UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- --- ACT OF 1934
For the quarterly period ended June 30, 2001.
-------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
- --- ACT OF 1934
For the transition period from to
----------------
Commission file number 001-13643
ONEOK, Inc.
(Exact name of registrant as specified in its charter)
Oklahoma 73-1520922
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation of organization)
100 West Fifth Street, Tulsa, OK 74103
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (918) 588-7000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
---
Common stock, with par value of $0.01 - 59,568,895 shares outstanding at August
9, 2001.
ONEOK, Inc.
QUARTERLY REPORT ON FORM 10-Q
Part I. Financial Information Page No.
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Income -
Three and Six Months Ended June 30, 2001 and 2000 3
Consolidated Balance Sheets -
June 30, 2001 and December 31, 2000 4-5
Consolidated Statements of Cash Flows - 6
Six Months Ended June 30, 2001 and 2000
Notes to Consolidated Financial Statements 7-16
Item 2. Management's Discussion and Analysis of 17-29
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk 30
Part II. Other Information
Item 1. Legal Proceedings 31-32
Item 4. Submission of Matters to a Vote of Security Holders 33
Item 6. Exhibits and Reports on Form 8-K 34
Signatures
2
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
ONEOK, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Six Months Ended
June 30, June 30,
(Unaudited) 2001 2000 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars, except per share amounts)
Operating Revenues $1,402,399 $1,383,530 $4,359,323 $2,205,349
Cost of gas 1,208,355 1,192,783 3,897,016 1,812,058
- ----------------------------------------------------------------------------------------------------------------------------
Net Revenues 194,044 190,747 462,307 393,291
- ----------------------------------------------------------------------------------------------------------------------------
Operating Expenses
Operations and maintenance 69,268 67,437 141,465 118,489
Depreciation, depletion, and amortization 37,856 37,161 74,811 71,488
General taxes 14,978 12,116 31,043 24,355
- ----------------------------------------------------------------------------------------------------------------------------
Total Operating Expenses 122,102 116,714 247,319 214,332
- ----------------------------------------------------------------------------------------------------------------------------
Operating Income 71,942 74,033 214,988 178,959
- ----------------------------------------------------------------------------------------------------------------------------
Other income, net 566 1,082 3,865 17,494
Interest expense 36,249 28,343 73,784 50,328
Income taxes 12,651 19,610 54,451 58,056
- ----------------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of a change in 23,608 27,162 90,618 88,069
accounting principle
Cumulative effect of a change in - - (2,151) 2,115
accounting principle, net of tax (Notes I and K)
- ----------------------------------------------------------------------------------------------------------------------------
Net Income 23,608 27,162 88,467 90,184
Preferred stock dividends 9,275 9,275 18,550 18,550
- ----------------------------------------------------------------------------------------------------------------------------
Income Available for Common Stock $ 14,333 $ 17,887 $ 69,917 $ 71,634
============================================================================================================================
Earnings Per Share of Common Stock (Note E)
Basic $ 0.20 $ 0.23 $ 0.74 $ 0.76
============================================================================================================================
Diluted $ 0.20 $ 0.23 $ 0.74 $ 0.76
============================================================================================================================
Average Shares of Common Stock (Thousands)
Basic 99,407 98,284 99,311 98,330
Diluted 99,733 98,292 99,665 98,334
See accompanying Notes to Consolidated Financial Statements.
3
ONEOK, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
(Unaudited) 2001 2000
- ------------------------------------------------------------------------------------
(Thousands of Dollars)
Assets
Current Assets
Cash and cash equivalents $ 242 $ 249
Trade accounts and notes receivable 671,416 1,627,714
Materials and supplies 17,494 18,119
Gas in storage 78,347 72,979
Deferred income taxes 6,861 10,425
Unrecovered purchased gas costs 81,815 1,578
Assets from price risk management 834,815 1,416,368
activities
Deposits 83,630 120,800
Other current assets 26,587 71,906
- ------------------------------------------------------------------------------------
Total Current Assets 1,801,207 3,340,138
- ------------------------------------------------------------------------------------
Property, Plant and Equipment
Marketing and Trading 3,192 2,795
Gathering and Processing 1,008,103 1,001,994
Transportation and Storage 778,538 758,019
Distribution 1,916,051 1,860,181
Production 455,372 428,701
Power 115,852 75,891
Other 77,246 64,056
- -----------------------------------------------------------------------------------
Total Property, Plant and Equipment 4,354,354 4,191,637
Accumulated depreciation, depletion, 1,172,492 1,110,803
and amortization
- ------------------------------------------------------------------------------------
Net Property, Plant and Equipment 3,181,862 3,080,834
- ------------------------------------------------------------------------------------
Deferred Charges and Other Assets
Regulatory assets, net (Note B) 231,968 238,605
Goodwill 117,934 92,909
Assets from price risk management 402,044 405,666
activities
Investments and other 200,682 202,193
- ------------------------------------------------------------------------------------
Total Deferred Charges and Other Assets 952,628 939,373
- ------------------------------------------------------------------------------------
Total Assets $5,935,697 $7,360,345
====================================================================================
See accompanying Notes to Consolidated Financial Statements.
4
ONEOK, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
(Unaudited) 2001 2000
- -----------------------------------------------------------------------------------
(Thousands of Dollars)
Liabilities and Shareholders' Equity
Current Liabilities
Current maturities of long-term debt $ 250,000 $ 10,767
Notes payable 433,356 824,106
Accounts payable 527,058 1,247,519
Dividends Payable 9,232 -
Accrued taxes 8,865 8,735
Accrued interest 33,921 24,161
Customers' deposits 18,782 18,319
Liabilities from price risk management 652,457 1,296,041
activities
Other 57,650 96,913
- ------------------------------------------------------------------------------------
Total Current Liabilities 1,991,321 3,526,561
- ------------------------------------------------------------------------------------
Long-term Debt, excluding current 1,494,394 1,336,082
maturities
Deferred Credits and Other Liabilities
Deferred income taxes 397,454 382,363
Liabilities from price risk management 452,301 543,278
activities
Lease obligation 128,491 137,131
Other deferred credits 195,947 209,973
- ------------------------------------------------------------------------------------
Total Deferred Credits and Other 1,174,193 1,272,745
Liabilities
- ------------------------------------------------------------------------------------
Total Liabilities 4,659,908 6,135,388
- ------------------------------------------------------------------------------------
Commitments and Contingencies (Note F)
Shareholders' Equity
Convertible preferred stock, $0.01 par value:
Series A authorized 20,000,000 shares; issued and
outstanding 19,946,448 shares at June 30, 2001
and December 31, 2000 199 199
Common stock, $0.01 par value:
authorized 300,000,000 shares; issued 63,438,441 shares
and outstanding 59,559,936 shares at June 30, 2001;
issued 63,198,610 shares and outstanding 59,176,550
shares at December 31, 2000 634 632
Paid in capital (Note H) 901,332 895,352
Unearned compensation (2,479) (1,128)
Accumulated other comprehensive income 1,954 -
(Note J)
Retained earnings 430,060 387,789
Treasury stock at cost: 3,878,505 shares
at June 30, 2001;
and 4,022,060 shares at December 31, 2000 (55,911) (57,887)
- ------------------------------------------------------------------------------------
Total Shareholders' Equity 1,275,789 1,224,957
- ------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $5,935,697 $7,360,345
====================================================================================
5
ONEOK, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
June 30,
(Unaudited) 2001 2000
- -------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Operating Activities
Net income $ 88,467 $ 90,184
Depreciation, depletion, and amortization 74,811 71,488
Gain on sale of assets (1,120) (27,050)
Gain on sale of equity investments (758) -
Income from equity investments (6,209) (2,801)
Deferred income taxes 16,582 13,320
Amortization of restricted stock 627 324
Changes in assets and liabilities:
Accounts and notes receivable 956,298 (469,977)
Inventories (4,743) 40,353
Unrecovered purchased gas costs (80,237) 12,863
Deposits 37,170 (28,766)
Accounts payable and accrued liabilities (652,369) 544,582
Price risk management assets and liabilities (149,386) (15,816)
Other assets and liabilities (24,821) (30,730)
- -------------------------------------------------------------------------------------------------------------
Cash Provided by Operating Activities 254,312 197,974
- ------------------------------------------------------------------------------------------------------------
Investing Activities
Changes in other investments, net 1,504 (830)
Acquisitions (15,337) (460,472)
Capital expenditures (173,990) (125,356)
Proceeds from sale of property 7,911 60,659
Proceeds from sale of equity investment 7,425 -
- -------------------------------------------------------------------------------------------------------------
Cash Used in Investing Activities (172,487) (525,999)
- ------------------------------------------------------------------------------------------------------------
Financing Activities
Payments of notes payable, net (390,750) (215,139)
Change in bank overdraft (57,739) 28,985
Issuance of debt 400,000 589,429
Payment of debt (2,455) (21,395)
Issuance of common stock 5,169 -
Issuance (acquisition) of treasury stock, net 839 (10,181)
Dividends paid (36,896) (36,609)
- -------------------------------------------------------------------------------------------------------------
Cash Provided by (Used In) Financing Activities (81,832) 335,090
- -------------------------------------------------------------------------------------------------------------
Change in Cash and Cash Equivalents (7) 7,065
Cash and Cash Equivalents at Beginning of Period 249 72
- -------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 242 $ 7,137
=============================================================================================================
See accompanying Notes to Consolidated Financial Statements.
6
ONEOK, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A. Summary of Significant Accounting Policies
Interim Reporting - The accompanying unaudited consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States of America for interim financial information. The interim
consolidated financial statements reflect all adjustments, which, in the opinion
of management, are necessary for a fair presentation of the results for the
interim periods presented. All such adjustments are of a normal recurring
nature. Due to the seasonal nature of the business, the results of operations
for the three and six months ended June 30, 2001, are not necessarily indicative
of the results that may be expected for a twelve-month period. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's Form 10-K for the year ended December 31,
2000.
Derivative Instruments and Hedging Activities - On January 1, 2001, the Company
adopted Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (Statement 133), as amended by
Statements 137 and 138. See Note I in the Notes to Consolidated Financial
Statements.
Reclassifications - Certain amounts in the consolidated financial statements
have been reclassified to conform to the current presentation.
B. Regulatory Assets
The following table is a summary of the Company's regulatory assets, net of
amortization.
June 30, December 31,
2001 2000
- ------------------------------------------------------------------------------
(Thousands of Dollars)
Recoupable take-or-pay $ 76,772 $ 79,324
Pension costs 13,215 15,306
Postretirement costs other than pension 60,352 61,069
Transition costs 21,899 22,199
Reacquired debt costs 22,780 23,209
Income taxes 29,194 30,727
Other 7,756 6,771
- ------------------------------------------------------------------------------
Regulatory assets, net $231,968 $238,605
==============================================================================
C. Capital Stock
On January 18, 2001, the Company's Board of Directors approved, and on May 17,
2001, the shareholders of the Company voted in favor of, a two-for-one common
stock split, which was effected through the issuance of one additional share of
common stock for each share of common stock outstanding to holders of record on
May 23, 2001, with distribution of the shares on June 11, 2001. The Company
retained the current par value of $.01 per share for all shares of common stock.
Shareholders' equity reflects the stock split by reclassifying from Paid in
Capital to Common Stock an amount equal to the cumulative par value of the
additional shares issued to effect the split. All share and per share amounts
contained herein for all periods presented reflect this stock split.
Outstanding convertible preferred stock is assumed to convert to common stock on
a two-for-one basis in the calculations of earnings per share.
7
D. Supplemental Cash Flow Information
The following table is supplemental information relative to the Company's cash
flows.
Six Months Ended
June 30,
2001 2000
- -------------------------------------------------------------------------------------------
(Thousands of Dollars)
Cash paid during the period
Interest (including amounts capitalized) $64,024 $ 35,932
Income taxes $12,666 $ 3,651
Noncash transactions
Treasury stock transferred to compensation plans $ - $ 61
Acquisitions
Property, plant and equipment $ 837 $ 782,970
Current assets - 74,012
Current liabilities - (20,996)
Goodwill 14,500 14,459
Lease obligation - (139,000)
Price risk management activities - (239,660)
Deferred credits - (11,313)
- -------------------------------------------------------------------------------------------
Cash paid - Acquisitions $15,337 $ 460,472
===========================================================================================
Additions to goodwill are due to final purchase price adjustments related to the
Kinder Morgan acquisition.
E. Earnings per Share Information
In accordance with an announcement of the Financial Accounting Standards Board's
Staff at the Emerging Issues Task Force meeting in April 2001, codified as EITF
Topic No. D-95 (Topic D-95), the Company revised its computation of earnings per
common share (EPS). In accordance with Topic D-95, the dilutive effect of the
Company's Series A Convertible Preferred Stock is now considered in the
computation of basic EPS, utilizing the "if-converted" method. Under the
Company's "if-converted" method, the dilutive effect of the Series A Convertible
Preferred Stock on EPS cannot be less than the amount that would result from the
application of the "two-class" method of computing EPS. The "two-class" method
is an earnings allocation formula that determines EPS for the common stock and
the participating Series A Convertible Preferred Stock according to dividends
declared and participating rights in the undistributed earnings. The Series A
Convertible Preferred Stock is a participating instrument with the Company's
common stock with respect to the payment of dividends. For all periods
presented, the "two-class" method resulted in additional dilution. Accordingly,
EPS for such periods reflects this further dilution. The Company restated the
EPS amounts for the three and six months ended June 30, 2000 to be consistent
with the revised methodology.
8
The following is a reconciliation of the basic and diluted EPS computations.
Three Months Ended June 30, 2001
Per Share
Income Shares Amount
- ---------------------------------------------------------------------------------------------
(Thousands, except per share amounts)
Basic EPS
Income available for common stock $14,333 59,515
Convertible preferred stock 9,275 39,892
-------------------------------
Income available for common stock
and assumed conversion of preferred stock $23,608 99,407 $ 0.24
===============================
Further dilution from applying the "two-
class" method (0.04)
----------------
Basic earnings per share $ 0.20
================
Effect of Other Dilutive Securities
Options - 326
-------------------------------
Diluted EPS
Income available for common stock
and assumed exercise of stock options $23,608 99,733 $ 0.24
===============================
Further dilution from applying the "two-
class" method (0.04)
----------------
Diluted earnings per share $ 0.20
=============================================================================================
Three Months Ended June 30, 2000
Per Share
Income Shares Amount
- ---------------------------------------------------------------------------------------------
(Thousands, except per share amounts)
Basic EPS
Income available for common stock $17,887 58,392
Convertible preferred stock 9,275 39,892
-------------------------------
Income available for common stock
and assumed conversion of preferred stock $27,162 98,284 $ 0.28
===============================
Further dilution from applying the "two-
class" method (0.05)
----------------
Basic earnings per share $ 0.23
================
Effect of Other Dilutive Securities
Options - 8
-------------------------------
Diluted EPS
Income available for common stock
and assumed exercise of stock options $27,162 98,292 $ 0.28
===============================
Further dilution from applying the "two-
class" method (0.05)
----------------
Diluted earnings per share $ 0.23
=============================================================================================
9
Six Months Ended June 30, 2001
Per Share
Income Shares Amount
- ---------------------------------------------------------------------------------------------
(Thousands, except per share amounts)
Basic EPS
Income available for common stock $69,917 59,419
Convertible preferred stock 18,550 39,892
-------------------------------
Income available for common stock
and assumed conversion of preferred stock $88,467 99,311 $ 0.89
===============================
Further dilution from applying the "two-
class" method (0.15)
----------------
Basic earnings per share $ 0.74
================
Effect of Other Dilutive Securities
Options - 354
-------------------------------
Diluted EPS
Income available for common stock
and assumed exercise of stock options $88,467 99,665 $ 0.89
===============================
Further dilution from applying the "two-
class" method (0.15)
----------------
Diluted earnings per share $ 0.74
=============================================================================================
Six Months Ended June 30, 2000
Per Share
Income Shares Amount
- ---------------------------------------------------------------------------------------------
(Thousands, except per share amounts)
Basic EPS
Income available for common stock $71,634 58,438
Convertible preferred stock 18,550 39,892
-------------------------------
Income available for common stock
and assumed conversion of preferred stock $90,184 98,330 $ 0.92
===============================
Further dilution from applying the "two-
class" method (0.16)
----------------
Basic earnings per share $ 0.76
================
Effect of Other Dilutive Securities
Options - 4
-------------------------------
Diluted EPS
Income available for common stock
and assumed exercise of stock options $90,184 98,334 $ 0.92
===============================
Further dilution from applying the "two- (0.16)
class" method
----------------
Diluted earnings per share $ 0.76
=============================================================================================
There were 64,148 and 361,194 option shares excluded from the calculation of
diluted EPS for the three months ended June 30, 2001 and 2000, respectively, due
to being antidilutive for the periods. For the six months ended June 30, 2001
and 2000, there were 37,384 and 166,992 option shares excluded from the
calculation of diluted EPS, respectively, due to being antidilutive for the
periods.
10
The following is a reconciliation of the basic and diluted EPS computations on
income before the cumulative effect of a change in accounting principle to net
income.
Six Months Ended June 30,
Basic EPS Diluted EPS
2001 2000 2001 2000
- --------------------------------------------------------------------------------------------------------------------------
(Per share amounts)
Income available for common stock
before cumulative effect of a
change in accounting principle $ 0.76 $0.74 $ 0.76 $0.74
Cumulative effect of a change in
accounting principle, net of tax (0.02) 0.02 (0.02) 0.02
-------------------- ------------------- --------------- ---------------
Income available for common stock $ 0.74 $0.76 $ 0.74 $0.76
==========================================================================================================================
F. Commitments and Contingencies
In connection with the now terminated proposed acquisition of Southwest Gas
Corporation (Southwest), the Company is party to various lawsuits. These
lawsuits originally contained allegations that included, but were not limited
to, federal and state Racketeer Influenced and Corrupt Organizations (RICO) Act
violations and improper interference in a contractual or other business
relationship between Southwest and Southern Union Corporation (Southern Union).
Southern Union's complaint originally asked for $750 million damages to be
trebled for alleged RICO violations, compensatory damages of not less than $750
million, punitive damages, and rescission of the Confidentiality and Standstill
Agreement. On May 21, 2001, the Court denied Southern Union's motion to
reconsider its ruling dismissing the federal RICO claims against the Company or
to enter a judgment on the ruling. The Court also applied its ruling to dismiss
the state RICO claim asserted by Southern Union against the Company. The
Court's ruling on the RICO claims were made applicable to all defendants. On
June 21, 2001, the Court dismissed with prejudice Southern Union's claim for
fraudulent inducement against the Company, Gene Dubay and John Gaberino. The
Court did not dismiss the claim by Southern Union against Southwest and Michael
Maffie. The Court also dismissed with prejudice Southern Union's claims for
tortious interference with a contractual relationship against the Company. This
claim remains pending against only Gene Dubay, John Gaberino, James Irvin and
Jack Rose. The Court denied the motion to dismiss Southern Union's claim for
tortious interference with a prospective relationship against the Company, Gene
Dubay and John Gaberino. On June 29, 2001, the Company filed a motion for
summary judgment in its favor on the sole remaining claim asserted against it by
Southern Union. Various other motions for summary judgment were filed by other
parties, all of which are scheduled for hearing on August 24, 2001.
The Company, as third party beneficiary, has filed a lawsuit against Southern
Union for, among other things, breach of a confidentiality agreement with
Southern Union and Southwest and tortious interference with the Southwest merger
agreement. The Company filed suit against Southwest seeking a declaratory
judgment determining that it had properly terminated the merger agreement. In
response to this suit, Southwest brought a suit against the Company and Southern
Union alleging, among other things, fraud and breach of contract. Southwest is
seeking damages in excess of $75,000.
Most of the lawsuits discussed above have been consolidated into one case with
ONEOK being designated as the plaintiff regarding claims against Southern Union.
The court has entered an order setting the cases for jury trial on November 12,
2001.
11
Two substantially identical derivative actions were filed by shareholders
against the members of the Board of Directors of the Company for alleged
violation of their fiduciary duties to the Company by causing or allowing the
Company to engage in certain fraudulent and improper schemes designed to
"sabotage" Southern Union Company's competitive bid to acquire Southwest and
secure regulatory approval for the Company's own planned merger with Southwest.
Such conduct allegedly caused the Company to be sued by both Southwest and
Southern Union, which exposed the Company to millions of dollars in liabilities.
The allegations are used as a basis for causes of action for intentional breach
of fiduciary duty, derivative claim for negligent breach of fiduciary duty,
class and derivative claims for constructive fraud, and derivative claims for
gross mismanagement. Each plaintiff seeks a declaration that the lawsuit is
properly maintained as a derivative action, the defendants, and each of them,
have breached their fiduciary duties to the Company, an injunction permanently
enjoining defendants from further abuse of control and committing of gross
mismanagement and constructive fraud, and asks for an award of compensatory and
punitive damages and costs, disbursements and reasonable attorney fees. A Joint
Motion for Consolidation of both derivative actions was filed on June 6, 2000,
and Pretrial Order No. 1 was entered on that date consolidating the actions and
establishing a schedule for response to a consolidated petition. On July 21,
2000, the plaintiffs filed their Consolidated Petition. Stephen J. Jatras and
J.M. Graves have been eliminated as defendants in the Consolidated Petition, but
Eugene Dubay was added as a new defendant. The plaintiffs also dropped their
class and derivative claim for constructive fraud, but added a new derivative
claim for waste of corporate assets. On September 19, 2000, the Company, the
Independent Directors (Anderson, Bell, Cummings, Ford, Fricke, Lake, Mackie,
Newsom, Parker, Scott and Young), David Kyle, and Gene Dubay filed Motions to
Dismiss the action for failure of the plaintiffs to make a pre-suit demand on
the Company's Board of Directors. In addition, the Independent Directors, David
Kyle, and Gene Dubay filed Motions to Dismiss the Plaintiffs' Consolidated
Petition for failure to state a claim. On January 3, 2001, the Court dismissed
the action without prejudice as to its claims against Larry Brummett. On
February 26, 2001, the action was stayed until one of the parties notifies the
Court that a dissolution of the stay is requested.
If any of the plaintiffs should be successful in any of their claims against the
Company and substantial damages are awarded, it could have a material adverse
effect on the Company's operations, cash flow, and financial position. At the
present time, the Company is unable to estimate the possible loss, if any,
associated with these matters. The Company is defending itself vigorously
against all claims asserted by Southern Union and Southwest and all other
matters relating to the now terminated proposed acquisition with Southwest.
The Company has responsibility for 12 manufactured gas sites located in Kansas,
which may contain coal tar and other potentially harmful materials that are
classified as hazardous material. Hazardous materials are subject to control or
remediation under various environmental laws and regulations. A consent
agreement with the Kansas Department of Health and Environment (KDHE) presently
governs all future work at these sites. The terms of the consent agreement
allow the Company to investigate these sites and set remediation priorities
based upon the results of the investigations and risk analysis. The prioritized
sites will be investigated over a ten year period. At March 31, 2001, the costs
of the investigations and risk analysis have been immaterial. Limited
information is available about the sites and no testing has been performed.
Management's best estimate of the cost of remediation ranges from $100 thousand
to $10 million per site based on a limited comparison of costs incurred to
remediate comparable sites. These estimates do not give effect to potential
insurance recoveries, recoveries through rates or from third parties. The
Kansas Corporation Commission (KCC) has permitted others to recover their
remediation costs through rates. It should be noted that additional information
and testing could result in costs significantly below or in excess of the
amounts estimated above. To the extent that such remediation costs are not
recovered, the costs could be material to the Company's results of operations
and cash flows depending on the degree of remediation required and number of
years over which the remediation must be completed.
The Oklahoma Corporation Commission (OCC) staff recommended to the OCC that
ONG's unrecovered purchased gas cost (UPGC) clause be suspended because ONG
allegedly failed to "act prudently" in acquiring its gas supply for the
2000/2001 heating season resulting in an alleged $72.1 million in excess charges
to ratepayers through March 31, 2001. The hearing on the merits of the OCC's
case was conducted on June 25-27, 2001, after which the OCC took the matter
under advisement. ONG and the OCC submitted proposed orders on July 13, 2001.
If the OCC staff is successful, the Company would not be allowed to recover
approximately $72.1 million in UPGC. The Company believes that the OCC staff's
recommendation is without merit and is defending itself vigorously against this
recommendation.
12
Two separate class action lawsuits have been filed against the Company in
connection with the natural gas explosions and eruptions of natural gas geysers
that occurred in Hutchinson, Kansas in January, 2001. Although no assurances
can be given, management believes that the ultimate resolution of these matters
will not have a material adverse effect on its financial position or results of
operations. The Company is vigorously defending itself against all claims.
The Company is a party to other litigation matters and claims, which are normal
in the course of its operations, and while the results of litigation and claims
cannot be predicted with certainty, management believes the final outcome of
such matters will not have a materially adverse effect on consolidated results
of operations, financial position, or liquidity.
G. Segments
The Company conducts its operations through seven segments: (1) the Marketing
and Trading segment markets natural gas to wholesale and retail customers; (2)
the Gathering and Processing segment gathers and processes natural gas and
fractionates, stores and markets natural gas liquids; (3) the Transportation and
Storage segment transports and stores natural gas for others and buys and sells
natural gas; (4) the Distribution segment distributes natural gas to
residential, commercial and industrial customers, leases pipeline capacity to
others and provides transportation services for end-use customers; (5) the
Production segment develops and produces natural gas and oil; (6) the Power
segment produces and sells electricity during peak periods to wholesale
customers; and (7) the Other segment primarily operates and leases the Company's
headquarters building and a related parking facility.
Intersegment sales are recorded on the same basis as sales to unaffiliated
customers. All corporate overhead costs relating to a reportable segment have
been allocated for the purpose of calculating operating income. The Company's
equity method investments do not represent operating segments of the Company.
The Company has no single external customer from which it receives ten percent
or more of its revenues.
Three Months Ended Marketing Gathering Transportation Other
June 30, 2001 and and and and
Trading Processing Storage Distribution Production Power Eliminations Total
- ------------------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Sales to unaffiliated
customers $ 905,206 $218,033 $22,173 $225,051 $27,842 $ 3,908 $ 186 $1,402,399
Intersegment sales 105,810 135,634 25,706 772 7,182 - (275,104) $ -
- ------------------------------------------------------------------------------------------------------------------------------------
Total Revenues $1,011,016 $353,667 $47,879 $225,823 $35,024 $ 3,908 $(274,918) $1,402,399
- ------------------------------------------------------------------------------------------------------------------------------------
Net revenues $ 38,433 $ 43,080 $32,698 $ 72,290 $35,024 $ 900 $ (28,381) $ 194,044
Operating costs $ 2,150 $ 29,219 $12,348 $ 61,629 $ 7,149 $ 233 $ (28,482) $ 84,246
Depreciation, depletion and $ 124 $ 6,995 $ 4,751 $ 17,159 $ 8,159 $ 18 $ 650 $ 37,856
amortization
Operating income $ 36,159 $ 6,866 $15,599 $ (6,498) $19,716 $ 649 $ (549) $ 71,942
Income from equity $ - $ - $ 849 $ - $ (47) $ - $ - $ 802
investments
Capital expenditures $ 375 $ 9,562 $ 7,308 $ 30,216 $14,959 $11,600 $ 8,957 $ 82,977
- ------------------------------------------------------------------------------------------------------------------------------------
13
Three Months Ended Marketing Gathering Transportation Other
June 30, 2000 and and and and
Trading Processing Storage Distribution Production Power Eliminations Total
- -----------------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Sales to unaffiliated
customers $ 954,791 $198,040 $31,299 $187,772 $12,799 $ - $ (1,171) $1,383,530
Intersegment sales 53,262 24,921 14,357 915 4,648 - (98,103) $ -
- -----------------------------------------------------------------------------------------------------------------------------------
Total Revenues $1,008,053 $222,961 $45,656 $188,687 $17,447 $ - $(99,274) $1,383,530
- -----------------------------------------------------------------------------------------------------------------------------------
Net revenues $ 29,910 $ 58,125 $31,422 $ 74,343 $17,447 $ - $(20,500) $ 190,747
Operating costs $ 4,161 $ 22,116 $10,641 $ 55,249 $ 5,879 $ - $(18,493) $ 79,553
Depreciation, depletion and $ 314 $ 6,402 $ 5,004 $ 16,802 $ 7,990 $ - $ 649 $ 37,161
amortization
Operating income $ 25,435 $ 29,607 $15,777 $ 2,292 $ 3,578 $ - $ (2,656) $ 74,033
Income from equity $ - $ - $ 1,543 $ - $ 22 $ - $ - $ 1,565
investments
Capital expenditures $ - $ 5,466 $ 6,805 $ 29,599 $ 9,710 $10,172 $ 9,960 $ 71,712
- -----------------------------------------------------------------------------------------------------------------------------------
Six Months Ended Marketing Gathering Transportation Other Total
June 30, 2001 and and and and
Trading Processing Storage Distribution Production Power Eliminations
- -----------------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Sales to unaffiliated
customers $2,773,326 $ 491,720 $ 57,013 $ 986,226 $44,681 $ 3,908 $ 2,449 $4,359,323
Intersegment sales 525,848 338,539 44,069 1,505 19,629 - (929,590) $ -
- -----------------------------------------------------------------------------------------------------------------------------------
Total Revenues $3,299,174 $ 830,259 $101,082 $ 987,731 $64,310 $ 3,908 $(927,141) $4,359,323
- -----------------------------------------------------------------------------------------------------------------------------------
Net revenues $ 67,714 $ 92,305 $ 70,259 $ 213,062 $64,310 $ 900 $ (46,243) $ 462,307
Operating costs $ 6,503 $ 58,396 $ 25,237 $ 119,694 $14,954 $ 302 $ (52,578) $ 172,508
Depreciation, depletion and $ 261 $ 13,806 $ 9,501 $ 34,136 $15,744 $ 37 $ 1,326 $ 74,811
amortization
Operating income $ 60,950 $ 20,103 $ 35,521 $ 59,232 $33,612 $ 561 $ 5,009 $ 214,988
Cumulative effect of a change $ - $ - $ - $ - $(2,151) $ - $ - $ (2,151)
in accounting principle,
net of tax
Income from equity $ - $ - $ 1,508 $ - $ 4,701 $ - $ - $ 6,209
investments
Total assets $1,868,296 $1,247,510 $643,849 $1,844,662 $370,858 $ 119,260 $(158,738) $5,935,697
Capital expenditures $ 397 $ 16,713 $ 18,122 $ 57,394 $ 26,220 $ 39,961 $ 15,183 $ 173,990
- -----------------------------------------------------------------------------------------------------------------------------------
14
Six Months Ended Marketing Gathering Transportation Other Total
June 30, 2000 and and and and
Trading Processing Storage Distribution Production Power Eliminations
- -----------------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Sales to unaffiliated
customers $1,310,915 $ 248,089 $ 45,128 $ 567,482 $ 26,314 $ - $ 7,421 $2,205,349
Intersegment sales 145,978 43,317 28,721 1,827 9,964 - (229,807) $ -
- -----------------------------------------------------------------------------------------------------------------------------------
Total Revenues $1,456,893 $ 291,406 $ 73,849 $ 569,309 $ 36,278 $ - $(222,386) $2,205,349
- -----------------------------------------------------------------------------------------------------------------------------------
Net revenues $ 45,720 $ 74,165 $ 56,274 $ 209,774 $ 36,278 $ - $ (28,920) $ 393,291
Operating costs $ 6,700 $ 28,643 $ 18,719 $ 105,003 $ 11,525 $ - $ (27,746) $ 142,844
Depreciation, depletion and $ 505 $ 8,691 $ 9,197 $ 35,373 $ 16,452 $ - $ 1,270 $ 71,488
amortization
Operating income $ 38,515 $ 36,831 $ 28,358 $ 69,398 $ 8,301 $ - $ (2,444) $ 178,959
Cumulative effect of a change $ 2,115 $ - $ - $ - $ - $ - $ - $ 2,115
in accounting principle,
net of tax
Income from equity $ - $ - $ 2,772 $ - $ 29 $ - $ - $ 2,801
investments
Total assets $1,776,781 $1,003,288 $615,738 $1,633,375 $352,681 $37,318 $ (47,077) $5,372,104
Capital expenditures $ 45 $ 10,297 $ 14,408 $ 51,668 $ 17,922 $19,627 $ 11,389 $ 125,356
- -----------------------------------------------------------------------------------------------------------------------------------
H. Paid in Capital
Paid in capital was $337.1 million and $331.2 million for common stock at June
30, 2001, and December 31, 2000, respectively. Paid in capital for convertible
preferred stock was $564.2 million at June 30, 2001 and December 31, 2000.
I. Derivative Instruments and Hedging Activities
On January 1, 2001, the Company adopted the provisions of Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (Statement 133), amended by Statement No. 137 and Statement No.
138. Statement 137 delayed the implementation of Statement 133 until fiscal
years beginning after June 15, 2000. Statement 138 amended the accounting and
reporting standards of Statement 133 for certain derivative instruments and
hedging activities. Statement 138 also amends Statement 133 for decisions made
by the Financial Accounting Standards Board (FASB) relating to the Derivatives
Implementation Group (DIG) process. The FASB DIG is addressing Statement 133
implementation issues, the ultimate resolution of which may impact the
application of Statement 133.
Under Statement 133, entities are required to record all derivative instruments
in the balance sheet at fair value. The accounting for changes in the fair
value of a derivative instrument depends on whether it has been designated and
qualifies as part of a hedging relationship and, if so, on the reason for
holding it. If certain conditions are met, entities may elect to designate a
derivative instrument as a hedge of exposures to changes in fair values, cash
flows, or foreign currencies. If the hedged exposure is a fair value exposure,
the gain or loss on the derivative instrument is recognized in earnings in the
period of change together with the offsetting loss or gain on the hedged item
attributable to the risk being hedged. If the hedged exposure is a cash flow
exposure, the effective portion of the gain or loss on the derivative instrument
is reported initially as a component of other comprehensive income (outside
earnings) and subsequently reclassified into earnings when the forecasted
transaction affects earnings. Any amounts excluded from the assessment of hedge
effectiveness, as well as the ineffective portion of the hedge, are reported in
earnings immediately.
15
In 2000, the Company entered into derivative instruments related to the
production of natural gas, most of which will expire by the end of 2001. These
derivative instruments are designed to hedge the Production segment's exposure
to changes in the price of natural gas. Changes in the fair value of the
derivative instruments are reflected initially in other comprehensive income
(loss) and subsequently realized in earnings when the forecasted transaction
affects earnings. The Company recorded a cumulative effect charge of $2.2
million, net of tax, in the income statement and $28 million, net of tax, in
accumulated other comprehensive loss to recognize at fair value the ineffective
and effective portions, respectively, of the losses on all derivative
instruments that are designated as cash flow hedging instruments, which
primarily consist of costless option collars and swaps on natural gas
production.
The Company recognized $5.0 million in earnings, representing the change in the
ineffective portion of the cash flow hedges for the six months ended June 30,
2001. The Company realized a $26.0 million loss in earnings that was
reclassified from accumulated other comprehensive loss resulting from the
settlement of contracts when the natural gas was sold. These gains and losses
are reported in Operating Revenues. Other comprehensive income of $2.0 million
at June 30, 2001 is related to a cash flow exposure and will be realized in
earnings within the next seven months.
J. Comprehensive Income
Three Months Ended Six Months Ended
June 30, 2001 June 30, 2001
- --------------------------------------------------------------------------------------------------------------------------
Net Income $23,608 $88,467
Other comprehensive income (loss):
Cumulative effect of a change in accounting $ - $(45,556)
principle
Unrealized gains on derivative instruments 10,300 22,726
Realized losses in net income 5,179 26,015
-------------------- ---------------
Other comprehensive income before taxes 15,479 3,185
Income tax benefit on other comprehensive income (5,987) (1,231)
------------------------------------ ------------------------------
Other comprehensive income $ 9,492 $ 1,954
---------------- ---------------
Comprehensive income $33,100 $90,421
==========================================================================================================================
K. Energy Trading and Risk Management Activities
The Company engages in price risk management activities for both trading and
non-trading purposes. On January 1, 2000, the Company adopted Emerging Issues
Task Force Issue No. 98-10, "Accounting for Energy Trading and Risk Management
Activities" (EITF 98-10) for its energy trading contracts. EITF 98-10 requires
entities involved in energy trading activities to account for energy trading
contracts using mark-to-market accounting. Prior to the adoption of EITF 98-10,
the Company accounted for its trading activities on the accrual method based on
settlement of physical positions. The adoption of EITF 98-10 was accounted for
as a change in accounting principle and the cumulative effect at January 1, 2000
of $2.1 million, net of tax, was recognized. Forwards, swaps, options, and
energy transportation and storage contracts utilized for trading activities are
reflected at fair value as assets and liabilities from price risk management
activities in the consolidated balance sheets. The fair value of these assets
and liabilities are affected by the actual timing of settlements related to
these contracts and current period changes resulting primarily from newly
originated transactions and the impact of price movements. Changes in fair
value are recognized in net revenues in the consolidated statement of income.
Market prices used to fair value these assets and liabilities reflect
management's best estimate considering various factors including closing
exchange and over-the-counter quotations, time value and volatility underlying
the commitments. Market prices are adjusted for the potential impact of
liquidating the Company's position in an orderly manner over a reasonable period
of time under present market conditions.
16
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Some of the statements contained and incorporated in this Form 10-Q are forward-
looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995. The forward-looking statements relate to the anticipated
financial performance, management's plans and objectives for future operations,
business prospects, outcome of regulatory proceedings, market conditions and
other matters. The Private Securities Litigation Reform Act of 1995 provides a
safe harbor for forward-looking statements in various circumstances. The
following discussion is intended to identify important factors that could cause
future outcomes to differ materially from those set forth in the forward-looking
statements.
Forward-looking statements include the items identified in the preceding
paragraph, the information concerning possible or assumed future results of
operations and other statements contained or incorporated in this Form 10-Q
identified by words such as "anticipate," "estimate," "expect," "intend,"
"believe," "projection" or "goal."
You should not place undue reliance on the forward-looking statements. They are
based on known and unknown risks, uncertainties and other factors that may cause
our actual results, performance or achievements to be materially different from
any future results, performance or achievements expressed or implied by the
forward-looking statements. Those factors may affect our operations, markets,
products, services and prices. In addition to any assumptions and other factors
referred to specifically in connection with the forward-looking statements,
factors that could cause our actual results to differ materially from those
contemplated in any forward-looking statement include, among others, the
following:
. the effects of weather and other natural phenomena on sales and prices;
. increased competition from other energy suppliers as well as alternative
forms of energy;
. the capital intensive nature of the Company's business;
. further deregulation, or "unbundling" of the natural gas business;
competitive changes in the natural gas gathering, transportation and storage
business resulting from deregulation, or "unbundling," of the natural gas
business;
. the profitability of assets or businesses acquired by the Company;
. risks of marketing, trading, and hedging activities as a result of changes in
energy prices;
. economic climate and growth in the geographic areas in which the Company does
business;
. the uncertainty of gas and oil reserve estimates;
. the timing and extent of changes in commodity prices for natural gas, natural
gas liquids, electricity, and crude oil;
. the effects of changes in governmental policies and regulatory actions,
including income taxes, environmental compliance, and authorized rates;
. the results of litigation related to the Company's now terminated proposed
acquisition of Southwest Gas Corporation (Southwest) or to the termination of
the Company's merger agreement with Southwest; and
. the other factors listed in the reports the Company has filed and may file
with the Securities and Exchange Commission, which are incorporated by
reference.
Other factors and assumptions not identified above were also involved in the
making of the forward-looking statements. The failure of those assumptions to be
realized, as well as other factors, may also cause actual results to differ
materially from those projected.
17
A. Results of Operations
Consolidated Operations
The Company is a diversified energy company whose objective is to maximize value
for shareholders by vertically integrating its business operations from the
wellhead to the burner tip. This strategy has led the Company to focus on
acquiring assets that provide synergistic trading and marketing opportunities
along the natural gas energy chain. Products and services are provided to its
customers through the following segments:
. Marketing and Trading
. Gathering and Processing
. Transportation and Storage
. Distribution
. Production
. Power
. Other
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Financial Results
Operating revenues $1,402,399 $1,383,530 $4,359,323 $2,205,349
Cost of gas 1,208,355 1,192,783 3,897,016 1,812,058
- ------------------------------------------------------------------------------------------------------------------------------------
Net revenues 194,044 190,747 462,307 393,291
Operating costs 84,246 79,553 172,508 142,844
Depreciation, depletion, and amortization 37,856 37,161 74,811 71,488
- ------------------------------------------------------------------------------------------------------------------------------------
Operating income $ 71,942 $ 74,033 $ 214,988 $ 178,959
====================================================================================================================================
Other income, net $ 566 $ 1,082 $ 3,865 $ 17,494
====================================================================================================================================
Cumulative effect of a change in accounting principle $ - $ - $ (3,508) $ 3,449
Income tax - - 1,357 1,334
- ------------------------------------------------------------------------------------------------------------------------------------
Cumulative effect of a change in accounting principle, net of tax $ - $ - $ (2,151) $ 2,115
====================================================================================================================================
The Company's operating results decreased for the three months ended June 30,
2001 compared to the same period in 2000 primarily due to decreases in the
Gathering and Processing and Distribution segments. Increased operating income
in the Marketing and Production segments largely offset these decreases.
Operating costs increased primarily due to increased personnel costs necessary
to support the expanded base of operations resulting from the acquisitions in
2000. Other income, net includes income from equity investments that was
partially offset by ongoing litigation costs associated with the terminated
acquisition of Southwest.
The Company's operating results increased for the six-month period due to
acquisitions in 2000 , the impact of volatility in gas prices and higher
average hedged prices on the Production segment. Other income, net for the six
months ended June 30, 2001 includes approximately $6.2 million in income from
equity investments that was partially offset by a charge of $2.2 million related
to ongoing litigation costs associated with the terminated acquisition of
Southwest. Other income, net for the six months ended June 30, 2000 includes a
$26.7 million gain on the sale of assets and income from equity investments
which were partially offset by a charge of $9.4 million of previously deferred
costs and ongoing litigation costs associated with the terminated acquisition of
Southwest, and other charges.
18
Marketing and Trading
The Marketing and Trading segment purchases, stores, markets and trades natural
gas to both the wholesale and retail sectors in 28 states. The Company has
strong mid-continent region storage positions and transport capacity of 1 Bcf
per day that allows for trade from the California border, throughout the
Rockies, to the Chicago city gate. With total storage capacity of 69 Bcf,
withdrawal capability of 2.5 Bcf per day and injection of 1.4 Bcf per day, the
Company has direct access to all regions of the country with great flexibility
in capturing volatility in the energy markets.
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Financial Results
Gas sales $1,010,503 $1,007,276 $3,297,916 $1,455,915
Cost of gas 972,583 978,143 3,231,460 1,411,173
- ----------------------------------------------------------------------------------------------------------------------------------
Gross margin on gas sales 37,920 29,133 66,456 44,742
Other revenues 513 777 1,258 978
- ----------------------------------------------------------------------------------------------------------------------------------
Net revenues 38,433 29,910 67,714 45,720
Operating costs 2,150 4,161 6,503 6,700
Depreciation, depletion, and amortization 124 314 261 505
- ----------------------------------------------------------------------------------------------------------------------------------
Operating income $ 36,159 $ 25,435 $ 60,950 $ 38,515
==================================================================================================================================
Cumulative effect of change in accounting principle, $ - $ - $ - $ 3,449
before tax
==================================================================================================================================
Higher gas prices and increased price volatility for the three and six months
ended June 30, 2001 compared to the same periods in 2000, resulted in increased
gas sales and cost of gas, although for the three-month period, a reduction in
volumes partially offset the increase in prices. The decrease in sales volumes
was due to higher storage injections relative to the prior year as the Company
has focused on opportunistically securing storage volumes that are then hedged
at favorable winter/summer spreads. For the six-month period, increased
volumes are primarily a result of the acquisition in 2000. Marketing and
trading sales volumes averaged 2.2 Bcf/d and 2.8 Bcf/d for the three and six
months ended June 30, 2001 compared with 3.0 Bcf/d and 2.4 Bcf/d for the same
periods in 2000.
Operating costs decreased approximately $2.0 million for the three months ended
June 30, 2001 compared to the same period in 2000 due to a decrease in reserves
for doubtful accounts. This decrease was partially offset by increased
personnel costs necessary to support the expanded base of marketing and trading
activities resulting from the acquisitions.
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------------
Operating Information
Natural gas volumes (MMcf) 200,999 273,222 498,352 435,415
Gross margin ($/Mcf) $ 0.189 $ 0.107 $ 0.133 $ 0.103
Capital expenditures (Thousands) $ 375 $ - $ 397 $ 45
Total assets (Thousands) $ - $ - $1,868,296 $1,776,781
- -----------------------------------------------------------------------------------------------------------------------------------
Gross margin per Mcf improved for the three and six-month periods as the Company
has now fully integrated its mid-continent marketing and trading base and is
successfully executing its transportation and storage arbitrage strategy that
focuses on capturing higher margin sales.
19
Gathering and Processing
The Gathering and Processing segment currently owns and operates 25 gas
processing plants and has an ownership interest in four additional gas
processing plants which it does not operate. Six operated plants are
temporarily idled. The total processing capacity of plants operated and the
Company's proportionate interest in plants not operated by the Company is 2.2
Bcf/d, of which 0.331 Bcf/d has been idled temporarily. A total of over 19,300
miles of gathering pipelines support the gas processing plants.
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
- --------------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Financial Results
Natural gas liquids and condensate sales $157,300 $109,159 $342,687 $145,084
Gas sales 174,855 90,760 439,591 116,698
Gathering, compression, dehydration and processing 21,371 20,380 47,702 25,496
fees
Cost of sales 310,587 164,836 737,954 217,241
- --------------------------------------------------------------------------------------------------------------------------------
Gross margin 42,939 55,463 92,026 70,037
Other revenues 141 2,662 279 4,128
- --------------------------------------------------------------------------------------------------------------------------------
Net revenues 43,080 58,125 92,305 74,165
Operating costs 29,219 22,116 58,396 28,643
Depreciation, depletion, and amortization 6,995 6,402 13,806 8,691
- --------------------------------------------------------------------------------------------------------------------------------
Operating income $ 6,866 $ 29,607 $ 20,103 $ 36,831
================================================================================================================================
Other income, net $ - $ - $ - $ 26,585
================================================================================================================================
Natural gas liquids and condensate sales, gas sales, fee-based revenues and cost
of sales increased for the three and six months ended June 30, 2001 compared to
the same periods in 2000, due primarily to stronger commodity prices. The
impact of increases in natural gas liquids and condensate prices was partially
offset by decreased volumes resulting from the company and producers opting to
not extract liquids in periods when low or negative processing spreads made it
uneconomic to do so. The increase in fee-based revenues from gathering,
compression, dehydration and processing was partially offset by a decrease due
to the expiration of a contract. The contract was reinstated in June 2001 under
terms that were more favorable to the Company. Gross margin decreased for the
three-month period due to the effect of higher commodity prices, which increased
cost of sales. Included in the cost of sales are higher fuel and shrinkage
costs, which resulted in reduced processing spreads on keep whole contracts.
For the six-month period, increased volumes associated with the acquisitions in
2000 also contributed to the increases in revenues and cost of sales.
Operating costs increased for the three and six months ended June 30, 2001
compared to the same periods in 2000 primarily due to increased personnel costs
to support the expanded base of operations resulting from the acquisitions. The
increase in assets from well connects and system enhancements also contributed
to the increase in depreciation, depletion, and amortization.
Other income, net in 2000 included the gain on the sale of the Company's 42.4
percent interest in the Indian Basin gas processing plant and gathering system
of $26.7 million.
20
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
- ----------------------------------------------------------------------------------------------------------------------
Gas Processing Plants Operating Information
Average NGL price realized ($/Gal) $0.532 $0.328 $0.602 $0.329
Average gas sales price realized ($/Mcf) $5.52 $2.74 $6.51 $2.62
Total gas gathered (MMbtu/d) 1,537,375 1,604,813 1,495,151 1,079,033
Total gas processed (MMcf/d) 1,232 1,351 1,154 880
Natural gas liquids sales (MBbls) 6,472 5,958 12,591 8,385
Natural gas liquids produced (Bbls/d) 82,983 100,164 80,978 63,893
Gas sales (MMcf) 33,201 33,133 68,808 44,581
Natural Gas Liquids by Component (%)
Ethane 33 39 34 43
Propane 35 32 35 30
Iso butane 6 5 6 5
Normal butane 13 12 13 11
Natural gasoline 13 12 12 11
Contract %
Percent of Proceeds 43 39 43 39
Keep Whole 23 47 23 47
Fee 34 14 34 14
Capital expenditures (Thousands) $ 9,562 $ 5,466 $16,713 $ 10,297
Total assets (Thousands) $ - $ - $1,247,510 $1,003,288
- ----------------------------------------------------------------------------------------------------------------------
Stronger market prices resulted in increases of 62 percent and 83 percent for
average NGL price realized and 101 percent and 148 percent for average gas sales
price realized for the three and six months, respectively. Volumes of natural
gas gathered and processed decreased slightly for the three months ended June
30, 2001 compared to the same period in 2000 while volumes of gas and natural
gas liquids sold increased slightly for the same period. The same volumes
increased for the six-month period due to the increased processing and
fractionation capacity acquired in the acquisitions. These acquisitions
increased the Company's processing and fractionation capacity by 1.6 Bcf/d. The
volume of natural gas liquids produced decreased for the three-month period
since prices made it uneconomical during certain times to extract liquids and
the Company opted not to process during those times.
Ethane sales as a percentage of total product sales decreased for the three and
six-month periods in 2001 compared to the same periods in 2000 due to ethane
rejection resulting from abnormally high natural gas prices relative to ethane.
Capital expenditures increased for the three and six months ended June 30, 2001
compared to the corresponding prior periods due to increased costs to sustain
operations due to having a higher asset base resulting from the acquisitions in
2000.
Total assets increased $244.2 million to $1.2 billion at June 30, 2001 from June
30, 2000 due primarily to a $166.8 million increase in accounts receivable as a
result of higher prices and a $57.1 million increase in net property, plant and
equipment.
Transportation and Storage
The transportation and storage segment represents the Company's intrastate
transmission pipelines and natural gas storage facilities. The Company has four
storage facilities in Oklahoma, two in Kansas and three in Texas with a combined
working capacity of approximately 58 Bcf. The Company's intrastate transmission
pipelines operate in Oklahoma, Kansas and Texas and are regulated by the
Oklahoma Corporation Commission (OCC), Kansas Corporation Commission (KCC), and
Texas Railroad Commission (TRC), respectively.
21
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Financial Results
Transportation and gathering revenues $28,591 $25,145 $64,757 $44,148
Storage revenues 11,384 6,633 21,338 13,947
Cost of fuel 8,983 5,783 20,039 9,124
- -----------------------------------------------------------------------------------------------------------------------------------
Gross margin on transportation, gathering and 30,992 25,995 66,056 48,971
storage revenues
Gas sales 6,259 12,487 11,315 12,487
Cost of gas 6,198 8,451 10,784 8,451
- -----------------------------------------------------------------------------------------------------------------------------------
Gross margin on gas sales 61 4,036 531 4,036
Other revenues 1,645 1,391 3,672 3,267
- -----------------------------------------------------------------------------------------------------------------------------------
Net revenues 32,698 31,422 70,259 56,274
Operating costs 12,348 10,641 25,237 18,719
Depreciation, depletion, and amortization 4,751 5,004 9,501 9,197
- -----------------------------------------------------------------------------------------------------------------------------------
Operating income $15,599 $15,777 $35,521 $28,358
===================================================================================================================================
Other income, net $ 849 $ 1,543 $ 8 $ 2,772
===================================================================================================================================
Transportation and gathering revenues increased for the three and six months
ended June 30, 2001 compared to the same period in 2000 primarily due to
increased volumes transported as a result of the acquisitions in 2000. A new
power plant load contributed to the increase in the three-month period. Storage
revenues increased for the three and six-month periods primarily due to
increased storage rates and as a result of increased storage capacity from the
acquisitions. Cost of fuel increased for the three and six-month periods due
to increased prices and increased volumes. Gross margin on gas sales relate to
merchant gas sales acquired in 2000 and incremental purchases and sales in 2001.
Most gas sales are on a fixed price basis while cost of gas reflects the higher
gas prices.
Operating costs increased for the three and six-month periods primarily as a
result of increased personnel costs to support the expanded base of operations
resulting from the acquisitions in 2000 and increased gathering costs.
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------------
Operating Information
Volumes transported (MMcf) 126,940 122,088 286,785 235,510
Capital expenditures (Thousands) $ 7,308 $ 6,805 $ 18,122 $ 14,408
Total assets (Thousands) $ - $ - $643,849 $615,738
- -----------------------------------------------------------------------------------------------------------------------------------
Capital expenditures increased for the three and six months ended June 30, 2001
compared to the same periods in 2000 due to sustaining an increased asset base.
Total assets increased at June 30, 2001 compared to June 30, 2000 due to an
increase in property, plant and equipment.
Distribution
The Distribution segment provides natural gas distribution services in Oklahoma
and Kansas to residential, commercial and industrial customers. The Company's
operations in Oklahoma are primarily conducted through Oklahoma Natural Gas
(ONG). Operations in Kansas are conducted through Kansas Gas Service (KGS).
The Distribution segment serves about 80 percent of Oklahoma and about 72
percent of Kansas. ONG is subject to regulatory oversight by the OCC, and KGS
is subject to regulatory oversight by the KCC.
22
An Order received in May 2000 from the OCC, provided for a $20 million net
revenue reduction in rates which will be offset by an annual reduction in
depreciation expense of $11.4 million. Pursuant to this Order, the Oklahoma
assets and customers of KGS were transferred to ONG. This Order also adjusted
rates for the removal of the gathering and storage assets no longer included in
base rates and provided for the recovery of gas purchase, operations and
maintenance expenses and line losses through a rider rather than base rates. An
Order from the KCC effective in July, 2000 reduced tariff rates. The Order also
provided for the recovery of certain costs through a cost of gas rider rather
than through tariff rates, which reduces gross margin and operating costs by a
like amount. See further discussion of matters with the OCC in the "Liquidity"
section, page 27.
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
- -------------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Financial Results
Gas sales $210,867 $172,416 $948,583 $530,106
Cost of gas 153,533 114,344 774,669 359,535
- -------------------------------------------------------------------------------------------------------------------------------
Gross margin 57,334 58,072 173,914 170,571
PCL and ECT Revenues 10,652 11,720 28,782 30,571
Other revenues 4,304 4,551 10,366 8,632
- -------------------------------------------------------------------------------------------------------------------------------
Net revenues 72,290 74,343 213,062 209,774
Operating costs 61,629 55,249 119,694 105,003
Depreciation, depletion, and 17,159 16,802 34,136 35,373
amortization
- -------------------------------------------------------------------------------------------------------------------------------
Operating income (loss) $ (6,498) $ 2,292 $ 59,232 $ 69,398
===============================================================================================================================
Gas sales and cost of gas increased for the three and six months ended June 30,
2001 compared to the same periods in 2000 primarily due to increased gas costs.
Lower tariff rates and the impact of the temperature adjustment clause
negatively impacted gross margin for the three and six-month periods. Weather
was colder than normal during the heating season in 2001, accordingly, margins
for customers whose rates are weather normalized were adjusted downward to
reflect the impact of normal weather. However, during the heating season in
2000, KGS did not have weather normalized rates and did not receive the benefit
that weather normalized rates would have provided due to weather that was warmer
than normal. For the six-month period, increased revenue from a line loss and
gathering rider and increased customer service revenue positively impacted gross
margin.
Increased bad debts due to the strong natural gas prices resulted in an increase
to operating costs of $7.5 million and $12.0 million for the three and six
months, respectively.
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------
Gross Margin per Mcf
Oklahoma
Residential $4.87 $5.22 $2.51 $2.58
Commercial $2.76 $2.86 $2.05 $2.23
Industrial $1.89 $1.01 $1.22 $1.14
Pipeline capacity leases $0.30 $0.25 $0.30 $0.26
Kansas
Residential $5.07 $3.17 $2.06 $2.25
Commercial $3.28 $2.33 $1.60 $1.82
Industrial $1.53 $1.97 $1.44 $1.81
End-use customer transportation $0.51 $0.51 $0.65 $0.62
- ------------------------------------------------------------------------------------------------------------------------------
23
Residential and commercial gross margin per Mcf for the Oklahoma customers
decreased due to lower tariff rates effective in June, 2000. Reduced volumes
for industrial customers in Oklahoma resulted in the customer charge being
spread over less volumes, which offset the effect of lower tariff rates and
resulted in a higher margin per Mcf.
Gross margin per Mcf for the Kansas residential and commercial customers
increased for the three-month period compared to the same period in 2000 despite
tariff reductions in July 2000. The period of April through June, 2001 was
warmer than normal in Kansas resulting in increased revenues due to the weather
normalization process approved by the KCC effective December 1, 2000. This
process spread higher revenues over the actual delivered volumes contributing to
a higher margin per Mcf. Additionally, the WeatherProof rate program in Kansas,
which provides for a levelized bill each month, contributed to higher margins
per Mcf in a period in which weather was warmer than normal. Industrial margins
in Kansas are lower due to the tariff reductions.
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
- ----------------------------------------------------------------------------------------------------------------------------
Operating Information
Average Number of Customers 1,468,896 1,431,406 1,473,315 1,436,932
Capital expenditures (Thousands) $ 30,216 $ 29,599 $ 57,394 $ 51,668
Total Assets (Thousands) $ - $ - $1,844,662 $1,633,375
Customers per employee 605 554 594 535
- ----------------------------------------------------------------------------------------------------------------------------
Total assets increased $211.3 million at June 30, 2001 compared to the same date
in 2000 due primarily to a $75.5 million increase in accounts receivable and an
$80.3 million increase in unrecovered purchased gas costs resulting from the
increase in natural gas prices. Customers per employee for the three and six-
month periods increased as a result of the decline in numbers of employees due
to normal attrition while the customer base continues to grow.
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------------------------------------------
Volumes (MMcf)
Gas sales
Residential 10,658 14,242 64,430 65,631
Commercial 4,388 5,486 25,257 24,294
Industrial 518 930 2,469 3,012
Wholesale 6,440 9,403 7,758 17,479
- ---------------------------------------------------------------------------------------------------------------------------------
Total volumes sold 22,004 30,061 99,914 110,416
PCL and ECT 29,344 38,469 68,775 82,296
- ---------------------------------------------------------------------------------------------------------------------------------
Total volumes delivered 51,348 68,530 168,689 192,712
=================================================================================================================================
Total residential and commercial volumes decreased for the three months due to
warmer weather in the second quarter of 2001 compared to the same period in
2000. For the six months, the decrease during the second quarter was generally
offset by the effect of colder than normal weather during the first quarter of
2001 compared to warmer than normal weather during the first quarter of 2000.
Wholesale, PCL and ECT volumes decreased due to certain customers curtailing
manufacturing due to the high natural gas prices. These decreases in volumes
were partially offset by more customers qualifying for PCL and ECT rates due to
a reduction in the minimum capacity requirements pursuant to regulatory orders.
24
Certain costs to be recovered through the rate making process have been recorded
as regulatory assets in accordance with Statement of Financial Accounting
Standards No. 71, "Accounting for the Effects of Certain Types of Regulation".
As services continue to unbundle, certain of these assets may no longer meet the
criteria of a regulatory asset, and accordingly, a write-off of regulatory
assets and stranded costs may be required. The Company's most recent Orders
did not change the recoverability of regulatory assets. The Company has been
authorized to recover transition costs incurred due to natural gas industry
restructuring. An initial amount of $1.8 million has been authorized. This
recovery level will be updated annually. Accordingly, the Company does not
anticipate that write-off of costs, if any, will be material.
Production
The Production segment owns and develops natural gas and oil reserves primarily
in Oklahoma and Kansas. The Company has proved reserves of 250.4 Bcf of natural
gas and 4.3 million barrels of oil.
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Financial Results
Natural gas sales $32,188 $15,489 $58,741 $31,665
Oil sales 2,787 1,762 5,440 4,174
Other revenues 49 196 129 439
- -----------------------------------------------------------------------------------------------------------------------------
Net revenues 35,024 17,447 64,310 36,278
Operating costs 7,149 5,879 14,954 11,525
Depreciation, depletion, and amortization 8,159 7,990 15,744 16,452
- -----------------------------------------------------------------------------------------------------------------------------
Operating income $19,716 $ 3,578 $33,612 $ 8,301
=============================================================================================================================
Other income, net $ 217 $ 1,215 $ 5,327 $ 2,389
=============================================================================================================================
Cumulative effect of change in accounting principle, before tax $ - $ - $(3,508) $ -
=============================================================================================================================
For the three and six months ended June 30, 2001 compared to the same periods in
2000, natural gas sales and oil sales increased due to substantially higher
realized prices with the increase in prices partially offset by the reduction in
natural gas sales volumes due to normal production declines. For the same
periods, operating costs increased primarily due to increased production taxes
resulting from the higher prices. Production taxes are calculated based on
wellhead price rather than realized price.
Three Months Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
- -----------------------------------------------------------------------------------------------------
Operating Information
Proved reserves
Gas (MMcf) - - 250,403 242,530
Oil (MBbls) - - 4,299 3,977
Production
Gas (MMcf) 6,528 6,893 12,650 13,868
Oil (MBbls) 106 98 201 226
Average realized price
Gas (MMcf) $ 4.93 $ 2.25 $ 4.64 $ 2.28
Oil (MBbls) $ 26.29 $17.94 $ 27.06 $ 18.44
Capital expenditures (Thousands) $14,959 $9,710 $ 26,220 $ 17,922
Total assets (Thousands) $ - $ - $370,858 $352,681
- -----------------------------------------------------------------------------------------------------
Average realized price, above, reflects the impact of hedging activities.
25
Power
The Company created the Power segment on January 1, 2001, to include the
operating results of the peak electric generating plant constructed by the
Company. The Company's strategy is to capture the spark spread primarily during
peak demand periods. Prior to January 1, 2001, capital expenditures for the
construction of the plant had been included in the Marketing and Trading
segment. These capital expenditures have been reclassified and included in the
Power segment for the periods shown in this report. The plant was capable of
operation in May 2001. For the three and six months ended June 30, 2001,
capital expenditures relating to the construction of the electric generating
plant were $11.6 million and $40.0 million, respectively, compared to $10.2
million and $19.6 for the same periods in 2000, respectively.
B. Financial Flexibility and Liquidity
Operating Cash Flows
Operating cash flows for the six months ended June 30, 2001, as compared to the
same period one year ago, were $254.3 million compared to $198.0 million. Cash
flow from operating activities was positively impacted in the current year due
to the collection of increased accounts receivables and reduced deposits, which
were partially offset by increased cash used for payment of accounts payable and
gas in storage and reduced recovery of unrecovered purchased gas costs.
Receivables are typically higher during the heating season, however they were
higher than normal at December 31, 2000 due to the higher gas prices and the
integration of the businesses acquired in 2000. Consistent with receivables,
accounts payable are typically higher during the heating season resulting in
payments being made during the first six months of the year. A reduction in
margin deposits required on futures and options contracts for the Marketing
and Trading segment is due to the drop in gas prices at June 30, 2001 compared
to December 31, 2000. The increase in gas in storage during the six months ended
June 30, 2001 compared to the decrease in gas in storage for the prior six-month
period is a result of increased volumes in storage as well as higher gas prices
as the Company focused on opportunistically securing volumes that are then
hedged at favorable winter/summer spreads. For the six months ended June 30,
2000, the increase in the unrecovered purchased gas costs is due to higher gas
prices and the OCC's extending the recovery of the costs to mitigate the impact
on customers. See "Liquidity", page 27. Although receivables and payables would
normally have been expected to decrease from December 31, 1999 to June 30, 2000
due to seasonality as discussed above, receivables and payables increased during
this period due to the acquisitions.
Investing Cash Flows
Cash paid for capital expenditures and acquisitions for the six months ended
June 30, 2001, was $174.0 million and $15.3 million, respectively. Capital
expenditures include $40.0 million for construction of an electric generating
plant. For the same period one year ago, capital expenditures were $125.4
million and acquisitions were $460.5 million. Capital expenditures for the six
months ended June 30, 2000 relating to the construction of an electric
generating plant were $19.6 million. The increase in capital expenditures for
the six months ended June 30, 2001 compared to the same period in 2000 is
primarily attributable to increased cost of sustaining a higher asset base due
to the acquisitions and the costs related to construction of the electric
generating plant. Acquisitions for 2001 included $14.5 million of purchase
price adjustments related to the Kinder Morgan acquisition.
Financing Cash Flows
The Company's capitalization structure is 42 percent equity and 58 percent debt
at June 30, 2001, compared to 48 percent equity and 52 percent debt at December
31, 2000. At June 30, 2001, $1.74 billion of long-term debt was outstanding. As
of that date, the Company could have issued $739 million of additional long-term
debt under the most restrictive provisions contained in its various borrowing
agreements. The increase in debt, incurred to finance acquisitions, resulted in
the increase in interest costs for the six months ended June 30, 2001 compared
to the same period in 2000.
26
In April 2001, the Company issued $400 million of ten year, 7.125 percent, fixed
rate notes to pay off short-term debt.
On July 18, 2001, the Company filed a "shelf" registration statement on Form S-3
pursuant to which the Company may offer debt securities and shares of the
Company's Common Stock in one or more offerings with a total initial offering
price of up to $500 million.
The Board of Directors has authorized up to $1.2 billion of short term financing
to be obtained as necessary for the operation of the corporation and its
subsidiaries. The Company has an $850 million revolving credit facility with a
maturity date of June 27, 2002. This credit facility is primarily used to
support the commercial paper program. At June 30, 2001, $414.4 million of
commercial paper was outstanding.
Although cash provided by operating activities continues as the primary source
for meeting day-to-day cash requirements, due to seasonal fluctuations,
acquisitions, and additional capital requirements, the Company accesses funds
through commercial paper, and short-term credit agreements and, if necessary,
through long-term borrowing.
Liquidity
Competition continues to increase in all segments of the Company's business.
The loss of major customers without recoupment of those revenues and lower
spreads in the Gathering and Processing segment are events that could have a
material adverse effect on the Company's financial condition. However,
strategies such as aggressive negotiations to reduce keep whole contract
exposure, weather normalization in Kansas and Oklahoma, and increased use of
storage in the day trading market are expected to reduce other risks to the
Company. Additionally, rates in the Distribution segment are structured to
reduce the Company's risk in serving its large customers.
The OCC staff recommended to the OCC that ONG's unrecovered purchased gas cost
(UPGC) clause be suspended because ONG allegedly failed to "act prudently" in
acquiring its gas supply for the 2000/2001 heating season resulting in an
alleged $72.1 million in excess charges to ratepayers through March 31, 2001.
The hearing on the merits of the OCC's case was conducted on June 25-27, 2001,
after which the OCC took the matter under advisement. ONG and the OCC submitted
proposed orders on July 13, 2001. If the OCC staff is successful, the Company
would not be allowed to recover approximately $72.1 million in UPGC which could
have a material adverse effect on the Company's operations, cash flow, and
financial position. The Company believes that the OCC staff's recommendation is
without merit and is defending itself vigorously against this recommendation.
The Company believes that internally generated funds and access to financial
markets will be sufficient to meet its normal debt services, dividend
requirements, and capital expenditures.
C. Impact of Recently Issued Accounting Pronouncements
In July 2001, the FASB issued Statement of Financial Accounting Standards No.
141, "Business Combinations" (Statement 141), Statement of Financial Accounting
Standards No. 142, "Goodwill and Other Intangible Assets" (Statement 142), and
Statement of Financial Accounting Standards No. 143, "Accounting for Asset
Retirement Obligations" (Statement 143). Statement 141 requires that the
purchase method of accounting be used for all business combinations initiated
after June 30, 2001. Statement 142 will require that goodwill and intangible
assets with indefinite useful lives no longer be amortized, but instead tested
for impairment at least annually in accordance with the provisions of Statement
142. The Company is required to adopt the provisions of Statement 141
immediately, and Statement 142 effective January 1, 2002. Goodwill acquired in
business combinations completed before July 1, 2001 will continue to be
amortized prior to the adoption of Statement 142. Statement 143 requires
entities to record the fair value of a liability for an asset retirement
obligation in the period in which it is incurred and a corresponding increase in
the carrying amount of the related long-lived asset. Statement 143 is effective
for fiscal years beginning after June 15, 2002. The Company is currently
assessing the impact of Statement 143 on its financial condition and results of
operations.
27
In connection with the Company's adoption of Statement 142, the Company will be
required to perform an assessment of whether there is an indication that
goodwill, including equity-method goodwill, is impaired as of the date of
adoption. Any transitional impairment loss will be recognized as the cumulative
effect of a change in accounting principle in the Company's statement of
earnings.
As of June 30, 2001, the Company has unamortized goodwill in the amount of
$149.1 million, which will be subject to the transition provisions of Statement
142. Amortization expense related to goodwill was $3.2 million and $2.2 million
for the year ended December 31, 2000 and the six months ended June 30, 2001,
respectively. Because of the extensive effort needed to comply with adopting
Statements 141 and 142, no estimate is available of the impact of adopting these
Statements. The Company will discontinue amortization of goodwill effective
January 1, 2002, with the adoption of Statement 142.
D. Other
Southwest Gas Corporation
In connection with the now terminated proposed acquisition of Southwest Gas
Corporation (Southwest), the Company is party to various lawsuits. These
lawsuits originally contained allegations that include, but are not limited to,
federal and state Racketeer Influenced and Corrupt Organizations (RICO) Act
violations and improper interference in a contractual or other business
relationship between Southwest and Southern Union Corporation (Southern Union).
Southern Union's complaint originally asked for $750 million damages to be
trebled for alleged RICO violations, compensatory damages of not less than $750
million, punitive damages, and rescission of the Confidentiality and Standstill
Agreement. On June 21, 2001, the Court dismissed with prejudice Southern
Union's claim for fraudulent inducement against the Company, Gene Dubay and John
Gaberino. The Court did not dismiss the claim by Southern Union against
Southwest and Michael Maffie. The Court also dismissed with prejudice Southern
Union's claims for tortious interference with a contractual relationship against
the Company. This claim remains pending against only Gene Dubay, John Gaberino,
James Irvin and Jack Rose. The Court denied the motion to dismiss Southern
Union's claim for tortious interference with a prospective relationship against
the Company, Gene Dubay and John Gaberino. On June 29, 2001, the Company filed
a motion for summary judgment in its favor on the sole remaining claim asserted
against it by Southern Union. Various other motions for summary judgment were
filed by other parties, all of which are scheduled for hearing on August 24,
2001.
The Company, as third party beneficiary, has filed a lawsuit against Southern
Union for, among other things, breach of a confidentiality agreement with
Southern Union and Southwest and tortious interference with the Southwest merger
agreement. The Company filed suit against Southwest seeking a declaratory
judgment determining that it had properly terminated the merger agreement. In
response to this suit, Southwest brought a suit against the Company and Southern
Union alleging, among other things, fraud and breach of contract. Southwest is
seeking damages in excess of $75,000.
Most of the lawsuits discussed above have been consolidated into one case. The
court has entered an order setting the cases for jury trial on November 12,
2001.
Two substantially identical derivative actions were filed by shareholders
against the members of the Board of Directors of the Company for alleged
violation of their fiduciary duties to the Company by causing or allowing the
Company to engage in certain fraudulent and improper schemes designed to
"sabotage" Southern Union Company's competitive bid to acquire Southwest and
secure regulatory approval for the Company's own planned merger with Southwest.
Such conduct allegedly caused the Company to be sued by both Southwest and
Southern Union, which exposed the company to millions of dollars in liabilities.
The allegations are used as a basis for causes of action for intentional breach
of fiduciary duty, derivative claim for negligent breach of fiduciary duty,
class and derivative claims for constructive fraud, and derivative claims for
gross mismanagement. Each plaintiff seeks a declaration that the lawsuit is
properly maintained as a derivative action, the defendants, and each of them,
have breached their fiduciary duties to the Company, an injunction permanently
enjoining defendants from further abuse of control and committing of gross
mismanagement and constructive fraud, and asks for an award of compensatory and
punitive damages and costs, disbursements and reasonable attorney fees. A Joint
Motion for Consolidation of both derivative actions was filed on
28
June 6, 2000, and Pretrial No. 1 was entered on that date consolidating the
actions and establishing a schedule for response to a consolidated petition. On
July 21, 2000, the plaintiffs filed their Consolidated petition. Stephen J.
Jatras and J.M. Graves have been eliminated as defendants in the Consolidated
petition, but Eugene Dubay was added as a new defendant. The plaintiffs also
dropped their class and derivative claim for constructive fraud, but added a new
derivative claim for waste of corporate assets. On September 19, 2000, the
Company, the Independent Directors (Anderson, Bell, Cummings, Ford, Fricke,
Lake, Mackie, Newsom, Parker, Scott and Young), David Kyle, and Gene Dubay filed
Motions to Dismiss the action for failure of the plaintiffs to make a pre-suit
demand on the Company's Board of Directors. In addition, the Independent
Directors, David Kyle, and Gene Dubay filed Motions to Dismiss the Plaintiffs'
Consolidated Petition for failure to state a claim. On January 3, 2001, the
Court dismissed the action without prejudice as to its claims against Larry
Brummett. On February 26, 2001, the action was stayed until one of the parties
notifies the Court that a dissolution of the stay is requested.
If any of the plaintiffs should be successful in any of their claims against the
Company and substantial damages are awarded, it could have a material adverse
effect on the Company's operations, cash flow, and financial position. At the
present time, the Company is unable to estimate the possible loss, if any,
associated with these matters. The Company is defending itself vigorously
against all claims asserted by Southern Union and Southwest and all other
matters relating to the now terminated proposed acquisition with Southwest.
29
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Risk Management - The Company, substantially through its non-utility segments,
is exposed to market risk in the normal course of its business operations and to
the impact of market fluctuations in the price of natural gas, NGLs and crude
oil. Market risk refers to the risk of loss in cash flows and future earnings
arising from adverse changes in commodity energy prices. The Company's primary
exposure arises from fixed price purchase or sale agreements which extend for
periods of up to 48 months, gas in storage inventories utilized by the gas
marketing and trading operation, and anticipated sales of natural gas and oil
production. To a lesser extent, the Company is exposed to risk of changing
prices or the cost of intervening transportation resulting from purchasing gas
at one location and selling it at another (hereinafter referred to as basis
risk). To minimize the risk from market fluctuations in the price of natural
gas, NGLs and crude oil, the Company uses commodity derivative instruments such
as futures contracts, swaps and options to manage market risk of existing or
anticipated purchase and sale agreements, existing physical gas in storage, and
basis risk. The Company adheres to policies and procedures that limit its
exposure to market risk from open positions and monitors its exposure to market
risk.
Interest Rate Risk - The Company is subject to the risk of fluctuation in
interest rates in the normal course of business. The Company manages interest
rate risk through the use of fixed rate debt, floating rate debt and at times
interest rate swaps. The Company had no interest rate swaps at June 30, 2001.
However, in July 2001, the Company entered into an interest rate swap on a total
of $400 million in long term debt. The rate resets periodically based on the
three-month LIBOR or the six-month LIBOR at the reset date. Excluding the
effect of these new swap agreements, a hypothetical 10 percent change in
interest rates would result in an annual $1.8 million change in interest costs
related to short-term and floating rate debt based on principal balances
outstanding at June 30, 2001.
Value-at-Risk Disclosure of Market Risk - ONEOK measures entity-wide market risk
in its trading, price risk management, and its non-trading portfolios using
value-at-risk. The quantification of market risk using value-at-risk provides a
consistent measure of risk across diverse energy markets and products with
different risk factors in order to set overall risk tolerance, to determine risk
targets and set position limits. The use of this methodology requires a number
of key assumptions including the selection of a confidence level and the holding
period to liquidation. ONEOK relies on value-at-risk to determine the potential
reduction in the trading and price risk management portfolio values arising from
changes in market conditions over a defined period.
ONEOK's value-at-risk exposure represents an estimate of potential losses that
would be recognized for its trading and price risk management portfolio of
derivative financial instruments, physical contracts and gas in storage assuming
hypothetical movements in commodity market assumptions with no change in
positions and are not necessarily indicative of actual results that may occur.
Value-at-risk does not represent the maximum possible loss nor any expected loss
that may occur because actual future gains and losses will differ from those
estimated based on actual fluctuations in commodity prices, operating exposures
and timing thereof, and the changes in the Company's trading and price risk
management portfolio of derivative financial instruments and physical contracts.
At June 30, 2001, the Company's estimated potential one-day favorable or
unfavorable impact on future earnings, as measured by the value-at-risk, using a
95 percent confidence level and diversified correlation assuming one day to
liquidate positions was $2.7 million for its non-trading portfolio and
immaterial for its trading portfolio.
30
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
ONEOK, Inc. v. Southern Union Company, No. 99-CV-0345-H(M), United States
- -------------------------------------
District Court for the Northern District of Oklahoma, transferred, No. CV-00-
1812-PHX-ROS, in the United States District Court for the District of Arizona,
on appeal of preliminary injunction, United States Court of Appeals for the
Tenth Circuit, Case Number 99-5103. On June 1, 2001, the Court ordered that
this case be consolidated with Case No. CIV-99-1294-PHX-ROS brought by Southern
Union in the United States District Court for the District of Arizona. On June
29, 2001, Southern Union filed a motion for summary judgment in its favor on the
claims asserted against it by the Company in this action. A hearing on the
motion is scheduled for August 24, 2001.
Southern Union Company v. Southwest Gas Corporation, et al., No. CIV-99-1294-
- ----------------------------------------------------------
PHX-ROS, United States District Court for the District of Arizona. On May 21,
2001, the Court denied Southern Union's motion to reconsider its ruling
dismissing the federal RICO claim against the Company or to enter a judgment on
the ruling. The Court also applied its ruling to dismiss the state RICO claim
asserted by Southern Union against the Company. The Court's rulings on the RICO
claims were made applicable to all defendants. On June 1, 2001, the Court
ordered that Case Nos. 99-CV-0345-H(M) and 00-CV-063-H(E) brought by the Company
against Southern Union and Southwest be consolidated with this action. On June
21, 2001, the Court ruled on the defendants' motions to dismiss the claims
asserted by Southern Union. The Court dismissed with prejudice Southern Union's
claims for fraudulent inducement against the Company and Messrs. Dubay and
Gaberino. This claim by Southern Union remains pending against Southwest and
Mr. Maffie. The Court also dismissed with prejudice Southern Union's claim for
tortious interference with a contractual relationship against the Company. This
claim by Southern Union remains pending against only Messrs. Dubay, Gaberino,
Irvin, and Rose. The Court denied the motions to dismiss Southern Union's claim
for tortious interference with a prospective business relationship against the
Company and Messrs. Dubay and Gaberino. The Court's June 21 order also
determined several other pending motions and related issues which will affect
the conduct of the trial. On June 29, 2001, the Company filed a motion for
summary judgment in its favor on the sole remaining claim asserted against it by
Southern Union. Various other motions for summary judgment were filed by other
parties, all of which are scheduled for hearing on August 24, 2001. A jury
trial is scheduled for November 12, 2001.
ONEOK, Inc. v. Southwest Gas Corporation, No. 00-CV-063-H(E), United States
- ----------------------------------------
District Court for the Northern District of Oklahoma, transferred, No. CIV-00-
1775-PHX-ROS, United States District Court for the District of Arizona. On June
1, 2001, the Court ordered that this case be consolidated with Case No. CIV-99-
1294-PHX-ROS brought by Southern Union in the United States District Court for
the District of Arizona. On June 29, 2001, Southwest filed a motion for summary
judgment on the claims asserted against it by the Company in this action. A
hearing on the motion is scheduled for August 24, 2001.
Southwest Gas Corporation v. ONEOK, Inc., No. CIV-00-0119-PHX-ROS, United States
- ----------------------------------------
District Court for the District of Arizona. On June 29, 2001, the Company filed
a motion for partial summary judgment on the claims asserted against it by
Southwest in this action. A hearing on the motion is scheduled for August 24,
2001.
Quinque Operating Company, et al. v. Gas Pipelines, et al., 26th Judicial
- ---------------------------------------------------------
District, Stevens County, Kansas, Civil Department, Case No. 99C30. On June 8,
2001, a Second Amended Petition was filed as a purported class action against
225 defendants, including ONEOK, Inc., one of its divisions and five of its
subsidiaries. The Second Amended Petition was purportedly filed on behalf of
all producers and royalty owners who have lost money as the result of
mismeasurement of gas since 1974 from any of the 225 defendants. The Second
Amended Petition alleges that each of the 225 defendants engaged in one or more
specific "mismeasurement techniques" and conspired with one another to
undermeasure the gas sold by the alleged class members. One of the named
subsidiaries of the Company, ONEOK WesTex Transmission, Inc., is a former
subsidiary of Kinder Morgan and was named as a defendant in the First Amended
Petition. Kinder Morgan has agreed to assume the defense of ONEOK WesTex while
reserving its rights and denying that it has any obligation to indemnify the
Company against any loss suffered by ONEOK WesTex as result of this litigation.
The ONEOK defendants, other than
31
ONEOK WesTex, were not originally joined in this lawsuit until the Second
Amended Petition was filed by the plaintiffs. Discovery, except on class
certification and personal jurisdictional grounds, has been stayed. The Company
intends to vigorously defend all aspects of these claims, including procedural
and class action issues and will seek indemnification from Kinder Morgan on any
claims dealing with ONEOK WesTex. The case is in the early procedural stages and
the Company is not yet in a position to assess the materiality of this
litigation.
Cause PUD 01-57, Oklahoma Corporation Commission. The Supreme Court denied the
- ---------------
writ of prohibition on May 22, 2001. The hearing on the merits of the
Commission's case involving the allegation of excess gas charges by ONG of
$72,060,044 was conducted before the Commission en banc on June 25-27, 2001,
after which the Commission took the matter under advisement. ONG and the OCC
Staff submitted proposed orders on July 13, 2001.
Loyd Smith, et al v. Kansas Gas Service Company, Inc., ONEOK, Inc., Western
- ---------------------------------------------------------------------------
Resources, Inc., Mid Continent Market Center, Inc., ONEOK Gas Storage, L.L.C.,
- ------------------------------------------------------------------------------
ONEOK Gas Storage Holdings, Inc., and ONEOK Gas Transportation, L.L.C., Case No.
- ---------------------------------------------------------------------
01-C-0029, in the District Court of Reno County, Kansas, and Management
----------
Resources, Group, L.L.C., et al. v. Kansas Gas Service Company, ONEOK, Inc.,
- ----------------------------------------------------------------------------
ONEOK Gas Storage, L.L.C., ONEOK Gas Storage Holdings, Inc., ONEOK Gas
- ----------------------------------------------------------------------
Transportation, L.L.C., and Mid Continent Market Center, Inc., Case No. 01-C-
- ------------------------------------------------------------
0047, in the District Court of Reno County, Kansas. On April 5, 2001, the Court
entered an order consolidating these cases.
For additional information regarding the Company's legal proceedings, see the
Company's Form 10-K for the period ended December 31, 2000 and the Company's
Form 10-Q for the period ending March 31, 2001.
32
Item 4. Submission of Matters to Vote of Security Holders
(A) Date of Annual Meeting
May 17, 2001
(B) Directors Elected Directors Continuing
Douglas T. Lake Edwyna G. Anderson
Douglas Ann Newsom William M. Bell
J.D. Scott Douglas R. Cummings
John B. Dicus William L. Ford
David L. Kyle
Bert H. Mackie
Gary D. Parker
(C) Matters Voted Upon
Votes
-----------------------------------------------------
For Against Abstain
Approval of Amending the ONEOK, Inc.
Certificate of Incorporation to Increase
Authorized Capital Stock and Split Up
the Outstanding Common Stock on a
Two-for-One Basis 24,810,585 1,786,706 145,791
Approval of the Rerservation of
1,450,000 Additional Shares of Common
Stock for Issuance Under the ONEOK,
Inc. Long-term Incentive Plan 21,490,933 4,943,903 308,246
Appointment of KPMG LLP as
principal independent auditor 26,318,126 174,184 250,772
Election of Directors For Withheld
Douglas T. Lake 26,489,828 253,254
Douglas Ann Newsom 26,423,947 319,135
J.D. Scott 25,465,865 1,277,217
John B. Dicus 26,418,994 324,088
33
Item 6. Exhibits and Reports of Form 8-K
(A) Documents Filed as Part of this Report
(10) $850,000,000 364-Day Credit Agreement dated June 28, 2001, among ONEOK,
Inc., Bank of America, N.A., as Administrative Agent and as a Bank,
Letter of Credit Issuing Bank and Swing Line Bank, Bank One, N.A., as
Co-Syndicate Agent and as a Bank, First Union National Bank, as Co-
Syndicate Agent and as a Bank, ABN AMRO Bank, N.V., as Co-Documentation
Agent and as a Bank, and Fleet National Bank, as Co-Documentation Agent
and as a Bank.
(12) Computation of Ratio of Earnings to Combined Fixed Charges and Preferred
Stock Dividend Requirement for the six months ended June 30, 2001 and
2000.
(12)(a) Computation of Ratio of Earnings to Fixed Charges for the six months
ended June 30, 2001 and 2000.
(B) Reports on Form 8-K
May 23, 2001 - Announced a revision in the Company's computation of
earnings per share for common stock to conform to a recent announcement
of the Financial Accounting Standards Board Staff codified in Emerging
Issues Task Force Topic D-95.
May 25, 2001 - Reported revised projected earnings per share amounts to
conform with Emerging Issues Task Force Topic D-95 and giving effect to
the two-for-one stock split approved by Company shareholders on May 17,
2001.
May 30, 2001 - Announced that a motion filed by Southern Union seeking
reconsideration of the previous dismissal of the Federal Racketeer
Influenced and Corrupt Organizations Act (RICO) claims was denied.
Announced that similar state law racketeering claims against the Company
were dismissed.
June 26, 2001 - Announced that certain claims against the Company
asserted by Southern Union Company related to the proposed Southwest Gas
Corporation merger were dismissed.
August 9, 2001 - Reported a clarification in the second quarter earnings
release.
August 9, 2001 - Reported a conference call with financial analysts to
discuss second quarter earnings.
34
Signatures
Pursuant to the requirements of Section 13 or 15(d) 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, on this 13th day of August
2001.
ONEOK, Inc.
Registrant
By: /s/ Jim Kneale
-------------------------------------
Jim Kneale
Senior Vice President, Treasurer and
Chief Financial Officer
(Principal Financial Officer)
35