<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 September 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 45,730,629 shares as of October 30, 1998.
- -------------------------------------------------------------------
<PAGE> 2
Form 10-Q
K N ENERGY, INC. AND SUBSIDIARIES
FORM 10-Q
QUARTER ENDED SEPTEMBER 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 - 14
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations............ 15 - 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................... 24
Item 6. Exhibits and Reports on Form 8-K................ 24
SIGNATURE................................................. 25
<PAGE> 3
Form 10-Q
CONSOLIDATED BALANCE SHEETS (Unaudited)
K N Energy, Inc. and Subsidiaries
(Dollars in Thousands)
<TABLE>
<CAPTION>
September 30 December 31
1998 1997
-------------- -------------
<S> <C> <C>
ASSETS:
Current Assets:
Cash and Cash Equivalents $ 25,081 $ 22,471
Restricted Deposits 44,291 11,339
U.S. Government Securities 1,088,601 -
Accounts Receivable 625,270 409,937
Materials and Supplies 43,906 13,476
Gas in Underground Storage 158,745 33,558
Prepaid Expenses 30,372 22,194
Gas Imbalances 128,157 46,171
Other 24,324 17,384
---------- ----------
2,168,747 576,530
---------- ----------
Investments 293,931 149,869
---------- ----------
Property, Plant and Equipment 7,732,136 1,971,601
Less Accumulated Depreciation and
Amortization 679,906 550,626
---------- ----------
7,052,230 1,420,975
---------- ----------
Deferred Charges and Other Assets 173,613 158,431
---------- ----------
Total Assets $9,688,521 $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>
September 30 December 31
1998 1997
-------------- --------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current Liabilities:
Current Maturities of Long-Term Debt $ 16,952 $ 30,751
Notes Payable 755,499 329,200
Substitute Note 1,394,846 -
Accounts Payable 430,947 334,418
Accrued Expenses 86,049 37,264
Accrued Taxes 39,142 7,445
Gas Imbalances 119,030 37,516
Payable for Purchase of Thermo Companies 121,074 -
Other 91,974 20,217
---------- ----------
3,055,513 796,811
---------- ----------
Deferred Liabilities, Credits and Reserves:
Deferred Income Taxes 1,691,685 168,583
Other 422,125 26,160
---------- ----------
2,113,810 194,743
---------- ----------
Long-Term Debt 2,905,688 553,816
---------- ----------
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 67,966 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 - 45,033,635 and 32,024,557
Shares, Respectively 225,168 160,123
Additional Paid-in Capital 839,822 270,678
Retained Earnings 211,427 185,658
Deferred Compensation (11,169) (9,203)
Treasury Stock, at Cost - 38,174 and 28,482
Shares, Respectively (1,704) (1,124)
---------- ----------
Total Common Stockholders' Equity 1,263,544 606,132
---------- ----------
Total Stockholders' Equity 1,270,544 613,132
---------- ----------
Total Liabilities and Stockholders' Equity $9,688,521 $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 Months Ended Nine Months Ended
September 30 September 30
-------------------------- --------------------------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Operating Revenues:
Upstream Gathering and Processing Services $ 156,674 $ 137,022 $ 447,084 $ 397,369
Midstream Sales, Transportation and Storage Services 414,717 46,423 1,079,908 166,789
Downstream Retail and Marketing Services 655,464 391,896 2,108,641 1,026,779
Intersegment Eliminations (181,803) (57,152) (384,341) (225,154)
---------- ---------- ---------- ----------
Total Operating Revenues 1,045,052 518,189 3,251,292 1,365,783
---------- ---------- ---------- ----------
Operating Costs and Expenses:
Gas Purchases and Other Costs of Sales 791,326 417,407 2,518,202 1,060,884
Operations and Maintenance 93,386 46,771 282,625 146,109
Depreciation and Amortization 52,999 13,110 142,198 41,101
Taxes, Other Than Income Taxes 14,449 6,218 39,736 18,144
Merger-related Costs - - 5,763 -
---------- ---------- ---------- ----------
Total Operating Costs and Expenses 952,160 483,506 2,988,524 1,266,238
---------- ---------- ---------- ----------
Operating Income 92,892 34,683 262,768 99,545
---------- ---------- ---------- ----------
Other Income and (Deductions):
Interest Expense, Net (64,507) (10,817) (178,340) (30,991)
Minority Interests (4,394) (2,736) (11,390) (5,681)
Other, Net 14,861 5,497 28,032 11,653
---------- ---------- ---------- ----------
Total Other Income and (Deductions) (54,040) (8,056) (161,698) (25,019)
---------- ---------- ---------- ----------
Income Before Income Taxes 38,852 26,627 101,070 74,526
Income Taxes 14,377 8,819 37,398 25,488
---------- ---------- ---------- ----------
Net Income 24,475 17,808 63,672 49,038
Less - Preferred Stock Dividends 88 88 263 263
---------- ---------- ---------- ----------
Earnings Available For Common Stock $ 24,387 $ 17,720 $ 63,409 $ 48,775
========== ========== ========== ==========
Number of Shares Used in Computing
Basic Earnings Per Common Share 44,995 31,372 41,689 30,892
========== ========== ========== ==========
Basic Earnings Per Common Share $ 0.54 $ 0.56 $ 1.52 $ 1.58
========== ========== ========== ==========
Number of Shares Used in Computing
Diluted Earnings Per Common Share 45,327 31,709 42,150 31,397
========== ========== ========== ==========
Diluted Earnings Per Common Share $ 0.54 $ 0.56 $ 1.50 $ 1.55
========== ========== ========== ==========
Dividends Per Common Share $ 0.28 $ 0.27 $ 0.84 $ 0.81
========== ========== ========== ==========
</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
(Thousands of Dollars)
<TABLE>
<CAPTION>
Nine Months Ended
September 30
------------------------
1998 1997
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 63,672 $ 49,038
Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities:
Depreciation and Amortization, Excluding Amortization
of Gas Plant Acquisition Adjustment 71,137 41,101
Deferred Income Taxes 13,867 8,781
Deferred Purchased Gas Costs 13,151 (14,736)
Gain on Sale of Facilities (18,424) -
Proceeds from Gas Contract Settlement 27,500 -
Change in Gas in Underground Storage (69,478) 5,409
Changes in Other Working Capital Items (Note 3) (60,501) 31,444
Changes in Deferred Revenues 14,567 (11,699)
Other, Net (52,396) (6,721)
---------- ---------
NET CASH FLOWS FROM OPERATING ACTIVITIES 3,095 102,617
---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital Expenditures (205,320) (213,320)
Cash Paid for Acquisition of MidCon, Net of Cash Acquired (2,181,954) -
Other Acquisitions (15,327) (102,918)
Investments (19,148) (10,796)
Sale of U.S. Government Securities 1,093,591 -
Purchase of U.S. Government Securities (2,182,192) -
Purchase of U.S. Government Securities as Collateral for Thermo
Purchase Obligation (34,028) -
Proceeds from Sales of Assets 28,795 9,938
---------- ---------
NET CASH FLOWS USED IN INVESTING ACTIVITIES (3,515,583) (317,096)
---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-Term Debt, Net 425,812 155,700
Long-Term Debt - Issued 2,350,000 -
Long-Term Debt - Retired (23,627) (21,136)
Common Stock Issued in Public Offering 650,000 -
Other Common Stock Issuance 11,694 15,802
Mandatorily Redeemable Preferred Trust Securities Issued 175,000 100,000
Treasury Stock - Issued 685 974
- Acquired (1,265) (1,602)
Cash Dividends - Common (37,640) (25,254)
- Preferred (263) (263)
Minority Interests - Contributions 16,844 -
Securities Issuance Costs (52,142) (1,262)
---------- --------
NET CASH FLOWS FROM FINANCING ACTIVITIES 3,515,098 222,959
---------- --------
Net Increase in Cash and Cash Equivalents 2,610 8,480
Cash and Cash Equivalents at Beginning of Period 22,471 10,339
---------- ----------
Cash and Cash Equivalents at End of Period $ 25,081 $ 18,819
========== ==========
</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 Sales
In September 1998, K N sold certain of its microwave towers and
associated land and equipment to Boston-based American Tower
Corp. for $14.6 million. The sale resulted in a pre-tax gain of
$10.9 million ($6.9 million or $0.15 per diluted share after tax)
included in the accompanying Consolidated Statement of Income
under the caption "Other, Net".
During the third quarter of 1998, K N completed its previously
announced acquisition of interests in four independent power
plants in Colorado from the Denver-based Thermo Companies
("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
Ft. Lupton, Co. (272 megawatts) and Greeley, Co. (108 megawatts)
and sell their power output to Public Service Company of Colorado
under long-term agreements. At September 30, 1998, K N had
purchased approximately $34.0 million of U.S. government
securities as collateral for the initial purchase price payment,
which amount is included under "Restricted Deposits" in the
accompanying Consolidated Balance Sheet and under "Purchase of
U.S. Government Securities as Collateral for Thermo Purchase
Obligation" in the accompanying Consolidated Statement of Cash
Flows. Payment for these interests will be made over a two-
year period, with the initial payment of 689,810 shares of K N
common stock having been made on October 21, 1998. The remaining
payments (in 1999 and 2000) will be made in a combination of cash
and common stock as agreed to by K N and Thermo, with the default
mix being 50% stock and 50% cash. In conjunction with this
transaction, accounted for as a purchase, at September 30, 1998,
K N had recorded a current liability of $121.1 million (shown in
the accompanying Consolidated Balance Sheet as "Payable for
Purchase of Thermo Companies") and a long-term liability of $31.4
million (included in the accompanying Consolidated Balance Sheet
under the caption "Deferred Liabilities, Credits and Reserves:
Other") representing the purchase price obligation. K N's investment
in Thermo is shown in the accompanying Consolidated Balance Sheet
at September 30, 1998 under "Investments" ($67.3 million), with the
significant majority of the balance shown as additions to "Property,
Plant and Equipment", and lesser amounts included with other asset and
liability accounts.
In March 1998, K N completed the sale of its Kansas retail
natural gas distribution properties, located in 58 Kansas
communities and serving approximately 30,000 residential,
commercial and industrial customers, to Midwest Energy, Inc., a
customer-owned cooperative based in Hays, Kansas. K N received
approximately $24 million in cash in conjunction with the sale
and recorded a pre-tax gain of approximately $8.5 million
(approximately $5.5 million or $0.13 per diluted share after
tax). Concurrently with the sale, K N received $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.
<PAGE> 8
Form 10-Q
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 credit agreements
(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 system includes 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.
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 the 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 nine
months ended September 30, 1998, approximately $26.7 million and
$71.1 million of such amortization, 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. Historical information for
periods prior to January 30, 1998 does not reflect any impact
associated with the MidCon acquisition.
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.
<PAGE> 9
Form 10-Q
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
------------------------ ------------------------
Unaudited Pro Forma Financial Information 1998* 1997 1998 1997
---- ---- ---- ----
(dollars in millions, except per share amounts)
<S> <C> <C> <C> <C>
Operating Revenues $ 1,045.1 $ 1,175.2 $ 3,519.3 $ 3,448.4
Net Income 24.5 22.7 67.6 57.7
Diluted Earnings per Common Share $ 0.54 $ 0.71 $ 1.60 $ 1.83
Number of Shares Used in Computing Diluted Earnings
per Common Share (in thousands) 45,327 31,709 42,150 31,397
</TABLE>
* As reported; reflects the acquisition of MidCon for the entire
period.
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.
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>
Nine Months Ended
September 30
--------------------------
1998 1997
---- ----
<S> <C> <C>
CHANGES IN OTHER WORKING CAPITAL ITEMS:
(Net of Effects of Acquisitions and Sales)
Accounts Receivable $ 195,913 $ 114,630
Materials and Supplies Inventory (13,778) (3,331)
Other Current Assets (7,924) (5,188)
Accounts Payable (248,178) (68,117)
Other Current Liabilities 13,466 (6,550)
---------- ----------
$ (60,501) $ 31,444
========== ==========
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash Paid for:
Interest (Net of Amount Capitalized) $ 184,855 $ 35,050
========== ==========
Distributions on Preferred Capital Trust Securities $ 4,280 $ -
========== ==========
Income Taxes $ 37,877 $ 15,496
========== ==========
</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
<PAGE> 10
Form 10-Q
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.
In the third quarter of 1998, K N purchased interests in four
independent power plants in Colorado from the Thermo Companies.
The initial payment for this purchase was made in October 1998
with K N common stock and the remaining payments will be a
combination of cash and K N common stock. A portion of K N's
January 1998 acquisition of MidCon was made through the
assumption of a note. In December 1997, K N acquired Interenergy
Corporation in a non-cash transaction. For additional
information on these transactions, see Note 2.
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,
regulated natural gas distribution and electric power generation
and sales.
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.
<PAGE> 11
Form 10-Q
<TABLE>
<CAPTION>
Three Months Ended September 30, 1998
-----------------------------------------------------------------------
Upstream Midstream Downstream Other Consolidated
-------- --------- ---------- ----- ------------
(dollars in millions)
<S> <C> <C> <C> <C> <C>
Revenues from External Customers $ 120.7 $ 339.5 $ 584.9 $1,045.1
Intersegment Revenues $ 36.0 $ 75.2 $ 70.6 $ 181.8
Operating Income (Loss) $ (3.9) $ 92.0 $ 4.8 $ 92.9
Other Income and (Deductions) (54.0)
--------
Income Before Income Taxes $ 38.9
========
Three Months Ended September 30, 1997
-----------------------------------------------------------------------
Upstream Midstream Downstream Other Consolidated
-------- --------- ---------- ----- ------------
(dollars in millions)
Revenues from External Customers $ 119.2 $ 18.6 $ 380.4 $ 518.2
Intersegment Revenues $ 17.8 $ 27.8 $ 11.5 $ 57.1
Operating Income $ 17.4 $ 11.7 $ 5.6 $ 34.7
Other Income and (Deductions) (8.1)
--------
Income Before Income Taxes $ 26.6
========
Nine Months Ended September 30, 1998
-----------------------------------------------------------------------
Upstream Midstream Downstream Other Consolidated
-------- --------- ---------- ----- ------------
(dollars in millions)
Revenues from External Customers $ 365.7 $ 863.4 $2,022.2 $3,251.3
Intersegment Revenues $ 81.4 $ 216.5 $ 86.4 $ 384.3
Operating Income (Loss) $ (12.0) $ 259.2 $ 21.4 $ (5.8)(1) $ 262.8
Other Income and (Deductions) (161.7)
--------
Income Before Income Taxes $ 101.1
========
Total Assets at September 30, 1998 $ 722.7 $6,100.4 $1,707.4 $1,158.0(2) $9,688.5
Nine Months Ended September 30, 1997
-----------------------------------------------------------------------
Upstream Midstream Downstream Other Consolidated
-------- --------- ---------- ----- ------------
(dollars in millions)
Revenues from External Customers $ 331.4 $ 71.0 $ 963.4 $1,365.8
Intersegment Revenues $ 66.0 $ 95.8 $ 63.4 $ 225.2
Operating Income $ 43.7 $ 32.7 $ 23.1 $ 99.5
Other Income and (Deductions) (25.0)
--------
Income Before Income Taxes $ 74.5
========
(1) Represents costs related to the MidCon Acquisition (see Note 2).
(2) Corporate assets represent principally cash, restricted deposits and U.S. government securities.
</TABLE>
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
described preceding, K N assumed a short-term note for $1,395
million due January 1999 (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
<PAGE> 12
Form 10-Q
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. 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."
K N currently is in the process of offering to the public $375
million of 3-year senior notes ("the Senior Notes") and,
concurrently, premium equity participating security units - PEPS
Units ("PEPS Units"). The expected cash proceeds of
approximately $375 million from the sale of the PEPS Units will
be used to purchase treasury securities ("the Collateral"). The
Collateral will be pledged to the Company to secure the
obligation of the PEPS Units holders to purchase K N common stock
at the end of a three-year period coinciding with the maturity of
the Senior Notes. K N expects to receive initial net cash
proceeds from the Senior Notes offering of approximately $360.9
million, after deduction for underwriting fees and offering
expenses for both offerings. Such net proceeds are expected to
be used to repay a portion of currently outstanding short-term
borrowings.
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
<PAGE> 13
Form 10-Q
stockholders' equity. For the quarters ended September 30, 1998
and 1997, the respective unrealized after-tax investment gain
(loss) was $(3.8) million and $2.2 million, resulting in
comprehensive income of $20.7 million and $20.0 million,
respectively. For the nine month periods ended September 30,
1998 and 1997, the respective unrealized after-tax investment
gain (loss) was $(4.0) million and $2.3 million, resulting in
comprehensive income of $59.6 million and $51.4 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 Company
("TransColorado"), 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
southern terminus at the Blanco Hub near Aztec, New Mexico. The
pipeline is expected to be constructed at a cost of approximately
$280 million and have transmission capacity of approximately 300
million cubic feet of natural gas per day. On October 14, 1998,
TransColorado entered into a $200 million revolving credit
agreement with a group of commercial banks. K N will provide a
corporate guarantee for one-half of all amounts borrowed under
the agreement.
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
("AFUDC - Interest") and (ii) interest income related to and a
gain from the sale of government securities (collectively,
"Interest Income"), as shown in the following table.
<PAGE> 14
Form 10-Q
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30 September 30
------------------- -------------------
(dollars in millions)
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
AFUDC - Interest $ 2.6 $ 2.2 $ 4.3 $ 5.9
Interest Income $15.8 $ - $31.7 $ -
</TABLE>
As discussed in Note 2, in conjunction with the January 30, 1998
acquisition of MidCon Corp., K N was required by the associated
purchase/sale agreement to assume the Substitute Note for $1,395
million 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 preceding.
10. Equity in Earnings of Unconsolidated Subsidiaries
Equity in earnings of unconsolidated subsidiaries accounted for
under the equity method totaling $13.5 million and $3.3 million
for the nine months ended September 30, 1998 and 1997,
respectively, and $5.4 million and $2.3 million for the three
months ended September 30, 1998 and 1997, respectively, are
included in operating revenues (with the appropriate business
segment) in the accompanying interim Consolidated Statements of
Income.
11. Common Stock Split and Dividend Action
On November 9, 1998, the Board of Directors of K N Energy, Inc.
approved a 7.1 percent increase in the quarterly dividend and a
three-for-two split of the Company's common stock. The quarterly
dividend was declared at $0.30 per common share, up from $0.28
per common share. Giving effect to the stock split,
the quarterly dividend will be $0.20 per common share. The stock
split will be distributed and the increase in dividend will be
paid concurrently on December 31, 1998 to shareholders of record
at the close of business on December 15, 1998.
<PAGE> 15
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 sale 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 third quarter of 1998 was $24.5
million, a $6.7 million (37.6%) increase from 1997 third-quarter
net income of $17.8 million. After deduction for preferred
dividends, diluted earnings per common share was $0.54 and $0.56
in the third quarter of 1998 and 1997, respectively, based on
respective weighted average common shares outstanding of 45.3
million and 31.7 million. The increased number of common shares
outstanding in the third quarter of 1998 was principally due to
the 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 third quarter of 1998
included a pre-tax gain of $10.9 million ($6.9 million or $0.15
per diluted common share after tax) from the sale of certain
microwave towers (see Note 2 to the accompanying interim
Consolidated Financial Statements).
Consolidated net income for the nine months ended September 30,
1998 was $63.7 million, a $14.7 million (30.0%) increase from net
income of $49.0 million in the corresponding period of 1997.
After deduction for preferred dividends, diluted earnings per
common share was $1.50 and $1.55 for the nine months ended
September 30, 1998 and 1997, respectively, based on respective
weighted average common shares outstanding of 42.2 million and
31.4 million. The increased number of common shares outstanding
during 1998 was principally due to the March 1998 public sale of
common shares as previously described. Results for the nine
months ended September 30, 1998 included (i) a pre-tax gain of
approximately $8.5 million (approximately $5.4 million or $0.13
per diluted common share after tax) from the sale of K N's Kansas
natural gas distribution properties, (ii) a pre-tax gain of $10.9
million ($6.9 million or $0.16 per diluted common share after
tax) from the sale of certain microwave towers and (iii) a pre-
tax charge of approximately $5.8 million ($3.6 million or $0.09
per diluted common 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> 16
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 "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, regulated natural gas distribution and
electric power generation and sales (effective with the third-
quarter 1998 inclusion of transactions and balances related to
the Thermo acquisition - see Note 2 to the accompanying interim
Consolidated Financial Statements). 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, and exclude the previously described costs
attributable to the acquisition and integration of MidCon.
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months Ended September 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 $ 55.4 $ 35.8 $ 19.6 $ 154.5 $ 110.7 $ 43.8
Natural Gas Liquids Sales 67.3 67.7 (0.4) 193.0 202.5 (9.5)
Gathering, Transportation and Other 34.0 33.5 0.5 99.6 84.2 15.4
------- ------- ------- -------- ------- -------
156.7 137.0 19.7 447.1 397.4 49.7
------- ------- ------- -------- ------- -------
Operating Costs and Expenses
Gas Purchases and Other Costs of Sales 120.6 93.7 26.9 337.5 275.5 62.0
Operations and Maintenance 29.8 20.1 9.7 92.4 59.0 33.4
Depreciation and Amortization 7.0 3.3 3.7 19.9 12.1 7.8
Taxes, Other Than Income Taxes 3.2 2.5 0.7 9.3 7.1 2.2
------- ------- ------- -------- ------- -------
160.6 119.6 41.0 459.1 353.7 105.4
------- ------- ------- -------- ------- -------
Operating Income (Loss) $ (3.9) $ 17.4 $ (21.3) $ (12.0) $ 43.7 $ (55.7)
======= ======= ======= ======== ======= =======
Systems Throughput (Trillion Btus)
Gas Sales 30.3 19.4 10.9 79.8 53.2 26.6
Gathering and Transportation 90.1 79.9 10.2 262.8 214.8 48.0
------- ------- ------- -------- ------- -------
120.4 99.3 21.1 342.6 268.0 74.6
======= ======= ======= ======== ======= =======
Natural Gas Liquids Sales
(Million Gallons)
Company-Owned and Processed 228.2 153.1 75.1 592.0 457.9 134.1
Third-Party Marketed 26.5 29.3 (2.8) 80.8 67.7 13.1
------- ------- ------- -------- ------- -------
254.7 182.4 72.3 672.8 525.6 147.2
======= ======= ======= ======== ======= =======
</TABLE>
Upstream operating results decreased from income of $17.4 million
in the third quarter of 1997 to a loss of $3.9 million in the
third quarter of 1998. This net decrease reflected a $5.6
million positive contribution from 1998 operating results of
assets which were not included in the third quarter of 1997,
including assets acquired in connection with the MidCon, Red
Cedar and Interenergy acquisitions (see Note 2 to the
accompanying interim Consolidated Financial Statements), which
positive impact was more than offset by approximately
<PAGE> 17
Form 10-Q
$26.9 million of negative variance associated with assets owned
and operated during both periods. Approximately one half of this
negative variance was attributable to the recent weakness in NGLs
prices, coupled with the relative strength of gas prices, which
has significantly reduced the margins on K N's keep-whole
contracts. In those instances where natural gas is processed
under such contracts, both of these price variances negatively
affect margins due to the increased cost of natural gas for fuel
and shrinkage and the decreased sales proceeds from extracted
NGLs. In addition, weak NGLs prices overall have hurt Upstream's
margins. The remaining negative variance was principally due to
(i) reduced 1998 pipeline basis differentials, which negatively
affected the operating results from certain joint venture gas
marketing activities, (ii) decreased 1998 processed volumes at
certain facilities due to natural production declines behind the
plants and operational problems, (iii) reduced 1998 revenues from
the sale of NGLs marketing rights and processing agreements at
the Bushton facility and (iv) increased 1998 operating expenses
due, in part, to pressure reduction programs in the Hugoton Basin
directed toward realizing incremental wellhead production and the
early 1998 plant expansion at the Company's Douglas processing
facility.
Upstream operating results decreased from income of $43.7 million
in the nine months ended September 30, 1997 to a loss of $12.0
million in the corresponding period of 1998. This net decrease
of $55.7 million included an $11.1 million positive contribution
from the 1998 operating results of assets which were not included
in 1997 operating results, including assets acquired with MidCon,
Red Cedar and Interenergy. This positive impact was more than
offset by approximately $66.8 million of negative variance
associated with assets owned and operated during both periods.
Approximately sixty percent of this negative variance was
attributable to increased natural gas prices and decreased NGLs
prices during 1998. The remaining negative variance was
principally due to (i) 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 pipeline basis
differentials which reduced the operating results from certain
joint venture gas marketing activities, (iv) lower than expected
1998 NGLs recoveries at certain facilities reflecting a failure
of vendor-installed compression to meet specifications, (v)
reduced 1998 revenues from the sale of NGLs marketing rights and
processing agreements at the Bushton facility and (vi) increased
1998 operating expenses due, in part, to pressure reduction
programs in the Hugoton Basin and 1998 plant expansion at the
Company's Douglas processing facility as described preceding.
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months Ended September 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 $ 173.9 $ 30.9 $ 143.0 $ 472.5 $ 95.8 $ 376.7
Other 240.8 15.5 225.3 607.4 71.0 536.4
-------- -------- --------- -------- -------- ---------
414.7 46.4 368.3 1,079.9 166.8 913.1
-------- -------- --------- -------- -------- ---------
Operating Costs and Expenses
Gas Purchases and Other Costs of Sales 219.4 12.9 206.5 537.0 64.0 473.0
Operations and Maintenance 52.1 13.2 38.9 146.9 43.7 103.2
Depreciation and Amortization 41.8 6.7 35.1 111.3 19.9 91.4
Taxes, Other Than Income Taxes 9.4 1.9 7.5 25.5 6.5 19.0
-------- -------- --------- -------- -------- ---------
322.7 34.7 288.0 820.7 134.1 686.6
-------- -------- --------- -------- -------- ---------
Operating Income $ 92.0 $ 11.7 $ 80.3 $ 259.2 $ 32.7 $ 226.5
======== ======== ========= ======== ======== =========
Systems Throughput (Trillion Btus) 612.0 110.7 501.3 1,699.5 368.9 1,330.6
======== ======== ========= ======== ======== =========
</TABLE>
<PAGE> 18
Form 10-Q
Midstream operating income increased from $11.7 million in the
third quarter of 1997 to $92.0 million in the third quarter of
1998. This increase in operating income, as well as the
significant increases in operating revenues, operating expenses
and volumes shown in the preceding table, was attributable to the
inclusion, in the third quarter of 1998, of the operating results
of (i) the interstate and intrastate pipeline operations of
assets acquired with MidCon (see Note 2 to the accompanying
interim Consolidated Financial Statements) and (ii) the Pony
Express Pipeline, which began limited service in August 1997.
These incremental operations were responsible for virtually all
of the quarter-to-quarter positive variance.
Midstream operating income increased from $32.7 million in the
nine months ended September 30, 1997 to $259.2 million in the
corresponding period of 1998. This increase in operating income,
as well as the significant increases in operating revenues,
operating expenses and volumes shown in the preceding table, was
principally attributable to the inclusion, in 1998, of the
operating results of (i) the interstate and intrastate pipeline
operations of assets acquired with MidCon (see Note 2 to the
accompanying interim Consolidated Financial Statements) and (ii)
the Pony Express Pipeline, which began limited service in August
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
relatively small negative variance. This net negative variance
was principally due to (i) reduced 1998 margins on Texas
intrastate pipeline operations due to LDC unbundling and warmer
than normal weather (principally in the first quarter of 1998)
and (ii) reduced equity earnings in joint ventures, which
negative impacts were partially offset by increased 1998 earnings
from K N's other intrastate and interstate pipeline businesses.
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months Ended September 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 $608.0 $335.7 $ 272.3 $2,035.2 $ 932.0 $1,103.2
Transportation and Other 47.5 56.2 (8.7) 73.4 94.8 (21.4)
------ ------ ------- -------- -------- --------
655.5 391.9 263.6 2,108.6 1,026.8 1,081.8
------ ------ ------- -------- -------- --------
Operating Costs and Expenses
Gas Purchases and Other Costs of Sales 626.6 367.5 259.1 2,019.5 945.9 1,073.6
Operations and Maintenance 18.1 13.9 4.2 51.8 44.2 7.6
Depreciation and Amortization 4.2 3.1 1.1 11.0 9.1 1.9
Taxes, Other Than Income Taxes 1.8 1.8 - 4.9 4.5 0.4
------ ------ ------- -------- -------- --------
650.7 386.3 264.4 2,087.2 1,003.7 1,083.5
------ ------ ------- -------- -------- --------
Operating Income $ 4.8 $ 5.6 $ (0.8) $ 21.4 $ 23.1 $ (1.7)
====== ====== ======= ======== ======== ========
Systems Throughput (Trillion Btus)
Gas Sales 321.8 137.0 184.8 934.1 360.1 574.0
Transportation 8.0 6.2 1.8 16.2 15.1 1.1
------ ------ ------ -------- -------- --------
329.8 143.2 186.6 950.3 375.2 575.1
====== ====== ====== ======== ======== ========
</TABLE>
Downstream operating income decreased from $5.6 million in the
third quarter of 1997 to $4.8 million in the third quarter of
1998. Third-quarter 1998 operating income included $2.8 million
of income from K N Power, Thermo, K N Telecommunications and K N's
interest in the Hermosillo, Mexico natural gas distribution
system (a joint venture between a subsidiary of K N International
and Grupo Marhnos), new assets and businesses not included in
1997 results. Also, third-quarter 1998 equity in earnings from
en*able improved by $0.7 million compared to the same period in
1997. Additionally, third-quarter 1997 results included
approximately $4.0 million of power marketing losses. However,
these favorable variances were more than offset by a decrease of
$9.1 million in operating income from commodity marketing, which
reflected reduced 1998 sales of gas
<PAGE> 19
Form 10-Q
in storage and depressed 1998 basis differentials, primarily on
pipelines on which the Downstream segment holds firm capacity.
Downstream operating income decreased from $23.1 million in the
nine months ended September 30, 1997 to $21.4 million in the nine
months ended September 30, 1998. Operating income for the nine
months ended September 30, 1998 included $2.8 million of income
from certain new assets and businesses not included in 1997,
including K N Power, Thermo, K N Telecommunications and K N's
interest in the Hermosillo, Mexico natural gas distribution
system. Additionally, 1998 results were positively impacted, in
comparison to the same period for 1997, by (i) the fact that 1997
results included approximately $4.0 million of power marketing
losses and (ii) 1998 results included $3.9 million in refunds of
certain previously recorded gathering fees. However, these
favorable variances were more than offset by (i) a $4.3 million
decrease in operating income from regulated and non-regulated
retail and equity in earnings of en*able and (ii) a decrease of
$8.1 million in operating income from commodity marketing, which
reflected reduced 1998 sales of gas in storage, depressed 1998
basis differentials and milder weather.
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months ended September 30
----------------------------------- ----------------------------------
(dollars in millions)
<S> <C> <C> <C> <C> <C> <C>
Earnings Earnings
Increase Increase
Other Income and (Deductions) 1998 1997 (Decrease) 1998 1997 (Decrease)
---- ---- ---------- ---- ---- ----------
Interest Expense, Net $(64.5) $ (10.8) $ (53.7) $(178.3) $ (31.0) $ (147.3)
Minority Interests (4.4) (2.7) (1.7) (11.4) (5.7) (5.7)
Other, Net 14.9 5.5 9.4 28.0 11.7 16.3
------ ------- -------- ------- ------- --------
$(54.0) $ (8.0) $ (46.0) $(161.7) $ (25.0) $ (136.7)
====== ======= ======== ======= ======= ========
</TABLE>
The increase of $53.7 million in "Interest Expense, Net" from the
third quarter of 1997 to the third quarter of 1998 is principally
due to the incremental debt associated with (i) the acquisition
of MidCon effective January 30, 1998 (see Note 2 to the
accompanying interim Consolidated Financial Statements) and (ii)
the construction cost of the Pony Express Pipeline, which began
limited service in August 1997. The increase in "Minority
Interests" during the third quarter of 1998 in comparison to the
corresponding period of 1997 is principally due to the dividend
requirement associated with the $175 million of Capital Trust
Securities issued in April 1998. The increase in "Other, Net"
during the third quarter of 1998, in comparison to the
corresponding period of 1997, is principally due to the third-
quarter 1998 gain of $10.9 million from the sale of certain
microwave towers (see Note 2 to the accompanying interim
Consolidated Financial Statements).
The increase of $147.3 million in "Interest Expense, Net" from
the nine months ended September 30, 1997 to the nine months ended
September 30, 1998 is principally due to incremental debt
associated with 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 nine months ended September 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, and to the $100 million
issuance of similar securities in April 1997. The increase of
$16.3 million in "Other, Net" from the first nine months of 1997
to the first nine 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 and the third-quarter 1998
gain of $10.9 million from the sale of certain microwave towers
(see Note 2 to the accompanying interim Consolidated Financial
Statements).
<PAGE> 20
Form 10-Q
<TABLE>
<CAPTION>
Three Months Ended September 30 Nine Months Ended September 30
--------------------------------- ---------------------------------
(dollars in millions)
<S> <C> <C> <C> <C> <C> <C>
Increase Increase
Income Taxes 1998 1997 (Decrease) 1998 1997 (Decrease)
---- ---- ---------- ---- ---- ----------
Provision $ 14.4 $ 8.8 $ 5.6 $ 37.4 $ 25.5 $ 11.9
====== ====== ====== ====== ====== ======
Effective Tax Rate 37.0% 33.1% 3.9% 37.0% 34.2% 2.8%
====== ====== ====== ====== ====== ======
</TABLE>
Of the $5.6 million increase in income tax expense from the third
quarter of 1997 to the third quarter of 1998, approximately $4.0
million (71.4%) was attributable to an increase in 1998 pre-tax
income and the balance of approximately $1.6 million (28.6%) was
attributable to an increase in the third quarter 1998 effective
tax rate, principally due to certain 1997 adjustments as
described following.
Of the $11.9 million increase in income tax expense from the nine
months ended September 30, 1997 to the nine months ended
September 30, 1998 approximately $9.1 million (76.5%) was
attributable to an increase in 1998 pre-tax income and the
balance of approximately $2.8 million (23.5%) was attributable to
an increase in the effective tax rate in the first nine months of
1998, principally due to adjustments included in 1997 tax expense
related to the successful resolution of certain issues from prior
years' income tax filings, which lowered last year's effective
tax rate.
Liquidity and Capital Resources
The following table illustrates the sources of the Company's
invested capital for the last three years and at September 30,
1998 and 1997. The balances at September 30, 1998 reflect the
incremental capital associated with the acquisition of MidCon,
including the post-acquisition refinancings completed in 1998
(see Notes 2 and 5 to the accompanying interim Consolidated
Financial Statements).
<TABLE>
<CAPTION>
September 30 December 31
----------------------- ---------------------------------------
(dollars in thousands)
1998 1997 1997 1996 1995
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Long-Term Debt $2,905,688 $ 410,498 $ 553,816 $ 423,676 $ 315,564
Common Equity 1,263,544 566,158 606,132 519,794 426,760
Preferred Stock 7,000 7,000 7,000 7,000 7,572
Capital Trust Securities 275,000 100,000 100,000 - -
---------- ---------- ---------- --------- ----------
Capitalization 4,451,232 1,083,656 1,266,948 950,470 749,896
Short-Term Debt 2,167,297(1) 304,055 359,951 156,271 116,197
----------- ---------- ---------- ---------- ----------
Invested Capital $6,618,529 $1,387,711 $1,626,899 $1,106,741 $ 866,093
========== ========== ========== ========== ==========
Capitalization:
Long-Term Debt 65.2% 37.9% 43.7% 44.6% 42.1%
Common Equity 28.4% 52.2% 47.8% 54.7% 56.9%
Preferred Stock 0.2% 0.7% 0.6% 0.7% 1.0%
Capital Trust Securities 6.2% 9.2% 7.9% - -
Invested Capital:
Total Debt(2) 76.6% 51.5% 56.2% 52.4% 49.9%
Equity, Including Capital
Trust Securities 23.4% 48.5% 43.8% 47.6% 50.1%
- -----------------------------------------------------------------------------------------------
</TABLE>
(1) Includes the $1,394,846 Substitute Note assumed in
conjunction with the acquisition of MidCon.
(2) If the government securities held as collateral are offset
against the related debt, the ratio of total debt to invested
capital at September 30, 1998 is 72.8%.
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.
<PAGE> 21
Form 10-Q
Net Cash Flows from Operating Activities
"Net Cash Flows From Operating Activities" decreased from
approximately $102.6 million in the first nine months of 1997 to
approximately $3.1 million in the first nine months of 1998, a
decrease of approximately $99.5 million. This decrease was
principally attributable to the net impact of (i) cash used to
increase miscellaneous net working capital by approximately $60.5
million in 1998, (ii) the increase in earnings before non-cash
charges and credits for the nine months ended September 30, 1998,
largely due to the inclusion of the results of operations of
MidCon for eight months (see Note 2 to the accompanying interim
Consolidated Financial Statements), (iii) cash used to increase
gas in underground storage and (iv) the receipt of $27.5 million
in settlement of a gas contract during the first nine months of
1998.
Net Cash Flows from Investing Activities
"Net Cash Flows Used in Investing Activities" increased from
approximately $317.1 million in the first nine months of 1997 to
approximately $3.5 billion in the first nine months 1998, an
increase of approximately $3.2 billion principally due to (i) the
$2.2 billion of net cash paid in the first nine months of 1998
and (ii) the net purchases 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.
In addition, cash outflows for acquisitions other than MidCon
were approximately $88 million less in 1998 than in 1997 and 1998
cash flows reflect the largely offsetting impacts of proceeds
from assets sales and the purchase of collateral associated with
the Thermo acquisition. For additional information on these
transactions, see Note 2 of the accompanying interim Consolidated
Financial Statements.
Net Cash Flows from Financing Activities
"Net Cash Flows From Financing Activities" increased from
approximately $223.0 million in the first nine months of 1997 to
approximately $3.5 billion in the first nine months of 1998, an
increase of approximately $3.3 billion. This increase reflected
the 1998 receipt of (i) approximately $2.35 billion from the
public sale of debt securities, (ii) approximately $650 million
from the public sale of common stock and (iii) approximately $175
million from 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 $52.1 million (see Notes 2 and 5 to the
accompanying interim Consolidated Financial Statements). In
addition, the Company has increased it's short-term borrowings
under its bank facility (see Note 8(A) of Notes to Consolidated
Financial Statements included in K N's 1997 Annual Report on Form
10-K). Proceeds from the bank facility have been used principally
to fund increases in working capital requirements, including
increased gas in underground storage.
The Company's principal source of short-term liquidity is its
bank facility (see Note 8(A) of Notes to Consolidated Financial
Statements included in K N's 1997 Annual Report on Form 10-K)
which makes available a total working capital line of $1 billion.
At September 30, 1998, the Company had $100 million outstanding
under this facility, plus an additional $655.5 million of
commercial paper issued and outstanding (which is backed by the
working capital line).
K N currently is in the process of offering to the public $375
million of 3-year senior notes ("the Senior Notes") and,
concurrently, premium equity participating security units - PEPS
Units ("PEPS Units"). The expected cash proceeds of
approximately $375 million from the sale of the PEPS Units will
be used to purchase treasury securities ("the Collateral"). The
Collateral will be pledged to the Company to secure the
obligation of the PEPS Units holders to purchase K N common stock
at the end of a three-year period coinciding with the maturity of
the Senior Notes. K N expects to receive initial net cash
proceeds from the Senior Notes offering of approximately $360.9
million, after deduction for underwriting fees and offering
expenses for both offerings. Such net proceeds are expected to
be used to repay a portion of currently outstanding short-term
borrowings.
<PAGE> 22
Form 10-Q
In the ordinary course of business, K N currently is in the process
of establishing a credit facility to replace the $600 million,
364-day revolving credit facility expiring January 30, 1999. While
the ultimate size of the replacement facility may be affected by the
proceeds received from the public offerings now in process (as
described preceding), the Company believes that it will continue
to have sources of liquidity sufficient to meet its near-term
liquidity requirements.
Common Stock Split and Dividend Action
On November 9, 1998, the Board of Directors of K N Energy, Inc.
approved a 7.1 percent increase in the quarterly dividend and a
three-for-two split of the Company's common stock. The regular
quarterly dividend was declared at $0.30 per common share, up
from $0.28 per common share. Giving effect to the stock split,
K N's regular quarterly dividend will be $0.20 per common share.
The stock split will be distributed and the increase in dividend
will be paid concurrently on December 31, 1998 to shareholders of
record at the close of business on December 15, 1998.
Readiness for Year 2000
The SEC recently issued specific guidelines for public companies
regarding their disclosure of the Year 2000 problem. The
guidelines require a lengthy and more detailed disclosure of each
company's analysis of and approach to the Year 2000 problem.
Most current computer codes and programs store the Year 2000 as
"00". This year value can result in inaccurate date-related
calculations. It is expected that once the Year 2000 arrives,
computer programs that have not been modified to correct this
problem will not function normally. The Company relies on a
number of automated systems to conduct its operations and to
transact its business, as is common among large diversified
energy companies. In addition, certain of the Company's
pipelines and processing equipment and related systems contain
electric controls containing embedded chips. These controls may
also be affected by this problem.
The Company is currently evaluating the extent of the Year 2000
problem in its business and has developed a plan to address each
area of concern. Each of the Company's operating units is in
various stages of implementing the plan to deal with this issue,
which includes:
* an assessment of potential problems;
* an inventory of systems and areas which may need to be
corrected;
* remediation and implementation, as necessary;
the testing of such systems; and
* developing contingency plans in case the Company can not
correct the problem in time.
Specifically, the Company is in the process of correcting
programmable code, replacing non-Year 2000-ready embedded chips,
installing Year 2000-ready releases of certain vendor-supplied
computer systems and, in some cases, replacing existing systems
with new internally or externally developed software in advance
of December 31, 1999.
<PAGE> 23
Form 10-Q
The Company has completed an inventory of affected items in the
non-Information Technology area and is assessing the results.
The Company has begun testing and currently has found very few impacted
items. The Company expects testing and remediation to be
completed by mid-1999.
For the Company's plan to be successful, the Company must rely on
outside contractors. There is a risk that those contractors will
not complete their work prior to the Year 2000. The Company is
developing alternative ways to conduct its business if such
deadlines are not met. However, any alternative may involve
additional expense and may not be implemented in time to avoid
the Year 2000 problem. Ultimately, these alternatives may not be
successful.
The Company also relies on suppliers, business partners and other
third parties which may or may not be addressing their own
problems associated with the Year 2000 problem. The Company is
making inquiries of such third parties to determine what steps
they have taken to correct any Year 2000 problems they may have.
The Company has no control over their efforts, so the Company has
developed contingency plans in case these third parties do not
complete their efforts before the Year 2000. The Company does not
believe that the direct costs associated with the Year 2000
problem will be material to its business, financial condition or
results of operations.
The SEC guidelines also require the Company to address the most
reasonably likely worst case scenarios resulting from the Year
2000 problem. As a result of the Year 2000 problem, the Company
may lose electricity to its facilities, lose its
telecommunications connection or face interruptions to the
nation's transportation systems. In addition, the Company's key
suppliers may experience their own Year 2000 problems in a way
that materially adversely affects the Company's ability to do
business without interruption or disruption. As a result of the
cumulative impact of these events, the Company's business may be
adversely affected. The adverse impact of these events occurring
can not be quantified at this time. The Company is in the
process of developing contingency plans to address issues
associated with the reasonably likely worst case scenarios. The
Company expects to have such contingency plans formulated by the
end of June 1999.
<PAGE> 24
Form 10-Q
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On July 26, 1996, K N and Rocky Mountain Natural Gas Company,
along with over 70 other natural gas companies, were served by
Jack J. Grynberg, acting on behalf of the Government of the
United States, with a Civil False Claims Act lawsuit alleging
mismeasurement of the heating content and volume of natural gas
resulting in underpayment of royalties to the federal government.
K N and the other named companies filed a motion to dismiss the
lawsuit on grounds of improper joinder and lack of jurisdiction.
The motion was granted in 1997, but the court gave Mr. Grynberg
leave to refile this action in a court with proper jurisdiction.
Mr. Grynberg appealed the dismissal of the action based on
improper joinder, and the D.C. Court of Appeals affirmed the
joinder decision in October 1998. Mr. Grynberg has filed a new
case, modified somewhat from his original action, in Federal
District Court, District of Colorado. K N has not yet been
served in this new action, which is under seal pending federal
governmental reviews of the merits. The Department of Justice
has not yet made a decision regarding whether to intervene in
this new case. The Company has engaged in both formal and
informal discussions with the Government regarding this case.
The Company believes it has a meritorious position in this
matter, and does not expect this lawsuit to have a material
adverse effect on the Company's financial condition or results of
operations. (United States of America ex rel. Jack J. Grynberg
v. KN Energy, Inc. et al. (Qui Tam), Case No. 97-D-1233, United
States District Court, District of Colorado).
Item 6. Exhibits
(A) Exhibits
27 - Financial Data Schedule
<PAGE> 25
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)
November 12, 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)
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 25,081
<SECURITIES> 1,088,601
<RECEIVABLES> 625,270
<ALLOWANCES> 0
<INVENTORY> 202,651
<CURRENT-ASSETS> 2,168,747
<PP&E> 7,732,136
<DEPRECIATION> 679,906
<TOTAL-ASSETS> 9,688,521
<CURRENT-LIABILITIES> 3,055,513
<BONDS> 2,905,688
0
7,000
<COMMON> 225,168
<OTHER-SE> 1,038,376
<TOTAL-LIABILITY-AND-EQUITY> 9,688,521
<SALES> 3,251,292
<TOTAL-REVENUES> 3,251,292
<CGS> 2,518,202
<TOTAL-COSTS> 2,988,524
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 178,340
<INCOME-PRETAX> 101,070
<INCOME-TAX> 37,398
<INCOME-CONTINUING> 63,672
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 63,672
<EPS-PRIMARY> 1.52
<EPS-DILUTED> 1.50
</TABLE>