<PAGE> 1
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998
---------------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
-------------------- ---------------------
Commission File Number 1-6446
-----------------------------------------------------
K N ENERGY, INC.
- ---------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Kansas 48-0290000
- ---------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
370 Van Gordon Street
P.O. Box 281304, Lakewood, Colorado 80228-8304
- ---------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(303) 989-1740
- ---------------------------------------------------------------------------
(Registrant's telephone number, including area code)
- ---------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Common stock, $5 par value; authorized 150,000,000 shares;
- -------------------------------------------------------------------------
outstanding 44,990,698 shares as of July 31, 1998.
- -------------------------------------------------------------------------
<PAGE> 2
Form 10-Q
K N ENERGY, INC. AND SUBSIDIARIES
FORM 10-Q
QUARTER ENDED JUNE 30, 1998
Contents
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited) Page Number
Consolidated Balance Sheets.............................. 3 & 4
Consolidated Statements of Income........................ 5
Consolidated Statements of Cash Flows.................... 6
Notes to Consolidated Financial Statements............... 7 - 13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations...................... 14 - 21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings......................................... 22
Item 4. Submission of Matters to a Vote of Security Holders....... 22 - 23
Item 6. Exhibits and Reports on Form 8-K.......................... 23
SIGNATURE........................................................... 24
<PAGE> 3
Form 10-Q
CONSOLIDATED BALANCE SHEETS (Unaudited)
K N Energy, Inc. and Subsidiaries
(Dollars in Thousands)
<TABLE>
<CAPTION>
June 30 December 31
1998 1997
-------------- --------------
<S> <C> <C>
ASSETS:
Current Assets:
Cash and Cash Equivalents $ 37,882 $ 22,471
Restricted Deposits 13,487 11,339
U.S. Government Securities 1,061,203 -
Accounts Receivable 569,730 409,937
Materials and Supplies 48,944 13,476
Gas in Underground Storage 123,289 33,558
Prepaid Expenses 25,400 22,194
Gas Imbalances 87,929 46,171
Other 29,879 17,384
---------- ----------
1,997,743 576,530
---------- ----------
Investments 190,252 149,869
---------- ----------
Property, Plant and Equipment 7,486,380 1,971,601
Less Accumulated Depreciation and Amortization 620,531 550,626
---------- ----------
6,865,849 1,420,975
---------- ----------
Deferred Charges and Other Assets 160,731 158,431
---------- ----------
Total Assets $9,214,575 $2,305,805
========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
<PAGE> 4
Form 10-Q
CONSOLIDATED BALANCE SHEETS (Unaudited)
K N Energy, Inc. and Subsidiaries
(Dollars in Thousands)
<TABLE>
<CAPTION>
June 30 December 31
1998 1997
------------ --------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current Liabilities:
Current Maturities of Long-Term Debt $ 15,687 $ 30,751
Notes Payable 525,200 329,200
Substitute Note 1,394,846 -
Accounts Payable 469,739 334,418
Accrued Expenses 124,770 37,264
Accrued Taxes 45,214 7,445
Gas Imbalances 103,585 37,516
Other 94,589 20,217
---------- ----------
2,773,630 796,811
---------- ----------
Deferred Liabilities, Credits and Reserves:
Deferred Income Taxes 1,545,296 168,583
Other 404,807 26,160
---------- ----------
1,950,103 194,743
---------- ----------
Long-Term Debt 2,891,998 553,816
---------- ----------
K N-Obligated Mandatorily Redeemable Preferred
Capital Trust Securities of Subsidiary Trusts
Holding Solely Debentures of K N 275,000 100,000
---------- ----------
Minority Interests in Equity of Subsidiaries 58,815 47,303
---------- ----------
Stockholders' Equity:
Preferred Stock-
Authorized - Class A, 200,000 Shares:
Class B, 2,000,000 Shares,Without Par Value
Redeemable Solely at Option of Company at
$105 Per Share - Class A, $5.00 Cumulative
Series; 70,000 Shares Outstanding 7,000 7,000
---------- ----------
Common Stock-
Authorized - 150,000,000 Shares, Par Value $5 Per Share
Outstanding - 44,985,031 and 32,024,557 Shares,
Respectively 224,925 160,123
Additional Paid-in Capital 845,095 270,678
Retained Earnings 199,636 185,658
Deferred Compensation (10,636) (9,203)
Treasury Stock, at Cost - 22,384 and 28,482 Shares,
Respectively (991) (1,124)
---------- ----------
Total Common Stockholders' Equity 1,258,029 606,132
---------- ----------
Total Stockholders' Equity 1,265,029 613,132
---------- ----------
Total Liabilities and Stockholders' Equity $9,214,575 $2,305,805
========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
<PAGE> 5
Form 10-Q
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
K N Energy, Inc. and Subsidiaries
(In Thousands Except Per Share Amounts)
<TABLE>
<CAPTION>
Three Month Ended Six Months Ended
June 30 June 30
------------------------------- ------------------------------
1998 1997 1998 1997
<S> <C> <C> <C> <C>
Operating Revenues:
Upstream Gathering and Processing Services $ 151,311 $ 135,605 $ 290,410 $ 260,347
Midstream Sales, Transportation and Storage Services 379,293 40,560 665,191 120,366
Downstream Retail and Marketing Services 624,638 237,584 1,453,177 634,883
Intersegment Eliminations (115,523) (54,997) (202,538) (168,002)
---------- ---------- ---------- ----------
Total Operating Revenues 1,039,719 358,752 2,206,240 847,594
---------- ---------- ---------- ----------
Operating Costs and Expenses:
Gas Purchases and Other Costs of Sales 793,249 262,927 1,726,876 643,477
Operations and Maintenance 92,451 50,930 189,239 99,338
Depreciation and Amortization 47,379 13,691 89,199 27,991
Taxes, Other Than Income Taxes 13,139 5,879 25,287 11,926
Merger-related Costs 1,410 - 5,763 -
---------- ---------- ---------- ----------
Total Operating Costs and Expenses 947,628 333,427 2,036,364 782,732
---------- ---------- ---------- ----------
Operating Income 92,091 25,325 169,876 64,862
---------- ---------- ---------- ----------
Other Income and (Deductions):
Interest Expense, Net (63,491) (10,518) (113,833) (20,174)
Minority Interests (4,615) (2,442) (6,996) (2,945)
Other, Net 2,477 3,474 13,171 6,156
---------- ---------- ---------- ----------
Total Other Income and (Deductions) (65,629) (9,486) (107,658) (16,963)
---------- ---------- ---------- -----------
Income Before Income Taxes 26,462 15,839 62,218 47,899
Income Taxes 9,772 4,967 23,021 16,669
---------- ---------- ---------- ----------
Net Income 16,690 10,872 39,197 31,230
Less - Preferred Stock Dividends 87 87 175 175
---------- ---------- ---------- ----------
Earnings Available For Common Stock $ 16,603 $ 10,785 $ 39,022 $ 31,055
========== ========== ========== ==========
Number of Shares Used in Computing
Basic Earnings Per Common Share 44,780 30,787 40,010 30,653
========== ========== ========== ==========
Basic Earnings Per Common Share $ 0.37 $ 0.35 $ 0.98 $ 1.01
========== ========== ========== ==========
Number of Shares Used in Computing
Diluted Earnings Per Common Share 45,324 31,377 40,545 31,265
========== ========== ========== ==========
Diluted Earnings Per Common Share $ 0.37 $ 0.34 $ 0.96 $ 0.99
========== ========== ========== ==========
Dividends Per Common Share $ 0.28 $ 0.27 $ 0.56 $ 0.54
========== ========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
<PAGE> 6
Form 10-Q
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
K N Energy, Inc. and Subsidiaries
Increase (Decrease) in Cash and Cash Equivalents
(Dollars in Thousands)
<TABLE>
<CAPTION>
Six Months Ended
June 30
------------------------------
1998 1997
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 39,197 $ 31,230
Adjustments to Reconcile Net Income to Net Cash Flows
from Operating Activities:
Depreciation and Amortization, Excluding Amortization
of Gas Plant Acquisition Adjustment 44,839 27,991
Deferred Income Taxes 8,714 5,741
Deferred Purchased Gas Costs 14,777 (7,624)
Gain on Sale of Facilities (8,440) -
Proceeds from Gas Contract Settlement 27,500 -
Change in Gas in Underground Storage (46,938) 4,710
Changes in Other Working Capital Items (Note 3) 35,268 5,075
Changes in Deferred Revenues (3,497) (9,186)
Other, Net 14,285 5,875
---------- ----------
NET CASH FLOWS FROM OPERATING ACTIVITIES 125,705 63,812
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital Expenditures (189,256) (113,495)
Cash Paid for Acquisition of MidCon, Net of Cash
Acquired (2,177,591) -
Other Acquisitions (13,218) (95,601)
Investments 1,293 (9,725)
Purchase of U.S. Government Securities (1,061,203) -
Proceeds from Sales of Assets 28,985 9,671
---------- ----------
NET CASH FLOWS USED IN INVESTING ACTIVITIES (3,410,990) (209,150)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-Term Debt, Net 196,000 71,000
Long-Term Debt - Issued 2,350,000 -
Long-Term Debt - Retired (21,876) (18,708)
Common Stock Issued in Public Offering 650,000 -
Other Common Stock Issuance 11,956 13,795
Mandatorily Redeemable Preferred Trust Securities 175,000 100,000
Treasury Stock - Issued 632 879
- Acquired (499) (1,602)
Cash Dividends - Common (25,044) (16,781)
- Preferred (175) (175)
Minority Interests - Contributions 16,844 -
- Distributions - (197)
Securities Issuance Costs (52,142) -
---------- ----------
NET CASH FLOWS FROM FINANCING ACTIVITIES 3,300,696 148,211
---------- ----------
Net Increase in Cash and Cash Equivalents 15,411 2,873
Cash and Cash Equivalents at Beginning of Period 22,471 10,339
---------- ----------
Cash and Cash Equivalents at End of Period $ 37,882 $ 13,212
========== ==========
</TABLE>
For supplemental cash flow information, see Note 3.
The accompanying notes are an integral part of these statements.
<PAGE> 7
Form 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. General
-------
As used herein, "K N" or "the Company" refers to K N Energy, Inc.
and its consolidated subsidiaries unless the context otherwise
requires. In the opinion of Management, all adjustments
necessary for a fair presentation of the results for the
unaudited interim periods have been made. Except as explicitly
noted, these adjustments consist solely of normal recurring
accruals. Certain prior period amounts have been reclassified to
conform with the current presentation.
2. Acquisitions and Divestiture
----------------------------
On April 23, 1998, K N announced that it had agreed to purchase
partnership interests in four independent power plants in
Colorado from Denver-based Thermo Cos. ("Thermo"), representing
approximately 380 megawatts of electric generation capacity and
access to approximately 130 Bcf of natural gas reserves. These
generating facilities are located in Fort Lupton (272 megawatts)
and Greeley (108 megawatts) and sell their power output to Public
Service Company of Colorado under long-term contracts. The
purchase, the closing of which is subject to the completion of
certain agreements involving an existing partner in certain of
the generating facilities, is expected to be paid for over a
three-year period, with the initial payment of $35 million to be
made using 100% K N common stock and the remaining two payments
(in 1999 and 2000) being a combination of cash and K N common
stock as agreed to by the parties, with the default mix being 50%
stock and 50% cash.
In March 1998, K N completed the sale of its Kansas retail
natural gas distribution properties, located in 58 Kansas
communities and serving approximately 30,000 residential,
commercial and industrial customers, to Midwest Energy, Inc., a
customer-owned cooperative based in Hays, Kansas. K N received
approximately $24 million in cash in conjunction with the sale
and recorded a pre-tax gain of approximately $8.5 million
(approximately $5.5 million after tax). Concurrently with the sale,
K N received approximately $27.5 million in cash in exchange
for the release of the purchaser from certain contractual gas
purchase obligations, which amount will be amortized by K N
over a period of years as the associated volumes are sold.
On January 30, 1998, pursuant to a definitive stock purchase
agreement (the "Agreement"), K N acquired all of the outstanding
shares of capital stock of MidCon Corp. ("MidCon") from
Occidental Petroleum Corporation ("Occidental") for $2.1 billion
in cash and the assumption of a $1.39 billion note (the
"Substitute Note"), at which time MidCon became a wholly owned
subsidiary of K N Energy, Inc. (the "Acquisition"). The
Substitute Note bears interest at 5.798%, is due January 4, 1999,
and is required to be collateralized by U.S. government
securities, letters of credit or a combination thereof. In
conjunction with the Acquisition, K N also assumed MidCon's
obligation to lease the MidCon Texas intrastate pipeline system
under a 30-year operating lease, requiring average annual lease
payments of approximately $30 million. The Acquisition was
initially financed through a combination of commitments referred
to as the bank facility (see Note 5).
MidCon is engaged in the purchase, gathering, processing,
transmission, storage and sale of natural gas to utilities,
municipalities, and industrial and commercial users.
MidCon's pipeline subsidiaries operate over 13,000 miles of
natural gas pipelines located in the center of the North American
pipeline grid, with access to major supply and market areas.
MidCon is also one of the nation's largest natural gas storage
operators and owns and operates several natural gas gathering
and natural gas processing facilities.
<PAGE> 8
Form 10-Q
The Acquisition was accounted for as a purchase for accounting
purposes and, accordingly, the MidCon assets acquired and
liabilities assumed have been preliminarily recorded at their
respective estimated fair market values as of the acquisition
date. The final fair market values will be assigned after
completion of a more extensive review of the relevant assets,
liabilities and issues identified as of the acquisition date.
The preliminary allocation of purchase price has resulted in the
recognition of a gas plant acquisition adjustment of
approximately $3.8 billion, principally representing the excess
of the assigned fair market value of the assets of Natural Gas
Pipeline Company of America ("NGPL"), a wholly owned subsidiary
of MidCon, over the historical cost for ratemaking purposes.
This gas plant acquisition adjustment, none of which is currently
being recognized for rate-making purposes, is being amortized
over 36 years, approximately the estimated remaining useful life
of NGPL's interstate pipeline system. For the quarter and six
months ended June 30, 1998, approximately $24.6 million and $44.4
million, respectively, was charged to expense. The assets,
liabilities and results of operations of MidCon are included with
those of the Company beginning with the January 30, 1998
acquisition date.
The following pro forma information gives effect to the
acquisition of MidCon as if the business combination had occurred
at the beginning of each period presented. The pro forma
adjustments which have been made are based on a preliminary
allocation of the purchase price to assets acquired and
liabilities assumed. In addition, no pro forma adjustments to
prior periods have been made for the post-acquisition
refinancings completed by K N. This unaudited pro forma
information should be read in conjunction with the accompanying
interim Consolidated Financial Statements, Management's
Discussion and Analysis of Financial Condition and Results of
Operations and with the previously filed unaudited pro forma
consolidated financial statements and related notes. This pro
forma information is not necessarily indicative of the financial
results which would have occurred had the Acquisition taken place
on the dates indicated, nor is it necessarily indicative of
future financial results.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30 June 30
------------------------- ---------------------------
<S> <C> <C> <C> <C>
Unaudited Pro forma Financial Information 1998* 1997 1998 1997
---- ---- ---- ----
(dollars in millions, except per share amounts)
Operating Revenues $ 1,039.7 $ 930.8 $ 2,475.5 $ 2,273.2
Net Income (Loss) $ 16.7 $ (1.9) $ 43.2 $ 35.0
Diluted Earnings (Loss) per Common Share $ 0.37 $ (0.06) $ 1.06 $ 1.11
Number of Shares Used in Computing Diluted Earnings
per Common Share (in thousands) 45,324 31,377 40,545 31,265
* As reported; reflects the acquisition of MidCon
for the entire period.
</TABLE>
In December 1997, K N acquired Interenergy Corporation
("Interenergy"), a diversified energy company providing natural
gas gathering, processing and marketing services in the Rocky
Mountain and mid-continent areas. In a transaction accounted for
as a purchase, K N exchanged 544,604 shares of K N common stock
for all the outstanding shares of Interenergy and assumed
Interenergy's debt. Also in December 1997, K N purchased an
equity interest in Red Cedar Gathering Company ("Red Cedar"), a
gathering system located in the northern San Juan Basin on the
Southern Ute Indian Reservation in La Plata County, Colorado.
Red Cedar is jointly owned by the Southern Ute Indian Tribe.
<PAGE> 9
Form 10-Q
In March 1997, K N completed its purchase of several Enron
Corporation subsidiaries that owned or operated the Bushton
natural gas processing facility located in Ellsworth County,
Kansas, and other Hugoton Basin gathering assets located in
Kansas and Oklahoma. The Company assumed operation of these
facilities effective April 1, 1997, and has accounted for this
transaction as a purchase. K N leases the processing facilities
at Bushton under operating leases requiring semi-annual payments
averaging $23.1 million per annum for the remaining term of the
leases.
3. Supplemental Cash Flow Information
----------------------------------
Changes in Other Working Capital Items Summary and Supplemental
Disclosures of Cash Flow Information are as follows (in
thousands):
<TABLE>
<CAPTION>
Six Months Ended
June 30
------------------------------
1998 1997
---- ----
<S> <C> <C>
CHANGES IN OTHER WORKING CAPITAL ITEMS:
(Net of Effects of Acquisitions and Divestitures)
Accounts Receivable $ 253,676 $ 105,826
Materials and Supplies Inventory (18,776) (3,346)
Other Current Assets (19,213) 1,548
Accounts Payable (255,480) (83,904)
Other Current Liabilities 75,061 (15,049)
---------- ----------
$ 35,268 $ 5,075
========== ==========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash Paid for:
Interest (Net of Amount Capitalized) $ 64,238 $ 20,636
========== =========
Distributions on Preferred Capital Trust Securities $ 4,280 $ -
========== ==========
Income Taxes $ 22,496 $ 15,635
========== ==========
</TABLE>
The Company considers all highly liquid investments purchased
with an original maturity of three months or less to be cash
equivalents. "Other, Net", presented as a component of "Net Cash
Flows from Operating Activities" in the accompanying Consolidated
Statements of Cash Flows includes, among other things, the
amortization of the gas plant acquisition adjustment recorded in
conjunction with the acquisition of MidCon, undistributed equity
in earnings of unconsolidated subsidiaries and joint ventures and
other non-cash charges and credits to income.
4. Business Segments
-----------------
K N Energy, Inc. has adopted a strategy of extracting profit from
the energy value stream, which extends from the purchase or
production of the fuel through the sale of the energy to the end-
user. Consistent with this strategy, K N manages its business
and has segregated its activities into three business segments,
"Upstream", "Midstream" and "Downstream", based on where in the
value stream such activities are conducted. In general, these
segments are also differentiated by the nature of their
processes, their principal suppliers, and their target markets
and customers. The Company's Upstream operations consist of (i)
natural gas gathering, (ii) natural gas processing and (iii)
natural gas liquids ("NGLs") extraction and marketing; Midstream
operations consist of transportation, storage and bundled sales
transactions for K N's interstate and intrastate pipelines;
Downstream operations principally consist of energy marketing and
regulated natural gas distribution.
<PAGE> 10
Form 10Q
The accounting policies applied in the generation of segment
information are generally the same as those described in the
summary of significant accounting policies in K N's 1997 Report
on Form 10-K except that, in general, items below the "Operating
Income" line are either not allocated to business segments or are
not considered by Management in its evaluation of business unit
performance. In addition, certain items included in operating
income (such as the merger-related costs incurred in 1998) are
not allocated to individual business segments. With adjustment
for these items, K N currently evaluates business segment
performance primarily based on operating income in relation to
the level of capital employed. In general, intersegment sales
are accounted for at market prices, while asset transfers are
made at either market value or, in some instances, book value.
For comparative purposes, prior period results and balances have
been reclassified to conform to the current presentation.
<TABLE>
<CAPTION>
Three Months Ended June 30, 1998
-----------------------------------------------------------------------------
Upstream Midstream Downstream Other Consolidated
-------- --------- ---------- ----- ------------
(millions of dollars)
<S> <C> <C> <C> <C> <C>
Revenues from External Customers $ 124.4 $ 311.3 $ 604.0 $1,039.7
Intersegment Revenues $ 26.9 $ 68.0 $ 20.6 115.5
Operating Income (Loss) $ (4.0) $ 90.7 $ 6.8 $ (1.4)(1) 92.1
Other Income and (Deductions) (65.6)
--------
Income Before Income Taxes $ 26.5
========
Three Months Ended June 30, 1997
-----------------------------------------------------------------------------
Upstream Midstream Downstream Other Consolidated
-------- --------- ---------- ----- ------------
(millions of dollars)
Revenues from External Customers $ 118.4 $ 13.2 $ 227.2 $ 358.8
Intersegment Revenues $ 17.2 $ 27.4 $ 10.4 55.0
Operating Income $ 17.3 $ 6.3 $ 1.7 25.3
Other Income and (Deductions) (9.5)
--------
Income Before Income Taxes $ 15.8
========
Six Months Ended June 30, 1998
-----------------------------------------------------------------------------
Upstream Midstream Downstream Other Consolidated
-------- --------- ---------- ----- ------------
(millions of dollars)
Revenues from External Customers $ 245.0 $ 523.9 $1,437.3 $2,206.2
Intersegment Revenues $ 45.4 $ 141.3 $ 15.9 202.6
Operating Income (Loss) $ (8.1) $ 167.2 $ 16.6 $ (5.8)(1) 169.9
Other Income and (Deductions) (107.7)
--------
Income Before Income Taxes $ 62.2
========
Total Assets at June 30, 1998 $ 703.7 $6,362.8 $ 992.6 $1,155.5(2) $9,214.6
Six Months Ended June 30, 1997
-----------------------------------------------------------------------------
Upstream Midstream Downstream Other Consolidated
-------- --------- ---------- ----- ------------
(millions of dollars)
Revenues from External Customers $ 212.2 $ 52.4 $ 583.0 $ 847.6
Intersegment Revenues $ 48.1 $ 68.0 $ 51.9 168.0
Operating Income $ 26.3 $ 21.0 $ 17.6 64.9
Other Income and (Deductions) (17.0)
--------
Income Before Income Taxes $ 47.9
========
(1) Represents costs related to the MidCon Merger (see Note 2).
(2) Corporate assets represent principally cash, restricted
deposits and U.S. government securities.
</TABLE>
<PAGE> 11
Form 10-Q
5. Financing
---------
The total amount of funds required by K N to complete the
Acquisition, pay related fees and expenses and to repay
borrowings under K N's existing credit facility was approximately
$2,518 million, financed through borrowings under credit
agreements dated January 30, 1998 (the "Bank Facility") among
K N, Morgan Guaranty Trust Company of New York and a syndicate of
other lenders. A working capital facility replaced the revolving
credit agreement previously in place (the "Pre-Acquisition
Facility"). An acquisition facility was also part of the overall
Bank Facility structure. See Note 8(A) of Notes to Consolidated
Financial Statements on pages 41-42 of K N's 1997 Annual Report
on Form 10-K for additional information regarding the Bank
Facility and the Pre-Acquisition Facility. In addition to the
working capital and acquisition components of the Bank Facility
explained preceding, K N assumed a short-term note for $1,395
million (the "Substitute Note") which, pursuant to the Agreement,
was initially collateralized by letters of credit issued under a
commitment for that purpose within the Bank Facility.
In March 1998, K N received net proceeds of approximately $624.6
million from a public offering of 12,500,000 shares of K N common
stock and approximately $2,341.5 million from the concurrent public
offerings of senior debt securities of varying maturities totaling
$2.35 billion. The net proceeds from these offerings were used to
refinance borrowings under the Bank Facility and to purchase U.S.
government securities to replace a portion of the letters of credit
that collateralized the Substitute Note.
Following are the principal amounts, maturity dates and coupon
rates for the senior debt securities issued:
$500 million - 6.45% Senior Notes due March 1, 2003
$500 million - 6.65% Senior Notes due March 1, 2005
$300 million - 6.80% Senior Notes due March 1, 2008
$500 million - 7.25% Senior Debentures due March 1, 2028
$150 million - 7.45% Senior Debentures due March 1, 2098
$400 million - 6.30% Reset Put Securities due March 1, 2021
The 2003 Senior Notes and the 2005 Senior Notes are not
redeemable prior to maturity. The 2008 Senior Notes, 2028 Senior
Debentures and 2098 Senior Debentures are redeemable as a whole
or in part, at the option of the Company at any time, at
redemption prices defined in the associated prospectus
supplement. The Reset Put Securities due March 1, 2021 (the
"2021 REPS") are subject to mandatory redemption from the then-
existing holders on March 1, 2001 either (i) through the exercise
of a call option by Morgan Stanley & Co. International Limited
(the "Callholder") or (ii) in the event the Callholder does not
exercise the call option, the automatic exercise of a mandatory
put by First Trust National Association on behalf of the holders.
The $12 million of proceeds received by K N from the Callholder
as consideration for the call option are being amortized as an
adjustment to the effective interest rate on the 2021 REPS. If
the Callholder elects to exercise the call option, the interest
rate will be reset at that time.
In April 1998, K N sold $175 million of 7.63% Capital Securities
(the "Capital Securities") due April 15, 2028, in an underwritten
public offering. The sale was effected through a wholly owned
business trust, K N Capital Trust III (the "Trust"). The Company
used the net proceeds from the offering to purchase U.S.
government securities to replace a portion of the letters of
credit that collateralized the Substitute Note.
<PAGE> 12
Form 10-Q
The financial statements of the Trust are included in the
Company's consolidated financial statements, with the Capital
Securities treated as a minority interest, shown in the Company's
consolidated balance sheet under the caption "K N-Obligated
Mandatorily Redeemable Preferred Capital Trust Securities of
Subsidiary Trust Holding Solely Debentures of K N."
6. Comprehensive Income
--------------------
Statement of Financial Accounting Standards No. 130, "Reporting
of Comprehensive Income", effective for fiscal years beginning
after December 15, 1997, requires that enterprises report a total
for comprehensive income. Currently, the only difference between
"net income" and "comprehensive income" for K N is the
unrealized gain or loss on its investment in available-for-sale
securities which is recorded directly to stockholders' equity.
For the quarters ended June 30, 1998 and 1997, the respective
unrealized after-tax investment gain (loss) was $(2.1) million
and $1.6 million, resulting in comprehensive income of $14.6
million and $12.5 million, respectively. For the six month
periods ended June 30, 1998 and 1997, the respective unrealized
after-tax investment gain (loss) was $(0.3) million and $0.2
million, resulting in comprehensive income of $38.9 million and
$31.4 million, respectively.
7. Accounting for Derivative Instruments and Hedging Activities
------------------------------------------------------------
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133, Accounting
for Derivative Instruments and Hedging Activities ("the
Statement"). The Statement establishes accounting and reporting
standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be
recorded in the balance sheet as either an asset or liability
measured at its fair value. The Statement requires that changes
in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met. If
the derivatives meet these criteria, the Statement allows a
derivative's gains and losses to offset related results on the
hedged item in the income statement, and requires that a company
must formally designate a derivative as a hedge and document and
assess the effectiveness of derivatives associated with
transactions that receive hedge accounting.
The Statement is effective for fiscal years beginning after June
15, 1999. A company may also implement the Statement as of the
beginning of any fiscal quarter after issuance (that is, fiscal
quarters beginning June 16, 1998 and thereafter). The Statement
cannot be applied retroactively. The Statement must be applied
to (a) derivative instruments and (b) certain derivative
instruments embedded in hybrid contracts that were issued,
acquired, or substantively modified after December 31, 1997
(and, at the company's election, before January 1, 1998).
K N has not yet quantified the impacts of adopting the Statement
on its financial statements and has not determined the timing of
or method of adoption of the Statement.
8. TransColorado Pipeline Project
------------------------------
On July 14, 1998, the TransColorado Gas Transmission Co., an
enterprise jointly owned by K N and Questar Corp., announced the
winning bidders to construct the TransColorado Pipeline Project
and also noted that it had received approval from the Bureau of
Land Management, the U.S. Forest Service and the Federal Energy
Regulatory Commission to begin construction. In late July,
construction began on the 280 mile long natural gas pipeline
project which will include two compressor stations and extend
from near Rangely, Colorado to its
<PAGE> 13
Form 10-Q
southern terminus at the Blanco Hub near Aztec, New Mexico. The
pipeline is expected to be constructed at a cost of approximately
$240 million and have transmission capacity of approximately 300
million cubic feet of natural gas per day.
9. Interest Expense, Net
---------------------
"Interest Expense, Net" as presented in the accompanying
Consolidated Statements of Income is net of (i) the debt
component of the allowance for funds used during construction and
(ii) interest income on government securities of $1.3 million and
$13.3 million, respectively, for the three months ended June 30,
1998 and $1.7 million and $15.8 million, respectively, for the
six months ended June 30, 1998. For the three months and six
months ended June 30, 1997, "Interest Expense, Net" is net of the
debt component of the allowance for funds used during
construction of $2.2 million and $3.7 million, respectively. As
discussed in K N's quarterly report on Form 10-Q for the three
months ended March 31, 1998, in conjunction with the January 30,
1998 acquisition of MidCon Corp., K N was required by the
associated purchase/sale agreement to issue the Substitute Note
for approximately $1.4 billion and to collateralize the
Substitute Note with bank letters of credit, a portfolio of
government securities or a combination of the two. As a result,
K N has a significant amount of interest income associated with
the issuance of the Substitute Note, which has been reported
together with the related interest expense as described
previously.
10. Equity in Earnings (Losses) of Unconsolidated Subsidiaries
----------------------------------------------------------
Equity in earnings (losses) of unconsolidated subsidiaries
accounted for under the equity method totaling $7.8 million and
$(0.5) million for the six months ended June 30, 1998 and 1997,
respectively, and $4.5 million and $(1.4) million for the three
months ended June 30, 1998 and 1997, respectively, are included
in operating revenues in the accompanying interim Consolidated
Statements of Income.
<PAGE> 14
Form 10-Q
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
- -------
The following discussion should be read in conjunction with (i)
the accompanying interim Consolidated Financial Statements and
related Notes and (ii) the Consolidated Financial Statements,
related Notes and Management's Discussion and Analysis of
Financial Condition and Results of Operations included in K N's
1997 Report on Form 10-K. Due to the seasonal variation in
energy demand, among other factors, the interim results which
follow may not be indicative of the results to be expected for an
entire year. As discussed in Note 2 to the accompanying interim
Consolidated Financial Statements, the Company has engaged in
acquisition and divestiture transactions which affect the
comparison of results between periods.
Certain information contained herein may include forward-looking
statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of
1934. Although the Company believes that these statements are
based upon reasonable assumptions, it can give no assurance that
its goals will be achieved. Important factors that could cause
actual results to differ materially from those in the forward-
looking statements contained herein include, among other factors,
the pace of deregulation of retail natural gas and electricity
markets in the United States, federal and state regulatory
developments, the timing and extent of changes in commodity
prices for oil, gas, NGLs, electricity, certain agricultural
products and interest rates, the extent of success in acquiring
natural gas facilities, the timing and success of efforts to
develop power, pipeline and other projects, political
developments in foreign countries, and conditions of capital
markets and equity markets during the periods covered by the
forward-looking statements.
Consolidated Financial Results
- ------------------------------
Consolidated net income for the second quarter of 1998 was $16.7
million, a $5.8 million (53.2%) increase from 1997 second-quarter
net income of $10.9 million. After deduction for preferred
dividends, diluted earnings per share was $0.37 and $0.34 in the
second quarter of 1998 and 1997, respectively, based on
respective weighted average common shares outstanding of 45.3
million and 31.4 million. The increased number of common shares
outstanding in the second quarter of 1998 was principally due to
the early March 1998 public sale of 12.5 million shares of common
stock as described in Note 5 to the accompanying interim
Consolidated Financial Statements. Results for the second
quarter of 1998 included a pre-tax charge of approximately $1.4
million (approximately $0.9 million or $0.02 per diluted share
after tax) due to costs attributable to the acquisition and
integration of MidCon (see Note 2 to the accompanying interim
Consolidated Financial Statements).
Consolidated net income for the six months ended June 30, 1998
was $39.2 million, an $8.0 million (25.6%) increase from net
income of $31.2 million in the corresponding period of 1997.
After deduction for preferred dividends, diluted earnings per
share was $0.96 and $0.99 for the six months ended June 30, 1998
and 1997, respectively, based on respective weighted average
common shares outstanding of 40.5 million and 31.3 million. The
increased number of common shares outstanding during 1998 was
principally due to the March 1998 public sale of common shares as
described preceding. Results for the six months ended June 30,
1998 included a pre-tax gain of approximately $8.5 million
(approximately $5.5 million or $0.14 per share after tax) from
the sale of K N's Kansas natural gas distribution properties and
a pre-tax charge of approximately $5.8 million (approximately
$3.7 million or $0.09 per diluted share after tax) due to costs
attributable to the acquisition and integration of MidCon (see
Note 2 to the accompanying interim Consolidated Financial
Statements).
<PAGE> 15
Form 10-Q
Results of Operations
- ---------------------
Following is a discussion of (i) operating results by business
segment, (ii) "Other Income and (Deductions)" and (iii) "Income
Taxes". In conjunction with the adoption of Statement of
Financial Accounting Standards No. 131, Disclosure About Segments
of an Enterprise and Related Information, and reflecting the
Company's strategy of extracting margins from the various
segments of the energy value stream, the Company has segregated
its results of operations into its "Upstream", "Midstream" and
"Downstream" components. The Company's Upstream operations
consist of (i) natural gas gathering, (ii) natural gas processing
and (iii) natural gas liquids ("NGLs") extraction and marketing
activities. Midstream operations consist of transportation,
storage and bundled sales transactions for K N's interstate and
intrastate pipelines. Downstream activities principally consist
of energy marketing and regulated natural gas distribution. For
comparative purposes, the Company's previously reported results
have been restated to conform to the current presentation. The
following segment operating revenues, gas purchases, operations
and maintenance expenses and volumetric data are before
intersegment eliminations.
<TABLE>
<CAPTION>
Three Months Ended June 30 Six Months Ended June 30
-------------------------------- -----------------------------------
(dollars in millions)
<S> <C> <C> <C> <C> <C> <C>
Increase Increase
Upstream Gathering and Processing 1998 1997 (Decrease) 1998 1997 (Decrease)
---- ---- ---------- ---- ---- ----------
Operating Revenues
Gas Sales $ 48.9 $ 34.2 $14.7 $ 99.1 $ 74.9 $24.2
Natural Gas Liquids Sales 69.9 70.3 (0.4) 125.7 134.8 (9.1)
Gathering, Transportation
and Other 32.5 31.1 1.4 65.6 50.6 15.0
------ ------ ----- ------ ------- -----
151.3 135.6 15.7 290.4 260.3 30.1
------ ------ ----- ------ ------- -----
Operating Costs and Expenses
Gas Purchases and Other
Costs of Sales 114.5 87.6 26.9 216.9 181.8 35.1
Operations and Maintenance 31.5 23.1 8.4 62.6 38.8 23.8
Depreciation and Amortization 6.6 4.9 1.7 12.9 8.9 4.0
Taxes, Other Than Income Taxes 2.7 2.7 - 6.1 4.5 1.6
------ ------ ------ ------ ------- ------
155.3 118.3 37.0 298.5 234.0 64.5
------ ------ ------ ------ ------- ------
Operating Income (Loss) $ (4.0) $ 17.3 $(21.3) $ (8.1) $ 26.3 $(34.4)
====== ====== ====== ====== ====== ======
Systems Throughput
(Trillion Btus)
Gas Sales 24.7 19.3 5.4 49.5 33.8 15.7
Gathering and Transportation 86.8 85.2 1.6 172.7 134.9 37.8
------ ------ ------ ------ ------- ------
111.5 104.5 7.0 222.2 168.7 53.5
====== ====== ====== ====== ======= ======
Natural Gas Liquids Sales
(Million Gallons)
Company-Owned and Processed 209.1 165.9 43.2 363.8 304.8 59.0
Third-Party Marketed 28.9 26.9 2.0 54.3 38.4 15.9
------ ------ ------ ------ ------- ------
238.0 192.8 45.2 418.1 343.2 74.9
====== ====== ====== ====== ======= ======
</TABLE>
Upstream operating income decreased from income of $17.3 million
in the second quarter of 1997 to a loss of $4.0 million in the
second quarter of 1998, a decline of $21.3 million. This net
decrease reflected a $4.6 million positive variance due to the
1998 operating results of assets which were not owned in the
second quarter of 1997, including MidCon, Red Cedar and
Interenergy (see Note 2 of the accompanying interim Consolidated
Financial Statements), which positive impact was more than
offset by approximately $25.9 million of negative variance
associated with assets owned and operated during both periods.
Approximately one half of this negative variance was attributable
to increased natural gas prices and decreased NGLs prices during
1998. In those instances where natural gas is processed under
"keep whole" agreements, both of these price variances negatively
affect margins due to the increased cost of natural gas for fuel
and shrinkage and the
<PAGE> 16
Form 10-Q
decreased sales proceeds from extracted NGLs. The remaining one
half of the negative variance was principally due to (i) the
plant turnaround and additional measurement facilities added at
the Bushton facility during 1998, resulting in additional
operating costs and lost margin, (ii) reduced 1998 basis
differentials which reduced the operating results from certain
marketing activities, (iii) decreased 1998 processed volumes at
certain facilities due to natural production declines behind the
plants and increased 1998 down time due to maintenance, and (iv)
increased 1998 operational, general and administrative expenses.
Upstream operating income decreased from income of $26.3 million
in the six months ended June 30, 1997 to a loss of $8.1 million
in the corresponding period of 1998. This net decrease of $34.4
million reflected a $4.5 million positive variance due to the
1998 operating results of assets which were not owned for any or
some portion of the first six months of 1997, including MidCon,
Red Cedar and Interenergy, which positive impact was more than
offset by approximately $38.9 million of negative variance
associated with assets owned and operated during both periods.
More than half of this negative variance was attributable to
increased natural gas prices and decreased NGLs prices during
1998. Both of which variances, as described preceding,
negatively affect processing margins. The remaining negative
variance was principally due to (i) the plant turnaround and
additional measurement facilities added at the Bushton plant
during 1998, resulting in additional operating costs and lost
margin, (ii) decreased 1998 processed volumes at certain
facilities due to natural production declines behind the plants
and increased 1998 down time due to maintenance, (iii) reduced
basis differentials which reduced the operating results from
certain marketing activities, (iv) lower than expected 1998 NGLs
recoveries at certain facilities reflecting a failure of vendor-
installed compression to meet specifications, and (v) increased
1998 operational, general and administrative expenses.
<TABLE>
<CAPTION>
Three Months Ended June 30 Six Months Ended June 30
------------------------------------ -----------------------------------
(dollars in millions)
<S> <C> <C> <C> <C> <C> <C>
Increase Increase
Midstream Sales, Transportation 1998 1997 (Decrease) 1998 1997 (Decrease)
- ------------------------------- ---- ---- ---------- ---- ---- ----------
and Storage
- -----------
Operating Revenues
Transportation and Storage $162.1 $27.5 $134.6 $298.6 $ 64.9 $233.7
Other 217.2 13.1 204.1 366.6 55.5 311.1
------ ----- ------ ------ ------ ------
379.3 40.6 338.7 665.2 120.4 544.8
------ ----- ------ ------ ------ ------
Operating Costs and Expenses
Gas Purchases and Other Costs
of Sales 191.5 11.9 179.6 317.5 51.1 266.4
Operations and Maintenance 50.0 13.7 36.3 94.9 30.5 64.4
Depreciation and Amortization 37.6 6.5 31.1 69.5 13.1 56.4
Taxes, Other Than Income Taxes 9.5 2.2 7.3 16.1 4.7 11.4
------ ------ ------ ------ ------ ------
288.6 34.3 254.3 498.0 99.4 398.6
------ ------ ------ ------ ------ ------
Operating Income $ 90.7 $ 6.3 $ 84.4 $167.2 $ 21.0 $146.2
====== ===== ====== ====== ====== ======
Systems Throughput
(Trillion Btus) 619.2 124.1 495.1 1,087.5 258.2 829.3
====== ===== ===== ======= ====== ======
</TABLE>
Midstream operating income increased from $6.3 million in the
second quarter of 1997 to $90.7 million in the second quarter of
1998, an increase of $84.4 million. This increase in operating
income, as well as the significant increases in operating
revenues, operating expenses and volumes shown previously, was
principally attributable to the inclusion, in the second quarter
of 1998, of the operating results of (i) the interstate and
intrastate operations of MidCon (see Note 2 to the accompanying
interim Consolidated Financial Statements) and (ii) the Pony
Express Pipeline which entered service in the fourth quarter of
1997. These incremental operations were responsible for
virtually all of the quarter-to-quarter positive variance, with
operating results of assets owned in both periods remaining
essentially level.
<PAGE> 17
Form 10-Q
Midstream operating income increased from $21.0 million in the
six months ended June 30, 1997 to $167.2 million in the
corresponding period of 1998, an increase of approximately $146.2
million. This increase in operating income, as well as the
significant increases in operating revenues, operating expenses
and volumes shown preceding, was principally attributable to the
inclusion, in the second quarter of 1998, of the operating
results of (i) the interstate and intrastate operations of MidCon
(see Note 2 to the accompanying interim Consolidated Financial
Statements) and (ii) the Pony Express Pipeline which entered
service in the fourth quarter of 1997. These incremental
operations were responsible for virtually all of the period-to-
period positive variance, with operating results of assets owned
in both periods generating a small negative variance. This
negative variance was principally due to reduced 1998 margins on
Texas intrastate pipeline operations due to LDC unbundling and
warmer than normal weather (principally in the first quarter of
1998).
<TABLE>
<CAPTION>
Three Months Ended June 30 Six Months Ended June 30
---------------------------------- ------------------------------------
(dollars in millions)
<S> <C> <C> <C> <C> <C> <C>
Increase Increase
Downstream Retail and Marketing 1998 1997 (Decrease) 1998 1997 (Decrease)
- ------------------------------- ---- ---- ---------- ---- ---- ----------
Operating Revenues
Gas Sales $607.3 $217.8 $389.5 $1,427.2 $596.3 $830.9
Transportation and Other 17.3 19.8 (2.5) 26.0 38.6 (12.6)
------ ------ ------ -------- ------ ------
624.6 237.6 387.0 1,453.2 634.9 818.3
------ ------ ------ -------- ------ ------
Operating Costs and Expenses
Gas Purchases and Other Costs
of Sales 601.4 218.1 383.3 1,393.0 578.3 814.7
Operations and Maintenance 12.3 14.5 (2.2) 33.7 30.3 3.4
Depreciation and Amortization 3.2 2.3 0.9 6.8 6.0 0.8
Taxes, Other Than Income Taxes 0.9 1.0 (0.1) 3.1 2.7 0.4
------ ------ ------ -------- ------ ------
617.8 235.9 381.9 1,436.6 617.3 819.3
------ ------ ------ -------- ------ ------
Operating Income $ 6.8 $ 1.7 $ 5.1 $ 16.6 $ 17.6 $ (1.0)
====== ====== ====== ======== ====== ======
Systems Throughput
(Trillion Btus)
Gas Sales 273.9 90.5 183.4 612.3 223.1 389.2
Transportation 3.5 4.7 (1.2) 8.2 8.9 (0.7)
------ ------ ------ -------- ------ ------
277.4 95.2 182.2 620.5 232.0 388.5
====== ====== ====== ======== ====== ======
</TABLE>
Downstream operating income increased from $1.7 million in the
second quarter of 1997 to $6.8 million in the second quarter of
1998, an increase of $5.1 million. This increase was due to the
1998 results of operations for businesses not included in the
second quarter of 1997 including MidCon and Interenergy (see Note
2 of the accompanying interim Consolidated Financial Statements).
The operations included in both periods contributed a small
negative variance due to a number of factors including weather-
related demand changes, startup costs for the Nebraska ChoiceGas
program and the March 31, 1998 sale of K N's Kansas natural gas
distribution properties.
Downstream operating income decreased from $17.6 million in the
six months ended June 30, 1997 to $16.6 million in the six months
ended June 30, 1998, a decrease of approximately $1.0 million
(5.7%). This net decrease reflected a favorable variance of
approximately $10 million due to the inclusion, in 1998 results
of operations, of businesses not owned and operated in the prior
year, including MidCon and Interenergy. The negative variance of
approximately $11 million associated with operations included in
both periods was due to a number of factors including (i) reduced
1998 sales of gas in storage and (ii) reduced margins due to
depressed 1998 basis differentials on the Pony Express Pipeline
and milder weather. These unfavorable variances were partially
offset by a refund of certain previously recorded gathering fees
and reduced 1998 allocations of Corporate shared service
expenses.
<PAGE> 18
Form 10-Q
<TABLE>
<CAPTION>
Three Months Ended June 30 Six Months ended June 30
--------------------------------- ------------------------------------
(dollars in millions)
<S> <C> <C> <C> <C> <C> <C>
Earnings Earnings
Increase Increase
Other Income and 1998 1997 (Decrease) 1998 1997 (Decrease)
(Deductions) ---- ---- ---------- ---- ---- ----------
Interest Expense, Net $(63.5) $(10.5) $(53.0) $(113.8) $(20.2) $(93.6)
Minority Interests (4.6) (2.4) (2.2) (7.0) (3.0) (4.0)
Other, Net 2.5 3.4 (0.9) 13.1 6.2 6.9
------ ------ ------ ------- ------ ------
$(65.6) $ (9.5) (56.1) $(107.7) $(17.0) (90.7)
====== ====== ====== ======= ====== ======
</TABLE>
The increase of $53.0 million in "Interest Expense, Net" from the
second quarter of 1997 to the second quarter of 1998 is
principally due to the incremental debt associated with (i) the
acquisition of MidCon effective January 30, 1998, (see Note 2 to
the accompanying interim Consolidated Financial Statements) and
(ii) the construction cost of the Pony Express Pipeline, placed
in service during the latter part of 1997. The increase in net
expense associated with "Minority Interests" during the second
quarter of 1998 in comparison to the corresponding period of 1997
is principally due to the dividend requirements associated with
the $100 million and $175 million of Capital Trust Securities
issued in April 1997 and April 1998, respectively.
The increase of $93.6 million in "Interest Expense, Net" from the
six months ended June 30, 1997 to the six months ended June 30,
1998 is principally due to the MidCon acquisition and the
construction costs associated with the Pony Express Pipeline as
described preceding. The increase in net expense associated with
"Minority Interests" during the six months ended June 30, 1998 in
comparison to the corresponding period of 1997 is principally due
to the dividend requirements associated with the Capital Trust
Securities, as described preceding. The increase of $6.9 million
in "Other, Net" from the first six months of 1997 to the first
six months of 1998 was principally due to the first-quarter 1998
gain of $8.5 million from K N's sale of its Kansas natural gas
distribution properties.
<TABLE>
<CAPTION>
Three Months Ended June 30 Six Months Ended June 30
--------------------------------- -----------------------------------
(dollars in millions)
<S> <C> <C> <C> <C> <C> <C>
Increase Increase
Income Taxes 1998 1997 (Decrease) 1998 1997 (Decrease)
---- ---- ---------- ---- ---- ----------
Provision $ 9.77 $ 4.97 $ 4.80 $23.02 $16.67 $ 6.35
====== ====== ====== ====== ====== ======
Effective Tax Rate 36.9% 31.4% 5.5% 37.0% 34.8% 2.2%
====== ====== ====== ====== ====== ======
</TABLE>
Of the $4.8 million increase in income tax expense from the
second quarter of 1997 to the second quarter of 1998,
approximately $3.3 million (68.7%) was attributable to an
increase in 1998 pre-tax income and the balance of approximately
$1.5 million (31.3%) was attributable to an increase in the
second quarter 1998 effective tax rate.
Of the $6.4 million increase in income tax expense from the six
months ended June 30, 1997 to the six months ended June 30, 1998
approximately $5.0 million (78.1%) was attributable to an
increase in 1998 pre-tax income and the balance of approximately
$1.4 million (21.9%) was attributable to an increase in the
effective tax rate in the first six months of 1998, principally
due to adjustments related to the successful resolution of
certain issues from prior years' income tax filings included in
1997 tax expense.
<PAGE> 19
Form 10-Q
Liquidity and Capital Resources
- -------------------------------
The following table illustrates the sources of the Company's
invested capital for the last three years and at
June 30, 1998 and 1997. The balances at June 30, 1998 reflect
the incremental capital associated with the acquisition of
MidCon, including the post-acquisition refinancings completed in
the first quarter of 1998 (see Note 2 to the accompanying interim
Consolidated Financial Statements). In addition, during April
1998, the Company issued $175 million of Capital Trust
Securities. For additional information on these financing
activities, see Note 5 to the accompanying interim Consolidated
Financial Statements.
<TABLE>
<CAPTION>
June 30 December 31
------------------------ ---------------------------------------
(dollars in thousands)
<s > <C> <C> <C> <C> <C>
1998 1997 1997 1996 1995
---- ---- ---- ---- ----
Long-Term Debt $2,891,998 $ 412,912 $ 553,816 $ 423,676 $ 315,564
Common Equity 1,258,029 550,967 606,132 519,794 426,760
Preferred Stock 7,000 7,000 7,000 7,000 7,572
Capital Trust Securities 275,000 100,000 100,000 - -
---------- ---------- ---------- ---------- ----------
Capitalization 4,432,027 1,070,879 1,266,948 950,470 749,896
Short-Term Debt 1,935,733(1) 219,355 359,951 156,271 116,197
---------- ---------- ---------- ---------- ----------
Invested Capital $6,367,760 $1,290,234 $1,626,899 $1,106,741 $ 866,093
========== ========== ========== ========== ==========
Capitalization:
Long-Term Debt 65.2% 38.6% 43.7% 44.6% 42.1%
Common Equity 28.4% 51.4% 47.8% 54.7% 56.9%
Preferred Stock 0.2% 0.7% 0.6% 0.7% 1.0%
Capital Trust Securities 6.2% 9.3% 7.9% - -
Invested Capital:
Total Debt(2) 75.8% 49.0% 56.2% 52.4% 49.9%
Equity, Including Capital
Trust Securities 24.2% 51.0% 43.8% 47.6% 50.1%
- -----------------------------------------------------------------------------------------------
(1) Includes the $1,394,846 Substitute Note assumed in
conjunction with the acquisition of MidCon.
(2) If the government securities held as collateral are offset
against the related debt, the ratio of total debt to invested
capital at June 30, 1998 is 71.0%.
</TABLE>
The following discussion of cash flows should be read in
conjunction with the accompanying interim Consolidated Statements
of Cash Flows and related supplemental disclosures and with the
Consolidated Statements of Cash Flows included in the Company's
1997 Report on Form 10-K.
Net Cash Flows from Operating Activities
- ----------------------------------------
"Net Cash Flows From Operating Activities" increased from
approximately $63.8 million in the first six months of 1997 to
approximately $115.0 million in the first six months of 1998, an
increase of approximately $51.2 million (80.3%). This increase
was principally attributable to (i) the increase in six months
ended June 30, 1998 earnings before non-cash charges and credits,
largely due to the inclusion of the results of operations of
MidCon for five months (see Note 2 to the accompanying interim
Consolidated Financial Statements), (ii) the receipt of $27.5
million in settlement of a gas contract during the first six
months of 1998 and (iii) an increase in cash provided from
miscellaneous working capital items in 1998. These favorable
variances were partially offset by incremental cash used in the
first six months of 1998 to purchase storage gas.
<PAGE> 20
Form 10-Q
Net Cash Flows from Investing Activities
- ----------------------------------------
"Net Cash Flows Used in Investing Activities" increased from
approximately $209.2 million in the first six months of 1997 to
approximately $3.4 billion in the first quarter of 1998, an
increase of approximately $3.2 billion principally due to (i) the
$2.2 billion of net cash paid in the first six months of 1998 and
(ii) the purchase of approximately $1.1 billion of U.S.
government securities to be held as collateral for the Substitute
Note, in each case in conjunction with the acquisition of MidCon
(see Note 2 to the accompanying interim Consolidated Financial
Statements). The increased cash used for capital expenditures in
the first six months of 1998 was largely offset by increased cash
received from sales of assets and reduced cash used for
acquisitions.
Net Cash Flows from Financing Activities
- ----------------------------------------
"Net Cash Flows From Financing Activities" increased from
approximately $148.2 million in the first six months of 1997 to
approximately $3.3 billion in the first six months of 1998, an
increase of approximately $3.2 billion. This increase reflected
the receipt of (i) approximately $2.36 billion in conjunction
with the public sale of debt securities, (ii) approximately $650
million in conjunction with the public sale of common stock and
(iii) approximately $175 million in conjunction with the public
sale of Capital Trust Securities (in each case representing the
refinancing of acquisition debt associated with the purchase of
MidCon), net of associated issuance costs of approximately $64.1
million (see Notes 2 and 5 to the accompanying interim
Consolidated Financial Statements).
The Company's principal source of short-term liquidity is its
bank facility (see Note 8(A) of Notes to Consolidated Financial
Statements included in K N's 1997 Annual Report of Form 10-K)
which makes available a total working capital line of $1 billion.
At June 30, 1998, the Company had issued $525.2 million of
commercial paper under this facility. The Company believes its
remaining capacity under this facility is adequate for its
expected short-term cash requirements.
Readiness for Year 2000
- -----------------------
The year 2000, when used in most current computer codes and
programs, is stored as a 2-digit number, which results in a year
value of "00". This year value can cause date-related
calculations to produce erroneous results (the "Year 2000
Problem"). It is widely anticipated that when the year 2000
arrives, computer programs that have not been upgraded to
accommodate the date-related calculation issue will not function
normally. K N relies on a number of automated systems to
conduct its operations and transact its business, as do other
large diversified energy companies. In addition to the automated
computer systems which are used to conduct accounting and other
financial matters, certain of K N's pipeline and processing
equipment and peripheral systems contain electronic controls that
may be affected by the Year 2000 Problem. In addition, many of
K N's suppliers, customers and other business partners face similar
issues.
K N is conducting an ongoing structured evaluation of the extent
of its Year 2000 Problem and has developed a plan to address each
area of concern. The Company's operating units are in various
stages of implementing the plan which includes an assessment of
the potential problems, an inventory of systems and areas which
need to be addressed, testing of such systems, remediation and
implementation as necessary and the development of contingency
plans in the event the remediation is unsuccessful.
Specifically, the Company is in the process of correcting
programming code, replacing non-Year-2000-ready embedded chips,
installing Year 2000-ready releases of certain vendor-supplied
computer systems and, in some instances, replacing existing
systems with new internally developed or vendor-supplied software
in advance of December 31, 1999.
Where K N is relying on external entities to provide Year 2000-
ready system upgrades or to provide Year 2000-ready software
systems, the risk exists that such vendors will be unable to
perform on a timely basis. K N
<PAGE> 21
Form 10-Q
is developing alternative methods to conduct its
business in the event of such non-performance, although such
alternatives may involve additional expense and there is no
guarantee that such alternative methods will work or will be
implemented in a timely fashion. In addition, the Company relies
on suppliers, business partners and other external parties which
may or may not be addressing their Year 2000 Problem. Although
K N has initiated a program for making inquiries of its customers,
suppliers and business partners as to their state of Year 2000
readiness, the Company has no control over these external parties.
The Company is in the process of developing its contingency
plans in the event that these external parties fail or are unable
fully to successfully address the Year 2000 Problem.
<PAGE> 22 Form 10-Q
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
As previously reported in the Company's 1997 Annual Report on
Form 10-K, in May 1997 the Nebraska Department of Environmental
Quality ("NDEQ") issued a violation notice to K N Interstate Gas
Transmission Co. ("KNI") regarding historical Prevention of
Significant Deterioration permitting issues related to certain
engines at the Big Springs, Nebraska facility. On June 9, 1998,
KNI settled this matter and entered into a Consent Decree
requiring the payment of a $300,000 penalty, performance of a
Supplemental Environmental Project involving ambient air quality
monitoring, and obtaining appropriate permits and installing
required emissions controls on three engines. The penalty has
been paid and the costs associated with this matter are not
expected to have a material adverse effect on the Company's
business, financial position, or results of operations.
Pursuant to certain acquisition agreements involving Cabot
Corporation ("Cabot"), Cabot indemnified the Company for certain
environmental liabilities associated with assets in Texas,
Oklahoma and New Mexico acquired from American Oil and Gas
Corporation. Issues arose concerning Cabot's indemnification
obligations, and the Company and Cabot entered into binding
arbitration to resolve all issues in dispute. The binding
decision of the arbitrators resulted in the requirement that
Cabot pay the Company for substantially all past and future
environmental related costs associated with the properties. The
Company does not expect its potential exposure for such
liabilities to have a material adverse impact on the Company's
business, financial position or results of operations.
.
Item 4. Submission of Matters to a Vote of Security Holders
a) The Company held its Annual Meeting of Shareholders on April
16, 1998 (the "Annual Meeting").
b) Proxies for the Annual Meeting were solicited pursuant to
Regulation 14A of the Securities Exchange Act of 1934. There was
no solicitation in opposition to management's nominees for
directors as listed in the Proxy Statement and all such nominees
were elected, which included Messrs. Battey, Hall, Kinder,
Riordan and True. In addition, those directors continuing in
office after the meeting included Messrs. Austin, Bliss,
Burkholder, Carmichael, Chitwood, Coghlan, Haines, Hybl, Randall
and Taylor. The number of votes for and withheld for the
nominees elected at the meeting were as follows:
For Withheld
Charles W. Battey 27,219,040 495,344
Larry D. Hall 27,253,200 461,194
Richard D. Kinder 27,302,329 412,065
John F. Riordan 27,307,611 406,783
H.A. True, III 27,315,463 398,931
<PAGE> 23 Form 10-Q
c) The following matters were voted on at the Annual Meeting:
(1) A proposal to amend the Restated Articles of
Incorporation of the Company to increase the authorized
Common Stock, par value $5.00 per share, of the Company
from 50,000,000 shares to 150,000,000 shares was approved
and the number of affirmative votes, negative votes, and
abstentions with respect to this matter were as follows:
For 21,351,184
Against 6,208,963
Abstain 154,247
(2) A proposal to increase the number of shares
authorized for issuance under the 1994 K N Energy, Inc.
Long Term Incentive Plan by 1,600,000 shares was approved
and the number of affirmative votes, negative votes,
abstentions and broker no votes with respect to the
matter were as follows:
For 18,753,088
Against 5,794,413
Abstain 228,514
Broker No Votes 2,938,379
(3) A proposal to increase the number of shares
authorized for issuance under the 1990 Employee Stock
Purchase Plan by 1,000,000 shares was approved and the
number of affirmative votes, negative votes, abstentions
and broker no votes with respect to the matter were as
follows:
For 23,940,655
Against 678,556
Abstain 156,804
Broker No Votes 2,938,379
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits
27 - Financial Data Schedule
(B) Reports on Form 8-K
Current Report on Form 8-K dated April 24, 1998 to report the
issuance by K N Capital Trust III of $175,000,000 aggregate
liquidation amount of its 7.63% Capital Securities, the proceeds
of which were used to invest in the 7.63% Junior Subordinated
Debentures of the Company due 2028.
Current Report on Form 8-K dated June 4, 1998 to present
unaudited pro forma condensed statement of income for the year
ended December 31, 1997 and the three months ended March 31, 1998
and related notes.
<PAGE> 24
Form 10-Q
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
K N ENERGY, INC.
(Registrant)
August 13, 1998 /s/ Clyde E. McKenzie
------------------------------------------
Clyde E. McKenzie
Vice President and Chief Financial Officer
(On Behalf of the Registrant and as
Principal Financial and Accounting Officer)
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<MULTIPLIER> 1,000
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<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 37,882
<SECURITIES> 1,061,203
<RECEIVABLES> 569,730
<ALLOWANCES> 0
<INVENTORY> 172,233
<CURRENT-ASSETS> 1,997,743
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<BONDS> 2,891,998
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<COMMON> 224,925
<OTHER-SE> 1,033,104
<TOTAL-LIABILITY-AND-EQUITY> 9,214,575
<SALES> 2,206,240
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<INCOME-PRETAX> 62,218
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