-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SjREtKh4Y9F5nnNbtQ/3uNZcXCOK0cYastSm7RjtsPHo6CKsGfqr2SKxk+CX46dt 0pCYfRlcGpG77uRcKUFKKQ== 0000950123-98-000379.txt : 19980119 0000950123-98-000379.hdr.sgml : 19980119 ACCESSION NUMBER: 0000950123-98-000379 CONFORMED SUBMISSION TYPE: 8-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19980105 ITEM INFORMATION: ITEM INFORMATION: FILED AS OF DATE: 19980116 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: K N ENERGY INC CENTRAL INDEX KEY: 0000054502 STANDARD INDUSTRIAL CLASSIFICATION: NATURAL GAS TRANSMISSION & DISTRIBUTION [4923] IRS NUMBER: 480290000 STATE OF INCORPORATION: KS FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 8-K SEC ACT: SEC FILE NUMBER: 001-06446 FILM NUMBER: 98508746 BUSINESS ADDRESS: STREET 1: 370 VAN GORDON ST STREET 2: PO BOX 281304 CITY: LAKEWOOD STATE: CO ZIP: 80228-8304 BUSINESS PHONE: 3039891740 MAIL ADDRESS: STREET 1: 370 VAN GORDON STREET STREET 2: P O BOX 281304 CITY: LAKEWOOD STATE: CO ZIP: 80228-8304 FORMER COMPANY: FORMER CONFORMED NAME: KN ENERGY INC DATE OF NAME CHANGE: 19920430 FORMER COMPANY: FORMER CONFORMED NAME: KANSAS NEBRASKA NATURAL GAS CO INC DATE OF NAME CHANGE: 19830403 8-K 1 FORM 8-K 1 ============================================================================= SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549-1004 -------------------- FORM 8-K -------------------- CURRENT REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED) DECEMBER 18, 1997 ------------------- K N ENERGY, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) ------------------- KANSAS 1-6446 48-0290000 (State or other (Commission File Number) (I.R.S. Employer jurisdiction of Identification No.) incorporation or organization) 370 VAN GORDON STREET P.O. BOX 281304 LAKEWOOD, COLORADO 80228-8304 (Address of Principal (Zip Code) Executive Offices) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (303) 989-1740 ============================================================================= 2 ITEM 5. OTHER EVENTS On December 18, 1997, K N Energy, Inc., a Kansas corporation (the "Company"), and Occidental Petroleum Corporation, a Delaware corporation ("Occidental"), entered into a Stock Purchase Agreement, upon and subject to the terms and conditions of which the Company will acquire all of the issued and outstanding shares of common stock, par value $.01 per share, of MidCon Corp., a Delaware corporation and a wholly owned subsidiary of Occidental ("MidCon"), for $3.49 billion (including assumption of indebtness). Copies of (i) MidCon's financial statements for the year ended December 31, 1996, (ii) MidCon's financial statements for the nine months ended September 30, 1997 and (iii) unaudited pro forma consolidated financial statements are attached hereto as Exhibits 7(1), 7(2) and 7(3), respectively, and are incorporated herein by reference. ITEM 7. FINANCIAL STATEMENT AND EXHIBITS. (a) FINANCIAL STATEMENTS OF BUSINESS TO BE ACQUIRED The financial statements relative to the proposed acquisition of MidCon from Occidental described in Item 5 of Form 8-K of K N Energy, Inc. dated January 16, 1998 are attached hereto as exhibits and incorporated herein by this reference. (b) UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION The unaudited pro forma consolidated financial information relative to the proposed acquisition of MidCon from Occidental described in Item 5 of Form 8-K of K N Energy, Inc. dated January 16, 1998 is attached hereto as an exhibit and incorporated herein by this reference. (c) EXHIBITS [CAPTION] EXHIBIT DESCRIPTION NO. - ------- ----------- 1 Financial Statements for MidCon Corp. and subsidiaries for the year ended December 31, 1996. 2 Financial Statements for MidCon Corp. and subsidiaries for the nine months ended September 30, 1997. 3 Unaudited Pro Forma Consolidated Financial Information. 99 Consent of Arthur Andersen LLP.
3 2 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. K N Energy, Inc. Dated: January 16, 1998 By: /s/ Clyde E. McKenzie ______________________________ Clyde E. McKenzie Vice President and Chief Financial Officer 4 EXHIBIT INDEX EXHIBIT NO. DESCRIPTION - ----------- ----------- 1 Financial Statements for MidCon Corp. and subsidiaries for the year ended December 31, 1996. 2 Financial Statements for MidCon Corp. and subsidiaries for the nine months ended September 30, 1997. 3 Unaudited Pro Forma Consolidated Financial Information. 99 Consent of Arthur Andersen LLP. EX-99.1 2 FINANCIAL STATEMENTS 1 EXHIBIT 1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Board of Directors of Midcon Corp.: We have audited the accompanying consolidated balance sheets of MIDCON CORP. (a Delaware corporation and a wholly-owned subsidiary of Occidental Petroleum Corporation) and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholder's equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of MidCon Corp. and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Chicago, Illinois January 31, 1997 1 2 MIDCON CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, (THOUSANDS)
1996 1995 1994 ---------- ---------- ---------- REVENUES: Gas sales, transportation, storage and other operating revenues............................... $2,574,211 $2,038,444 $2,109,834 Interest and other income (Note 3.h)................ 1,187 11,686 24,486 Earnings of pipeline ventures (Note 16)............. 12,716 18,155 13,100 ---------- ---------- ---------- 2,588,114 2,068,285 2,147,420 ---------- ---------- ---------- COSTS AND OTHER DEDUCTIONS: Cost of sales....................................... 1,981,235 1,473,370 1,561,331 Selling, general and administrative and other operating expenses (Note 3.n).................... 108,347 167,235 109,556 Depreciation (Note 3.f)............................. 177,511 193,112 191,672 Taxes other than income taxes....................... 46,226 42,357 45,585 Interest expense (Note 2.a)......................... 79,626 23,286 8,101 Other............................................... 2,000 1,646 1,802 ---------- ---------- ---------- 2,394,945 1,901,006 1,918,047 ---------- ---------- ---------- INCOME BEFORE INCOME TAXES............................ 193,169 167,279 229,373 PROVISIONS FOR AND CHARGE-IN-LIEU OF INCOME TAXES (Note 7)............................................ 76,684 60,653 85,164 ---------- ---------- ---------- NET INCOME............................................ $ 116,485 $ 106,626 $ 144,209 ========= ========= =========
The accompanying notes are an integral part of these financial statements. 2 3 MIDCON CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AT DECEMBER 31, (THOUSANDS) ASSETS
1996 1995 ----------- ----------- CURRENT ASSETS: Cash and cash equivalents (Note 3.c).................................................. $ 4,258 $ 10,414 Restricted deposits (Note 3.g)........................................................ 38,623 24,645 Receivables Affiliated companies (Note 3.d)..................................................... 415,643 222,979 Customers........................................................................... 9,363 3,362 Other............................................................................... 26,324 26,781 Interest-bearing receivables, net -- affiliated companies (Note 3.c and 14)........... 25,361 -- Gas transportation imbalances (Note 3.i).............................................. 56,106 77,131 Materials and supplies (Note 3.e)..................................................... 11,718 16,821 Net properties to be dividended, net of tax (Note 2.d)................................ 308,804 -- Gas stored underground (Note 15)...................................................... 39,343 66,732 Prepayments........................................................................... 20,187 12,535 Deferred income taxes (Note 7)........................................................ 77,277 100,348 ----------- ----------- Total Current Assets............................................................ 1,033,007 561,748 ----------- ----------- PROPERTY, PLANT AND EQUIPMENT (Note 2.c and 3.f)........................................ 6,876,061 8,069,359 Accumulated depreciation (Note 2.c)................................................... (1,785,257) (2,005,399) ----------- ----------- Net Property, Plant and Equipment (Note 3.m).................................... 5,090,804 6,063,960 ----------- ----------- LONG-TERM INTERCOMPANY RECEIVABLE (Note 7).............................................. 33,197 -- GAS STORED UNDERGROUND -- NONCURRENT (Note 15).......................................... 413,334 378,508 INVESTMENTS IN PIPELINE VENTURES (Note 16).............................................. 53,141 54,184 DEFERRED CHARGES AND OTHER ASSETS....................................................... 28,879 37,094 ----------- ----------- TOTAL ASSETS.................................................................... $ 6,652,362 $ 7,095,494 ========== ========== LIABILITIES AND STOCKHOLDER'S EQUITY CURRENT LIABILITIES: Payables -- Affiliated companies (Note 3.d)..................................................... $ 2,857 $ 6,886 Trade............................................................................... 301,569 108,027 Contract impairment (Note 3.h)...................................................... 1,126 19,708 Other............................................................................... 115,943 121,948 Interest-bearing payables, net -- affiliated companies (Note 3.c and 14).............. -- 87,310 Dividend payable, affiliates (Note 2.d)............................................... 308,804 -- Rate refund provision (Note 5)........................................................ 15,218 3,073 Gas transportation imbalances (Note 3.i).............................................. 83,310 95,841 Current portion of long-term ESOP debt (Note 2.a)..................................... 12,574 -- Other................................................................................. 120,213 70,827 ----------- ----------- Total Current Liabilities....................................................... 961,614 513,620 ----------- ----------- OTHER LIABILITIES AND DEFERRED CREDITS: Reserve for contract impairment (Note 3.h)............................................ 43,775 61,464 Intercompany liability (Note 14)...................................................... 32,696 134,316 Interest-bearing notes, affiliated companies (Notes 2.b and 3.c)...................... 1,600,000 740,583 Long-term ESOP debt (Note 2.a)........................................................ 1,386,026 -- Postretirement benefits other than pensions (Note 8).................................. 89,780 97,200 Other................................................................................. 157,400 227,634 ----------- ----------- Total Other Liabilities and Deferred Credits.................................... 3,309,677 1,261,197 ----------- ----------- DEFERRED INCOME TAXES (Note 2.c and 7).................................................. 1,680,354 1,987,290 ----------- ----------- CONTINGENT LIABILITIES AND COMMITMENTS (Notes 4, 5, 6 and 12) MINORITY EQUITY IN SUBSIDIARIES AND PARTNERSHIPS (Note 1)............................... 8,076 5,349 ----------- ----------- STOCKHOLDER'S EQUITY: Common Stock, $.01 par value, authorized 2,000,000 shares, outstanding 1,400,000 shares in 1996; $1 par value, authorized 1,000 shares, outstanding 1 share in 1995 (Note 2.b).......................................................................... 14 -- Unearned ESOP shares (Note 9)......................................................... (1,393,849) -- Additional paid-in capital............................................................ 2,000,060 3,358,107 Retained earnings (deficit)........................................................... 86,416 (30,069) ----------- ----------- Total Stockholder's Equity...................................................... 692,641 3,328,038 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY...................................... $ 6,652,362 $ 7,095,494 ========== ==========
The accompanying notes are an integral part of these financial statements. 3 4 MIDCON CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (THOUSANDS)
UNEARNED ADDITIONAL RETAINED COMMON ESOP PAID-IN EARNINGS STOCK SHARES CAPITAL (DEFICIT) ------------ ----------- ---------- --------- BALANCE, DECEMBER 31, 1993............ $ -- $ -- $4,280,577 $ (52,576) Net income............................ -- -- -- 144,209 ---- ----------- ---------- -------- BALANCE, DECEMBER 31, 1994............ -- -- 4,280,577 91,633 Net income............................ -- -- -- 106,626 Dividend of intercompany receivable to Parent (Note 3.c)................... -- -- (922,470) (228,328) ---- ----------- ---------- -------- BALANCE, DECEMBER 31, 1995............ -- -- 3,358,107 (30,069) Net income............................ -- -- -- 116,485 Dividend of subsidiaries and properties (Note 2.c)............... -- -- (672,407) -- Contribution of intercompany debt (Note 2.b).......................... -- -- 914,703 -- Non-cash dividend (Note 2.b).......... -- -- (1,600,000) -- Stock split (Note 2.b) 14 -- (14) -- Unearned ESOP shares (Note 9)......... -- (1,400,000) -- -- Dividends on unearned ESOP shares..... -- -- 3,348 -- Release of ESOP shares, net of tax effect (Note 9)..................... -- 6,151 (3,677) -- ---- ----------- ---------- -------- BALANCE, DECEMBER 31, 1996............ $ 14 $(1,393,849) $2,000,060 $ 86,416 ==== =========== ========== ========
The accompanying notes are an integral part of these financial statements. 4 5 MIDCON CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, (THOUSANDS)
1996 1995 1994 --------- --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net Income............................................... $ 116,485 $ 106,626 144,209 Income adjustments -- Depreciation.......................................... 177,511 193,112 191,672 Deferred income tax benefit........................... (1,909) (65,710) (372) Other noncash charges (credits) to income, net (Note 3.h and 3.n)........................................ 28,966 43,382 (15,030) Distributions from (to) pipeline ventures, net of earnings............................................ 1,385 (3,439) 5,567 Compensation expense (Note 9)......................... 217 -- -- Changes in operating assets and liabilities: Decrease in accounts receivable....................... 1,248 2,166 17,320 Decrease (increase) in accounts receivable from affiliates.......................................... (190,120) 17,405 15,425 Decrease in inventories............................... 32,492 16,448 9,193 Decrease (increase) in prepaid and other assets....... (26,384) (7,959) 39,304 Change in gas transportation imbalances, net.......... 8,494 (4,513) 11,463 Increase (decrease) in accounts payable and accrued liabilities (Note 5)................................ 150,089 (160,088) 88,447 Decrease in accounts payable to affiliates............ (4,029) (752) (23,882) Increase (decrease) in income taxes................... (2,805) 4,319 2,979 Other operating, net..................................... (24,567) 26,308 (31,912) --------- --------- --------- Net cash provided by operating activities........ 267,073 167,305 454,383 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures..................................... (146,883) (150,229) (92,656) Acquisition of cushion gas............................... (91,212) -- -- Proceeds (costs) from disposal of property, plant and equipment, net........................................ 4,111 (2,682) (1,572) Other investing, net..................................... (1,008) 267 (1,651) --------- --------- --------- Net cash used by investing activities............ (234,992) (152,644) (95,879) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Retirement of debt....................................... (7,500) (500) (500) Amounts paid to minority interest........................ (2,583) (3,745) (1,936) Net change in interest-bearing receivables/payables with affiliated companies and intercompany liability....... (28,154) (8,100) (352,570) --------- --------- --------- Net cash used in financing activities............ (38,237) (12,345) (355,006) --------- --------- --------- Increase (decrease) in cash and cash equivalents........... (6,156) 2,316 3,498 --------- --------- --------- Cash and cash equivalents at beginning of year............. 10,414 8,098 4,600 --------- --------- --------- Cash and cash equivalents at end of year................... $ 4,258 $ 10,414 $ 8,098 ========= ========= =========
The accompanying notes are an integral part of these financial statements. 5 6 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) DESCRIPTION OF COMPANY MidCon Corp. (Company) is a wholly-owned subsidiary of Occidental Petroleum Corporation (Occidental). The Company through its subsidiaries engages in interstate and intrastate natural gas transmission and marketing as well as electric power marketing. The Company's subsidiaries purchase, transport, store and process gas and sell gas to utilities, municipalities and industrial and commercial users. Another subsidiary purchases electricity from electric utilities and other electric power producers and marketers and resells electricity to wholesale customers. The principal subsidiaries of the Company are Natural Gas Pipeline Company of America (Natural), which operates a major interstate pipeline transmission system along with several storage facilities; MidCon Texas Pipeline Operator, Inc., (MTPO), which operates an intrastate pipeline system in Texas (see Note 2.c and 2.d); MidCon Gas Services Corp., which together with its subsidiaries, (MidCon Gas), engages in the purchase and sale of gas and arranges for the transportation and storage of natural gas; and MidCon Power Services Corp. (MidCon Power), which engages in the purchase and sale at wholesale of electric power and arranges for the transmission of such power. Other subsidiaries of the Company own interests in several gas pipeline joint ventures (see Note 16). Natural's interstate pipeline and storage operations are subject to extensive regulation by the Federal Energy Regulatory Commission (the "FERC"). The FERC regulates, among other things, rates and charges for storage and transportation of gas in interstate commerce, the construction and operation of interstate pipeline facilities and the accounts and records of interstate pipelines. Certain of MidCon Texas Pipeline Corp.'s (MidCon Texas) and MTPO's rates and other aspects of its business are subject to regulation by the Texas Railroad Commission. (2) MIDCON RECAPITALIZATION (a) ESOP In November 1996, Occidental established the MidCon Corp. Employee Stock Ownership Plan (ESOP) (see Note 9) for the benefit of the employees of the Company and its subsidiaries. Also, in November 1996, Occidental sold $1.4 billion of Occidental's Cumulative MidCon-Indexed Convertible Preferred Stock (CMIC Preferred Stock) to the MidCon Corp. ESOP Trust (the Trust). The CMIC Preferred Stock is convertible into Occidental common stock based on the value of the Company. The Trust paid for the CMIC Preferred Stock with a $1.4 billion 30-year promissory note (ESOP note), bearing interest at 7.9 percent per annum, guaranteed by the Company. Principal and interest payments on the ESOP note are due on December 31 in annual installments of approximately $123 million, commencing December 31, 1997, and continuing up to and excluding December 31, 2026, upon which date all principal and interest remaining unpaid shall be immediately due and payable. Dividends on the CMIC Preferred Stock are payable at an annual rate of $21 per share, when and as declared by Occidental's Board of Directors. It is anticipated that the Company will make discretionary annual contributions to the MidCon ESOP which, together with the annual dividends, will be used to repay the ESOP note. Dividends of $3.3 million on unearned shares and cash payments of $9.2 million were used for debt service on the ESOP note in 1996. Future earnings will be reduced by interest expense on the $1.4 billion ESOP note and compensation expense as discussed in Note 9. (b) Other Capital Transactions Concurrent with the establishment of the ESOP, several transactions were recorded. The Company had a 1,400,000-for-one split of the outstanding shares of its common stock while the par value of such stock was 6 7 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) changed from $1.00 per share to $.01 per share. Occidental contributed to the capital of the Company $741 million of promissory notes previously issued by the Company and $154 million of non-interest bearing intercorporate advances made by Occidental to the Company that were outstanding as of November 30, 1996. In addition, the Company declared a dividend, payable in the form of a $1.6 billion note payable to Occidental. The principal amount of this note is due and payable on December 31, 2026 and bears interest at an annual rate of 7.9 percent payable monthly through December 31, 2001. Thereafter, the rate changes to the London Interbank Offered Rate (LIBOR) plus 1.25 percent. Future earnings will be reduced by interest expense on the $1.6 billion note payable. (c) Dividend of Subsidiaries and Properties During 1996, the Company dividended all the outstanding shares of common stock of its subsidiaries, Occidental Energy Ventures Corp. (OEVC) and MC Panhandle, Inc., to Occidental. Properties from other Company subsidiaries comprising certain oil and gas properties and well compressor properties were dividended to Occidental effective on December 31, 1996. The net income from these operations was $15 million, $9 million and $10 million for the twelve months ended December 31, 1996, 1995 and 1994, respectively. Also, effective December 31, 1996, the Company dividended 51 percent of its interest in an intrastate pipeline limited liability partnership to Occidental (see Note 2.d). A summary of the 1996 adjustments showing the effect of the above transactions on certain balance sheet accounts is presented below (in millions):
INCREASE (DECREASE) ---------- Property, Plant and Equipment..................................... $ (1,339) Accumulated Depreciation.......................................... $ (345) Deferred Income Taxes............................................. $ (322) Additional Paid-in Capital........................................ $ (672)
(d) Lease of Intrastate Pipeline Assets In December 1996, the Company merged its subsidiary MidCon Texas into a limited partnership which then owned its Texas intrastate pipeline and related facilities. On December 31, 1996, fifty-one percent of the Company's ownership in the partnership was dividended to a subsidiary of Occidental with a dividend of the remaining 49 percent to be paid on January 1, 1998. This 49 percent interest is reflected in the accompanying consolidated balance sheets as "Net properties to be dividended, net of tax." The Company formed a new subsidiary, MTPO, which assumed certain of the contracts and obligations of MidCon Texas before the merger. In addition, MTPO entered into an agreement with the limited partnership to lease the intrastate pipeline system owned by the limited partnership over a 30 year period commencing on January 1, 1997. The Company accounts for this lease as an operating lease. The initial annual lease fee is $30 million in 1997. The lease fee changes to $20 million for the years 1998 through 2001, $40 million for the years 2002 through 2005 and $30 million during the remaining lease term. Lease expense of $30 million will be recognized annually. The lease agreement requires MTPO to pay for taxes, insurance and maintenance expense and contains restrictions concerning additions, dispositions and modifications to the leased property. The annual lease fee approximates MidCon Texas' 1996 depreciation expense and any difference is not expected to have a material impact on future years' net income. 7 8 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (3) SIGNIFICANT ACCOUNTING POLICIES (a) Principles of Consolidation and Basis of Presentation The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. The consolidated balance sheet at December 31, 1996, reflects the transactions discussed in Note 2. The consolidated income statement presented for 1996 includes the results of operations for the assets dividended for the entire twelve months with the exception of OEVC, which is included for nine months. All material intercompany transactions have been eliminated. The equity method of accounting is used for investments in pipeline ventures in which 50 percent or less of the voting interest is owned. The Company's financial statements reflect adjustments needed to present transactions with Occidental on a stand-alone basis. Certain reclassifications have been made to the prior years' financial statements to conform to the 1996 presentation. (b) Accounting Changes The Company's adoption of Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of", effective January 1, 1996, which assumed that the Company will continue to operate, maintain and, where appropriate, expand its business, did not have an impact on the Company's consolidated financial position or results of operations. The provisions require the Company to review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If it is determined that an impairment loss has occurred based on expected future cash flows, then a loss will be recognized in the income statement using a fair-value based model. (c) Cash and Cash Equivalents and Interest-Bearing Receivables/Payables, Net -- Affiliated Companies Cash equivalents consist of interest bearing commercial paper and other bank deposits with initial maturities of three months or less. Cash equivalents totaled approximately $1.5 million and $1.7 million at December 31, 1996 and 1995, respectively. Occidental and its subsidiaries utilize a cash-management system designed to minimize cash balances and external borrowing. Amounts due from or to affiliates under this program are reflected as current assets and liabilities in the accompanying financial statements. Interest income and expense is allocated to the participating companies on the basis of the principal contributed or borrowed, respectively. The Company has periodically dividended, to its parent company, its interest bearing receivables from Occidental under the former cash management system. In November 1996, the Company entered into a new intercompany cash management agreement with Occidental. This agreement, which is effective January 1, 1997, engages Occidental to continue to provide the Company with certain financing and cash management services. During 1995, the Company declared a dividend to Occidental of an intercompany receivable due from a then wholly-owned subsidiary. The balance of the intercompany receivable, which prior to the dividend was eliminated in the Company's, consolidation, is shown on the December 31, 1995 consolidated balance sheet as a noncurrent interest-bearing payable to affiliated companies representing an amount due Occidental (see Note 2.b). (d) Receivables/Payables with Affiliated Companies Receivable and payable balances with affiliates arise from transactions between the Company's subsidiaries and Occidental's other subsidiaries. These transactions occur in the normal course of business at prices which approximate market. 8 9 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company transfers to an Occidental special purpose affiliate certain trade receivables under a revolving sales program with limited recourse, in connection with the ultimate sale for cash of such receivables. The Company retains the collection responsibility with respect to the receivables sold. An interest in new receivables is transferred monthly, representing the net difference between newly created receivables and collections made from customers. Fees and expenses related to the sales of receivables under this program are included in Selling, general and administrative and other operating expenses. (e) Inventories Inventories are stated at the lower of cost or market. Inventories of natural gas are determined using the average-cost method by MidCon Gas and the last-in, first-out (LIFO) method by Natural (see Note 15). The cost of materials and supplies inventories is determined using the average-cost method. (f) Property, Plant and Equipment and Related Depreciation Property additions and major renewals and improvements are capitalized at cost. Interest costs incurred in connection with capital expenditures are capitalized and amortized over the lives of the related assets. Depreciation of natural gas transmission facilities is provided using primarily the straight-line method. Prior to the dividend of its oil and gas properties to Occidental, the Company accounted for these properties using the successful-efforts method. Costs of acquiring nonproducing acreage, costs of drilling successful explorations wells and development costs were capitalized (see Note 2.c). Depreciation of oil and gas producing properties was determined by the units-of-production method and was based on estimated recoverable reserves. Effective January 1, 1996, MidCon Texas revised the estimated average useful lives used to compute depreciation to a remaining useful life of 38 years. This revision was made to more properly reflect the current economic lives of the assets based on anticipated industry conditions. The aggregate effect of this change was an increase in net income for the year ended December 31, 1996 of $14.9 million. Property, plant and equipment includes purchase price adjustments related to the acquisition of the Company by Occidental in 1986, For Natural's rate making purposes, recovery is limited to the original cost of property, plant and equipment which includes an allowance for funds used during construction. The allocated purchase price, less subsequent accumulated depreciation, exceeded the amount subject to recovery through the rate-regulatory process by $4.1 billion and $4.2 billion at December 31, 1996 and 1995, respectively. This excess amount as of December 31, 1996 is being depreciated over a remaining period of 37 years. (g) Restricted Deposits The Company engages in hedging to decrease its exposure to natural gas price risk. In accordance with New York Mercantile Exchange rules, $38.6 million and $24.6 million of monies on deposit with brokers was restricted at December 31, 1996 and 1995, respectively, to meet trading requirements (see Notes 3.1 and 11). (h) Reserve for Contract Impairment The contract impairment reserve recognizes the disadvantageous aspects of certain gas-purchase and sales contracts resulting from economic and regulatory conditions. Nearly all of these contracts or the disadvantageous aspects of these contracts have now been resolved. The contract impairment reserve includes reserves for the cost of the resolution of these gas purchase and sales contracts, including "take-or-pay" obligations. The noncurrent portion of the reserve was reduced by $52 million and $66 million in 1996 and 1995, respectively, with no impact on net income, primarily to reflect the settlement of an impaired contract, partial payment thereon and the payment of above market costs. 9 10 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The noncurrent portion of the reserve was reduced by $20 million in 1994 to reflect a decrease in the net exposure under disadvantageous gas purchase contracts, the elimination of certain potential claims, the successful resolution of litigation, settlements or other changes in the expected outcome of matters covered by the reserve. (i) Gas Transportation Imbalances Gas transportation imbalances receivable and payable reflect gas volumes owed to Natural, MTPO and MidCon Gas or to their customers. For MTPO and MidCon Gas, imbalances are valued primarily at the weighted average Cost of purchased gas. Natural's current imbalances are being settled on a monthly basis through established cashout procedures. These imbalances are valued at the applicable percentage of an average monthly index price determined in the month the imbalance occurred. The remaining imbalances not under the cashout procedure are valued primarily at the current market price. (j) Supplemental Cash Flow Information Cash payments during the years 1996, 1995 and 1994 included income taxes of approximately $5.0 million, $6.4 million and $4.7 million, respectively. Interest paid for the same period, net of amounts capitalized, was $74.3 million, $.3 million and $2.9 million. (k) Fair Value of Financial Instruments Statement of Financial Accounting Standards No. 107, "Disclosures about Fair Value of Financial Instruments" requires the disclosure of the fair value of off- and on-balance sheet financial instruments, The Company has no material off-balance sheet financial instruments. All balances reflected in the consolidated balance sheets for financial instruments approximate market value. (l) Hedging Activities The Company uses commodity futures contracts, options and swaps to hedge the impact of natural gas price fluctuations related to its business activities. Gains and losses on hedge contracts are deferred and recognized as an adjustment to sales revenue or purchase costs when the related transaction being hedged is finalized (see Note 11). (m) Risks and Uncertainties The process of preparing consolidated financial statements in conformity with generally accepted accounting principles (GAAP) requires the use of estimates and assumptions regarding certain types of assets, liabilities, revenues and expenses. Such estimates primarily relate to unsettled transactions and events as of the date of the consolidated financial statements. Accordingly, upon settlement, actual results may differ from estimated amounts, generally not by material amounts. Management believes that these estimates and assumptions provide a reasonable basis for the fair presentation of the Company's financial position and results of operations. Included in the accompanying balance sheet is net property, plant and equipment at a carrying value of $5.1 billion as of December 31, 1996. These carrying values are based on the Company's plans and intentions to continue to operate, maintain and, where it is economically desirable, to expand its businesses. If future economic conditions result in changes in management's plans or intentions, the carrying values of the affected assets will be reviewed again and any appropriate adjustments made. 10 11 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (n) Liabilities Accrued liabilities current and other noncurrent liabilities include reserves relating to a reorganization of the Company's operations initiated in 1995 which were initially recorded as selling, general and administrative and other operating expenses for $37 million during the fourth quarter of 1995. The current and noncurrent portion of the reserve totaled approximately $9 million and $12 million, respectively, at December 31, 1996 and $16 million and $21 million, respectively, at December 31, 1995. (4) LITIGATION There are various lawsuits and proceedings pending against the Company and its subsidiaries. It is impossible at this time to determine the ultimate legal liabilities that may arise therefrom. However, in management's opinion, after taking into account reserves, the pending lawsuits and proceedings and claims should not have a material adverse effect upon the consolidated financial position or results of operations of the Company. (5) REGULATORY MATTERS On December 1, 1992, Natural filed with the FERC for a general rate increase to recover higher operating costs. The FERC permitted Natural to put the new rates into effect on June 1, 1993, subject to refund. In November 1994, Natural filed a proposed settlement of the rate case with the FERC. The settlement was approved by the FERC in January 1995. This settlement resulted in refunds being made to customers of approximately $128 million in 1995. On June 1, 1995, Natural filed a general rate case with the FERC to establish new rates as well as new or revised services. The FERC permitted Natural to place new rates and services into effect, subject to refund, on December 1, 1995. This date corresponded to the effective date of new transportation and storage agreements between Natural and its principal local distribution customers. Major issues in the rate case include throughput levels used in the design of rates, discounting adjustments, levels of depreciation rates and return on investment, and the level and design of fuel rates. In May 1996, Natural filed with the FERC an offer of settlement to resolve the remaining issues in this proceeding. Natural is currently negotiating with intervenors to reach accommodations to allow the settlement to be certified as unopposed. In 1994, a federal appellate court remanded to the FERC two orders determining that Great Lakes Gas Transmission Limited Partnership ("Great Lakes") should implement incremental rates rather than rolled in rates to recover the costs of certain expansions to its pipeline system. Under those orders, the customers of Great Lakes for which the expansion facilities had been built paid an incremental rate to cover the cost of the facilities while rates to other shippers, such as Natural, were unaffected. In June 1995, the FERC issued an order reversing its prior incremental rate decisions with retroactive effect to November 1991. As a result of the 1995 order, Natural has paid Great Lakes an additional $13.5 million for the period from November 1, 1991 through November 1, 1995, the date Natural's contract with Great Lakes terminated. Natural's request for rehearing of the FERC's June 1995 order was denied and Natural has sought judicial review of this FERC decision. Natural has also filed a mechanism for recovery of the additional amounts paid to Great Lakes as a result of the June 1995 order. The FERC issued an order that would permit Natural to recover from its customers any allocated and approved costs from Great Lakes for post-December 1, 1993 service. In January 1997, the FERC approved a settlement filed by Natural that resolves all issues related to Natural's recovery from customers of a portion of the additional payment made to Great Lakes. In January 1997, Amoco Production Company and Amoco Energy Trading Corporation ("Amoco") filed a complaint against Natural before the FERC contending that Natural had improperly provided its affiliate, MidCon Gas Services Corp. ("MidCon Gas"), transportation service on preferential terms. Amoco has requested, among other things, that the FERC require Natural to terminate the transportation services it 11 12 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) provides to MidCon Gas. Natural believes it has treated all shippers, including Amoco, fairly and it will vigorously defend its actions. (6) CONTINGENT LIABILITIES AND COMMITMENTS Natural has been a party to a number of contracts that required Natural to purchase natural gas at prices in excess of the prevailing market price. As a result of a FERC order (Order 636) prohibiting interstate pipelines from using their gas transportation and storage facilities to market gas to sales customers, Natural no longer had a sales market for the gas it is required to purchase under these contracts. Order 636 went into effect on Natural's system on December 1, 1993. Natural has agreed to pay substantial transition costs to reform these contracts with gas suppliers. Settlement agreements reached by Natural and its former sales customers, under which Natural is recovering from those customers over a four year period beginning December 1, 1993, a significant amount of the gas supply realignment (GSR) costs it incurs, have been approved by the FERC. The FERC has also permitted Natural to implement a tariff mechanism to recover additional portions of its GSR costs in rates charged to transportation customers that were not party to the settlements. In July 1996, a Federal appellate court remanded Order 636 to the FERC for further explanation of aspects of its decision regarding recovery of GSR costs by interstate pipelines. The Company has certain other commitments and contingent liabilities under contracts, guarantees and joint ventures. In management's opinion, after taking into account reserves, none of such commitments and contingencies discussed above should have a material adverse effect upon the consolidated financial position or results of operations of the Company. (7) INCOME TAXES The Company and its subsidiaries are included in Occidental's consolidated federal tax return and unitary state tax returns. The consolidated provisions for these income taxes are allocated to the Company on the basis of a tax sharing agreement with Occidental. Under the agreement, the amount of consolidated current and deferred tax provisions is determined as if the Company were a corporation that was not owned by Occidental and filed a separate consolidated income tax return. In addition, state income taxes are provided in all states in which the Company is included in a state return with Occidental, notwithstanding that the Company may not have been subject to tax in that jurisdiction but for its affiliation with Occidental. Taxable gains were recorded by the Company resulting from dividends and asset transfers to Occidental during 1996 (see Note 2.c), Since the Company is included in the consolidated federal income tax return with Occidental, these taxable gains are deferred until the Company is transferred outside the consolidated group. Under the Company's tax sharing agreement, the tax payments associated with the gains will be reimbursed to the Company over the remaining tax lives of the transferred assets. A long-term intercompany receivable from Occidental has been recorded on the consolidated balance sheet to reflect these reimbursements. 12 13 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The provisions (credits) for income taxes for the years ended December 31 were as follows (in millions):
ALLOCATED CONSOLIDATED TAXES STATE TOTAL ------------ ----- ------ 1996 Current........................................... $ 68.0 $10.6 $ 78.6 Deferred.......................................... (2.0) .1 (1.9) ------ ----- ----- $ 66.0 $10.7 $ 76.7 ====== ===== ===== 1995 Current........................................... $115.6 $10.8 $126.4 Deferred.......................................... (60.4) (5.3) (65.7) ------ ----- ----- $ 55.2 $ 5.5 $ 60.7 ====== ===== ===== 1994 Current........................................... $ 79.0 $ 6.5 $ 85.5 Deferred.......................................... 1.0 (1.4) (.4) ------ ----- ----- $ 80.0 $ 5.1 $ 85.1 ====== ===== =====
The following is a reconciliation, stated as a percentage of pretax income, of the U.S. statutory federal income tax rate to the Company's effective allocated consolidated tax rate on income:
FOR THE YEARS ENDED DECEMBER 31, ------------------------------ 1996 1995 1994 ---- ---- ---- U.S. federal statutory tax rate......................... 35% 35% 35% State taxes, net of federal benefit..................... 5 3 2 Income tax reserve no longer required................... -- (2) -- --- --- --- Allocated consolidated tax rate......................... 40% 36% 37% === === ===
Tax effects of temporary differences at December 31, 1996 and 1995 were as follows (in millions):
1996 1995 -------------------------- -------------------------- DEFERRED DEFERRED DEFERRED DEFERRED ITEMS RESULTING IN TEMPORARY TAX TAX TAX TAX DIFFERENCES ASSETS LIABILITIES ASSETS LIABILITIES --------------------------------------- -------- ----------- -------- ----------- Property, plant and equipment, net..... $ -- $ 1,866 $ -- $ 2,182 Contract impairment reserves........... 49 -- 74 -- Postretirement benefit accruals........ 47 -- 47 -- State income taxes..................... 91 28 99 23 Regulatory liabilities................. 39 -- 32 -- Investment in partnerships............. 8 23 9 25 All other.............................. 107 27 92 10 ---- ------ ---- ------ Total deferred taxes......... $341 $ 1,944 $353 $ 2,240 ==== ====== ==== ======
(8) RETIREMENT AND POSTRETIREMENT BENEFITS The Company's retirement and postretirement defined benefit plans are accrued based on various assumptions and discount rates, as described below. The actuarial assumptions used could change in the near term as a result of changes in expected future trends and other factors which, depending on the nature of the changes, could cause increases or decreases in the liabilities accrued. 13 14 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Pension costs for the Company's defined benefit pension plan, determined by independent actuarial valuations, are funded by payments to trust funds, which are administered by independent trustees. The components of the net pension cost for 1996, 1995 and 1994 were as follows (in millions):
FOR THE YEARS ENDED DECEMBER 31, ----------------------------- 1996 1995 1994 ----- ----- ----- Service cost -- benefits earned during the period....... $ 1.4 $ 1.4 $ 1.4 Interest cost on projected benefit obligation........... 0.7 0.5 0.5 Actual return on plan assets............................ (0.7) (0.7) (0.1) Net amortization and deferral........................... -- 0.1 (0.4) ----- ----- ----- Net pension cost........................................ $ 1.4 $ 1.3 $ 1.4 ===== ===== =====
The following table sets forth the plan's funded status and amounts recognized in the Company's consolidated balance sheets at December 31, 1996 and 1995 (in millions):
BALANCE AT DECEMBER 31, ------------------------------- 1996 1995 ------------- ------------- ACCUMULATED ACCUMULATED BENEFITS BENEFITS EXCEED ASSETS EXCEED ASSETS ------------- ------------- Present value of the estimated pension benefits to be paid in the future: Total projected benefit obligations.................... 10.6 8.8 Estimated fair value of plan assets.................... 9.4 7.7 ----- ----- Projected benefit obligations in excess of plan assets.............................................. $ 1.2 $ 1.1 ===== ===== Projected benefit obligations in excess of plan assets.............................................. $ 1.2 $ 1.1 Unrecognized prior service benefit..................... 0.1 0.2 Unrecognized net loss.................................. (0.7) (0.5) ----- ----- Pension liability...................................... $ 0.6 $ 0.8 ===== =====
The discount rate used in determining the actuarial present value of the projected benefit obligations was 7.5 percent in 1996 and 1995. The rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligations was 5.5 percent in 1996 and 1995. The expected long-term rate of return on assets was 8 percent in 1996 and 1995. The Company provides medical, dental and life insurance for certain active, retired and disabled employees and their eligible dependents. Beginning in 1993, participants pay for all medical cost increases in excess of increases in the Consumer Price Index (CPI). The benefits generally are funded by the Company as the benefits are paid during the year. The cost of providing these benefits is based on claims filed and insurance premiums paid for the period. The total benefits costs were approximately $14.6 million, $15.5 million and $16.3 million in 1996, 1995 and 1994, respectively. The 1996, 1995 and 1994 costs included $5.7 million, $6.6 million and $7.5 million, respectively, for postretirement costs, as discussed below. The postretirement benefit obligation at December 31, 1996 and 1995 was determined by application of the terms of medical, dental, and life insurance plans, including the effect of established maximums on covered costs, together with relevant actuarial assumptions and health-care cost trend rates projected at a CPI increase of 3.0 percent and 4.0 percent in 1996 and 1995, respectively. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.5 percent as of December 31, 1996 and 1995. The Company's funding policy generally is to pay claims as they come due with the exception 14 15 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) of Natural which began funding for its obligation effective June 1, 1993. A FERC policy statement allows collection of these costs currently in rates as the appropriate funds are placed in an irrevocable trust. The trust was established during 1993 and assets are invested in a variety of instruments, such as bonds, money market accounts and equity investments. The following table sets forth the postretirement plan's status, reconciled with the amounts included in the consolidated balance sheets at December 31, 1996 and 1995 (in millions):
BALANCE AT DECEMBER 31, -------------------- 1996 1995 ----- ------ Accumulated postretirement benefit obligation Retirees...................................................... $63.4 $ 75.7 Fully eligible actives........................................ 14.3 8.1 Other actives................................................. 12.4 17.2 ----- ------ Total accumulated postretirement benefit obligation............. 90.1 101.0 Plan assets at fair value....................................... 34.2 26.4 ----- ------ Unfunded status................................................. 55.9 74.6 Unrecognized net gain........................................... 37.9 26.4 ----- ------ Accrued postretirement benefit cost............................. $93.8 $101.0 ===== ======
The benefit obligation decreased due primarily to the effect of the decrease in the CPI discussed above, as well as favorable retiree claims experience. Net periodic postretirement benefit cost for 1996, 1995 and 1994 included the following components (in millions):
FOR THE YEARS ENDED DECEMBER 31, ----------------------------- 1996 1995 1994 ----- ----- ----- Service cost -- benefits attributed to service during the period............................................ $ 1.1 $ 1.1 $ 1.0 Interest cost on accumulated postretirement benefit obligation............................................ 7.2 7.2 7.7 Actual return on plan assets............................ (1.3) (0.7) (0.6) Net amortization and deferral........................... (1.1) (1.0) (0.6) Other................................................... (0.2) -- -- ----- ----- ----- Net periodic postretirement benefit cost................ $ 5.7 $ 6.6 $ 7.5 ===== ===== =====
(9) RETIREMENT PLANS AND ESOP All employees are participants in defined contribution retirement and savings plans. The plans provide for periodic contributions based on the salary and age level of employees and/or employee contributions. The Company's expense under the provisions of the plans was $12.5 million, $13.2 million and $12 million for 1996, 1995 and 1994, respectively. Beginning January 1, 1997, the Company's contribution under the salaried retirement plan, totaling $7.6 million, $7.7 million and $7.4 million for 1996, 1995 and 1994, respectively, will be reduced over time pursuant to the terms of the plan. Effective November 20, 1996, Occidental established the ESOP for all eligible employees of the Company. Generally, the shares of the CMIC Preferred Stock held by the ESOP are released and allocated to participant accounts based on the proportion of the payment on the note for the respective period compared to the total remaining payments due on the note. Dividends on the CMIC Preferred Stock are payable at an annual rate of $21 per share, when and as declared by Occidental's Board of Directors. It is anticipated that the Company will make discretionary annual contributions to the MidCon ESOP which, together with the annual dividends, will be used to repay the ESOP note. The Company accounts for its ESOP in accordance 15 16 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) with Statement of Position 93-6, "Employers' Accounting for Employee Stock Ownership Plans" which requires that compensation expense be measured based on the fair value of shares committed to be released. The ESOP loan guarantee is recorded as a long-term intercompany liability and the shares of CMIC Preferred Stock pledged as collateral are reported as unearned ESOP shares in the consolidated balance sheet. As shares are released from collateral, the Company reports compensation expense equal to the estimated current market price of the shares. Dividends on allocated ESOP shares result in a reduction to additional paid-in capital. Dividends on unallocated ESOP shares will be used to satisfy debt service. ESOP compensation expense was $217,000 for 1996. The ESOP has 6,151 allocated shares and 1,393,849 unreleased shares outstanding at December 31, 1996. (10) STOCK BASED COMPENSATION PLANS Certain Company executives participate in various Occidental incentive stock plans. These plans include options with vesting terms of 3 years and maximum terms of 10 years and one month, Under these plans, 168,000 and 143,332 options were granted for the years ended December 31, 1996 and 1995, respectively. In addition, 4,589 and 10,909 of Occidental's $.20 par value restricted stock were granted during the years ended December 31, 1996 and 1995, respectively. These grants vest after 4 years (5 years for awards issued prior to December 1995) or earlier under certain conditions. The Company accounts for these plans under Accounting Principles Board Opinion No. 25. The difference in compensation expense for these plans determined in accordance with SFAS No. 123, "Accounting for Stock Based Compensation" is not significant. (11) HEDGING ACTIVITIES The Company uses commodity futures contracts, options and swaps to hedge the impact of natural gas price fluctuations related to two major categories of business: purchases for and sales from storage and fixed-price sales and purchase contracts. STORAGE Storage activities consist of purchasing and injecting natural gas into storage during low-price, low-demand periods (typically the months of April through October) and withdrawing that gas for sale during high-price, high-demand periods (typically the period from November through March). These periods may vary depending primarily on weather conditions and competing fuel prices in the market areas. The Company uses derivatives (mainly futures contracts) to hedge the sales and purchase prices related to its storage program. The hedging contracts used have terms of less than 18 months. Gains and losses on these hedging contracts are deferred and recognized in income when the transactions being hedged are finalized. A small number of options were sold against inventory capacity or physical inventory with results included in periodic income. FIXED-PRICE SALES AND PURCHASES Fixed-price gas sales and purchase contracts vary by agreement. Hedges are placed nearly simultaneously with the consummation of many of the sales-purchase agreements. All agreements are for less than 18 months. Gains and losses on these hedging contracts are deferred and recognized in income when the transactions being hedged are finalized. New York Mercantile Exchange (NYMEX), Kansas City Board of Trade (KCBT), (collectively, the Exchanges) and over-the-counter (OTC) hedge instruments are utilized. 16 17 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) All hedging activity is matched to physical natural gas buying and selling activity and is done with natural gas futures or derivative instruments. There is essentially no discrepancy with regard to timing, i.e., hedges are placed for the same month in which the price risk for the underlying physical movement is anticipated to occur, based on analysis of sales and purchase contracts and historical data. Hedges are removed upon consummation of the underlying physical activity. All deferred gains or losses are then recognized. Because the commodity covered by the Exchanges' natural gas futures contracts is substantially the same commodity that the Company buys and sells in the physical market, no special correlation studies, other than monitoring the degree of convergence between the futures and the cash markets, are deemed necessary. Geographic basis risk (the difference in value of gas at the Exchanges' delivery points versus the points of the Company's transaction) is monitored and where appropriate, hedged using OTC instruments. Exchange-traded futures and options are valued using settlement prices published by the Exchanges. OTC options are valued using a standard option pricing model that requires published exchange prices, market volatility per broker quotes, and the time value of money. Swaps are valued by comparing current broker quotes for price or basis with the corresponding price or basis in the related swap agreement and then discounting the result to present value. Although futures and options traded on the Exchanges are included in the table below, they are not financial instruments as defined in GAAP, since physical delivery of natural gas may be, and occasionally is, made pursuant to these contracts. However, they are a major part of the Company's commodity risk management program. The following table summarizes the types of hedges used and the related financial information as of December 31, 1996 and 1995:
OVER-THE- EXCHANGES (a) COUNTER(b) TOTAL ------------- ------------- ------------- HEDGES OF 1996 1995 1996 1995 1996 1995 ------------ ---- ---- ---- ---- ---- ---- (NOTIONAL VOLUMES IN BCF) Price Hedge: Futures........................... Purchases 32 62 -- -- 32 62 Swaps............................. Purchases -- -- -- 8 -- 8 Sales -- -- 1 -- 1 -- Options........................... Purchases -- -- 2 -- 2 -- Basis Hedge: Basis Swaps(c).................... Purchases -- -- 33 9 33 9 Sales -- -- 34 7 34 7
OVER-THE- EXCHANGES COUNTER BOOK VALUE FAIR VALUE ----------- ----------- ----------- ----------- 1996 1995 1996 1995 1996 1995 1996 1995 ---- ---- ---- ---- ---- ---- ---- ---- (DOLLARS IN MILLIONS) Deferred net gains (losses): Firm commitment/forecast transactions.......... $(3) $14 $ -- $ -- Assets: Basis swaps.................................... $ -- $-- $ 1 $-- Liabilities: Price swaps.................................... $ -- $ 2 $-- $ 6 Basis swaps.................................... $ -- $ 1 $-- $ 2
- --------------- (a) Not financial instruments as defined in GAAP, but included as they are a major part of the program. (b) Excluding the nine-year swap agreement, the average weighted term is less than twelve months. Ninety percent of the notional volumes are hedged with counterparties with a BBB or better credit rating. 17 18 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (c) Basis swaps are utilized to hedge the geographic price differentials due primarily to transportation cost and local supply-demand factors. (12) LEASES Rent expense under primarily operating leases was $14.6 million in 1996 and $13.9 million in 1995 and 1994. At December 31, 1996, future minimum rental commitments under noncancellable operating leases, including the MTPO lease agreement (see Note 2.d), were as follows (in millions):
CALENDAR YEAR ----------------------------------------------------------- 1997.................................................... $ 42.1 1998.................................................... 32.5 1999.................................................... 33.7 2000.................................................... 33.8 2001.................................................... 32.8 Remaining years......................................... 854.0 -------- Total............................................ $1,028.9 ========
(13) MAJOR CUSTOMERS Revenues realized from major customers, which are defined as those providing in excess of ten percent of total operating revenues, were as follows for the years ended December 31, (in millions):
1996 1995 1994 ------ ------ ------ Northern Illinois Gas Company............................ $114.5 $267.0 $332.3 The Peoples Gas Light and Coke Company................... $114.3 $214.7 $285.7
(14) TRANSACTIONS WITH AFFILIATES Excess funds are invested with Occidental through its centralized cash-management system. All intercompany loans are evidenced by a cash management agreement. Interest earned or charged is calculated at prevailing market rates. Occidental provides and directly bills the Company's subsidiaries for various services including information technology services, administrative services for payroll, and employee benefits for which the Company was allocated for 1996 and 1995 approximately $5.2 million and $5.4 million, respectively. In addition, Occidental charges the Company for expense incurred on its behalf such as insurance. All these charges, which were part of the noninterest-bearing long-term intercompany liability at December 31, 1996 and 1995, approximate the amounts management believes would be incurred if the Company were to independently secure these services. The charges for these services are not reflected in the table on the following page. On November 20, 1996, the Company entered into a 10 year service agreement with Occidental. This agreement, which is effective January 1, 1997, provides for the continuation of various services performed on the Company's behalf by Occidental. The initial annual fee for these current services will be $13 million through December 31, 2001, after which time the fee will be renegotiated. The services provided will include, among others, insurance, internal audit, legal and investor relations. In addition, the agreement provides for the allocation of certain out-of-pocket expenses incurred on the Company's behalf and for separate fees to be billed to the Company by Occidental for such services as tax, regulatory compliance, payroll. and benefits and information technology. The fees charged will generally replace the "Charges for Occidental's general and administrative costs" indicated in the table below. 18 19 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Principal transactions with affiliated companies, except as disclosed elsewhere in these financial statements were as follows (in millions):
FOR THE YEARS ENDED DECEMBER 31, ---------------------------- 1996 1995 1994 ------ ------ ------ Affiliated company transactions: Transfer of trade receivables........................ $410.6 $219.8 $226.4 Fees and expenses on trade receivables transferred... $ 10.4 $ 8.4 $ 8.4 Sales, transportation and storage of natural gas and other revenues.................................... $ 3.7 $ 2.8 $ -- Purchases and transportation of natural gas.......... $ 2.1 $ 0.9 $ 1.8 Charge for Occidental's general and administrative costs............................................. $ 18.3 $ 21.1 $ 19.0 Net interest income (expense)................ $(66.1) $(11.6) $ 8.6 Pipeline venture transactions: Cash distributions................................... $ 14.1 $ 16.8 $ 18.7 Transportation of natural gas charged to operation expense........................................... $ 8.3 $ 9.8 $ 20.2
(15) GAS STORED UNDERGROUND At December 31, 1996 and 1995, Natural's current gas storage inventory which is accounted for on the LIFO method was $5 million and $1.8 million, respectively. The remaining current gas storage inventory is accounted for under the average cost method. Noncurrent gas inventory is stated primarily at the allocated purchase cost. During 1994, inventory quantities were reduced at Natural resulting in a liquidation of LIFO inventory quantities carried at lower costs that prevailed in prior years. The effect of this liquidation was to reduce cost of sales by $13.6 million. (16) PIPELINE VENTURES Investments in active companies in which the Company has a voting interest of not more than 50 percent are accounted for on the equity method. At December 31, 1996, the Company's equity investments consisted primarily of:
INVESTEE OWNERSHIP INTEREST --------------------------------------------------------------------- ------------------ West Cameron Dehydration Company..................................... 50% Stingray Pipeline Company............................................ 50% Gulf Processing...................................................... 50% U-T Offshore System.................................................. 33 1/3% Trailblazer Pipeline Company......................................... 33 1/3% High Island Offshore System.......................................... 20% Overthrust Pipeline Company.......................................... 18%
Summarized financial information of these ventures is set forth below (in millions):
FOR THE YEARS ENDED DECEMBER 31, ---------------------------- 1996 1995 1994 ------ ------ ------ Operating revenues....................................... $116.3 $138.1 $121.9 Costs and expenses....................................... 65.9 72.2 83.0 ------ ------ ------ Net income..................................... $ 50.4 $ 65.9 $ 38.9 ====== ====== ======
19 20 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
BALANCE AT DECEMBER 31, --------------------- 1996 1995 ------ ------ Current assets................................................. $ 79.2 $ 95.3 Noncurrent assets.............................................. $290.9 $314.8 Current liabilities............................................ $ 69.1 $ 77.9 Noncurrent liabilities......................................... $145.2 $175.4 Shareholders' equity........................................... $155.8 $156.8
In accordance with project financing arrangements of certain of these ventures and under tariffs approved by the FERC, Natural is required to pay demand charges to certain of these ventures for contracted transportation services. The demand charges for the years 1996, 1995 and 1994 were approximately $10.7 million, $9.2 million, and $20.7 million, respectively. (17) CONCENTRATION OF CREDIT RISK The Company and its subsidiaries sell and transport natural gas in interstate and intrastate commerce primarily in the central and Gulf regions of the United States, respectively. Although affected by the economic climate for natural gas, the end-use market of these companies' customers is diversified among residential, commercial and industrial users. These companies mitigate credit risk by requiring collateral or financial guarantees and letters of credit from customers with specific credit concerns. 20 EX-99.2 3 FINANCIAL STATEMENTS 1 EXHIBIT 2 MIDCON CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDING SEPTEMBER 30, 1997 AND 1996 (THOUSANDS) (UNAUDITED)
NINE MONTHS NINE MONTHS ENDING ENDING SEPTEMBER 30, SEPTEMBER 30, 1997 1996 ------------- ------------- REVENUES: Gas sales, transportation, storage and other operating revenues..................................................... $ 2,063,058 $ 1,776,703 Interest and other income....................................... 9,595 7,721 Earnings of pipeline ventures................................... 9,965 9,899 ----------- ----------- 2,082,618 1,794,323 ----------- ----------- COSTS AND OTHER DEDUCTIONS: Cost of sales................................................... 1,684,980 1,338,188 Selling, general and administrative and other operating expenses..................................................... 77,853 83,959 Depreciation.................................................... 110,924 131,676 Taxes other than income taxes................................... 23,087 36,341 Interest expense................................................ 181,601 43,379 Other........................................................... 1,005 1,439 ----------- ----------- 2,079,450 1,634,982 ----------- ----------- INCOME BEFORE INCOME TAXES........................................ 3,168 159,341 PROVISIONS FOR AND CHARGE-IN-LIEU OF INCOME TAXES................. 87 59,276 ----------- ----------- NET INCOME........................................................ $ 3,081 $ 100,065 =========== ===========
The accompanying notes are an integral part of these financial statements. 1 2 MIDCON CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AT SEPTEMBER 30, 1997 AND DECEMBER 31, 1996 (THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------- ------------ ASSETS CURRENT ASSETS: Cash and cash equivalents................................................................ $ 6,278 $ 4,258 Restricted deposits...................................................................... 30,678 38,623 Receivables Affiliated companies................................................................... 268,947 415,643 Customers.............................................................................. 14,592 9,363 Other.................................................................................. 17,858 26,324 Interest-bearing receivables, net-affiliated companies................................... 147,519 25,361 Gas transportation imbalances............................................................ 44,438 56,106 Materials and supplies................................................................... 11,320 11,718 Net properties to be dividended, net of tax.............................................. 303,451 308,804 Gas stored underground................................................................... 73,312 39,343 Prepayments.............................................................................. 3,771 20,187 Deferred income taxes.................................................................... 46,878 77,277 ------------ ------------ Total Current Assets............................................................... 969,042 1,033,007 ------------ ------------ PROPERTY, PLANT AND EQUIPMENT.............................................................. 6,648,818 6,876,061 Accumulated depreciation................................................................. (1,617,826) (1,785,257) ------------ ------------ Net Property, Plant and Equipment...................................................... 5,030,992 5,090,804 ------------ ------------ LONG-TERM INTERCOMPANY RECEIVABLE.......................................................... 31,390 33,197 GAS STORED UNDERGROUND -- NONCURRENT....................................................... 400,619 413,334 INVESTMENTS IN PIPELINE VENTURES........................................................... 53,498 53,141 DEFERRED CHARGES AND OTHER ASSETS.......................................................... 24,972 28,879 ------------ ------------ TOTAL ASSETS............................................................................... $ 6,510,513 $ 6,652,362 ============ ============ LIABILITIES AND STOCKHOLDER'S EQUITY CURRENT LIABILITIES: Payables -- Affiliated companies................................................................... $ 3,576 $ 2,857 Trade.................................................................................. 194,818 301,569 Contract impairment.................................................................... 605 1,126 Other.................................................................................. 91,661 115,943 Dividend payable, affiliates............................................................. 303,452 308,804 Accrued interest payable, affiliates..................................................... 82,867 -- Rate refund provision.................................................................... 13,756 15,218 Gas transportation imbalances............................................................ 80,990 83,310 Current portion of long-term ESOP debt................................................... 12,574 12,574 Other.................................................................................... 103,062 120,213 ------------ ------------ Total Current Liabilities.......................................................... 887,361 961,614 ------------ ------------ OTHER LIABILITIES AND DEFERRED CREDITS: Reserve for contract impairment.......................................................... 13,773 43,775 Intercompany liability................................................................... -- 32,696 Interest-bearing notes, affiliated companies............................................. 1,600,000 1,600,000 Long-term ESOP debt...................................................................... 1,386,026 1,386,026 Postretirement benefits other than pensions.............................................. 90,889 89,780 Other.................................................................................... 133,684 157,400 ------------ ------------ Total Other Liabilities and Deferred Credits....................................... 3,224,372 3,309,677 ------------ ------------ DEFERRED INCOME TAXES...................................................................... 1,690,440 1,680,354 ------------ ------------ CONTINGENT LIABILITIES AND COMMITMENTS MINORITY EQUITY IN SUBSIDIARIES AND PARTNERSHIPS........................................... 7,456 8,076 ------------ ------------ STOCKHOLDER'S EQUITY: Common Stock, $.01 par value, authorized 2,000,000 shares, outstanding 1,400,000 shares in 1996; $1 par value, authorized 1,000 shares, outstanding 1 share in 1995............ 14 14 Unearned ESOP shares..................................................................... (1,359,002) (1,393,849) Additional paid-in capital............................................................... 1,970,375 2,000,060 Retained earnings........................................................................ 89,497 86,416 ------------ ------------ Total Stockholder's Equity......................................................... 700,884 692,641 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY................................................. $ 6,510,513 $ 6,652,362 ============ ============
The accompanying notes are an integral part of these financial statements. 2 3 MIDCON CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDING SEPTEMBER 30, 1997 AND 1996 (THOUSANDS) (UNAUDITED)
NINE MONTHS NINE MONTHS ENDED ENDED SEPTEMBER 30, SEPTEMBER 30, 1997 1996 ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net Income...................................................... $ 3,081 $ 100,065 Income adjustments -- Depreciation................................................. 110,924 131,676 Deferred income tax provision (benefit)...................... 38,531 6,424 Other noncash (credits) charges to income, net............... (23,416) 43,831 Distributions from (to) pipeline ventures, net of earnings... (307) 1,851 Compensation expense......................................... 1,148 -- Changes in operating assets and liabilities: Decrease in accounts receivable.............................. 35,770 39,671 Decrease in accounts receivable from affiliates.............. 153,836 13,233 (Increase) decrease in inventories........................... (35,307) 19,757 Decrease (increase) in prepaid and other assets.............. 2,654 (42,176) Change in gas transportation imbalances, net................. 9,708 (8,845) (Decrease) increase in accounts payable and accrued liabilities................................................. (165,633) 64,579 Increase (decrease) in accounts payable to affiliates........ 719 (256) Decrease in income taxes..................................... (7,597) (1,532) Other operating, net............................................ 8,067 4,478 --------- --------- Net cash provided by operating activities.................... 132,178 372,756 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures............................................ (56,578) (102,031) Acquisition of cushion gas...................................... -- (90,409) Proceeds (costs) from disposal of property, plant and equipment, net.......................................................... 8,738 (6,399) Other investing, net............................................ (5,565) (2,953) --------- --------- Net cash used by investing activities........................ (53,405) (201,792) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments debt......................................... -- (7,500) Amounts paid to minority interest............................... (1,941) -- Net change in interest-bearing receivables/payables with affiliated companies and intercompany liability.............. (74,812) (162,920) --------- --------- Net cash used by financing activities........................ (76,753) (170,420) --------- --------- Increase (decrease) in cash and cash equivalents.................. 2,020 544 --------- --------- Cash and cash equivalents at beginning of year.................... 4,258 10,414 --------- --------- Cash and cash equivalents at end of period........................ $ 6,278 $ 10,958 ========= =========
The accompanying notes are an integral part of these financial statements. 3 4 MIDCON CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (THOUSANDS) (UNAUDITED)
UNEARNED ADDITIONAL RETAINED COMMON ESOP PAID-IN EARNINGS STOCK SHARES CAPITAL (DEFICIT) ------ ----------- ----------- --------- Balance, December 31, 1994................. $ -- $ -- $ 4,280,577 $ 91,633 Net income............................... -- -- -- 106,626 Dividend of intercompany receivable to Parent (Note 3.c)..................... -- -- (922,470) (228,328) ------ ----------- ----------- --------- Balance, December 31, 1995................. -- -- 3,358,107 (30,069) Net income............................... -- -- -- 116,485 Dividend of subsidiaries and properties (Note 2.c)............................ -- -- (672,407) -- Contribution of intercompany debt (Note 2.b).................................. -- -- 914,703 -- Non-cash dividend (Note 2.b)............. -- -- (1,600,000) -- Stock split (Note 2.b)................... 14 -- (14) -- Unearned ESOP shares (Note 9)............ -- (1,400,000) -- -- Dividends on unearned ESOP shares (Note 2.a).................................. -- -- 3,348 -- Release of ESOP shares, net of tax effect (Note 9).............................. -- 6,151 (3,677) -- ------ ----------- ----------- --------- Balance, December 31, 1996................. 14 (1,393,849) 2,000,000 86,416 Net income............................... -- -- -- 3,081 Release of ESOP shares, net of tax effect................................ -- 34,847 (31,275) -- Noncash dividend of properties........... -- -- (3,764) -- Adjustment to dividend of subsidiaries and properties........................ -- -- 5,354 -- ------ ----------- ----------- --------- Balance, September 30, 1997................ $ 14 $(1,359,002) $ 1,970,375 $ 89,497 ====== ========== ========== =========
The accompanying notes are an integral part of these financial statements. 4 5 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) DESCRIPTION OF COMPANY The accompanying unaudited consolidated condensed financial statements have been prepared by MidCon Corp. pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and disclosures normally included in consolidated financial statements have been condensed or omitted pursuant to such rules and regulations, but resultant disclosures are in accordance with generally accepted accounting principles as they apply to interim reporting. The consolidated condensed financial statements should be read in conjunction with MidCon Corp.'s audited consolidated financial statements for the year ended December 31, 1996 ("1996 financial statements"). In the opinion of MidCon Corp.'s management, the accompanying consolidated condensed financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary to present fairly MidCon Corp.'s consolidated financial position as of September 30, 1997, and the consolidated results of operations and consolidated cash flows for the nine months then ended. The results of operations and cash flows for the nine month periods ended September 30, 1997 and 1996 are not necessarily indicative of the results of operations and cash flows to be expected for the full year. MidCon Corp. ("MidCon" and, together with its subsidiaries, "Company") is a wholly-owned subsidiary of Occidental Petroleum Corporation (Occidental). On December 18, 1997, Occidental announced that it had signed a definitive agreement to sell the Company for $3.49 billion consideration, subject to certain supplemental adjustments. The transaction is expected to close in the first quarter 1998. (2) MIDCON RECAPITALIZATION (a) ESOP In November 1996, Occidental established the MidCon Corp. Employee Stock Ownership Plan (ESOP) (see Note 9) for the benefit of the eligible employees of the Company. Also, in November 1996, Occidental sold $1.4 billion of Occidental's Cumulative MidCon-Indexed Convertible Preferred Stock (CMIC Preferred Stock) to the MidCon Corp. ESOP Trust (the Trust). The CMIC Preferred Stock is convertible into Occidental common stock based on the value of the Company. The Trust paid for the CMIC Preferred Stock with $1.4 million cash and a $1.3986 billion 30-year promissory note (ESOP note), bearing interest at 7.9 percent per annum, guaranteed by MidCon. Principal and interest payments on the ESOP note are due on December 31 in annual installments of approximately $123 million, commencing December 31, 1997, and continuing through December 31, 2026, upon which date all principal and interest remaining unpaid shall be immediately due and payable. Dividends on the CMIC Preferred Stock are payable at an annual rate of $21 per share, when and as declared by Occidental's Board of Directors. It is anticipated that MidCon will make discretionary annual contributions to the MidCon ESOP which, together with the annual dividends, will be used to repay the ESOP note. Dividends of $3.3 million on unearned shares and a cash contribution of $9.2 million were used for debt service on the ESOP note in 1996. Results for the nine month period ended September 30, 1997 include interest expense of $82.9 million on the ESOP note and compensation expense of $1.1 million as discussed in Note 9. (b) Other Capital Transactions Concurrent with the establishment of the ESOP, several transactions were recorded. MidCon had a 1,400,000-for-one split of the outstanding shares of its common stock, while the par value of such stock was changed from $1.00 per share to $.01 per share. Occidental contributed to the capital of MidCon $741 million of promissory notes previously issued by MidCon and $154 million of non-interest bearing intercorporate advances made by Occidental to MidCon that were outstanding as of November 30, 1996. In addition, 5 6 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MidCon declared a dividend, payable in the form of a $1.6 billion note payable to Occidental. The principal amount of this note is due and payable on December 31, 2026 and bears interest at an annual rate of 7.9 percent payable monthly through December 31, 2001. Thereafter, the rate changes to the London Interbank Offered Rate (LIBOR) plus 1.25 percent. Results for the nine month period ended September 30, 1997 include interest expense of $96.1 million on the $1.6 billion note. (c) Dividend of Subsidiaries and Properties During 1996, MidCon dividended all the outstanding shares of common stock of its subsidiaries, Occidental Energy Ventures Corp. (OVEC) and MC Panhandle, Inc., to Occidental. Properties from other Company subsidiaries comprising certain oil and gas properties and well compressor properties were dividended to Occidental effective on December 31, 1996. The net income from these operations was $7.8 million for the nine months ended September 30, 1996. Also, effective December 31, 1996, MidCon dividended 51 percent of its interest in an intrastate pipeline limited liability partnership to Occidental (see Note 2.d). A summary of the 1996 adjustments showing the effect of the above transactions on certain balance sheet accounts is presented below (in millions):
INCREASE (DECREASE) ---------- Property, Plant and Equipment..................................... $ (1,339) Accumulated Depreciation.......................................... $ (345) Deferred Income Taxes............................................. $ (322) Additional Paid-in Capital........................................ $ (672)
(d) Lease of Intrastate Pipeline Assets In December 1996, MidCon merged its subsidiary MidCon Texas Pipeline Corp. (MidCon Texas) into a limited partnership, which then owned its Texas intrastate pipeline and related facilities. On December 31, 1996, fifty-one percent of the Company's ownership in the partnership was dividended to a subsidiary of Occidental with a dividend of the remaining 49 percent to be paid on January 1, 1998. This 49 percent interest is reflected in the accompanying consolidated balance sheets as "Net properties to be dividended, net of tax." MidCon formed a new subsidiary, MidCon Texas Pipeline Operator, Inc. ("MTPO"), which assumed certain of the contracts and obligations of MidCon Texas before the merger. In addition, MTPO entered into an agreement with the limited partnership to lease the intrastate pipeline system owned by the limited partnership over a 30 year period commencing on January 1, 1997. The Company accounts for this lease as an operating lease. The initial annual lease fee is $30 million in 1997. The lease fee changes to $20 million for the years 1998 through 2001, $40 million for the years 2002 through 2005 and $30 million during the remaining lease term. Lease expense of $30 million will be recognized annually. The lease agreement requires MTPO to pay for taxes, insurance and maintenance expenses and contains restrictions concerning additions, dispositions and modifications to the leased property. (3) SIGNIFICANT ACCOUNTING POLICIES Reference is made to Note 3 in MidCon's 1996 financial statements for a summary of significant accounting policies. 6 7 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (a) Cash and Cash Equivalents and Interest-Bearing Receivables/Payables, Net-Affiliated Companies Cash equivalents consist of interest bearing commercial paper and other bank deposits with initial maturities of three months or less. Cash equivalents totaled approximately $3.4 million and $1.5 million at September 30, 1997 and December 31, 1996, respectively. Occidental and its subsidiaries utilize a cash-management system designed to minimize cash balances and external borrowing. In November 1996, MidCon entered into a new intercompany cash management agreement with Occidental. This agreement, which was effective January 1, 1997, engages Occidental to continue to provide the Company with certain financing and cash management services. Amounts due from or to affiliates under this program are reflected as current assets and liabilities in the accompanying financial statements. Interest income and expense is allocated to the participating companies on the basis of the principal contributed or borrowed, respectively. Under the former cash management system, MidCon has periodically dividended, to its parent company, its interest bearing receivables from Occidental. (b) Accounting Changes In June 1996, the Financial Accounting Standards Board (FASB) issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities." The statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. The Company's adoption of SFAS No. 125, effective January 1, 1997, did not have an impact on the Company's financial position or results of operations. In October 1996, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position No. 96-1, "Environmental Remediation Liabilities" (SOP 96-1), which provides authoritative guidance on specific accounting issues that are present in the recognition, measurement, display and disclosure of environmental remediation liabilities. The Company's adoption of SOP 96-1, effective January 1, 1997, did not have an impact on the Company's financial position or results of operations. The FASB has issued SFAS No. 129, "Disclosure of Information about Capital Structure" to be effective for periods ending after December 15, 1997. SFAS No. 129 establishes standards for disclosing information about an entity's capital structure. The Company does not believe that the application of the new standard will have a material effect on the Company's financial position or results of operations. The FASB has issued SFAS No. 130, "Reporting Comprehensive Income" to be effective for periods beginning after December 15, 1997. SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. The Company does not believe that the application of the new standard will have a material effect on the Company's financial position or results of operations. The FASB has issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information" to be effective for periods beginning after December 15, 1997. SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas and major customers. The Company does not believe that the application of the new standard will have a material effect on the Company's financial position or results of operations. (c) Property, Plant and Equipment and Related Depreciation Reference is made to the 1996 financial statements and Note 3(f) thereto for a description of investments in property, plant and equipment. 7 8 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (d) Restricted Deposits The Company engages in hedging to decrease or modify its exposure to natural gas price risk. In accordance with New York Mercantile Exchange (NYMEX) rules, $30.7 million and $38.6 million of monies on deposit with brokers was restricted at September 30, 1997 and December 31, 1996, respectively, to meet trading requirements. (e) Supplemental Cash Flow Information Cash payments during the nine months ended September 30, 1997 and 1996 included income taxes of approximately $3.4 million and $4.0 million, respectively. Interest paid for the same periods, net of amounts capitalized, was $95.9 million and $0. (f) Hedging Activities The Company uses commodity futures contracts, options and swaps to hedge the impact of natural gas price fluctuations related to its business activities. Gains and losses on hedge contracts are deferred and recognized as an adjustment to sales revenue or purchase costs when the related transaction being hedged is finalized. (g) Liabilities "Accrued liabilities current" and "Other noncurrent liabilities" include reserves relating to a reorganization of the Company's operations initiated in 1995. The Company recorded a reserve of $37 million during the fourth quarter of 1995. The current and noncurrent portion of the reserve totaled approximately $7 million and $4 million, respectively at September 30, 1997 and $9 million and $12 million, respectively, at December 31, 1996. (4) LITIGATION There are various lawsuits and proceedings pending against the Company. It is impossible at this time to determine the ultimate legal liabilities that may arise therefrom. However, in management's opinion, after taking into account reserves, the pending lawsuits and proceedings and claims should not have a material adverse effect upon the consolidated financial position or results of operations of the Company. (5) REGULATORY MATTERS On November 3, 1997, the FERC approved a settlement of the general rate case of the Natural Gas Pipeline Company of America ("Natural") filed on June 1, 1995, substantially consistent with what Natural proposed. This settlement of the rate case has had a favorable impact of approximately $9 million on operating margin for the nine months ended September 30, 1997. In January 1997, Amoco Production Company and Amoco Energy Trading Corporation ("Amoco") filed a complaint against Natural before the FERC contending that Natural had improperly provided its affiliate, MidCon Gas, transportation service on preferential terms, seeking termination of currently effective contracts and the imposition of civil penalties. A subsequent FERC staff audit made proposed findings that Natural has favored MidCon Gas, which Natural has challenged. In July, Amoco and Natural agreed to a settlement of this proceeding. Amoco has filed to withdraw its complaint subject to the FERC's procedures. Several intervenors have opposed the withdrawal of the complaint and Natural has filed an answer to that opposition. The matter is pending before the FERC. 8 9 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (6) CONTINGENT LIABILITIES AND COMMITMENTS The FERC has allowed certain rates for gas supply realignment GSR costs to go into effect on December 1, 1997, subject to refund, to recover any shortfall in recoveries of GSR costs allocated to interruptible transportation (See Note 5 to the 1996 financial statements). However, the FERC rejected Natural's filing for rehearing that Natural be allowed to recoup a portion of any shortfall on title transfers and interruptible transportation to pooling points. The Company has certain other commitments and contingent liabilities under contracts, guarantees and joint ventures. In management's opinion, after taking into account reserves, none of such commitments and contingencies discussed above should have a material adverse effect upon the consolidated financial position or results of operations of the Company. (7) INCOME TAXES The Company is included in Occidental's consolidated federal tax return and unitary state tax returns. The consolidated provisions for these income taxes are allocated to the Company on the basis of a tax sharing agreement with Occidental. Under the agreement, the amount of consolidated current and deferred tax provisions is determined as if the Company were a corporation that was not owned by Occidental and filed a separate consolidated income tax return. In addition, state income taxes are provided for all states in which the Company is included in a state return with Occidental, notwithstanding that the Company may not have been subject to tax in that jurisdiction but for its affiliation with Occidental. The provision for taxes based on income for the 1997 and 1996 interim periods was computed in accordance with Interpretation No. 18 of APB Opinion No. 28 on reporting taxes for interim periods and was based on projections of total year pretax income. Taxable gains were recorded by the Company resulting from dividends and asset transfers to Occidental during 1996 (see Note 2.c). Since the Company is included in the consolidated federal income tax return with Occidental, these taxable gains are deferred until the Company is transferred outside the consolidated group. Under the Company's tax sharing agreement, so long as the Company is part of the consolidated group, the tax payments associated with the gains will be reimbursed to the Company over the remaining tax lives of the transferred assets. An intercompany receivable from Occidental has been recorded on the consolidated balance sheet to reflect these reimbursements. Taxable gains were recorded by the Company resulting from asset transfers unrelated to the dividends and asset transfers to Occidental during 1996 (see Note 2.c), and the tax associated therewith will not be reimbursed by Occidental under the Company's tax sharing agreement. (8) RETIREMENT AND POSTRETIREMENT BENEFITS Reference is made to Note 8 to MidCon's 1996 financial statements for a description of the retirement plans and Postretirement benefits. (9) RETIREMENT PLANS AND ESOP All employees are participants in a defined contribution retirement plan and are eligible to participate in a defined contribution savings plan. Effective January 1, 1997, the Company established the MidCon Corp. Retirement Plan (MRA) and the MidCon Corp. Savings Plan (MSA). Related plan assets from Occidental Petroleum Corporation Retirement Plan and the Occidental Petroleum Corporation Savings Plan were transferred to the MRA and MSA, respectively. The plans provide for periodic contributions based on the 9 10 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS salary and age level of employees and/or employee contributions. Beginning January 1, 1997, the Company's contribution under the MRA is being reduced over time pursuant to the terms of the plan. Effective November 20, 1996, Occidental established the ESOP for all eligible employees of the Company. Generally, the shares of the CMIC Preferred Stock held by the ESOP are released and allocated to participant accounts based on the proportion of the payment on the ESOP note for the respective period compared to the total remaining payments due on the note. Dividends on the CMIC Preferred Stock are payable at an annual rate of $21 per share, when and as declared by Occidental's Board of Directors. It is anticipated that MidCon will make discretionary annual contributions to the MidCon ESOP which, together with the annual dividends, will be used to repay the ESOP note. The Company accounts for its ESOP in accordance with AICPA Statement of Position 93-6, "Employers' Accounting for Employee Stock Ownership Plans" which requires that compensation expense be measured based on the fair value of shares committed to be released. The ESOP loan guarantee is recorded as an intercompany liability and the shares of CMIC Preferred Stock pledged as collateral are reported as unearned ESOP shares in the consolidated balance sheet. The Company reports compensation expense equal to the estimated current market price of the shares. Dividends on allocated ESOP shares result in a reduction to additional paid-in capital. Dividends on ESOP shares have been used to satisfy debt service. ESOP compensation expense was $1.1 million and $0 for the nine months ended September 30, 1997 and 1996, respectively. The ESOP has 40,998 and 6,151 allocated shares and 1,359,002 and 1,393,849 unreleased shares outstanding at September 30, 1997 and December 31, 1996, respectively. (10) TRANSACTIONS WITH AFFILIATES Excess funds are invested with Occidental through its centralized cash-management system. All intercompany loans are evidenced by a cash management agreement. Interest earned or charged is calculated at prevailing market rates. Occidental provides and directly bills the Company for various services including information technology services, administrative services for payroll, and employee benefits for which the Company was allocated approximately $4.0 million and $3.8 million for the nine month periods ended September 30, 1997 and 1996, respectively. In addition, Occidental charges the Company for expense incurred on its behalf such as insurance. All these charges, which were part of the noninterest-bearing long-term intercompany liability at September 30, 1997 and December 31, 1996, approximate the amounts management believes would be incurred if the Company were to independently secure these services. The charges for these services are not reflected in the table on the following page. Effective January 1, 1997, MidCon entered into a 10-year service agreement with Occidental. This agreement provides for the continuation of various services performed on the Company's behalf by Occidental. The initial annual fee for these services will be $13 million through December 31, 2001, after which time the fee will be renegotiated. The services provided will include, among others, insurance administration, internal audit, legal and investor relations. In addition, the agreement provides for the allocation of certain out-of-pocket expenses incurred on the Company's behalf and for separate fees to be billed to the Company by Occidental for such services as tax, regulatory compliance, payroll and benefits and information technology. The fees charged are reflected for the nine months ended September 30, 1997, as "Charges for Occidental's general and administrative costs" indicated in the table below. 10 11 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Principal transactions with affiliated companies, except as disclosed elsewhere in these financial statements, were as follows for the nine month periods indicated (in millions):
SEPTEMBER 30, ------------------ 1997 1996 ------- ------ Affiliated company transactions: Transfer of trade receivables................................... $ 258.9 $200.9 Fees and expenses on trade receivables transferred.............. $ 9.9 $ 8.0 Sales, transportation and storage of natural gas and other revenues..................................................... $ 1.4 $ 2.1 Purchases and transportation of natural gas..................... $ 24.5 $ 0.3 Charge for Occidental's general and administrative costs........ $ 9.8 $ 13.7 Net interest income (expense)................................... $(164.8) $(32.5) Pipeline venture transactions: Cash distributions.............................................. $ 9.7 $ 11.8 Transportation of natural gas charged to operation expense...... $ 7.6 $ 6.2
(11) GAS STORED UNDERGROUND At September 30, 1997 and December 31, 1996, Natural's current top gas storage inventory, which is accounted for on the LIFO method, was $2.6 million and $5.0 million, respectively. Noncurrent top gas inventory is stated on the LIFO method. The current value of the noncurrent top gas inventory exceeded the LIFO valuation by $236.9 million and $413.7 million at September 30, 1997 and December 31, 1996, respectively. Noncurrent cushion gas inventory is stated at average cost. (12) PIPELINE VENTURES Investments in active companies in which the Company has a voting interest of not more than 50 percent are accounted for on the equity method. At September 30, 1997, the Company's equity investments consisted primarily of:
OWNERSHIP INVESTEE INTEREST ------------------------------------------------------------------ --------- West Cameron Dehydration Company.................................. 50% Stingray Pipeline Company......................................... 50% Gulf Processing................................................... 50% U-T Offshore System............................................... 33 1/3% Trailblazer Pipeline Company...................................... 33 1/3% High Island Offshore System....................................... 20% Overthrust Pipeline Company....................................... 18%
Summarized financial information of these ventures is set forth below (in millions):
NINE MONTHS ENDED SEPTEMBER 30, ----------------- 1997 1996 ------- ------ Operating revenues.......................................... $ 100.0 $ 87.6 Costs and expenses.......................................... 64.4 48.7 ------- ------ Net income.................................................. $ 35.6 $ 38.9 ====== =====
11 12 MIDCON CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------- ------------ Current assets..................................... $ 48.4 $ 79.2 Noncurrent assets.................................. $ 280.1 $290.9 Current liabilities................................ $ 47.3 $ 69.1 Noncurrent liabilities............................. $ 132.3 $145.2 Stockholders' equity............................... $ 148.8 $155.8
In accordance with project financing arrangements of certain of these ventures and under tariffs approved by the FERC, Natural is required to pay demand charges to certain of these ventures for contracted transportation services. The demand charges for the nine month periods ended September 30, 1997 and 1996 were approximately $7.5 million and $6.1 million, respectively. (13) YEAR 2000 COMPLIANCE MidCon has completed an assessment of its information systems to determine what modifications, if any, are necessary for proper functioning of these systems in the year 2000. Cost related to maintenance or modification of these systems will be expensed as incurred. MidCon does not anticipate the related costs to have a material impact on its results of operations. 12 EX-99.3 4 UNAUDITED PRO FORMA CONSOLIDATED FIN. INFO 1 EXHIBIT 3 ---------- UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS The following unaudited pro forma financial statements give effect to (i) the acquisition of MidCon by K N Energy, Inc. ("K N") (see K N's Report on Form 8-K dated January 5, 1998) ("the Acquisition") and (ii) the anticipated issuance (in a private offering not registered under the Securities Act of 1933, as amended) of $300 million of K N-Obligated Mandatorily Redeemable Capital Trust Pass-Through Securities of Subsidiary Trust ("the Capital Securities") and application of the net proceeds therefrom ($297 million) to the reduction of short-term debt. The unaudited pro forma condensed balance sheet as of September 30, 1997 is presented as if the Acquisition had occurred on that date. The unaudited pro forma condensed statements of income for the year ended December 31, 1996 and the nine months ended September 30, 1997 assume that the Acquisition occurred at the beginning of each such period. The Acquisition will be recorded as a purchase for accounting purposes and, accordingly, the assets acquired and liabilities assumed will be recorded at their estimated respective fair market values. The unaudited pro forma financial statements should be read in conjunction with the historical financial statements of K N and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in K N's 1996 Annual Report on Form 10-K and the historical financial statements of MidCon included in K N's Report on Form 8-K dated January 16, 1998. The unaudited pro forma condensed statements of income are not necessarily indicative of the financial results that would have occurred had the Acquisition been consummated on the dates indicated, nor are they necessarily indicative of future financial results. Results for the interim periods are not necessarily indicative of results to be expected for a full year. The pro forma adjustments are based on preliminary assumptions and estimates made by K N's management and do not reflect adjustments for anticipated operating efficiencies and cost savings which K N expects to achieve as a result of the Acquisition. The actual allocation of the consideration paid by K N for MidCon may differ from that reflected in the unaudited pro forma combined condensed financial statements after a more extensive review of the fair market values of the assets acquired and liabilities assumed has been completed. Amounts allocated will be based upon the estimated fair values at the closing date of the Acquisition, which amounts could vary significantly from the amounts at September 30, 1997. 1 2 UNAUDITED PRO FORMA CONDENSED BALANCE SHEET SEPTEMBER 30, 1997 (IN THOUSANDS)
ASSETS HISTORICAL PRO FORMA ------------------------- ---------------------------- K N ENERGY MIDCON ADJUSTMENTS COMBINED ---------- ----------- ----------- ----------- Current Assets: Cash and Cash Equivalents.................................. $ 18,819 $ 6,278 $ (6,278) (a) $ 18,819 Restricted Deposits........................................ 6,448 30,678 37,126 Accounts Receivable........................................ 192,523 448,916 641,439 Materials and Supplies..................................... 14,998 11,320 26,318 Gas in Underground Storage................................. 23,660 73,312 96,972 Prepaid Gas................................................ 9,572 -- 9,572 Other Prepaid Expenses..................................... 14,983 3,771 18,754 Net properties to be dividended, net of tax................ -- 303,451 (303,451) (b) -- Gas Imbalances and Other................................... 70,995 91,316 162,311 ---------- ----------- ----------- ----------- 351,998 969,042 (309,730) 1,011,310 Investments.................................................. 75,197 53,498 1,398,600 (c) 1,527,295 Property, Plant and Equipment, at Cost....................... 1,861,679 7,049,437 (257,163) (d) 8,653,953 Less Accumulated Depreciation and Amortization............... (542,905) (1,617,826) (2,160,731) ---------- ----------- ----------- ----------- Net Property, Plant and Equipment............................ 1,318,774 5,431,611 (257,163) 6,493,222 Long-Term Receivable -- Occidental Petroleum................. -- 31,390 (31,390) (e) -- Deferred Charges and Other Assets............................ 106,488 24,972 3,000 (n) 134,460 ---------- ----------- ----------- ----------- Total Assets......................................... $1,852,457 $ 6,510,513 $ 803,317 $ 9,166,287 ========== =========== =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Current Maturities of Long-Term Debt....................... $ 19,055 -- $ 19,055 Notes Payable.............................................. 285,000 -- $3,556,322 (a) 5,025,789 1,481,467 (c) (297,000) (n) Accounts Payable........................................... 173,070 $ 290,660 463,730 Accrued Expenses........................................... 25,952 -- 25,952 Accrued Taxes.............................................. 26,673 -- 26,673 Accrual for Duplicate Facilities & Relocation.............. -- -- 10,000 (d) 10,000 Dividend payable........................................... -- 303,452 (303,452) (b) -- Current portion of ESOP debt............................... -- 12,574 (12,574) (f) -- Gas Imbalances and Other................................... 51,045 197,808 (37,700) (g) 211,153 Interest Payable to Affiliates............................. -- 82,867 (82,867) (c) -- ---------- ----------- ----------- ----------- 580,795 887,361 4,314,196 5,782,352 Deferred Liabilities, Credits and Reserves: Deferred Income Taxes...................................... 131,567 1,690,440 (92,579) (d) 1,698,038 (31,390) (e) Other...................................................... 26,628 238,346 264,974 ---------- ----------- ----------- ----------- 158,195 1,928,786 (123,969) 1,963,012 ESOP debt.................................................... -- 1,386,026 (1,386,026) (f) Long-Term Debt............................................... 410,498 1,600,000 (1,600,000) (i) 410,498 K N-Obligated Mandatorily Redeemable Capital Trust Pass-through Securities of Subsidiary Trust............ 100,000 -- 300,000 (n) 400,000 Minority Interests in Equity of Subsidiaries................. 31,160 7,456 38,616 Stockholders' Equity: Preferred Stock............................................ 7,000 -- 7,000 Common Stock............................................... 157,232 14 (14) (j) 157,232 Additional Paid-in Capital................................. 252,030 1,970,375 (1,970,375) (j) 252,030 Retained Earnings.......................................... 166,099 89,497 (89,497) (j) 166,099 Unearned ESOP shares....................................... -- (1,359,002) 1,359,002 (j) -- Deferred Compensation...................................... (9,667) -- (9,667) Treasury Stock............................................. (885) -- (885) ---------- ----------- ----------- ----------- Total Common Stockholders' Equity...................... 564,809 700,884 (700,884) 564,809 ---------- ----------- ----------- ----------- Total Stockholders' Equity............................. 571,809 700,884 (700,884) 571,809 ---------- ----------- ----------- ----------- Total Liabilities and Stockholders' Equity........... $1,852,457 $ 6,510,513 $ 803,317 $ 9,166,287 ========== =========== =========== ===========
See Notes to Unaudited Pro Forma Combined Condensed Financial Statements 2 3 UNAUDITED PRO FORMA CONDENSED STATEMENT OF INCOME YEAR ENDED DECEMBER 31, 1996 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
HISTORICAL PRO FORMA ------------------------- -------------------------- K N ENERGY MIDCON ADJUSTMENTS COMBINED ---------- ---------- ----------- ---------- Operating Revenues......................... $1,443,174 $2,574,211 $4,017,385 ---------- ---------- ---------- Operating Costs and Expenses: Gas Purchases and Other Costs of Sales... 1,062,062 1,981,235 3,043,297 Operations and Maintenance............... 175,778 108,347 284,125 Depreciation and Amortization............ 51,212 177,511 $ (109)(k) 228,614 Taxes, Other Than Income Taxes........... 19,321 46,226 65,547 ---------- ---------- --------- ---------- Total Operating Costs and Expenses....................... 1,308,373 2,313,319 (109) 3,621,583 ---------- ---------- --------- ---------- Operating Income........................... 134,801 260,892 109 395,802 ---------- ---------- --------- ---------- Other Income and (Deductions): Interest Expense......................... (35,933) (79,626) (268,726)(l) (384,285) Minority Interests....................... (2,946) -- (23,010)(n) (25,956) Other, Net............................... 3,794 11,903 10,387(m) 109,900 83,916(c) (100)(n) ---------- ---------- --------- ---------- Total Other Income and (Deductions)........ (35,085) (67,723) (197,533) (300,341) ---------- ---------- --------- ---------- Income Before Income Taxes................. 99,716 193,169 (197,424) 95,461 Income Taxes............................... 35,897 76,684 (71,112)(h) 41,469 ---------- ---------- --------- ---------- Net Income................................. 63,819 116,485 (126,312) 53,992 Less -- Preferred Stock Dividends.......... 398 -- 398 ---------- ---------- --------- ---------- Earnings Available For Common Stock........ $ 63,421 $ 116,485 $(126,312) $ 53,594 ========== ========== ========= ========== Earnings Per Common Share.................. $ 2.14 $ 1.81 Number of Shares Used in Computing Earnings Per Common Share......................... 29,624 29,624 Dividends Per Common Share................. $ 1.05 $ 1.05
See Notes to Unaudited Pro Forma Combined Condensed Financial Statements 3 4 UNAUDITED PRO FORMA CONDENSED STATEMENT OF INCOME NINE MONTHS ENDED SEPTEMBER 30, 1997 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
HISTORICAL PRO FORMA ------------------------- -------------------------- K N ENERGY MIDCON ADJUSTMENTS COMBINED ---------- ---------- ----------- ---------- Operating Revenues......................... $1,362,457 $2,063,058 $3,425,515 ---------- ---------- ---------- Operating Costs and Expenses: Gas Purchases and Other Costs of Sales... 1,060,884 1,684,980 2,745,864 Operations and Maintenance............... 146,109 77,853 $ (2,663)(f) 221,299 Depreciation and Amortization............ 41,101 110,924 (43)(k) 151,982 Taxes, Other Than Income Taxes........... 18,144 23,087 41,231 ---------- ---------- --------- ---------- Total Operating Costs and Expenses....................... 1,266,238 1,896,844 (2,706) 3,160,376 ---------- ---------- --------- ---------- Operating Income........................... 96,219 166,214 2,706 265,139 ---------- ---------- --------- ---------- Other Income and (Deductions): Interest Expense......................... (30,991) (181,601) (44,529)(l) (267,001) (9,880)(m) Minority Interests....................... (5,681) -- (17,258)(n) (22,939) Other, Net............................... 14,979 18,555 9,881(m) 106,277 62,937(c) (75)(n) ---------- ---------- --------- ---------- Total Other Income and (Deductions)........ (21,693) (163,046) 1,076 (183,663) Income Before Income Taxes................. 74,526 3,168 3,782 81,476 Income Taxes............................... 25,488 87 1,346(h) 26,921 ---------- ---------- --------- ---------- Net Income................................. 49,038 3,081 2,436 54,555 Less -- Preferred Stock Dividends.......... 263 -- 263 ---------- ---------- --------- ---------- Earnings Available For Common Stock........ $ 48,775 $ 3,081 $ 2,436 $ 54,292 ========== ========== ========= ========== Earnings Per Common Share.................. $ 1.55 $ 1.73 Number of Shares Used in Computing Earnings Per Common Share......................... 31,397 31,397 Dividends Per Common Share................. $ 0.81 $ 0.81
See Notes to Unaudited Pro Forma Combined Condensed Financial Statements 4 5 NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS (a) Acquisition debt is calculated based on the following assumptions:
(THOUSANDS) ---------- Cash Consideration to be Paid at Closing.............................. $2,104,000 Government Securities Purchased as Collateral for Substitute Note, see Note(c)............................................................ 1,481,467 Transaction Costs..................................................... 60,000 Less: MidCon Cash Balance at September 30, 1997............................. (6,278) ---------- Total Acquisition Debt........................................ 3,639,189 ---------- Accrued interest allocated to Substitute Note......................... (82,867) ---------- Net Acquisition Debt.......................................... $3,556,322 ==========
The net acquisition debt, which will mature 364 days after draw-down, is shown as a current liability in the accompanying unaudited Pro Forma Condensed Balance Sheet, although it is currently K N's intention to refinance a significant portion of the acquisition debt through the issuance of debt and equity securities. (b) Gives pro forma effect to the January 1, 1998 dividend by MidCon to a subsidiary of Occidental Petroleum Corporation of MidCon's 49% interest in a limited partnership which owns MidCon Texas Pipeline Corp. (c) In accordance with the terms of the Agreement, K N will issue the Substitute Note to Occidental for the total of the principal due on the ESOP Note ($1,398,600,000) plus interest accrued to date of closing on the ESOP Note ($82,867,000), estimated to total $1,481,467,000, bearing interest at an estimated 6.3%, maturing on January 1, 1999 and collateralized by a portfolio of U.S. Government securities purchased by K N. The portfolio of U.S. Government securities, contractually required to be held by K N until maturity of the Substitute Note, is estimated to generate interest income at 6.0%. (d) The following preliminary allocation of purchase price to assets acquired and liabilities assumed reflects the assumption that current assets and current liabilities are carried at historical amounts which approximate their fair market value. The fair market value of property, plant and equipment includes a gas plant acquisition adjustment of approximately $3.7 billion which represents the excess of the estimated fair market value of MidCon's interstate pipeline assets over their recorded historical cost for regulatory purposes, which will be amortized over 35 years (approximately the estimated remaining life of MidCon's interstate pipeline assets).
(THOUSANDS) ----------- CALCULATION OF PURCHASE PRICE: Cash Consideration to be paid at Closing............................. $ 2,104,000 Note Payable to Occidental........................................... 1,481,467 Transaction Costs.................................................... 60,000 ----------- Total........................................................ $ 3,645,467 ===========
5 6 NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED)
(THOUSANDS) ----------- PRELIMINARY ALLOCATION OF PURCHASE PRICE Cash and Cash Equivalents............................................ $ 6,278 Restricted Deposits.................................................. 30,678 Accounts Receivable.................................................. 448,916 Materials and Supplies............................................... 11,320 Gas in Underground Storage........................................... 73,312 Other Prepaid Expenses............................................... 3,771 Gas Imbalances and Other............................................. 91,315 Investments.......................................................... 53,498 Deferred Charges and Other Assets.................................... 24,972 Property, Plant and Equipment, Net(*)................................ 5,174,448 Accounts Payable..................................................... (290,660) Gas Imbalances and Other............................................. (160,108) Deferred Income Taxes................................................ (1,566,471) Other Non-Current Liabilities........................................ (238,346) Accrual for Duplicate Facilities and Relocation...................... (10,000) Minority Interest in Unconsolidated Subsidiaries..................... (7,456) ----------- Total........................................................ $ 3,645,467 ==========
(*) The fair market value assigned by K N, inclusive of the gas plant acquisition adjustment, is less than MidCon's historical book value (which included a gas plant acquisition adjustment of approximately $3.9 billion) by approximately $257.2 million. (e) To eliminate the receivable and corresponding deferred taxes associated with deferred intercompany gains which will be settled at closing of the Acquisition. (f) Gives pro forma effect to the termination of MidCon's Employee Stock Ownership Plan instituted in November 1996, including cancellation of the related debt and removal of the associated administrative expenses. (g) Represents the elimination of the deferred net gain recorded in conjunction with MidCon's postretirement benefit plan. (h) Represents the tax effect at the effective rate for all pre-tax pro forma adjustments not representing permanent book/tax differences. (i) Gives pro forma effect to the elimination of MidCon's long-term payable to Occidental recorded in conjunction with a November 30, 1996 dividend declaration of $1.6 billion. (j) Represents the elimination of the historical equity balances of MidCon. (k) The pro forma adjustments to Depreciation and Amortization consist of the following:
(THOUSANDS) ----------- Year Ended December 31, 1996 Elimination of MidCon's Historical Depreciation and, exclusive of depreciation on MidCon Texas Pipeline Corp., see Note (b)............................... $ (147,950) K N's Recomputed Depreciation and Amortization, see Note (d).......................................... 147,841 ---------- Total........................................ $ (109) ========== Nine Months Ended September 30, 1997 Elimination of MidCon's Historical Depreciation and Amortization...................................... $ (110,924) K N's Recomputed Depreciation and Amortization, see Note (d).......................................... 110,881 ---------- Total........................................ $ (43) ==========
6 7 NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL STATEMENTS -- (CONTINUED) (l) The pro forma adjustments to Interest Expense consist of the following:
(THOUSANDS) ----------- Year Ended December 31, 1996 Elimination of MidCon's Historical Interest Expense on its ESOP debt... $ (12,584) Elimination of MidCon's Historical Interest Expense on its $1.6 billion Payable to Occidental............................................... (16,502) Elimination of interest expense due to the reduction in short-term debt resulting from the application of the net proceeds of the Capital Securities, see Note (n)............................................ (17,850) Interest Expense on Acquisition Debt at 6.36%(*) weighted average rate, see Note (c) 226,152 Interest Expense at 6.4% on incremental debt required to purchase government securities............................................... 89,510 --------- Total $ 268,726 ========= Nine Months Ended September 30, 1997 Elimination of MidCon's Historical Interest Expense on its ESOP debt... $ (82,867) Elimination of MidCon's Historical Interest Expense on its $1.6 billion Payable to Occidental............................................... (96,117) Elimination of interest expense due to the reduction in short-term debt resulting from the application of the net proceeds of the Capital Securities, see Note (n)............................................ (13,254) Interest Expense on Acquisition Debt at 6.36%(*) weighted average rate, see Note (a)........................................................ 169,614 Interest Expense at 6.4% on incremental debt (exclusive of accrued interest of $82,867) required to purchase government securities..... 67,133 Interest Expense on ESOP Administration................................ 19 --------- Total.......................................................... $ 44,528 =========
(*) For purposes of the unaudited pro forma combined condensed financial statements, the annual weighted average interest rate on the acquisition debt is assumed to be 6.36%. A 1% change in the interest rate on the acquisition debt would change annual interest expense by approximately $35.6 million for the year ended December 31, 1996 and interest expense for the nine-months ended September 30, 1997 by approximately $26.7 million. The acquisition debt is expected to be obtained from a syndicate of commercial banks. K N believes that the interest rate assumed is appropriate under current market conditions for a BBB credit obligation, although it may differ from the rate actually obtained at the time the funds are borrowed. (m) To eliminate facility fees (and, in the nine months ended September 30, 1997, interest income) associated with MidCon's participation in a sale of receivables facility, which participation will terminate concurrently with closing of the Acquisition. (n) Gives pro forma effect to the issuance of the Capital Securities ($297 million after reduction for an estimated underwriting discount of $3.0 million) and the application of the net proceeds to reduce short-term borrowings, see Note (l). 7 EX-99.99 5 CONSENT OF ARTHUR ANDERSEN LLP 1 Exhibit 99 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the inclusion in this Form 8-K of our report dated January 31, 1997 on MidCon Corp.'s consolidated financial statements for the year ended December 31, 1996. /s/ ARTHUR ANDERSEN LLP Chicago, Illinois January 16, 1998 -----END PRIVACY-ENHANCED MESSAGE-----