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 September 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 - 59,707,645 shares outstanding at
November 5, 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 Nine Months Ended September 30, 2001 and 2000 3
Consolidated Balance Sheets -
September 30, 2001 and December 31, 2000 4-5
Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 2001 and 2000 6
Notes to Consolidated Financial Statements 7-17
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 18-29
Item 3. Quantitative and Qualitative Disclosures about Market Risk 30
Part II. Other Information
Item 1. Legal Proceedings 31-32
Item 6. Exhibits and Reports on Form 8-K 33
Signatures
2
Part I - FINANCIAL INFORMATION
Item 1. Financial Statements
ONEOK, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended Nine Months Ended
September 30, September 30,
(Unaudited) 2001 2000 2001 2000
--------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars, except per share amounts)
Operating Revenues $1,127,189 $1,753,806 $5,486,019 $3,964,021
Cost of gas 923,940 1,563,953 4,771,447 3,354,992
--------------------------------------------------------------------------------------------------------------------
Net Revenues 203,249 189,853 714,572 609,029
--------------------------------------------------------------------------------------------------------------------
Operating Expenses
Operations and maintenance 92,493 91,478 283,466 236,541
Depreciation, depletion, and amortization 39,322 36,068 114,133 107,556
General taxes 15,209 15,239 46,252 39,594
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Total Operating Expenses 147,024 142,785 443,851 383,691
--------------------------------------------------------------------------------------------------------------------
Operating Income 56,225 47,068 270,721 225,338
--------------------------------------------------------------------------------------------------------------------
Other income, net (2,406) 384 1,951 18,567
Interest expense 34,731 32,337 108,515 82,665
Income taxes (Note L) 301 5,029 54,752 63,085
--------------------------------------------------------------------------------------------------------------------
Income before cumulative effect of a change in
accounting principle 18,787 10,086 109,405 98,155
Cumulative effect of a change in
accounting principle, net of tax (Notes I and K) - - (2,151) 2,115
--------------------------------------------------------------------------------------------------------------------
Net Income 18,787 10,086 107,254 100,270
Preferred stock dividends 9,275 9,275 27,825 27,825
--------------------------------------------------------------------------------------------------------------------
Income Available for Common Stock $ 9,512 $ 811 $ 79,429 $ 72,445
====================================================================================================================
Earnings Per Share of Common Stock (Note E)
Basic $ 0.16 $ 0.01 $ 0.90 $ 0.85
====================================================================================================================
Diluted $ 0.16 $ 0.01 $ 0.90 $ 0.85
====================================================================================================================
Average Shares of Common Stock (Thousands)
Basic 99,521 98,292 99,382 98,320
Diluted 99,633 98,300 99,648 98,326
See accompanying Notes to Consolidated Financial Statements.
3
ONEOK, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
(Unaudited) 2001 2000
---------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Assets
Current Assets
Cash and cash equivalents $ 106 $ 249
Trade accounts and notes receivable 539,456 1,627,714
Materials and supplies 18,161 18,119
Gas in storage 96,070 72,979
Deferred income taxes 8,009 10,425
Unrecovered purchased gas costs 74,465 1,578
Assets from price risk management activities 708,483 1,416,368
Deposits 68,805 120,800
Other current assets 29,736 71,906
---------------------------------------------------------------------------------------------------
Total Current Assets 1,543,291 3,340,138
---------------------------------------------------------------------------------------------------
Property, Plant and Equipment
Marketing and Trading 3,218 2,795
Gathering and Processing 1,016,535 1,001,994
Transportation and Storage 784,576 758,019
Distribution 1,946,679 1,860,181
Production 471,808 428,701
Power 116,861 75,891
Other 81,205 64,056
---------------------------------------------------------------------------------------------------
Total Property, Plant and Equipment 4,420,882 4,191,637
Accumulated depreciation, depletion, and amortization 1,205,596 1,110,803
---------------------------------------------------------------------------------------------------
Net Property, Plant and Equipment 3,215,286 3,080,834
---------------------------------------------------------------------------------------------------
Deferred Charges and Other Assets
Regulatory assets, net (Note B) 227,631 238,605
Goodwill 117,279 92,909
Assets from price risk management activities 370,667 405,666
Investments and other 217,786 202,193
---------------------------------------------------------------------------------------------------
Total Deferred Charges and Other Assets 933,363 939,373
---------------------------------------------------------------------------------------------------
Total Assets $5,691,940 $7,360,345
===================================================================================================
See accompanying Notes to Consolidated Financial Statements.
4
ONEOK, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEETS
September 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 545,331 824,106
Accounts payable 363,004 1,247,519
Dividends Payable 9,256 -
Accrued taxes 59,259 8,735
Accrued interest 26,531 24,161
Customers' deposits 19,604 18,319
Liabilities from price risk management activities 464,182 1,296,041
Other 36,021 96,913
----------------------------------------------------------------------------------------------------
Total Current Liabilities 1,773,188 3,526,561
----------------------------------------------------------------------------------------------------
Long-term Debt, excluding current maturities 1,514,153 1,336,082
Deferred Credits and Other Liabilities
Deferred income taxes 449,216 382,363
Liabilities from price risk management activities 368,264 543,278
Lease obligation 125,251 137,131
Other deferred credits 179,437 209,973
----------------------------------------------------------------------------------------------------
Total Deferred Credits and Other Liabilities 1,122,168 1,272,745
----------------------------------------------------------------------------------------------------
Total Liabilities 4,409,509 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 September 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 59,702,698 shares at September 30, 2001; issued
63,198,610 shares and outstanding 59,176,550 shares at
December 31, 2000 634 632
Paid in capital (Note H) 901,692 895,352
Unearned compensation (2,212) (1,128)
Accumulated other comprehensive income (Note J) 5,623 -
Retained earnings 430,348 387,789
Treasury stock at cost: 3,735,743 shares at September 30, 2001;
and 4,022,060 shares at December 31, 2000 (53,853) (57,887)
----------------------------------------------------------------------------------------------------
Total Shareholders' Equity 1,282,431 1,224,957
----------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $5,691,940 $7,360,345
====================================================================================================
5
ONEOK, Inc. and Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended
September 30,
(Unaudited) 2001 2000
--------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Operating Activities
Net income $ 107,254 $ 100,270
Depreciation, depletion, and amortization 114,133 107,556
Gain on sale of assets (1,120) (27,050)
Gain on sale of equity investments (758) -
Income from equity investments (8,100) (3,357)
Deferred income taxes 65,394 28,633
Amortization of restricted stock 844 492
Changes in assets and liabilities:
Accounts and notes receivable 1,088,258 (776,605)
Inventories (23,133) (121,935)
Unrecovered purchased gas costs (72,887) 2,174
Deposits 51,995 (47,908)
Accounts payable and accrued liabilities (781,922) 806,352
Price risk management assets and liabilities (231,768) (38,021)
Other assets and liabilities (85,957) (22,305)
--------------------------------------------------------------------------------------------------------
Cash Provided by Operating Activities 222,233 8,296
--------------------------------------------------------------------------------------------------------
Investing Activities
Changes in other investments, net 756 (111)
Acquisitions (15,345) (460,472)
Capital expenditures (243,244) (217,904)
Proceeds from sale of property 7,911 60,659
Proceeds from sale of equity investment 7,425 -
--------------------------------------------------------------------------------------------------------
Cash Used in Investing Activities (242,497) (617,828)
--------------------------------------------------------------------------------------------------------
Financing Activities
Payments of notes payable, net (278,775) 18,863
Change in bank overdraft (48,414) 89,632
Issuance of debt 401,367 589,429
Payment of debt (7,115) (22,948)
Issuance of common stock 5,171 -
Issuance (acquisition) of treasury stock, net 3,257 (10,401)
Dividends paid (55,370) (54,978)
--------------------------------------------------------------------------------------------------------
Cash Provided by Financing Activities 20,121 609,597
--------------------------------------------------------------------------------------------------------
Change in Cash and Cash Equivalents (143) 65
Cash and Cash Equivalents at Beginning of Period 249 72
--------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 106 $ 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 nine months ended September 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.
September 30, December 31,
2001 2000
----------------------------------------------------------------------
(Thousands of Dollars)
Recoupable take-or-pay $ 75,486 $ 79,324
Pension costs 12,169 15,306
Postretirement costs other than pension 59,993 61,069
Transition costs 21,748 22,199
Reacquired debt costs 22,566 23,209
Income taxes 28,427 30,727
Other 7,242 6,771
----------------------------------------------------------------------
Regulatory assets, net $ 227,631 $ 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.
Nine Months Ended
September 30,
2001 2000
----------------------------------------------------------------------------
(Thousands of Dollars)
Cash paid during the period
Interest (including amounts capitalized) $106,105 $ 86,124
Income taxes $ 13,047 $ 41,243
Noncash transactions
Treasury stock transferred to compensation plans $ - $ 61
Acquisitions
Property, plant and equipment $ 845 $ 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 $ 15,345 $ 460,472
============================================================================
Additions to goodwill are due to purchase price adjustments related to the
Kinder Morgan acquisition.
E. Earnings per Share Information
In accordance with a pronouncement 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, except the three months ended September 30, 2000, 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
nine months ended September 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 September 30, 2001
Per Share
Income Shares Amount
--------------------------------------------------------------------------------------------------
(Thousands, except per share amounts)
Basic EPS
Income available for common stock $ 9,512 $59,629
Convertible preferred stock 9,275 39,892
--------------------------
Income available for common stock
and assumed conversion of preferred stock 18,787 99,521 $0.19
==========================
Further dilution from applying the "two-
class" method (0.03)
------------
Basic earnings per share $ 0.16
============
Effect of Other Dilutive Securities
Options - 112
--------------------------
Diluted EPS
Income available for common stock
and assumed exercise of stock options $18,787 $99,633 $ 0.19
==========================
Further dilution from applying the "two-
class" method (0.03)
------------
Diluted earnings per share $ 0.16
==================================================================================================
Three Months Ended September 30, 2000
Per Share
Income Shares Amount
--------------------------------------------------------------------------------------------------
(Thousands, except per share amounts)
Basic EPS
Income available for common stock $ 811 58,400 $ 0.01
============
Effect of Other Dilutive Securities
Options - 8
--------------------------
Diluted EPS
Income available for common stock
and assumed exercise of stock options $ 811 58,408 $ 0.01
==================================================================================================
9
Nine Months Ended September 30, 2001
Per Share
Income Shares Amount
-----------------------------------------------------------------------------------------------------
(Thousands, except per share amounts)
Basic EPS
Income available for common stock $ 79,429 59,490
Convertible preferred stock 27,825 39,892
---------------------
Income available for common stock
and assumed conversion of preferred stock $107,254 99,382 $ 1.08
=====================
Further dilution from applying the "two-
class" method (0.18)
-----------
Basic earnings per share $ 0.90
===========
Effect of Other Dilutive Securities
Options - 266
---------------------
Diluted EPS
Income available for common stock
and assumed exercise of stock options $107,254 99,648 $ 1.08
=====================
Further dilution from applying the "two-
class" method (0.18)
-----------
Diluted earnings per share $ 0.90
=====================================================================================================
Nine Months Ended September 30, 2000
Per Share
Income Shares Amount
-----------------------------------------------------------------------------------------------------
(Thousands, except per share amounts)
Basic EPS
Income available for common stock $ 72,445 58,428
Convertible preferred stock 27,825 39,892
---------------------
Income available for common stock
and assumed conversion of preferred stock $100,270 98,320 $ 1.02
=====================
Further dilution from applying the "two-
class" method (0.17)
-----------
Basic earnings per share $ 0.85
===========
Effect of Other Dilutive Securities
Options - 6
---------------------
Diluted EPS
Income available for common stock
and assumed exercise of stock options $100,270 98,326 $ 1.02
=====================
Further dilution from applying the "two-
class" method (0.17)
-----------
Diluted earnings per share $ 0.85
=====================================================================================================
There were 332,915 and 113,354 option shares excluded from the calculation of
diluted EPS for the three months ended September 30, 2001 and 2000,
respectively, due to being antidilutive for the periods. There were 39,892,896
common share equivalents relative to the convertible preferred stock excluded
from the calculation of diluted EPS due to the assumed conversion effect being
antidilutive for the three months ended September 30, 2000. For the nine months
ended September 30, 2001 and 2000, there were 121,664 and 307,278 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.
Nine Months Ended September 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 $ 0.92 $ 0.83 $ 0.92 $ 0.83
Cumulative effect of a change in
accounting principle, net of tax (0.02) 0.02 (0.02) 0.02
------- ------- ------- -------
Income available for common stock $ 0.90 $ 0.85 $ 0.90 $ 0.85
=========================================================================================
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 was 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, and
subsequently dismissed its claims as to Gene Dubay and John Gaberino. This claim
remains pending against only 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, Gene Dubay and
John Gaberino joined in that motion. Various other motions for summary judgment
on other claims in the lawsuits were filed by other parties, all of which were
heard August 24, 2001 or October 19, 2001. The Court has not yet ruled on the
motions heard on October 19, 2001. On September 25, 2001, the Court entered an
order that denied the Company's motion for summary judgment on Southern Union's
claims for tortious interference with a prospective relationship; however, the
Court's ruling limited any recovery by Southern Union to out-of-pocket damages
and punitive damages.
The Company, as third party beneficiary, filed a lawsuit against Southern Union
for, among other things, breach of a confidentiality agreement between Southern
Union and Southwest; the Company also asserts that Southern Union tortiously
interfered 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.
The lawsuits discussed above have been consolidated into one case with Southwest
and ONEOK being designated as the plaintiffs regarding claims against Southern
Union. The court has entered an order setting the cases for jury trial on May
28, 2002.
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 September 30, 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.
12
The OCC staff filed an application on February 1, 2001 to review the gas
procurement practices of ONG in acquiring its gas supply for the 2000/2001
heating season to determine if they were consistent with least cost procurement
practices and whether the Company's decisions resulted in fair, just and
reasonable costs being borne by its customers. In a hearing on October 31, 2001,
the OCC issued an oral ruling that ONG not be allowed to recover the balance in
the Company's unrecovered purchased gas cost (UPGC) account related to the
unrecovered gas costs from the 2000/2001 winter effective with the first billing
cycle for the month following the issuance of a final order. Until such time as
a final order is issued, the amount at issue is not known, and the oral ruling
is not appealable. The Company believes that decisions made by the Company were
prudent based upon the facts and circumstances existing at the time the
decisions were made, which is the standard applicable to the Proceeding as
stated by the OCC. The Company believes that the oral ruling is without merit
based upon the evidence presented and will defend itself vigorously; however,
the failure to recover the unrecovered purchased gas costs could have a material
adverse affect on the financial condition and results of operations. As of
September 30, 2001, ONG's total unrecovered purchased gas costs was $47.5
million, not all of which is related to the 2000/2001 heating season.
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.
13
Three Months Marketing Gathering Transportation
Ended and and and Other and
September 30, 2001 Trading Processing Storage Distribution Production Power Eliminations Total
------------------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Sales to unaffiliated
customers $ 732,806 $ 173,377 $ 14,002 $ 166,301 $ 20,143 $17,118 $ 3,442 $1,127,189
Intersegment sales 41,424 95,174 27,033 1,826 3,040 - (168,497) $ -
------------------------------------------------------------------------------------------------------------------------------------
Total Revenues $ 774,230 $ 268,551 $ 41,035 $ 168,127 $ 23,183 $17,118 (165,055) $1,127,189
------------------------------------------------------------------------------------------------------------------------------------
Net revenues $ 27,500 $ 52,821 $ 30,337 $ 62,579 $ 23,183 $ 5,182 $ 1,647 $ 203,249
Operating costs $ 5,805 $ 28,319 $ 12,599 $ 54,585 $ 5,612 $ 509 $ 273 $ 107,702
Depreciation, depletion
and amortization $ 145 $ 7,406 $ 4,843 $ 17,390 $ 8,134 $ 982 $ 422 $ 39,322
Operating income $ 21,550 $ 17,096 $ 12,895 $ (9,396) $ 9,437 $ 3,691 $ 952 $ 56,225
Income from equity
investments $ - $ - $ 992 $ - $ 899 $ - $ - $ 1,891
Capital expenditures $ 26 $ 10,369 $ 4,102 $ 32,109 $ 16,587 $ 1,009 $ 5,052 $ 69,254
------------------------------------------------------------------------------------------------------------------------------------
Three Months Marketing Gathering Transportation
Ended and and and Other and
September 30, 2000 Trading Processing Storage Distribution Production Power Eliminations Total
------------------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Sales to unaffiliated
customers $1,226,166 $ 307,317 $ 33,033 $ 169,107 $ 11,377 $ - $ 6,806 $1,753,806
Intersegment sales $ 49,892 $ 51,125 $ 12,152 $ 1,021 $ 5,914 $ - $(120,104) $ -
------------------------------------------------------------------------------------------------------------------------------------
Total Revenues $1,276,058 $ 358,442 $ 45,185 $ 170,128 $ 17,291 $ - $(113,298) $1,753,806
------------------------------------------------------------------------------------------------------------------------------------
Net revenues $ 15,811 $ 70,816 $ 33,006 $ 55,210 $ 17,291 $ - $ (2,281) $ 189,853
Operating costs $ 4,558 $ 31,328 $ 13,321 $ 51,552 $ 6,443 $ - $ (485) $ 106,717
Depreciation, depletion
and amortization $ 192 $ 6,839 $ 4,628 $ 16,087 $ 7,701 $ - $ 621 $ 36,068
Operating income $ 11,061 $ 32,649 $ 15,057 $ (12,429) $ 3,147 $ - $ (2,417) $ 47,068
Income from equity
investments $ - $ - $ 519 $ - $ 37 $ - $ - $ 556
Capital expenditures $ 36 $ 22,366 $ 10,911 $ 26,482 $ 11,808 $11,890 $ 9,055 $ 92,548
------------------------------------------------------------------------------------------------------------------------------------
14
Nine Months Marketing Gathering Transportation
Ended and and and Other and
September 30, 2001 Trading Processing Storage Distribution Production Power Eliminations Total
------------------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Sales to unaffiliated
customers $3,505,888 $ 665,097 $ 69,936 $1,152,448 $ 64,798 $21,026 $ 6,826 $5,486,019
Intersegment sales 567,272 433,713 71,102 3,331 22,669 - (1,098,087) $ -
------------------------------------------------------------------------------------------------------------------------------------
Total Revenues $4,073,160 $1,098,810 $ 141,038 $1,155,779 $ 87,467 $21,026 $(1,091,261) $5,486,019
------------------------------------------------------------------------------------------------------------------------------------
Net revenues $ 94,970 $ 145,126 $ 99,517 $ 275,562 $ 87,467 $ 6,082 $ 5,848 $ 714,572
Operating Costs $ 12,308 $ 86,715 $ 37,836 $ 174,279 $ 20,566 $ 811 $ (2,797) $ 329,718
Depreciation, depletion
and amortization $ 406 $ 21,212 $ 14,344 $ 51,526 $ 23,878 $ 1,019 $ 1,748 $ 114,133
Operating income $ 82,256 $ 37,199 $ 47,337 $ 49,757 $ 43,023 $ 4,252 $ 6,897 $ 270,721
Cumulative effect of a
change in accounting
principle, net of tax $ - $ - $ - $ - $ (2,151) $ - $ - $ (2,151)
Income from equity
investments $ - $ - $ 2,500 $ - $ 5,600 $ - $ - $ 8,100
Total assets $1,206,647 $1,394,147 $ 741,850 $1,641,109 $ 380,067 $ 9,450 $ 318,670 $5,691,940
Capital expenditures $ 423 $ 27,082 $ 22,224 $ 89,503 $ 42,807 $40,970 $ 20,235 $ 243,244
------------------------------------------------------------------------------------------------------------------------------------
Nine Months Marketing Gathering Transportation
Ended and and and Other and
September 30, 2000 Trading Processing Storage Distribution Production Power Eliminations Total
------------------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Sales to unaffiliated
customers $2,536,683 $ 556,216 $ 78,036 $ 735,799 $ 42,131 $ - $ 15,156 $3,964,021
Intersegment sales 195,870 94,442 40,873 2,848 11,357 - (345,390) $ -
------------------------------------------------------------------------------------------------------------------------------------
Total Revenues $2,732,553 $ 650,658 $ 118,909 $ 738,647 $ 53,488 $ - $ (330,234) $3,964,021
------------------------------------------------------------------------------------------------------------------------------------
Net revenues $ 61,133 $ 144,756 $ 89,155 $ 264,194 $ 53,488 $ - $ (3,697) $ 609,029
Operating costs $ 11,258 $ 59,971 $ 32,040 $ 156,555 $ 17,968 $ - $ (1,657) $ 276,135
Depreciation, depletion
and amortization $ 697 $ 15,530 $ 13,825 $ 51,460 $ 24,153 $ - $ 1,891 $ 107,556
Operating income $ 49,178 $ 69,255 $ 43,290 $ 56,179 $ 11,367 $ - $ (3,931) $ 225,338
Cumulative effect of a
change in accounting
principle, net of tax $ 2,115 $ - $ - $ - $ - $ - $ - $ 2,115
Income from equity
investments $ - $ - $ 3,291 $ - $ 66 $ - $ - $ 3,357
$ $
Total assets $2,431,465 $1,394,540 $ 631,128 $1,716,326 $ 353,892 $49,740 $ (230,140) $6,346,951
Capital expenditures $ 81 $ 32,663 $ 25,319 $ 78,150 $ 29,730 $31,517 $ 20,444 $ 217,904
------------------------------------------------------------------------------------------------------------------------------------
H. Paid in Capital
Paid in capital is $337.5 million and $331.2 million for common stock at
September 30, 2001, and December 31, 2000, respectively. Paid in capital for
convertible preferred stock was $564.2 million at September 30, 2001 and
December 31, 2000.
15
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.
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 $3.6 million in earnings, representing the ineffective
portion of the cash flow hedges for the nine months ended September 30, 2001.
The Company realized a $25.4 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 $5.6 million at September 30, 2001 is
related to a cash flow exposure and will be realized in earnings within the next
three months.
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. In
July 2001, the Company entered into interest rate swaps on a total of $400
million in fixed rate long-term debt. The rate resets periodically based on the
three-month LIBOR or the six-month LIBOR at the reset date. The Company recorded
a $23.1 million increase in price risk management assets and long-term debt
relating to these fair value hedges.
16
J. Comprehensive Income
Three Months Ended Nine Months Ended
September 30, 2001 September 30, 2001
--------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Net Income $18,787 $107,254
Other comprehensive income (loss):
Cumulative effect of a change in accounting principle $ - $(45,556)
Unrealized gains on derivative instruments 6,604 29,330
Realized losses in net income (620) 25,395
------- --------
Other comprehensive income before taxes 5,984 9,169
Income tax benefit on other comprehensive income (2,315) (3,546)
------- --------
Other comprehensive income $ 3,669 $ 5,623
------- --------
Comprehensive income $22,456 $112,877
========================================================================================================
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 assumptions 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.
L. Income Taxes
The reduction in the effective income tax rate in the third quarter is the
result of changes in estimates of prior year tax liabilities.
17
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.
18
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 Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
-----------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Financial Results
Operating revenues $1,127,189 $1,753,806 $5,486,019 $3,964,021
Cost of gas 923,940 1,563,953 4,771,447 3,354,992
-----------------------------------------------------------------------------------------------------------------------
Net revenues 203,249 189,853 714,572 609,029
Operating costs 107,702 106,717 329,718 276,135
Depreciation, depletion, and amortization 39,322 36,068 114,133 107,556
-----------------------------------------------------------------------------------------------------------------------
Operating income $ 56,225 $ 47,068 $ 270,721 $ 225,338
=======================================================================================================================
Other income, net $ (2,406) $ 384 $ 1,951 $ 18,567
=======================================================================================================================
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 income increased 19 percent for the three months ended
September 30, 2001 compared to the same period in 2000. Other income, net
includes income from equity investments as well as ongoing litigation costs
associated with the terminated acquisition of Southwest.
The Company's operating income increased 20 percent for the nine-month period
primarily due to the impact of volatility on gas prices on the Marketing segment
and higher average hedged prices on the Production segment. Other income, net
for the nine months ended September 30, 2001 includes approximately $8.1 million
in income from equity investments that was partially offset by a charge of $3.7
million related to ongoing litigation costs associated with the terminated
acquisition of Southwest. Other income, net for the nine months ended September
30, 2000 includes a $26.7 million gain on the sale of assets and $3.4 income
from equity investments which were partially offset by a charge of $10.6 million
of previously deferred costs and ongoing litigation costs associated with the
terminated acquisition of Southwest, and other charges. The reduction in the
effective income tax rate in the third quarter is the result of changes in
estimates of prior year tax liabilities.
19
Marketing and Trading
The Marketing and Trading segment purchases, stores, markets and trades natural
gas to both wholesale and retail sectors in 28 states. The Company has strong
mid-continent region storage positions and transport capacity of 1 Bcf/d (Bcf
per day) that allows for trade from the California border, throughout the
Rockies, to the Chicago city gate. With total storage capacity of 73 Bcf,
withdrawal capability of 2.5 Bcf/d and injection of 1.4 Bcf/d, the Company has
direct access to all regions of the country with great flexibility in capturing
volatility in the energy markets.
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
----------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Financial Results
Gas sales $773,815 $1,275,568 $4,071,731 $2,731,483
Cost of gas 746,730 1,260,247 3,978,190 2,671,420
----------------------------------------------------------------------------------------------------------------------
Gross margin on gas sales 27,085 15,321 93,541 60,063
Other revenues 415 490 1,429 1,070
----------------------------------------------------------------------------------------------------------------------
Net revenues 27,500 15,811 94,970 61,133
Operating costs 5,805 4,558 12,308 11,258
Depreciation, depletion, and amortization 145 192 406 697
----------------------------------------------------------------------------------------------------------------------
Operating income $ 21,550 $ 11,061 $ 82,256 $ 49,178
======================================================================================================================
Other income, net $ 39 $ 126 $ 283 $ 524
======================================================================================================================
Cumulative effect of change in accounting principle, before tax $ - $ - $ - $ 3,449
======================================================================================================================
Lower gas prices and sales volumes for the three months ended September 30, 2001
compared to the same period in 2000, resulted in decreased gas sales and cost of
gas. Sales volumes decreased due to higher storage injections relative to the
prior year. The Company continues to expand its storage position and focus on
opportunistically securing storage volumes that are then hedged at favorable
winter/summer spreads. The Company also benefited from falling prices that
positively impacted fuel costs associated with its long-term transportation
contracts.
For the nine-month period, higher gas prices and increased price volatility in
2001 resulted in increased gas sales and cost of gas compared to the same period
in 2000. Increased volumes primarily resulting from acquisitions in 2000 were
partially offset by the reduction in gas sales volumes resulting from higher
storage injections in 2001.
Gross margin and gross margin per Mcf improved for the three and nine-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.
Operating costs increased for the three months ended September 30, 2001 compared
to the same period in 2000 due to an increase in reserves for doubtful accounts.
Operating costs increased for the nine months ended September 30, 2001 compared
to the same period in 2000 due to an increase in personnel costs resulting from
the acquisitions in 2000.
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
--------------------------------------------------------------------------------
Operating Information
Natural gas volumes (MMcf) 233,879 285,783 732,225 721,198
Gross margin ($/Mcf) $ 0.116 $ 0.054 $ 0.128 $ 0.083
Capital expenditures (Thousands) $ 26 $ 36 $ 423 $ 81
Total assets (Thousands) $ - $ - $1,206,647 $2,431,465
--------------------------------------------------------------------------------
20
Total assets at September 30, 2001 compared to September 30, 2000 decreased due
to decreases in accounts receivables and assets from price risk management
activities.
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
idle. 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 Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
----------------------------------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Financial Results
Natural gas liquids and condensate sales $134,926 $189,453 $477,613 $333,864
Gas sales 110,942 145,076 550,533 261,774
Gathering, compression, dehydration and processing fees and other
revenues 22,683 23,913 70,664 55,020
Cost of sales 215,730 287,626 953,684 505,902
----------------------------------------------------------------------------------------------------------------------------
Net revenues 52,821 70,816 145,126 144,756
Operating costs 28,319 31,328 86,715 59,971
Depreciation, depletion, and amortization 7,406 6,839 21,212 15,530
============================================================================================================================
Operating income $ 17,096 $ 32,649 $ 37,199 $ 69,255
============================================================================================================================
Other income, net $ (119) $ 75 $ (119) $ 26,885
============================================================================================================================
Lower prices for the three months ended September 30, 2001 compared to the same
period in 2000 resulted in decreases in natural gas liquids and condensate
sales, gas sales and cost of sales, despite increases in volumes. For the
nine-month period, increased volumes resulting from acquisitions in 2000 and
higher prices resulted in increased natural gas liquids and condensate sales,
gas sales and cost of sales. Fee-based revenues increased for the nine-month
period due to the acquisitions in 2000.
Decreases in the processing spreads and lower prices resulted in lower net
revenues for the three-month period. For the nine-month period, increased
volumes associated with the acquisitions in 2000 resulted in increased revenues,
cost of sales and net revenues.
Operating costs decreased for the three months ended September 30, 2001 compared
to the same period in 2000 primarily due to lower general taxes and employee
costs. For the nine months, operating costs increased 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
resulted in increases in depreciation, depletion, and amortization for the three
and nine-month periods.
Other income, net in 2000 included the $26.7 million gain on the sale of the
Company's 42.4 percent interest in the Indian Basin gas processing plant and
gathering system.
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
---------------------------------------------------------------------------------------------------
Gas Processing Plants Operating Information
Total gas gathered (MMbtu/D) 1,652 1,572 1,552 1,248
Total gas processed (MMBtu/D) 1,525 1,439 1,391 1,124
Natural gas liquids sales (MBbls) 7,229 6,891 19,820 16,742
Natural gas liquids produced (Bbls/d) 82,164 80,947 71,712 65,718
Gas sales (MMMBtu) 40,495 34,808 109,302 79,284
Capital expenditures (Thousands) $10,369 $22,366 $ 27,082 $ 32,663
Total assets (Thousands) $ - $ - $1,394,147 $1,394,540
----------------------------------------------------------------------------------------------------
21
Strong market prices early in 2001 resulted in increases for NGL prices and gas
prices for the nine months, despite decreases in market prices during the third
quarter of 2001. The Conway OPIS composite NGL price increased 20 percent to
$0.551 from $0.461 and the Five Pipe IFERC gas price increased 73 percent to
$5.194 from $3.004 over the same nine-month period in 2000. For the three-month
period, the Conway OPIS composite NGL price decreased 24 percent to $0.431 from
$0.565 and the Five Pipe IFERC gas price decreased 20 percent to $3.224 from
$4.024. The volume of natural gas liquids produced increased for the three-month
period as decreases in gas prices made it more economical to extract liquids
than it had been during 2000.
Volumes of natural gas gathered, processed and sold and natural gas liquids
produced and sold increased for the nine months ended September 30, 2001
compared to the same period in 2000 primarily due to increased processing and
fractionation capacity acquired in acquisitions during 2000. These acquisitions
increased the Company's processing and fractionation capacity by 1.6 Bcf/d.
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.
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
-----------------------------------------------------------------------------------------------
(Thousands of Dollars)
Financial Results
Transportation and gathering revenues $27,515 $26,906 $92,272 $71,054
Storage revenues 8,812 13,119 30,150 27,066
Gas sales and other 4,708 5,160 18,616 20,789
Cost of fuel and gas 10,698 12,179 41,521 29,754
-----------------------------------------------------------------------------------------------
Net revenues 30,337 33,006 99,517 89,155
Operating costs 12,599 13,321 37,836 32,040
Depreciation, depletion, and amortization 4,843 4,628 14,344 13,825
-----------------------------------------------------------------------------------------------
Operating income $12,895 $15,057 $47,337 $43,290
===============================================================================================
Other income, net $ 989 $ 567 $ 2,076 $ 3,464
===============================================================================================
Transportation and gathering revenues increased for the three and nine months
ended September 30, 2001 compared to the same periods in 2000 due to increased
transportation rates. A new power plant load for the nine-month period and
acquisitions in 2000 also contributed to the increase in revenues. Storage
revenues decreased for the three months due to lower storage capacity
availability in Kansas and Texas. For the nine months, storage revenues
increased primarily due to increased volumes resulting from increased storage
capacity acquired in 2000 and the industry's movement to maintain more gas in
storage for use during the heating season. Cost of fuel was impacted for the
nine months by the effect of higher prices.
Operating costs increased for the nine-month period 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.
22
Three Months Ended Nine Months Ended
September 30, June 30,
2001 2000 2001 2000
----------------------------------------------------------------------------------------------------------
Operating Information
Volumes transported (MMcf) 124,777 160,977 411,562 396,484
Capital expenditures (Thousands) $ 4,102 $ 10,911 $ 22,224 $ 25,319
Total assets (Thousands) $ - $ - $741,850 $631,128
----------------------------------------------------------------------------------------------------------
For the three-month period, transportation volumes decreased due to a lack of
injections into a Kansas gas storage facility and the resulting lack of
transportation to that facility.
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.
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. This 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.
The OCC staff filed an application on February 1, 2001 to review the gas
procurement practices of ONG in acquiring its gas supply for the 2000/2001
heating season to determine if they were consistent with least cost procurement
practices and whether the Company's decisions resulted in fair, just and
reasonable costs being borne by its customers. In a hearing on October 31, 2001,
the OCC issued an oral ruling that ONG not be allowed to recover the balance in
the Company's unrecovered purchased gas cost account related to the unrecovered
gas costs from the 2000/2001 winter effective with the first billing cycle for
the month following the issuance of a final order. Until such time as a final
order is issued, the amount at issue is not known, and the oral ruling is not
appealable. The Company believes that decisions made by the Company were prudent
based upon the facts and circumstances existing at the time the decisions were
made, which is the standard applicable to the Proceeding as stated by the OCC.
The Company believes that the oral ruling is without merit based upon the
evidence presented and will defend itself vigorously; however, the failure to
recover the unrecovered purchased gas costs could have a material adverse affect
on the financial condition and results of operations. As of September 30, 2001,
ONG's total unrecovered purchased gas costs was $47.5 million, not all of which
is related to the 2000/2001 heating season.
23
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
----------------------------------------------------------------------------------------------
(Thousands of Dollars)
Financial Results
Gas sales $150,464 $154,130 $1,099,047 $684,236
Cost of gas 105,548 114,918 880,217 474,453
----------------------------------------------------------------------------------------------
Gross margin 44,916 39,212 218,830 209,783
PCL and ECT Revenues 12,012 12,382 40,794 42,953
Other revenues 5,651 3,616 15,938 11,458
----------------------------------------------------------------------------------------------
Net revenues 62,579 55,210 275,562 264,194
Operating costs 54,585 51,552 174,279 156,555
Depreciation, depletion, and amortization 17,390 16,087 51,526 51,460
----------------------------------------------------------------------------------------------
Operating income (loss) $ (9,396) $(12,429) $ 49,757 $ 56,179
==============================================================================================
Other income, net $ (726) $ 172 $ (647) $ 962
==============================================================================================
Gas sales and cost of gas decreased for the three months ended September 30,
2001 compared to the same period in 2000 due to decreased gas costs. Higher gas
prices in the early part of 2001 resulted in an increase in gas sales and cost
of gas for the nine months ended September 30, 2001 compared to the same period
in 2000.
Increased customer participation in the WeatherProof rate program, a Kansas
program which provides for a levelized bill each month, and colder weather
contributed to higher gross margins for the three and nine-month period.
Increased revenue from a line loss and gathering rider and increased customer
service revenue positively impacted gross margin. Increased late payment charges
contributed to the increase in Other revenues.
Increased bad debts due to the high natural gas prices resulted in an increase
in operating costs of $6.0 million and $18.0 million for the three and nine
months, respectively.
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
--------------------------------------------------------------------------------
Gross Margin per Mcf
Oklahoma
Residential $7.02 $6.50 $2.95 $2.99
Commercial $3.75 $2.71 $2.23 $2.30
Industrial $1.65 $1.38 $1.30 $1.20
Pipeline capacity leases (PCL) $0.32 $0.25 $0.31 $0.26
Kansas
Residential $6.17 $5.71 $2.43 $2.53
Commercial $2.36 $2.96 $1.71 $1.93
Industrial $1.48 $1.96 $1.45 $1.86
End-use customer transportation (ECT) $0.48 $0.46 $0.59 $0.55
--------------------------------------------------------------------------------
Residential, commercial and industrial gross margins per Mcf for the Oklahoma
customers increased for the three months ended September 30, 2001 compared to
the same period in 2000 due to reduced volumes which resulted in customer-based
fees being spread over less volumes.
Gross margin per Mcf for the Kansas residential customers increased for the
three-month period compared to the same period in 2000 due to increased
participation in the WeatherProof rate program. Commercial and industrial
margins in Kansas were lower for the three and nine-month periods due to the
tariff reductions.
24
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
---------------------------------------------------------------------------------------------------------------
Operating Information
Average Number of Customers 1,409,034 1,409,349 1,429,311 1,437,737
Capital expenditures (Thousands) $ 32,109 $ 26,482 $ 89,503 $ 78,150
Total Assets (Thousands) $ - $ - $1,641,109 $1,716,326
Customers per employee 592 555 594 554
---------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
---------------------------------------------------------------------------------------------------------------
Volumes (MMcf)
Gas sales
Residential 6,721 6,937 71,151 72,568
Commercial 3,447 3,915 28,704 28,209
Industrial 524 1,003 2,993 4,015
Wholesale 12,133 10,078 19,891 27,556
--------------------------------------------------------------------------------------------------------------
Total volumes sold 22,825 21,933 122,739 132,348
PCL and ECT 31,836 37,674 100,611 119,971
--------------------------------------------------------------------------------------------------------------
Total volumes delivered 54,661 59,607 223,350 252,319
==============================================================================================================
Total residential and commercial volumes decreased for the three months due to
warmer weather and fewer customers in the third quarter of 2001 compared to the
same period in 2000. The decrease in customers is due to more customers staying
off the system for longer periods primarily due to the increased payments
required to reconnect service. For the nine months, the decrease during the
third 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 for the
three and nine-month periods due to the loss of a large customer to an affiliate
in June 2001 and 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.
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. The current annual recovery level is set at $2.1 million. This
recovery level will be updated annually. Accordingly, the Company does not
anticipate that write-off of costs, if any, will be material.
25
Production
The Production segment owns, develops and produces natural gas and oil reserves
primarily in Oklahoma and Kansas.
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
--------------------------------------------------------------------------------------------------
(Thousands of Dollars)
Financial Results
Natural gas sales $19,869 $15,279 $78,610 $46,944
Oil sales 3,276 1,548 8,716 5,722
Other revenues 38 464 141 822
--------------------------------------------------------------------------------------------------
Net revenues 23,183 17,291 87,467 53,488
Operating costs 5,612 6,443 20,566 17,968
Depreciation, depletion, and amortization 8,134 7,701 23,878 24,153
--------------------------------------------------------------------------------------------------
Operating income $ 9,437 $ 3,147 $43,023 $11,367
==================================================================================================
Other income, net $ 165 $ 1,138 $ 5,518 $ 3,608
==================================================================================================
Cumulative effect of change in accounting principle,
before tax $ - $ - $(3,508) $ -
==================================================================================================
For the three and nine months ended September 30, 2001 compared to the same
periods in 2000, natural gas sales and oil sales increased due to substantially
higher realized prices which were partially offset by the reduction in natural
gas sales volumes due to normal production declines. New wells added in the
third quarter of 2001 resulted in increased oil production volumes. For the
three-month period, operating costs decreased primarily due to decreased
production taxes and overhead costs. Production taxes are calculated based on
wellhead price, which was lower for the three-month period, rather than realized
price, which was higher as a result of hedging activities. For the nine-month
period, operating costs increased primarily due to increased production taxes
resulting from the higher wellhead prices.
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2000 2001 2000
------------------------------------------------------------------------------------------------------------------------------
Operating Information
Proved reserves
Gas (MMcf) - - 252,349 258,310
Oil (MBbls) - - 4,724 4,151
Production
Gas (MMcf) 6,419 6,705 19,069 20,573
Oil (MBbls) 127 88 328 314
Average realized price
Gas (MMcf) $ 3.10 $ 2.28 $ 4.12 $ 2.28
Oil (MBbls) $ 25.80 $ 17.59 $ 26.57 $ 18.20
Capital expenditures (Thousands) $16,587 $11,808 $ 42,807 $ 29,730
Total assets (Thousands) $ - $ - $380,067 $353,892
-----------------------------------------------------------------------------------------------------------------------------
Average realized price, above, reflects the impact of hedging activities.
26
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 premium primarily
during peak demand periods. The plant was capable of operation in May 2001.
Operating income for three and nine months ended September 30, 2001, was $3.7
million and $4.3 million, respectively. 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. For the
three and nine months ended September 30, 2001, capital expenditures relating to
the construction of the electric generating plant were $1.0 million and $41.0
million, respectively, compared to $11.9 million and $31.5 million for the same
periods in 2000, respectively.
B. Financial Flexibility and Liquidity
Operating Cash Flows
Operating cash flows for the nine months ended September 30, 2001, as compared
to the same period one year ago, were $222.2 million compared to $8.3 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. Although
receivables and payables would normally have been expected to decrease from
December 31, 1999 to September 30, 2000 due to seasonality as discussed above,
receivables and payables increased during this period due to the acquisitions.
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 September 30,
2001 compared to December 31, 2000. The increase in gas in storage during the
nine months ended September 30, 2001 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. The
increase in gas in storage during the nine months ended September 30, 2000 is
due to the acquisitions. For the nine months ended September 30, 2001, 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 28.
Investing Cash Flows
Cash paid for capital expenditures for the nine months ended September 30, 2001,
was $243.2 million. Capital expenditures include $41.0 million for construction
of an electric generating plant. For the same period one year ago, capital
expenditures were $217.9 million which included $31.5 million for the
construction of the electric generating plant. The increase in capital
expenditures for the nine months ended September 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.
27
Financing Cash Flows
The Company's capitalization structure is 36 percent equity and 64 percent debt
at September 30, 2001, compared to 48 percent equity and 52 percent debt at
December 31, 2000. At September 30, 2001, $1.7 billion of long-term debt was
outstanding. As of that date, the Company could have issued $702.9 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 nine months
ended September 30, 2001 compared to the same period in 2000.
In April 2001, the Company issued $400 million of ten year, 7.125 percent, fixed
rate notes to pay off short-term debt. In July 2001, the Company entered into
interest rate swaps on this debt. In October 2001, the Company fixed the
interest rate on this debt at 3.63% through 2002.
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 September 30, 2001, $545.3 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 filed an application on February 1, 2001 to review the gas
procurement practices of ONG in acquiring its gas supply for the 2000/2001
heating season to determine if they were consistent with least cost procurement
practices and whether the Company's decisions resulted in fair, just and
reasonable costs being borne by its customers. In a hearing on October 31, 2001,
the OCC issued an oral ruling that ONG not be allowed to recover the balance in
the Company's unrecovered purchased gas cost account related to the unrecovered
gas costs from the 2000/2001 winter effective with the first billing cycle for
the month following the issuance of a final order. Until such time as a final
order is issued, the amount at issue is not known, and the oral ruling is not
appealable. The Company believes that decisions made by the Company were prudent
based upon the facts and circumstances existing at the time the decisions were
made, which is the standard applicable to the Proceeding as stated by the OCC.
The Company believes that the oral ruling is without merit based upon the
evidence presented and will defend itself vigorously; however, the failure to
recover the unrecovered purchased gas costs could have a material adverse affect
on the financial condition and results of operations. As of September 30, 2001,
ONG's total unrecovered purchased gas costs was $47.5 million, not all of which
is related to the 2000/2001 heating season.
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.
28
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). In October, 2001, the FASB issued
Statement of Financial Accounting Standards No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" (Statement 144).
Statement 141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001. Statement 142 requires 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.
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 a cumulative
effect of a change in accounting principle in the Company's statement of
earnings.
As of September 30, 2001, the Company has unamortized goodwill in the amount of
$147.9 million, which will be subject to the transition provisions of Statement
142. Amortization expense related to goodwill was $3.2 million and $3.3 million
for the year ended December 31, 2000 and the nine months ended September 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.
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.
Statement 144 retains the requirement to report separately discontinued
operations and extends that reporting to a component of an entity that either
has been disposed of or is classified as held for sale. Statement 144 is
effective for fiscal years beginning after December 15, 2001, and for interim
periods within those fiscal years. The Company is currently assessing the impact
of Statements 143 and 144 on its financial condition and results of operations.
D. Other
Southwest Gas Corporation
Information related to the terminated proposed acquisition of Southwest Gas
Corporation is presented in Note F in the Notes to the Consolidated Financial
Statements and Part II, Item 1 of this Form 10-Q.
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. In July 2001, the Company entered into interest rate swaps
on a total of $400 million in long-term debt. In October 2001, the Company fixed
the interest rates through 2002. A hypothetical 10 percent change in interest
rates would result in an annual $1.8 million change in interest costs related to
short-term, floating rate debt, and interest rate swaps based on principal
balances outstanding at September 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 September 30, 2001, the Company's estimated potential one-day favorable or
unfavorable impact on future earnings, as measured by value-at-risk, using a 95
percent confidence level and diversified correlation assuming one day to
liquidate positions was $2.2 million for its non-trading portfolio and $2.3
million 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 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 was held on October 19,
2001. No decision has been rendered by the Court concerning Southern Union's
motion for summary judgment.
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 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. On August 24,
2001, the Court heard 10 motions for summary judgment and related motions
asserted by the corporate and individual parties. On September 25, 2001, the
Court granted in part and denied in part the motions of ONEOK and Messrs. Dubay
and Gaberino. The Court's rulings struck the damages of $750 million asserted by
Southern Union, holding that any recovery in this action by Southern Union would
be limited to out-of-pocket expenses and punitive damages relating to the failed
merger. The Court determined that Southern Union's sole remaining liability
claim, interference with a prospective economic advantage, would be set for a
jury trial scheduled to commence on May 28, 2002.
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 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 was
held on October 19, 2001. No decision has been rendered by the Court concerning
Southwest's motion for summary judgment.
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 was held on October 19, 2001.
No decision has been rendered by the Court on the Company's motion for summary
judgment.
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. Discovery, except on class certification
and personal jurisdictional grounds, has been stayed. The jurisdictional
discovery sought by the plaintiffs has been limited by the Court. The response
of ONEOK Gas Transportation, LLC, the only ONEOK subsidiary named as a defendant
that is seeking dismissal on grounds of personal jurisdiction, was served on the
plaintiff on October 29, 2001.
Cause PUD 01-57, Oklahoma Corporation Commission. On October 31, 2001, by a 2-1
---------------
vote, the Commission orally ruled that ONG should not be allowed to recover the
balance in the UPGC account related to last winter's gas costs, effective with
the first billing period after the order is issued. The Commission directed
Staff to conduct an audit of the UPGC account to determine the amount. The
Company then expects that a final written order will be entered by the
Commission, which will be subject to appeal by the Company.
31
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 periods ending March 31, 2001 and June 30, 2001.
32
Item 6. Exhibits and Reports of Form 8-K
(A) Documents Filed as Part of this Report
(12) Computation of Ratio of Earnings to Combined Fixed Charges and Preferred
Stock Dividend Requirement for the nine months ended September 30, 2001
and 2000
(12)(a) Computation of Ratio of Earnings to Fixed Charges for the nine months
ended September 30, 2001 and 2000
(B) Reports on Form 8-K
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
September 27, 2001 - Announced that ONEOK was granted a motion for summary
judgment on a claim against ONEOK by Southern Union Company for tortious
interference with Southern Union's prospective relationship with Southwest Gas
Corporation
September 27, 2001 - Announced ONEOK's stock repurchase plan
33
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 7th day of
November 2001.
ONEOK, Inc.
Registrant
By: /s/ Jim Kneale
-------------------------------------------
Jim Kneale
Senior Vice President, Treasurer and
Chief Financial Officer
(Principal Financial Officer)
34