<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
------------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
--------------------- -------------------------
Commission File Number 1-6446
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K N ENERGY, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Kansas 48-0290000
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
370 Van Gordon Street
P.O. Box 281304, Lakewood, Colorado 80228-8304
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(303) 989-1740
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------ ---------
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common stock, $5 par value; authorized 150,000,000 shares; outstanding
44,706,488 shares as of April 30, 1998.
<PAGE> 2
Form 10-Q
K N ENERGY, INC. AND SUBSIDIARIES
FORM 10-Q
QUARTER ENDED MARCH 31, 1998
Contents
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited) Page Number
<S> <C> <C>
Consolidated Balance Sheets................................................................... 3 & 4
Consolidated Statements of Income............................................................. 5
Consolidated Statements of Cash Flows......................................................... 6 & 7
Notes to Consolidated Financial Statements.................................................... 8 - 12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................................................... 13 - 18
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K......................................................................... 19
SIGNATURE........................................................................................................... 20
</TABLE>
2
<PAGE> 3
Form 10-Q
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
K N Energy, Inc. and Subsidiaries
(Dollars in Thousands)
<TABLE>
<CAPTION>
MARCH 31 DECEMBER 31
1998 1997
------------ ------------
<S> <C> <C>
ASSETS:
CURRENT ASSETS:
Cash and Cash Equivalents $ 28,298 $ 22,471
Restricted Deposits 16,264 11,339
U.S. Government Securities 884,223 --
Accounts Receivable 737,106 409,937
Materials and Supplies 32,682 13,476
Gas in Underground Storage 59,041 33,558
Prepaid Expenses 27,974 22,194
Gas Imbalances 76,015 46,171
Other 19,624 17,384
------------ ------------
1,881,227 576,530
------------ ------------
INVESTMENTS 180,690 149,869
------------ ------------
PROPERTY, PLANT AND EQUIPMENT 7,636,234 1,971,601
LESS ACCUMULATED DEPRECIATION AND AMORTIZATION 560,433 550,626
------------ ------------
7,075,801 1,420,975
------------ ------------
DEFERRED CHARGES AND OTHER ASSETS 128,863 158,431
------------ ------------
TOTAL ASSETS $ 9,266,581 $ 2,305,805
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
3
<PAGE> 4
Form 10-Q
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
K N Energy, Inc. and Subsidiaries
(Dollars in Thousands)
<TABLE>
<CAPTION>
MARCH 31 DECEMBER 31
1998 1997
------------ ------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY:
CURRENT LIABILITIES:
Current Maturities of Long-Term Debt $ 19,055 $ 30,751
Notes Payable 385,000 329,200
Substitute Note 1,394,846 --
Accounts Payable 664,530 334,418
Accrued Expenses 81,029 37,264
Accrued Taxes 46,274 7,445
Gas Imbalances 97,133 37,516
Other 135,163 20,217
------------ ------------
2,823,030 796,811
------------ ------------
DEFERRED LIABILITIES, CREDITS AND RESERVES:
Deferred Income Taxes 1,935,541 168,583
Other 206,378 26,160
------------ ------------
2,141,919 194,743
------------ ------------
LONG-TERM DEBT 2,894,864 553,816
------------ ------------
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 50,750 47,303
------------ ------------
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 Outstanding 7,000 7,000
------------ ------------
Common Stock-
Authorized - 150,000,000 Shares, Par Value $5 Per Share
Outstanding - 44,691,823 and 32,024,557 Shares, Respectively 223,459 160,123
Additional Paid-in Capital 840,510 270,678
Retained Earnings 195,582 185,658
Deferred Compensation (9,818) (9,203)
Treasury Stock, at Cost - 18,005 and 28,482 Shares, Respectively (715) (1,124)
------------ ------------
Total Common Stockholders' Equity 1,249,018 606,132
------------ ------------
Total Stockholders' Equity 1,256,018 613,132
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 9,266,581 $ 2,305,805
============ ============
</TABLE>
The accompanying notes are an integral part of these statements.
4
<PAGE> 5
Form 10-Q
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
K N Energy, Inc. and Subsidiaries
(In Thousands Except Per Share Amounts)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
--------------------------
1998 1997
----------- -----------
<S> <C> <C>
OPERATING REVENUES:
Upstream Gathering and Processing Services $ 132,620 $ 121,831
Midstream Sales, Transportation and Storage Services 235,906 83,919
Downstream Retail and Marketing Services 875,729 397,943
Intersegment Eliminations (79,805) (114,220)
----------- -----------
Total Operating Revenues 1,164,450 489,473
----------- -----------
OPERATING COSTS AND EXPENSES:
Gas Purchases and Other Costs of Sales 953,647 380,813
Operations and Maintenance 78,661 48,408
Depreciation and Amortization 41,453 14,300
Taxes, Other Than Income Taxes 12,148 6,047
Merger-related Costs 4,353 --
----------- -----------
Total Operating Costs and Expenses 1,090,262 449,568
----------- -----------
OPERATING INCOME 74,188 39,905
----------- -----------
OTHER INCOME AND (DEDUCTIONS):
Interest Expense (52,304) (9,656)
Minority Interests (2,829) (503)
Other, Net 16,702 2,314
----------- -----------
Total Other Income and (Deductions) (38,431) (7,845)
----------- -----------
INCOME BEFORE INCOME TAXES 35,757 32,060
Income Taxes 13,249 11,702
----------- -----------
NET INCOME 22,508 20,358
Less - Preferred Stock Dividends 88 88
----------- -----------
EARNINGS AVAILABLE FOR COMMON STOCK $ 22,420 $ 20,270
=========== ===========
Number of Shares Used in Computing
Basic Earnings Per Common Share 35,090 30,518
=========== ===========
BASIC EARNINGS PER COMMON SHARE $ 0.64 $ 0.66
=========== ===========
Number of Shares Used in Computing
Diluted Earnings Per Common Share 35,619 31,169
=========== ===========
DILUTED EARNINGS PER COMMON SHARE $ 0.63 $ 0.65
=========== ===========
DIVIDENDS PER COMMON SHARE $ 0.28 $ 0.27
=========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
5
<PAGE> 6
Form 10-Q
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
K N Energy, Inc. and Subsidiaries
Increase (Decrease) in Cash and Cash Equivalents
(In Thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
--------------------------
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 22,508 $ 20,358
Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities:
Depreciation and Amortization 41,453 14,300
Deferred Income Taxes 7,213 4,042
Deferred Purchased Gas Costs 17,414 (11,297)
Provision for Losses on Accounts Receivable 39 233
(Gain) Loss on Sale of Facilities (8,252) --
Proceeds from Gas Contract Settlement 27,500 --
Change in Gas in Underground Storage 2,214 13,633
Changes in Other Working Capital Items 7,951 (17,261)
Changes in Deferred Revenues (1,466) 506
Other, Net (25,551) 18,823
----------- -----------
NET CASH FLOWS FROM OPERATING ACTIVITIES 91,023 43,337
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital Expenditures (81,163) (44,853)
Cash Paid for Acquisition of MidCon, Net of Cash Acquired (2,139,752) --
Other Acquisitions (9,137) (93,729)
Investments (2,526) (16,127)
Purchase of U.S. Government Securities (884,223) --
Proceeds from Sales of Assets 25,152 407
----------- -----------
NET CASH FLOWS USED IN INVESTING ACTIVITIES (3,091,649) (154,302)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-Term Debt, Net 55,800 132,700
Long-Term Debt - Issued 2,362,000 --
Long-Term Debt - Retired (20,662) (6,001)
Common Stock Issued in Public Offering 650,000 --
Other Common Stock Issuance 4,070 1,544
Treasury Stock - Issued 409 567
- Acquired -- (586)
Cash Dividends - Common (12,496) (8,259)
- Preferred (88) (88)
Minority Interests - Contributions 13,311 --
- Distributions -- (197)
Securities Issuance Costs (45,891) --
----------- -----------
NET CASH FLOWS FROM FINANCING ACTIVITIES 3,006,453 119,680
----------- -----------
Net Increase in Cash and Cash Equivalents 5,827 8,715
Cash and Cash Equivalents at Beginning of Period 22,471 10,339
----------- -----------
Cash and Cash Equivalents at End of Period $ 28,298 $ 19,054
=========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
6
<PAGE> 7
Form 10-Q
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
K N Energy, Inc. and Subsidiaries
Increase (Decrease) in Cash and Cash Equivalents
(In Thousands)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
--------------------------
1998 1997
----------- -----------
<S> <C> <C>
CHANGES IN OTHER WORKING CAPITAL ITEMS:
(NET OF EFFECTS OF ACQUISITIONS AND DIVESTITURE)
Accounts Receivable $ 72,952 $ 88,362
Materials and Supplies Inventory (7,514) 403
Other Current Assets (11,796) 14,707
Accounts Payable (60,688) (103,008)
Other Current Liabilities 14,997 (17,725)
----------- -----------
$ 7,951 $ (17,261)
=========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash Paid for:
Interest (Net of Amount Capitalized) $ 31,120 $ 13,199
=========== ===========
Income Taxes Paid (Refunded), Net $ (228) $ 1,559
=========== ===========
</TABLE>
7
<PAGE> 8
Form 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. General
As used herein, "K N" or "the Company" refers to K N Energy, Inc. and its
consolidated subsidiaries unless the context otherwise requires. In the opinion
of Management, all adjustments necessary for a fair presentation of the results
for the unaudited interim periods have been made. Except as explicitly noted,
these adjustments consist solely of normal recurring accruals. Certain prior
period amounts have been reclassified to conform with the current presentation.
2. Acquisitions and Divestiture
On April 23, 1998, K N announced that it had agreed to purchase partnership
interests in four independent power plants in Colorado from Denver-based Thermo
Cos. ("Thermo"), representing approximately 380 megawatts of electric generation
capacity and access to approximately 130 Bcf of natural gas reserves. These
generating facilities are located in Fort Lupton (272 megawatts) and Greeley
(108 megawatts) and sell their power output to Public Service Co. of Colorado
under long-term contracts. The purchase, subject to the completion of certain
agreements involving an existing partner in certain of the generating
facilities, is expected to be paid for over a three-year period, with the
initial payment of $35 million to be made using 100% K N common stock and the
remaining two payments (in 1999 and 2000) being a combination of cash and K N
common stock as agreed to by the parties, with the default mix being 50% stock
and 50% cash.
In March 1998, K N completed the sale of its Kansas retail natural gas
distribution properties, located in 58 Kansas communities and serving
approximately 30,000 residential, commercial and industrial customers, to
Midwest Energy, Inc., a customer-owned cooperative based in Hays, Kansas. K N
received approximately $24 million in cash in conjunction with the sale and
recorded a pre-tax gain of approximately $8.5 million (approximately $5.5
million or $0.15 per diluted share after tax). Concurrently with the sale, K N
received approximately $27.5 million in cash in exchange for the release of the
purchaser from certain contractual gas purchase obligations, which amount will
be amortized by K N over a period of years as the associated volumes are sold.
On January 30, 1998, pursuant to a definitive stock purchase agreement (the
"Agreement"), K N acquired all of the outstanding shares of capital stock of
MidCon Corp. ("MidCon") from Occidental Petroleum Corporation ("Occidental") for
$2.1 billion in cash and the assumption of a $1.39 billion note (the "Substitute
Note"), at which time MidCon became a wholly owned subsidiary of K N Energy,
Inc. (the "Acquisition"). The Substitute Note bears interest at 5.798%, is due
January 4, 1999, and is required to be collateralized by U.S. government
securities, letters of credit or a combination thereof. In conjunction with the
Acquisition, K N also assumed MidCon's obligation to lease the MidCon Texas
intrastate pipeline system under a 30-year operating lease, requiring average
annual lease payments of approximately $30 million. The Acquisition was
initially financed through a combination of commitments referred to as the bank
facility (see Note 3).
MidCon is engaged in the purchase, gathering, processing, transmission, storage
and sale of natural gas to utilities, municipalities, and industrial and
commercial users. Prior to the acquisition, MidCon also purchased electricity
from electric utilities and other electric power producers and marketers and
resold the electricity to wholesale and end-use customers. MidCon's pipeline
subsidiaries operate over 13,000 miles of natural gas pipelines located in the
center of the North American pipeline grid, with access to major supply and
market
8
<PAGE> 9
Form 10-Q
areas. MidCon is also one of the nation's largest natural gas storage operators
and owns and operates several natural gas gathering and natural gas processing
facilities.
The Acquisition was accounted for as a purchase for accounting purposes and,
accordingly, the MidCon assets acquired and liabilities assumed have been
preliminarily recorded at their respective estimated fair market values as of
the acquisition date. The final fair market values will be assigned after
completion of a more extensive review of the relevant assets, liabilities and
issues identified as of the acquisition date, and may differ materially from the
preliminary values. The preliminary allocation of purchase price resulted in the
recognition of a gas plant acquisition adjustment of approximately $4.3 billion,
representing the excess of the assigned fair market value of the assets of
Natural Gas Pipeline Company of America ("NGPL") over its historical cost for
ratemaking purposes. This gas plant acquisition adjustment, none of which is
currently being recognized for rate-making purposes, is being amortized over 36
years, approximately the estimated remaining useful life of NGPL's interstate
pipeline system and, for the quarter ended March 31, 1998, approximately $19.8
million was charged to expense (representing the two months subsequent to the
Acquisition). The assets, liabilities and results of operations of MidCon are
included with those of the Company beginning with the acquisition date.
The following pro forma information gives effect to the acquisition of MidCon as
if the business combination had occurred at the beginning of each period
presented. The pro forma adjustments which have been made are based on a
preliminary allocation of the purchase price to assets acquired and liabilities
assumed and do not reflect adjustments for anticipated operating efficiencies
and cost savings which K N expects to achieve in conjunction with the
acquisition. In addition, no pro forma adjustments have been made for the
post-acquisition refinancings completed by K N. This unaudited pro forma
information should be read in conjunction with the accompanying interim
Consolidated Financial Statements, Management's Discussion and Analysis of
Financial Condition and Results of Operations and with the previously-filed
unaudited pro forma consolidated financial statements and related notes. This
pro forma information is not necessarily indicative of the financial results
which would have occurred had the Acquisition taken place on the dates
indicated, nor is it necessarily indicative of future financial results.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31
--------------------------------------
<S> <C> <C>
Unaudited Pro Forma Financial Information 1998 1997
-------- --------
(dollars in millions, except
per share amounts)
Operating Revenues $1,432.5 $1,342.8
Net Income $ 26.5 $ 36.9
Diluted Earnings per Common Share $ 0.75 $ 1.21
Weighted Average Shares Outstanding (in thousands) 35,090 30,518
</TABLE>
In December 1997, K N acquired Interenergy Corporation ("Interenergy"), a
diversified energy company involved with natural gas gathering, processing and
marketing in the Rocky Mountain and mid-continent states. In a transaction
accounted for as a purchase, K N exchanged 544,604 shares of K N common stock
for all the outstanding shares of Interenergy and assumed Interenergy's debt.
Also in December 1997, K N purchased an equity interest in Red Cedar Gathering
Company ("Red Cedar"), a gathering system located in the northern San Juan Basin
on the Southern Ute Indian Reservation in La Plata County, Colorado.
Red Cedar is jointly-owned by the Southern Ute Indian Tribe.
9
<PAGE> 10
Form 10-Q
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 Company assumed operation of these
facilities effective April 1, 1997, and has accounted for this transaction as a
purchase. K N leases the processing facilities at Bushton under operating leases
requiring semi-annual payments averaging $23.1 million per annum for the
remaining term of the leases. Under the terms of these leases, K N 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, K N may purchase the processing facilities upon
termination of the leases.
3. Business Segments
K N Energy, Inc. has adopted a strategy of extracting profit from the energy
value stream which extends from the purchase or production of the fuel through
the sale of the energy to the end-user. Consistent with this strategy, K N
manages its business and has segregated its activities into three business
segments, "Upstream", "Midstream" and "Downstream", based on where in the value
stream such activities are conducted. In general, these segments are also
differentiated by the nature of their processes, their principal suppliers and
their target markets and customers. The Company's Upstream operations consist of
(i) natural gas gathering, (ii) natural gas processing and (iii) natural gas
liquids ("NGLs") extraction and marketing; Midstream operations consist of
transportation, storage and bundled sales transactions for K N's interstate and
intrastate pipelines; Downstream operations consist of energy marketing and
regulated natural gas distribution.
The accounting policies applied in the generation of segment information are
generally the same as those described in the summary of significant accounting
policies in K N's 1997 Report on Form 10-K except that, in general, items below
the "Operating Income" line are either not allocated to business segments or are
not considered by Management in its evaluation of business unit performance. In
addition, certain items included in operating income (such as the merger-related
costs included in the first quarter of 1998) are not allocated to individual
business segments. With adjustment for these items, K N currently evaluates
business segment performance primarily based on operating income in relation to
the level of capital employed. In general, intersegment sales are accounted for
at market prices, while asset transfers are made at either market value or, in
some instances, book value. For comparative purposes, prior period results and
balances have been reclassified to conform to the current presentation.
10
<PAGE> 11
Form 10-Q
<TABLE>
<CAPTION>
Three Months Ended March 31, 1998
-------------------------------------------------------------------------------------
Upstream Midstream Downstream Other Consolidated
-------- --------- ---------- ----- ------------
(millions of dollars)
<S> <C> <C> <C> <C> <C>
Revenues from External Customers $115.3 $ 180.1 $ 869.1 $ -- $1,164.5
Intersegment Revenues $ 17.3 $ 55.8 $ 6.7 $ -- 79.8
Operating Income (Loss) $ (8.3) $ 79.3 $ 7.6 $ (4.4)(1) 74.2
Other Income and (Deductions) (38.4)
--------
Income Before Income Taxes $ 35.8
========
Total Assets at March 31, 1998 $594.4 $6,521.9 $1,040.8 $1,109.5 (2) $9,266.6
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended March 31, 1997
-------------------------------------------------------------------------------------
Upstream Midstream Downstream Other Consolidated
-------- --------- ---------- ----- ------------
(millions of dollars)
<S> <C> <C> <C> <C> <C>
Revenues from External Customers $ 91.5 $ 41.6 $ 356.4 $ -- $ 489.5
Intersegment Revenues $ 30.4 $ 42.3 $ 41.5 $ -- 114.2
Operating Income $ 8.3 $ 15.1 $ 16.5 $ -- 39.9
Other Income and (Deductions) (7.8)
--------
Income Before Income Taxes $ 32.1
========
</TABLE>
(1) Represents costs related to the MidCon Merger (see Note 2).
(2) Corporate assets represent principally cash, restricted deposits, U.S.
government securities and investments in unconsolidated subsidiaries.
4. Financing
The total amount of funds required by K N to complete the Acquisition, pay
related fees and expenses and to repay borrowings under K N's existing credit
facility was approximately $2,518 million which was financed through borrowings
under credit agreements dated January 30, 1998 (the "Bank Facility") among K N,
Morgan Guaranty Trust Company of New York and a syndicate of other lenders. A
working capital facility replaced the revolving credit agreement previously in
place (the "Pre-Acquisition Facility"). An acquisition facility was also part of
the overall Bank Facility structure. See Note 8(A) of Notes to Consolidated
Financial Statements on pages 41-42 of K N's 1997 Annual Report on Form 10-K for
additional information regarding the Bank Facility and the Pre-Acquisition
Facility. In addition to the working capital and acquisition components of the
Bank Facility explained preceding, K N assumed a short-term note for $1,395
million (the "Substitute Note") which, pursuant to the Agreement, was initially
collateralized by letters of credit issued under a commitment for that purpose
within the Bank Facility.
In March 1998, K N received net proceeds of approximately $624.6 million from an
underwritten public offering of 12,500,000 shares of K N common stock and
approximately $2,341.5 million from the concurrent underwritten public offerings
of senior debt securities of varying maturities totaling $2.35 billion. The net
proceeds from these offerings were used to refinance borrowings under the Bank
Facility and to purchase U.S. government securities to replace a portion of the
letters of credit that collateralized the Substitute Note.
Following are the principal amounts, maturity dates and coupon rates for the
senior debt securities issued:
<TABLE>
<CAPTION>
<S> <C>
$500 million - 6.45% Senior Notes due March 1, 2003
$500 million - 6.65% Senior Notes due March 1, 2005
$300 million - 6.80% Senior Notes due March 1, 2008
$500 million - 7.25% Senior Debentures due March 1, 2028
$150 million - 7.45% Senior Debentures due March 1, 2098
$400 million - 6.30% Reset Put Securities due March 1, 2021
</TABLE>
11
<PAGE> 12
Form 10-Q
The 2003 Senior Notes and the 2005 Senior Notes are not redeemable prior to
maturity. The 2008 Senior Notes, 2028 Senior Debentures and 2098 Senior
Debentures are redeemable as a whole or in part, at the option of the Company at
any time, at redemption prices defined in the associated prospectus supplement.
The Reset Put Securities due March 1, 2021 (the "2021 REPS") are subject to
mandatory redemption from the then-existing holders on March 1, 2001 either (i)
through the exercise of a call option 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 a mandatory put by First Trust
National Association on behalf of the holders. The $12 million of proceeds
received by K N from the Callholder as consideration for the call option are
being amortized as an adjustment to the effective interest rate on the 2021
REPS. If the Callholder elects to exercise the call option, the interest rate
will be reset at that time.
In April 1998, K N sold $175 million of 7.63% Capital Securities (the "Capital
Securities") due April 15, 2028, in an underwritten public offering. The sale
was effected through a wholly owned business trust, K N Capital Trust III (the
"Trust"). The Company used the net proceeds from the offering to purchase U.S.
government securities to replace a portion of the letters of credit that
collateralized the Substitute Note.
The financial statements of the Trust will be consolidated into the Company's
consolidated financial statements, with the Capital Securities treated as a
minority interest and included in the Company's consolidated balance sheet under
the caption "K N-Obligated Mandatorily Redeemable Preferred Capital Trust
Securities of Subsidiary Trust Holding Solely Debentures of K N."
5. Comprehensive Income
Statement of Financial Accounting Standards No. 130, "Reporting of Comprehensive
Income", effective for fiscal years beginning after December 15, 1997, requires
that enterprises report a total for comprehensive income. Currently, the only
difference between "net income" and "comprehensive income" for K N is the
unrealized gain or loss on its investment in available-for-sale securities which
is recorded directly to stockholders' equity. For the quarters ended March 31,
1998 and 1997, the respective unrealized after-tax investment gain (loss) was
$1.8 million and $(1.4) million, resulting in comprehensive income of $24.3
million and $19.0 million, respectively.
12
<PAGE> 13
Form 10-Q
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The following discussion should be read in conjunction with (i) the accompanying
interim Consolidated Financial Statements and related Notes and (ii) the
Consolidated Financial Statements, related Notes and Management's Discussion and
Analysis of Financial Condition and Results of Operations included in K N's 1997
Report on Form 10-K. Due to the seasonal variations in energy demand, among
other factors, the interim results which follow may not be indicative of the
results to be expected for an entire year. As discussed in Note 2 to the
accompanying interim Consolidated Financial Statements, the Company has engaged
in acquisition and divestiture transactions which affect the comparison of
results between periods.
Certain information contained herein may include forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933 and Section 21E
of the Securities Exchange Act of 1934. Although the Company believes that these
statements are based upon reasonable assumptions, it can give no assurance that
its goals will be achieved. Important factors that could cause actual results to
differ materially from those in the forward-looking statements contained herein
include, among other factors, the pace of deregulation of retail natural gas and
electricity markets in the United States, federal and state regulatory
developments, the timing and extent of changes in commodity prices for oil, gas,
NGLs, electricity, certain agricultural products and interest rates, the extent
of success in acquiring natural gas facilities, the timing and success of
efforts to develop power, pipeline and other projects, political developments in
foreign countries, and conditions of the capital markets and equity markets
during the periods covered by the forward-looking statements.
CONSOLIDATED FINANCIAL RESULTS
Consolidated net income for the first quarter of 1998 was $22.5 million, a $2.1
million (10.3%) increase from 1997 first-quarter net income of $20.4 million.
After deduction for preferred dividends, diluted earnings per share was $0.63
and $0.65 in the first quarter of 1998 and 1997, respectively, based on
respective weighted average common shares outstanding of 35.6 million and 31.2
million. The increased number of common shares outstanding in the first quarter
of 1998 was principally due to the early March 1998 public sale of $12.5 million
shares of common stock as described in Note 4 to the accompanying interim
Consolidated Financial Statements. Results for the first quarter of 1998
included (i) a pre-tax charge of approximately $4.4 million (approximately $2.7
million or $0.08 per diluted share after tax) due to costs attributable to the
acquisition and integration of MidCon, principally severance and relocation
costs associated with current or former K N employees and (ii) a pre-tax gain of
approximately $8.5 million (approximately $5.5 million or $0.15 per diluted
share after tax) from the sale of K N's Kansas natural gas distribution
properties (see Note 2 to the accompanying interim Consolidated Financial
Statements).
RESULTS OF OPERATIONS
Following is a discussion of (i) operating results by business segment, (ii)
"Other income (Deductions)" and (iii) "Income Taxes". In conjunction with the
adoption of Statement of Financial Accounting Standards No. 131, "Disclosure
About Segments of an Enterprise and Related Information", and reflecting the
Company's strategy of extracting margins from the various segments of the energy
value stream, the Company has segregated its results of operations into its
"Upstream", "Midstream" and "Downstream" components. The Company's Upstream
operations consist of (i) natural gas gathering, (ii) natural gas processing and
(iii) natural gas liquids
13
<PAGE> 14
Form 10-Q
("NGLs") extraction and marketing activities; Midstream operations consist of
transportation, storage and bundled sales transactions for K N's interstate and
intrastate pipelines; Downstream activities consist of energy marketing and
regulated natural gas distribution. For comparative purposes, the Company's
previously reported results have been restated to conform to the current
presentation. Segment operating revenues, gas purchases, operations and
maintenance expenses and volumetric data given following are before intersegment
eliminations.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
-------------------------------
(DOLLARS IN MILLIONS)
INCREASE
UPSTREAM GATHERING AND PROCESSING 1998 1997 (DECREASE)
-------- -------- ----------
<S> <C> <C> <C>
Operating Revenues
Gas Sales $ 50.3 $ 40.7 $ 9.6
Natural Gas Liquids Sales 55.8 65.7 (9.9)
Gathering, Transportation and Other 26.5 15.4 11.1
-------- -------- --------
132.6 121.8 10.8
-------- -------- --------
Operating Costs and Expenses
Gas Purchases and Other Costs of Sales 102.0 93.5 8.5
Operations and Maintenance 29.7 14.6 15.1
Depreciation and Amortization 6.0 3.8 2.2
Taxes, Other Than Income Taxes 3.2 1.6 1.6
-------- -------- --------
140.9 113.5 27.4
-------- -------- --------
Operating Income (Loss) $ (8.3) $ 8.3 $ (16.6)
======== ======== ========
Systems Throughput (Trillion Btus)
Gas Sales 24.8 14.5 10.3
Gathering and Transportation 85.6 51.5 34.1
-------- -------- --------
110.4 66.0 44.4
-------- -------- --------
Natural Gas Liquids Sales (Million Gallons)
Company-Owned and Processed 154.4 103.4 51.0
Third-Party Marketed 25.4 47.0 (21.6)
-------- -------- --------
179.8 150.4 29.4
======== ======== ========
</TABLE>
Upstream operating income decreased from income of $8.3 million in the first
quarter of 1997 to a loss of $(8.3) million in the first quarter of 1998, a
decline of $16.6 million. Approximately $2.8 million (16.9%) of this unfavorable
variance was attributable to the first-quarter 1998 net results of Upstream
assets not owned or operated in the first quarter of 1997, including Bushton,
Interenergy and the gathering and processing assets of MidCon (see Note 2 to the
accompanying interim consolidated financial statements). The addition of these
assets was principally responsible for the increases in operating revenues,
operating expenses and volumes shown preceding, while the associated net
negative operating results were principally due to relatively low NGL prices as
discussed following which reduced margins from processing. With respect to the
$13.8 million negative variance associated with assets and operations included
in both quarters, approximately $8.7 million (63.0%) was attributable to a
decline in NGL prices from the first quarter of 1997 to the first quarter of
1998. Average NGL sales prices during these periods declined by approximately
$0.11 per gallon (26.8%). The remaining unfavorable variance was principally
attributable to reduced NGL recoveries at certain processing facilities
and a refund of certain previously recorded gathering revenues.
14
<PAGE> 15
Form 10-Q
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------------
(DOLLARS IN MILLIONS)
INCREASE
MIDSTREAM SALES, TRANSPORTATION AND STORAGE 1998 1997 (DECREASE)
---------- ---------- ----------
<S> <C> <C> <C>
Operating Revenues
Transportation and Storage $ 87.8 $ 39.6 $ 48.2
Other 148.1 44.3 103.8
---------- ---------- ----------
235.9 83.9 152.0
---------- ---------- ----------
Operating Costs and Expenses
Gas Purchases and Other Costs of Sales 86.2 41.2 45.0
Operations and Maintenance 32.9 18.2 14.7
Depreciation and Amortization 30.7 6.7 24.0
Taxes, Other Than Income Taxes 6.8 2.7 4.1
---------- ---------- ----------
156.6 68.8 87.8
---------- ---------- ----------
Operating Income $ 79.3 $ 15.1 $ 64.2
========== ========== ==========
Systems Throughput (Trillion Btus) 416.7 136.7 280.0
========== ========== ==========
</TABLE>
Midstream operating income increased from $15.1 million in the first quarter of
1997 to $79.3 million in the first quarter of 1998, an increase of $64.2
million. This increase in operating income, as well as the significant increases
in operating revenues, operating expenses and volumes as shown preceding, was
principally attributable to the inclusion, in the first quarter of 1998, of two
months of operating results for the interstate and intrastate pipeline
operations of MidCon (see Note 2 to the accompanying interim Consolidated
Financial Statements) and a full quarter of results from the Pony Express
Pipeline, which was placed in service in the fourth quarter of 1997. These
incremental operations were responsible for approximately $71.1 million of
first-quarter 1998 operating income. The unfavorable variance of $6.9 million
associated with other operations in the Midstream segment was principally due to
a first-quarter 1998 decline in the profitability of certain Texas intrastate
pipeline operations due to a decline in sales volumes under certain contracts
resulting from (i) LDC unbundling and (ii) relatively warmer first-quarter 1998
weather. Additional unfavorable variance was attributable to the impact of
relatively warmer first-quarter 1998 weather on throughput and margins for the
remainder of K N's midstream operations.
15
<PAGE> 16
Form 10-Q
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------------------
(DOLLARS IN MILLIONS)
INCREASE
DOWNSTREAM RETAIL AND MARKETING 1998 1997 (DECREASE)
------------ ------------ ------------
<S> <C> <C> <C>
Operating Revenues
Gas Sales $ 863.4 $ 378.5 $ 484.9
Transportation and Other 12.3 19.4 (7.1)
------------ ------------ ------------
875.7 397.9 477.8
------------ ------------ ------------
Operating Costs and Expenses
Gas Purchases and Other Costs of Sales 844.4 360.2 484.2
Operations and Maintenance 16.8 15.7 1.1
Depreciation and Amortization 4.8 3.8 1.0
Taxes, Other Than Income Taxes 2.1 1.7 0.4
------------ ------------ ------------
868.1 381.4 486.7
------------ ------------ ------------
Operating Income $ 7.6 $ 16.5 $ (8.9)
============ ============ ============
Systems Throughput (Trillion Btus)
Gas Sales 352.6 132.6 220.0
Transportation 4.7 4.2 0.5
------------ ------------ ------------
357.3 136.8 220.5
============ ============ ============
</TABLE>
Downstream operating income decreased from $16.5 million in the first quarter of
1997 to $7.6 million in the first quarter of 1998, a decrease of $8.9 million
(53.9%), principally due to a decline of $6.7 million in operating income
attributable to limited sales of storage gas. Operating income for the first
quarter of 1998 also reflected a small positive contribution due to the addition
of the downstream activities of MidCon and Interenergy subsequent to their
acquisition (see Note 2 to the accompanying interim Consolidated Financial
Statements). In addition, the substantial increases in operating revenues,
operating expenses and volumes are largely due to the first-quarter 1998 impact
of these activities which were not a part of K N in the first quarter of 1997.
Activities included in both periods also experienced significant increases in
volume as well as associated operating revenues and expenses principally due to
intensified marketing efforts supported by an increased marketing staff. A small
decrease in the contribution from regulated retail activities reflected sales
volumes of approximately 6% below the first quarter of 1997, largely due to
warmer first-quarter 1998 weather.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
-------------------------------------
(DOLLARS IN MILLIONS)
EARNINGS
INCREASE
OTHER INCOME AND (DEDUCTIONS) 1998 1997 (DECREASE)
---------- ---------- ----------
<S> <C> <C> <C>
Interest Expense $ (52.3) $ (9.7) $ (42.6)
Minority Interests (2.8) (0.5) (2.3)
Other, Net 16.7 2.4 14.3
---------- ---------- ----------
$ (38.4) $ (7.8) (30.6)
========== ========== ==========
</TABLE>
The increase of $42.6 million in interest expense from the first quarter of 1997
to the first quarter of 1998 is principally due to the incremental debt
associated with (i) the acquisition of MidCon effective January 30, 1998, (see
Note 2 to the accompanying interim Consolidated Financial Statements) and (ii)
the construction cost of the Pony Express Pipeline, which was placed in service
during the latter part of 1997. The increased first-quarter 1998 net expense
associated with "Minority Interests" was principally due to the dividend
requirement associated with the $100 million of Capital Trust Securities issued
in April 1997. The increase of $14.3 million in "Other, Net" from the first
quarter of 1997 to the first quarter of 1998 was principally due to (i) the
first-quarter 1998 gain of $8.5 million from K N's sale of its Kansas natural
gas distribution
16
<PAGE> 17
Form 10-Q
properties, (ii) the increase of $2.6 million in interest income attributable to
earnings on the U.S. government securities held as collateral for the Substitute
Note issued in conjunction with the acquisition of MidCon and (iii) an increase
of $3.8 million in first-quarter 1998 income attributable to equity in the
earnings of unconsolidated subsidiaries (see Note 2 to the accompanying interim
Consolidated Financial Statements).
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
--------------------------------------
(DOLLARS IN MILLIONS)
INCREASE
INCOME TAXES 1998 1997 (DECREASE)
---------- ---------- ----------
<S> <C> <C> <C>
Provisions $ 13.25 $ 11.70 $ 1.55
========== ========== ==========
Effective Tax Rate 36.9% 36.5% 0.4%
========== ========== ==========
</TABLE>
Of the $1.55 million increase in income tax expense from the first quarter of
1997 to the first quarter of 1998, approximately $1.35 million (87.2%) was
attributable to an increase in 1998 pre-tax income and the balance of
approximately $0.2 million (12.8%) was attributable to a minor increase in the
first-quarter 1998 effective tax rate.
LIQUIDITY AND CAPITAL RESOURCES
The following table illustrates the sources of the Company's invested capital
for the last three years and at March 31, 1998 and 1997. The balances at March
31, 1998 reflect the incremental capital associated with the acquisition of
MidCon, including the post-acquisition refinancings completed in the first
quarter of 1998. In addition, during April 1998, the Company issued $175 million
of Capital Trust Securities. For additional information on these financing
activities, see Note 4 to the accompanying interim Consolidated Financial
Statements.
<TABLE>
<CAPTION>
MARCH 31 DECEMBER 31
--------------------------- ------------------------------------------
(DOLLARS IN THOUSANDS)
1998 1997 1997 1996 1995
---------- ------------ ---------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Long-Term Debt $2,894,864 $ 414,689 $ 553,816 $ 423,676 $ 315,564
Common Equity 1,249,018 534,080 606,132 519,794 426,760
Preferred Stock 7,000 7,000 7,000 7,000 7,572
Capital Trust Securities 100,000 -- 100,000 -- --
---------- ------------ ---------- ------------ ------------
Capitalization 4,250,882 955,769 1,266,948 950,470 749,896
Short-Term Debt 1,798,901(1) 291,971 359,951 156,271 116,197
---------- ------------ ---------- ------------ ------------
Invested Capital $6,049,783 $ 1,247,740 $1,626,899 $ 1,106,741 $ 866,093
========== ============ ========== ============ ============
Capitalization:
Long-Term Debt 68.1% 43.4% 43.7% 44.6% 42.1%
Common Equity 29.4% 55.9% 47.8% 54.7% 56.9%
Preferred Stock 0.2% 0.7% 0.6% 0.7% 1.0%
Capital Trust Securities 2.3% 0.0% 7.9% 0.0% 0.0%
Invested Capital:
Total Debt(2) 77.6% 56.6% 56.2% 52.4% 49.9%
Equity, Including Capital
Trust Securities 22.4% 43.4% 43.8% 47.6% 50.1%
</TABLE>
(1) Includes the $1,394,846 Substitute Note assumed in conjunction with the
acquisition of MidCon.
(2) If the government securities held as collateral are offset against the
related debt, the ratio of total debt to total capitalization is 73.7%.
17
<PAGE> 18
Form 10-Q
The following discussion of cashflows should be read in conjunction with the
accompanying interim Consolidated Statement of Cash Flows and related
Supplemental Disclosures and with the Consolidated Statement of Cash Flows
included in the Company's 1997 Report on Form 10-K.
NET CASH FLOWS FROM OPERATING ACTIVITIES
"Net Cash Flows From Operating Activities" increased from approximately $43.3
million in the first quarter of 1997 to approximately $91.0 million in the
first quarter of 1998, an increase of approximately $47.7 million (110.2%).
This increase was principally attributable to (i) the increase in first-quarter
1998 earnings before non-cash charges and credits, largely due to the inclusion
of the results of operations of MidCon for two months (see Note 2 to the
accompanying interim Consolidated Financial Statements), (ii) the first-quarter
1998 receipt of $27.5 million in settlement of a gas contract and (iii) an
increase in first-quarter 1998 cash provided from miscellaneous working capital
items. These favorable variances were partially offset by cash used in the
first quarter of 1998 for miscellaneous non-working capital items.
NET CASH FLOWS FROM INVESTING ACTIVITIES
"Net Cash Flows Used in Investing Activities" increased from approximately
$154.3 million in the first quarter of 1997 to approximately $3.1 billion in
the first quarter of 1998, an increase of approximately $2.9 billion
principally due to (i) the $2.1 billion of net cash paid in the first quarter
of 1998 and (ii) the purchase of approximately $0.9 billion of U.S. government
securities to be held as collateral for the Substitute Note, in each case in
conjunction with the acquisition of MidCon (see Note 2 to the accompanying
interim Consolidated Financial Statements). Increased first-quarter 1998 cash
used for capital expenditures was largely offset by cash received from sales of
assets and reduced cash used for the purchase of investments.
NET CASH FLOWS FROM FINANCING ACTIVITIES
"Net Cash Flows From Financing Activities" increased from approximately $119.7
million in the first quarter of 1997 to approximately $3.0 billion in the first
quarter of 1998, an increase of approximately $2.9 billion. This increase
reflected the receipt of (i) approximately $2.36 billion in conjunction with the
public sale of debt securities and (ii) approximately $650 million in
conjunction with the public sale of common stock (in each case representing the
refinancing of acquisition debt associated with the purchase of MidCon), net of
associated issuance costs of approximately $45.9 million (see Notes 2 and 4 to
the accompanying interim Consolidated Financial Statements).
The Company's principal source of short-term liquidity is its bank facility
(see Note 8 (A) of Notes to Consolidated Financial Statements included in K N's
1997 Annual Report on Form 10-K) which makes available a total working capital
line of $1 billion. At March 31, 1998, the Company had borrowed $250 million
under this facility and had issued $135 million of commercial paper. The
Company believes its remaining capacity under this facility is adequate for its
expected short-term cash requirements.
18
<PAGE> 19
Form 10-Q
OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits
27 - Financial Data Schedule
(B) Reports on Form 8-K
Current Report on Form 8-K dated January 5, 1998 to report the entering into a
stock purchase on December 18, 1997 for the acquisition of MidCon Corp. from
Occidental Petroleum Corporation.
Current Report on Form 8-K dated January 16, 1998 to present MidCon Corp. and
subsidiaries financial statements for the year ended December 31, 1996, the nine
months ended September 30, 1997 and unaudited pro forma consolidated financial
information.
Amended Current Report on Form 8-K/A filed February 12, 1998 to report the
closing of the acquisition of MidCon Corp. from Occidental Petroleum Corporation
on January 30, 1998 and to present audited financial statements for MidCon Corp.
and subsidiaries financial statements for the three years ended December 31,
1997 and unaudited pro forma condensed balance sheet at September 30, 1997 and
unaudited pro forma condensed statements of income for the year ended December
31, 1996 and the nine months ended September 30, 1997.
Current Report on Form 8-K dated March 6, 1998 to report the issuance of debt
securities in the aggregate amount of $2,350,000,000 and equity securities in
the aggregate amount of $650,000,000.
19
<PAGE> 20
Form 10-Q
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
K N ENERGY, INC.
(Registrant)
May 14, 1998 /s/ Clyde E. McKenzie
-----------------------------------------------
Clyde E. McKenzie
Vice President and Chief Financial Officer
(On Behalf of the Registrant and as
Principal Financial and Accounting Officer)
20
<PAGE> 21
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NUMBER DESCRIPTION
- -------------- -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 28,298
<SECURITIES> 884,223
<RECEIVABLES> 737,106
<ALLOWANCES> 0
<INVENTORY> 91,723
<CURRENT-ASSETS> 1,881,227
<PP&E> 7,636,234
<DEPRECIATION> 560,433
<TOTAL-ASSETS> 9,266,581
<CURRENT-LIABILITIES> 2,823,030
<BONDS> 2,894,864
0
7,000
<COMMON> 223,459
<OTHER-SE> 1,025,559
<TOTAL-LIABILITY-AND-EQUITY> 9,266,581
<SALES> 1,164,450
<TOTAL-REVENUES> 1,164,450
<CGS> 953,647
<TOTAL-COSTS> 1,090,262
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 52,304
<INCOME-PRETAX> 35,757
<INCOME-TAX> 13,249
<INCOME-CONTINUING> 22,508
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 22,508
<EPS-PRIMARY> 0.64
<EPS-DILUTED> 0.63
</TABLE>
