of a corporation's outstanding voting
stock) or an affiliate or associate thereof unless (a) prior to an interested
stockholder becoming such, the board of directors of the corporation has
approved either the business combination or the transaction by which the
interested stockholder became such; (b) upon consummation of the transaction
resulting in an interested stockholder becoming such, the interested stockholder
owns 85% of the voting stock that was outstanding at the time the transaction
commenced (excluding, from the calculation of outstanding shares, shares
beneficially owned by management, directors and certain employees stock plans);
or (c) on or after the date an interested stockholder becomes such, the business
combination is approved by (i) the Board of Directors and (ii) the affirmative
vote of the holders of at least 66 2/3% of the outstanding shares (other than
those shares beneficially owned by the interested stockholder) at a meeting of
stockholders.
KANSAS CONTROL SHARE ACQUISITIONS ACT
K N is also subject to Sections 17-1286 et seq. of the K.S.A. (the "Kansas
Control Share Acquisitions Act"), which applies to public corporations
incorporated in Kansas that have certain other connections with the state. The
Kansas Control Share Acquisitions Act relates principally to the acquisition of
"control shares" in such a corporation. Under the Kansas Control Share
Acquisitions Act, a control share acquisition is one that, except for the
operation of the Act, would raise the acquiring person's voting power in the
election of directors of the subject corporation to or above any of three
thresholds: one-fifth or more but less than one-third of all voting power;
one-third or more but less than a majority of all voting power; and at least a
majority of all voting power. Whenever a control share acquisition occurs, the
acquiring person has no voting rights with respect to those shares unless both a
majority of all outstanding shares and a majority of all such shares excluding
all "interested shares" (in general, shares beneficially controlled by the
acquiring person or any officer or inside director of the subject corporation)
approve the acquisition. If the control shares are accorded voting rights, then
dissenters' rights are available under the Kansas Control Share Acquisitions Act
to stockholders who did not vote in favor of the control share acquisition and
who comply with certain prescribed procedures. If the stockholders vote not to
accord voting rights to the control shares, however, then the issuing
corporation has a 60-day option to redeem all such shares at market value.
OTHER MATTERS
The Bank of New York serves as registrar and transfer agent for the Common
Stock and for the Class A $5.00 Cumulative Preferred Stock.
DESCRIPTION OF STOCK PURCHASE CONTRACTS AND STOCK PURCHASE UNITS
The Company may issue Stock Purchase Contracts, including contracts
obligating holders to purchase from the Company, and the Company to sell to the
holders, a specified number of shares of Common Stock at a future date or dates.
The consideration per share of Common Stock may be fixed at the time the Stock
Purchase Contracts are issued or may be determined by reference to a specific
formula set forth in the Stock
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Purchase Contracts. The Stock Purchase Contracts may be issued separately or as
Stock Purchase Units consisting of a Stock Purchase Contract and Debt
Securities, Preferred Securities or debt obligations of third parties, including
U.S. Treasury securities, securing the holders' obligations to purchase the
Common Stock under the Stock Purchase Contracts. The Stock Purchase Contracts
may require the Company to make periodic payments to the holders of the Stock
Purchase Units or vice versa, and such payments may be unsecured or prefunded on
some basis. The Stock Purchase Contracts may require holders to secure their
obligations thereunder in a specified manner.
The applicable Prospectus Supplement will describe the terms of any Stock
Purchase Contracts or Stock Purchase Units. The description in the Prospectus
Supplement will not necessarily be complete, and reference will be made to the
Stock Purchase Contracts, and, if applicable, collateral arrangements and
depositary arrangements, relating to such Stock Purchase Contracts or Stock
Purchase Units. Certain material United States federal income tax considerations
applicable to the Stock Purchase Units and the Stock Purchase Contracts will be
discussed in the Prospectus Supplement relating thereto.
BOOK-ENTRY ISSUANCE
Unless otherwise specified in the applicable Prospectus Supplement, The
Depositary Trust Company ("DTC") will act as depositary for Securities issued in
the form of Global Securities. Such Securities will be issued only as
fully-registered securities registered in the name of Cede & Co. (DTC's
nominee). One or more fully-registered Global Securities will be issued for such
Securities representing in the aggregate the total number of such Securities,
and will be deposited with or on behalf of DTC.
DTC is a limited purpose trust company organized under the New York Banking
Law, a "banking organization" within the meaning of the New York Banking Law, a
member of the Federal Reserve System, a "clearing corporation" within the
meaning of the New York Uniform Commercial Code, and a "clearing agency"
registered pursuant to the provisions of Section 17A of the Exchange Act. DTC
holds securities that its Participants deposit with DTC. DTC also facilitates
the settlement among Participants of securities transactions, such as transfers
and pledges, in deposited securities through electronic computerized book-entry
changes in Participants' accounts, thereby eliminating the need for physical
movement of securities certificates. Direct Participants include securities
brokers and dealers, banks, trust companies, clearing corporations and certain
other organizations ("Direct Participants"). DTC is owned by a number of its
Direct Participants and by the New York Stock Exchange, Inc., the American Stock
Exchange, Inc. and the National Association of Securities Dealers, Inc. Access
to the DTC system is also available to others such as securities brokers and
dealers, banks and trust companies that clear through or maintain custodial
relationships with Direct Participants, either directly or indirectly ("Indirect
Participants"). The rules applicable to DTC and its Participants are on file
with the Commission.
Purchases of Securities within the DTC system must be made by or through
Direct Participants, which will receive a credit for such Securities on DTC's
records. The ownership interest of each actual purchaser of each Security
("Beneficial Owner") is in turn to be recorded on the Direct and Indirect
Participants' records. Beneficial Owners will not receive written confirmation
from DTC of their purchases, but Beneficial Owners are expected to receive
written confirmations providing details of the transactions, as well as periodic
statements of their holdings, from the Direct or Indirect Participants through
which the Beneficial Owners purchased Securities. Transfers of ownership
interests in Securities issued in the form of Global Securities are to be
accomplished by entries made on the books of Participants acting on behalf of
Beneficial Owners. Beneficial Owners will not receive certificates representing
their ownership interests in such Securities, except in the event that use of
the book-entry system for such Securities is discontinued.
DTC has no knowledge of the actual Beneficial Owners of the Securities
issued in the form of Global Securities; DTC's records reflect only the identity
of the Direct Participants to whose accounts such Securities are credited, which
may or may not be the Beneficial Owners. The Participants will remain
responsible for keeping account of their holdings on behalf of their customers.
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Conveyance of notices and other communications by DTC to Direct
Participants, by Direct Participants to Indirect Participants, and by Direct
Participants and Indirect Participants to Beneficial Owners will be governed by
arrangements among them, subject to any statutory or regulatory requirements as
may be in effect from time to time.
Redemption notices shall be sent to Cede & Co. as the registered holder of
Securities issued in the form of Global Securities. If less than all of a series
of such Securities are being redeemed, DTC's current practice is to determine by
lot the amount of the interest of each Direct Participant to be redeemed.
Although voting with respect to Securities issued in the form of Global
Securities is limited to the holders of record of such Securities, in those
instances in which a vote is required, neither DTC nor Cede & Co. will itself
consent or vote with respect to such Securities. Under its usual procedures, DTC
would mail an omnibus proxy (the "Omnibus Proxy") to the issuer of such
Securities as soon as possible after the record date. The Omnibus Proxy assigns
Cede & Co.'s consenting or voting rights to those Direct Participants to whose
accounts such Securities are credited on the record date (identified in a
listing attached to the Omnibus Proxy).
Payments in respect of Securities issued in the form of Global Securities
will be made by the issuer of such Securities to DTC. DTC's practice is to
credit Direct Participants' accounts on the relevant payment date in accordance
with their respective holdings shown on DTC's records unless DTC has reason to
believe that it will not receive payments on such payment date. Payments by
Participants to Beneficial Owners will be governed by standing instructions and
customary practices and will be the responsibility of such Participant and not
of DTC, the Institutional Trustee, either Trust or the Company, subject to any
statutory or regulatory requirements as may be in effect from time to time.
Payments to DTC are the responsibility of the issuer of the applicable
Securities, disbursement of such payments to Direct Participants is the
responsibility of DTC, and disbursements of such payments to the Beneficial
Owners is the responsibility of Direct and Indirect Participants.
DTC may discontinue providing its services as depositary with respect to
any Securities at any time by giving reasonable notice to the issuer of such
Securities. In the event that a successor depositary is not obtained, individual
Security certificates representing such Securities are required to be printed
and delivered. The Company, at its option, may decide to discontinue use of the
system of book-entry transfers through DTC (or a successor depositary).
The information in this section concerning DTC and DTC's book-entry system
has been obtained from sources that the Trust and the Company believe to be
accurate, but the Trust and the Company assume no responsibility for the
accuracy thereof. Neither the Trust nor the Company has any responsibility for
the performance by DTC or its Participants of their respective obligations as
described herein or under the rules and procedures governing their respective
operations.
PLAN OF DISTRIBUTION
Any of the Securities being offered hereby may be sold in any one or more
of the following ways from time to time: (i) through agents; (ii) to or through
underwriters; (iii) through dealers; and (iv) directly by the Company or, in the
case of Preferred Securities, by the Trust to purchasers.
The distribution of the Securities may be effected from time to time in one
or more transactions at a fixed price or prices, which may be changed, at market
prices prevailing at the time of sale, at prices related to such prevailing
market prices or at negotiated prices.
Offers to purchase Securities may be solicited by agents designated by the
Company from time to time. Any such agent involved in the offer or sale of the
Securities in respect of which this Prospectus is delivered will be named, and
any commissions payable by the Company or the Trust to such agent will be set
forth, in the applicable Prospectus Supplement. Unless otherwise indicated in
such Prospectus Supplement, any such agent will be acting on a reasonable best
efforts basis for the period of its appointment. Any such agent may be
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deemed to be an underwriter, as that term is defined in the Securities Act, of
the Securities so offered and sold.
If Securities are sold by means of an underwritten offering, the Company
and, in the case of an offering of Preferred Securities, the Trust will execute
an underwriting agreement with an underwriter or underwriters at the time an
agreement for such sale is reached, and the names of the specific managing
underwriter or underwriters, as well as any other underwriters, the respective
amounts underwritten and the terms of the transaction, including commissions,
discounts and any other compensation of the underwriters and dealers, if any,
will be set forth in the applicable Prospectus Supplement which will be used by
the underwriters to make resales of the Securities in respect of which this
Prospectus is being delivered to the public. If underwriters are utilized in the
sale of any Securities in respect of which this Prospectus is being delivered,
such Securities will be acquired by the underwriters for their own account and
may be resold from time to time in one or more transactions, including
negotiated transactions, at fixed public offering prices or at varying prices
determined by the underwriters at the time of sale. Securities may be offered to
the public either through underwriting syndicates represented by managing
underwriters or directly by one or more underwriters. If any underwriter or
underwriters are utilized in the sale of Securities, unless otherwise indicated
in the applicable Prospectus Supplement, the underwriting agreement will provide
that the obligations of the underwriters are subject to certain conditions
precedent and that the underwriters with respect to a sale of such Securities
will be obligated to purchase all such Securities if any are purchased.
The Company or the Trust, as applicable, may grant to the underwriters
options to purchase additional Securities, to cover over-allotments, if any, at
the initial public offering price (with additional underwriting commissions or
discounts), as may be set forth in the Prospectus Supplement relating thereto.
If the Company or the Trust, as applicable, grants any over-allotment option,
the terms of such over-allotment option will be set forth in the Prospectus
Supplement for such Securities.
If a dealer is utilized in the sale of the Securities in respect of which
this Prospectus is delivered, the Company or the Trust, as applicable, will sell
such Securities to the dealer as principal. The dealer may then resell such
Securities to the public at varying prices to be determined by such dealer at
the time of resale. Any such dealer may be deemed to be an underwriter, as such
term is defined in the Securities Act, of the Securities so offered and sold.
The name of the dealer and the terms of the transaction will be set forth in the
Prospectus Supplement relating thereto.
Offers to purchase Securities may be solicited directly by the Company or
the Trust, as applicable, and the sale thereof may be made by the Company or the
Trust directly to institutional investors or others, who may be deemed to be
underwriters within the meaning of the Securities Act with respect to any resale
thereof. The terms of any such sales will be described in the Prospectus
Supplement relating thereto.
Securities may also be offered and sold, if so indicated in the applicable
Prospectus Supplement, in connection with a remarketing upon their purchase, in
accordance with a redemption or repayment pursuant to their terms, or otherwise,
by one or more firms ("remarketing firms"), acting as principals for their own
accounts or as agents for the Company or the Trust, as applicable. Any
remarketing firm will be identified and the terms of its agreement, if any, with
the Company or the Trust and its compensation will be described in the
applicable Prospectus Supplement. Remarketing firms may be deemed to be
underwriters, as that term is defined in the Securities Act, in connection with
the Securities remarketed thereby.
If so indicated in the applicable Prospectus Supplement, the Company or the
Trust, as applicable, may authorize agents and underwriters to solicit offers by
certain institutions to purchase Securities from the Company or the Trust at the
public offering price set forth in the applicable Prospectus Supplement pursuant
to delayed delivery contracts providing for payment and delivery on the date or
dates stated in the applicable Prospectus Supplement. Such delayed delivery
contracts will be subject to only those conditions set forth in the applicable
Prospectus Supplement. A commission indicated in the applicable Prospectus
supplement will be paid to underwriters and agents soliciting purchases of
Securities pursuant to delayed delivery contracts accepted by the Company or the
Trust, as applicable.
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Agents, underwriters, dealers and remarketing firms may be entitled under
relevant agreements with the Company or the Trust, as applicable, to
indemnification by the Company or the Trust against certain liabilities,
including liabilities under the Securities Act, or to contribution with respect
to payments which such agents, underwriters, dealers and remarketing firms may
be required to make in respect thereof.
Each series of Securities will be a new issue and, other than the Common
Stock, which is listed on the New York Stock Exchange, will have no established
trading market. The Company may elect to list any series of Securities on an
exchange, and in the case of the Common Stock, on any additional exchange, but,
unless otherwise specified in the applicable Prospectus Supplement, the Company
shall not be obligated to do so. No assurance can be given as to the liquidity
of the trading market for any of the Securities.
Agents, underwriters, dealers and remarketing firms may be customers of,
engage in transactions with, or perform services for, the Company and its
subsidiaries in the ordinary course of business.
LEGAL MATTERS
The validity of the Preferred Securities will be passed upon on behalf of K
N Energy and the Trust by Richards, Layton & Finger P.A., special Delaware
counsel to K N Energy and the Trust. The validity of the Trust Debentures, the
Guarantee, the Debt Securities and Stock Purchase Contracts and certain matters
relating thereto will be passed upon for K N Energy and the Trust by Simpson
Thacher & Bartlett (a partnership which includes professional corporations), New
York, New York. The validity of the Common Stock and the Stock Purchase Units
will be passed upon by Martha B. Wyrsch, General Counsel of the Company. As of
January 29, 1998, Ms. Wyrsch owned 2,553 shares of Common Stock and held options
to purchase an additional 32,299 shares of Common Stock. The validity of the
Offered Securities will be passed upon for any agents, dealers or underwriters
by counsel named in the applicable Prospectus Supplement.
EXPERTS
The consolidated financial statements of K N Energy, Inc. and subsidiaries
as of December 31, 1996 and 1995, and for each of the three years in the period
ended December 31, 1996, incorporated in this Prospectus and elsewhere in the
Registration Statement by reference to its Annual Report on Form 10-K for the
year ended December 31, 1996, as amended, have been audited by Arthur Andersen
LLP, independent public accountants, as indicated in their report with respect
thereto, and are incorporated by reference herein in reliance upon the authority
of said firm as experts in accounting and auditing in giving said report.
The consolidated financial statements of MidCon Corp. and subsidiaries as
of December 31, 1996 and 1995, and for each of the three years in the period
ended December 31, 1996, incorporated in this Prospectus and elsewhere in the
Registration Statement by reference to the Current Report on Form 8-K filed with
the Commission on January 16, 1998, have been audited by Arthur Andersen LLP,
independent public accountants, as indicated in their report with respect
thereto, and are incorporated by reference herein in reliance upon the authority
of said firm as experts in accounting and auditing in giving said report.
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