<PAGE> 1
=============================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549-1004
--------------------
FORM 8-K
--------------------
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED) DECEMBER 18, 1997
-------------------
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
=============================================================================
<PAGE> 2
ITEM 5. OTHER EVENTS
On December 18, 1997, K N Energy, Inc., a Kansas corporation (the
"Company"), and Occidental Petroleum Corporation, a Delaware corporation
("Occidental"), entered into a Stock Purchase Agreement, upon and subject to the
terms and conditions of which the Company will acquire all of the issued and
outstanding shares of common stock, par value $.01 per share, of MidCon Corp., a
Delaware corporation and a wholly owned subsidiary of Occidental ("MidCon"), for
$3.49 billion (including assumption of indebtness). Copies of (i) MidCon's
financial statements for the year ended December 31, 1996, (ii) MidCon's
financial statements for the nine months ended September 30, 1997 and (iii)
unaudited pro forma consolidated financial statements are attached hereto as
Exhibits 7(1), 7(2) and 7(3), respectively, and are incorporated herein by
reference.
ITEM 7. FINANCIAL STATEMENT AND EXHIBITS.
(a) FINANCIAL STATEMENTS OF BUSINESS TO BE ACQUIRED
The financial statements relative to the proposed acquisition of MidCon
from Occidental described in Item 5 of Form 8-K of K N Energy, Inc. dated
January 16, 1998 are attached hereto as exhibits and incorporated herein by this
reference.
(b) UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
The unaudited pro forma consolidated financial information relative
to the proposed acquisition of MidCon from Occidental described in Item 5 of
Form 8-K of K N Energy, Inc. dated January 16, 1998 is attached hereto as an
exhibit and incorporated herein by this reference.
(c) EXHIBITS
[CAPTION]
<TABLE>
<S> <C>
EXHIBIT DESCRIPTION
NO.
- ------- -----------
1 Financial Statements for MidCon Corp. and subsidiaries for
the year ended December 31, 1996.
2 Financial Statements for MidCon Corp. and subsidiaries for
the nine months ended September 30, 1997.
3 Unaudited Pro Forma Consolidated Financial Information.
99 Consent of Arthur Andersen LLP.
</TABLE>
<PAGE> 3
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: January 16, 1998 By: /s/ Clyde E. McKenzie
______________________________
Clyde E. McKenzie
Vice President and
Chief Financial Officer
<PAGE> 4
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
1 Financial Statements for MidCon Corp. and subsidiaries for
the year ended December 31, 1996.
2 Financial Statements for MidCon Corp. and subsidiaries
for the nine months ended September 30, 1997.
3 Unaudited Pro Forma Consolidated Financial Information.
99 Consent of Arthur Andersen LLP.
<PAGE> 1
EXHIBIT 1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Midcon Corp.:
We have audited the accompanying consolidated balance sheets of MIDCON
CORP. (a Delaware corporation and a wholly-owned subsidiary of Occidental
Petroleum Corporation) and subsidiaries as of December 31, 1996 and 1995, and
the related consolidated statements of operations, stockholder's equity and cash
flows for each of the three years in the period ended December 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of MidCon Corp. and
subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Chicago, Illinois
January 31, 1997
1
<PAGE> 2
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31,
(THOUSANDS)
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
REVENUES:
Gas sales, transportation, storage and other
operating revenues............................... $2,574,211 $2,038,444 $2,109,834
Interest and other income (Note 3.h)................ 1,187 11,686 24,486
Earnings of pipeline ventures (Note 16)............. 12,716 18,155 13,100
---------- ---------- ----------
2,588,114 2,068,285 2,147,420
---------- ---------- ----------
COSTS AND OTHER DEDUCTIONS:
Cost of sales....................................... 1,981,235 1,473,370 1,561,331
Selling, general and administrative and other
operating expenses (Note 3.n).................... 108,347 167,235 109,556
Depreciation (Note 3.f)............................. 177,511 193,112 191,672
Taxes other than income taxes....................... 46,226 42,357 45,585
Interest expense (Note 2.a)......................... 79,626 23,286 8,101
Other............................................... 2,000 1,646 1,802
---------- ---------- ----------
2,394,945 1,901,006 1,918,047
---------- ---------- ----------
INCOME BEFORE INCOME TAXES............................ 193,169 167,279 229,373
PROVISIONS FOR AND CHARGE-IN-LIEU OF INCOME TAXES
(Note 7)............................................ 76,684 60,653 85,164
---------- ---------- ----------
NET INCOME............................................ $ 116,485 $ 106,626 $ 144,209
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE> 3
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AT DECEMBER 31,
(THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
1996 1995
----------- -----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents (Note 3.c).................................................. $ 4,258 $ 10,414
Restricted deposits (Note 3.g)........................................................ 38,623 24,645
Receivables
Affiliated companies (Note 3.d)..................................................... 415,643 222,979
Customers........................................................................... 9,363 3,362
Other............................................................................... 26,324 26,781
Interest-bearing receivables, net -- affiliated companies (Note 3.c and 14)........... 25,361 --
Gas transportation imbalances (Note 3.i).............................................. 56,106 77,131
Materials and supplies (Note 3.e)..................................................... 11,718 16,821
Net properties to be dividended, net of tax (Note 2.d)................................ 308,804 --
Gas stored underground (Note 15)...................................................... 39,343 66,732
Prepayments........................................................................... 20,187 12,535
Deferred income taxes (Note 7)........................................................ 77,277 100,348
----------- -----------
Total Current Assets............................................................ 1,033,007 561,748
----------- -----------
PROPERTY, PLANT AND EQUIPMENT (Note 2.c and 3.f)........................................ 6,876,061 8,069,359
Accumulated depreciation (Note 2.c)................................................... (1,785,257) (2,005,399)
----------- -----------
Net Property, Plant and Equipment (Note 3.m).................................... 5,090,804 6,063,960
----------- -----------
LONG-TERM INTERCOMPANY RECEIVABLE (Note 7).............................................. 33,197 --
GAS STORED UNDERGROUND -- NONCURRENT (Note 15).......................................... 413,334 378,508
INVESTMENTS IN PIPELINE VENTURES (Note 16).............................................. 53,141 54,184
DEFERRED CHARGES AND OTHER ASSETS....................................................... 28,879 37,094
----------- -----------
TOTAL ASSETS.................................................................... $ 6,652,362 $ 7,095,494
========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES:
Payables --
Affiliated companies (Note 3.d)..................................................... $ 2,857 $ 6,886
Trade............................................................................... 301,569 108,027
Contract impairment (Note 3.h)...................................................... 1,126 19,708
Other............................................................................... 115,943 121,948
Interest-bearing payables, net -- affiliated companies (Note 3.c and 14).............. -- 87,310
Dividend payable, affiliates (Note 2.d)............................................... 308,804 --
Rate refund provision (Note 5)........................................................ 15,218 3,073
Gas transportation imbalances (Note 3.i).............................................. 83,310 95,841
Current portion of long-term ESOP debt (Note 2.a)..................................... 12,574 --
Other................................................................................. 120,213 70,827
----------- -----------
Total Current Liabilities....................................................... 961,614 513,620
----------- -----------
OTHER LIABILITIES AND DEFERRED CREDITS:
Reserve for contract impairment (Note 3.h)............................................ 43,775 61,464
Intercompany liability (Note 14)...................................................... 32,696 134,316
Interest-bearing notes, affiliated companies (Notes 2.b and 3.c)...................... 1,600,000 740,583
Long-term ESOP debt (Note 2.a)........................................................ 1,386,026 --
Postretirement benefits other than pensions (Note 8).................................. 89,780 97,200
Other................................................................................. 157,400 227,634
----------- -----------
Total Other Liabilities and Deferred Credits.................................... 3,309,677 1,261,197
----------- -----------
DEFERRED INCOME TAXES (Note 2.c and 7).................................................. 1,680,354 1,987,290
----------- -----------
CONTINGENT LIABILITIES AND COMMITMENTS (Notes 4, 5, 6 and 12)
MINORITY EQUITY IN SUBSIDIARIES AND PARTNERSHIPS (Note 1)............................... 8,076 5,349
----------- -----------
STOCKHOLDER'S EQUITY:
Common Stock, $.01 par value, authorized 2,000,000 shares, outstanding 1,400,000
shares in 1996; $1 par value, authorized 1,000 shares, outstanding 1 share in 1995
(Note 2.b).......................................................................... 14 --
Unearned ESOP shares (Note 9)......................................................... (1,393,849) --
Additional paid-in capital............................................................ 2,000,060 3,358,107
Retained earnings (deficit)........................................................... 86,416 (30,069)
----------- -----------
Total Stockholder's Equity...................................................... 692,641 3,328,038
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY...................................... $ 6,652,362 $ 7,095,494
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 4
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(THOUSANDS)
<TABLE>
<CAPTION>
UNEARNED ADDITIONAL RETAINED
COMMON ESOP PAID-IN EARNINGS
STOCK SHARES CAPITAL (DEFICIT)
------------ ----------- ---------- ---------
<S> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1993............ $ -- $ -- $4,280,577 $ (52,576)
Net income............................ -- -- -- 144,209
---- ----------- ---------- --------
BALANCE, DECEMBER 31, 1994............ -- -- 4,280,577 91,633
Net income............................ -- -- -- 106,626
Dividend of intercompany receivable to
Parent (Note 3.c)................... -- -- (922,470) (228,328)
---- ----------- ---------- --------
BALANCE, DECEMBER 31, 1995............ -- -- 3,358,107 (30,069)
Net income............................ -- -- -- 116,485
Dividend of subsidiaries and
properties (Note 2.c)............... -- -- (672,407) --
Contribution of intercompany debt
(Note 2.b).......................... -- -- 914,703 --
Non-cash dividend (Note 2.b).......... -- -- (1,600,000) --
Stock split (Note 2.b) 14 -- (14) --
Unearned ESOP shares (Note 9)......... -- (1,400,000) -- --
Dividends on unearned ESOP shares..... -- -- 3,348 --
Release of ESOP shares, net of tax
effect (Note 9)..................... -- 6,151 (3,677) --
---- ----------- ---------- --------
BALANCE, DECEMBER 31, 1996............ $ 14 $(1,393,849) $2,000,060 $ 86,416
==== =========== ========== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 5
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31,
(THOUSANDS)
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income............................................... $ 116,485 $ 106,626 144,209
Income adjustments --
Depreciation.......................................... 177,511 193,112 191,672
Deferred income tax benefit........................... (1,909) (65,710) (372)
Other noncash charges (credits) to income, net (Note
3.h and 3.n)........................................ 28,966 43,382 (15,030)
Distributions from (to) pipeline ventures, net of
earnings............................................ 1,385 (3,439) 5,567
Compensation expense (Note 9)......................... 217 -- --
Changes in operating assets and liabilities:
Decrease in accounts receivable....................... 1,248 2,166 17,320
Decrease (increase) in accounts receivable from
affiliates.......................................... (190,120) 17,405 15,425
Decrease in inventories............................... 32,492 16,448 9,193
Decrease (increase) in prepaid and other assets....... (26,384) (7,959) 39,304
Change in gas transportation imbalances, net.......... 8,494 (4,513) 11,463
Increase (decrease) in accounts payable and accrued
liabilities (Note 5)................................ 150,089 (160,088) 88,447
Decrease in accounts payable to affiliates............ (4,029) (752) (23,882)
Increase (decrease) in income taxes................... (2,805) 4,319 2,979
Other operating, net..................................... (24,567) 26,308 (31,912)
--------- --------- ---------
Net cash provided by operating activities........ 267,073 167,305 454,383
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures..................................... (146,883) (150,229) (92,656)
Acquisition of cushion gas............................... (91,212) -- --
Proceeds (costs) from disposal of property, plant and
equipment, net........................................ 4,111 (2,682) (1,572)
Other investing, net..................................... (1,008) 267 (1,651)
--------- --------- ---------
Net cash used by investing activities............ (234,992) (152,644) (95,879)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Retirement of debt....................................... (7,500) (500) (500)
Amounts paid to minority interest........................ (2,583) (3,745) (1,936)
Net change in interest-bearing receivables/payables with
affiliated companies and intercompany liability....... (28,154) (8,100) (352,570)
--------- --------- ---------
Net cash used in financing activities............ (38,237) (12,345) (355,006)
--------- --------- ---------
Increase (decrease) in cash and cash equivalents........... (6,156) 2,316 3,498
--------- --------- ---------
Cash and cash equivalents at beginning of year............. 10,414 8,098 4,600
--------- --------- ---------
Cash and cash equivalents at end of year................... $ 4,258 $ 10,414 $ 8,098
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
5
<PAGE> 6
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) DESCRIPTION OF COMPANY
MidCon Corp. (Company) is a wholly-owned subsidiary of Occidental Petroleum
Corporation (Occidental). The Company through its subsidiaries engages in
interstate and intrastate natural gas transmission and marketing as well as
electric power marketing. The Company's subsidiaries purchase, transport, store
and process gas and sell gas to utilities, municipalities and industrial and
commercial users. Another subsidiary purchases electricity from electric
utilities and other electric power producers and marketers and resells
electricity to wholesale customers.
The principal subsidiaries of the Company are Natural Gas Pipeline Company
of America (Natural), which operates a major interstate pipeline transmission
system along with several storage facilities; MidCon Texas Pipeline Operator,
Inc., (MTPO), which operates an intrastate pipeline system in Texas (see Note
2.c and 2.d); MidCon Gas Services Corp., which together with its subsidiaries,
(MidCon Gas), engages in the purchase and sale of gas and arranges for the
transportation and storage of natural gas; and MidCon Power Services Corp.
(MidCon Power), which engages in the purchase and sale at wholesale of electric
power and arranges for the transmission of such power. Other subsidiaries of the
Company own interests in several gas pipeline joint ventures (see Note 16).
Natural's interstate pipeline and storage operations are subject to
extensive regulation by the Federal Energy Regulatory Commission (the "FERC").
The FERC regulates, among other things, rates and charges for storage and
transportation of gas in interstate commerce, the construction and operation of
interstate pipeline facilities and the accounts and records of interstate
pipelines. Certain of MidCon Texas Pipeline Corp.'s (MidCon Texas) and MTPO's
rates and other aspects of its business are subject to regulation by the Texas
Railroad Commission.
(2) MIDCON RECAPITALIZATION
(a) ESOP
In November 1996, Occidental established the MidCon Corp. Employee Stock
Ownership Plan (ESOP) (see Note 9) for the benefit of the employees of the
Company and its subsidiaries.
Also, in November 1996, Occidental sold $1.4 billion of Occidental's
Cumulative MidCon-Indexed Convertible Preferred Stock (CMIC Preferred Stock) to
the MidCon Corp. ESOP Trust (the Trust). The CMIC Preferred Stock is convertible
into Occidental common stock based on the value of the Company. The Trust paid
for the CMIC Preferred Stock with a $1.4 billion 30-year promissory note (ESOP
note), bearing interest at 7.9 percent per annum, guaranteed by the Company.
Principal and interest payments on the ESOP note are due on December 31 in
annual installments of approximately $123 million, commencing December 31, 1997,
and continuing up to and excluding December 31, 2026, upon which date all
principal and interest remaining unpaid shall be immediately due and payable.
Dividends on the CMIC Preferred Stock are payable at an annual rate of $21 per
share, when and as declared by Occidental's Board of Directors. It is
anticipated that the Company will make discretionary annual contributions to the
MidCon ESOP which, together with the annual dividends, will be used to repay the
ESOP note. Dividends of $3.3 million on unearned shares and cash payments of
$9.2 million were used for debt service on the ESOP note in 1996.
Future earnings will be reduced by interest expense on the $1.4 billion
ESOP note and compensation expense as discussed in Note 9.
(b) Other Capital Transactions
Concurrent with the establishment of the ESOP, several transactions were
recorded. The Company had a 1,400,000-for-one split of the outstanding shares of
its common stock while the par value of such stock was
6
<PAGE> 7
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
changed from $1.00 per share to $.01 per share. Occidental contributed to the
capital of the Company $741 million of promissory notes previously issued by the
Company and $154 million of non-interest bearing intercorporate advances made by
Occidental to the Company that were outstanding as of November 30, 1996. In
addition, the Company declared a dividend, payable in the form of a $1.6 billion
note payable to Occidental. The principal amount of this note is due and payable
on December 31, 2026 and bears interest at an annual rate of 7.9 percent payable
monthly through December 31, 2001. Thereafter, the rate changes to the London
Interbank Offered Rate (LIBOR) plus 1.25 percent.
Future earnings will be reduced by interest expense on the $1.6 billion
note payable.
(c) Dividend of Subsidiaries and Properties
During 1996, the Company dividended all the outstanding shares of common
stock of its subsidiaries, Occidental Energy Ventures Corp. (OEVC) and MC
Panhandle, Inc., to Occidental. Properties from other Company subsidiaries
comprising certain oil and gas properties and well compressor properties were
dividended to Occidental effective on December 31, 1996. The net income from
these operations was $15 million, $9 million and $10 million for the twelve
months ended December 31, 1996, 1995 and 1994, respectively.
Also, effective December 31, 1996, the Company dividended 51 percent of its
interest in an intrastate pipeline limited liability partnership to Occidental
(see Note 2.d).
A summary of the 1996 adjustments showing the effect of the above
transactions on certain balance sheet accounts is presented below (in millions):
<TABLE>
<CAPTION>
INCREASE
(DECREASE)
----------
<S> <C>
Property, Plant and Equipment..................................... $ (1,339)
Accumulated Depreciation.......................................... $ (345)
Deferred Income Taxes............................................. $ (322)
Additional Paid-in Capital........................................ $ (672)
</TABLE>
(d) Lease of Intrastate Pipeline Assets
In December 1996, the Company merged its subsidiary MidCon Texas into a
limited partnership which then owned its Texas intrastate pipeline and related
facilities. On December 31, 1996, fifty-one percent of the Company's ownership
in the partnership was dividended to a subsidiary of Occidental with a dividend
of the remaining 49 percent to be paid on January 1, 1998. This 49 percent
interest is reflected in the accompanying consolidated balance sheets as "Net
properties to be dividended, net of tax." The Company formed a new subsidiary,
MTPO, which assumed certain of the contracts and obligations of MidCon Texas
before the merger. In addition, MTPO entered into an agreement with the limited
partnership to lease the intrastate pipeline system owned by the limited
partnership over a 30 year period commencing on January 1, 1997. The Company
accounts for this lease as an operating lease. The initial annual lease fee is
$30 million in 1997. The lease fee changes to $20 million for the years 1998
through 2001, $40 million for the years 2002 through 2005 and $30 million during
the remaining lease term. Lease expense of $30 million will be recognized
annually. The lease agreement requires MTPO to pay for taxes, insurance and
maintenance expense and contains restrictions concerning additions, dispositions
and modifications to the leased property. The annual lease fee approximates
MidCon Texas' 1996 depreciation expense and any difference is not expected to
have a material impact on future years' net income.
7
<PAGE> 8
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(3) SIGNIFICANT ACCOUNTING POLICIES
(a) Principles of Consolidation and Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its majority-owned subsidiaries. The consolidated balance sheet at December
31, 1996, reflects the transactions discussed in Note 2. The consolidated income
statement presented for 1996 includes the results of operations for the assets
dividended for the entire twelve months with the exception of OEVC, which is
included for nine months. All material intercompany transactions have been
eliminated. The equity method of accounting is used for investments in pipeline
ventures in which 50 percent or less of the voting interest is owned. The
Company's financial statements reflect adjustments needed to present
transactions with Occidental on a stand-alone basis.
Certain reclassifications have been made to the prior years' financial
statements to conform to the 1996 presentation.
(b) Accounting Changes
The Company's adoption of Statement of Financial Accounting Standards
(SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets To Be Disposed Of", effective January 1, 1996, which assumed
that the Company will continue to operate, maintain and, where appropriate,
expand its business, did not have an impact on the Company's consolidated
financial position or results of operations. The provisions require the Company
to review long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If it is determined that an impairment loss has occurred based on
expected future cash flows, then a loss will be recognized in the income
statement using a fair-value based model.
(c) Cash and Cash Equivalents and Interest-Bearing Receivables/Payables,
Net -- Affiliated Companies
Cash equivalents consist of interest bearing commercial paper and other
bank deposits with initial maturities of three months or less. Cash equivalents
totaled approximately $1.5 million and $1.7 million at December 31, 1996 and
1995, respectively.
Occidental and its subsidiaries utilize a cash-management system designed
to minimize cash balances and external borrowing. Amounts due from or to
affiliates under this program are reflected as current assets and liabilities in
the accompanying financial statements. Interest income and expense is allocated
to the participating companies on the basis of the principal contributed or
borrowed, respectively. The Company has periodically dividended, to its parent
company, its interest bearing receivables from Occidental under the former cash
management system.
In November 1996, the Company entered into a new intercompany cash
management agreement with Occidental. This agreement, which is effective January
1, 1997, engages Occidental to continue to provide the Company with certain
financing and cash management services.
During 1995, the Company declared a dividend to Occidental of an
intercompany receivable due from a then wholly-owned subsidiary. The balance of
the intercompany receivable, which prior to the dividend was eliminated in the
Company's, consolidation, is shown on the December 31, 1995 consolidated balance
sheet as a noncurrent interest-bearing payable to affiliated companies
representing an amount due Occidental (see Note 2.b).
(d) Receivables/Payables with Affiliated Companies
Receivable and payable balances with affiliates arise from transactions
between the Company's subsidiaries and Occidental's other subsidiaries. These
transactions occur in the normal course of business at prices which approximate
market.
8
<PAGE> 9
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company transfers to an Occidental special purpose affiliate certain
trade receivables under a revolving sales program with limited recourse, in
connection with the ultimate sale for cash of such receivables. The Company
retains the collection responsibility with respect to the receivables sold. An
interest in new receivables is transferred monthly, representing the net
difference between newly created receivables and collections made from
customers. Fees and expenses related to the sales of receivables under this
program are included in Selling, general and administrative and other operating
expenses.
(e) Inventories
Inventories are stated at the lower of cost or market. Inventories of
natural gas are determined using the average-cost method by MidCon Gas and the
last-in, first-out (LIFO) method by Natural (see Note 15). The cost of materials
and supplies inventories is determined using the average-cost method.
(f) Property, Plant and Equipment and Related Depreciation
Property additions and major renewals and improvements are capitalized at
cost. Interest costs incurred in connection with capital expenditures are
capitalized and amortized over the lives of the related assets. Depreciation of
natural gas transmission facilities is provided using primarily the
straight-line method.
Prior to the dividend of its oil and gas properties to Occidental, the
Company accounted for these properties using the successful-efforts method.
Costs of acquiring nonproducing acreage, costs of drilling successful
explorations wells and development costs were capitalized (see Note 2.c).
Depreciation of oil and gas producing properties was determined by the
units-of-production method and was based on estimated recoverable reserves.
Effective January 1, 1996, MidCon Texas revised the estimated average
useful lives used to compute depreciation to a remaining useful life of 38
years. This revision was made to more properly reflect the current economic
lives of the assets based on anticipated industry conditions. The aggregate
effect of this change was an increase in net income for the year ended December
31, 1996 of $14.9 million.
Property, plant and equipment includes purchase price adjustments related
to the acquisition of the Company by Occidental in 1986, For Natural's rate
making purposes, recovery is limited to the original cost of property, plant and
equipment which includes an allowance for funds used during construction. The
allocated purchase price, less subsequent accumulated depreciation, exceeded the
amount subject to recovery through the rate-regulatory process by $4.1 billion
and $4.2 billion at December 31, 1996 and 1995, respectively. This excess amount
as of December 31, 1996 is being depreciated over a remaining period of 37
years.
(g) Restricted Deposits
The Company engages in hedging to decrease its exposure to natural gas
price risk. In accordance with New York Mercantile Exchange rules, $38.6 million
and $24.6 million of monies on deposit with brokers was restricted at December
31, 1996 and 1995, respectively, to meet trading requirements (see Notes 3.1 and
11).
(h) Reserve for Contract Impairment
The contract impairment reserve recognizes the disadvantageous aspects of
certain gas-purchase and sales contracts resulting from economic and regulatory
conditions. Nearly all of these contracts or the disadvantageous aspects of
these contracts have now been resolved.
The contract impairment reserve includes reserves for the cost of the
resolution of these gas purchase and sales contracts, including "take-or-pay"
obligations. The noncurrent portion of the reserve was reduced by $52 million
and $66 million in 1996 and 1995, respectively, with no impact on net income,
primarily to reflect the settlement of an impaired contract, partial payment
thereon and the payment of above market costs.
9
<PAGE> 10
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The noncurrent portion of the reserve was reduced by $20 million in 1994 to
reflect a decrease in the net exposure under disadvantageous gas purchase
contracts, the elimination of certain potential claims, the successful
resolution of litigation, settlements or other changes in the expected outcome
of matters covered by the reserve.
(i) Gas Transportation Imbalances
Gas transportation imbalances receivable and payable reflect gas volumes
owed to Natural, MTPO and MidCon Gas or to their customers. For MTPO and MidCon
Gas, imbalances are valued primarily at the weighted average Cost of purchased
gas.
Natural's current imbalances are being settled on a monthly basis through
established cashout procedures. These imbalances are valued at the applicable
percentage of an average monthly index price determined in the month the
imbalance occurred. The remaining imbalances not under the cashout procedure are
valued primarily at the current market price.
(j) Supplemental Cash Flow Information
Cash payments during the years 1996, 1995 and 1994 included income taxes of
approximately $5.0 million, $6.4 million and $4.7 million, respectively.
Interest paid for the same period, net of amounts capitalized, was $74.3
million, $.3 million and $2.9 million.
(k) Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments" requires the disclosure of the fair value
of off- and on-balance sheet financial instruments, The Company has no material
off-balance sheet financial instruments. All balances reflected in the
consolidated balance sheets for financial instruments approximate market value.
(l) Hedging Activities
The Company uses commodity futures contracts, options and swaps to hedge
the impact of natural gas price fluctuations related to its business activities.
Gains and losses on hedge contracts are deferred and recognized as an adjustment
to sales revenue or purchase costs when the related transaction being hedged is
finalized (see Note 11).
(m) Risks and Uncertainties
The process of preparing consolidated financial statements in conformity
with generally accepted accounting principles (GAAP) requires the use of
estimates and assumptions regarding certain types of assets, liabilities,
revenues and expenses. Such estimates primarily relate to unsettled transactions
and events as of the date of the consolidated financial statements. Accordingly,
upon settlement, actual results may differ from estimated amounts, generally not
by material amounts. Management believes that these estimates and assumptions
provide a reasonable basis for the fair presentation of the Company's financial
position and results of operations.
Included in the accompanying balance sheet is net property, plant and
equipment at a carrying value of $5.1 billion as of December 31, 1996. These
carrying values are based on the Company's plans and intentions to continue to
operate, maintain and, where it is economically desirable, to expand its
businesses. If future economic conditions result in changes in management's
plans or intentions, the carrying values of the affected assets will be reviewed
again and any appropriate adjustments made.
10
<PAGE> 11
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(n) Liabilities
Accrued liabilities current and other noncurrent liabilities include
reserves relating to a reorganization of the Company's operations initiated in
1995 which were initially recorded as selling, general and administrative and
other operating expenses for $37 million during the fourth quarter of 1995. The
current and noncurrent portion of the reserve totaled approximately $9 million
and $12 million, respectively, at December 31, 1996 and $16 million and $21
million, respectively, at December 31, 1995.
(4) LITIGATION
There are various lawsuits and proceedings pending against the Company and
its subsidiaries. It is impossible at this time to determine the ultimate legal
liabilities that may arise therefrom. However, in management's opinion, after
taking into account reserves, the pending lawsuits and proceedings and claims
should not have a material adverse effect upon the consolidated financial
position or results of operations of the Company.
(5) REGULATORY MATTERS
On December 1, 1992, Natural filed with the FERC for a general rate
increase to recover higher operating costs. The FERC permitted Natural to put
the new rates into effect on June 1, 1993, subject to refund. In November 1994,
Natural filed a proposed settlement of the rate case with the FERC. The
settlement was approved by the FERC in January 1995. This settlement resulted in
refunds being made to customers of approximately $128 million in 1995.
On June 1, 1995, Natural filed a general rate case with the FERC to
establish new rates as well as new or revised services. The FERC permitted
Natural to place new rates and services into effect, subject to refund, on
December 1, 1995. This date corresponded to the effective date of new
transportation and storage agreements between Natural and its principal local
distribution customers. Major issues in the rate case include throughput levels
used in the design of rates, discounting adjustments, levels of depreciation
rates and return on investment, and the level and design of fuel rates. In May
1996, Natural filed with the FERC an offer of settlement to resolve the
remaining issues in this proceeding. Natural is currently negotiating with
intervenors to reach accommodations to allow the settlement to be certified as
unopposed.
In 1994, a federal appellate court remanded to the FERC two orders
determining that Great Lakes Gas Transmission Limited Partnership ("Great
Lakes") should implement incremental rates rather than rolled in rates to
recover the costs of certain expansions to its pipeline system. Under those
orders, the customers of Great Lakes for which the expansion facilities had been
built paid an incremental rate to cover the cost of the facilities while rates
to other shippers, such as Natural, were unaffected. In June 1995, the FERC
issued an order reversing its prior incremental rate decisions with retroactive
effect to November 1991. As a result of the 1995 order, Natural has paid Great
Lakes an additional $13.5 million for the period from November 1, 1991 through
November 1, 1995, the date Natural's contract with Great Lakes terminated.
Natural's request for rehearing of the FERC's June 1995 order was denied and
Natural has sought judicial review of this FERC decision. Natural has also filed
a mechanism for recovery of the additional amounts paid to Great Lakes as a
result of the June 1995 order. The FERC issued an order that would permit
Natural to recover from its customers any allocated and approved costs from
Great Lakes for post-December 1, 1993 service. In January 1997, the FERC
approved a settlement filed by Natural that resolves all issues related to
Natural's recovery from customers of a portion of the additional payment made to
Great Lakes.
In January 1997, Amoco Production Company and Amoco Energy Trading
Corporation ("Amoco") filed a complaint against Natural before the FERC
contending that Natural had improperly provided its affiliate, MidCon Gas
Services Corp. ("MidCon Gas"), transportation service on preferential terms.
Amoco has requested, among other things, that the FERC require Natural to
terminate the transportation services it
11
<PAGE> 12
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
provides to MidCon Gas. Natural believes it has treated all shippers, including
Amoco, fairly and it will vigorously defend its actions.
(6) CONTINGENT LIABILITIES AND COMMITMENTS
Natural has been a party to a number of contracts that required Natural to
purchase natural gas at prices in excess of the prevailing market price. As a
result of a FERC order (Order 636) prohibiting interstate pipelines from using
their gas transportation and storage facilities to market gas to sales
customers, Natural no longer had a sales market for the gas it is required to
purchase under these contracts. Order 636 went into effect on Natural's system
on December 1, 1993. Natural has agreed to pay substantial transition costs to
reform these contracts with gas suppliers. Settlement agreements reached by
Natural and its former sales customers, under which Natural is recovering from
those customers over a four year period beginning December 1, 1993, a
significant amount of the gas supply realignment (GSR) costs it incurs, have
been approved by the FERC. The FERC has also permitted Natural to implement a
tariff mechanism to recover additional portions of its GSR costs in rates
charged to transportation customers that were not party to the settlements. In
July 1996, a Federal appellate court remanded Order 636 to the FERC for further
explanation of aspects of its decision regarding recovery of GSR costs by
interstate pipelines.
The Company has certain other commitments and contingent liabilities under
contracts, guarantees and joint ventures.
In management's opinion, after taking into account reserves, none of such
commitments and contingencies discussed above should have a material adverse
effect upon the consolidated financial position or results of operations of the
Company.
(7) INCOME TAXES
The Company and its subsidiaries are included in Occidental's consolidated
federal tax return and unitary state tax returns. The consolidated provisions
for these income taxes are allocated to the Company on the basis of a tax
sharing agreement with Occidental. Under the agreement, the amount of
consolidated current and deferred tax provisions is determined as if the Company
were a corporation that was not owned by Occidental and filed a separate
consolidated income tax return. In addition, state income taxes are provided in
all states in which the Company is included in a state return with Occidental,
notwithstanding that the Company may not have been subject to tax in that
jurisdiction but for its affiliation with Occidental.
Taxable gains were recorded by the Company resulting from dividends and
asset transfers to Occidental during 1996 (see Note 2.c), Since the Company is
included in the consolidated federal income tax return with Occidental, these
taxable gains are deferred until the Company is transferred outside the
consolidated group. Under the Company's tax sharing agreement, the tax payments
associated with the gains will be reimbursed to the Company over the remaining
tax lives of the transferred assets. A long-term intercompany receivable from
Occidental has been recorded on the consolidated balance sheet to reflect these
reimbursements.
12
<PAGE> 13
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The provisions (credits) for income taxes for the years ended December 31
were as follows (in millions):
<TABLE>
<CAPTION>
ALLOCATED
CONSOLIDATED
TAXES STATE TOTAL
------------ ----- ------
<S> <C> <C> <C>
1996
Current........................................... $ 68.0 $10.6 $ 78.6
Deferred.......................................... (2.0) .1 (1.9)
------ ----- -----
$ 66.0 $10.7 $ 76.7
====== ===== =====
1995
Current........................................... $115.6 $10.8 $126.4
Deferred.......................................... (60.4) (5.3) (65.7)
------ ----- -----
$ 55.2 $ 5.5 $ 60.7
====== ===== =====
1994
Current........................................... $ 79.0 $ 6.5 $ 85.5
Deferred.......................................... 1.0 (1.4) (.4)
------ ----- -----
$ 80.0 $ 5.1 $ 85.1
====== ===== =====
</TABLE>
The following is a reconciliation, stated as a percentage of pretax income,
of the U.S. statutory federal income tax rate to the Company's effective
allocated consolidated tax rate on income:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER
31,
------------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
U.S. federal statutory tax rate......................... 35% 35% 35%
State taxes, net of federal benefit..................... 5 3 2
Income tax reserve no longer required................... -- (2) --
--- --- ---
Allocated consolidated tax rate......................... 40% 36% 37%
=== === ===
</TABLE>
Tax effects of temporary differences at December 31, 1996 and 1995 were as
follows (in millions):
<TABLE>
<CAPTION>
1996 1995
-------------------------- --------------------------
DEFERRED DEFERRED DEFERRED DEFERRED
ITEMS RESULTING IN TEMPORARY TAX TAX TAX TAX
DIFFERENCES ASSETS LIABILITIES ASSETS LIABILITIES
--------------------------------------- -------- ----------- -------- -----------
<S> <C> <C> <C> <C>
Property, plant and equipment, net..... $ -- $ 1,866 $ -- $ 2,182
Contract impairment reserves........... 49 -- 74 --
Postretirement benefit accruals........ 47 -- 47 --
State income taxes..................... 91 28 99 23
Regulatory liabilities................. 39 -- 32 --
Investment in partnerships............. 8 23 9 25
All other.............................. 107 27 92 10
---- ------ ---- ------
Total deferred taxes......... $341 $ 1,944 $353 $ 2,240
==== ====== ==== ======
</TABLE>
(8) RETIREMENT AND POSTRETIREMENT BENEFITS
The Company's retirement and postretirement defined benefit plans are
accrued based on various assumptions and discount rates, as described below. The
actuarial assumptions used could change in the near term as a result of changes
in expected future trends and other factors which, depending on the nature of
the changes, could cause increases or decreases in the liabilities accrued.
13
<PAGE> 14
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pension costs for the Company's defined benefit pension plan, determined by
independent actuarial valuations, are funded by payments to trust funds, which
are administered by independent trustees. The components of the net pension cost
for 1996, 1995 and 1994 were as follows (in millions):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER
31,
-----------------------------
1996 1995 1994
----- ----- -----
<S> <C> <C> <C>
Service cost -- benefits earned during the period....... $ 1.4 $ 1.4 $ 1.4
Interest cost on projected benefit obligation........... 0.7 0.5 0.5
Actual return on plan assets............................ (0.7) (0.7) (0.1)
Net amortization and deferral........................... -- 0.1 (0.4)
----- ----- -----
Net pension cost........................................ $ 1.4 $ 1.3 $ 1.4
===== ===== =====
</TABLE>
The following table sets forth the plan's funded status and amounts
recognized in the Company's consolidated balance sheets at December 31, 1996 and
1995 (in millions):
<TABLE>
<CAPTION>
BALANCE AT DECEMBER 31,
-------------------------------
1996 1995
------------- -------------
ACCUMULATED ACCUMULATED
BENEFITS BENEFITS
EXCEED ASSETS EXCEED ASSETS
------------- -------------
<S> <C> <C>
Present value of the estimated pension benefits to be
paid in the future:
Total projected benefit obligations.................... 10.6 8.8
Estimated fair value of plan assets.................... 9.4 7.7
----- -----
Projected benefit obligations in excess of plan
assets.............................................. $ 1.2 $ 1.1
===== =====
Projected benefit obligations in excess of plan
assets.............................................. $ 1.2 $ 1.1
Unrecognized prior service benefit..................... 0.1 0.2
Unrecognized net loss.................................. (0.7) (0.5)
----- -----
Pension liability...................................... $ 0.6 $ 0.8
===== =====
</TABLE>
The discount rate used in determining the actuarial present value of the
projected benefit obligations was 7.5 percent in 1996 and 1995. The rate of
increase in future compensation levels used in determining the actuarial present
value of the projected benefit obligations was 5.5 percent in 1996 and 1995. The
expected long-term rate of return on assets was 8 percent in 1996 and 1995.
The Company provides medical, dental and life insurance for certain active,
retired and disabled employees and their eligible dependents. Beginning in 1993,
participants pay for all medical cost increases in excess of increases in the
Consumer Price Index (CPI). The benefits generally are funded by the Company as
the benefits are paid during the year. The cost of providing these benefits is
based on claims filed and insurance premiums paid for the period. The total
benefits costs were approximately $14.6 million, $15.5 million and $16.3 million
in 1996, 1995 and 1994, respectively. The 1996, 1995 and 1994 costs included
$5.7 million, $6.6 million and $7.5 million, respectively, for postretirement
costs, as discussed below.
The postretirement benefit obligation at December 31, 1996 and 1995 was
determined by application of the terms of medical, dental, and life insurance
plans, including the effect of established maximums on covered costs, together
with relevant actuarial assumptions and health-care cost trend rates projected
at a CPI increase of 3.0 percent and 4.0 percent in 1996 and 1995, respectively.
The weighted average discount rate used in determining the accumulated
postretirement benefit obligation was 7.5 percent as of December 31, 1996 and
1995. The Company's funding policy generally is to pay claims as they come due
with the exception
14
<PAGE> 15
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of Natural which began funding for its obligation effective June 1, 1993. A FERC
policy statement allows collection of these costs currently in rates as the
appropriate funds are placed in an irrevocable trust. The trust was established
during 1993 and assets are invested in a variety of instruments, such as bonds,
money market accounts and equity investments.
The following table sets forth the postretirement plan's status, reconciled
with the amounts included in the consolidated balance sheets at December 31,
1996 and 1995 (in millions):
<TABLE>
<CAPTION>
BALANCE AT DECEMBER
31,
--------------------
1996 1995
----- ------
<S> <C> <C>
Accumulated postretirement benefit obligation
Retirees...................................................... $63.4 $ 75.7
Fully eligible actives........................................ 14.3 8.1
Other actives................................................. 12.4 17.2
----- ------
Total accumulated postretirement benefit obligation............. 90.1 101.0
Plan assets at fair value....................................... 34.2 26.4
----- ------
Unfunded status................................................. 55.9 74.6
Unrecognized net gain........................................... 37.9 26.4
----- ------
Accrued postretirement benefit cost............................. $93.8 $101.0
===== ======
</TABLE>
The benefit obligation decreased due primarily to the effect of the
decrease in the CPI discussed above, as well as favorable retiree claims
experience.
Net periodic postretirement benefit cost for 1996, 1995 and 1994 included
the following components (in millions):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER
31,
-----------------------------
1996 1995 1994
----- ----- -----
<S> <C> <C> <C>
Service cost -- benefits attributed to service during
the period............................................ $ 1.1 $ 1.1 $ 1.0
Interest cost on accumulated postretirement benefit
obligation............................................ 7.2 7.2 7.7
Actual return on plan assets............................ (1.3) (0.7) (0.6)
Net amortization and deferral........................... (1.1) (1.0) (0.6)
Other................................................... (0.2) -- --
----- ----- -----
Net periodic postretirement benefit cost................ $ 5.7 $ 6.6 $ 7.5
===== ===== =====
</TABLE>
(9) RETIREMENT PLANS AND ESOP
All employees are participants in defined contribution retirement and
savings plans. The plans provide for periodic contributions based on the salary
and age level of employees and/or employee contributions. The Company's expense
under the provisions of the plans was $12.5 million, $13.2 million and $12
million for 1996, 1995 and 1994, respectively. Beginning January 1, 1997, the
Company's contribution under the salaried retirement plan, totaling $7.6
million, $7.7 million and $7.4 million for 1996, 1995 and 1994, respectively,
will be reduced over time pursuant to the terms of the plan.
Effective November 20, 1996, Occidental established the ESOP for all
eligible employees of the Company. Generally, the shares of the CMIC Preferred
Stock held by the ESOP are released and allocated to participant accounts based
on the proportion of the payment on the note for the respective period compared
to the total remaining payments due on the note. Dividends on the CMIC Preferred
Stock are payable at an annual rate of $21 per share, when and as declared by
Occidental's Board of Directors. It is anticipated that the Company will make
discretionary annual contributions to the MidCon ESOP which, together with the
annual dividends, will be used to repay the ESOP note. The Company accounts for
its ESOP in accordance
15
<PAGE> 16
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
with Statement of Position 93-6, "Employers' Accounting for Employee Stock
Ownership Plans" which requires that compensation expense be measured based on
the fair value of shares committed to be released.
The ESOP loan guarantee is recorded as a long-term intercompany liability
and the shares of CMIC Preferred Stock pledged as collateral are reported as
unearned ESOP shares in the consolidated balance sheet. As shares are released
from collateral, the Company reports compensation expense equal to the estimated
current market price of the shares. Dividends on allocated ESOP shares result in
a reduction to additional paid-in capital. Dividends on unallocated ESOP shares
will be used to satisfy debt service. ESOP compensation expense was $217,000 for
1996. The ESOP has 6,151 allocated shares and 1,393,849 unreleased shares
outstanding at December 31, 1996.
(10) STOCK BASED COMPENSATION PLANS
Certain Company executives participate in various Occidental incentive
stock plans. These plans include options with vesting terms of 3 years and
maximum terms of 10 years and one month, Under these plans, 168,000 and 143,332
options were granted for the years ended December 31, 1996 and 1995,
respectively. In addition, 4,589 and 10,909 of Occidental's $.20 par value
restricted stock were granted during the years ended December 31, 1996 and 1995,
respectively. These grants vest after 4 years (5 years for awards issued prior
to December 1995) or earlier under certain conditions.
The Company accounts for these plans under Accounting Principles Board
Opinion No. 25. The difference in compensation expense for these plans
determined in accordance with SFAS No. 123, "Accounting for Stock Based
Compensation" is not significant.
(11) HEDGING ACTIVITIES
The Company uses commodity futures contracts, options and swaps to hedge
the impact of natural gas price fluctuations related to two major categories of
business: purchases for and sales from storage and fixed-price sales and
purchase contracts.
STORAGE
Storage activities consist of purchasing and injecting natural gas into
storage during low-price, low-demand periods (typically the months of April
through October) and withdrawing that gas for sale during high-price,
high-demand periods (typically the period from November through March). These
periods may vary depending primarily on weather conditions and competing fuel
prices in the market areas. The Company uses derivatives (mainly futures
contracts) to hedge the sales and purchase prices related to its storage
program. The hedging contracts used have terms of less than 18 months. Gains and
losses on these hedging contracts are deferred and recognized in income when the
transactions being hedged are finalized. A small number of options were sold
against inventory capacity or physical inventory with results included in
periodic income.
FIXED-PRICE SALES AND PURCHASES
Fixed-price gas sales and purchase contracts vary by agreement. Hedges are
placed nearly simultaneously with the consummation of many of the sales-purchase
agreements. All agreements are for less than 18 months.
Gains and losses on these hedging contracts are deferred and recognized in
income when the transactions being hedged are finalized. New York Mercantile
Exchange (NYMEX), Kansas City Board of Trade (KCBT), (collectively, the
Exchanges) and over-the-counter (OTC) hedge instruments are utilized.
16
<PAGE> 17
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
All hedging activity is matched to physical natural gas buying and selling
activity and is done with natural gas futures or derivative instruments. There
is essentially no discrepancy with regard to timing, i.e., hedges are placed for
the same month in which the price risk for the underlying physical movement is
anticipated to occur, based on analysis of sales and purchase contracts and
historical data. Hedges are removed upon consummation of the underlying physical
activity. All deferred gains or losses are then recognized. Because the
commodity covered by the Exchanges' natural gas futures contracts is
substantially the same commodity that the Company buys and sells in the physical
market, no special correlation studies, other than monitoring the degree of
convergence between the futures and the cash markets, are deemed necessary.
Geographic basis risk (the difference in value of gas at the Exchanges' delivery
points versus the points of the Company's transaction) is monitored and where
appropriate, hedged using OTC instruments. Exchange-traded futures and options
are valued using settlement prices published by the Exchanges. OTC options are
valued using a standard option pricing model that requires published exchange
prices, market volatility per broker quotes, and the time value of money. Swaps
are valued by comparing current broker quotes for price or basis with the
corresponding price or basis in the related swap agreement and then discounting
the result to present value.
Although futures and options traded on the Exchanges are included in the
table below, they are not financial instruments as defined in GAAP, since
physical delivery of natural gas may be, and occasionally is, made pursuant to
these contracts. However, they are a major part of the Company's commodity risk
management program.
The following table summarizes the types of hedges used and the related
financial information as of December 31, 1996 and 1995:
<TABLE>
<CAPTION>
OVER-THE-
EXCHANGES (a) COUNTER(b) TOTAL
------------- ------------- -------------
HEDGES OF 1996 1995 1996 1995 1996 1995
------------ ---- ---- ---- ---- ---- ----
(NOTIONAL VOLUMES IN BCF)
<S> <C> <C> <C> <C> <C> <C> <C>
Price Hedge:
Futures........................... Purchases 32 62 -- -- 32 62
Swaps............................. Purchases -- -- -- 8 -- 8
Sales -- -- 1 -- 1 --
Options........................... Purchases -- -- 2 -- 2 --
Basis Hedge:
Basis Swaps(c).................... Purchases -- -- 33 9 33 9
Sales -- -- 34 7 34 7
</TABLE>
<TABLE>
<CAPTION>
OVER-THE-
EXCHANGES COUNTER BOOK VALUE FAIR VALUE
----------- ----------- ----------- -----------
1996 1995 1996 1995 1996 1995 1996 1995
---- ---- ---- ---- ---- ---- ---- ----
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Deferred net gains (losses):
Firm commitment/forecast transactions.......... $(3) $14 $ -- $ --
Assets:
Basis swaps.................................... $ -- $-- $ 1 $--
Liabilities:
Price swaps.................................... $ -- $ 2 $-- $ 6
Basis swaps.................................... $ -- $ 1 $-- $ 2
</TABLE>
- ---------------
(a) Not financial instruments as defined in GAAP, but included as they are a
major part of the program.
(b) Excluding the nine-year swap agreement, the average weighted term is less
than twelve months. Ninety percent of the notional volumes are hedged with
counterparties with a BBB or better credit rating.
17
<PAGE> 18
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(c) Basis swaps are utilized to hedge the geographic price differentials due
primarily to transportation cost and local supply-demand factors.
(12) LEASES
Rent expense under primarily operating leases was $14.6 million in 1996 and
$13.9 million in 1995 and 1994.
At December 31, 1996, future minimum rental commitments under
noncancellable operating leases, including the MTPO lease agreement (see Note
2.d), were as follows (in millions):
<TABLE>
<CAPTION>
CALENDAR YEAR
-----------------------------------------------------------
<S> <C>
1997.................................................... $ 42.1
1998.................................................... 32.5
1999.................................................... 33.7
2000.................................................... 33.8
2001.................................................... 32.8
Remaining years......................................... 854.0
--------
Total............................................ $1,028.9
========
</TABLE>
(13) MAJOR CUSTOMERS
Revenues realized from major customers, which are defined as those
providing in excess of ten percent of total operating revenues, were as follows
for the years ended December 31, (in millions):
<TABLE>
<CAPTION>
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Northern Illinois Gas Company............................ $114.5 $267.0 $332.3
The Peoples Gas Light and Coke Company................... $114.3 $214.7 $285.7
</TABLE>
(14) TRANSACTIONS WITH AFFILIATES
Excess funds are invested with Occidental through its centralized
cash-management system. All intercompany loans are evidenced by a cash
management agreement. Interest earned or charged is calculated at prevailing
market rates.
Occidental provides and directly bills the Company's subsidiaries for
various services including information technology services, administrative
services for payroll, and employee benefits for which the Company was allocated
for 1996 and 1995 approximately $5.2 million and $5.4 million, respectively. In
addition, Occidental charges the Company for expense incurred on its behalf such
as insurance. All these charges, which were part of the noninterest-bearing
long-term intercompany liability at December 31, 1996 and 1995, approximate the
amounts management believes would be incurred if the Company were to
independently secure these services. The charges for these services are not
reflected in the table on the following page.
On November 20, 1996, the Company entered into a 10 year service agreement
with Occidental. This agreement, which is effective January 1, 1997, provides
for the continuation of various services performed on the Company's behalf by
Occidental. The initial annual fee for these current services will be $13
million through December 31, 2001, after which time the fee will be
renegotiated. The services provided will include, among others, insurance,
internal audit, legal and investor relations. In addition, the agreement
provides for the allocation of certain out-of-pocket expenses incurred on the
Company's behalf and for separate fees to be billed to the Company by Occidental
for such services as tax, regulatory compliance, payroll. and benefits and
information technology. The fees charged will generally replace the "Charges for
Occidental's general and administrative costs" indicated in the table below.
18
<PAGE> 19
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Principal transactions with affiliated companies, except as disclosed
elsewhere in these financial statements were as follows (in millions):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
----------------------------
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Affiliated company transactions:
Transfer of trade receivables........................ $410.6 $219.8 $226.4
Fees and expenses on trade receivables transferred... $ 10.4 $ 8.4 $ 8.4
Sales, transportation and storage of natural gas and
other revenues.................................... $ 3.7 $ 2.8 $ --
Purchases and transportation of natural gas.......... $ 2.1 $ 0.9 $ 1.8
Charge for Occidental's general and administrative
costs............................................. $ 18.3 $ 21.1 $ 19.0
Net interest income (expense)................ $(66.1) $(11.6) $ 8.6
Pipeline venture transactions:
Cash distributions................................... $ 14.1 $ 16.8 $ 18.7
Transportation of natural gas charged to operation
expense........................................... $ 8.3 $ 9.8 $ 20.2
</TABLE>
(15) GAS STORED UNDERGROUND
At December 31, 1996 and 1995, Natural's current gas storage inventory
which is accounted for on the LIFO method was $5 million and $1.8 million,
respectively. The remaining current gas storage inventory is accounted for under
the average cost method. Noncurrent gas inventory is stated primarily at the
allocated purchase cost.
During 1994, inventory quantities were reduced at Natural resulting in a
liquidation of LIFO inventory quantities carried at lower costs that prevailed
in prior years. The effect of this liquidation was to reduce cost of sales by
$13.6 million.
(16) PIPELINE VENTURES
Investments in active companies in which the Company has a voting interest
of not more than 50 percent are accounted for on the equity method. At December
31, 1996, the Company's equity investments consisted primarily of:
<TABLE>
<CAPTION>
INVESTEE OWNERSHIP INTEREST
--------------------------------------------------------------------- ------------------
<S> <C>
West Cameron Dehydration Company..................................... 50%
Stingray Pipeline Company............................................ 50%
Gulf Processing...................................................... 50%
U-T Offshore System.................................................. 33 1/3%
Trailblazer Pipeline Company......................................... 33 1/3%
High Island Offshore System.......................................... 20%
Overthrust Pipeline Company.......................................... 18%
</TABLE>
Summarized financial information of these ventures is set forth below (in
millions):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
----------------------------
1996 1995 1994
------ ------ ------
<S> <C> <C> <C>
Operating revenues....................................... $116.3 $138.1 $121.9
Costs and expenses....................................... 65.9 72.2 83.0
------ ------ ------
Net income..................................... $ 50.4 $ 65.9 $ 38.9
====== ====== ======
</TABLE>
19
<PAGE> 20
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
BALANCE AT
DECEMBER 31,
---------------------
1996 1995
------ ------
<S> <C> <C>
Current assets................................................. $ 79.2 $ 95.3
Noncurrent assets.............................................. $290.9 $314.8
Current liabilities............................................ $ 69.1 $ 77.9
Noncurrent liabilities......................................... $145.2 $175.4
Shareholders' equity........................................... $155.8 $156.8
</TABLE>
In accordance with project financing arrangements of certain of these
ventures and under tariffs approved by the FERC, Natural is required to pay
demand charges to certain of these ventures for contracted transportation
services. The demand charges for the years 1996, 1995 and 1994 were
approximately $10.7 million, $9.2 million, and $20.7 million, respectively.
(17) CONCENTRATION OF CREDIT RISK
The Company and its subsidiaries sell and transport natural gas in
interstate and intrastate commerce primarily in the central and Gulf regions of
the United States, respectively. Although affected by the economic climate for
natural gas, the end-use market of these companies' customers is diversified
among residential, commercial and industrial users. These companies mitigate
credit risk by requiring collateral or financial guarantees and letters of
credit from customers with specific credit concerns.
20
<PAGE> 1
EXHIBIT 2
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDING SEPTEMBER 30, 1997 AND 1996
(THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDING ENDING
SEPTEMBER 30, SEPTEMBER 30,
1997 1996
------------- -------------
<S> <C> <C>
REVENUES:
Gas sales, transportation, storage and other operating
revenues..................................................... $ 2,063,058 $ 1,776,703
Interest and other income....................................... 9,595 7,721
Earnings of pipeline ventures................................... 9,965 9,899
----------- -----------
2,082,618 1,794,323
----------- -----------
COSTS AND OTHER DEDUCTIONS:
Cost of sales................................................... 1,684,980 1,338,188
Selling, general and administrative and other operating
expenses..................................................... 77,853 83,959
Depreciation.................................................... 110,924 131,676
Taxes other than income taxes................................... 23,087 36,341
Interest expense................................................ 181,601 43,379
Other........................................................... 1,005 1,439
----------- -----------
2,079,450 1,634,982
----------- -----------
INCOME BEFORE INCOME TAXES........................................ 3,168 159,341
PROVISIONS FOR AND CHARGE-IN-LIEU OF INCOME TAXES................. 87 59,276
----------- -----------
NET INCOME........................................................ $ 3,081 $ 100,065
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
1
<PAGE> 2
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AT SEPTEMBER 30, 1997 AND DECEMBER 31, 1996
(THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................................................ $ 6,278 $ 4,258
Restricted deposits...................................................................... 30,678 38,623
Receivables
Affiliated companies................................................................... 268,947 415,643
Customers.............................................................................. 14,592 9,363
Other.................................................................................. 17,858 26,324
Interest-bearing receivables, net-affiliated companies................................... 147,519 25,361
Gas transportation imbalances............................................................ 44,438 56,106
Materials and supplies................................................................... 11,320 11,718
Net properties to be dividended, net of tax.............................................. 303,451 308,804
Gas stored underground................................................................... 73,312 39,343
Prepayments.............................................................................. 3,771 20,187
Deferred income taxes.................................................................... 46,878 77,277
------------ ------------
Total Current Assets............................................................... 969,042 1,033,007
------------ ------------
PROPERTY, PLANT AND EQUIPMENT.............................................................. 6,648,818 6,876,061
Accumulated depreciation................................................................. (1,617,826) (1,785,257)
------------ ------------
Net Property, Plant and Equipment...................................................... 5,030,992 5,090,804
------------ ------------
LONG-TERM INTERCOMPANY RECEIVABLE.......................................................... 31,390 33,197
GAS STORED UNDERGROUND -- NONCURRENT....................................................... 400,619 413,334
INVESTMENTS IN PIPELINE VENTURES........................................................... 53,498 53,141
DEFERRED CHARGES AND OTHER ASSETS.......................................................... 24,972 28,879
------------ ------------
TOTAL ASSETS............................................................................... $ 6,510,513 $ 6,652,362
============ ============
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES:
Payables --
Affiliated companies................................................................... $ 3,576 $ 2,857
Trade.................................................................................. 194,818 301,569
Contract impairment.................................................................... 605 1,126
Other.................................................................................. 91,661 115,943
Dividend payable, affiliates............................................................. 303,452 308,804
Accrued interest payable, affiliates..................................................... 82,867 --
Rate refund provision.................................................................... 13,756 15,218
Gas transportation imbalances............................................................ 80,990 83,310
Current portion of long-term ESOP debt................................................... 12,574 12,574
Other.................................................................................... 103,062 120,213
------------ ------------
Total Current Liabilities.......................................................... 887,361 961,614
------------ ------------
OTHER LIABILITIES AND DEFERRED CREDITS:
Reserve for contract impairment.......................................................... 13,773 43,775
Intercompany liability................................................................... -- 32,696
Interest-bearing notes, affiliated companies............................................. 1,600,000 1,600,000
Long-term ESOP debt...................................................................... 1,386,026 1,386,026
Postretirement benefits other than pensions.............................................. 90,889 89,780
Other.................................................................................... 133,684 157,400
------------ ------------
Total Other Liabilities and Deferred Credits....................................... 3,224,372 3,309,677
------------ ------------
DEFERRED INCOME TAXES...................................................................... 1,690,440 1,680,354
------------ ------------
CONTINGENT LIABILITIES AND COMMITMENTS
MINORITY EQUITY IN SUBSIDIARIES AND PARTNERSHIPS........................................... 7,456 8,076
------------ ------------
STOCKHOLDER'S EQUITY:
Common Stock, $.01 par value, authorized 2,000,000 shares, outstanding 1,400,000 shares
in 1996; $1 par value, authorized 1,000 shares, outstanding 1 share in 1995............ 14 14
Unearned ESOP shares..................................................................... (1,359,002) (1,393,849)
Additional paid-in capital............................................................... 1,970,375 2,000,060
Retained earnings........................................................................ 89,497 86,416
------------ ------------
Total Stockholder's Equity......................................................... 700,884 692,641
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY................................................. $ 6,510,513 $ 6,652,362
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
2
<PAGE> 3
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDING SEPTEMBER 30, 1997 AND 1996
(THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1996
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income...................................................... $ 3,081 $ 100,065
Income adjustments --
Depreciation................................................. 110,924 131,676
Deferred income tax provision (benefit)...................... 38,531 6,424
Other noncash (credits) charges to income, net............... (23,416) 43,831
Distributions from (to) pipeline ventures, net of earnings... (307) 1,851
Compensation expense......................................... 1,148 --
Changes in operating assets and liabilities:
Decrease in accounts receivable.............................. 35,770 39,671
Decrease in accounts receivable from affiliates.............. 153,836 13,233
(Increase) decrease in inventories........................... (35,307) 19,757
Decrease (increase) in prepaid and other assets.............. 2,654 (42,176)
Change in gas transportation imbalances, net................. 9,708 (8,845)
(Decrease) increase in accounts payable and accrued
liabilities................................................. (165,633) 64,579
Increase (decrease) in accounts payable to affiliates........ 719 (256)
Decrease in income taxes..................................... (7,597) (1,532)
Other operating, net............................................ 8,067 4,478
--------- ---------
Net cash provided by operating activities.................... 132,178 372,756
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures............................................ (56,578) (102,031)
Acquisition of cushion gas...................................... -- (90,409)
Proceeds (costs) from disposal of property, plant and equipment,
net.......................................................... 8,738 (6,399)
Other investing, net............................................ (5,565) (2,953)
--------- ---------
Net cash used by investing activities........................ (53,405) (201,792)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments debt......................................... -- (7,500)
Amounts paid to minority interest............................... (1,941) --
Net change in interest-bearing receivables/payables with
affiliated companies and intercompany liability.............. (74,812) (162,920)
--------- ---------
Net cash used by financing activities........................ (76,753) (170,420)
--------- ---------
Increase (decrease) in cash and cash equivalents.................. 2,020 544
--------- ---------
Cash and cash equivalents at beginning of year.................... 4,258 10,414
--------- ---------
Cash and cash equivalents at end of period........................ $ 6,278 $ 10,958
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE> 4
MIDCON CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
UNEARNED ADDITIONAL RETAINED
COMMON ESOP PAID-IN EARNINGS
STOCK SHARES CAPITAL (DEFICIT)
------ ----------- ----------- ---------
<S> <C> <C> <C> <C>
Balance, December 31, 1994................. $ -- $ -- $ 4,280,577 $ 91,633
Net income............................... -- -- -- 106,626
Dividend of intercompany receivable to
Parent (Note 3.c)..................... -- -- (922,470) (228,328)
------ ----------- ----------- ---------
Balance, December 31, 1995................. -- -- 3,358,107 (30,069)
Net income............................... -- -- -- 116,485
Dividend of subsidiaries and properties
(Note 2.c)............................ -- -- (672,407) --
Contribution of intercompany debt (Note
2.b).................................. -- -- 914,703 --
Non-cash dividend (Note 2.b)............. -- -- (1,600,000) --
Stock split (Note 2.b)................... 14 -- (14) --
Unearned ESOP shares (Note 9)............ -- (1,400,000) -- --
Dividends on unearned ESOP shares (Note
2.a).................................. -- -- 3,348 --
Release of ESOP shares, net of tax effect
(Note 9).............................. -- 6,151 (3,677) --
------ ----------- ----------- ---------
Balance, December 31, 1996................. 14 (1,393,849) 2,000,000 86,416
Net income............................... -- -- -- 3,081
Release of ESOP shares, net of tax
effect................................ -- 34,847 (31,275) --
Noncash dividend of properties........... -- -- (3,764) --
Adjustment to dividend of subsidiaries
and properties........................ -- -- 5,354 --
------ ----------- ----------- ---------
Balance, September 30, 1997................ $ 14 $(1,359,002) $ 1,970,375 $ 89,497
====== ========== ========== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
4
<PAGE> 5
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) DESCRIPTION OF COMPANY
The accompanying unaudited consolidated condensed financial statements have
been prepared by MidCon Corp. pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and disclosures normally
included in consolidated financial statements have been condensed or omitted
pursuant to such rules and regulations, but resultant disclosures are in
accordance with generally accepted accounting principles as they apply to
interim reporting. The consolidated condensed financial statements should be
read in conjunction with MidCon Corp.'s audited consolidated financial
statements for the year ended December 31, 1996 ("1996 financial statements").
In the opinion of MidCon Corp.'s management, the accompanying consolidated
condensed financial statements contain all adjustments (consisting only of
normal recurring adjustments) necessary to present fairly MidCon Corp.'s
consolidated financial position as of September 30, 1997, and the consolidated
results of operations and consolidated cash flows for the nine months then
ended. The results of operations and cash flows for the nine month periods ended
September 30, 1997 and 1996 are not necessarily indicative of the results of
operations and cash flows to be expected for the full year.
MidCon Corp. ("MidCon" and, together with its subsidiaries, "Company") is a
wholly-owned subsidiary of Occidental Petroleum Corporation (Occidental). On
December 18, 1997, Occidental announced that it had signed a definitive
agreement to sell the Company for $3.49 billion consideration, subject to
certain supplemental adjustments. The transaction is expected to close in the
first quarter 1998.
(2) MIDCON RECAPITALIZATION
(a) ESOP
In November 1996, Occidental established the MidCon Corp. Employee Stock
Ownership Plan (ESOP) (see Note 9) for the benefit of the eligible employees of
the Company.
Also, in November 1996, Occidental sold $1.4 billion of Occidental's
Cumulative MidCon-Indexed Convertible Preferred Stock (CMIC Preferred Stock) to
the MidCon Corp. ESOP Trust (the Trust). The CMIC Preferred Stock is convertible
into Occidental common stock based on the value of the Company. The Trust paid
for the CMIC Preferred Stock with $1.4 million cash and a $1.3986 billion
30-year promissory note (ESOP note), bearing interest at 7.9 percent per annum,
guaranteed by MidCon.
Principal and interest payments on the ESOP note are due on December 31 in
annual installments of approximately $123 million, commencing December 31, 1997,
and continuing through December 31, 2026, upon which date all principal and
interest remaining unpaid shall be immediately due and payable. Dividends on the
CMIC Preferred Stock are payable at an annual rate of $21 per share, when and as
declared by Occidental's Board of Directors. It is anticipated that MidCon will
make discretionary annual contributions to the MidCon ESOP which, together with
the annual dividends, will be used to repay the ESOP note. Dividends of $3.3
million on unearned shares and a cash contribution of $9.2 million were used for
debt service on the ESOP note in 1996.
Results for the nine month period ended September 30, 1997 include interest
expense of $82.9 million on the ESOP note and compensation expense of $1.1
million as discussed in Note 9.
(b) Other Capital Transactions
Concurrent with the establishment of the ESOP, several transactions were
recorded. MidCon had a 1,400,000-for-one split of the outstanding shares of its
common stock, while the par value of such stock was changed from $1.00 per share
to $.01 per share. Occidental contributed to the capital of MidCon $741 million
of promissory notes previously issued by MidCon and $154 million of non-interest
bearing intercorporate advances made by Occidental to MidCon that were
outstanding as of November 30, 1996. In addition,
5
<PAGE> 6
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MidCon declared a dividend, payable in the form of a $1.6 billion note payable
to Occidental. The principal amount of this note is due and payable on December
31, 2026 and bears interest at an annual rate of 7.9 percent payable monthly
through December 31, 2001. Thereafter, the rate changes to the London Interbank
Offered Rate (LIBOR) plus 1.25 percent.
Results for the nine month period ended September 30, 1997 include interest
expense of $96.1 million on the $1.6 billion note.
(c) Dividend of Subsidiaries and Properties
During 1996, MidCon dividended all the outstanding shares of common stock
of its subsidiaries, Occidental Energy Ventures Corp. (OVEC) and MC Panhandle,
Inc., to Occidental. Properties from other Company subsidiaries comprising
certain oil and gas properties and well compressor properties were dividended to
Occidental effective on December 31, 1996. The net income from these operations
was $7.8 million for the nine months ended September 30, 1996.
Also, effective December 31, 1996, MidCon dividended 51 percent of its
interest in an intrastate pipeline limited liability partnership to Occidental
(see Note 2.d).
A summary of the 1996 adjustments showing the effect of the above
transactions on certain balance sheet accounts is presented below (in millions):
<TABLE>
<CAPTION>
INCREASE
(DECREASE)
----------
<S> <C>
Property, Plant and Equipment..................................... $ (1,339)
Accumulated Depreciation.......................................... $ (345)
Deferred Income Taxes............................................. $ (322)
Additional Paid-in Capital........................................ $ (672)
</TABLE>
(d) Lease of Intrastate Pipeline Assets
In December 1996, MidCon merged its subsidiary MidCon Texas Pipeline Corp.
(MidCon Texas) into a limited partnership, which then owned its Texas intrastate
pipeline and related facilities. On December 31, 1996, fifty-one percent of the
Company's ownership in the partnership was dividended to a subsidiary of
Occidental with a dividend of the remaining 49 percent to be paid on January 1,
1998. This 49 percent interest is reflected in the accompanying consolidated
balance sheets as "Net properties to be dividended, net of tax." MidCon formed a
new subsidiary, MidCon Texas Pipeline Operator, Inc. ("MTPO"), which assumed
certain of the contracts and obligations of MidCon Texas before the merger. In
addition, MTPO entered into an agreement with the limited partnership to lease
the intrastate pipeline system owned by the limited partnership over a 30 year
period commencing on January 1, 1997. The Company accounts for this lease as an
operating lease. The initial annual lease fee is $30 million in 1997. The lease
fee changes to $20 million for the years 1998 through 2001, $40 million for the
years 2002 through 2005 and $30 million during the remaining lease term. Lease
expense of $30 million will be recognized annually. The lease agreement requires
MTPO to pay for taxes, insurance and maintenance expenses and contains
restrictions concerning additions, dispositions and modifications to the leased
property.
(3) SIGNIFICANT ACCOUNTING POLICIES
Reference is made to Note 3 in MidCon's 1996 financial statements for a
summary of significant accounting policies.
6
<PAGE> 7
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(a) Cash and Cash Equivalents and Interest-Bearing Receivables/Payables,
Net-Affiliated Companies
Cash equivalents consist of interest bearing commercial paper and other
bank deposits with initial maturities of three months or less. Cash equivalents
totaled approximately $3.4 million and $1.5 million at September 30, 1997 and
December 31, 1996, respectively.
Occidental and its subsidiaries utilize a cash-management system designed
to minimize cash balances and external borrowing. In November 1996, MidCon
entered into a new intercompany cash management agreement with Occidental. This
agreement, which was effective January 1, 1997, engages Occidental to continue
to provide the Company with certain financing and cash management services.
Amounts due from or to affiliates under this program are reflected as current
assets and liabilities in the accompanying financial statements. Interest income
and expense is allocated to the participating companies on the basis of the
principal contributed or borrowed, respectively. Under the former cash
management system, MidCon has periodically dividended, to its parent company,
its interest bearing receivables from Occidental.
(b) Accounting Changes
In June 1996, the Financial Accounting Standards Board (FASB) issued SFAS
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities." The statement provides consistent standards for
distinguishing transfers of financial assets that are sales from transfers that
are secured borrowings. The Company's adoption of SFAS No. 125, effective
January 1, 1997, did not have an impact on the Company's financial position or
results of operations.
In October 1996, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position No. 96-1, "Environmental Remediation
Liabilities" (SOP 96-1), which provides authoritative guidance on specific
accounting issues that are present in the recognition, measurement, display and
disclosure of environmental remediation liabilities. The Company's adoption of
SOP 96-1, effective January 1, 1997, did not have an impact on the Company's
financial position or results of operations.
The FASB has issued SFAS No. 129, "Disclosure of Information about Capital
Structure" to be effective for periods ending after December 15, 1997. SFAS No.
129 establishes standards for disclosing information about an entity's capital
structure. The Company does not believe that the application of the new standard
will have a material effect on the Company's financial position or results of
operations.
The FASB has issued SFAS No. 130, "Reporting Comprehensive Income" to be
effective for periods beginning after December 15, 1997. SFAS No. 130
establishes standards for reporting and display of comprehensive income and its
components in a full set of general purpose financial statements. The Company
does not believe that the application of the new standard will have a material
effect on the Company's financial position or results of operations.
The FASB has issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information" to be effective for periods beginning after
December 15, 1997. SFAS No. 131 establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim financial reports. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. The Company does not believe that the
application of the new standard will have a material effect on the Company's
financial position or results of operations.
(c) Property, Plant and Equipment and Related Depreciation
Reference is made to the 1996 financial statements and Note 3(f) thereto
for a description of investments in property, plant and equipment.
7
<PAGE> 8
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(d) Restricted Deposits
The Company engages in hedging to decrease or modify its exposure to
natural gas price risk. In accordance with New York Mercantile Exchange (NYMEX)
rules, $30.7 million and $38.6 million of monies on deposit with brokers was
restricted at September 30, 1997 and December 31, 1996, respectively, to meet
trading requirements.
(e) Supplemental Cash Flow Information
Cash payments during the nine months ended September 30, 1997 and 1996
included income taxes of approximately $3.4 million and $4.0 million,
respectively. Interest paid for the same periods, net of amounts capitalized,
was $95.9 million and $0.
(f) Hedging Activities
The Company uses commodity futures contracts, options and swaps to hedge
the impact of natural gas price fluctuations related to its business activities.
Gains and losses on hedge contracts are deferred and recognized as an adjustment
to sales revenue or purchase costs when the related transaction being hedged is
finalized.
(g) Liabilities
"Accrued liabilities current" and "Other noncurrent liabilities" include
reserves relating to a reorganization of the Company's operations initiated in
1995. The Company recorded a reserve of $37 million during the fourth quarter of
1995. The current and noncurrent portion of the reserve totaled approximately $7
million and $4 million, respectively at September 30, 1997 and $9 million and
$12 million, respectively, at December 31, 1996.
(4) LITIGATION
There are various lawsuits and proceedings pending against the Company. It
is impossible at this time to determine the ultimate legal liabilities that may
arise therefrom. However, in management's opinion, after taking into account
reserves, the pending lawsuits and proceedings and claims should not have a
material adverse effect upon the consolidated financial position or results of
operations of the Company.
(5) REGULATORY MATTERS
On November 3, 1997, the FERC approved a settlement of the general rate
case of the Natural Gas Pipeline Company of America ("Natural") filed on June 1,
1995, substantially consistent with what Natural proposed. This settlement of
the rate case has had a favorable impact of approximately $9 million on
operating margin for the nine months ended September 30, 1997.
In January 1997, Amoco Production Company and Amoco Energy Trading
Corporation ("Amoco") filed a complaint against Natural before the FERC
contending that Natural had improperly provided its affiliate, MidCon Gas,
transportation service on preferential terms, seeking termination of currently
effective contracts and the imposition of civil penalties. A subsequent FERC
staff audit made proposed findings that Natural has favored MidCon Gas, which
Natural has challenged. In July, Amoco and Natural agreed to a settlement of
this proceeding. Amoco has filed to withdraw its complaint subject to the FERC's
procedures. Several intervenors have opposed the withdrawal of the complaint and
Natural has filed an answer to that opposition. The matter is pending before the
FERC.
8
<PAGE> 9
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) CONTINGENT LIABILITIES AND COMMITMENTS
The FERC has allowed certain rates for gas supply realignment GSR costs to
go into effect on December 1, 1997, subject to refund, to recover any shortfall
in recoveries of GSR costs allocated to interruptible transportation (See Note 5
to the 1996 financial statements). However, the FERC rejected Natural's filing
for rehearing that Natural be allowed to recoup a portion of any shortfall on
title transfers and interruptible transportation to pooling points.
The Company has certain other commitments and contingent liabilities under
contracts, guarantees and joint ventures.
In management's opinion, after taking into account reserves, none of such
commitments and contingencies discussed above should have a material adverse
effect upon the consolidated financial position or results of operations of the
Company.
(7) INCOME TAXES
The Company is included in Occidental's consolidated federal tax return and
unitary state tax returns. The consolidated provisions for these income taxes
are allocated to the Company on the basis of a tax sharing agreement with
Occidental. Under the agreement, the amount of consolidated current and deferred
tax provisions is determined as if the Company were a corporation that was not
owned by Occidental and filed a separate consolidated income tax return. In
addition, state income taxes are provided for all states in which the Company is
included in a state return with Occidental, notwithstanding that the Company may
not have been subject to tax in that jurisdiction but for its affiliation with
Occidental.
The provision for taxes based on income for the 1997 and 1996 interim
periods was computed in accordance with Interpretation No. 18 of APB Opinion No.
28 on reporting taxes for interim periods and was based on projections of total
year pretax income.
Taxable gains were recorded by the Company resulting from dividends and
asset transfers to Occidental during 1996 (see Note 2.c). Since the Company is
included in the consolidated federal income tax return with Occidental, these
taxable gains are deferred until the Company is transferred outside the
consolidated group. Under the Company's tax sharing agreement, so long as the
Company is part of the consolidated group, the tax payments associated with the
gains will be reimbursed to the Company over the remaining tax lives of the
transferred assets. An intercompany receivable from Occidental has been recorded
on the consolidated balance sheet to reflect these reimbursements.
Taxable gains were recorded by the Company resulting from asset transfers
unrelated to the dividends and asset transfers to Occidental during 1996 (see
Note 2.c), and the tax associated therewith will not be reimbursed by Occidental
under the Company's tax sharing agreement.
(8) RETIREMENT AND POSTRETIREMENT BENEFITS
Reference is made to Note 8 to MidCon's 1996 financial statements for a
description of the retirement plans and Postretirement benefits.
(9) RETIREMENT PLANS AND ESOP
All employees are participants in a defined contribution retirement plan
and are eligible to participate in a defined contribution savings plan.
Effective January 1, 1997, the Company established the MidCon Corp. Retirement
Plan (MRA) and the MidCon Corp. Savings Plan (MSA). Related plan assets from
Occidental Petroleum Corporation Retirement Plan and the Occidental Petroleum
Corporation Savings Plan were transferred to the MRA and MSA, respectively. The
plans provide for periodic contributions based on the
9
<PAGE> 10
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
salary and age level of employees and/or employee contributions. Beginning
January 1, 1997, the Company's contribution under the MRA is being reduced over
time pursuant to the terms of the plan.
Effective November 20, 1996, Occidental established the ESOP for all
eligible employees of the Company. Generally, the shares of the CMIC Preferred
Stock held by the ESOP are released and allocated to participant accounts based
on the proportion of the payment on the ESOP note for the respective period
compared to the total remaining payments due on the note. Dividends on the CMIC
Preferred Stock are payable at an annual rate of $21 per share, when and as
declared by Occidental's Board of Directors. It is anticipated that MidCon will
make discretionary annual contributions to the MidCon ESOP which, together with
the annual dividends, will be used to repay the ESOP note. The Company accounts
for its ESOP in accordance with AICPA Statement of Position 93-6, "Employers'
Accounting for Employee Stock Ownership Plans" which requires that compensation
expense be measured based on the fair value of shares committed to be released.
The ESOP loan guarantee is recorded as an intercompany liability and the
shares of CMIC Preferred Stock pledged as collateral are reported as unearned
ESOP shares in the consolidated balance sheet. The Company reports compensation
expense equal to the estimated current market price of the shares. Dividends on
allocated ESOP shares result in a reduction to additional paid-in capital.
Dividends on ESOP shares have been used to satisfy debt service. ESOP
compensation expense was $1.1 million and $0 for the nine months ended September
30, 1997 and 1996, respectively. The ESOP has 40,998 and 6,151 allocated shares
and 1,359,002 and 1,393,849 unreleased shares outstanding at September 30, 1997
and December 31, 1996, respectively.
(10) TRANSACTIONS WITH AFFILIATES
Excess funds are invested with Occidental through its centralized
cash-management system. All intercompany loans are evidenced by a cash
management agreement. Interest earned or charged is calculated at prevailing
market rates.
Occidental provides and directly bills the Company for various services
including information technology services, administrative services for payroll,
and employee benefits for which the Company was allocated approximately $4.0
million and $3.8 million for the nine month periods ended September 30, 1997 and
1996, respectively. In addition, Occidental charges the Company for expense
incurred on its behalf such as insurance. All these charges, which were part of
the noninterest-bearing long-term intercompany liability at September 30, 1997
and December 31, 1996, approximate the amounts management believes would be
incurred if the Company were to independently secure these services. The charges
for these services are not reflected in the table on the following page.
Effective January 1, 1997, MidCon entered into a 10-year service agreement
with Occidental. This agreement provides for the continuation of various
services performed on the Company's behalf by Occidental. The initial annual fee
for these services will be $13 million through December 31, 2001, after which
time the fee will be renegotiated. The services provided will include, among
others, insurance administration, internal audit, legal and investor relations.
In addition, the agreement provides for the allocation of certain out-of-pocket
expenses incurred on the Company's behalf and for separate fees to be billed to
the Company by Occidental for such services as tax, regulatory compliance,
payroll and benefits and information technology. The fees charged are reflected
for the nine months ended September 30, 1997, as "Charges for Occidental's
general and administrative costs" indicated in the table below.
10
<PAGE> 11
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Principal transactions with affiliated companies, except as disclosed
elsewhere in these financial statements, were as follows for the nine month
periods indicated (in millions):
<TABLE>
<CAPTION>
SEPTEMBER 30,
------------------
1997 1996
------- ------
<S> <C> <C>
Affiliated company transactions:
Transfer of trade receivables................................... $ 258.9 $200.9
Fees and expenses on trade receivables transferred.............. $ 9.9 $ 8.0
Sales, transportation and storage of natural gas and other
revenues..................................................... $ 1.4 $ 2.1
Purchases and transportation of natural gas..................... $ 24.5 $ 0.3
Charge for Occidental's general and administrative costs........ $ 9.8 $ 13.7
Net interest income (expense)................................... $(164.8) $(32.5)
Pipeline venture transactions:
Cash distributions.............................................. $ 9.7 $ 11.8
Transportation of natural gas charged to operation expense...... $ 7.6 $ 6.2
</TABLE>
(11) GAS STORED UNDERGROUND
At September 30, 1997 and December 31, 1996, Natural's current top gas
storage inventory, which is accounted for on the LIFO method, was $2.6 million
and $5.0 million, respectively. Noncurrent top gas inventory is stated on the
LIFO method. The current value of the noncurrent top gas inventory exceeded the
LIFO valuation by $236.9 million and $413.7 million at September 30, 1997 and
December 31, 1996, respectively. Noncurrent cushion gas inventory is stated at
average cost.
(12) PIPELINE VENTURES
Investments in active companies in which the Company has a voting interest
of not more than 50 percent are accounted for on the equity method. At September
30, 1997, the Company's equity investments consisted primarily of:
<TABLE>
<CAPTION>
OWNERSHIP
INVESTEE INTEREST
------------------------------------------------------------------ ---------
<S> <C>
West Cameron Dehydration Company.................................. 50%
Stingray Pipeline Company......................................... 50%
Gulf Processing................................................... 50%
U-T Offshore System............................................... 33 1/3%
Trailblazer Pipeline Company...................................... 33 1/3%
High Island Offshore System....................................... 20%
Overthrust Pipeline Company....................................... 18%
</TABLE>
Summarized financial information of these ventures is set forth below (in
millions):
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
1997 1996
------- ------
<S> <C> <C>
Operating revenues.......................................... $ 100.0 $ 87.6
Costs and expenses.......................................... 64.4 48.7
------- ------
Net income.................................................. $ 35.6 $ 38.9
====== =====
</TABLE>
11
<PAGE> 12
MIDCON CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
<S> <C> <C>
Current assets..................................... $ 48.4 $ 79.2
Noncurrent assets.................................. $ 280.1 $290.9
Current liabilities................................ $ 47.3 $ 69.1
Noncurrent liabilities............................. $ 132.3 $145.2
Stockholders' equity............................... $ 148.8 $155.8
</TABLE>
In accordance with project financing arrangements of certain of these
ventures and under tariffs approved by the FERC, Natural is required to pay
demand charges to certain of these ventures for contracted transportation
services. The demand charges for the nine month periods ended September 30, 1997
and 1996 were approximately $7.5 million and $6.1 million, respectively.
(13) YEAR 2000 COMPLIANCE
MidCon 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. MidCon does not anticipate the related
costs to have a material impact on its results of operations.
12
<PAGE> 1
EXHIBIT 3
----------
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 dated January 5, 1998) ("the Acquisition") and (ii) the anticipated issuance
(in a private offering not registered under the Securities Act of 1933, as
amended) of $300 million of K N-Obligated Mandatorily Redeemable Capital Trust
Pass-Through Securities of Subsidiary Trust ("the Capital Securities") and
application of the net proceeds therefrom ($297 million) to the reduction of
short-term debt. The unaudited pro forma condensed balance sheet as of September
30, 1997 is presented as if the Acquisition 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 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> 2
UNAUDITED PRO FORMA CONDENSED BALANCE SHEET
SEPTEMBER 30, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
ASSETS
HISTORICAL PRO FORMA
------------------------- ----------------------------
K N ENERGY MIDCON ADJUSTMENTS COMBINED
---------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Current Assets:
Cash and Cash Equivalents.................................. $ 18,819 $ 6,278 $ (6,278) (a) $ 18,819
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................ -- 303,451 (303,451) (b) --
Gas Imbalances and Other................................... 70,995 91,316 162,311
---------- ----------- ----------- -----------
351,998 969,042 (309,730) 1,011,310
Investments.................................................. 75,197 53,498 1,398,600 (c) 1,527,295
Property, Plant and Equipment, at Cost....................... 1,861,679 7,049,437 (257,163) (d) 8,653,953
Less Accumulated Depreciation and Amortization............... (542,905) (1,617,826) (2,160,731)
---------- ----------- ----------- -----------
Net Property, Plant and Equipment............................ 1,318,774 5,431,611 (257,163) 6,493,222
Long-Term Receivable -- Occidental Petroleum................. -- 31,390 (31,390) (e) --
Deferred Charges and Other Assets............................ 106,488 24,972 3,000 (n) 134,460
---------- ----------- ----------- -----------
Total Assets......................................... $1,852,457 $ 6,510,513 $ 803,317 $ 9,166,287
========== =========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current Maturities of Long-Term Debt....................... $ 19,055 -- $ 19,055
Notes Payable.............................................. 285,000 -- $3,556,322 (a) 5,025,789
1,481,467 (c)
(297,000) (n)
Accounts Payable........................................... 173,070 $ 290,660 463,730
Accrued Expenses........................................... 25,952 -- 25,952
Accrued Taxes.............................................. 26,673 -- 26,673
Accrual for Duplicate Facilities & Relocation.............. -- -- 10,000 (d) 10,000
Dividend payable........................................... -- 303,452 (303,452) (b) --
Current portion of ESOP debt............................... -- 12,574 (12,574) (f) --
Gas Imbalances and Other................................... 51,045 197,808 (37,700) (g) 211,153
Interest Payable to Affiliates............................. -- 82,867 (82,867) (c) --
---------- ----------- ----------- -----------
580,795 887,361 4,314,196 5,782,352
Deferred Liabilities, Credits and Reserves:
Deferred Income Taxes...................................... 131,567 1,690,440 (92,579) (d) 1,698,038
(31,390) (e)
Other...................................................... 26,628 238,346 264,974
---------- ----------- ----------- -----------
158,195 1,928,786 (123,969) 1,963,012
ESOP debt.................................................... -- 1,386,026 (1,386,026) (f)
Long-Term Debt............................................... 410,498 1,600,000 (1,600,000) (i) 410,498
K N-Obligated Mandatorily Redeemable Capital
Trust Pass-through Securities of Subsidiary Trust............ 100,000 -- 300,000 (n) 400,000
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) (j) 157,232
Additional Paid-in Capital................................. 252,030 1,970,375 (1,970,375) (j) 252,030
Retained Earnings.......................................... 166,099 89,497 (89,497) (j) 166,099
Unearned ESOP shares....................................... -- (1,359,002) 1,359,002 (j) --
Deferred Compensation...................................... (9,667) -- (9,667)
Treasury Stock............................................. (885) -- (885)
---------- ----------- ----------- -----------
Total Common Stockholders' Equity...................... 564,809 700,884 (700,884) 564,809
---------- ----------- ----------- -----------
Total Stockholders' Equity............................. 571,809 700,884 (700,884) 571,809
---------- ----------- ----------- -----------
Total Liabilities and Stockholders' Equity........... $1,852,457 $ 6,510,513 $ 803,317 $ 9,166,287
========== =========== =========== ===========
</TABLE>
See Notes to Unaudited Pro Forma Combined Condensed Financial Statements
2
<PAGE> 3
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 $ (109)(k) 228,614
Taxes, Other Than Income Taxes........... 19,321 46,226 65,547
---------- ---------- --------- ----------
Total Operating Costs and
Expenses....................... 1,308,373 2,313,319 (109) 3,621,583
---------- ---------- --------- ----------
Operating Income........................... 134,801 260,892 109 395,802
---------- ---------- --------- ----------
Other Income and (Deductions):
Interest Expense......................... (35,933) (79,626) (268,726)(l) (384,285)
Minority Interests....................... (2,946) -- (23,010)(n) (25,956)
Other, Net............................... 3,794 11,903 10,387(m) 109,900
83,916(c)
(100)(n)
---------- ---------- --------- ----------
Total Other Income and (Deductions)........ (35,085) (67,723) (197,533) (300,341)
---------- ---------- --------- ----------
Income Before Income Taxes................. 99,716 193,169 (197,424) 95,461
Income Taxes............................... 35,897 76,684 (71,112)(h) 41,469
---------- ---------- --------- ----------
Net Income................................. 63,819 116,485 (126,312) 53,992
Less -- Preferred Stock Dividends.......... 398 -- 398
---------- ---------- --------- ----------
Earnings Available For Common Stock........ $ 63,421 $ 116,485 $(126,312) $ 53,594
========== ========== ========= ==========
Earnings Per Common Share.................. $ 2.14 $ 1.81
Number of Shares Used in Computing Earnings
Per Common Share......................... 29,624 29,624
Dividends Per Common Share................. $ 1.05 $ 1.05
</TABLE>
See Notes to Unaudited Pro Forma Combined Condensed Financial Statements
3
<PAGE> 4
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)(f) 221,299
Depreciation and Amortization............ 41,101 110,924 (43)(k) 151,982
Taxes, Other Than Income Taxes........... 18,144 23,087 41,231
---------- ---------- --------- ----------
Total Operating Costs and
Expenses....................... 1,266,238 1,896,844 (2,706) 3,160,376
---------- ---------- --------- ----------
Operating Income........................... 96,219 166,214 2,706 265,139
---------- ---------- --------- ----------
Other Income and (Deductions):
Interest Expense......................... (30,991) (181,601) (44,529)(l) (267,001)
(9,880)(m)
Minority Interests....................... (5,681) -- (17,258)(n) (22,939)
Other, Net............................... 14,979 18,555 9,881(m) 106,277
62,937(c)
(75)(n)
---------- ---------- --------- ----------
Total Other Income and (Deductions)........ (21,693) (163,046) 1,076 (183,663)
Income Before Income Taxes................. 74,526 3,168 3,782 81,476
Income Taxes............................... 25,488 87 1,346(h) 26,921
---------- ---------- --------- ----------
Net Income................................. 49,038 3,081 2,436 54,555
Less -- Preferred Stock Dividends.......... 263 -- 263
---------- ---------- --------- ----------
Earnings Available For Common Stock........ $ 48,775 $ 3,081 $ 2,436 $ 54,292
========== ========== ========= ==========
Earnings Per Common Share.................. $ 1.55 $ 1.73
Number of Shares Used in Computing Earnings
Per Common Share......................... 31,397 31,397
Dividends Per Common Share................. $ 0.81 $ 0.81
</TABLE>
See Notes to Unaudited Pro Forma Combined Condensed Financial Statements
4
<PAGE> 5
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 to be Paid at Closing.............................. $2,104,000
Government Securities Purchased as Collateral for Substitute Note, see
Note(c)............................................................ 1,481,467
Transaction Costs..................................................... 60,000
Less:
MidCon Cash Balance at September 30, 1997............................. (6,278)
----------
Total Acquisition Debt........................................ 3,639,189
----------
Accrued interest allocated to Substitute Note......................... (82,867)
----------
Net Acquisition Debt.......................................... $3,556,322
==========
</TABLE>
The net 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) 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.
(c) In accordance with the terms of the Agreement, K N will issue 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), estimated to total $1,481,467,000, bearing
interest at an estimated 6.3%, maturing on January 1, 1999 and
collateralized by a portfolio of U.S. Government securities purchased by K
N. The portfolio of U.S. Government securities, contractually required to
be held by K N until maturity of the Substitute Note, is estimated to
generate interest income at 6.0%.
(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 $3.7
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 to be paid at Closing............................. $ 2,104,000
Note Payable to Occidental........................................... 1,481,467
Transaction Costs.................................................... 60,000
-----------
Total........................................................ $ 3,645,467
===========
</TABLE>
5
<PAGE> 6
NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED
FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
(THOUSANDS)
-----------
<S> <C>
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
Deferred Charges and Other Assets.................................... 24,972
Property, Plant and Equipment, Net(*)................................ 5,174,448
Accounts Payable..................................................... (290,660)
Gas Imbalances and Other............................................. (160,108)
Deferred Income Taxes................................................ (1,566,471)
Other Non-Current Liabilities........................................ (238,346)
Accrual for Duplicate Facilities and Relocation...................... (10,000)
Minority Interest in Unconsolidated Subsidiaries..................... (7,456)
-----------
Total........................................................ $ 3,645,467
==========
</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
$257.2 million.
(e) To eliminate the receivable and corresponding deferred taxes
associated with deferred intercompany gains which will be settled at
closing of the Acquisition.
(f) 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.
(g) Represents the elimination of the deferred net gain recorded in
conjunction with MidCon's postretirement benefit plan.
(h) Represents the tax effect at the effective rate for all pre-tax pro
forma adjustments not representing permanent book/tax differences.
(i) 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.
(j) Represents the elimination of the historical equity balances of
MidCon.
(k) 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,
exclusive of depreciation on MidCon Texas Pipeline
Corp., see Note (b)............................... $ (147,950)
K N's Recomputed Depreciation and Amortization, see
Note (d).......................................... 147,841
----------
Total........................................ $ (109)
==========
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).......................................... 110,881
----------
Total........................................ $ (43)
==========
</TABLE>
6
<PAGE> 7
NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED
FINANCIAL STATEMENTS -- (CONTINUED)
(l) 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 debt... $ (12,584)
Elimination of MidCon's Historical Interest Expense on its $1.6 billion
Payable to Occidental............................................... (16,502)
Elimination of interest expense due to the reduction in short-term debt
resulting from the application of the net proceeds of the Capital
Securities, see Note (n)............................................ (17,850)
Interest Expense on Acquisition Debt at 6.36%(*) weighted average rate,
see Note (c) 226,152
Interest Expense at 6.4% on incremental debt required to purchase
government securities............................................... 89,510
---------
Total $ 268,726
=========
Nine Months Ended September 30, 1997
Elimination of MidCon's Historical Interest Expense on its ESOP debt... $ (82,867)
Elimination of MidCon's Historical Interest Expense on its $1.6 billion
Payable to Occidental............................................... (96,117)
Elimination of interest expense due to the reduction in short-term debt
resulting from the application of the net proceeds of the Capital
Securities, see Note (n)............................................ (13,254)
Interest Expense on Acquisition Debt at 6.36%(*) weighted average rate,
see Note (a)........................................................ 169,614
Interest Expense at 6.4% on incremental debt (exclusive of accrued
interest of $82,867) required to purchase government securities..... 67,133
Interest Expense on ESOP Administration................................ 19
---------
Total.......................................................... $ 44,528
=========
</TABLE>
(*) For purposes of the unaudited pro forma combined condensed
financial statements, the annual weighted average interest
rate on the acquisition debt is assumed to be 6.36%. A 1%
change in the interest rate on the acquisition debt would
change annual interest expense by approximately $35.6 million
for the year ended December 31, 1996 and interest expense for
the nine-months ended September 30, 1997 by approximately
$26.7 million. The acquisition debt is expected to be
obtained from a syndicate of commercial banks. K N believes
that the interest rate assumed is appropriate under current
market conditions for a BBB credit obligation, although it
may differ from the rate actually obtained at the time the
funds are borrowed.
(m) 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.
(n) Gives pro forma effect to the issuance of the Capital Securities ($297
million after reduction for an estimated underwriting discount of $3.0
million) and the application of the net proceeds to reduce short-term
borrowings, see Note (l).
7
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Exhibit 99
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the inclusion in this
Form 8-K of our report dated January 31, 1997 on MidCon Corp.'s consolidated
financial statements for the year ended December 31, 1996.
/s/ ARTHUR ANDERSEN LLP
Chicago, Illinois
January 16, 1998