<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 8-K
Current Report
Pursuant to section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of earliest event reported: April 23, 1998
SONAT INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
Delaware 1-7179 63-0647939
(State of (Commission (IRS Employer
Incorporation) File Number) Identification No.)
</TABLE>
AmSouth-Sonat Tower
Birmingham, Alabama 35203
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code:
205-325-3800
<PAGE> 2
Item 5. Other Events
Sonat Exploration Company Restructuring
On April 23, 1998, Sonat Inc. announced its results of operations for
the first quarter of 1998 and a major restructuring of its wholly owned Sonat
Exploration Company. A copy of the press release, including first quarter
results, is filed as an exhibit to this report.
The restructuring of Sonat Exploration involves property divestitures,
a reduction in the number of business units and substantial cost reduction
activities. The purpose of the program is to significantly improve Sonat
Exploration's ability to earn returns in excess of its cost of capital.
Oil and natural gas properties having approximately 487 billion cubic
feet of proven natural gas equivalent reserves and daily production of
approximately 200 million cubic feet of natural gas equivalent will be sold.
These volumes represent approximately 19 percent of the company's total proven
oil and natural gas reserves and 24 percent of its current daily production.
The divestiture will include all of the company's Austin Chalk, Arkoma,
Basin properties and substantially all onshore Gulf Coast properties as well as
various properties from other business units. No significant properties acquired
in the Zilkha Energy Company merger or in the Cotton Valley Pinnacle Reef Trend
are included in the divestiture program. Although the exact timing of the
property sales will depend on market conditions, it is expected that the
divestiture program will be substantially completed by the end of the third
quarter of 1998 with the proceeds used to reduce debt.
Sonat Exploration will consolidate its business units from seven to
three. This action, together with related staff reductions, will reduce its
workforce by approximately 220 people, or approximately one-quarter of the Sonat
Exploration workforce, including those currently employed by Sonat Exploration
GOM Inc., the former Zilkha Energy Company. John B. Holmes, who is currently
president and chief executive officer of Sonat Exploration GOM Inc., will become
president and chief executive officer of Sonat Exploration upon the retirement
of Sonat Exploration's Chairman and Chief Executive Officer Donald G. Russell on
April 30, 1998. Mr. Russell will also retire from the Sonat Inc. Board of
Directors effective that date.
Based on a preliminary estimate of sales proceeds from the divestiture
program and the costs related to the restructuring, the company expects to take
an after-tax charge of approximately $250 million to $275 million in the second
quarter of 1998, substantially all of which will be non-cash.
<PAGE> 3
Supplemental Consolidated Financial Statements
Sonat Inc. also files in this Current Report its supplemental
consolidated financial statements for each of the three years in the period
ended December 31, 1997, which have been restated to reflect the merger with
Zilkha Energy Company. These supplemental financial statements include the
financial results of Zilkha Energy Company for the years indicated on a
"pooling-of-interests" basis. The merger with Zilkha Energy Company was
completed on January 30, 1998, and its name changed to Sonat Exploration Company
GOM Inc. These supplemental consolidated financial statements will become the
historical financial statements upon the Company's filing of its quarterly
report on Form 10-Q for the first quarter of 1998.
Cautionary Statement Concerning Forward-Looking Statements
This report includes certain forward-looking statements, which are
based on assumptions the Company believes are reasonable, but a variety of
factors could cause the Company's actual results and experience to differ
materially from the anticipated results or other expectations expressed in
management's forward-looking statements.
The costs and benefits of Sonat Exploration's restructuring program
have been estimated based on a number of assumptions, including estimates of
sales proceeds from its divestiture program, the timing of such sales, the
expenses associated with the reorganization and assumed oil and gas prices.
Actual results may differ from such assumptions and there can be no assurance
that the estimated costs and benefits will be incurred or realized as planned or
that the expected charge to earnings will be in the range estimated.
INDEX TO FINANCIAL STATEMENTS
1. Financial Statements
<TABLE>
Page
<S> <C>
Report of Ernst & Young LLP, Independent Auditors 3
Supplemental Consolidated Balance Sheets at
December 31, 1997 and 1996 4
Supplemental Consolidated Statements of Income
for the Years Ended December 31, 1997,
1996, and 1995 6
Supplemental Consolidated Statements of Changes in
Stockholders' Equity for the Years Ended
December 31, 1997, 1996, and 1995 7
Supplemental Consolidated Statements of Cash Flows
for the Years Ended December 31, 1997,
1996, and 1995 8
Notes to Supplemental Consolidated Financial Statements 9
</TABLE>
2
<PAGE> 4
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND STOCKHOLDERS
SONAT INC.
We have audited the supplemental consolidated balance sheets of Sonat Inc.
(formed as a result of the consolidation of Sonat Inc. and Zilkha Energy
Company) as of December 31, 1997 and 1996, and the related supplemental
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. The
supplemental consolidated financial statements give retroactive effect to the
merger of Sonat Inc. and Zilkha Energy Company on January 30, 1998, which has
been accounted for using the pooling of interests method as described in the
notes to the supplemental consolidated financial statements. These supplemental
financial statements are the responsibility of the management of Sonat Inc. Our
responsibility is to express an opinion on these supplemental financial
statements based on our audits. We did not audit the financial statements of
Zilkha Energy Company which statements reflect total assets constituting 5
percent for 1996 of the related supplemental consolidated financial statement
totals, and which reflect net income constituting approximately 11 percent of
the related supplemental consolidated financial statement totals for the two
year period ended December 31, 1996. Those statements were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it
relates to data included for Zilkha Energy Company, is based solely on the
report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
supplemental financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Sonat Inc. at December
31, 1997 and 1996, and the consolidated results of its operations and its cash
flows for each of the three years in the period ended December 31, 1997, after
giving retroactive effect to the merger of Zilkha Energy Company, as described
in the notes to the supplemental consolidated financial statements, in
conformity with generally accepted accounting principles.
Birmingham, Alabama
April 20, 1998
3
<PAGE> 5
SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS Sonat Inc. and Subsidiaries
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, 1997 1996
- --------------------------------------------------------------------------
(In Thousands)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents $ 27,278 $ 48,009
Restricted cash (Note 1) 115,956 --
Accounts receivable 619,581 611,800
Inventories (Note 4) 65,161 31,050
Gas imbalance receivables 16,644 21,694
Assets from price risk management activities
(Note 3) 92,150 --
Other 44,037 34,909
- --------------------------------------------------------------------------
Total Current Assets 980,807 747,462
- --------------------------------------------------------------------------
Investments and Advances:
Unconsolidated affiliates (Note 5) 491,681 414,560
Other investments (Note 3) 61,937 69,410
- --------------------------------------------------------------------------
553,618 483,970
- --------------------------------------------------------------------------
Plant, Property and Equipment, successful
efforts method of accounting used for
oil and gas properties (Notes 6 and 13) 6,079,239 5,436,924
Less Accumulated Depreciation, Depletion
and Amortization 3,096,541 2,828,315
- --------------------------------------------------------------------------
2,982,698 2,608,609
- --------------------------------------------------------------------------
Deferred Charges and Other:
Assets from price risk management activities
(Note 3) 27,686 --
Other 179,599 186,434
- --------------------------------------------------------------------------
207,285 186,434
- --------------------------------------------------------------------------
Total Assets $4,724,408 $4,026,475
==========================================================================
</TABLE>
See accompanying notes.
4
<PAGE> 6
SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS Sonat Inc. and Subsidiaries
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, 1997 1996
- --------------------------------------------------------------------------
(In Thousands)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Long-term debt due within one year (Note 7) $ 14,508 $ 57,707
Unsecured notes (Note 7) 446,721 158,030
Accounts payable 631,722 551,775
Accrued income taxes 18,274 26,726
Accrued interest 37,242 31,218
Accrued long-term compensation 73,799 4,306
Gas imbalance payables 14,320 20,680
Liabilities from price risk management
activities (Note 3) 103,446 --
Other 75,299 55,487
- --------------------------------------------------------------------------
Total Current Liabilities 1,415,331 905,929
- --------------------------------------------------------------------------
Long-Term Debt (Note 7) 1,237,734 980,755
- --------------------------------------------------------------------------
Deferred Credits and Other:
Deferred income taxes (Note 8) 298,681 284,351
Reserves for regulatory matters (Note 9) 4,432 14,644
Liabilities from price risk management
activities (Note 3) 5,014 --
Other 149,226 181,995
- --------------------------------------------------------------------------
457,353 480,990
- --------------------------------------------------------------------------
Commitments and Contingencies (Note 9)
Stockholders' Equity:
Common stock, $1.00 par; 400,000,000 shares
authorized, 111,385,858 and 111,390,953
shares issued in 1997 and 1996,
respectively (Note 10) 111,385 111,391
Other capital 56,401 60,662
Retained earnings 1,511,085 1,516,451
- --------------------------------------------------------------------------
1,678,871 1,688,504
Less treasury stock at cost, 1,438,793
and 830,908 shares in 1997 and 1996,
respectively (Note 10) 64,881 29,703
- --------------------------------------------------------------------------
Total Stockholders' Equity 1,613,990 1,658,801
- --------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $4,724,408 $4,026,475
==========================================================================
</TABLE>
See accompanying notes.
5
<PAGE> 7
SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS Sonat Inc. and Subsidiaries
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- -------------------------------------------------------------------------------------
(In Thousands, Except Per-Share Amounts)
<S> <C> <C> <C>
Revenues (Note 12) $ 4,371,902 $ 3,204,199 $ 1,902,630
- -------------------------------------------------------------------------------------
Costs and Expenses:
Natural gas cost 2,949,766 1,973,147 912,966
Electric power cost 224,294 65,699 88
Operating and maintenance 178,838 90,671 177,133
Exploration cost 157,775 86,343 54,326
General and administrative 235,508 182,417 157,698
Depreciation, depletion and
amortization 410,802 354,133 352,615
Taxes, other than income 43,800 47,447 41,244
- -------------------------------------------------------------------------------------
4,200,783 2,799,857 1,696,070
- -------------------------------------------------------------------------------------
Operating Income 171,119 404,342 206,560
- -------------------------------------------------------------------------------------
Other Income (Loss), Net:
Equity in earnings of
unconsolidated affiliates (Note 5) 43,020 34,211 46,258
Sale of stock of subsidiary (Note 2) -- -- 188,012
Minority interest (4,394) (4,907) (888)
Other income, net 10,296 6,543 (37,126)
- -------------------------------------------------------------------------------------
48,922 35,847 196,256
- -------------------------------------------------------------------------------------
Interest:
Interest income 4,908 4,874 7,080
Interest expense (109,547) (101,403) (112,211)
Interest capitalized 7,447 7,642 8,072
- -------------------------------------------------------------------------------------
(97,192) (88,887) (97,059)
- -------------------------------------------------------------------------------------
Income Before Income Taxes 122,849 351,302 305,757
Income Tax Expense (Note 8) 35,437 113,468 101,521
- -------------------------------------------------------------------------------------
Net Income $ 87,412 $ 237,834 $ 204,236
=====================================================================================
Earnings Per Share of Common Stock
(Note 10) $ .79 $ 2.15 $ 1.85
Earnings Per Share of Common Stock-
Assuming Dilution (Note 10) $ .78 $ 2.13 $ 1.84
=====================================================================================
Weighted Average Shares Outstanding 110,099 110,370 110,428
Weighted Average Shares Outstanding-
Assuming Dilution 111,669 111,722 111,261
=====================================================================================
</TABLE>
See accompanying notes.
6
<PAGE> 8
SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS Sonat Inc. and Subsidiaries
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------
Shares Amount Shares Amount Shares Amount
- ---------------------------------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C> <C> <C>
Common Stock, $1.00 Par; 400,000,000
Shares Authorized (Note 10):
Balance at beginning of year 111,391 $ 111,391 111,402 $ 111,402 111,410 $ 111,410
Canceled (6) (6) (11) (11) (8) (8)
- ---------------------------------------------------------------------------------------------------------------
Balance at end of year 111,385 111,385 111,391 111,391 111,402 111,402
- ---------------------------------------------------------------------------------------------------------------
Other Capital:
Balance at beginning of year 60,662 65,257 66,974
Benefit plans transactions and other (4,261) (4,595) (1,717)
- ---------------------------------------------------------------------------------------------------------------
Balance at end of year 56,401 60,662 65,257
- ---------------------------------------------------------------------------------------------------------------
Retained Earnings:
Balance at beginning of year 1,516,451 1,371,757 1,260,611
Net income 87,412 237,834 204,236
Cash dividends paid by Sonat at
$1.08 per share (92,778) (93,140) (93,090)
- ---------------------------------------------------------------------------------------------------------------
Balance at end of year 1,511,085 1,516,451 1,371,757
- ---------------------------------------------------------------------------------------------------------------
Treasury Stock, at cost:
Balance at beginning of year (831) (29,703) (1,077) (31,534) (871) (25,016)
Purchased (1,058) (53,176) (774) (30,914) (645) (19,230)
Issued 451 17,998 1,020 32,745 439 12,712
- ---------------------------------------------------------------------------------------------------------------
Balance at end of year (1,438) (64,881) (831) (29,703) (1,077) (31,534)
- ---------------------------------------------------------------------------------------------------------------
Total Stockholders' Equity 109,947 $ 1,613,990 110,560 $ 1,658,801 110,325 $ 1,516,882
===============================================================================================================
</TABLE>
See accompanying notes.
7
<PAGE> 9
SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS Sonat Inc. and Subsidiaries
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- ------------------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net income $ 87,412 $ 237,834 $ 204,236
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation, depletion and amortization 410,802 354,133 352,615
Exploration cost 157,775 86,343 54,326
Deferred income taxes 14,935 90,606 31,633
Equity in earnings of unconsolidated
affiliates, less distributions (31,914) (23,040) (34,265)
Gain on sale of stock of subsidiary and
net gain on disposal of assets (7,499) (68,514) (152,492)
Reserves for regulatory matters (10,212) (167,154) (1,545)
Gas supply realignment costs 7,514 187,929 (80,553)
Change in:
Accounts receivable (7,781) (261,932) (87,120)
Inventories (34,111) (7,002) 2,700
Accounts payable 79,947 226,370 78,846
Accrued interest and income taxes, net (2,248) 30,695 (29,083)
Accrued long-term compensation 57,493 5,541 (2,235)
Other current assets (4,256) (3,589) 4,178
Other current liabilities 13,452 6,534 (15,237)
Net change from price risk management activities (11,376) -- --
Net change in restricted cash (115,956) -- --
Other, net (3,688) (74,273) (24,392)
- ------------------------------------------------------------------------------------------------
Net cash provided by operating
activities 600,289 620,481 301,612
- ------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Plant, property and equipment additions (864,883) (654,268) (567,034)
Net proceeds from sale of subsidiary stock
and disposal of assets 49,842 149,367 600,810
Exploration cost, excluding lease write-offs (124,121) (70,687) (45,518)
Investments in unconsolidated affiliates
and other (47,127) (9,143) (9,331)
- ------------------------------------------------------------------------------------------------
Net cash used in investing activities (986,289) (584,731) (21,073)
- ------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Proceeds from issuance of
long-term debt 2,025,041 987,088 3,196,000
Payments of long-term debt (1,812,023) (862,877) (3,386,565)
Changes in short-term borrowings 288,691 (60,870) 18,900
- ------------------------------------------------------------------------------------------------
Net changes in debt 501,709 63,341 (171,665)
Dividends paid (92,778) (93,140) (93,090)
Treasury stock purchases (53,176) (30,914) (19,230)
Other 9,514 22,264 38,494
- ------------------------------------------------------------------------------------------------
Net cash provided by (used in)
financing activities 365,269 (38,449) (245,491)
- ------------------------------------------------------------------------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents (20,731) (2,699) 35,048
Cash and Cash Equivalents at Beginning
of Year 48,009 50,708 15,660
- ------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Year $ 27,278 $ 48,009 $ 50,708
================================================================================================
Supplemental Disclosures of Cash Flow Information
Cash Paid For:
Interest (net of amount capitalized) $ 99,426 $ 75,870 $ 91,300
Income taxes paid (refunds received), net 20,124 (4,914) 96,455
================================================================================================
</TABLE>
See accompanying notes.
8
<PAGE> 10
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
Sonat Inc. and Subsidiaries
1. BUSINESS DESCRIPTION AND SIGNIFICANT ACCOUNTING POLICIES
Business Description - The Consolidated Financial Statements of Sonat
Inc. (Sonat) and its subsidiaries (the Company) reflect operations in the
Exploration and Production, Natural Gas Transmission and Energy Services
segments. The Exploration and Production segment is engaged in exploration,
development and production of domestic oil and natural gas. The Natural Gas
Transmission segment is primarily engaged in the interstate transmission of
natural gas. The Energy Services segment is primarily engaged in the marketing
of natural gas and electric power. For further description of business segments,
see Note 12. For a description of financial instruments, credit risk and
contingencies, see Notes 3 and 9.
Principles of Consolidation - The Consolidated Financial Statements
have been restated and include the accounts of Sonat and its subsidiaries and
Sonat Exploration GOM Inc. (see Note 2). Intercompany transactions and accounts
have been eliminated in consolidation. The equity method of accounting is used
for investments in affiliates owned 50 percent or less.
The 1996 and 1995 periods have also been restated to reflect the
reclassification of natural gas sales, natural gas cost and transition cost
recovery to other revenues to conform with the 1997 presentation. Certain other
amounts in the 1996 and 1995 Consolidated Financial Statements and Notes have
been reclassified to conform with the 1997 presentation.
Use of Estimates in the Preparation of Financial Statements - In
preparing financial statements in conformity with generally accepted accounting
principles, management is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the financial statements and revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Cash Equivalents - Cash equivalents are typically money-market
investments in the form of repurchase agreements, certificates of deposit and
time deposits with maturities of three months or less at the time of purchase.
These investments are accounted for at cost.
Restricted Cash - As of December 31, 1997, the Company had $116.0
million of restricted cash. The restricted cash is held in trust by the issuing
bank, is restricted as to withdrawal and use, and is invested in cash
equivalents. The restricted cash usage is limited to the payment of certain
merger expenses (see Note 2).
Inventories - At December 31, 1997, inventories consist primarily of
materials and supplies and gas stored underground, which is carried at average
cost and does not exceed net realizable value.
Gas Imbalance Receivables and Payables - Gas imbalances represent the
difference between gas receipts from and gas deliveries to the Company's
transportation and storage customers. Gas imbalances arise when these customers
9
<PAGE> 11
1. BUSINESS DESCRIPTION AND SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
deliver more or less gas into the pipeline than they take out. Imbalances
incurred prior to implementation of Order No. 636 are settled through exchange
of gas. Imbalances incurred after implementation of Order No. 636 are settled
monthly.
Plant, Property and Equipment and Depreciation - Plant, property and
equipment is carried at cost. The Company provides for depreciation on a
composite or straight-line basis, except for oil and gas properties. (See Notes
6 and 13.)
Accounting for Regulated Operations - The regulated operations of the
Company are subject to the provisions of Statement of Financial Accounting
Standards (SFAS) No. 71, Accounting for the Effects of Certain Types of
Regulation. Accordingly, the Company records certain assets and liabilities that
result from the effects of the ratemaking process that would not be recorded
under generally accepted accounting principles for non-regulated entities. The
regulatory assets and regulatory liabilities of the Company are classified as
Deferred Charges and Other and Deferred Credits and Other, respectively, in the
Consolidated Balance Sheets.
Revenue Recognition - Revenue is recognized in the Exploration and
Production segment when deliveries of oil and natural gas are made. The
Company's Natural Gas Transmission segment recognizes revenue from natural gas
transportation in the period the service is provided. Reserves are provided on
revenues collected subject to refund when appropriate. Revenues are recognized
in the Energy Services segment in either the period a transaction is consummated
(for items in the mark-to-market portfolio) or in the period the physical
commodity is delivered.
Commodity Price-Risk Management Activities - Through May 1997, the
Company used derivative instruments (commodity futures contracts, options and
price swap agreements) solely to hedge its commodity price risk on natural gas,
crude oil and electricity. In June 1997, the Company also began using derivative
instruments as a market maker (trading activity) in natural gas.
Natural gas, crude oil and electricity futures contracts are traded on
the New York Mercantile Exchange (NYMEX). Natural gas contracts are for fixed
units of 10,000 MMBtu and are available for up to 36 months in the future. Crude
oil contracts are for fixed units of 1,000 barrels and are available for up to
34 months in the future. Electricity contracts are for 736 megawatt hours and
are available for up to 18 months in the future.
Price swap agreements call for one party to make monthly payments to
(or receive payments from) another party based upon the differential between a
fixed and a variable price (fixed-price swap) or two variable prices (basis
swap) for a notional volume specified by the contract.
Options can be exchange traded on the NYMEX or traded over the counter.
Exchange traded options give the owner the right, but not the obligation, to a
10
<PAGE> 12
1. BUSINESS DESCRIPTION AND SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
futures contract. Over-the-counter options give the owner the right, but not the
obligation, to buy or sell an underlying commodity at a given price. At December
31, 1997, the Company had only over-the-counter options.
Non-Trading Activities - Derivative positions taken specifically to
mitigate market price risk associated with significant physical transactions are
accounted for using hedge accounting provided they meet hedge accounting
criteria. Under hedge accounting, gains and losses from futures are deferred in
the Consolidated Balance Sheets in Other Deferred Credits and recognized in
earnings in conjunction with the earnings recognition of the underlying
physical. Each net payment/receipt due or owed under the swap agreement is
recognized in earnings during the period to which the payment/receipt relates,
and there is no recognition in the Consolidated Balance Sheets for changes in
the swap's fair value. Cash flows from hedging activities are recognized in the
same section of the Consolidated Statements of Cash Flows as the hedged
transaction.
The derivative instruments used to hedge commodity transactions have
historically had high correlation with commodity prices and are expected to
continue to do so. In the event that correlation falls below allowable levels,
the gains or losses associated with the hedging instruments are immediately
recognized to the extent that correlation is lost. In the fourth quarter of
1995, the Company recognized a pretax loss of $8.4 million due to the loss of
correlation of the NYMEX futures market for natural gas with the price of
natural gas in certain parts of the country.
Trading Activities - The Company's trading portfolio consists of short-
and long-term energy-related purchase and sale commitments (physical and
derivative). All of these investments and commitments are valued at market or
fair value and accounted for under mark-to-market accounting guidelines. The
fair value of these commitments are recorded under the headings of Assets and
Liabilities from Price Risk Management Activities in the Consolidated Balance
Sheets. The change in fair value of these commitments is recognized in income
currently and is recorded as revenue in the Consolidated Statements of Income.
Such fair values or market values are subject to change in the near term and
reflect the Company's best estimate of market prices considering various factors
including closing exchange and over-the-counter broker quotations, the terms of
the contract, credit considerations, time value and volatility factors
underlying the positions (see Note 3).
Environmental Expenditures - The Company provides for environmental
liabilities when environmental assessments and/or remediation are probable and
such costs to the Company can be reasonably estimated. Accruals for
environmental remediation liabilities are not material and have not been
discounted.
Stock-Based Compensation - The Company follows the provisions of
Accounting Principles Board Opinion (APB) No. 25 for its stock-based
compensation awards (see Note 10).
11
<PAGE> 13
1. BUSINESS DESCRIPTION AND SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
Issuance of Stock by Subsidiary - The Company follows an accounting
policy of income statement recognition for issuances of stock by a subsidiary.
(See Note 2.)
Capitalized Interest - The Company capitalizes interest costs
associated with non-producing leases and exploration and major development
projects until the related properties are evaluated and subject to depletion.
The Company also capitalizes interest costs on major projects during
construction. Interest is capitalized on borrowed funds and, where regulation by
the Federal Energy Regulatory Commission (FERC) exists, on internally generated
funds. The weighted average rate used by regulated subsidiaries is calculated in
accordance with FERC rules. Rates used by unregulated subsidiaries approximate
the average interest rate on related debt. Interest capitalized on internally
generated funds is included in other income, net.
Income Taxes - The Company follows a liability and asset approach in
accounting for income taxes. Deferred tax liabilities and assets are determined
using the tax rate for the period in which those amounts are expected to be paid
or received. (See Note 8.)
Earnings Per Share - In 1997, the Financial Accounting Standards Board
(FASB) issued SFAS No. 128, Earnings per Share. SFAS No. 128 replaced the
calculation of primary and fully diluted earnings per share with basic (earnings
per share of common stock) and diluted (earnings per share of common
stock-assuming dilution) earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. All earnings per share
amounts for all periods have been presented, and where appropriate, restated to
conform to the SFAS No. 128 requirements (see Note 10).
12
<PAGE> 14
2. CHANGES IN OPERATIONS
Business Combination - On January 30, 1998, following a special
shareholders' meeting, the Company completed the merger with Zilkha Energy
Company by exchanging approximately 24.2 million common shares for all of the
outstanding shares of Zilkha Energy. Zilkha Energy was a privately owned
exploration and production company. Immediately thereafter Zilkha Energy's name
was changed to Sonat Exploration GOM Inc. It operated in the shallow waters of
the Gulf of Mexico where it had accumulated the industry's largest net leasehold
position in the shallow-water area.
The merger constituted a tax-free reorganization and has been accounted
for as a pooling of interests under APB No. 16. Accordingly, all prior period
consolidated financial statements and notes have been restated to include Sonat
Exploration GOM as if it had always been a part of Sonat. These supplemental
consolidated financial statements will become the historical financial
statements upon the Company's filing of its quarterly report on Form 10-Q for
the first quarter of 1998.
There were no transactions between Sonat and Sonat Exploration GOM
prior to the combination. Certain reclassifications were made to the Sonat
Exploration GOM financial statements to conform to Sonat's presentation.
The following are the revenues and net income (loss) for the previously
separate companies and the combined amounts presented in these consolidated
financial statements.
<TABLE>
<CAPTION>
1997 1996 1995
- --------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Revenues
Sonat Inc. $ 4,174,624 $3,039,014 $1,754,341
Sonat Exploration GOM 197,278 165,185 148,289
- --------------------------------------------------------------------------------
Combined $ 4,371,902 $3,204,199 $1,902,630
================================================================================
Net Income (Loss)
Sonat Inc. $ 175,920 $ 201,189 $ 192,888
Sonat Exploration GOM (88,508) 36,645 11,348
- --------------------------------------------------------------------------------
Combined $ 87,412 $ 237,834 $ 204,236
================================================================================
</TABLE>
In connection with the merger, Sonat Exploration GOM recorded charges
of $71.6 million ($46.5 million after taxes) to operating expenses in 1997 for
direct and other merger-related costs pertaining to the merger transaction.
At December 31, 1997, Sonat Exploration GOM had accrued $73.8 million,
which represented compensation due to certain employees under deferred
compensation plans. The liability was estimated based on the fair market value
of Sonat Exploration GOM as of December 31, 1997. During the years ended
December 31, 1997, 1996, and 1995, $61.8 million, $12.0 million, and $8.5
million, respectively, was expensed related to the deferred compensation plans.
All debt of Sonat Exploration GOM was paid off in connection with the
merger.
13
<PAGE> 15
2. CHANGES IN OPERATIONS (Cont'd)
Other Acquisitions and Divestitures - During 1996, the Company disposed
of certain oil and gas properties resulting in a pretax gain of $65.1 million.
The gains from these transactions are included in operating income in the
Consolidated Statements of Income.
Sonat Marketing Company L.P. (Sonat Marketing) was formed in September
1995 and is jointly owned by the Company and a subsidiary of AGL Resources, Inc.
Sonat's wholly owned subsidiary, Sonat Marketing Company, contributed all of its
assets and liabilities except $32.0 million of accounts receivable in exchange
for a 65 percent ownership interest in Sonat Marketing and Atlanta Gas Light
Company, another subsidiary of AGL Resources, contributed $32.0 million in cash
to Sonat Marketing in exchange for a 35 percent ownership interest. AGL
Resources has certain rights to resell to the Company its interest in Sonat
Marketing, including a right until August 31, 2000, to receive the greater of
fair market value or a formula price. The pretax gain on the transaction of
approximately $23.4 million, which is included in Other Deferred Credits in the
Consolidated Balance Sheet, has been deferred.
In June 1995, the Company sold back to Baker Hughes Incorporated for
$167.0 million the four million shares of Baker Hughes convertible preferred
stock that the Company received as partial consideration for its sale of Teleco
Oilfield Services Inc. to Baker Hughes in 1992. The sale resulted in an
after-tax loss of $8.2 million.
In July 1995, the Company made a capital contribution of its remaining
shares of Sonat Offshore Drilling Inc.'s common stock to Sonat Exploration
Company. On July 26, 1995, Sonat Exploration sold in an underwritten public
offering these shares of Sonat Offshore common stock at $30.25 per share. The
net proceeds after underwriters' discounts and commissions were $326.0 million,
which resulted in a pretax gain of $188.0 million. The Company realized an
after-tax gain of $110.1 million on the transaction.
In April 1995, Sonat Power Marketing Inc. was formed to market electric
power. In the second quarter of 1996, AGL Resources acquired a 35 percent
ownership interest in Sonat Power Marketing L.P. (Sonat Power Marketing), to
which Sonat Power Marketing Inc. contributed all of its assets and liabilities.
The transaction resulted in a $.5 million pretax gain, which is included in
Other income, net in the Consolidated Statements of Income.
14
<PAGE> 16
3. FINANCIAL INSTRUMENTS
DERIVATIVE COMMODITY INSTRUMENTS HELD OR ISSUED FOR TRADING PURPOSES
The Company, through Sonat Marketing, began a trading operation in June
1997 that maintains active trading positions in natural gas futures, swap and
option contracts and limits its risk to changes in the value of its outstanding
positions through the use of Value-at-Risk models, establishment of offsetting
positions, and limit and monitoring procedures. The trading operation also
enters into natural gas purchase and sale commitments. These activities
constitute its trading business and are essential to provide customers with
market products at competitive prices. All of these trading positions are
reported at fair value and recorded under the heading of Assets and Liabilities
from Price Risk Management Activities (current and long-term) in the
Consolidated Balance Sheet. The change in fair value is recognized in revenues
as it occurs. Fair value is subject to change and reflects management's best
estimate of market prices considering various factors including closing exchange
and over-the-counter quotations, time value and volatility factors underlying
the commitments. These market prices are adjusted to reflect the potential
impact of liquidating Sonat Marketing's position in an orderly manner over a
reasonable period of time under present market conditions.
The amounts disclosed below represent the end of period fair value and
the average fair value (period commenced June 1, 1997) of the trading portfolio.
<TABLE>
<CAPTION>
Fair Value Average Fair Value
(Carrying Amount) for the Year
as of 12/31/97 Ended 12/31/97
- --------------------------------------------------------------------------
(In Thousands)
<S> <C> <C>
Natural Gas Trading:
Assets $119,836 $57,079
Liabilities 108,460 51,450
==========================================================================
</TABLE>
DERIVATIVE COMMODITY INSTRUMENTS HELD OR ISSUED FOR PURPOSES OTHER THAN TRADING
Sonat Exploration Company's production is hedged by entering into
intercompany swaps with Sonat Marketing. The exposure that Sonat Marketing
assumes from Sonat Exploration is then hedged by entering into derivative
instruments with outside counterparties. Sonat Marketing and Sonat Power
Marketing also hedge third party purchases and sales by entering into commodity
futures, swaps and options. Prior to the merger, Sonat Exploration GOM hedged
its commodity price risk through the use of options and swaps. The information
in the following table represents the consolidated derivative positions that
were open as of December 31, 1997 and 1996, and the fair value of those
positions. Not included are the related physical positions that these
derivative positions hedge.
15
<PAGE> 17
3. FINANCIAL INSTRUMENTS (Cont'd)
<TABLE>
<CAPTION>
Fair Value
Notional Volume As of December 31,
1997 1996 1997 1996
- -----------------------------------------------------------------------------------------
(TBtu) (In Thousands)
<S> <C> <C> <C> <C>
Natural Gas:
Futures 18.9 12.1 $ (873) $ (5,518)
Swaps 92.6 223.4 (27,458) (37,192)
Options 46.5 79.5 (516) (2,901)
Crude Oil:
Futures -- 12.9 -- (3,379)
Options 2.9 5.8 -- 6
- ----------------------------------------------------------------------------------------
</TABLE>
Deferred amounts on open futures positions will mature over 1998, 1999
and 2000.
CREDIT RISK FROM DERIVATIVE ACTIVITIES
NYMEX traded futures are guaranteed by the NYMEX and have nominal
credit risk. On all other transactions described above, the Company is exposed
to credit risk in the event of nonperformance by the counterparties. Due to
changes in market conditions, the value of swaps and options can change in
relation to their value to the Company. The energy services group has
established policies and procedures to evaluate potential counterparties for
creditworthiness before entering into over-the-counter swap and option
agreements. The credit risk resulting from in-the-money swaps is monitored on a
regular basis against established collateralization limits. At December 31,
1997, the market value of the Company's in-the-money swaps and options was $7.9
million, and all counterparties were within collateral limits. Reserves for
credit risk are established as necessary.
FINANCIAL RISK
On January 22, 1996, the Company entered into a forward rate agreement
to hedge the interest rate risk of an anticipated future borrowing under an
existing shelf registration statement. In September 1996, due to revised
expectations of external financing requirements, 50 percent of the forward rate
agreement was liquidated resulting in a gain of $3.9 million. A gain of $2.4
million was recognized upon final settlement of this agreement in 1997.
16
<PAGE> 18
3. FINANCIAL INSTRUMENTS (Cont'd)
OTHER FINANCIAL INSTRUMENTS
The carrying amounts and fair values of the Company's financial
instruments, other than derivative instruments, are as follows:
<TABLE>
<CAPTION>
December 31, 1997 Carrying Amounts Fair Value
- --------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C>
Cash and Cash Equivalents $ 27,278 $ 27,278
Restricted Cash 115,956 115,956
Investment in Debt and Equity Securities 52,231 53,101
Gas Supply Realignment Costs 3,630 3,630
Unsecured Notes 446,721 446,721
Long-Term Debt 1,252,242 1,294,854
<CAPTION>
December 31, 1997 Carrying Amounts Fair Value
- --------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C>
Cash and Cash Equivalents $ 48,009 $ 48,009
Investment in Debt and Equity Securities 58,869 60,148
Gas Supply Realignment Costs 11,144 11,144
Unsecured Notes 158,030 158,030
Long-Term Debt 1,038,462 1,075,526
</TABLE>
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for balance sheet financial instruments:
Cash and cash equivalents, restricted cash, gas supply realignment
(GSR) costs, and unsecured notes - The carrying amount reported in the
Consolidated Balance Sheets approximates its fair value.
Investment in debt and equity securities - The fair values for
marketable debt and equity securities are based on quoted market prices.
Long-term debt - The fair values of the Company's long-term debt are
based on quoted market values or estimated using discounted cash flow analyses,
based on the Company's current incremental borrowing rates for similar types of
borrowing arrangements.
All of the Company's financial instruments, other than certain
derivative instruments, are held for purposes other than trading.
The Company's financial instruments that are exposed to concentrations
of credit risk consist primarily of cash equivalents, restricted cash deposits,
investments, accounts receivable and GSR costs which the Company expects to
recover from its customers.
17
<PAGE> 19
3. FINANCIAL INSTRUMENTS (Cont'd)
The Company's cash equivalents, restricted cash deposits and short-term
investments represent securities placed with various high investment grade
institutions. This investment practice limits the Company's exposure to
concentrations of credit risk.
Accounts receivable of the Exploration and Production segment are
primarily from joint-interest partners, oil and gas marketing companies and
pipeline companies. A majority of its revenues are from Sonat Marketing, which
is headquartered in the Southeast. Accounts receivable of the Natural Gas
Transmission segment relate to business conducted with gas distribution
companies, municipalities, gas districts, industrial customers and interstate
pipeline companies in the Southeast. Accounts receivable of the Energy Services
segment relate to trading with other marketing companies, industrial end users
and local distribution companies, with primary concentration in the Gulf Coast,
Southeastern, Northeastern and Midwestern markets.
The Company performs ongoing credit evaluations of its customers'
financial condition and, in some circumstances, requires collateral from its
customers. Accounts receivable are stated net of valuation allowances of $8.2
million in 1997 and $9.7 million in 1996.
18
<PAGE> 20
4. INVENTORIES
The table below shows the values of various categories of the Company's
inventories by segment.
<TABLE>
<CAPTION>
December 31, 1997 1996
- -----------------------------------------------------------------
(In Thousands)
<S> <C> <C>
Exploration and Production:
Materials and supplies $16,954 $ 2,908
Natural Gas Transmission:
Materials and supplies 21,529 24,197
Energy Services:
Materials and supplies 247 --
Gas stored underground 26,418 3,938
Other 13 7
- -----------------------------------------------------------------
$65,161 $31,050
=================================================================
</TABLE>
19
<PAGE> 21
5. UNCONSOLIDATED AFFILIATES
At December 31, 1997, the Company's investments in unconsolidated
affiliates totaled $491.7 million, and the Company's share of underlying equity
in net assets of the investees was $551.7 million. The difference is primarily
due to the excess over cost of the Company's share of the underlying equity in
net assets of Citrus Corp., which is being amortized over the depreciable life
of Citrus' assets. Through December 31, 1997, the Company's cumulative equity in
earnings of these unconsolidated affiliates was $329.1 million and cumulative
dividends received from them totaled $175.5 million.
The following table presents the components of equity in earnings of
unconsolidated affiliates:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- -------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
COMPANY'S SHARE OF REPORTED EARNINGS (LOSSES)
Exploration and Production $ 445 $ 408 $ 615
- -------------------------------------------------------------------------------
Natural Gas Transmission:
Citrus Corp. (including $1,383,000 of
amortization of basis difference in
each year) 28,676 22,902 28,196
Bear Creek Storage 10,679 10,184 9,596
Other 1,170 (554) (239)
- -------------------------------------------------------------------------------
40,525 32,532 37,553
- -------------------------------------------------------------------------------
Energy Services 817 9 (5)
- -------------------------------------------------------------------------------
Other:
Sonat Offshore Drilling -- -- 6,734
Other 1,233 1,262 1,361
- -------------------------------------------------------------------------------
1,233 1,262 8,095
- -------------------------------------------------------------------------------
$43,020 $ 34,211 $ 46,258
===============================================================================
</TABLE>
20
<PAGE> 22
5. UNCONSOLIDATED AFFILIATES (Cont'd)
Natural Gas Transmission Affiliates - Sonat owns 50 percent of Citrus,
the parent company of Florida Gas Transmission Company. A subsidiary of Southern
owns 50 percent of Bear Creek Storage Company, an underground gas storage
company.
The following is summarized financial information for Citrus:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- -----------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Revenues $ 735,402 $769,335 $ 682,387
Expenses (Income):
Natural gas cost 416,953 428,842 362,635
Operating expenses 107,370 94,573 94,647
Depreciation and amortization 60,470 83,563 81,227
Allowance for funds used
during construction (599) 153 (42,804)
Interest and other 79,162 91,926 99,238
Income taxes 17,460 27,240 33,818
- -----------------------------------------------------------------------------
Income Reported $ 54,586 $ 43,038 $ 53,626
=============================================================================
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997 1996
- ------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C>
ASSETS
Current $ 80,737 $ 107,114
Net transmission plant and property 2,346,123 2,362,038
Other 67,671 84,900
- ------------------------------------------------------------------------------
$2,494,531 $2,554,052
==============================================================================
LIABILITIES AND EQUITY
Current $ 133,481 $ 211,228
Long-term debt and other liabilities 1,496,724 1,533,084
Stockholders' equity 864,326 809,740
- ------------------------------------------------------------------------------
$2,494,531 $2,554,052
==============================================================================
</TABLE>
21
<PAGE> 23
5. UNCONSOLIDATED AFFILIATES (Cont'd)
The following is summarized financial information for Bear Creek. No
provision for income taxes has been included since its income taxes are paid
directly by the joint-venture participants.
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- -----------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Revenues $ 36,226 $ 36,258 $ 36,167
Expenses:
Operating expenses 4,440 4,817 5,408
Depreciation 5,430 5,415 5,399
Other expenses, net 4,997 5,657 6,167
- -----------------------------------------------------------------------------
Income Reported $ 21,359 $ 20,369 $ 19,193
=============================================================================
</TABLE>
<TABLE>
<CAPTION>
December 31, 1997 1996
- ------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C>
ASSETS
Current $ 6,503 $ 7,205
Net plant and property 149,334 154,388
Other 296 338
- ------------------------------------------------------------------------------
$ 156,133 $ 161,931
==============================================================================
LIABILITIES AND EQUITY
Current $ 8,298 $ 8,525
Long-term debt and other liabilities 48,799 55,729
Participants' equity 99,036 97,677
- ------------------------------------------------------------------------------
$ 156,133 $ 161,931
==============================================================================
</TABLE>
In 1995 Southern executed a Capital Contribution Agreement in
connection with the project financing for Bear Creek from The Prudential
Insurance Company of America. In the event that Bear Creek does not refinance
the remaining principal, this agreement provides that Southern and its partner
will contribute $21.0 million each to Bear Creek on October 31, 2000, to provide
funds to enable Bear Creek to make a principal payment due under the financing.
22
<PAGE> 24
6. PLANT, PROPERTY AND EQUIPMENT AND DEPRECIATION
Plant, property and equipment, by business segment, is shown in the
following table:
<TABLE>
<CAPTION>
December 31, 1997 1996
- ------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C>
Exploration and Production $3,471,891 $2,932,381
Natural Gas Transmission 2,456,773 2,422,845
Energy Services 78,168 11,508
Other 72,407 70,190
- ------------------------------------------------------------------------------
$6,079,239 $5,436,924
==============================================================================
</TABLE>
Plant, property and equipment includes construction work in progress of
$137.1 million and $108.0 million at December 31, 1997 and 1996, respectively.
Plant, property and equipment also includes $130.1 million and $124.8 million of
gas stored underground at December 31, 1997 and 1996, respectively.
The accumulated depreciation, depletion and amortization amounts, by
business segment, are as follows:
<TABLE>
<CAPTION>
December 31, 1997 1996
- ------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C>
Exploration and Production $1,531,746 $1,252,912
Natural Gas Transmission 1,497,828 1,539,983
Energy Services 33,254 3,143
Other 33,713 32,277
- ------------------------------------------------------------------------------
$3,096,541 $2,828,315
==============================================================================
</TABLE>
The annual depreciation rates or useful productive lives, by business
segment, are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
=========================================================================
<S> <C> <C> <C>
Natural Gas Transmission:
Mainline transmission property 2.0% 2.0% 2.0%
Gas supply 2.9% 2.9% 2.9%
Gas gathering 2.8% 2.8% 2.8%
Underground storage facilities 3.3% 3.3% 3.3%
Liquefied natural gas facilities 3.2% 3.2% 3.2%
Other 2-30 yrs. 2-25 yrs. 3-20 yrs.
=========================================================================
</TABLE>
The successful efforts method of accounting used for oil and gas
properties in the Exploration and Production segment results in the cost of
proved oil and gas properties and development dry holes being capitalized and
amortized on a unit-of-production basis over the life of remaining proved
reserves. Also included in amortization on a unit-of-production basis are the
estimated future dismantlement and abandonment costs. The total estimated future
dismantlement
23
<PAGE> 25
6. PLANT, PROPERTY AND EQUIPMENT AND DEPRECIATION (Cont'd)
and abandonment costs being amortized as of December 31, 1997, was approximately
$60.1 million.
The Company recognized impairment expenses associated with certain oil
and gas properties of $52.3 million, $4.3 million and $23.0 million during the
years ended December 31, 1997, 1996 and 1995, respectively. The impairments are
included in depreciation, depletion and amortization expense in the Consolidated
Statements of Income and were based on fair value of expected future net cash
flows discounted at a market rate of interest.
24
<PAGE> 26
7. DEBT AND LINES OF CREDIT
Long-Term Debt - Long-term debt consists of:
<TABLE>
<CAPTION>
December 31, 1997 1996
- --------------------------------------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C>
Sonat Inc.
Revolving Credit Agreement at rates based on prime, international or
money-market lending rates (an effective rate of 6.14% and 5.76% at
December 31, 1997 and 1996, respectively)
expiring on June 30, 2001 $ 130,000 $ 155,000
6.75% Notes due October 1, 2007 100,000 --
6-7/8% Notes due June 1, 2005 200,000 200,000
9-1/2% Notes due August 15, 1999 100,000 100,000
8.65% Notes due through July 29, 1997 -- 9,286
9.41% Notes due July 29, 1997 -- 35,000
9% Notes due May 1, 2001 100,000 100,000
8.24% Senior Notes due through December 31, 2000 6,200 8,400
Sonat Exploration GOM Inc.
Senior Revolving Credit Facility (an
effective rate of 7.22% and 6.61% at
December 31, 1997 and 1996, respectively)
expiring on October 31, 1999 145,000 55,000
10.6% Senior Subordinated Notes due July 26, 2001 50,000 50,000
Southern Natural Gas Company
6.70% Notes due October 1, 2007 100,000 --
7.85% Notes due January 15, 2002 100,000 100,000
8-5/8% Notes due May 1, 2002 100,000 100,000
8-7/8% Notes due February 15, 2001 100,000 100,000
South Georgia Natural Gas Company
9.85% Term Loan due through December 31, 1997 -- 880
7.80% Term Loan due through December 31, 1997 -- 400
Southern LNG Inc.
Promissory Note (an effective rate of 6.53% and
6.75% at December 31, 1997 and 1996, respectively)
due through April 1, 1999 10,000 15,000
Capital Leases and Other 11,042 9,496
- -------------------------------------------------------------------------------------------------
Total Outstanding 1,252,242 1,038,462
Less Long-Term Debt Due Within One Year 14,508 57,707
- -------------------------------------------------------------------------------------------------
$1,237,734 $ 980,755
=================================================================================================
</TABLE>
Annual maturities of long-term debt at December 31, 1997, are as
follows:
<TABLE>
<CAPTION>
Years (In Thousands)
- --------------------------------------------------------------------------------
<S> <C>
1998 $ 14,508
1999 254,422
2000 3,120
2001 380,192
2002 200,000
2003-2007 400,000
- --------------------------------------------------------------------------------
$1,252,242
================================================================================
</TABLE>
25
<PAGE> 27
7. DEBT AND LINES OF CREDIT (Cont'd)
Sonat has a bank revolving credit agreement that provides for periodic
borrowings and repayments of up to $500.0 million through June 30, 2001.
Borrowings are supported by unsecured promissory notes that, at the option of
the Company, will bear interest at the banks' prevailing prime or international
lending rate, or such rates as the banks may competitively bid. During 1997,
$1.730 billion was borrowed and $1.755 billion was repaid under the revolving
credit agreement, resulting in $130.0 million outstanding at December 31, 1997,
at an effective rate of 6.14 percent.
At December 31, 1997, Sonat Exploration GOM had its own loan agreement
(Senior Revolving Credit Facility). Advances could be drawn on the Senior
Revolving Credit Facility up to the lesser of the maximum commitment of $250
million or the borrowing base. At December 31, 1997 and 1996, Sonat Exploration
GOM had an outstanding balance of $145 million and $55 million, respectively,
under the facility. The Senior Revolving Credit Facility was secured by oil and
gas properties with interest at variable rates based on LIBOR, 7.22 percent and
6.61 percent at December 31, 1997 and 1996, respectively. (See Note 2.)
In September 1997, Sonat and Southern issued a total of $200.0 million
under their shelf registration statements. Sonat issued $100.0 million of 6.75
percent Notes due October 1, 2007, at 99.748 percent to yield 6.785 percent.
Southern issued $100.0 million of 6.70 percent Notes due October 1, 2007, at
99.891 percent to yield 6.715 percent. The net proceeds were subsequently used
to repay amounts borrowed under Sonat's commercial paper program and under its
revolving credit agreement.
Unsecured Notes - Loans under all short-term credit facilities are for
a duration of less than three months.
At December 31, 1997, Sonat and Southern had available short-term lines
of credit of $200.0 million and $50.0 million, respectively, through May 26,
1998. Borrowings are available for a period of not more than 364 days and are in
the form of unsecured promissory notes that bear interest at rates based on the
banks' prevailing prime, international or money-market lending rates. At
December 31, 1997, no amounts were outstanding under Sonat's agreement. At
December 31, 1996, Sonat had $21.0 million outstanding under its agreement at a
rate of 6.90 percent. At December 31, 1997 and 1996, no amounts were outstanding
under Southern's agreement. (See Note 15.)
Sonat had $446.6 million and $137.0 million, respectively, in
commercial paper outstanding at average rates of 6.31 percent and 5.76 percent
at December 31, 1997 and 1996, respectively.
26
<PAGE> 28
8. INCOME TAXES
An analysis of the Company's income tax expense (benefit) is as
follows:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- ------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Current:
Federal $12,435 $ 18,841 $ 71,931
State 8,067 4,021 (2,043)
- ------------------------------------------------------------------------------
20,502 22,862 69,888
- ------------------------------------------------------------------------------
Deferred:
Federal 12,463 85,215 28,404
State 2,472 5,391 3,229
- ------------------------------------------------------------------------------
14,935 90,606 31,633
- ------------------------------------------------------------------------------
Income Tax Expense $35,437 $113,468 $ 101,521
==============================================================================
</TABLE>
Net deferred tax liabilities are comprised of the following:
<TABLE>
<CAPTION>
December 31, 1997 1996
- ------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C>
Deferred Tax Liabilities:
Depreciation $ 398,045 $ 338,397
Inventories 11,573 11,572
Other 10,468 11,239
- ------------------------------------------------------------------------------
Total deferred tax liabilities 420,086 361,208
- ------------------------------------------------------------------------------
Deferred Tax Assets:
GSR and other transition costs 10,210 13,228
Employee benefits 36,607 17,604
Net operating loss carryforwards 46,065 16,607
Tax credit carryforwards 14,713 9,154
Other accounting accruals 7,954 16,705
Other 17,361 15,064
- ------------------------------------------------------------------------------
132,910 88,362
Less valuation allowance (11,505) (11,505)
- ------------------------------------------------------------------------------
Total deferred tax assets 121,405 76,857
- ------------------------------------------------------------------------------
Net Deferred Tax Liabilities $ 298,681 $ 284,351
==============================================================================
</TABLE>
The Company has a valuation allowance related to $32.8 million of net
operating loss carryforwards which may not be fully realizable. In assessing the
realizability of deferred tax assets, management considers whether it is more
likely than not some portion or all of the deferred tax assets will not be
realized. The Company believes it is more likely than not that the remaining
deferred tax assets will be realized through the future reversal of existing
taxable temporary differences within the carryforward period or through the use
of future pretax book income.
27
<PAGE> 29
8. INCOME TAXES (Cont'd)
At December 31, 1997, the Company had available net operating loss
carryforwards of approximately $131.6 million for income tax purposes which
expire between 1998 and 2011. The Company has an alternative minimum tax
carryforward of approximately $14.7 million which can be carried forward
indefinitely.
Consolidated income tax expense is different from the amount computed
by applying the U.S. federal income tax rate to income before income tax. The
reasons for this difference are as follows:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- -------------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Income Tax Expense at Statutory
Federal Income Tax Rates $ 42,998 $ 122,956 $ 107,015
Increases (Decreases)
Resulting From:
State income taxes,
net of federal
income tax benefit 6,851 6,118 771
Non-conventional fuel tax
credits (7,220) (9,465) (11,380)
Refunds and adjustment of
accrued tax position 47 880 14,639
Dividend exclusion (8,029) (6,413) (11,248)
Other 790 (608) 1,724
- -------------------------------------------------------------------------------------------
Income Tax Expense $ 35,437 $ 113,468 $ 101,521
===========================================================================================
</TABLE>
28
<PAGE> 30
9. COMMITMENTS AND CONTINGENCIES
Rate Matters - Periodically, Southern and its subsidiaries make general
rate filings with the FERC to provide for the recovery of cost of service and a
return on equity. The FERC normally allows the filed rates to become effective,
subject to refund, until it rules on the approved level of rates. Southern and
its subsidiaries provide reserves relating to such amounts collected subject to
refund, as appropriate, and make refunds upon establishment of the final rates.
At December 31, 1997, Southern's rates are established by a settlement that was
approved by FERC orders issued in 1995 and 1996. All of its customers are
parties to the settlement.
Leases - The Company has operating lease commitments expiring at
various dates, principally for office space and equipment. The Company has no
significant capital leases.
Rental expense for all operating leases is summarized below.
RENTAL EXPENSE
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- ----------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Non-Affiliated Operating Leases $20,377 $18,444 $18,347
Affiliated Operating Leases 3,544 3,680 3,635
- ----------------------------------------------------------------------
$23,921 $22,124 $21,982
======================================================================
</TABLE>
At December 31, 1997, future minimum payments for non-cancelable
operating leases for the years 1998 through 2002 are $9 million or less per
year. Future minimum rentals to be received under subleases for the years 1998
through 2002 are less than $2 million per year.
29
<PAGE> 31
10. CAPITAL STOCK AND STOCK-BASED COMPENSATION
Per-share prices of the Company's common stock, based on the New York
Stock Exchange listing of composite transactions, and dividends paid per common
share for the last two years are summarized below.
PRICE RANGE AND DIVIDENDS PAID PER COMMON SHARE
(Unaudited)
<TABLE>
<CAPTION>
Quarter 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C>
Price Range High-Low
First $57 - $45-1/2 $37-1/4 - $31-1/8
Second 59-1/8 - 50 5/8 45-3/8 - 36-1/8
Third 54-1/4 - 45-3/8 47-1/2 - 41
Fourth 51-5/16 - 42-1/4 54-3/4 - 44-1/8
==============================================================================
Dividend Rate (Note)
First $ .27 $ .27
Second .27 .27
Third .27 .27
Fourth .27 .27
- ------------------------------------------------------------------------------
$1.08 $1.08
==============================================================================
Shareholders of
Record at Year-End 11,258 12,020
==============================================================================
</TABLE>
Note: The dividend rate is the actual rate paid per common share of Sonat
stock, exclusive of shares issued for the merger in January 1998 (see
Note 2).
The Company had no restrictions on the payment of dividends at December
31, 1997.
The Company has a Preference Share Rights Plan designed to protect the
interest of stockholders in the event of a hostile attempt to take over the
Company and to make it more difficult for a person to gain control of the
Company in a manner or on terms not approved by the Board of Directors. The plan
provides for the issuance of one right with respect to each outstanding share of
common stock. The rights issued under the plan are redeemable at any time by the
Company before their expiration on February 3, 2006, unless certain triggering
events have occurred. The rights outstanding under the plan are exercisable for
one one-hundredth of a share of Series A Participating Preference Stock, par
value $1.00, with each share having substantially the rights and preferences of
100 shares of common stock. As of December 31, 1997, 1,000,000 shares of Series
A Participating Preference Stock were reserved for issuance under this plan.
30
<PAGE> 32
10. CAPITAL STOCK AND STOCK-BASED COMPENSATION (Cont'd)
Earnings Per Share - The following table presents the computation of
basic and diluted earnings per share of common stock:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- -------------------------------------------------------------------------------------
(In Thousands, Except
Per-Share Amounts)
<S> <C> <C> <C>
Numerator:
Net income $ 87,412 $237,834 $204,236
=====================================================================================
Denominator:
Denominator for Basic Earnings Per Share:
Weighted average number of shares
of common stock outstanding 110,099 110,370 110,428
Effect of Dilutive Securities:
Common stock equivalents applicable
to outstanding stock options 1,570 1,352 833
- -------------------------------------------------------------------------------------
Denominator for Diluted Earnings Per Share:
Adjusted weighted average shares
using treasury stock method for
assumed conversions 111,669 111,722 111,261
=====================================================================================
Earnings Per Share of Common Stock $ .79 $ 2.15 $ 1.85
=====================================================================================
Earnings Per Share of Common Stock-
Assuming Dilution $ .78 $ 2.13 $ 1.84
=====================================================================================
</TABLE>
Executive Award Plan - The Company has an Executive Award Plan that
provides awards to certain key employees in the form of stock options,
restricted stock and stock appreciation rights (SARs) in tandem with any or all
stock options. In years prior to 1991, tax offset payments were generally
provided in conjunction with these awards. SARs permit the holder of an
exercisable option to surrender that option for an amount equal to the excess of
the market price of the common stock on the date of exercise over the option
price (appreciation). The appreciation is payable in cash, common stock or a
combination of both. SARs are subject to the same terms and conditions as the
options to which they are related. Commencing in November 1995, the Company has
issued, in tandem with its regular stock options, SARs that are exercisable only
in the event of a change in control (limited SARs). In November 1995, the
Company also issued limited SARs to certain key employees with respect to all of
their then outstanding options. No other SARs have been issued since 1990. At
December 31, 1997, 161,000 SARs relating to the earlier periods were
outstanding. All options granted since December 1992 have 10-year terms and vest
and become fully exercisable at the end of five years of continued employment.
Options issued after 1992 also contain an acceleration provision dependent upon
a specified increase in the Company's stock
31
<PAGE> 33
10. CAPITAL STOCK AND STOCK-BASED COMPENSATION (Cont'd)
price. Options granted prior to December 1992 vested over three years and had no
accelerated vesting provisions. The Company issued 80,100 shares of restricted
stock with a $43 13/16 per share market value to employees during 1997 and
97,000 shares with a $52.00 per share market value during 1996. At December 31,
1997, 173,498 of the 531,800 cumulative restricted shares issued have vested. A
new plan was authorized during 1995 which made an additional four million shares
available for issuance.
The Company has elected to follow APB No. 25, Accounting for Stock
Issued to Employees, and related Interpretations in accounting for its employee
stock options. Under APB No. 25, compensation expense is recognized for the
difference between the option price and market value on the measurement date for
variable stock option awards and restricted stock grants. No compensation
expense is recognized for options the Company issued after 1990 because the
exercise price of the stock options equals the market price of the underlying
stock on the date of grant.
Stock-based compensation increased pretax income by $2.0 million in
1997 and decreased it by $13.2 million in 1996 and $7.9 million in 1995.
Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, Accounting for Stock-Based Compensation, and has been
determined as if the Company had accounted for its employee stock options under
the fair value method of the Statement. The fair value for these options was
estimated at the date of grant using a Black-Scholes option pricing model with
the following weighted-average assumptions for 1997 and 1996, respectively:
interest rates (zero-coupon U.S. government issues with a remaining life of six
years) of 5.93 percent and 6.10 percent; dividend yields of 2.47 percent and
2.35 percent; volatility factors of the expected market price of the Company's
common stock of .266 and .255; and a weighted-average expected life of the
options of six years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
32
<PAGE> 34
10. CAPITAL STOCK AND STOCK-BASED COMPENSATION (Cont'd)
The Company's pro forma information follows:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- -----------------------------------------------------------------------------
(In Thousands, Except
Per-Share Amounts)
<S> <C> <C> <C>
Net Income:
As reported $87,412 $237,834 $204,236
Pro forma 86,190 235,167 204,191
Earnings Per Share:
As reported $ .79 $ 2.15 $ 1.85
Pro forma .78 2.13 1.85
Earnings Per Share-Assuming Dilution:
As reported $ .78 $ 2.13 $ 1.84
Pro forma .77 2.11 1.84
=============================================================================
</TABLE>
For purposes of the pro forma disclosures, the estimated fair value of
the options is amortized to expense over the options' vesting period, which is
five years for the awards. However, since all of the 1995 stock option grants
vested under an accelerated vesting clause in 1996, the entire remaining cost
for that award is reflected in 1996. Because the Company's stock options vest
generally over five years and additional awards are typically made each year,
the above pro forma disclosures are not likely to be representative of the
effects on pro forma net income for future years.
33
<PAGE> 35
10. CAPITAL STOCK AND STOCK-BASED COMPENSATION (Cont'd)
A summary of the Company's stock option activity and related
information follows:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------------------------
Weighted-Avg. Weighted-Avg. Weighted-Avg.
Options Exercise Price Options Exercise Price Options Exercise Price
------- -------------- ------- -------------- ------- --------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding -
Beginning of Year 4,178,226 $30.16 4,578,600 $25.24 4,358,820 $23.52
Granted 712,400 43.81 633,700 52.00 682,300 32.25
Exercised (453,907) 25.69 (1,013,954) 21.58 (450,020) 19.06
Forfeited (20,500) 46.90 (20,120) 31.81 (12,500) 27.33
- -----------------------------------------------------------------------------------------------------------------------------------
Outstanding -
End of Year 4,416,219 32.74 4,178,226 30.16 4,578,600 25.24
===================================================================================================================================
Exercisable -
End of Year 3,217,419 27.38 3,544,526 26.26 2,566,520 21.55
===================================================================================================================================
Shares Authorized for
Future Grants 2,884,700 3,597,100 4,230,800
===================================================================================================================================
Fair Value of Options
Granted During the Year $12.50 $14.87 $6.33
===================================================================================================================================
</TABLE>
34
<PAGE> 36
10. CAPITAL STOCK AND STOCK-BASED COMPENSATION (Cont'd)
The following table summarizes information about stock options
outstanding at December 31, 1997:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------------ ---------------------------------
Weighted-Avg.
Number Remaining Number
Range of Exercise Outstanding Contractual Weighted-Avg. Exercisable Weighted-Avg.
Prices 12/31/97 Life Exercise Price 12/31/97 Exercise Price
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$13.625 - $17.4375 476,624 3.2 $15.75 476,624 $15.75
$21.125 - $29.125 1,300,380 5.7 25.51 1,300,380 25.51
$30.00 - $32.25 1,308,915 6.8 31.01 1,308,915 31.01
$43.8125 - $52.00 1,330,300 9.5 47.62 131,500 52.00
- ----------------------------------------------------------------------------------------------------------------------------
4,416,219 3,217,419
============================================================================================================================
</TABLE>
35
<PAGE> 37
10. CAPITAL STOCK AND STOCK-BASED COMPENSATION (Cont'd)
Directors' Restricted Stock Plan - The Company has a Restricted Stock
Plan for non-employee members of the Board of Directors of the Company. Full
rights vest over a maximum of five years. The Company did not issue any shares
under this plan during 1997 and 1996. At December 31, 1997, 33,460 of the 37,460
cumulative shares granted have vested.
Treasury Stock - The Company's stock repurchase program has been
extended to December 31, 1998, which allows for the repurchase of up to
1,000,000 additional shares of common stock. Shares purchased are being reissued
in connection with employee stock options and restricted stock programs.
Serial Preference Stock - At December 31, 1997 and 1996, there were
10,000,000 shares of $1.00 par value Serial Preference Stock authorized, with
none issued.
36
<PAGE> 38
11. RETIREMENT PLANS AND OTHER POSTEMPLOYMENT BENEFITS
Retirement Plans - Sonat has a trusteed, non-contributory, tax
qualified defined benefit retirement plan (the Retirement Plan) covering
substantially all employees of the Company. A supplemental benefit plan (the
Supplemental Plan) that provides retirement benefits in excess of those allowed
under the Company's tax qualified retirement plan is also in effect for the
Company. Benefits under the plans are based on a combination of years of service
and a percentage of compensation. Benefits vest after a period of five years.
The Company determines the amount of funding to the Retirement Plan on
a year-to-year basis, with amounts consistent with minimum and maximum funding
requirements established by various governmental bodies. Amounts are being
placed in a trust established to provide benefits under the Supplemental Plan.
However, this trust is not subject to any funding requirements. At December 31,
1997, this trust had assets with a fair market value of $41.7 million available
to pay benefits. These assets are not considered plan assets under SFAS No. 87,
Employers' Accounting for Pensions.
The Company's net periodic pension (income) cost consists of the
following components:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- ----------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Service Cost - Benefits Earned During
the Period $ 7,848 $ 8,818 $ 5,756
Interest Cost on Projected Benefit
Obligation 26,858 26,550 25,822
Gain on Assets (111,983) (46,475) (97,687)
Net Amortization and Deferral 68,686 7,945 61,307
- ----------------------------------------------------------------------------------
$ (8,591) $ (3,162) $ (4,802)
==================================================================================
</TABLE>
The change in the net periodic pension income from 1996 to 1997 was
primarily attributable to the change in plan assumptions and the growth in plan
assets.
37
<PAGE> 39
11. RETIREMENT PLANS AND OTHER POSTEMPLOYMENT BENEFITS (Cont'd)
The following table sets forth the assets and liabilities of the plans
and the amount of the net pension asset or liability recognized in the Company's
Consolidated Balance Sheets:
<TABLE>
<CAPTION>
Plan with Obligations Plan with Obligations
Less than Assets (1) in Excess of Assets (2)
December 31, December 31,
-------------------------------------------------------
1997 1996 1997 1996
- ---------------------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C> <C>
Actuarial Present Value of
Benefit Obligations:
Vested benefit obligations $ 274,768 $ 281,818 $ 28,314 $ 26,778
Non-vested benefit obligations 8,844 8,149 1,573 532
- ---------------------------------------------------------------------------------------------------
Accumulated benefit obligations 283,612 289,967 29,887 27,310
Effect of projected future
salary increases 48,704 58,271 10,483 11,277
- ---------------------------------------------------------------------------------------------------
Projected benefit obligations 332,316 348,238 40,370 38,587
Plan Assets at Fair Value (3) 550,982 461,299 -- --
- ---------------------------------------------------------------------------------------------------
Projected Benefit Obligations
(in Excess of) or Less than
Plan Assets 218,666 113,061 (40,370) (38,587)
Unrecognized Net (Assets) or
Obligations at Transition (4) (9,496) (11,226) 204 256
Unrecognized Net (Gain) Loss (5) (179,954) (86,441) 7,387 6,763
Unrecognized Prior Service Cost 3,954 4,853 3,134 3,540
Net Unamortized Deferred Charge
from Early Retirement
Termination Benefits (6) 598 411 -- --
Adjustment Required to Recognize
Minimum Pension Liability -- -- (242) --
- ---------------------------------------------------------------------------------------------------
Net Pension Asset (Liability)
Recognized in the Consolidated
Balance Sheets $ 33,768 $ 20,658 $(29,887) $(28,028)
===================================================================================================
</TABLE>
(1) The Retirement Plan.
(2) The Supplemental Plan.
(3) Plan assets consist primarily of debt and equity securities, and
investments in equity index and foreign index funds.
(4) Amortization periods for unrecognized net (asset) or obligation at
transition are 16.5 years for the Retirement Plan and 15 years for the
Supplemental Plan.
(5) Amortization periods for unrecognized net (gain) loss are 15.6 and 15.7
years for the Retirement Plan and 15.2 and 14.2 years for the
Supplemental Plan for 1997 and 1996, respectively.
(6) The amortization period for early retirement termination benefits is 10
years for the Retirement Plan.
38
<PAGE> 40
11. RETIREMENT PLANS AND OTHER POSTEMPLOYMENT BENEFITS (Cont'd)
The provisions of SFAS No. 87 require recognition in the balance sheet
of an additional minimum liability and related intangible asset for pension
plans with accumulated benefits in excess of plan assets. At December 31, 1997,
an additional liability and intangible asset of $.2 million is reflected in the
Company's Consolidated Balance Sheet. There was no amount of additional minimum
liability required for 1996.
The assumed rates used to measure the projected benefit obligations and
the expected earnings of plan assets are:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Weighted Average Discount Rate 7.5% 7.0% 7.0%
Long-Term Rate of Return 9.5% 9.5% 9.5%
Increase in Future Compensation Levels
(Composite Rate):
Retirement and Supplemental Plans 5.0% 5.0% 5.5%
===============================================================================
</TABLE>
Other Postemployment Benefits - The Company has plans that provide for
postretirement health care and life insurance benefits to substantially all of
its employees when they retire. The Company accrues the cost of postretirement
health care and life insurance benefits within the employees' active service
periods. The Company has elected to amortize the transition obligation over a
20-year period.
The annual net periodic cost for postretirement health care and life
insurance benefits consists of the following components:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- -------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Service Cost $ 2,138 $ 2,161 $ 1,672
Interest Cost 6,575 6,387 7,409
Return on Plan Assets (3,983) (3,922) (3,398)
Net Amortization and Deferral 4,690 5,535 5,546
- -------------------------------------------------------------------------
$ 9,420 $10,161 $11,229
=========================================================================
</TABLE>
39
<PAGE> 41
11. RETIREMENT PLANS AND OTHER POSTEMPLOYMENT BENEFITS (Cont'd)
The Company funds postretirement health care benefits for employees of
its regulated subsidiaries in an amount generally equal to the subsidiaries'
annual expense. The regulated subsidiaries currently recover their portion of
postretirement expense through rates. The Company also funds its Retiree Life
Insurance Plan for all its subsidiaries with the amount of funding determined on
a year-to-year basis with the objective of having assets equal plan liabilities.
The following table sets forth the funded status at December 31, 1997
and 1996, for the Company's postretirement health care and life insurance plans:
<TABLE>
<CAPTION>
December 31, 1997 1996
- -----------------------------------------------------------------------------
(In Thousands)
<S> <C> <C>
Accumulated Postretirement Benefit Obligation:
Retirees $ 56,664 $ 63,750
Fully eligible active plan participants 6,962 5,221
Other active plan participants 19,330 26,056
- -----------------------------------------------------------------------------
82,956 95,027
Plan Assets at Fair Value (1) 38,923 32,595
- -----------------------------------------------------------------------------
Accumulated Postretirement Benefit Obligation in
Excess of Plan Assets (44,033) (62,432)
Unrecognized Transition Obligation 51,994 57,544
Unrecognized Net Gain (2) (31,649) (15,013)
Net Unamortized Deferred Charge
from Early Retirement Termination
Benefits 1,980 288
- -----------------------------------------------------------------------------
Accrued Postretirement Benefit Liability $(21,708) $(19,613)
=============================================================================
</TABLE>
(1) Retiree Medical Plan assets are comprised of equity securities,
municipal tax exempt bonds and short-term investment funds. Retiree
Life Insurance Plan assets are held in an investment account, which
consists primarily of fixed income securities.
(2) Amortization periods for unrecognized net gain are 15.1 and 15.4 years
for 1997 and 1996, respectively.
The assumed rates used to measure the projected benefit obligation and
the expected earnings of plan assets are:
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- -----------------------------------------------------------------------
<S> <C> <C> <C>
Discount Rate 7.5% 7.0% 7.0%
Long-Term Rate of Return:
Medical assets 5.5% 5.5% 5.5%
Life insurance assets 7.5% 7.5% 7.5%
=======================================================================
</TABLE>
40
<PAGE> 42
11. RETIREMENT PLANS AND OTHER POSTEMPLOYMENT BENEFITS (Cont'd)
The rate of increase in the per capita costs of covered health care
benefits is assumed to be 4.5 percent in 1998 and for all future years.
Increasing the assumed health care cost trend rate by one percentage point would
increase the accumulated postretirement benefit obligation as of December 31,
1997, by approximately $9.7 million and increase the service cost and interest
cost components of the net periodic postretirement benefit cost by approximately
$1.1 million.
41
<PAGE> 43
12. BUSINESS SEGMENT ANALYSIS
The Company's consolidated financial statements reflect operations in
three segments: Exploration and Production, Natural Gas Transmission and Energy
Services.
The Company is engaged in the exploration for and the acquisition,
development and production of oil and natural gas through its Exploration and
Production segment. The oil and gas properties of the Exploration and Production
segment are located principally onshore in the Southern coastal states, in
various states in the Southwest and Midwest, and in federal waters offshore
Louisiana and Texas. It derives a significant portion of its revenues from sales
to Sonat Marketing (included in the Energy Services segment).
The principal business of the Natural Gas Transmission segment is the
transmission of natural gas in interstate commerce. Its transmission systems are
located in the Southeastern United States. Transportation service is provided
for its distribution customers, direct industrial customers and other end-users,
gas producers, other gas pipelines, and gas marketing and trading companies. It
provides transportation service in both its gas supply and market areas. The
principal industries served directly by the natural gas transmission segment's
pipeline system and indirectly through its distribution customers' systems
include the electric generation, chemical, pulp and paper, textile, primary
metals, stone, clay and glass industries.
The Energy Services segment is engaged primarily in natural gas and
electric power marketing for industrial and commercial users, gas distribution
companies and gas producers throughout the Gulf Coast, Southeastern, Midwestern
and Northeastern United States and development of power systems and power
plants.
The Company's results of operations, revenues from major customers,
capital expenditures and assets by business segment are shown in the following
tables. Intersegment sales are primarily gas sales by the Exploration and
Production segment and are priced at market rates. The Company has no foreign
operations.
42
<PAGE> 44
12. BUSINESS SEGMENT ANALYSIS (Cont'd)
Operating profit is revenues less operating expenses. In determining
operating profit, none of the following items have been included: unallocated
general corporate revenues and expenses, interest, dividend and other income,
interest expense, income taxes and equity in earnings of unconsolidated
affiliates. Minority interest is included in Other Income, Net.
BUSINESS SEGMENT ANALYSIS
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- -------------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Revenues:
Exploration and production $ 755,734 $ 730,839 $ 551,777
Natural gas transmission 393,292 398,828 412,327
Energy services 3,723,932 2,592,703 1,249,903
Other 32,937 44,352 37,122
Intersegment revenue (533,993) (562,523) (348,499)
- -------------------------------------------------------------------------------------------
$4,371,902 $3,204,199 $1,902,630
===========================================================================================
Depreciation, Depletion and Amortization:
Exploration and production $ 354,124 $ 302,360 $ 293,068
Natural gas transmission 47,769 48,293 52,274
Energy services 5,557 1,729 955
Other, including depreciation
of corporate equipment 3,352 1,751 6,318
- -------------------------------------------------------------------------------------------
$ 410,802 $ 354,133 $ 352,615
===========================================================================================
Operating Profit (Loss):
Exploration and production $ (23,137) $ 224,958 $ 40,594
Natural gas transmission 178,348 165,587 158,329
Energy services 10,613 10,184 6,510
Other 5,134 3,981 2,317
- -------------------------------------------------------------------------------------------
Operating profit 170,958 404,710 207,750
Corporate Income (Expenses), Net 161 (368) (1,190)
- -------------------------------------------------------------------------------------------
Operating income 171,119 404,342 206,560
Equity in Earnings (Losses) of
Unconsolidated Affiliates:
Exploration and production 445 408 615
Natural gas transmission 40,525 32,532 37,553
Energy services 817 9 (5)
Other 1,233 1,262 8,095
Other Income, Net 5,902 1,636 149,998
Interest Expense, Net (97,192) (88,887) (97,059)
- -------------------------------------------------------------------------------------------
Income Before Income Taxes $ 122,849 $ 351,302 $ 305,757
===========================================================================================
</TABLE>
43
<PAGE> 45
12. BUSINESS SEGMENT ANALYSIS (Cont'd)
REVENUES FROM MAJOR CUSTOMERS
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- ------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Enron and affiliates:
Exploration and production $181,206 $167,843 $147,698
Natural gas transmission 180 156 157
Energy services 264,399 202,130 100,521
- ------------------------------------------------------------------------
$445,785 $370,129 $248,376
========================================================================
Atlanta Gas Light:
Natural gas transmission $130,425 $134,062 $136,806
Energy services 51,069 54,191 38,342
- ------------------------------------------------------------------------
$181,494 $188,253 $175,148
========================================================================
Alabama Gas Corporation:
Natural gas transmission $ 48,300 $ 38,662 $ 40,019
Energy services 87,994 86,062 50,134
- ------------------------------------------------------------------------
$136,294 $124,724 $ 90,153
========================================================================
</TABLE>
All of the major customers or their affiliates participate with the
Company in certain joint venture operations.
Capital expenditures for unconsolidated affiliates are accounted for on
the books of the unconsolidated affiliates and therefore are not reflected in
the totals appearing in the Company's Consolidated Financial Statements.
CAPITAL EXPENDITURES BY BUSINESS SEGMENT
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- ----------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Consolidated:
Exploration and production
(excluding exploratory costs) $705,140 $513,157 $495,628
Natural gas transmission 144,269 130,417 62,720
Energy services 10,978 4,736 2,758
Other 4,496 5,958 5,928
- ----------------------------------------------------------------------------------------
864,883 654,268 567,034
- ----------------------------------------------------------------------------------------
Unconsolidated Affiliates (Company's Portion):
Exploration and production 512 222 723
Natural gas transmission 41,772 15,138 100,489
Other 244 490 525
- ----------------------------------------------------------------------------------------
42,528 15,850 101,737
- ----------------------------------------------------------------------------------------
$907,411 $670,118 $668,771
========================================================================================
</TABLE>
44
<PAGE> 46
12. BUSINESS SEGMENT ANALYSIS (Cont'd)
Identifiable assets by business segment are those assets that are used
in the Company's operations in each business. Corporate assets are typically
investments, cash and equipment. Included in corporate assets at December 31,
1997, is restricted cash of $116.0 million (see Note 1).
ASSETS BY BUSINESS SEGMENT
<TABLE>
<CAPTION>
December 31, 1997 1996 1995
- -------------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Identifiable Assets:
Exploration and production $2,223,646 $1,957,320 $1,787,233
Natural gas transmission 1,187,880 1,181,440 1,285,404
Energy services 752,717 524,768 261,751
Other 41,911 41,449 37,850
Adjustments
and eliminations (157,215) (156,140) (103,579)
- -------------------------------------------------------------------------------------------
4,048,939 3,548,837 3,268,659
- -------------------------------------------------------------------------------------------
Investments in Unconsolidated Affiliates:
Exploration and production 5,679 5,255 4,876
Natural gas transmission 467,453 392,180 368,527
Energy services 5,639 5,457 490
Other 12,910 11,668 12,188
- -------------------------------------------------------------------------------------------
491,681 414,560 386,081
Corporate Assets 183,788 63,078 51,535
- -------------------------------------------------------------------------------------------
Total Assets $4,724,408 $4,026,475 $3,706,275
===========================================================================================
</TABLE>
45
<PAGE> 47
13. OIL AND GAS OPERATIONS (Unaudited)
At December 31, 1997, the Company had interests in oil and gas
properties that are located primarily in Texas, Oklahoma, Louisiana, Arkansas,
Alabama, and offshore Louisiana and Texas in the Gulf of Mexico. The Company
does not own or lease any oil and gas properties outside the United States.
Capitalized costs relating to oil and gas producing activities and
related accumulated depreciation, depletion and amortization were as follows:
CAPITALIZED COSTS
<TABLE>
<CAPTION>
December 31, 1997 1996
- --------------------------------------------------------------
(In Thousands)
<S> <C> <C>
Oil and Gas Properties:
Proved properties $3,270,787 $2,765,418
Unproved properties 201,104 166,963
- --------------------------------------------------------------
3,471,891 2,932,381
Less Accumulated Depreciation,
Depletion and Amortization 1,531,746 1,252,912
- --------------------------------------------------------------
$1,940,145 $1,679,469
==============================================================
</TABLE>
Costs incurred in oil and gas producing activities, whether capitalized
or expensed, were as follows:
COSTS INCURRED
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- ---------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Property Acquisition Costs:
Proved properties $ 5,578 $ 58,699 $210,218
Unproved properties 75,414 69,997 22,809
Exploration Costs 276,684 169,332 102,432
Development Costs 469,331 282,804 204,262
- ---------------------------------------------------------------------
Total Costs $827,007 $580,832 $539,721
=====================================================================
</TABLE>
46
<PAGE> 48
13. OIL AND GAS OPERATIONS (Unaudited) (Cont'd)
Net quantities of proved developed and undeveloped reserves of natural
gas and crude oil, including condensate and natural gas liquids, and changes in
such quantities were as follows:
RESERVE DATA
<TABLE>
<CAPTION>
Liquids Gas Liquids Gas Liquids Gas
(MBbls) (Bcf) (MBbls) (Bcf) (MBbls) (Bcf)
- -------------------------------------------------------------------------------------------------------------------
December 31, 1997 1996 1995
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Proved (Developed and
Undeveloped) Reserves, Net:
Beginning of year 65,984 2,006.4 55,304 1,711.7 40,895 1,542.6
Revisions of previous
estimates 4,506 156.6 4,134 58.0 3,763 122.7
Extensions, discoveries
and other additions 10,540 287.1 21,307 457.2 9,076 233.3
Purchases of reserves
in place 850 20.6 2,158 151.3 16,954 248.1
Sales of reserves
in place (433) (43.7) (7,941) (103.5) (7,408) (196.7)
Production (8,565) (266.4) (8,978) (268.3) (7,976) (238.3)
- -------------------------------------------------------------------------------------------------------------------
End of Year 72,882 2,160.6 65,984 2,006.4 55,304 1,711.7
===================================================================================================================
Proved Developed Reserves:
Beginning of year 33,327 1,395.8 30,455 1,184.1 26,134 1,075.2
End of year 45,225 1,557.5 33,327 1,395.8 30,455 1,184.1
===================================================================================================================
</TABLE>
MBbls-Thousands of barrels
Bcf-Billion cubic feet
The significant changes to reserves, other than acquisitions,
dispositions or production, are due to reservoir performance in existing fields
and drilling of additional wells in existing fields. There were no major
discoveries or other events, favorable or adverse, that may be considered to
have caused a significant change in the estimated proved reserves since December
31, 1997.
47
<PAGE> 49
13. OIL AND GAS OPERATIONS (Unaudited) (Cont'd)
Results of operations from producing activities by fiscal year were as
follows:
RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- -----------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Net Revenues:
Sales $ 345,846 $ 320,459 $ 323,321
Affiliated sales 409,889 410,380 228,456
- -----------------------------------------------------------------------------------
Total 755,735 730,839 551,777
Production Costs (109,344) (100,473) (93,588)
Exploration Expenses (157,775) (86,343) (54,326)
Depreciation, Depletion
and Amortization (354,124) (302,360) (293,068)
- -----------------------------------------------------------------------------------
134,492 241,663 110,795
Income Tax Expense (39,891) (75,200) (27,535)
- -----------------------------------------------------------------------------------
Results of Operations from Producing
Activities (Excluding Corporate
Overhead and Interest Costs) $ 94,601 $ 166,463 $ 83,260
===================================================================================
</TABLE>
The standardized measure of discounted future net cash flows relating
to proved oil and gas reserves follows:
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
<TABLE>
<CAPTION>
December 31, 1997 1996 1995
- -------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Future Cash Inflows $ 6,059,477 $ 8,551,630 $ 4,261,062
Future Production and
Development Costs (1,889,348) (1,881,447) (1,477,361)
Future Income Tax Expenses (912,059) (1,776,403) (455,454)
- -------------------------------------------------------------------------------
Future Net Cash Flows 3,258,070 4,893,780 2,328,247
10% Annual Discount for
Estimated Timing of
Cash Flows (1,058,622) (1,499,656) (685,856)
- -------------------------------------------------------------------------------
Standardized Measure of
Discounted Future Net
Cash Flows $ 2,199,448 $ 3,394,124 $ 1,642,391
===============================================================================
</TABLE>
48
<PAGE> 50
13. OIL AND GAS OPERATIONS (Unaudited) (Cont'd)
For the calculations in the preceding table, estimated future cash
inflows from estimated future production of proved reserves were computed using
realized oil and gas prices for the month of December of each respective year.
The following are the principal sources of change in the standardized
measure of discounted future net cash flows:
CHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31, 1997 1996 1995
- --------------------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C> <C>
Sales and Transfers of Oil and Gas
Produced, Net of Production Costs $ (646,391) $ (630,222) $(458,031)
Net Changes in Prices and
Production Costs (1,858,641) 1,583,673 271,928
Extensions, Discoveries and
Improved Recovery, Less Related Costs 328,665 1,156,729 284,547
Changes in Estimated Future
Development Costs (83,805) (18,579) (37,240)
Development Costs Incurred During
the Period 228,798 154,057 159,222
Revisions of Previous Quantity
Estimates 175,081 164,214 212,865
Accretion of Discount 449,400 185,091 128,497
Net Change in Income Taxes 611,351 (891,355) (233,261)
Purchases of Reserves in Place 23,628 318,084 333,260
Sales of Reserves in Place (47,170) (256,706) (275,584)
Changes in Production Rates
(Timing) and Other (375,592) (13,253) (53,528)
- --------------------------------------------------------------------------------------------
$(1,194,676) $ 1,751,733 $ 332,675
============================================================================================
</TABLE>
49
<PAGE> 51
14. QUARTERLY RESULTS (Unaudited)
Selected unaudited quarterly data is shown below:
<TABLE>
<CAPTION>
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
- --------------------------------------------------------------------------------------------------
(In Thousands, Except Per-Share Amounts)
<S> <C> <C> <C> <C>
1997 (1)
Revenues $1,123,570 $855,570 $1,073,503 $1,319,259
Operating Income 111,033 37,223 2,689 20,174
Net Income 69,866 16,851 (5,384) 6,079
==================================================================================================
Earnings Per Share of Common Stock $ .63 $ .15 $ (.05) $ .06
==================================================================================================
Earnings Per Share of Common Stock-
Assuming Dilution $ .62 $ .15 $ (.05) $ .05
==================================================================================================
1996 (2)
Revenues $ 746,580 $673,339 $ 777,695 $1,006,585
Operating Income 130,651 62,652 97,720 113,319
Net Income 75,449 32,368 61,273 68,744
==================================================================================================
Earnings Per Share of Common Stock $ .68 $ .29 $ .56 $ .62
==================================================================================================
Earnings Per Share of Common Stock-
Assuming Dilution $ .68 $ .29 $ .55 $ .61
==================================================================================================
</TABLE>
(1) Net income for the third quarter of 1997 includes a charge of $34.0
million, or $.31 per share (basic and diluted), related to the
impairment of certain oil and gas properties.
Net income for the fourth quarter of 1997 includes a charge of $46.5
million, or $.42 per share (basic and diluted), related to merger
expenses (see Note 2).
(2) During the first quarter of 1996, the Company sold its working interest
in certain oil and gas properties located in the Gulf of Mexico,
resulting in an after-tax gain of $25.0 million, or $.23 per share
(basic) or $.22 per share (diluted).
During the third quarter of 1996, the Company sold all of its working
interest in East Cameron 328 and High Island 116, resulting in an
after-tax gain of $16.5 million, or $.15 per share (basic and diluted).
50
<PAGE> 52
15. SUBSEQUENT EVENTS (Unaudited)
Debt Issuances and Lines of Credit - In late January 1998, Sonat made
two public offerings of Notes pursuant to its shelf registration statement. In
one offering, Sonat issued $100 million of 6 5/8 percent Notes due February 1,
2008, at 99.531 percent to yield 6.69 percent. In the other offering, Sonat
issued $100 million of 7 percent Notes due February 1, 2018, at 99.787 percent
to yield 7.02 percent. The net proceeds from the offerings were used for general
corporate purposes, including capital expenditures, working capital and
repayment of debt.
Also in late January 1998, Sonat completed a new 364-day $700 million
revolving credit facility with 20 banks. In connection with this new facility
the Company terminated existing lines of credit providing for up to $200 million
of borrowings.
Sonat Exploration Company Restructuring - On April 23, 1998, the
Company announced a restructuring of Sonat Exploration Company. The
restructuring will include significant property sales and other cost reduction
activities. Oil and natural gas properties having approximately 487 billion
cubic feet of natural gas equivalent reserves and daily production of
approximately 200 million cubic feet of natural gas equivalent will be sold. The
volumes represent approximately 19 percent of the Company's total proven oil and
natural gas reserves and 24 percent of its current daily production. Although
the timing of the property sales will depend on market conditions, the Company
expects the sales will be completed by the end of the third quarter of 1998 with
the proceeds used to pay down debt. Based on a preliminary estimate of sales
proceeds and estimates of other restructuring expenses, the Company expects to
take an after-tax charge of approximately $250 million to $275 million in the
second quarter of 1998, substantially all of which will be non-cash.
51
<PAGE> 53
SELECTED CONSOLIDATED FINANCIAL DATA
Sonat Inc. and Subsidiaries
<TABLE>
<CAPTION>
1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------------
(In Millions, Except Per-Share Amounts)
<S> <C> <C> <C> <C> <C>
Revenues (1) $4,371.9 $3,204.2 $1,902.6 $1,482.5 $1,597.2
Costs and Expenses (1) 4,200.8 2,799.8 1,696.1 1,322.1 1,388.0
- ------------------------------------------------------------------------------------------------------------------
Operating Income 171.1 404.4 206.5 160.4 209.2
Other Income, Net (2) 48.9 35.8 196.3 63.6 196.9
Interest Expense, Net (97.2) (88.9) (97.1) (77.3) (48.2)
- ------------------------------------------------------------------------------------------------------------------
Income before Extraordinary Item
and Income Taxes 122.8 351.3 305.7 146.7 357.9
Income Tax Expense 35.4 113.5 101.5 12.1 99.6
- ------------------------------------------------------------------------------------------------------------------
Income before Extraordinary Items 87.4 237.8 204.2 134.6 258.3
Extraordinary Loss, Net of Tax (3) -- -- -- -- (3.8)
- ------------------------------------------------------------------------------------------------------------------
Net Income $ 87.4 $ 237.8 $ 204.2 $ 134.6 $ 254.5
==================================================================================================================
Earnings Per Share before
Extraordinary Item $ .79 $ 2.15 $ 1.85 $ 1.21 $ 2.33
Earnings Per Share $ .79 $ 2.15 $ 1.85 $ 1.21 $ 2.30
Earnings Per Share before
Extraordinary Item-Assuming Dilution $ .78 $ 2.13 $ 1.84 $ 1.20 $ 2.31
Earnings Per Share-Assuming Dilution $ .78 $ 2.13 $ 1.84 $ 1.20 $ 2.28
Weighted Average Shares
Outstanding (thousands) 110,099 110,370 110,428 111,278 110,861
Weighted Average Shares Outstanding-
Assuming Dilution (thousands) 111,669 111,722 111,261 112,228 111,773
Dividend Rate $ 1.08 $ 1.08 $ 1.08 $ 1.08 $ 1.04
==================================================================================================================
Assets $4,724.4 $4,026.5 $3,706.2 $3,678.4 $3,308.2
Debt Maturing within One Year $ 461.2 $ 215.7 $ 241.7 $ 225.3 $ 236.9
Long-Term Debt 1,237.7 980.8 805.8 993.9 765.7
Stockholders' Equity 1,614.0 1,658.8 1,516.8 1,414.0 1,393.2
- ------------------------------------------------------------------------------------------------------------------
Total Capitalization $3,312.9 $2,855.3 $2,564.3 $2,633.2 $2,395.8
==================================================================================================================
</TABLE>
(1) The 1993-1996 periods have been restated to reflect the
reclassification of natural gas sales, natural gas cost and transition
cost recovery to other revenues.
(2) In June 1993, the Company reduced its ownership of Sonat Offshore from
100 percent to 40 percent. In July 1995, the Company disposed of its
remaining shares of Sonat Offshore common stock.
(3) In March 1993, the Company recognized a loss on the redemption of the
Company's 7-1/4 Percent Zero Coupon, Subordinated Convertible Notes,
which were due September 6, 2005.
52
<PAGE> 54
Item 7. Financial Statements, Pro Forma Financial
Information and Exhibits
(c) Exhibits
The following documents are filed herewith as exhibits to this
Current Report:
<TABLE>
<CAPTION>
Exhibit
No. Exhibit
- ------- -------
<S> <C>
12 Computation of Ratio of Earnings to Fixed Charges
23.1 Consent of Ernst & Young LLP, Independent Auditor
23.2 Consent of KPMG Peat Marwick LLP, Independent Auditor
27.1 Financial Data Schedule for the period ended December 31,
1997, filed electronically only
27.2 Financial Data Schedule for the period ended December 31,
1996, filed electronically only
27.3 Financial Data Schedule for the period ended December 31,
1995, filed electronically only
99.1 Press Release dated April 23, 1998
99.2 Report of KPMG Peat Marwick LLP, Independent Auditor
</TABLE>
53
<PAGE> 55
SIGNATURES
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 hereunto duly authorized.
Sonat Inc.
By: /s/ James E. Moylan, Jr.
----------------------------
James E. Moylan, Jr.
Senior Vice President and
Chief Financial Officer
Dated: April 23, 1998
54
<PAGE> 56
SONAT INC.
CURRENT REPORT ON FORM 8-K
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
No. Exhibit
- ------- -------
<S> <C>
12* Computation of Ratio of Earnings to Fixed Charges
23.1* Consent of Ernst & Young LLP, Independent Auditor
23.2* Consent of KPMG Peat Marwick LLP, Independent Auditor
27.1* Financial Data Schedule for the period ended December 31,
1997, filed electronically only
27.2* Financial Data Schedule for the period ended December 31,
1996, filed electronically only
27.3* Financial Data Schedule for the period ended December 31,
1995, filed electronically only
99.1* Press Release dated April 23, 1998
99.2* Report of KPMG Peat Marwick LLP, Independent Auditor
</TABLE>
- -----------------
* Filed herewith
<PAGE> 1
EXHIBIT 12
SONAT INC. AND SUBSIDIARIES
COMPUTATION OF RATIOS OF EARNINGS
FROM CONTINUING OPERATIONS TO FIXED CHARGES
TOTAL ENTERPRISE (a)
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- -------- -------- --------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Earnings from Continuing Operations:
Income before income taxes $122,849 $351,302 $300,373 $144,423 $354,325
Fixed charges (see computation below) 168,981 162,291 174,634 133,902 130,670
Less allowance for interest capitalized (7,447) (7,642) (8,072) (7,736) (4,329)
-------- -------- -------- -------- --------
Total Earnings Available for Fixed Charges $284,383 $505,951 $466,935 $270,589 $480,666
======== ======== ======== ======== ========
Fixed Charges:
Interest expense before deducting
interest capitalized $160,829 $154,769 $167,068 $126,193 $123,619
Rentals(b) 8,152 7,522 7,566 7,709 7,051
-------- -------- -------- -------- --------
$168,981 $162,291 $174,634 $133,902 $130,670
======== ======== ======== ======== ========
Ratio of Earnings to Fixed Charges 1.7 3.1 2.7 2.0 3.7
======== ======== ======== ======== ========
</TABLE>
- -----------
(a) Amounts include the Company's portion of the captions as they relate to
persons accounted for by the equity method.
(b) These amounts represent 1/3 of rentals which approximate the interest
factor applicable to such rentals of the Company and its subsidiaries
and unconsolidated affiliates.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITOR
We consent to the incorporation by reference in (i) the Registration Statement
(Form S-8, No. 33-64367) pertaining to the Sonat Inc. Executive Award Plan and
the related Prospectus and (ii) the Registration Statement (Form S-8, No.
33-50142) pertaining to the Sonat Savings Plan and the related Prospectus of our
report dated April 20, 1998, with respect to the supplemental consolidated
financial statements of Sonat Inc. for the three years ended December 31, 1997,
included in the Current Report (Form 8-K), filed with the Securities and
Exchange Commission.
ERNST & YOUNG LLP
Birmingham, Alabama
April 20, 1998
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT AUDITOR
The Board of Directors
Sonat Exploration GOM Inc.
(formerly Zilkha Energy Company)
We consent to the incorporation by reference in registration statements (No.
33-64367 and No. 33-50142) on Form S-8 of Sonat Inc. of our report dated
December 8, 1997, with respect to the balance sheets of Zilkha Energy Company
as of December 31, 1996 and 1995, and the related statements of operations,
stockholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1996, which report appears in the Form 8-K of Sonat
Inc. dated April 23, 1998.
Our report refers to a change in accounting for oil and gas properties from the
full cost method to the successful efforts method.
KPMG Peat Marwick LLP
Houston, Texas
April 23, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 143,234
<SECURITIES> 0
<RECEIVABLES> 619,581
<ALLOWANCES> 0
<INVENTORY> 65,161
<CURRENT-ASSETS> 980,807
<PP&E> 6,079,239
<DEPRECIATION> 3,096,541
<TOTAL-ASSETS> 4,724,408
<CURRENT-LIABILITIES> 1,415,331
<BONDS> 1,237,734
0
0
<COMMON> 111,385
<OTHER-SE> 1,502,605
<TOTAL-LIABILITY-AND-EQUITY> 4,724,408
<SALES> 3,694,942
<TOTAL-REVENUES> 4,371,902
<CGS> 3,174,060
<TOTAL-COSTS> 3,510,673
<OTHER-EXPENSES> 410,802
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 102,100
<INCOME-PRETAX> 122,849
<INCOME-TAX> 35,437
<INCOME-CONTINUING> 87,412
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 87,412
<EPS-PRIMARY> .79
<EPS-DILUTED> .78
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 48,009
<SECURITIES> 0
<RECEIVABLES> 611,800
<ALLOWANCES> 0
<INVENTORY> 31,050
<CURRENT-ASSETS> 747,462
<PP&E> 5,436,924
<DEPRECIATION> 2,828,315
<TOTAL-ASSETS> 4,026,475
<CURRENT-LIABILITIES> 905,929
<BONDS> 980,755
0
0
<COMMON> 111,391
<OTHER-SE> 1,547,410
<TOTAL-LIABILITY-AND-EQUITY> 4,026,475
<SALES> 2,556,822
<TOTAL-REVENUES> 3,204,199
<CGS> 2,038,846
<TOTAL-COSTS> 2,215,860
<OTHER-EXPENSES> 354,133
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 93,761
<INCOME-PRETAX> 351,302
<INCOME-TAX> 113,468
<INCOME-CONTINUING> 237,834
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 237,834
<EPS-PRIMARY> 2.15
<EPS-DILUTED> 2.13
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-END> DEC-31-1995
<CASH> 50,708
<SECURITIES> 0
<RECEIVABLES> 373,296
<ALLOWANCES> 0
<INVENTORY> 23,956
<CURRENT-ASSETS> 532,783
<PP&E> 5,084,453
<DEPRECIATION> 2,671,839
<TOTAL-ASSETS> 3,706,275
<CURRENT-LIABILITIES> 681,299
<BONDS> 805,813
0
0
<COMMON> 111,402
<OTHER-SE> 1,405,480
<TOTAL-LIABILITY-AND-EQUITY> 3,706,275
<SALES> 1,236,953
<TOTAL-REVENUES> 1,902,630
<CGS> 913,054
<TOTAL-COSTS> 1,144,513
<OTHER-EXPENSES> 352,615
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 104,139
<INCOME-PRETAX> 305,757
<INCOME-TAX> 101,521
<INCOME-CONTINUING> 204,236
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 204,236
<EPS-PRIMARY> 1.85
<EPS-DILUTED> 1.84
</TABLE>
<PAGE> 1
EXHIBIT 99.1
Bruce L. Connery FOR RELEASE: April 23, 1998
Contact 205 325 3898
SONAT REPORTS FIRST QUARTER EARNINGS;
ANNOUNCES RESTRUCTURING AT SONAT EXPLORATION COMPANY
BIRMINGHAM, Ala. -- Ronald L. Kuehn, Jr., chairman, president and chief
executive officer of Sonat Inc. (NYSE: SNT), announced today that the company's
earnings for the three months ended March 31, 1998, were $38 million, or $.35
per share, compared with $69.9 million, or $.63 per share, for the first quarter
of 1997. The principal reasons for the earnings decline were sharply lower oil
and natural gas prices and increased costs at Sonat Exploration Company. He also
announced a major restructuring initiative at Sonat Exploration which, when
completed, will significantly improve its ability to earn returns in excess of
its cost of capital. The restructuring involves property divestitures, a
reduction in the number of business units and substantial cost reduction
actions.
SONAT EXPLORATION RESTRUCTURING
Following the acquisition of Zilkha Energy Company in January 1998,
Sonat undertook a comprehensive review of its exploration and production
business to improve its overall financial performance. This effort was recently
completed, and a
- more -
<PAGE> 2
-2-
major restructuring program was approved by the Sonat Board of Directors late
yesterday. The restructuring program includes the following steps.
Oil and gas properties having approximately 487 billion cubic feet
(Bcf) of proven natural gas equivalent reserves and daily production of
approximately 200 million cubic feet (MMcf) of natural gas equivalent will be
sold. These volumes represent approximately 19 percent of the company's total
proven oil and natural gas reserves and 24 percent of its current daily
production. The divestiture will include all of the company's Austin Chalk,
Arkoma Basin properties and substantially all onshore Gulf Coast properties as
well as various properties from other business units. No significant properties
acquired in the Zilkha Energy merger or in the Cotton Valley Pinnacle Reef Trend
are included in the divestiture program. Although the exact timing of the
property sales will depend on market conditions, it is expected that the
divestiture program will be substantially completed by the end of the third
quarter of 1998 with the proceeds used to reduce debt.
Sonat Exploration will consolidate its business units from seven to
three. This action, together with related staff reductions, will reduce its
workforce by approximately 220 people, or approximately one-fourth of the Sonat
Exploration workforce, including those currently employed by Sonat Exploration
GOM Inc., the former Zilkha Energy. John B. Holmes, who is currently president
and chief executive officer of Sonat Exploration GOM Inc., will become president
and chief executive officer of Sonat Exploration upon the retirement of Sonat
Exploration's
-more-
<PAGE> 3
-3-
Chairman and Chief Executive Officer Donald G. Russell on April 30, 1998. Mr.
Russell will also retire from the Sonat Inc. Board of Directors effective that
date.
Based on a preliminary estimate of sales proceeds from the divestiture
program and the costs related to the restructuring, the company expects to take
an after-tax charge of approximately $250 million to $275 million in the second
quarter of 1998, substantially all of which will be non-cash.
The steps being taken will significantly improve Sonat Exploration's
financial performance. General and administrative and operating costs are
expected to be reduced by approximately $55 million on an annual basis. Annual
interest expense is expected to be reduced by $20 million or more. In addition,
the per-unit amortization rate is expected to decline from a current $1.01 per
thousand cubic feet (Mcf) of natural gas equivalent to about $.75 per Mcf. These
actions are not expected to result in a material change to Sonat's debt to
capitalization.
Kuehn said, "This restructuring is absolutely necessary to enable Sonat
to continue to grow our exploration and production business profitably. We
cannot commit capital and incur costs for returns below our cost of capital.
Going forward, our strategic focus for this business is to emphasize higher
return exploration and development programs. The details of this strategy will
be outlined at our May 21 security analyst presentation in New York."
-more-
<PAGE> 4
-4-
EXPLORATION AND PRODUCTION RESULTS AND OPERATIONS
Sonat Exploration's earnings before interest and taxes (EBIT) for the
first quarter of 1998 were $13 million, compared with $63 million in 1997.
Realized natural gas prices were $2.01 per Mcf as compared with $2.53 per Mcf
for the 1997 quarter, while realized oil prices declined to $14.76 per barrel
from $21.91 in 1997. Total production was 78 Bcf of natural gas equivalent
versus 77 Bcf of natural gas equivalent in the first quarter of 1997. The unit
amortization rate for the first quarter of 1998 was $1.01 per Mcf equivalent
versus $.89 in 1997.
In March, Sonat Exploration was the apparent successful bidder on five
tracts in the Central Gulf of Mexico Lease Sale 169. Sonat Exploration's net
share of the high bids is $12.7 million. While three of the tracts are in
shallow water areas, two of the tracts are in deep water, an emerging
exploratory area for the company. Sonat Exploration will have a 100 percent
working interest in four of the tracts and a 25 percent interest in one of the
deep-water tracts. The bids are subject to review and evaluation by the Minerals
Management Service before being finally awarded. So far this year, Sonat
Exploration has drilled four exploratory wells in the Gulf of Mexico with a 50
percent success rate.
NATURAL GAS TRANSMISSION RESULTS AND OPERATIONS
First quarter EBIT for the natural gas transmission segment was $69
million compared with $60 million in the first quarter of 1997. The increase is
due to the
-more-
<PAGE> 5
-5-
contributions of new expansions, improvement at Sea Robin Pipeline Company and
miscellaneous quarter-to-quarter variances. Total natural gas throughput rose to
280 Bcf from 250 Bcf last year due to colder weather and expansion volumes.
Construction is progressing on the 1-Bcf-per-day Destin Pipeline, which
is on schedule to begin operations in July 1998. In addition to Shell and Amoco,
other producers have recently committed reserves to this project, which will
result in the construction of pipeline extensions. With these additions, this
pipeline is expected to be operating at a rate of approximately 600 MMcf per day
by mid-1999.
ENERGY SERVICES RESULTS
First quarter 1998 financial results for Sonat Energy Services Company
were essentially flat with the previous year with EBIT of $836,000 compared with
$924,000 in 1997. While natural gas and electric marketing volumes were both
higher, and origination activities increased, mild winter weather depressed
margin opportunities. Sonat Marketing's sales volume rose to 4 Bcf per day from
3.4 Bcf per day in 1997, while Sonat Power Marketing's sales volumes reached 3.2
million megawatt hours, up significantly from 1.4 million megawatt hours in the
first quarter of 1997.
Sonat Inc., headquartered in Birmingham, is a diversified energy
company engaged in exploration and production of oil and natural gas, interstate
transmission of natural gas, and energy services.
-more-
<PAGE> 6
-6-
Cautionary Statement Concerning Forward-Looking Statements
This press release includes certain forward-looking statements, which are based
on assumptions the Company believes are reasonable, but a variety of factors
could cause the Company's actual results and experience to differ materially
from the anticipated results or other expectations expressed in management's
forward-looking statements.
The costs and benefits of Sonat Exploration's restructuring program have been
estimated based on a number of assumptions, including estimates of sales
proceeds from its divestiture program, the timing of such sales, the expenses
associated with the reorganization and assumed oil and gas prices. Actual
results may differ from such assumptions and there can be no assurance that the
estimated costs and benefits will be incurred or realized as planned or that the
expected charge to earnings will be in the range estimated. In addition,
unanticipated regulatory and construction delays could result in the Destin
project not being constructed and placed in service on schedule.
Additional factors that may affect the Company can be found under the caption
"Cautionary Statement Concerning Forward-Looking Statements" in the Company's
1997 Annual Report on Form 10-K. This report, which is filed with the Securities
and Exchange Commission, is hereby referenced in its entirety for further
information about the Company, its operations and its financial statements.
# # #
98-18
<PAGE> 7
SONAT INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
<TABLE>
<CAPTION>
3 Months
-------------------------------
Periods Ended March 31, 1998 1997
- -------------------------------------------------------------------------------
(In Thousands, Except
Per-Share Amounts)
<S> <C> <C>
Revenues $ 1,108,885 $ 1,123,570
Costs and Expenses 1,033,928 1,012,537
----------- -----------
Operating Income 74,957 111,033
Other Income 9,823 15,417
----------- -----------
Earnings Before Interest and Taxes 84,780 126,450
Interest Expense, Net (28,506) (21,628)
----------- -----------
Income before Income Taxes 56,274 104,822
Income Tax Expense 18,261 34,956
----------- -----------
Net Income $ 38,013 $ 69,866
=========== ===========
Earnings Per Share of Common Stock $ .35 $ .63
=========== ===========
Earnings Per Share of Common Stock-
Assuming Dilution $ .34 $ .62
=========== ===========
Weighted Average Shares Outstanding 109,966 110,387
=========== ===========
Weighted Average Shares Outstanding-
Assuming Dilution 111,134 112,057
=========== ===========
Cash Dividends Paid Per Common Share $ .27 $ .27
=========== ===========
</TABLE>
Note: The 1997 information has been restated to reflect the Company's merger
with Zilkha Energy Company on January 30, 1998, which was accounted for
as a pooling of interests.
<PAGE> 8
SONAT INC. AND SUBSIDIARIES
SUPPLEMENTAL DATA
(Unaudited)
<TABLE>
<CAPTION>
3 Months
------------------------------
Periods Ended March 31, 1998 1997
- -------------------------------------------------------------------------------
(In Thousands)
<S> <C> <C>
BUSINESS SEGMENT
Revenues:
Exploration and production $ 161,903 $ 205,629
Natural gas transmission 105,501 99,166
Energy services 936,755 959,684
Other 12,376 8,896
Intersegment revenue (107,650) (149,805)
----------- -----------
$ 1,108,885 $ 1,123,570
=========== ===========
Operating Income:
Exploration and production $ 12,877 $ 60,818
Natural gas transmission 59,280 46,810
Energy services 1,149 1,496
Other, net of corporate expenses 1,651 1,909
----------- -----------
$ 74,957 $ 111,033
=========== ===========
Earnings Before Interest and Taxes:
Exploration and production $ 13,037 $ 62,902
Natural gas transmission 68,915 60,104
Energy services 836 924
Other, net of corporate expenses 1,992 2,520
----------- -----------
$ 84,780 $ 126,450
=========== ===========
INTEREST EXPENSE, NET:
Interest income $ 2,200 $ 1,182
Interest expense (32,130) (24,853)
Interest capitalized 1,424 2,043
----------- -----------
$ (28,506) $ (21,628)
=========== ===========
</TABLE>
<PAGE> 9
SONAT INC. AND SUBSIDIARIES
OPERATIONAL DATA
(Unaudited)
EXPLORATION AND PRODUCTION
<TABLE>
<CAPTION>
Three Months
Ended March 31,
---------------------------
1998 1997
------ ------
<S> <C> <C>
Net Sales Volumes:
Gas (Bcf) 63 66
Oil and condensate (MBbls) 1,950 1,394
Natural gas liquids (MBbls) 584 383
- --------------------------------------------------------------------------------
Average Sales Prices:
Gas ($/Mcf) $ 2.01 $ 2.53
Oil and condensate ($/Bbl) 14.76 21.91
Natural gas liquids ($/Bbl) 9.73 16.75
- --------------------------------------------------------------------------------
</TABLE>
NATURAL GAS TRANSMISSION
<TABLE>
<CAPTION>
Three Months
Ended March 31,
---------------------------
1998 1997
------ ------
(Billion Cubic Feet)
<S> <C> <C>
Southern Volumes:
Market transportation 185 170
Supply transportation 95 80
------ ------
Total Volumes 280 250
====== ======
Florida Gas Volumes (100%) 102 105
====== ======
</TABLE>
- --------------------------------------------------------------------------------
Energy Services
<TABLE>
<CAPTION>
Three Months
Ended March 31,
---------------------------
1998 1997
------ ------
<S> <C> <C>
Sonat Marketing Sales Volumes (100%)
(Billion Cubic Feet) 360 304
====== ======
Sonat Power Marketing Sales Volumes (100%)
(Thousands of Megawatt Hours) 3,170 1,397
====== ======
</TABLE>
<PAGE> 1
EXHIBIT 99.2
INDEPENDENT AUDITORS' REPORT
The Sole Director
Zilkha Energy Company:
We have audited the accompanying consolidated balance sheets of Zilkha
Energy Company as of December 31, 1996 and 1995, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
years in the three-year period ended December 31, 1996 (not presented
separately herein). These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
Zilkha Energy Company as of December 31, 1996 and 1995, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 1996 in conformity with generally accepted accounting
principles.
As discussed in note 1 to the consolidated financial statements, the
Company has given retroactive effect to the change in accounting for oil and
gas properties from the full cost method to the successful efforts method.
KPMG Peat Marwick LLP
Houston, Texas
December 8, 1997
