<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549-1004
--------------------
FORM 8-K/A
--------------------
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED) JANUARY 30, 1998
-------------------
K N ENERGY, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
-------------------
KANSAS 1-6446 48-0290000
(State or other (Commission File Number) (I.R.S. Employer
jurisdiction of Identification No.)
incorporation or
organization)
370 VAN GORDON STREET
P.O. BOX 281304
LAKEWOOD, COLORADO 80228-8304
(Address of Principal (Zip Code)
Executive Offices)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (303) 989-1740
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<PAGE> 2
ITEM 2. ACQUISITION OR DISPOSITION OF ASSETS
(a) On January 30, 1998, K N Energy, Inc., a Kansas corporation (the
"Company"), acquired from Occidental Petroleum Corporation, a Delaware
corporation ("Occidental"), all of the outstanding shares of common stock, par
value $.01 per share, of MidCon Corp., a Delaware corporation and a wholly-owned
subsidiary of Occidental ("MidCon"), and a note issued by MidCon's employee
stock ownership plan for approximately $2.1 billion in cash and a short-term
note in the aggregate principal amount of approximately $1.39 billion. The
purchase price was determined as a result of arm's length negotiations between
senior management of the Company and Occidental. As a result of the
acquisition, MidCon became a wholly-owned subsidiary of the Company.
The total amount of funds required by the Company to complete the
acquisition, including payment of related transaction costs, was approximately
$2,449 million, which was financed through Credit Agreements, dated as of
January 30, 1998, among the Company, Morgan Guarantee Trust Company of New York
and a syndicate of lenders.
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 addition, MidCon is one of the nation's
largest storage operators. MidCon also purchases electricity from electric
utilities, and other electric power producers and marketers and resells the
electricity to wholesale and end-use customers.
A copy of the Company's press release dated January 30, 1998, is
attached hereto as an exhibit and incorporated herein by reference.
(b) Certain of the assets of MidCon constitute plant, equipment and
other physical property utilized in the business of MidCon as previously
described, and the Company intends to continue such use.
ITEM 7. FINANCIAL STATEMENT AND EXHIBITS.
(a) FINANCIAL STATEMENTS OF BUSINESS ACQUIRED
Audited financial statements for MidCon Corp. and subsidiaries as of and
for each of the three years ended December 31, 1997 are included herein.
(b) UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
Unaudited pro forma condensed balance sheet at September 30, 1997,
unaudited pro forma condensed statements of income for the year ended December
31, 1996 and the nine months ended September 30, 1997 and related notes are
included herein.
(c) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
NO.
- ------- -----------
<S> <C>
2 Stock Purchase Agreement, dated December 18, 1997, between
Occidental Petroleum Corporation and K N Energy, Inc.
(incorporated by reference to Exhibit 2.1 to the Company's
registration statement on Form S-3 (File No. 333-44421)).
23 Consent of Arthur Andersen LLP.
99.1 Press Release dated January 30, 1998.
</TABLE>
<PAGE> 3
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, 1997 and 1996, 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, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of MidCon Corp. and subsidiaries
as of December 31, 1997 and 1996, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Chicago, Illinois
January 23, 1998
<PAGE> 4
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
(THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
REVENUES:
Gas sales, transportation, storage and
other operating revenues $3,045,081 $2,574,211 $2,038,444
Interest and other income 13,115 1,187 11,686
Earnings of pipeline ventures (Note 15) 11,799 12,716 18,155
----------------- ----------------- ----------------
3,069,995 2,588,114 2,068,285
----------------- ----------------- ----------------
COSTS AND OTHER DEDUCTIONS:
Cost of sales 2,540,928 1,981,235 1,473,370
Selling, general and administrative and other
operating expenses (Note 3.n) 111,824 108,347 167,235
Depreciation (Note 3.f) 149,599 177,511 193,112
Taxes other than income taxes 30,297 46,226 42,357
Interest expense (Notes 2.a and 2.b) 241,838 79,626 23,286
Other 1,445 2,000 1,646
----------------- ----------------- ----------------
3,075,931 2,394,945 1,901,006
----------------- ----------------- ----------------
INCOME (LOSS) BEFORE INCOME TAXES (5,936) 193,169 167,279
PROVISIONS FOR AND CHARGE-IN-LIEU OF
INCOME TAXES (NOTE 7) (1,426) 76,684 60,653
----------------- ----------------- ----------------
NET INCOME (LOSS) ($4,510) $116,485 $106,626
================= ================= ================
</TABLE>
The accompanying notes are an integral part of these financial statements.
-1-
<PAGE> 5
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AT DECEMBER 31,
(THOUSANDS)
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents (Note 3.c) $14,122 $4,258
Restricted deposits (Note 3.g) 19,074 38,623
Receivables
Affiliated companies (Note 3.d, 7, and 13) 348,912 415,643
Customers 32,501 9,363
Other 10,178 26,324
Interest-bearing receivables,
net - affiliated companies (Note 3.c and 13) 87,495 25,361
Gas transportation imbalances (Note 3.i) 55,090 56,106
Materials and supplies (Note 3.e) 16,938 11,718
Net properties to be dividended, net of tax (Note 2.d) 301,582 308,804
Gas stored underground (Note 14) 33,730 39,343
Prepayments 7,774 20,187
Deferred income taxes (Note 7) 49,759 77,277
------------------ -----------------
Total Current Assets 977,155 1,033,007
------------------ -----------------
PROPERTY, PLANT AND EQUIPMENT (NOTE 2.c AND 3.f) 6,658,587 6,876,061
Accumulated depreciation (Note 2.c) (1,622,325) (1,785,257)
------------------ -----------------
Net Property, Plant and Equipment (Note 3.m) 5,036,262 5,090,804
------------------ -----------------
LONG-TERM INTERCOMPANY RECEIVABLE (NOTE 7) 50,345 33,197
GAS STORED UNDERGROUND-NONCURRENT (NOTE 14) 399,537 413,334
INVESTMENTS IN PIPELINE VENTURES (NOTE 15) 49,829 53,141
DEFERRED CHARGES AND OTHER ASSETS 14,540 28,879
------------------ -----------------
TOTAL ASSETS $6,527,668 $6,652,362
================== =================
</TABLE>
The accompanying notes are an integral part of these financial statements.
-2-
<PAGE> 6
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AT DECEMBER 31,
(THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
1997 1996
- ----------------------------------------------------------------------- ----------------- -----------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES:
Bank overdrafts $76,427 $68,153
Payables -
Affiliated companies (Note 3.d) 15,364 2,857
Trade 245,363 301,569
Contract impairment (Note 3.h) 5,745 1,126
Other 50,284 47,790
Dividend payable, affiliates (Note 2.d) 301,582 308,804
Rate refund payable (Note 5) - 15,218
Gas transportation imbalances (Note 3.i) 87,287 83,310
Current portion of long-term ESOP debt (Note 2.a) 13,568 12,574
Other 102,395 120,213
----------------- -----------------
Total Current Liabilities 898,015 961,614
----------------- -----------------
OTHER LIABILITIES AND DEFERRED CREDITS:
Reserve for contract impairment (Note 3.h) - 43,775
Intercompany liability (Note 13) - 32,696
Interest-bearing notes, affiliated companies (Notes 2.b) 1,600,000 1,600,000
Long-term ESOP debt (Note 2.a) 1,372,458 1,386,026
Postretirement benefits other than pensions (Note 8) 94,618 89,780
Other 134,227 157,400
----------------- -----------------
Total Other Liabilities and Deferred Credits 3,201,303 3,309,677
----------------- -----------------
DEFERRED INCOME TAXES (NOTE 2.c AND 7) 1,684,548 1,680,354
----------------- -----------------
CONTINGENT LIABILITIES AND COMMITMENTS (NOTES 4, 5, 6 AND 12)
MINORITY EQUITY IN SUBSIDIARIES AND PARTNERSHIPS (NOTE 1) 7,331 8,076
----------------- -----------------
STOCKHOLDER'S EQUITY:
Common Stock, $.01 par value, authorized 2,000,000 shares,
outstanding 1,400,000 shares 14 14
Unearned ESOP shares (Note 9) (1,347,387) (1,393,849)
Additional paid-in capital 2,001,938 2,000,060
Retained earnings 81,906 86,416
----------------- -----------------
Total Stockholder's Equity 736,471 692,641
----------------- -----------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $6,527,668 $6,652,362
================= =================
</TABLE>
The accompanying notes are an integral part of these financial statements.
-3-
<PAGE> 7
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, 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 loss - - - (4,510)
Release of ESOP shares, net of tax effect (Note 9) - 46,462 (28,882) -
Dividends on unearned ESOP shares, net of tax effect - - 19,400 -
(Note 2.a)
Non-cash dividend of properties - - (4,075) -
Adjustment to dividend of subsidiaries and properties - - 15,435 -
-------- -------- -------- --------
BALANCE, DECEMBER 31, 1997 $14 ($1,347,387) $2,001,938 $81,906
======== =========== ========== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
-4-
<PAGE> 8
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
(THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss) $ (4,510) $ 116,485 $ 106,626
Income adjustments -
Depreciation 149,599 177,511 193,112
Deferred income tax charge (benefit) 31,316 (1,909) (65,710)
Other noncash charges (credits) to income, net (Note 3.h and 3.n) (28,871) 28,966 43,382
Distributions from (to) pipeline ventures, net of earnings 3,357 1,385 (3,439)
Compensation expense (Note 9) 2,093 217 -
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable (583) 1,248 2,166
Decrease (increase) in accounts receivable from affiliates 65,102 (190,120) 17,405
Decrease (increase) in inventories (2,687) 32,492 16,448
Decrease (increase) in prepaid and other assets 16,601 (26,384) (7,959)
Change in gas transportation imbalances, net 4,993 8,494 (4,513)
Increase (decrease) in accounts payable and accrued
liabilities (Note 5) (80,871) 150,089 (160,088)
Increase (decrease) in accounts payable to affiliates 4,063 (4,029) (752)
Increase (decrease) in income taxes (11,063) (2,805) 4,319
Other operating, net 26,781 (24,567) 26,308
------ ------- ------
Net cash provided by operating activities 175,320 267,073 167,305
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (95,598) (146,883) (150,229)
Acquisition of cushion gas - (91,212) -
Proceeds (costs) from disposal of property, plant and equipment, net (1,534) 4,111 (2,682)
Other investing, net (6,214) (1,008) 267
------ ------ ---
Net cash used by investing activities (103,346) (234,992) (152,644)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Retirement of debt - (7,500) (500)
Amounts paid to minority interest (2,762) (2,583) (3,745)
Net change in interest-bearing receivables/payables with
affiliated companies and intercompany liability (59,348) (28,154) (8,100)
------- ------- ------
Net cash used in financing activities (62,110) (38,237) (12,345)
------- ------- -------
Increase (decrease) in cash and cash equivalents 9,864 (6,156) 2,316
----- ------ -----
Cash and cash equivalents at beginning of year 4,258 10,414 8,098
----- ------ -----
Cash and cash equivalents at end of year $14,122 $4,258 $10,414
======= ====== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
-5-
<PAGE> 9
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) DESCRIPTION OF COMPANY
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 of
consideration, subject to certain supplemental adjustments, to KN
Energy, Inc. The transaction is expected to close in the first quarter
of 1998.
MidCon, through its subsidiaries, engages in interstate and intrastate
natural gas transmission and marketing as well as electric power
marketing. The Company purchases, transports, stores and processes gas
and sells gas to utilities, municipalities and industrial and
commercial users. One subsidiary purchases electricity from electric
utilities and other electric power producers and marketers and resells
electricity to wholesale customers and other marketers.
The principal subsidiaries of MidCon are Natural Gas Pipeline Company
of America (Natural), which owns and 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 (collectively
MidCon Gas), engages in the purchase and sale of gas and arranges for
the transportation and storage of natural gas; mc(2) Inc., which
engages in the retail sale of natural gas and electricity; and MidCon
Power Services Corp. (MidCon Power), which engages in the purchase and
sale of electric power and arranges for the transmission of such power
(see Note 18). Subsidiaries of the principal subsidiaries own interests
in several gas pipeline joint ventures (see Note 15).
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 MTPO's rates
and other aspects of its business are subject to regulation by the
Texas Railroad Commission.
6
<PAGE> 10
(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
$29.4 million and $3.3 million on unearned shares and a cash
contribution of $93.6 million and $9.2 million were used for debt
service on the ESOP note in 1997 and 1996, respectively.
Results for the years 1997 and 1996, include interest expense of
$110.5 million and $12.6 million, respectively, on the ESOP note
and compensation expense of $2.1 million and $0.2 million,
respectively, 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, 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.
7
<PAGE> 11
(2) MIDCON RECAPITALIZATION (CONT'D)
(b) OTHER CAPITAL TRANSACTIONS (CONT'D)
Additionally, contributions to the Company's capital of $5.9
million and $11.6 million in 1997 and 1996, respectively, were
recorded as receivables to reflect Occidental's responsibility
under a tax sharing agreement with the Company to discharge the
Company's tax liabilities relative to the taxable gains resulting
from the 1996 dividends and asset transfers within MidCon (see
Note 7). The receivable relating to the $11.6 million recorded in
1996 is presented as "Interest-Bearing Receivables, net
affiliated companies" at December 31, 1996, and as "Long-Term
Intercompany Receivable" at December 31, 1997 (see Note 7).
Results for the years 1997 and 1996, include interest expense of
$128.2 million and $16.5 million, respectively, 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. (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 and $9 million for the twelve
months ended December 31, 1996 and 1995.
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>
8
<PAGE> 12
(2) MIDCON RECAPITALIZATION (CONT'D)
(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 Occidental, who
transferred it to a subsidiary of Occidental. A dividend to
Occidental of the remaining 49 percent was made 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, 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
(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 sheets at December 31, 1997 and 1996, reflect the
transactions discussed in Notes 2(a) through (d) and do not
consider the impact of the definitive agreement to sell the
Company to KN Energy, Inc. discussed in Note 1. 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.
9
<PAGE> 13
(3) SIGNIFICANT ACCOUNTING POLICIES (CONT'D)
(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.
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. 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 believes
that the application of the new standard will not 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 is currently assessing whether this
standard will impact financial reporting.
10
<PAGE> 14
(3) SIGNIFICANT ACCOUNTING POLICIES (CONT'D)
(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 $2.7 million and
$1.5 million at December 31, 1997 and 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.
(d) RECEIVABLES/PAYABLES WITH AFFILIATED COMPANIES
Receivable and payable balances with affiliates arise from
transactions between the Company and Occidental's other
subsidiaries. These transactions occur in the normal course of
business at prices which approximate market.
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."
Pursuant to the terms of the definitive agreement to sell MidCon
to KN Energy, Inc. (see Note 1), Occidental terminated this
revolving sales program for MidCon receivables on January 21,
1998. The Company has agreed to repurchase all of the receivables
previously sold by the Company that have not been collected prior
to the date of the termination.
11
<PAGE> 15
(3) SIGNIFICANT ACCOUNTING POLICIES (CONT'D)
(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. Natural determines top gas storage
inventory on the last-in, first-out (LIFO) method, while
recoverable cushion gas inventories are determined by the
average-cost method (see Note 14). 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 $4.0 billion and $4.1 billion at
December 31, 1997 and 1996, respectively. This amount is being
depreciated through the year 2034.
(g) 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 (NYMEX) rules, $19.1 million and $38.6 million of monies
on deposit with brokers was restricted at December 31, 1997 and
1996, respectively, to meet trading requirements (see Notes 3.l
and 11).
12
<PAGE> 16
(3) SIGNIFICANT ACCOUNTING POLICIES (CONT'D)
(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 $42 million in 1997 and $52 million in
1996, 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.
(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
at the projected gas settlement cost.
(j) SUPPLEMENTAL CASH FLOW INFORMATION
Cash payments during the years 1997, 1996 and 1995 included
income taxes of approximately $3.9 million, $5.0 million and $6.4
million, respectively. Interest paid for the same period, net of
amounts capitalized, was $238.7 million, $77.6 million and $2.1
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).
13
<PAGE> 17
(3) SIGNIFICANT ACCOUNTING POLICIES (CONT'D)
(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 $5.0 billion as of
December 31, 1997. 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.
(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 $6 million and $3 million, respectively at December
31, 1997 and $12 million and $13 million, respectively, at
December 31, 1996.
(o) INSURANCE
Effective November 1, 1997, the Company became self-insured for
its domestic general and products liability exposures up to $10
million per occurrence. As of December 31, 1997, the Company has
a self-insurance reserve of approximately $3.1 million.
(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.
14
<PAGE> 18
(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 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 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, Natural 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 Natural proposed and the related refunds were made
in December 1997. This settlement of the rate case has had a favorable
impact of approximately $9.0 million on operating margin for the year
ended December 31, 1997.
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 also filed a mechanism for recovery of the additional
amounts paid to Great Lakes as a result of the June 1995 order. 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 1998,
Natural was denied judicial review of the FERC decision. The Court also
found that additional interest is due the Great Lakes customers who
were erroneously charged incremental costs. Natural is reviewing the
Court's ruling and is considering whether, and to what extent, to avail
itself of its rights to further contest the ruling. Neither Natural nor
the Company believe the ultimate resolution of these issues will have a
material adverse effect upon the consolidated financial position or the
results of operations of the Company.
15
<PAGE> 19
(5) REGULATORY MATTERS (CONT'D)
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. By order issued January 16,
1998, the FERC ruled that Natural had violated certain of the
Commission's regulations regarding its business relationships with its
affiliate, MidCon Gas. The FERC provided notice to Natural that it
proposes to assess civil penalties of $8.8 million. 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. The Company has accrued $4.4
million as of December 31, 1997, relating to these civil penalties.
Natural 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 the penalty proposed in the order. Natural is reviewing the orders
and is considering whether, and to what extent, to avail itself of its
rights to further contest the provisions. Neither Natural nor the
Company believe the ultimate resolution of these issues will have a
material adverse effect upon the consolidated financial position or
results of operations of the Company.
(6) CONTINGENT LIABILITIES AND COMMITMENTS
As a result of FERC 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
was required to purchase, and Natural had a number of gas purchase
contracts at prices in excess of the prevailing market price. Order 636
went into effect on Natural's system on December 1, 1993. Natural
agreed to pay substantial transition costs to reform these contracts
with gas suppliers. Settlement agreements reached by Natural and its
former sales customers were approved by the FERC. Natural recovered a
significant amount of the gas supply realignment (GSR) costs from those
customers over a four year period beginning December 1, 1993. 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. Because of the settlements and FERC orders
authorizing Natural's GSR cost recovery mechanism, the remand is not
expected to have any significant impact on Natural. As of December 1,
1997, certain GSR costs allocated to interruptible transportation had
not been recovered. To provide for recovery, the FERC has allowed
additional GSR billing to new firm and interruptible contracts.
16
<PAGE> 20
(6) CONTINGENT LIABILITIES AND COMMITMENTS (CONT'D)
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 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. On the basis
of a tax sharing agreement, the MidCon consolidated current federal and
state tax liability owing to Occidental is reduced by an amount
relating to the recognition of taxable gains discussed below.
17
<PAGE> 21
(7) INCOME TAXES (CONT'D)
Taxable gains were recorded by the Company resulting from dividends and
asset transfers to Occidental and within MidCon during 1996 (see Notes
2.b and 2.c). Since the Company is included in the consolidated federal
income tax return of Occidental, these taxable gains are deferred and
amortized until an event occurs requiring recognition of any remaining
unamortized gains, such as the Company being transferred outside the
consolidated group. Under the tax sharing agreement, Occidental is
responsible for any tax associated with the gains resulting from
dividends and asset transfers to Occidental during 1996 and associated
transfers scheduled to occur on January 1, 1998, and is also
responsible for the tax on the unamortized balance of any taxable gains
resulting from the 1996 dividends and asset transfers within MidCon
upon the occurrence of any event requiring acceleration of gain
recognition. An intercompany receivable from Occidental has been
recorded to reflect Occidental's responsibility to discharge these
liabilities. This receivable will be applied to offset any tax
liability accrued by the Company upon recognition of the gains.
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.
The provisions (credits) for income taxes for the years ended December
31 were as follows (in millions):
<TABLE>
<CAPTION>
Allocated
Consolidated
Taxes State Total
------------ ----- -----
1997
----
<S> <C> <C> <C>
Current $(24.7) $(8.0) $ (32.7)
Deferred 22.2 9.1 31.3
------ ----- ------
$ (2.5) $ 1.1 $ (1.4)
====== ===== =======
1996
----
Current $ 68.0 $10.6 $ 78.6
Deferred (2.0) 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
====== ====== =======
</TABLE>
18
<PAGE> 22
(7) INCOME TAXES (CONT'D)
The following is a reconciliation of total tax expense to an amount
computed by applying the statutory federal income tax rate to pretax
income (in millions):
<TABLE>
<CAPTION>
For the years ended December 31, 1997 1996 1995
-------------------------------- ----- ---- ----
<S> <C> <C> <C>
Net income $(4.5) $116.5 $106.6
Income taxes (1.4) 76.7 60.7
----- ------ ------
Income before income taxes $(5.9) $193.2 $167.3
====== ====== ======
Amount derived by multiplying pretax
income by statutory rate $(2.0) $67.6 $58.6
Reconciling items multiplied by statutory rate:
Adjustments to pre-acquisition federal
tax reserve - - (2.6)
State income taxes, net of federal income
tax benefit 0.7 7.0 3.6
Other (0.1) 2.1 1.1
----- ------ -----
Total income taxes $(1.4) $76.7 $60.7
===== ====== =====
</TABLE>
As a result of the Company's recapitalization (Note 2), pretax income
is substantially reduced by interest expense on the ESOP note and the
$1.6 billion note payable to Occidental. A number of states in which
the Company does business require the filing and payment of state
income taxes on a "separate entity" basis. On a separate entity basis,
the interest expense cannot be fully utilized for state income tax
purposes.
Tax effects of temporary differences were as follows (in millions):
<TABLE>
<CAPTION>
December 31, 1997 December 31, 1996
Deferred Deferred Deferred Deferred
Tax Tax Tax Tax
Items Resulting in Temporary Differences Assets Liabilities Assets Liabilities
---------------------------------------- ------ ----------- ------ -----------
<S> <C> <C> <C> <C>
Property, plant and equipment, net $ - $1,858 $ - $1,866
Contract impairment reserves 14 - 49 -
Postretirement benefit accruals 45 - 47 -
State income taxes 123 35 91 28
Pending regulatory matters 6 - 39 -
Investment in partnerships 7 23 8 23
All other 92 6 107 27
-- - --- --
Total deferred taxes $ 287 $ 1,922 $ 341 $1,944
======= ======= ====== ======
</TABLE>
19
<PAGE> 23
(7) INCOME TAXES (CONT'D)
The Company is subject to audit by taxing authorities for varying
periods in various tax jurisdictions. Management believes that any
required adjustments to the Company's tax liabilities will not have a
material adverse impact on its financial position.
(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.
Pension costs for Occidental's defined benefit pension plan in which
the Company's employees participate, 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 1997, 1996 and 1995 were as follows (in millions):
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Service cost - benefits earned during the period $1.5 $1.4 $1.4
Interest cost on projected benefit obligation 0.7 0.7 0.5
Actual return on plan assets (1.1) (0.7) (0.7)
Net amortization and deferral 0.3 - 0.1
Curtailment/settlement loss 0.3 - -
-------- --------- --------
Net pension cost $1.7 $1.4 $1.3
======= ======= =======
</TABLE>
The following table sets forth the plan's funded status and amounts
recognized in the Company's consolidated balance sheets at December 31, 1997 and
1996 (in millions):
<TABLE>
<CAPTION>
December 31, December 31,
1997 1996
---- ----
<S> <C> <C>
Present value of the estimated pension
benefits to be paid in the future:
Total projected benefit obligations $8.5 $10.6
Estimated fair value of plan assets 7.9 9.4
----- ----
Projected benefit obligations in excess of
plan assets $0.6 $1.2
Unrecognized prior service benefit 0.1 0.1
Unrecognized net loss (0.7) (0.7)
------ ------
Pension liability $ - $0.6
======= ======
</TABLE>
20
<PAGE> 24
(8) RETIREMENT AND POSTRETIREMENT BENEFITS (CONT'D)
The discount rate used in determining the actuarial present value of
the projected benefit obligations was 7.5 percent as of December 31,
1997 and 1996. 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 1997 and 1996. The expected long-term
rate of return on assets was 8 percent in 1997 and 1996.
The Company provides medical, dental and life insurance for certain
active, retired and disabled employees and their eligible dependents.
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 $12.8 million, $14.6 million and $15.5 million in 1997,
1996 and 1995, respectively. The 1997, 1996 and 1995 costs included
$4.2 million, $5.7 million and $6.6 million, respectively, for
postretirement costs, as discussed below.
The postretirement benefit obligation at December 31, 1997 and 1996 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
in 1997 and 1996, respectively. The weighted average discount rate used
in determining the accumulated postretirement benefit obligation was
7.5 percent as of December 31, 1997 and 1996. The Company's funding
policy generally is to pay claims as they come due with the exception
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, 1997 and 1996 (in millions):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Accumulated postretirement benefit obligation
Retirees $57.7 $ 63.4
Fully eligible actives 14.8 14.3
Other actives 13.0 12.4
------ -----
Total accumulated postretirement benefit obligation 85.5 90.1
Plan assets at fair value 34.3 34.2
----- -----
Unfunded status 51.2 55.9
Unrecognized net gain 43.4 37.9
------ -------
Accrued postretirement benefit cost $94.6 $93.8
===== =====
</TABLE>
21
<PAGE> 25
(8) RETIREMENT AND POSTRETIREMENT BENEFITS (CONT'D)
Net periodic postretirement benefit cost for 1997, 1996 and 1995
included the following components (in millions):
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Service cost - benefits attributed to
service during the period $0.9 $1.1 $1.1
Interest cost on accumulated postretirement
benefit obligation 6.6 7.2 7.2
Actual return on plan assets (4.5) (1.3) (0.7)
Net amortization and deferral 1.2 (1.1) (1.0)
Other - (0.2) -
------ ------ ------
Net periodic postretirement benefit cost $4.2 $5.7 $6.6
====== ====== ======
</TABLE>
(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 the 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 the salary and age level of
employees and/or employee contributions. The Company's expense under
the provisions of the plans was $11.3 million, $12.5 million and $13.2
million for 1997, 1996 and 1995, respectively. The Company's
contribution under the salaried retirement plan was $6.8 million, $7.6
million and $7.7 million for 1997, 1996 and 1995, respectively.
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 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.
22
<PAGE> 26
(9) RETIREMENT PLANS AND ESOP (CONT'D)
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. 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 $2.1 million and $217,000 for
1997 and 1996, respectively. The ESOP has 52,613 and 6,151 allocated
shares and 1,347,387 and 1,393,849 unreleased shares outstanding at
December 31, 1997 and 1996, respectively.
(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,
188,000, 168,000 and 143,332 options were granted for the years
December 31, 1997, 1996 and 1995, respectively. In addition, 4,351,
4,589 and 10,909 of Occidental's $.20 par value restricted stock were
granted during the years ended December 31, 1997, 1996 and 1995,
respectively. These grants vest after 4 years (5 years for awards
issued prior to December 1995) or earlier under certain conditions.
Compensation expense related to these incentive stock plans recognized
by the Company was $256,000, $208,000 and $205,000 for the years 1997,
1996 and 1995, respectively.
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.
23
<PAGE> 27
(11) HEDGING ACTIVITIES
The Company uses commodity futures contracts, options and swaps to
hedge the impact of natural gas price fluctuations related to three
major categories of business: purchases for and sales from storage,
fixed-price sales and purchase contracts, and transportation.
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. If a
contract is hedged, hedges are placed nearly simultaneously with the
consummation of most of the sales-purchase agreements. All agreements
are for less than 24 months.
The Company transports gas using its own capacity and under agreements
with various other pipeline companies. The transport value is hedged
from time to time using geographic basis swap contracts with terms of
18 months or less.
Gains and losses on these hedging contracts are deferred and recognized
in income when the transactions being hedged are finalized. NYMEX,
Kansas City Board of Trade (KCBT), (collectively, the Exchanges) and
over-the-counter (OTC) hedge instruments are utilized.
24
<PAGE> 28
(11) HEDGING ACTIVITIES (CONT'D)
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 prices and volatility and the time value of money. Swaps
are valued comparing current broker quotes for price and 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.
25
<PAGE> 29
(11) HEDGING ACTIVITIES (CONT'D)
The following table summarizes the types of hedges used and the related
financial information as of December 31, 1997 and 1996:
<TABLE>
<CAPTION>
EXCHANGES OVER-THE-COUNTER(b) TOTAL
NOTIONAL VOLUMES IN PC HEDGES OF 1997 1996 1997 1996 1997 1996
- ---------------------- --------- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Price Hedge:
Futures (a) Purchases 27 32 - - 27 32
Sales 1 - - - 1 -
Swaps Purchases - - 2 - 2 -
Sales - - - 1 - 1
Options (a) Purchases - - 1 2 1 2
Sales - - 6 - 6 -
Basis Hedge:
Basis Swaps (c) Purchases - - 66 33 66 33
Sales - - 36 34 36 34
</TABLE>
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
EXCHANGES OVER-THE-COUNTER BOOK VALUE FAIR VALUE
DOLLARS IN MILLIONS 1997 1996 1997 1996 1997 1996 1997 1996
- ------------------- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Deferred net gains
(losses):
Firm commitment/
forecast transactions $(10) $(3) $6 $ -
Assets:
Basis swaps $ - $ - $6 $1
</TABLE>
- --------------------------------------------------------------------------------
(a) Not financial instruments as defined in GAAP, but included as they are
a major part of the program.
(b) The average weighted term is less than twelve months. The notional
volumes are hedged with counterparties with a BBB or better credit
rating at ninety-five percent in 1997 and ninety percent in 1996.
(c) Basis swaps are utilized to hedge the geographic price differentials
due primarily to transportation cost and local supply-demand factors.
26
<PAGE> 30
(12) LEASES
Rent expense under primarily operating leases were $43.5 million, $14.6
million and $13.9 million in 1997, 1996 and 1995, respectively.
At December 31, 1997, future minimum rental commitments under
noncancelable operating leases, including the MTPO lease agreement (see
Note 2.d), were as follows (in millions):
<TABLE>
<CAPTION>
Calendar Year
-------------
<S> <C>
1998 $32.5
1999 33.7
2000 33.8
2001 32.8
2002 52.3
Remaining years 801.4
------
Total $986.5
======
</TABLE>
At December 31, 1997, future rental receipts under noncancelable
subleases were as follows (in millions):
<TABLE>
<CAPTION>
Calendar Year
<S> <C>
1998 $1.1
1999 1.1
2000 1.1
2001 1.1
2002 0.7
Remaining years -
------
Total $5.1
======
</TABLE>
(13) 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 $3.8 million, $5.2 million and $5.4 million for 1997,
1996 and 1995, 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, 1997 and 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.
27
<PAGE> 31
(13) TRANSACTIONS WITH AFFILIATES (CONT'D)
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 year ended December 31, 1997, as "Charges
for Occidental's general and administrative costs" indicated in the
table below.
Pursuant to the terms of the definitive agreement to sell MidCon to KN
Energy, Inc. (see Note 1), Occidental will terminate this service
agreement. Occidental and KN Energy, Inc. will negotiate an interim
service agreement between Occidental and MidCon for the continuation of
any of the services provided by Occidental to MidCon under the former
service agreement.
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, 1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Affiliated company transactions:
Transfer of trade receivables (See note 3.d) $ 345.5 $ 410.6 $ 219.8
Fees and expenses on trade receivables transferred $ 13.5 $ 10.4 $ 8.4
(See note 3.d)
Sales, transportation and storage of natural gas
and other revenues $ 2.2 $ 3.7 $ 2.8
Purchases and transportation
of natural gas $ 36.3 $ 2.1 $ 0.9
Charge for Occidental's
general and administrative costs $ 13.0 $ 18.3 $ 21.1
Net interest expense (See notes 2.a and 2.b) $ (218.8) $ (66.1) $ (11.6)
Pipeline venture transactions:
Cash distributions $ 15.2 $ 14.1 $ 16.8
Transportation of natural gas charged to
operation expense $ 8.6 $ 8.3 $ 9.8
</TABLE>
28
<PAGE> 32
(14) GAS STORED UNDERGROUND
At December 31, 1997 and 1996, Natural's current top gas storage
inventory, which is accounted for on the LIFO method, was $6.0 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 $147.1 million and $413.7
million at December 31, 1997 and 1996, respectively. Noncurrent cushion
gas inventory is stated at average cost.
(15) 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, 1997, 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, 1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Operating revenues $114.4 $116.3 $138.1
Costs and expenses 70.2 65.9 72.2
------ ------ ------
Net income $ 44.2 $ 50.4 $ 65.9
======= ====== ======
</TABLE>
<TABLE>
<CAPTION>
Balance at December 31, 1997 1996
----------------------- ---- ----
<S> <C> <C>
Current assets $ 54.8 $ 79.2
Noncurrent assets $273.4 $290.9
Current liabilities $ 42.9 $ 69.1
Noncurrent liabilities $137.2 $145.2
Stockholders' equity $148.1 $155.8
</TABLE>
29
<PAGE> 33
(15) PIPELINE VENTURES (CONT'D)
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 1997, 1996
and 1995 were approximately $11.1 million, $10.7 million and $9.2
million, respectively.
(16) CONCENTRATION OF CREDIT RISK
The Company sells and transports 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.
(17) 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 will have
a material impact on its results of operations.
(18) DIVIDEND OF SUBSIDIARY
On January 20, 1998, the Company dividended at net book value its
interest in MidCon Power (Note 1) to Occidental. The net loss for
these operations was $861,000 and $581,000 for the years ended
December 31, 1997 and 1996, respectively.
(19) EVENT (UNAUDITED) SUBSEQUENT TO DATE OF AUDITORS' REPORT
On January 28, 1998, the Company dividended at net book value its
interest in MCN Coal Gasification Company to Occidental. The net
income for these operations was $5,000 and $4,500 for the years ended
December 31, 1997 and 1996, respectively. Also on January 28, 1998,
the Company will declare a dividend to Occidental payable immediately
in accordance with the definitive agreement to sell the Company (see
Note 1).
30
<PAGE> 34
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
The following unaudited pro forma financial statements give effect to (i)
the acquisition of MidCon by K N Energy, Inc. ("K N") (see K N's Report on Form
8-K/A dated February 12, 1998) (the "Acquisition") and (ii) the anticipated
issuance of 10,000,000 shares of K N's common stock, par value $.01 per share
(the "Equity Offering") and $2.35 billion aggregate principal amount of senior
notes of varying maturities (the "Senior Note Offerings" and, together with the
Equity Offering, the "Offerings"). 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 should be read in conjunction
with the historical financial statements of K N and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in K N's
1996 Annual Report on Form 10-K and the historical financial statements of
MidCon included in K N's Report on Form 8-K dated January 16, 1998. 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.
1
<PAGE> 35
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) $ 18,889
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) (i) 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
2
<PAGE> 36
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
3
<PAGE> 37
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(h) 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 $ 61,727
========= ========= ========= =========
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
4
<PAGE> 38
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.
(b) To record the Senior Note 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 (the
"Bank Facility") 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 Senior Note 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 in the assumed
interest rate of 1% 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 Acquisition 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>
5
<PAGE> 39
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), 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 Senior Note
Offerings and the Additional Offerings.
(g) Gives effect to the 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 its 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.
(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>
6
<PAGE> 40
NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED
FINANCIAL STATEMENTS -- (CONTINUED)
(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 concurrent Senior Note 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 letter 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 concurrent Senior Note 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 letter 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 will terminate concurrently 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.
7
<PAGE> 41
2
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.
Dated: February 12, 1998 By: /s/ Martha B. Wyrsch
______________________________
Martha B. Wyrsch
Vice President, General Counsel
and Secretary
<PAGE> 42
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
2 Stock Purchase Agreement, dated December 18, 1997, between
Occidental Petroleum Corporation and K N Energy, Inc.
(incorporated by reference to Exhibit 2.1 to the Company's
registration statement on Form S-3 (File No. 333-44421)).
23 Consent of Arthur Andersen LLP.
99.1 Press Release dated January 30, 1998.
<PAGE> 1
Exhibit 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the inclusion in this
Form 8-K/A of our report dated January 23, 1998 on MidCon Corp.'s consolidated
financial statements for the year ended December 31, 1997.
/s/ ARTHUR ANDERSEN LLP
Chicago, Illinois
February 11, 1998
<PAGE> 1
Exhibit 99.1
KN ENERGY COMPLETES MIDCON CORP. ACQUISITION
LAKEWOOD, COLO., January 30, 1998 - KN Energy, Inc. (NYSE: KNE), announced today
that it has closed on its purchase of MidCon Corp., after earlier receiving
federal approval for the transaction. The management of the new, $7.8 billion
entity will now begin efforts to combine the operations of the two companies.
The company announced in December 1997 its intent to purchase the assets
of MidCon, based in Lombard, Ill., from Occidental Petroleum for $3.49 billion.
Forecast performance of the combined entity will be immediately accretive to the
earnings expectations of KN Energy standing alone. KN Energy has completed
financing arrangements for the transaction, and will go to the public markets to
complete its long-term capital requirements within the next several months,
through a planned issuance of debt and equity securities.
"Our efforts will now focus on ensuring the successful integration of
MidCon and KN Energy," said Larry Hall, KN Energy chairman and chief executive
officer. "MidCon employees will play key roles in ensuring the success of this
transaction. We believe they will be valuable contributors to making us a
stronger company for our customers and shareholders."
Hall noted that KN Energy plans to use its "value stream" strategy of
developing non-regulated businesses around the regulated portion of its newly
acquired properties - a process KN Energy has successfully used in its own
regional markets.
"We have enhanced the value of our company and profitably grown our assets
for more than a decade by identifying and pursuing non-regulated business
opportunities. We have built KN Energy into a major player using this strategy,
and we plan to repeat it as we enter into new markets with our MidCon
acquisition," he said.
(more)
<PAGE> 2
KN ENERGY COMPLETES MIDCON TRANSACTION PAGE TWO
The company will achieve savings through elimination of duplicate
functions, combinations of certain operations and other synergies.
With completion of the transaction, KN Energy, through its various
subsidiaries, becomes the nation's second-largest pipeline operator, with more
than 27,150 miles in 15 states. It is also the seventh-largest gas marketing
company. The combined operations make KN Energy the sixth-largest integrated
energy company in total assets and the seventh-largest revenue company, with
$4.7 billion in operating revenue.
KN Energy has access to natural gas supplies in all of the major supply
basins in the United States, including Mid-Continent, West Texas, Rocky Mountain
and Gulf Coast regions, and will market in excess of 4 billion cubic feet per
day. KN Energy also becomes a top five producer of natural gas liquids, and is
projected to produce and market more than 90,000 barrels per day.
The acquisition also brings together two leaders in the push for
deregulation of the energy market, KN Energy's en-able joint venture with
PacifiCorp and MidCon's mc(2) Inc. Combined, the two entities will have a
specific focus on residential and small-business, mass-market opportunities.
MidCon primarily is engaged in the regulated purchase, gathering,
processing, transmission, storage and sale of natural gas to utilities,
municipalities, and large commercial and industrial companies from the Gulf of
Mexico to the Canadian border. MidCon's principal subsidiaries include NGPL,
MidCon Texas Pipeline Operator, Inc., MidCon Gas Services, MidCon Power Services
Corp., mc(2), which markets natural gas and electricity at retail levels, and
MidCon Gas Products Corp.
KN Energy, Inc., based in Lakewood, is Colorado's largest integrated
energy services company, with operations that include natural gas gathering,
processing, marketing, storage, transportation, energy commodity sales - natural
gas and natural gas liquids - and innovative services designed for consumers,
utilities and commercial entities. KN Energy is the sixth largest integrated
nearly energy company in the nation with operations in 15 states, and is the
second largest pipeline operator. It also jointly owns en-able, which markets
the Simple Choice(SM) brand of enhanced products and services for consumers
through their local utilities, and fully owns mc(2) Inc., which markets natural
gas and electricity.
