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, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ____ to ____
Commission File Number 1-16619
KERR-McGEE CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Delaware 73-1612389
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
Kerr-McGee Center, Oklahoma City, Oklahoma 73125
(Address of Principal Executive Offices and Zip Code)
Registrant's telephone number, including area code (405) 270-1313
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
----- -----
Number of shares of common stock, $1.00 par value, outstanding as of October 31,
2003: 100,848,298.
KERR-McGEE CORPORATION
INDEX
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements PAGE
----
Consolidated Statement of Operations for the Three and
Nine Months Ended September 30, 2003 and 2002 1
Consolidated Balance Sheet at September 30, 2003 and
December 31, 2002 2
Consolidated Statement of Cash Flows for the Nine
Months Ended September 30, 2003 and 2002 3
Notes to Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 31
Item 3. Quantitative and Qualitative Disclosures about Market Risk 40
Item 4. Controls and Procedures 42
Forward-Looking Information 42
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 42
Item 6. Exhibits and Reports on Form 8-K 43
SIGNATURE 44
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
KERR-McGEE CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
Three Months Nine Months
Ended Ended
September 30, September 30,
-------------------- --------------------
(Millions of dollars, except per-share amounts) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Sales $1,006.1 $ 964.8 $3,158.3 $2,682.2
-------- ------- -------- --------
Costs and Expenses
Costs and operating expenses 409.9 383.6 1,233.4 1,096.8
Selling, general and administrative expenses 98.3 61.0 248.3 238.1
Shipping and handling expenses 34.4 32.1 101.4 86.3
Depreciation and depletion 180.6 193.7 563.2 602.1
Accretion expense 6.3 - 18.8 -
Asset impairments, net of gains on disposal of assets held for sale (4.4) 24.0 (5.0) 181.5
Exploration, including dry holes and amortization of
undeveloped leases 79.8 70.2 286.9 148.9
Taxes, other than income taxes 23.5 28.8 69.9 83.4
Provision for environmental remediation and restoration,
net of reimbursements 47.2 (20.0) 66.4 70.4
Interest and debt expense 62.8 68.4 191.2 207.7
-------- ------- -------- --------
Total Costs and Expenses 938.4 841.8 2,774.5 2,715.2
-------- ------- -------- --------
67.7 123.0 383.8 (33.0)
Other Income (Expense) (17.5) (14.1) (42.7) (52.0)
-------- ------- -------- --------
Income (Loss) before Income Taxes 50.2 108.9 341.1 (85.0)
Provision for Income Taxes (21.1) (195.7) (138.0) (181.2)
-------- ------- -------- --------
Income (Loss) from Continuing Operations 29.1 (86.8) 203.1 (266.2)
Income (Loss) from Discontinued Operations (net of income tax
provision (benefit) of nil and $.7 for the third quarter of 2003
and 2002, respectively, and $.2 and $(23.8) for the first nine
months of 2003 and 2002, respectively) (.3) .4 (.1) 127.3
Cumulative Effect of Change in Accounting Principle (net of benefit
for income taxes of $18.2) - - (34.7) -
-------- ------- -------- --------
Net Income (Loss) $ 28.8 $(86.4) $ 168.3 $ (138.9)
======== ======= ======== ========
Income (Loss) per Common Share
Basic -
Continuing operations $ .29 $ (.86) $ 2.02 $ (2.65)
Discontinued operations - - - 1.27
Cumulative effect of change in accounting principle - - (.34) -
-------- ------- -------- --------
Total $ .29 $ (.86) $ 1.68 $ (1.38)
======== ======= ======== ========
Diluted -
Continuing operations $ .29 $ (.86) $ 1.98 $ (2.65)
Discontinued operations - - - 1.27
Cumulative effect of change in accounting principle - - (.31) -
-------- ------- -------- --------
Total $ .29 $ (.86) $ 1.67 $ (1.38)
======== ======= ======== ========
Dividends Declared per Common Share $ .45 $ .45 $ 1.35 $ 1.35
======== ======= ======== ========
The accompanying notes are an integral part of this statement.
KERR-McGEE CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
September 30, December 31,
(Millions of dollars) 2003 2002
- -------------------------------------------------------------------------------------------------------------------
ASSETS
- ------
Current Assets
Cash $ 194.9 $ 89.9
Accounts receivable 509.7 607.8
Inventories 375.6 402.4
Deposits, prepaid expenses and other assets 584.7 132.8
Current assets associated with properties held for disposal .6 57.2
--------- ---------
Total Current Assets 1,665.5 1,290.1
--------- ---------
Property, Plant and Equipment 14,024.6 13,722.8
Less reserves for depreciation, depletion and amortization (6,745.8) (6,687.2)
--------- ---------
7,278.8 7,035.6
--------- ---------
Investments and Other Assets 578.7 1,035.2
Goodwill 356.5 355.9
Long-Term Assets Associated with Properties Held for Disposal 36.2 192.0
--------- ---------
Total Assets $ 9,915.7 $ 9,908.8
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Accounts payable $ 653.9 $ 785.1
Long-term debt due within one year 672.3 105.8
Other current liabilities 700.2 716.8
Current liabilities associated with properties held for disposal .3 2.1
--------- ---------
Total Current Liabilities 2,026.7 1,609.8
--------- ---------
Long-Term Debt 3,048.2 3,798.1
--------- ---------
Deferred Income Taxes 1,234.1 1,145.1
Other Deferred Credits and Reserves 929.0 803.7
Long-Term Liabilities Associated with Properties Held for Disposal 19.1 16.1
--------- ---------
2,182.2 1,964.9
--------- ---------
Stockholders' Equity
Common stock, par value $1 - 300,000,000 shares
authorized, 100,873,854 shares issued at 9-30-03
and 100,391,054 shares issued at 12-31-02 100.9 100.4
Capital in excess of par value 1,707.5 1,687.3
Preferred stock purchase rights 1.0 1.0
Retained earnings 924.2 885.7
Accumulated other comprehensive income (loss) 10.6 (62.3)
Common shares in treasury, at cost - 25,556 shares
at 9-30-03 and 7,299 at 12-31-02 (1.3) (.4)
Deferred compensation (84.3) (75.7)
--------- ---------
Total Stockholders' Equity 2,658.6 2,536.0
--------- ---------
Total Liabilities and Stockholders' Equity $ 9,915.7 $ 9,908.8
========= =========
The "successful efforts" method of accounting for oil and gas exploration and
production activities has been followed in preparing this balance sheet.
The accompanying notes are an integral part of this statement.
KERR-McGEE CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Nine Months Ended
September 30,
---------------------------
(Millions of dollars) 2003 2002
- -------------------------------------------------------------------------------------------------------------------
Operating Activities
- --------------------
Net income (loss) $ 168.3 $ (138.9)
Adjustments to reconcile net income to net cash
provided by operating activities -
Depreciation, depletion and amortization 617.1 656.8
Accretion expense 18.8 -
Asset impairments, net of gains on disposal of assets held for sale 1.2 207.6
Dry hole costs 162.7 48.8
Deferred income taxes 85.8 126.3
Provision for environmental remediation and
restoration, net of reimbursements 66.3 80.0
Gain on divestiture of discontinued operations - (108.6)
(Gain) loss on sale and retirement of assets (2.1) 2.7
Cumulative effect of change in accounting principle 34.7 -
Noncash items affecting net income 123.8 99.5
Other net cash provided by (used in) operating activities (84.5) 68.3
-------- ---------
Net Cash Provided by Operating Activities 1,192.1 1,042.5
-------- ---------
Investing Activities
- --------------------
Capital expenditures (749.4) (886.2)
Dry hole costs (162.7) (48.8)
Proceeds from sales of assets 258.6 463.9
Acquisitions (69.6) (23.8)
Other investing activities (36.6) (43.1)
-------- ---------
Net Cash Used in Investing Activities (759.7) (538.0)
-------- ---------
Financing Activities
- --------------------
Issuance of long-term debt 31.5 783.0
Repayment of long-term debt (225.0) (1,092.4)
Decrease in short-term borrowings - (8.2)
Issuance of common stock - 5.4
Dividends paid (135.9) (135.4)
Other financing activities (.6) -
-------- ---------
Net Cash Used in Financing Activities (330.0) (447.6)
-------- ---------
Effects of Exchange Rate Changes on Cash and Cash Equivalents 2.6 (5.9)
-------- ---------
Net Increase in Cash and Cash Equivalents 105.0 51.0
Cash and Cash Equivalents at Beginning of Period 89.9 91.3
-------- ---------
Cash and Cash Equivalents at End of Period $ 194.9 $ 142.3
======== =========
The accompanying notes are an integral part of this statement.
KERR-McGEE CORPORATION AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2003
A. Basis of Presentation and Accounting Policies
Basis of Presentation
---------------------
The condensed financial statements included herein have been prepared by the
company, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission and, in the opinion of management,
include all adjustments, consisting only of normal recurring accruals,
necessary to present fairly the resulting operations for the indicated
periods. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles
generally accepted in the United States have been condensed or omitted
pursuant to such rules and regulations. Although the company believes that
the disclosures are adequate to make the information presented not
misleading, it is suggested that these condensed financial statements be
read in conjunction with the financial statements and the notes thereto
included in the company's latest annual report on Form 10-K.
Business Segments
-----------------
The company has three reportable segments: oil and gas exploration and
production, production and marketing of titanium dioxide pigment (chemicals
- pigment), and production and marketing of other chemicals (chemicals -
other). Other chemicals include the company's electrolytic manufacturing and
marketing operations and forest products treatment business.
Change in Accounting Principle - Asset Retirement Obligations
-------------------------------------------------------------
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (FAS) No. 143, "Accounting for
Asset Retirement Obligations." FAS 143 requires that an asset retirement
obligation (ARO) associated with the retirement of a tangible long-lived
asset be recognized as a liability in the period in which it is incurred and
becomes determinable (as defined by the standard), with an offsetting
increase in the carrying amount of the associated asset. The cost of the
tangible asset, including the initially recognized ARO, is depreciated such
that the cost of the ARO is recognized over the useful life of the asset.
The ARO is recorded at fair value, and accretion expense will be recognized
over time as the discounted liability is accreted to its expected settlement
value. The fair value of the ARO is measured using expected future cash
outflows discounted at the company's credit-adjusted risk-free interest
rate.
The company adopted FAS 143 on January 1, 2003, which resulted in an
increase in net property of $127.5 million, an increase in abandonment
liabilities of $180.4 million and a decrease in deferred income tax
liabilities of $18.2 million. The net impact of these changes resulted in an
after-tax charge to earnings of $34.7 million to recognize the cumulative
effect of retroactively applying the new accounting standard. In accordance
with the provisions of FAS 143, Kerr-McGee accrues an abandonment liability
associated with its oil and gas wells and platforms when those assets are
placed in service, rather than its past practice of accruing the expected
abandonment costs on a unit-of-production basis over the productive life of
the associated oil and gas field. No market risk premium has been included
in the company's calculation of the ARO for oil and gas wells and platforms
since no reliable estimate can be made by the company. In connection with
the change in accounting principle, abandonment expense of $9.1 million and
$26.7 million for the third quarter and first nine months of 2002,
respectively, has been reclassified from Costs and operating expenses to
Depreciation and depletion in the Consolidated Statement of Operations to be
consistent with the 2003 presentation. In January 2003, the company
announced its plan to close the synthetic rutile plant in Mobile, Alabama,
and closed the plant in June 2003. Since the plant had a determinate closure
date, the company accrued an abandonment liability of $17.6 million as of
January 1, 2003, associated with its plans to decommission the Mobile
facility.
A summary of the changes in the asset retirement obligation during the first
nine months of 2003 is included in the table below.
(Millions of dollars)
----------------------------------------------------------------------------
January 1, 2003 $395.6
Obligations incurred 6.8
Accretion expense 18.8
Abandonment expenditures (12.5)
Abandonment obligations settled through property divestitures (13.5)
------
September 30, 2003 $395.2
======
Pro forma net loss for the three months ended September 30, 2002, would have
been $88 million, with basic and diluted loss per share of $.88, if the
provisions of FAS 143 had been applied as of January 1, 2002, compared with
net income for the three months ended September 30, 2003, of $28.8 million,
with basic and diluted earnings per share of $.29. Pro forma net loss for
the nine months ended September 30, 2002, would have been $144.5 million,
with basic and diluted loss per share of $1.44, if the provisions of FAS 143
had been applied as of January 1, 2002, compared with net income for the
nine months ended September 30, 2003, of $203 million before the cumulative
effect of change in accounting principle, with basic and diluted earnings
per share of $2.02 and $1.98, respectively.
Employee Stock Option Plans
---------------------------
In December 2002, the FASB issued FAS 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," an amendment to FAS 123,
"Accounting for Stock-Based Compensation." FAS 148 provides alternative
methods of transition for companies choosing to voluntarily adopt the
fair-value based methodology of FAS 123 and amends the disclosure provisions
of FAS 123 and Accounting Principles Board Opinion (APB) No. 28, "Interim
Financial Reporting," to require pro forma disclosures in interim financial
statements of net income, stock-based compensation expense and earnings per
share as if a fair-value based method had been used. The amended disclosure
requirements of FAS 148 were effective for the company's first quarter of
2003.
The company accounts for its stock option plans under the intrinsic-value
method permitted by APB No. 25, "Accounting for Stock Issued to Employees."
Accordingly, no stock-based employee compensation cost is reflected in net
income for the issuance of stock options under the company's plans, since
all options were fixed-price options with an exercise price equal to the
market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per
share as if the company had applied the fair-value recognition provisions of
FAS 123 to stock-based employee compensation.
Three Nine
Months Ended Months Ended
September 30, September 30,
(Millions of dollars, ---------------- -----------------
except per share amounts) 2003 2002 2003 2002
------------------------------------- ----------------------------------------------------------------------
Net income (loss) as reported $28.8 $(86.4) $168.3 $(138.9)
Less stock-based compensation expense
determined using a fair-value method,
net of taxes (4.0) (4.0) (12.1) (11.0)
----- ------ ------ -------
Pro forma net income (loss) $24.8 $(90.4) $156.2 $(149.9)
===== ====== ====== =======
Net income (loss) per share -
Basic -
As reported $ .29 $ (.86) $ 1.68 $ (1.38)
Pro forma .25 (.90) 1.56 (1.49)
Diluted -
As reported .29 (.86) 1.67 (1.38)
Pro forma .25 (.90) 1.56 (1.49)
Goodwill and Intangible Assets
------------------------------
In accordance with FAS 142, "Goodwill and Other Intangible Assets," which
the company adopted on January 1, 2002, goodwill and certain
indefinite-lived intangibles are not amortized but are reviewed annually for
impairment, or more frequently if impairment indicators arise. The annual
test for impairment was completed in the second quarter of 2003, with no
impairment indicated for the $356.5 million of goodwill or the $54 million
of indefinite-lived intangible assets.
New Accounting Standards
------------------------
In January 2003, the FASB issued FASB Interpretation (FIN) No. 46,
"Consolidation of Variable Interest Entities - an Interpretation of ARB No.
51." For variable interest entities in existence as of February 1, 2003, FIN
46, as originally issued, required consolidation by the primary beneficiary
in the third quarter of 2003. In October 2003, the FASB deferred the
effective date of FIN 46 to the fourth quarter. In accordance with the
provisions of FIN 46, the company believes it would be required to
consolidate the business trust created to construct and finance the Gunnison
production platform. The construction is being financed by a synthetic lease
credit facility between the trust and groups of financial institutions for
up to $157 million. The company is required to make lease payments
sufficient to pay interest on the financing over the term of the synthetic
lease credit facility, which terminates in November 2006. Completion of the
Gunnison platform is anticipated to occur in either December 2003 or early
2004. The company is currently in negotiations to convert the Gunnison
synthetic lease to an operating lease agreement, under which different
trusts will become the lessor/owner of the platform and related equipment.
The new agreements are expected to close in December 2003 and/or January
2004; however, the ultimate closing date will be dependent on the completion
of the platform and the timeliness of the negotiation process and may occur
sometime thereafter. If the synthetic lease is converted to an operating
lease before year end, the company believes the variable interest entity
lessor will not be subject to consolidation. However, the ultimate
accounting treatment for the proposed restructured lease agreement or the
lessor trust can not be determined until the significant terms of the
agreement are finalized. If the synthetic lease is not replaced before year
end, the financing trust will be subject to consolidation at December 31,
2003. The company has reviewed the effects of FIN 46 relative to its other
relationships with possible variable interest entities, such as the lessor
trusts that are party to the Nansen and Boomvang operating leases and
certain joint-venture arrangements, and does not believe that consolidation
of these entities is required.
Reclassifications
-----------------
Certain reclassifications have been made to the prior year financial
statements to conform with the current year presentation. In the current
year, the company began recording in revenues only the net marketing fee
received from sales of non-equity North Sea crude oil marketed on behalf of
other partners. Prior to the third quarter of 2003, the company reported
purchases and sales of non-equity oil on a gross basis. For the six months
ended June 30, 2003, $48.7 million has been reclassified from Costs and
operating expenses to Sales in the Consolidated Statement of Operations. For
the three and nine months ended September 30, 2002, $19.6 million and $32.7
million, respectively, have been reclassified from Costs and operating
expenses to Sales in the Consolidated Statement of Operations. This change
in reporting had no impact on operating profit or net income.
B. Derivatives
The company is exposed to risk from fluctuations in crude oil and natural
gas prices, foreign currency exchange rates, and interest rates. To reduce
the impact of these risks on earnings and to increase the predictability of
its cash flow, from time to time the company enters into certain derivative
contracts, primarily swaps, collars and basis contracts for a portion of its
oil and gas production; forward contracts to buy and sell foreign
currencies; and interest rate swaps.
The company accounts for all its derivative financial instruments in
accordance with FAS 133, "Accounting for Derivative Instruments and Hedging
Activities." Derivative financial instruments are recorded as assets or
liabilities in the Consolidated Balance Sheet, measured at fair value. When
available, quoted market prices are used in determining fair value; however,
if quoted market prices are not available, the company estimates the fair
value using either quoted market prices of financial instruments with
similar characteristics or other valuation techniques.
Changes in the fair value of instruments that are designated as cash flow
hedges and that qualify for hedge accounting under the provisions of FAS 133
are recorded in accumulated other comprehensive income (loss). These hedging
gains or losses will be recognized in earnings in the periods during which
the hedged forecasted transactions affect earnings. The ineffective portion
of the change in fair value of such hedges, if any, is included in current
earnings. Instruments that do not meet the criteria for hedge accounting and
those designated as fair-value hedges under FAS 133 are recorded at fair
value with gains or losses reported currently in earnings.
Kerr-McGee Rocky Mountain Corp. and its marketing subsidiary, Kerr-McGee
Energy Services Corp., are parties to a number of derivative contracts for
purchases and sales of gas, basis differences and energy-related contracts.
Prior to 2002, the company had treated all of these derivatives as
speculative and marked to market through income each month the change in
derivative fair values. In 2002, the company designated the remaining
portion of the gas basis swaps that settled in 2002 and all that settle in
2003 as hedges.
In March 2002, the company began hedging a portion of its 2002 oil and
natural gas production with fixed-price swaps to increase the predictability
of its cash flow and support additional capital expenditures. During the
fourth quarter of 2002, the company expanded the hedging program to cover a
portion of the estimated 2003 crude oil and natural gas production by adding
fixed-price swaps, basis swaps and costless collars. The company has
continued to expand its hedging program, which now covers a portion of its
expected 2004 production. At September 30, 2003, the outstanding
commodity-related derivatives accounted for as hedges had a net liability
fair value of $48.6 million, of which $1 million was recorded in current
assets, $.7 million was recorded in non-current assets and $50.3 million was
recorded in current liabilities. At December 31, 2002, the outstanding
commodity-related derivatives accounted for as hedges had a net liability
fair value of $83.4 million, of which $27.1 million was recorded in current
assets and $110.5 million was recorded in current liabilities. The fair
value of these derivative instruments was determined based on prices
actively quoted, generally NYMEX and Dated Brent prices as of the balance
sheet dates. The company had after-tax deferred losses of $28.3 million and
$50.3 million in accumulated other comprehensive income associated with
these contracts at September 30, 2003 and December 31, 2002, respectively.
The company expects to reclassify deferred losses of $27.8 million into
earnings during the next twelve months, assuming no further changes in
fair-market value of the contracts.
The physical sale of crude oil and natural gas at prices higher than those
in the derivative contracts is offset by the losses realized on the contract
settlements. During the third quarter of 2003, the company realized pretax
losses on contract settlements of $13.4 million on domestic oil hedging,
$14.2 million on North Sea oil hedging and $30.9 million on domestic natural
gas hedging. During the first nine months of 2003, the company realized
pretax losses on contract settlements of $55.4 million on domestic oil
hedging, $46.7 million on North Sea oil hedging and $123 million on domestic
natural gas hedging. During the third quarter of 2002, the company realized
pre-tax losses on contract settlements of $11.4 million and $19.8 million on
domestic and North Sea oil hedging, respectively, and pre-tax gains of $12.3
million on domestic natural gas hedging. During the first nine months of
2002, the company realized pre-tax losses on contract settlements of $17.3
million and $32.2 million on domestic and North Sea oil hedging,
respectively, and pre-tax gains of $8.9 million on domestic natural gas
hedging. Hedge ineffectiveness is recognized in Sales in the Consolidated
Statement of Operations. A gain of $1.8 million for hedge ineffectiveness
was recognized in the 2003 third quarter, and losses of $1.9 million were
recognized in the first nine months of 2003. Losses for hedge
ineffectiveness of $1.2 million and $1.3 million were recognized in the 2002
third quarter and first nine months, respectively.
As discussed in the company's 2002 Form 10-K, the company is also party to
other commodity contracts associated with its Rocky Mountain marketing
activities (fixed-price natural gas physical and derivative contracts) that
have not been designated as cash flow hedges. These commodity contracts are
recorded in the balance sheet at fair value, with any changes in fair value
recorded through earnings. At September 30, 2003, the fair value of these
contracts was $14.4 million. Of this amount, $15.4 million was recorded in
current assets, $13.7 million in Investments and Other Assets, $11.5 million
in current liabilities, and $3.2 million in deferred credits. At December
31, 2002, the fair value of these contracts was $29.1 million. Of this
amount, $30.7 million was recorded in current assets, $22.4 million in
Investments and Other Assets, $23.3 million in current liabilities, and $.7
million in deferred credits. The net loss associated with the derivative
contracts was $5.3 million for the three months ended September 30, 2003, of
which $1.5 million was recorded as a gain in Sales in the Consolidated
Statement of Operations and $6.8 million was recorded as a loss in Other
Income. The net loss associated with the derivative contracts was $21.5
million for the nine months ended September 30, 2003, of which $8.2 million
loss was included in Sales in the Consolidated Statement of Operations and a
$13.3 million loss was included in Other Income. The net gain associated
with the derivative contracts totaled $1.6 million in the third quarter of
2002, of which $8.1 million was included as a loss in Sales and a $9.7
million was included as a gain in Other Income. For the first nine months of
2002, the net loss associated with the derivative contracts totaled $25.6
million, of which $18.9 million was included in Sales and $6.7 million was
included in Other Income.
From time to time, the company enters into forward contracts to buy and sell
foreign currencies. Certain of these contracts (purchases of Australian
dollars and British pound sterling, and sales of Euro) have been designated
and have qualified as cash flow hedges of the company's anticipated future
cash flow needs for a portion of its capital expenditures, raw material
purchases and operating costs. These forward contracts generally have
durations of less than three years. At September 30, 2003, the outstanding
foreign exchange derivative contracts accounted for as hedges had a net
asset fair value of $12.1 million, of which $11.6 million was recorded in
current assets, $1.8 million in Investments and Other Assets, $.9 million in
current liabilities, and $.4 million in deferred credits. Changes in the
fair value of these contracts are recorded in accumulated other
comprehensive income and will be recognized in earnings in the periods
during which the hedged forecasted transactions affect earnings (i.e., when
the hedged assets are depreciated in the case of a hedge of capital
expenditures, when finished inventory is sold in the case of a hedged raw
material purchase and when the forward contracts close in the case of a
hedge of operating costs). At September 30, 2003, the company had an
after-tax deferred gain of $8.3 million in accumulated other comprehensive
income related to these contracts. During the third quarter and first nine
months of 2003, the company reclassified $4.7 million and $9.7 million of
gains on forward contracts from accumulated other comprehensive income to
operating expenses in the statement of operations. Of the existing net gains
at September 30, 2003, approximately $6.1 million will be reclassified into
earnings during the next 12 months, assuming no further changes in fair
value of the contracts. No hedges were discontinued during the third
quarter, and no ineffectiveness was recognized.
The company has entered into other forward contracts to sell foreign
currencies, which will be collected as a result of pigment sales denominated
in foreign currencies, primarily European currencies. These contracts have
not been designated as hedges even though they do protect the company from
changes in foreign currency rates. The estimated fair value of these
contracts was not material at September 30, 2003.
Selected pigment receivables have been sold in an asset securitization
program at their equivalent U.S. dollar value at the date the receivables
were sold. As collection agent, the company retains the risk of foreign
currency rate changes between the date of sale and collection of the
receivables. Under the terms of the asset securitization agreement, the
company is required to enter into forward contracts for the value of the
Euro denominated receivables sold into the program to mitigate its foreign
currency risk. Gains or losses on the forward contracts are recognized
currently in earnings. For the three and nine months ended September 30,
2003, the company recognized losses of $1.3 million associated with these
contracts.
The company issued 5-1/2% debt exchangeable for common stock (DECS) in
August 1999, allowing each holder to receive between .85 and 1.0 share of
Devon stock or the equivalent amount of cash at maturity in August 2004.
Embedded options in the DECS provide Kerr-McGee a floor price on Devon's
common stock of $33.19 per share (the put option). The company also retains
the right to 15% of the shares if Devon's stock price is greater than $39.16
per share (the DECS holders have an imbedded call option on 85% of the
shares). If Devon's stock price at maturity is greater than $33.19 per share
but less than $39.16 per share, the company's right to retain Devon stock
will be reduced proportionately. The company is not entitled to retain any
Devon stock if the price of Devon stock at maturity is less than or equal to
$33.19 per share. Using the Black-Scholes valuation model, the company
recognizes in Other Income on a monthly basis any gains or losses of the put
and call options. At September 30, 2003, the fair values of the embedded put
and call options were nil and $79.4 million, respectively. On December 31,
2002, the fair values of the embedded put and call options were nil and
$66.6 million, respectively. During the third quarter of 2003, the company
recorded a gain of $45.3 million in Other Income for the changes in the fair
values of the put and call options, compared with a gain of $19.7 million
during the third quarter of 2002. During the first nine months of 2003 and
2002, the company recorded losses of $12.8 million and $54.5 million,
respectively, in Other Income for the changes in the fair values of the put
and call options. The fluctuation in the value of the put and call
derivative financial instruments will generally offset the increase or
decrease in the market value of 85% of the Devon stock owned by the company.
The fair value of the 8.4 million shares of Devon classified as trading
securities was $406.5 million at September 30, 2003, and $387.2 million at
December 31, 2002. During the third quarter of 2003 and 2002, the company
recorded unrealized losses of $44 million and $8.7 million, respectively, in
Other Income for the changes in fair value of the Devon shares classified as
trading. During the first nine months of 2003 and 2002, the company recorded
unrealized gains of $19.3 million and $81 million, respectively, in Other
Income for the changes in fair value of the Devon shares classified as
trading. The company accounts for the remaining 15% of the Devon shares as
available-for-sale securities in accordance with FAS 115, "Accounting for
Certain Investments in Debt and Equity Securities," with changes in market
value recorded in accumulated other comprehensive income. The DECS, the
derivative liability associated with the call option and the Devon shares
have been classified as current assets or current liabilities, as
appropriate, in the Consolidated Balance Sheet as of September 30, 2003.
In connection with the issuance of $350 million of 5.375% notes due April
15, 2005, the company entered into an interest rate swap agreement in April
2002. The terms of the agreement effectively change the interest the company
will pay on the debt until maturity from the fixed rate to a variable rate
of LIBOR plus .875%. The company considers the swap to be a hedge against
the change in fair value of the debt as a result of interest rate changes.
The estimated fair value of the interest rate swap was $23.1 million and
$20.6 million at September 30, 2003 and December 31, 2002, respectively. The
company recognized a reduction in interest expense from the swap arrangement
of $2.9 million and $8.4 million in the three and nine months ended
September 30, 2003, respectively, and $2.1 million and $3.9 million in the
three and nine months ended September 30, 2002, respectively.
C. Discontinued Operations, Asset Impairments and Asset Disposals
In August 2001, the FASB issued FAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." FAS 144 supersedes FAS 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of," and the portion of Accounting Principles Board Opinion No. 30 that
deals with disposal of a Discontibusiness segment. The company adopted FAS
144 as of January 1, 2002, and, in accordance with the standard,
Operatioclassified certain asset disposal groups whose operations and cash
flows could be clearly distinguished from Asset the rest of the company as
discontinued operations.
During the first quarter of 2002, the company approved a plan to dispose of
its exploration and production Asset operations in Kazakhstan and of its
interest in the Bayu-Undan project in the East Timor Sea offshore
DisposalAustralia. During the second quarter of 2002, the company approved a
plan to dispose of its exploration and production interest in the Jabung
block in Sumatra, Indonesia. These divestiture decisions were made as part
of the company's strategic plan to rationalize noncore oil and gas
properties. The results of these operations have been reported separately as
discontinued operations in the company's Consolidated Statement of
Operations. In connection with the then-planned disposals, the related
assets were evaluated and impairment losses were recorded for the Kazakhstan
operations, calculated as the difference between the estimated sales price
for the operation, less costs to sell, and the company's carrying value of
the assets. Impairment losses on the Kazakhstan operations of $1.4 million
and $26.1 million were recorded during the three and nine months ended
September 30, 2002, respectively, and are reported as part of discontinued
operations.
On May 3, 2002, the company completed the sale of its interest in the
Bayu-Undan project for $132.3 million in cash. The sale resulted in a pretax
gain of $34.8 million. On June 13, 2002, the company completed the sale of
its interest in the Jabung block in Sumatra for $170.7 million in cash with
an $11 million contingent purchase price pending government approval of an
LPG project. The sale resulted in a pretax gain of $72.5 million (excluding
the contingent purchase price). On March 31, 2003, the company completed the
sale of its Kazakhstan operations for $168.6 million in cash. In connection
with this sale, the company recorded a settlement liability due to the
purchaser for the net cash flow of the Kazakhstan operations from the
effective date of the transaction to the closing date. The settlement
liability, which totaled $18.6 million, was paid during the third quarter of
2003. The net proceeds received by the company for these divestitures were
used to reduce outstanding debt.
Revenues applicable to the discontinued operations were nil and $4.6 million
for the three months ended September 30, 2003 and 2002, respectively, and
$5.6 million and $29.8 million for the nine months ended September 30, 2003
and 2002, respectively. Pretax income (loss) for the discontinued operations
was $(.3) million and $1.1 million (including the impairment loss of $1.4
million) for the three months ended September 30, 2003 and 2002,
respectively, and $.1 million and $103.5 million (including the gains on
sale of $107.3 million and the impairment loss of $26.1 million) for the
nine months ended September 30, 2003 and 2002, respectively.
As part of the company's plan to divest noncore properties discussed above,
certain individually insignificant exploration and production segment assets
for which operations and cash flows were not clearly distinguishable from
the company's operations have been identified for disposal and classified as
held for sale. Pretax asset impairment charges related to certain assets
held for sale in the U.S. onshore, Gulf of Mexico shelf and U.K. North Sea
regions totaled $11.5 million and $20 million during the third quarter and
first nine months of 2003, respectively. The impairment charges on assets
held for sale for the three and nine months ended September 30, 2002,
totaled $6.7 million and $153.3 million, respectively. For the nine months
ended September 30, 2002, the $153.3 million of asset impairment charges
included $83 million related to certain domestic properties, $65.6 million
related to certain North Sea properties and $4.7 million for properties in
Ecuador. The impairment losses reflect the difference between the estimated
sales prices for the individual properties or group of properties, less the
costs to sell, and the carrying amount of the net assets. Impairment losses
on properties held for sale are subject to revision in future periods based
on final negotiated sales prices and normal post-closing adjustments.
Pretax impairment losses totaling $6.8 million and $11.9 million were also
recognized during the three and nine months ended September 30, 2003,
respectively, for certain mature oil and gas properties that are not
considered held for sale. For the three and nine months ended September 30,
2002, pretax impairment losses totaled $17.3 million and $28.2 million,
respectively, on assets not considered held for sale. These impairment
losses were related to properties located in the U.S. onshore, Gulf of
Mexico shelf and North Sea regions that were deemed impaired because
expectations of future cash flows were less than the carrying value of the
related assets.
During the third quarter of 2003, the company recognized a gain on disposal
of oil and gas properties of $22.7 million, primarily related to property
disposals in China and the Gulf of Mexico shelf region, as well as final
closing of North Sea divestitures. These gains are included with total asset
impairment charges of $18.3 million in the Consolidated Statement of
Operations. The company recognized a net gain on disposal of oil and gas
properties of $36.9 million during the first nine months of 2003, which is
included with total asset impairment charges of $31.9 million in the
Consolidated Statement of Operations. No gain on disposal of oil and gas
properties was recognized in the first nine months of 2002. The company
expects to complete the divestiture of its remaining held-for-sale assets in
the fourth quarter of 2003. The assets and liabilities of discontinued
operations and other assets held for sale have been classified as
Assets/Liabilities Associated with Properties Held for Disposal in the
Consolidated Balance Sheet.
D. Cash Flow Information
Net cash provided by operating activities reflects cash payments for income
taxes and interest as follows:
Nine Months Ended
September 30,
-------------------------
(Millions of dollars) 2003 2002
----------------------------------------------------------------------------
Income tax payments $ 92.8 $ 69.3
Less refunds received (46.5) (264.3)
------ -------
Net income tax payments (refunds) $ 46.3 $(195.0)
====== =======
Interest payments $198.7 $ 217.0
====== =======
Noncash items affecting net income included in the reconciliation of net
income to net cash provided by operating activities include the following:
Nine Months Ended
September 30,
-----------------
(Millions of dollars) 2003 2002
----------------------------------------------------------------------------
Unrealized gain on trading securities $(19.3) $(81.0)
Litigation reserve provisions 6.5 72.0
Increase in fair value of embedded options in the DECS 12.8 54.5
Other employee benefits 39.4 33.8
Loss from equity affiliates 23.7 20.5
Postretirement liability accrual, including curtailment
charges 24.1 15.7
Periodic pension credit for qualified plan, net of
curtailment charges (6.0) (37.1)
All other (1) 42.6 21.1
------ ------
Total $123.8 $ 99.5
====== ======
(1) No other individual item is material to total cash flows from
operations.
Other net cash provided by (used in) operating activities in the
Consolidated Statement of Cash Flows consists of the following:
Nine Months Ended
September 30,
------------------------
(Millions of dollars) 2003 2002
----------------------------------------------------------------------------
Changes in working capital accounts $ 18.8 $204.4
Environmental expenditures (61.8) (77.0)
Cash abandonment expenditures - exploration
and production (13.2) (37.0)
All other (1) (28.3) (22.1)
------ ------
Total $(84.5) $ 68.3
====== ======
(1) No other individual item is material to total cash flows from
operations.
E. Comprehensive Income and Financial Instruments
Comprehensive income (loss) for the three and nine months ended September
30, 2003 and 2002, is as follows:
Three Months Nine Months
Ended Ended
September 30, September 30,
----------------- ------------------
(Millions of dollars) 2003 2002 2003 2002
-------------------------------------------------------------------------------------------------------------
Net income (loss) $28.8 $ (86.4) $168.3 $(138.9)
Unrealized gains (losses) on securities (5.1) (1.2) 2.3 29.7
Change in fair value of cash flow hedges 51.9 (32.0) 38.2 (57.1)
Foreign currency translation adjustment 3.6 (1.0) 31.6 9.4
Other - - 0.8 -
----- ------- ------ --------
Comprehensive income (loss) $79.2 $(120.6) $241.2 $(156.9)
===== ======= ====== =======
The company has certain investments that are considered to be available for
sale. These financial instruments are carried in the Consolidated Balance
Sheet at fair value, which is based on quoted market prices. The company had
no securities classified as held to maturity at September 30, 2003 or
December 31, 2002. At September 30, 2003 and December 31, 2002,
available-for-sale securities for which fair value can be determined were as
follows:
September 30, 2003 December 31, 2002
-------------------------------- -------------------------------
Gross Gross
Unrealized Unrealized
Fair Holding Fair Holding
(Millions of dollars) Value Cost Gain Value Cost Gain
-------------------------------------------------------------------------------------------------------------
Equity securities $73.2 $31.9 $13.3 (1) $69.7 $31.9 $9.8 (1)
U.S. government obligations -
Maturing within one year 3.9 3.9 - 2.4 2.4 -
Maturing between one year
and four years - - - 1.6 1.6 -
----- ----
Total $13.3 $9.8
===== ====
(1) These amounts include $28 million of gross unrealized hedging losses on
15% of the exchangeable debt at the time of adoption of FAS 133.
F. Equity Affiliates
Investments in equity affiliates totaled $119.9 million at September 30,
2003, and $122.9 million at December 31, 2002. Equity loss related to the
investments is included in Other Income in the Consolidated Statement of
Operations and totaled $10.9 million and $4.8 million for the three months
ended September 30, 2003 and 2002, respectively. For the first nine months
of 2003, the loss in equity affiliates totaled $23.7 million, compared with
$20.5 million for the same 2002 period.
G. Workforce Reduction
In September 2003, the company announced a program to reduce its U.S.
nonbargaining workforce by 7% to 9%, or 200 to 250 employees. The program
consists of both voluntary early retirements and involuntary terminations.
Qualifying employees whose employment is terminated in connection with this
program will be given enhanced benefits under the company's pension and
postretirement plans, along with severance payments. The program is expected
to be completed by the end of 2003, with certain retiring employees staying
into 2004 for transition purposes.
The company has estimated the total cost of the program will be
approximately $40 million after-tax. Offers of voluntary early retirement
have been made to 260 employees with acceptances due by November 20, 2003.
Based on similar voluntary programs in the past, the company anticipates an
acceptance rate of approximately 75% resulting in a probable curtailment (as
defined in FAS 88) of the company's qualified pension plan and
postretirement plan. Based on the assumed acceptance rate and actuarial
calculations, the company recognized a pretax curtailment expense of $16.7
million in the third quarter of 2003 for the voluntary early retirements.
Other costs for special termination benefits within the retirement plans,
severance payments and outplacement expenses will be recognized in the
fourth quarter of 2003 or during 2004, as appropriate.
H. Restructuring Provisions and Exit Activities
The company closed its synthetic rutile plant in Mobile, Alabama, during
June 2003. During the third quarter and first nine months of 2003, the
company's chemical - pigment operating unit provided nil and $24.6 million
for costs associated with the closure of this facility. Included in the
$24.6 million were $14.1 million recorded as a cumulative effect of change
in accounting principle related to the recognition of an asset retirement
obligation and $10.5 million for the accrual of severance benefits. The
provision for severance benefits is included in the restructuring reserve
balance below (see Note A for a discussion of the asset retirement
obligation). Of the total provision of $10.5 million, $7.4 million has been
paid through the 2003 third quarter and $3.1 million remained in the accrual
at September 30, 2003. Approximately 140 employees will ultimately be
terminated in connection with this plant closure, of which 110 had been
terminated as of September 30, 2003. Additionally, during the first nine
months of 2003, the company recognized $15.1 million in accelerated
depreciation on the plant assets, $6.1 million for curtailment costs related
to pension and postretirement benefits, $8.2 million for cleanup and
decommissioning costs associated with the plant, and $.7 million for other
settlement costs.
During 2002, the company's chemical - other operating unit provided $16.5
million for costs associated with its plans to exit the forest products
business, of which $2.3 million was recorded in the third quarter of 2002
and $3 million was recorded during the first nine months of 2002. During the
first nine months of 2003, the company provided an additional $5.4 million
associated with exiting the forest products business. Included in the total
provision of $21.9 million were $15.6 million for dismantlement and closure
costs, and $6.3 million for severance costs. These costs are reflected in
costs and operating expenses in the Consolidated Statement of Operations. Of
the total accrual, $4.8 million has been paid through the 2003 third quarter
and $17.1 million remained in the accrual at September 30, 2003. In
connection with the plant closures, 252 employees will be terminated, of
which 95 were terminated as of September 30, 2003. Additionally, during the
first nine months of 2003, the company recognized $8.1 million for
curtailment costs related to pension and postretirement benefits, and $2.2
million in accelerated depreciation on plant assets.
In 2001, the company's chemical - pigment operating unit provided $31.8
million related to the closure of a plant in Antwerp, Belgium. The provision
consisted of $12 million for severance costs, $11.5 million for
dismantlement costs, $6.7 million for contract settlement costs and $1.6
million for other plant closure costs. Of this total accrual, $27 million
has been paid through the 2003 third quarter and $7.8 million remained in
the accrual at September 30, 2003. As a result of this plant closure, 121
employees have been terminated as of September 30, 2003.
Also in 2001, the company's chemical - other operating unit provided $11.9
million for the discontinuation of manganese metal production at its
Hamilton, Mississippi, facility. The provision consisted of $6.6 million for
pond-closure cost, $2.4 million for severance costs and $2.9 million for
other plant closure costs. Of the total provision, $10.5 million has been
paid through the 2003 third quarter and $1.4 million remained in the accrual
at September 30, 2003, for pond closure costs.
The provisions, payments, adjustments and restructuring reserve balances for
the nine-month period ended September 30, 2003, are included in the table
below.
Dismantlement
Personnel and
(Millions of dollars) Total Costs Closure
----------------------------------------------------------------------------
December 31, 2002 $26.6 $3.8 $22.8
Provisions 15.9 15.9 -
Payments (14.2) (8.3) (5.9)
Adjustments (1) 1.1 .4 .7
----- ----- -----
September 30, 2003 $29.4 $11.8 $17.6
===== ===== =====
(1) Foreign-currency translation adjustments related to Antwerp, Belgium,
accrual.
I. Debt
As of September 30, 2003, long-term debt due within one year consists of the
following.
September 30,
(Millions of dollars) 2003
----------------------------------------------------------------------------
5-1/2% Exchangeable Notes (DECS) due August 2, 2004, net
of unamortized discount of $6.5 million $323.8
8.375% Notes due July 15, 2004 145.0
8% Notes due October 15, 2003 100.0
Floating rate notes due June 28, 2004 100.0
Guaranteed Debt of Employee Stock Ownership Plan 9.61% Notes
due in installments through January 2, 2005 3.5
------
Total $672.3
======
J. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings
per share (EPS) from continuing operations for the three-month and
nine-month periods ended September 30, 2003 and 2002.
For the Three Months Ended September 30,
--------------------------------------------------------------------------------
2003 2002
------------------------------------ ------------------------------------
Income from Loss from
(In millions, except Continuing Per-Share Continuing Per-Share
per-share amounts) Operations Shares Income Operations Shares Loss
-------------------------------------------------------------------------------------------------------------
Basic EPS $29.1 100.1 $ .29 $(86.8) 100.4 $(.86)
===== =====
Effect of dilutive securities:
Restricted stock - .7 - -
Stock options - .1 - -
---- ----- ------ -----
Diluted EPS $29.1 100.9 $ .29 $(86.8) 100.4 $(.86)
===== ===== ===== ====== ===== =====
For the Nine Months Ended September 30,
--------------------------------------------------------------------------------
2003 2002
------------------------------------ -----------------------------------
Income from Loss from
(In millions, except Continuing Per-Share Continuing Per-Share
per-share amounts) Operations Shares Income Operations Shares Loss
-------------------------------------------------------------------------------------------------------------
Basic EPS $203.1 100.1 $2.02 $(266.2) 100.3 $(2.65)
===== ======
Effect of dilutive securities:
5 1/4% convertible
debentures 16.0 9.8 - -
Restricted stock - .7 - -
Stock options - .1 - -
------ ----- ------- -----
Diluted EPS $219.1 110.7 $1.98 $(266.2) 100.3 $(2.65)
====== ===== ===== ======= ===== ======
K. Accounts Receivable Sales
In December 2000, the company began an accounts receivable monetization
program for its pigment business through the sale of selected accounts
receivable with a three-year, credit-insurance-backed asset securitization
program. On July 30, 2003, the company restructured the existing accounts
receivable monetization program to include the sale of receivables
originated by the company's European chemical operations. The maximum
availability under the new program is $168 million. In addition, certain
other terms of the program have been modified as part of the restructuring.
Under the terms of the program, selected qualifying customer accounts
receivable may be sold monthly to a special-purpose entity (SPE), which in
turn sells an undivided ownership interest in the receivables to a
third-party multi-seller commercial paper conduit sponsored by an
independent financial institution. The company sells, and retains an
interest in, excess receivables to the SPE as over-collateralization for the
program. The company's retained interest in the SPE's receivables is
classified in trade accounts receivable in the accompanying Consolidated
Balance Sheet. The retained interest is subordinate to, and provides credit
enhancement for, the conduit's ownership interest in the SPE's receivables,
and is available to the conduit to pay certain fees or expenses due to the
conduit, and to absorb credit losses incurred on any of the SPE's
receivables in the event of termination. However, the company believes that
the risk of credit loss is very low since its bad-debt experience has
historically been insignificant. The company retains servicing
responsibilities and receives a servicing fee of 1.07% of the receivables
sold for the period of time outstanding, generally 60 to 120 days. No
recourse obligations were recorded since the company has no obligations for
any recourse actions on the sold receivables. The company also holds
preference stock in the special-purpose entity equal to 3.5% of the
receivables sold. The preference stock is essentially a retained deposit to
provide further credit enhancements, if needed, but otherwise recoverable by
the company at the end of the program.
The company sold $287.6 million and $199.2 million of its pigment
receivables during the third quarter of 2003 and 2002, respectively. The
sale of the receivables resulted in pretax losses of $1.3 million and $1.2
million during the third quarter of 2003 and 2002, respectively. The company
sold $600.1 million and $485.1 million of its pigment receivables during the
first nine months of 2003 and 2002, respectively. The sale of the
receivables resulted in pretax losses of $3.4 million and $3.5 million
during the first nine months of 2003 and 2002, respectively. The losses were
equal to the difference in the book value of the receivables sold and the
total of cash and the fair value of the deposit retained by the
special-purpose entity. The outstanding balance on receivables sold, net of
the company's retained interest in receivables serving as
over-collateralization, totaled $157.9 million at September 30, 2003, and
$110.6 million at December 31, 2002.
L. Income Taxes
The reported amount of income tax expense attributable to income (loss) from
continuing operations for the first nine months of 2003 and 2002 differs
from the amount that would be computed using the U.S. Federal income tax
rate. The primary reasons for the differences and related tax effects are as
follows:
Nine Months Ended
September 30,
------------------------
(Millions of dollars) 2003 2002
----------------------------------------------------------------------------
U.S. statutory provision (benefit) - 35% $119.4 $(29.8)
U.K. tax rate change - 146.4
Reversal of deferred tax asset associated
with U.K. properties held for sale - 51.6
U.K. petroleum revenue tax 12.1 19.5
All other 6.5 (6.5)
------ ------
Provision for income taxes $138.0 $181.2
====== ======
On July 24, 2002, the United Kingdom government made certain changes to its
existing tax laws. Under one of these changes, companies are now required to
pay a supplementary corporate tax charge of 10% on profits from their U.K.
oil and gas production. This is in addition to the previously required 30%
corporate tax on these profits. The U.K. government also accelerated tax
depreciation for capital investments in U.K. upstream activities and
abolished North Sea royalty. The catch-up adjustment for the tax rate
changes increased the company's 2002 third-quarter provision for deferred
income taxes by $137.6 million and the current provision on operations for
the first two quarters of 2002 by $8.8 million.
M. Condensed Consolidating Financial Information
In connection with the acquisition of HS Resources in 2001, a holding
company structure was implemented. The company formed a new holding company,
Kerr-McGee Holdco, which then changed its name to Kerr-McGee Corporation.
The former Kerr-McGee Corporation's name was changed to Kerr-McGee Operating
Corporation. At the end of 2002, another reorganization took place whereby
among other changes, Kerr-McGee Operating Corporation distributed its
investment in certain subsidiaries (primarily the oil and gas operating
subsidiaries) to a newly formed intermediate holding company, Kerr-McGee
Worldwide Corporation. Kerr-McGee Operating Corporation formed a new
subsidiary, Kerr-McGee Chemical Worldwide LLC, and merged into it.
On October 3, 2001, Kerr-McGee Corporation issued $1.5 billion of long-term
notes in a public offering. The notes are general, unsecured obligations of
the company and rank in parity with all of the company's other unsecured and
unsubordinated indebtedness. Kerr-McGee Chemical Worldwide LLC (formerly
Kerr-McGee Operating Corporation, which was previously the original
Kerr-McGee Corporation) and Kerr-McGee Rocky Mountain Corporation have
guaranteed the notes. Additionally, Kerr-McGee Corporation has guaranteed
all indebtedness of its subsidiaries, including the indebtedness assumed in
the purchase of HS Resources. As a result of these guarantee arrangements,
the company is required to present condensed consolidating financial
information. The top holding company is Kerr-McGee Corporation. The
guarantor subsidiaries include Kerr-McGee Chemical Worldwide LLC at
September 30, 2003 and December 31, 2002, and its predecessor, Kerr-McGee
Operating Corporation, at September 30, 2002, along with Kerr-McGee Rocky
Mountain Corporation in 2003 and 2002.
The following tables present condensed consolidating financial information
for (a) Kerr-McGee Corporation, the parent company, (b) the guarantor
subsidiaries, and (c) the non-guarantor subsidiaries on a consolidated
basis.
Kerr-McGee Corporation and Subsidiaries
Condensed Consolidating Statement of Operations
For the Three Months Ended September 30, 2003
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------
Sales $ - $180.6 $819.1 $ 6.4 $1,006.1
------ ------ ------ ------ --------
Costs and Expenses
Costs and operating expenses - 94.8 307.9 7.2 409.9
Selling, general and administrative expenses - 2.4 95.9 - 98.3
Shipping and handling expenses - 2.1 32.3 - 34.4
Depreciation and depletion - 30.7 149.9 - 180.6
Accretion expense - .6 5.7 - 6.3
Asset impairments, net of gains on disposal of
assets held for sale - (.3) (4.1) - (4.4)
Exploration, including dry holes and
amortization of undeveloped leases - 5.0 74.8 - 79.8
Taxes, other than income taxes - 7.9 15.6 - 23.5
Provision for environmental remediation
and restoration, net of reimbursements - 28.6 18.6 - 47.2
Interest and debt expense 29.3 9.4 65.1 (41.0) 62.8
------ ------ ------ ------ --------
Total Costs and Expenses 29.3 181.2 761.7 (33.8) 938.4
------ ------ ------ ------ --------
(29.3) (.6) 57.4 40.2 67.7
Other Income (Expense) 79.2 (17.5) 11.4 (90.6) (17.5)
------ ------ ------ ------ --------
Income (Loss) before Income Taxes 49.9 (18.1) 68.8 (50.4) 50.2
Benefit (Provision) for Income Taxes (21.1) 7.8 (28.9) 21.1 (21.1)
------ ------ ------ ------ --------
Income (Loss) from Continuing Operations 28.8 (10.3) 39.9 (29.3) 29.1
Loss from Discontinued Operations,
net of tax - - (.3) - (.3)
------ ------ ------ ------ --------
Net Income (Loss) $ 28.8 $(10.3) $ 39.6 $(29.3) $ 28.8
====== ====== ====== ====== ========
Kerr-McGee Corporation and Subsidiaries
Condensed Consolidating Statement of Operations
For the Three Months Ended September 30, 2002
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------
Sales $ - $ 83.5 $ 881.3 $ - $ 964.8
------- ------ ------- ------- -------
Costs and Expenses
Costs and operating expenses - 26.1 357.5 - 383.6
Selling, general and administrative expenses - 1.5 59.5 - 61.0
Shipping and handling expenses - 1.3 30.8 - 32.1
Depreciation and depletion - 29.0 164.7 - 193.7
Asset impairments - (.1) 24.1 - 24.0
Exploration, including dry holes and
amortization of undeveloped leases - 2.2 68.0 - 70.2
Taxes, other than income taxes - 4.1 24.7 - 28.8
Provision for environmental remediation
and restoration, net of reimbursements - - (20.0) - (20.0)
Interest and debt expense 29.0 9.5 80.0 (50.1) 68.4
------- ------ ------- ------- -------
Total Costs and Expenses 29.0 73.6 789.3 (50.1) 841.8
------- ------ ------- ------- -------
(29.0) 9.9 92.0 50.1 123.0
Other Income (Expense) 138.9 12.0 7.3 (172.3) (14.1)
------- ------ ------- ------- -------
Income before Income Taxes 109.9 21.9 99.3 (122.2) 108.9
Provision for Income Taxes (196.3) (9.0) (192.5) 202.1 (195.7)
------- ------ ------- ------- -------
Income (Loss) from Continuing Operations (86.4) 12.9 (93.2) 79.9 (86.8)
Income from Discontinued Operations,
net of tax - - .4 - .4
------- ------ ------- ------- -------
Net Income (Loss) $ (86.4) $ 12.9 $ (92.8) $ 79.9 $ (86.4)
======= ====== ======= ======= =======
Kerr-McGee Corporation and Subsidiaries
Condensed Consolidating Statement of Operations
For the Nine Months Ended September 30, 2003
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------
Sales $ - $503.7 $2,654.6 $ - $3,158.3
------- ------ -------- ------- --------
Costs and Expenses
Costs and operating expenses - 248.4 985.0 - 1,233.4
Selling, general and administrative expenses - 12.5 235.8 - 248.3
Shipping and handling expenses - 6.8 94.6 - 101.4
Depreciation and depletion - 91.0 472.2 - 563.2
Accretion expense - 1.8 17.0 - 18.8
Asset impairments, net of gains on disposal of
assets held for sale - 1.4 (6.4) - (5.0)
Exploration, including dry holes and
amortization of undeveloped leases - 11.8 275.1 - 286.9
Taxes, other than income taxes .2 16.6 53.1 - 69.9
Provision for environmental remediation
and restoration, net of reimbursements - 34.4 32.0 - 66.4
Interest and debt expense 87.0 26.0 208.0 (129.8) 191.2
------- ------ -------- ------- --------
Total Costs and Expenses 87.2 450.7 2,366.4 (129.8) 2,774.5
------- ------ -------- ------- --------
(87.2) 53.0 288.2 129.8 383.8
Other Income (Expense) 375.5 (42.7) 56.0 (431.5) (42.7)
------- ------ -------- ------- --------
Income before Income Taxes 288.3 10.3 344.2 (301.7) 341.1
Benefit (Provision) for Income Taxes (120.0) 5.0 (136.0) 113.0 (138.0)
------- ------ -------- ------- --------
Income from Continuing Operations 168.3 15.3 208.2 (188.7) 203.1
Income (Loss) from Discontinued Operations,
net of tax - 12.4 (12.5) - (.1)
Cumulative Effect of Change in Accounting
Principle, net of tax - (1.3) (33.4) - (34.7)
------- ------ -------- ------- --------
Net Income $ 168.3 $ 26.4 $ 162.3 $(188.7) $ 168.3
======= ====== ======== ======= ========
Kerr-McGee Corporation and Subsidiaries
Condensed Consolidating Statement of Operations
For the Nine Months Ended September 30, 2002
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------
Sales $ - $243.6 $2,438.6 $ - $2,682.2
------- ------ -------- ------- --------
Costs and Expenses
Costs and operating expenses - 73.8 1,023.0 - 1,096.8
Selling, general and administrative expenses - 3.1 235.0 - 238.1
Shipping and handling expenses - 3.9 82.4 - 86.3
Depreciation and depletion - 90.3 511.8 - 602.1
Asset impairments - 3.1 178.4 - 181.5
Exploration, including dry holes and
amortization of undeveloped leases - 7.4 141.5 - 148.9
Taxes, other than income taxes .1 11.4 71.9 - 83.4
Provision for environmental remediation
and restoration, net of reimbursements - - 70.4 - 70.4
Interest and debt expense 84.1 27.0 247.7 (151.1) 207.7
------- ------ -------- ------- --------
Total Costs and Expenses 84.2 220.0 2,562.1 (151.1) 2,715.2
------- ------ -------- ------- --------
(84.2) 23.6 (123.5) 151.1 (33.0)
Other Income (Expense) 102.6 19.9 48.9 (223.4) (52.0)
------- ------ -------- ------- --------
Income (Loss) before Income Taxes 18.4 43.5 (74.6) (72.3) (85.0)
Provision for Income Taxes (157.3) (21.5) (185.0) 182.6 (181.2)
------- ------ -------- ------- --------
Income (Loss) from Continuing Operations (138.9) 22.0 (259.6) 110.3 (266.2)
Income from Discontinued Operations,
net of tax - - 127.3 - 127.3
------- ------ -------- ------- --------
Net Income (Loss) $(138.9) $22.0 $ (132.3) $ 110.3 $ (138.9)
======= ====== ======== ======= ========
Kerr-McGee Corporation and Subsidiaries
Condensed Consolidating Balance Sheet
September 30, 2003
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------
ASSETS
- ------
Current Assets
Cash $ 1.5 $ - $ 193.4 $ - $ 194.9
Intercompany receivables 791.2 (31.5) 1,385.2 (2,144.9) -
Accounts receivable - 97.9 411.8 - 509.7
Inventories - 5.2 370.4 - 375.6
Deposits, prepaid expenses and other assets - 19.7 565.0 - 584.7
Current assets associated with properties
held for disposal - - .6 - .6
-------- -------- -------- --------- --------
Total Current Assets 792.7 91.3 2,926.4 (2,144.9) 1,665.5
Property, Plant and Equipment, net - 1,973.6 5,305.2 - 7,278.8
Investments and Other Assets 10.6 93.3 473.2 1.6 578.7
Goodwill - 346.4 10.1 - 356.5
Long-Term Assets Associated with Properties
Held for Disposal - - 36.2 - 36.2
Investments in and Advances to Subsidiaries 3,960.2 442.7 45.9 (4,448.8) -
-------- -------- -------- --------- --------
Total Assets $4,763.5 $2,947.3 $8,797.0 $(6,592.1) $9,915.7
======== ======== ======== ========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Accounts payable $ 45.4 $ 62.0 $ 546.5 $ - $ 653.9
Intercompany borrowings 68.9 538.6 1,450.1 (2,057.6) -
Long-Term debt due within one year - - 672.3 - 672.3
Other current liabilities (4.0) 130.2 553.3 20.7 700.2
Current liabilities associated with
properties held for disposal - - .3 - .3
-------- -------- -------- --------- --------
Total Current Liabilities 110.3 730.8 3,222.5 (2,036.9) 2,026.7
Long-Term Debt 1,847.3 - 1,200.9 - 3,048.2
Other Deferred Credits and Reserves - 752.2 1,431.6 (20.7) 2,163.1
Long-Term Liabilities Associated with
Properties Held for Disposal - - 19.1 - 19.1
Investments by and Advances from Parent - - 579.3 (579.3) -
Stockholders' Equity 2,805.9 1,464.3 2,343.6 (3,955.2) 2,658.6
-------- -------- -------- --------- --------
Total Liabilities and Stockholders' Equity $4,763.5 $2,947.3 $8,797.0 $(6,592.1) $9,915.7
======== ======== ======== ========= ========
Kerr-McGee Corporation and Subsidiaries
Condensed Consolidating Balance Sheet
December 31, 2002
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------
ASSETS
- ------
Current Assets
Cash $ 2.5 $ - $ 87.4 $ - $ 89.9
Intercompany receivables 956.6 46.6 1,641.2 (2,644.4) -
Accounts receivable - 73.5 534.3 - 607.8
Inventories - 6.5 395.9 - 402.4
Deposits, prepaid expenses and other assets - 59.6 75.0 (1.8) 132.8
Current assets associated with properties
held for disposal - - 57.2 - 57.2
-------- -------- -------- --------- --------
Total Current Assets 959.1 186.2 2,791.0 (2,646.2) 1,290.1
Property, Plant and Equipment, net - 1,956.1 5,079.5 - 7,035.6
Investments and Other Assets 11.8 117.9 985.7 (80.2) 1,035.2
Goodwill - 346.8 9.1 - 355.9
Long-Term Assets Associated with Properties
Held for Disposal - - 187.1 4.9 192.0
Investments in and Advances to Subsidiaries 3,673.0 694.9 80.1 (4,448.0) -
-------- -------- -------- --------- --------
Total Assets $4,643.9 $3,301.9 $9,132.5 $(7,169.5) $9,908.8
======== ======== ======== ========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Accounts payable $ 45.2 $ 78.1 $ 661.8 $ - $ 785.1
Intercompany borrowings 68.5 842.2 1,732.1 (2,642.8) -
Long-term debt due within one year - - 105.8 - 105.8
Other current liabilities 17.8 195.0 478.2 25.8 716.8
Current liabilities associated with
properties held for disposal - - 2.1 - 2.1
-------- -------- -------- --------- --------
Total Current Liabilities 131.5 1,115.3 2,980.0 (2,617.0) 1,609.8
Long-Term Debt 1,847.2 - 1,950.9 - 3,798.1
Other Deferred Credits and Reserves - 675.4 1,297.4 (24.0) 1,948.8
Long-Term Liabilities Associated with
Properties Held for Disposal - - 16.1 - 16.1
Investments by and Advances from Parent - - 728.7 (728.7) -
Stockholders' Equity 2,665.2 1,511.2 2,159.4 (3,799.8) 2,536.0
-------- -------- -------- --------- --------
Total Liabilities and Stockholders' Equity $4,643.9 $3,301.9 $9,132.5 $(7,169.5) $9,908.8
======== ======== ======== ========= ========
Kerr-McGee Corporation and Subsidiaries
Condensed Consolidating Statement of Cash Flows
For the Nine Months Ended September 30, 2003
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------
Operating Activities
- --------------------
Net income $ 168.3 $ 26.4 $ 162.3 $(188.7) $ 168.3
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities -
Depreciation, depletion and amortization - 94.5 522.6 - 617.1
Accretion expense - 1.8 17.0 - 18.8
Asset impairments, net of gains on
disposal of assets held for sale - - 1.2 - 1.2
Equity in (earnings) losses of subsidiaries (188.3) 38.9 - 149.4 -
Dry hole costs - - 162.7 - 162.7
Deferred income taxes - 54.2 31.6 - 85.8
Provision for environmental remediation
and restoration, net of reimbursements - 34.4 31.9 - 66.3
(Gain) loss on sale and retirement of
assets - (12.0) 9.9 - (2.1)
Cumulative effect of change in accounting
principle - 1.3 33.4 - 34.7
Noncash items affecting net income 1.3 39.9 82.6 - 123.8
Other net cash used in operating activities (36.2) (135.6) 87.3 - (84.5)
------- ------- -------- ------- --------
Net Cash Provided by (Used in)
Operating Activities (54.9) 143.8 1,142.5 (39.3) 1,192.1
------- ------- -------- ------- --------
Investing Activities
- --------------------
Capital expenditures - (91.6) (657.8) - (749.4)
Dry hole costs - - (162.7) - (162.7)
Proceeds from sales of assets - 7.1 251.5 - 258.6
Acquisitions - - (69.6) - (69.6)
Other investing activities - - (36.6) - (36.6)
------- ------- -------- ------- --------
Net Cash Used in Investing Activities - (84.5) (675.2) - (759.7)
------- ------- -------- ------- --------
Financing Activities
- --------------------
Issuance of long-term debt - - 31.5 - 31.5
Repayment of long-term debt - - (225.0) - (225.0)
Increase (decrease) in intercompany
notes payable 189.8 (59.3) (130.2) (.3) -
Dividends paid (135.9) - (40.9) 40.9 (135.9)
Other financing activities - - .7 (1.3) (.6)
------- ------- -------- ------- --------
Net Cash Provided by (Used in)
Financing Activities 53.9 (59.3) (363.9) 39.3 (330.0)
------- ------- -------- ------- --------
Effects of Exchange Rate Changes on Cash
and Cash Equivalents - - 2.6 - 2.6
------- ------- -------- ------- --------
Net Increase (Decrease) in Cash and Cash
Equivalents (1.0) - 106.0 - 105.0
Cash and Cash Equivalents at Beginning of
Period 2.5 - 87.4 - 89.9
------- ------- -------- ------- --------
Cash and Cash Equivalents at End of Period $ 1.5 $ - $ 193.4 $ - $ 194.9
======= ======= ======== ======= ========
Kerr-McGee Corporation and Subsidiaries
Condensed Consolidating Statement of Cash Flows
For the Nine Months Ended September 30, 2002
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------------
Operating Activities
- --------------------
Net income (loss) $(138.9) $ 22.0 $ (132.3) $ 110.3 $ (138.9)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating
activities -
Depreciation, depletion and amortization - 92.5 564.3 - 656.8
Asset impairments - - 207.6 - 207.6
Equity in (earnings) losses of 121.4 (11.1) - (110.3) -
subsidiaries
Dry hole costs - .1 48.7 - 48.8
Deferred income taxes - (7.7) 134.0 - 126.3
Provision for environmental remediation
and restoration, net of reimbursements - - 80.0 - 80.0
(Gain) loss on divestiture of discontinued
operations - .4 (109.0) - (108.6)
Loss on sale and retirement of assets - - 2.7 - 2.7
Noncash items affecting net income or loss .1 8.3 91.1 - 99.5
Other net cash provided by (used in)
operating activities (36.5) 14.5 90.3 - 68.3
------- ------ --------- ------- ---------
Net Cash Provided by (Used in)
Operating Activities (53.9) 119.0 977.4 - 1,042.5
------- ------ --------- ------- ---------
Investing Activities
- --------------------
Capital expenditures - (120.4) (765.8) - (886.2)
Dry hole costs - (.1) (48.7) - (48.8)
Proceeds from sales of assets - 52.3 411.6 - 463.9
Acquisitions - - (23.8) - (23.8)
Other investing activities - - (43.1) - (43.1)
------- ------ --------- ------- ---------
Net Cash Used in Investing Activities - (68.2) (469.8) - (538.0)
------- ------ --------- ------- ---------
Financing Activities
- --------------------
Issuance of long-term debt 350.0 - 433.0 - 783.0
Repayment of long-term debt - - (1,092.4) - (1,092.4)
Increase (decrease) in short-term borrowings (165.7) (63.6) 221.1 - (8.2)
Issuance of common stock 5.0 - .4 - 5.4
Dividends paid (135.4) - - - (135.4)
Other financing activities - 11.7 (11.7) - -
------- ------ --------- ------- ---------
Net Cash Provided by (Used in)
Financing Activities 53.9 (51.9) (449.6) - (447.6)
------- ------ --------- ------- ---------
Effects of Exchange Rate Changes on Cash
and Cash Equivalents - - (5.9) - (5.9)
------- ------ --------- ------- ---------
Net Increase (Decrease) in Cash and Cash
Equivalents - (1.1) 52.1 - 51.0
Cash and Cash Equivalents at Beginning of
Period - 1.1 90.2 - 91.3
------- ------ --------- ------- ---------
Cash and Cash Equivalents at End of Period $ - $ - $ 142.3 $ - $ 142.3
======= ====== ========= ======= =========
N. Contingencies
West Chicago, Illinois
In 1973, the company's chemical affiliate (Chemical) closed a facility in
West Chicago, Illinois, that processed thorium ores for the federal
government and for certain commercial purposes. Historical operations had
resulted in low-level radioactive contamination at the facility and in
surrounding areas. The original processing facility is regulated by the
State of Illinois (the State), and four vicinity areas are designated as
Superfund sites on the National Priorities List (NPL).
Closed Facility - In 1994, Chemical, the City of West Chicago (the City) and
the State reached agreement on the initial phase of the decommissioning plan
for the closed West Chicago facility, and Chemical began shipping material
from the site to a licensed permanent disposal facility. In February 1997,
Chemical executed an agreement with the City covering the terms and
conditions for completing the final phase of decommissioning work. The
agreement requires Chemical to excavate contaminated soil and ship it to a
licensed disposal facility, monitor and, if necessary, remediate groundwater
and restore the property. The State indicated approval of the agreement and
issued license amendments authorizing the work. Chemical expects most of the
work to be completed by the end of 2003, leaving principally surface
restoration and groundwater monitoring and/or remediation for subsequent
years. Surface restoration is expected to be completed in 2004, except for
areas designated for use in connection with the Kress Creek and Sewage
Treatment Plant remediation discussed below. The long-term scope, duration
and cost of groundwater monitoring and/or remediation are uncertain because
it is not possible to reliably predict how groundwater conditions will be
affected by the ongoing work.
Vicinity Areas - The Environmental Protection Agency (EPA) has listed four
areas in the vicinity of the closed West Chicago facility on the NPL and has
designated Chemical as a Potentially Responsible Party (PRP) in these four
areas. The EPA issued unilateral administrative orders for two of the areas
(known as the Residential Areas and Reed-Keppler Park), which required
Chemical to conduct removal actions to excavate contaminated soil and ship
the soil to a licensed disposal facility. Chemical has substantially
completed the work required by the two orders.
The other two NPL sites, known as Kress Creek and the Sewage Treatment
Plant, are contiguous and involve low levels of insoluble thorium residues,
principally in streambanks and streambed sediments, virtually all within a
floodway. Chemical has reached an agreement in principle with the
appropriate federal and state agencies and local communities regarding the
characterization and cleanup of the sites, past and future government
response costs, and the waiver of natural resource damage claims. The
agreement in principle is expected to be incorporated in a consent decree,
which must be agreed to by the appropriate federal and state agencies and
local communities and then entered by a federal court. Court approval is
expected in 2004. Chemical has already conducted an extensive
characterization of the two sites and, at the request of EPA, Chemical is
conducting limited additional characterization that is expected to be
completed in 2004. The cleanup work, which is expected to take about four
years to complete following entry of the consent decree, will require
excavation of contaminated soils and stream sediments, shipment of excavated
materials to a licensed disposal facility and restoration of affected areas.
Financial Reserves - As of September 30, 2003, the company had remaining
reserves of $107 million for costs related to West Chicago. This includes
$19 million added to the reserve in the third quarter of 2003 because of an
increase in soil volumes experienced at the Closed Facility, which will
result in additional excavation, handling and disposal costs as well as
extended oversight. Although actual costs may exceed current estimates, the
amount of any increases cannot be reasonably estimated at this time. The
amount of the reserve is not reduced by reimbursements expected from the
federal government under Title X of the Energy Policy Act of 1992 (Title X)
(discussed below).
Government Reimbursement - Pursuant to Title X, the U.S. Department of
Energy (DOE) is obligated to reimburse Chemical for certain decommissioning
and cleanup costs incurred in connection with the West Chicago sites in
recognition of the fact that about 55% of the facility's production was
dedicated to U.S. government contracts. The amount authorized for
reimbursement under Title X is $365 million plus inflation adjustments. That
amount is expected to cover the government's full share of West Chicago
cleanup costs. Through September 30, 2003, Chemical had been reimbursed
approximately $171 million under Title X.
Reimbursements under Title X are provided by congressional appropriations.
Historically, congressional appropriations have lagged Chemical's cleanup
expenditures. As of September 30, 2003, the government's share of costs
incurred by Chemical but not yet reimbursed by the DOE totaled approximately
$105 million. The company believes receipt of the remaining arrearage in due
course following additional congressional appropriations is probable and has
reflected the arrearage as a receivable in the financial statements. The
company will recognize recovery of the government's share of future
remediation costs for the West Chicago sites as Chemical incurs the costs.
Henderson, Nevada
In 1998, Chemical decided to exit the ammonium perchlorate business. At that
time, Chemical curtailed operations and began preparation for the shutdown
of the associated production facilities in Henderson, Nevada, that produced
ammonium perchlorate and other related products. Manufacture of perchlorate
compounds began at Henderson in 1945 in facilities owned by the U.S.
government. The U.S. Navy expanded production significantly in 1953 when it
completed construction of a plant for the manufacture of ammonium
perchlorate. The Navy continued to own the ammonium perchlorate plant as
well as other associated production equipment at Henderson until 1962, when
the plant was purchased by a predecessor of Chemical. The ammonium
perchlorate produced at the Henderson facility was used primarily in federal
government defense and space programs. Perchlorate has been detected in
nearby Lake Mead and the Colorado River.
Chemical began decommissioning the facility and remediating associated
perchlorate contamination, including surface impoundments and groundwater
when it decided to exit the business in 1998. In 1999 and 2001, Chemical
entered into consent orders with the Nevada Division of Environmental
Protection that require Chemical to implement both interim and long-term
remedial measures to capture and remove perchlorate from groundwater.
In 1999, Chemical initiated the interim measures required by the consent
orders. Chemical subsequently developed and installed a long-term
remediation system based on new technology, but startup difficulties
prevented successful commissioning of the long-term system. In April 2003,
Chemical determined that these startup difficulties could not be overcome
and initiated steps to install an alternate long-term remediation system
using a different technology. In June 2003, construction began on the
alternate long-term system. It is anticipated that this system will be
operational in early 2004. The interim system was enhanced and will be
utilized until the successful commissioning of the alternate long-term
system. The scope and duration of groundwater remediation will be driven in
the long term by drinking water standards, which to date have not been
formally established by state or federal regulatory authorities. EPA and
other federal and state agencies currently are evaluating the health and
environmental risks associated with perchlorate as part of the process for
ultimately setting a drinking water standard. The resolution of these issues
could materially affect the scope, duration and cost of the long-term
groundwater remediation that Chemical is required to perform.
Financial Reserves - The company's remaining reserves for Henderson totaled
$34 million as of September 30, 2003. As noted above, the long-term scope,
duration and cost of groundwater remediation are uncertain and, therefore,
additional costs may be incurred in the future. However, the amount of any
additions cannot be reasonably estimated at this time.
Government Litigation - In 2000, Chemical initiated litigation against the
United States seeking contribution for response costs. The suit is based on
the fact that the government owned the plant in the early years of its
operation, exercised significant control over production at the plant and
the sale of products produced at the plant, and was the largest consumer of
products produced at the plant. The litigation is in the discovery stage.
Although the outcome of the litigation is uncertain, Chemical believes it is
likely to recover a portion of its costs from the government. The amount and
timing of any recovery cannot be estimated at this time and, accordingly,
the company has not recorded a receivable or otherwise reflected in the
financial statements any potential recovery from the government.
Insurance - In 2001, Chemical purchased a 10-year, $100 million
environmental cost cap insurance policy for groundwater remediation at
Henderson. The insurance policy provides coverage only after Chemical
exhausts a self-insured retention of approximately $61 million and covers
only those costs incurred to achieve a cleanup level specified in the
policy. As noted above, federal and state agencies have not established a
drinking water standard and, therefore, it is possible that Chemical may be
required to achieve a cleanup level more stringent than that covered by the
policy. If so, the amount recoverable under the policy could be affected.
Through September 30, 2003, Chemical has incurred expenditures of about $48
million that it believes can be applied to the self-insured retention. The
company believes that the remaining reserve of $34 million at September 30,
2003, also will qualify under the insurance policy, which would exhaust the
self-insured retention and leave about $21 million for recovery under the
policy. The company believes that reimbursement of the $21 million under the
insurance policy is probable and, accordingly, the company has recorded a
$21 million receivable in the financial statements.
Milwaukee, Wisconsin
In 1976, Chemical closed a wood-treatment facility it had operated in
Milwaukee, Wisconsin. Operations at the facility prior to its closure had
resulted in the contamination of soil and groundwater at and around the site
with creosote and other substances used in the wood-treatment process. In
1984, EPA designated the Milwaukee wood-treatment facility as a Superfund
site under the Comprehensive Environmental Response, Compensation, and
Liability Act of 1980 (CERCLA), listed the site on the NPL and named
Chemical a PRP. Chemical executed a consent decree in 1991 that required it
to perform soil and groundwater remediation at and below the former
wood-treatment area and to address a tributary creek of the Menominee River
that had become contaminated as a result of the wood-treatment operations.
Actual remedial activities were deferred until after the decree was finally
entered in 1996 by a federal court in Milwaukee.
Groundwater treatment was initiated in 1996 to remediate groundwater
contamination below and in the vicinity of the former wood-treatment area.
It is not possible to reliably predict how groundwater conditions will be
affected by the ongoing soil remediation and groundwater treatment;
therefore, it is not known how long groundwater treatment will continue.
Soil cleanup of the former wood-treatment area began in 2000 and was
completed in 2002. Also in 2002, terms for addressing the tributary creek
were agreed upon with EPA, after which Chemical began the implementation of
a remedy to reroute the creek and to remediate associated sediment and
stream bank soils. It is expected that the soil and sediment remediation
will take about four more years.
As of September 30, 2003, the company had remaining reserves of $12 million
for the costs of the remediation work described above. Although actual costs
may exceed current estimates, the amount of any increases cannot be
reasonably estimated at this time.
Cushing, Oklahoma
In 1972, an affiliate of the company closed a petroleum refinery it had
operated near Cushing, Oklahoma. Prior to closing the refinery, the
affiliate also had produced uranium and thorium fuel and metal at the site
pursuant to licenses issued by the Atomic Energy Commission (AEC). The
uranium and thorium operations commenced in 1962 and were shut down in 1966,
at which time the affiliate decommissioned and cleaned up the portion of the
facility related to uranium and thorium operations to applicable standards.
The refinery also was cleaned up to applicable standards at the time of
closing.
Subsequent regulatory changes required more extensive remediation at the
site. In 1990, the affiliate entered into a consent agreement with the State
of Oklahoma to investigate the site and take appropriate remedial actions
related to petroleum refining and uranium and thorium residuals. Remediation
of hydrocarbon contamination is being performed under a plan approved by the
Oklahoma Department of Environmental Quality. Soil remediation to address
hydrocarbon contamination is expected to continue for about four more years.
The scope of any groundwater remediation that may be required is not known.
Additionally, in 1993, the affiliate received a decommissioning license from
the Nuclear Regulatory Commission (NRC), the successor to AEC's licensing
authority, to perform certain cleanup of uranium and thorium residuals. To
avoid anticipated future increases in disposal costs, much of the uranium
and thorium residuals were cleaned up and disposed in 2002 after obtaining
NRC approvals to conduct soil removal without first completing the site
characterization. Follow-up characterization and verification work conducted
this year have identified additional volumes of residuals that require
removal and disposal.
As of September 30, 2003, the company had remaining reserves of $30 million
for the costs of the ongoing remediation and decommissioning work described
above. This includes $17 million added to the reserve in the third quarter
of 2003 as a result of the increase in uranium and thorium residuals
experienced at the site, which will require excavation, transportation and
disposal, as well as additional characterization of petroleum hydrocarbons,
and extended support costs. Although actual costs may exceed current
estimates, the amount of any increases cannot be reasonably estimated at
this time.
New Jersey Wood-Treatment Site
In 1999, EPA notified Chemical and its parent company that they were
potentially responsible parties at a former wood-treatment site in New
Jersey that has been listed by EPA as a Superfund site. At that time, the
company knew little about the site as neither Chemical nor its parent had
ever owned or operated the site. A predecessor of Chemical had been the sole
stockholder of a company that owned and operated the site. The company that
owned the site already had been dissolved and the site had been sold to a
third party before Chemical became affiliated with the former stockholder in
1964. EPA has preliminarily estimated that cleanup costs may reach $120
million or more.
There are substantial uncertainties about Chemical's responsibility for the
site, and Chemical is evaluating possible defenses to any claim by EPA for
response costs. EPA has not articulated the factual and legal basis on which
EPA notified Chemical and its parent that they are potentially responsible
parties. The EPA notification may be based on a successor liability theory
premised on the 1964 transaction pursuant to which Chemical became
affiliated with the former stockholder of the company that had owned and
operated the site. Based on available historical records, it is uncertain
whether and, if so, under what terms, the former stockholder assumed
liabilities of the dissolved company. Moreover, as noted above, the site had
been sold to a third party and the company that owned and operated the site
had been dissolved before Chemical became affiliated with that company's
stockholder. In addition, there appear to be other potentially responsible
parties, though it is not known whether the other parties have received
notification from EPA. EPA has not ordered Chemical or its parent to perform
work at the site and is instead performing the work itself. The company has
not recorded a reserve for the site as it is not possible to reliably
estimate whatever liability Chemical or its parent may have for the cleanup
because of the aforementioned uncertainties and the existence of other
potentially responsible parties.
Other Sites
In addition to the sites described above, the company is responsible for
environmental costs related to certain other sites. These sites relate to
wood-treating, chemical production, landfills, mining, oil and gas
production, and petroleum refining, distribution and marketing. As of
September 30, 2003, the company had remaining reserves of $107 million for
the environmental costs incurred in connection with these other sites. This
includes $16 million added to the reserves in the third quarter of 2003
primarily because additional remediation, characterization and/or monitoring
costs were identified for certain of these sites.
Forest Products Litigation
Primary Lawsuits - Between 1999 and 2001, Kerr-McGee Chemical LLC (Chemical)
and its parent company were named in 22 lawsuits in three states
(Mississippi, Louisiana and Pennsylvania) in connection with present and
former forest products operations located in those states. The lawsuits seek
recovery under a variety of common law and statutory legal theories for
personal injuries and property damages allegedly caused by exposure to
and/or release of creosote and other substances used in the wood-treatment
process. Some of the lawsuits are filed on behalf of specifically named
individual plaintiffs, while others purport to be filed on behalf of classes
of allegedly similarly situated plaintiffs. Seven of the 22 cases were filed
in Mississippi and relate to Chemical's Columbus, Mississippi,
wood-treatment plant; seven cases were filed in Louisiana and relate to a
former wood-treatment plant that was located in Bossier City, Louisiana; and
eight cases were filed in Pennsylvania, and relate to a closed
wood-treatment plant in Avoca, Pennsylvania. The parties have executed
agreements to settle five of the seven Mississippi cases, all seven of the
Louisiana cases and all eight Pennsylvania cases.
The settlement agreements require Chemical to pay up to $65 million for the
benefit of about 10,500 identified claimants who are eligible under the
agreements and who sign releases. In addition, the agreements require
Chemical to pay up to an additional $11 million from any recovery in certain
insurance litigation that Chemical and its parent filed against their
insurance carriers (see below). The agreements also contemplate a
class-action settlement fund in Mississippi for the benefit of a class of
residents who do not sign individual releases and who do not choose to opt
out of the class settlements. Chemical may be required to pay up to a
maximum of $7.5 million to the Mississippi class-action settlement fund. The
class-action settlement agreement, including certification of the class and
approval of the settlement, was approved by the federal court in Mississippi
on February 21, 2003. However, two members of the class subsequently
appealed the order approving the class-action settlement. This appeal was
dismissed as premature by the court of appeals on September 4, 2003.
The implementation of the settlements is progressing. Of approximately 6,100
identified claimants in Columbus, Mississippi, approximately 5,300 claimants
have delivered releases. Of approximately 3,300 identified claimants in
Louisiana, approximately 3,000 claimants have delivered releases. Of
approximately 1,100 identified claimants in Pennsylvania, approximately
1,050 claimants have delivered releases. Through September 30, 2003,
Chemical had paid approximately $52 million pursuant to the settlement
agreements to Mississippi and Louisiana claimants who signed releases, and,
on October 6, 2003, Chemical paid an additional $8.3 million to Pennsylvania
claimants who signed releases. No payments will be made to the Mississippi
class settlement fund unless and until all objections to the settlement are
finally resolved and the approval of the settlement is established by a
final, non-appealable order.
The precise amount of Chemical's ultimate obligations under all the
foregoing agreements depends on the number of claimants who sign and deliver
valid individual releases, the number of the Mississippi class members whose
proof of claim forms are approved by a court-appointed administrator and the
number of class members who opt out of the class. Additionally, future
payments pursuant to the settlements of the nonclass-action cases are
subject to a number of conditions, including the signing and delivery of
releases by named plaintiffs and court approval of various matters such as
settlements with minors.
Although the settlement agreements are expected to resolve all of the
Louisiana and Pennsylvania lawsuits and substantially all of the Columbus,
Mississippi, lawsuits described above, the settlements will not resolve the
claims of plaintiffs who do not sign releases, the claims of any class
members who opt out of the class settlement, the claims by class members
that may arise in the future for currently unmanifested personal injuries,
or the claims of any class members if the court's order approving the
class-action settlement agreement is not ultimately upheld. The two cases in
Mississippi that are not covered by the settlement agreements together
involve 27 plaintiffs who allege property damage and/or personal injury
arising out of the Columbus, Mississippi, operations. The company is
vigorously defending those cases, pending any future settlement.
Insurance Litigation - In 2001, Chemical and its parent company filed suit
against two insurance carriers to recover losses associated with certain
environmental litigation, agency proceedings and the Pennsylvania forest
products litigation described above. Chemical and its parent believe that
they have valid claims against their insurers; however, the prospects for
recovery are uncertain and the litigation is in its early stages. Further,
some or all of any recovery will be paid to the plaintiffs in the forest
products litigation as a part of the settlement agreements described above.
Accordingly, the company has not recorded a receivable or otherwise
reflected in its financial statements any potential recovery from the
insurance litigation.
Financial Reserves - The company previously established a $70 million
reserve in connection with the forest products litigation. The reserve
includes the estimated amounts owed under the settlements described above
and an estimated amount for the remaining two Mississippi cases. Upon the
October 6, 2003 payment to Pennsylvania claimants who signed releases,
Chemical had paid approximately $60 million pursuant to the settlement
agreements, leaving remaining reserves for the forest products litigation of
$10 million. The company believes the reserve adequately provides for the
potential liability associated with these matters; however, there is no
assurance that the company will not be required to adjust the reserve in the
future in light of the uncertainties described above.
Follow-on Litigation - In the fall of 2002, the Mississippi legislature
enacted a tort reform law that became effective for lawsuits filed on or
after January 1, 2003. Among other things, the new law limits punitive
damages and makes other changes intended to help ensure fairness in the
Mississippi civil justice system. The tort reform law resulted in numerous
lawsuits being filed in Mississippi immediately before the effective date of
the new law. On December 31, 2002, approximately 245 lawsuits were filed
against Chemical and its affiliates on behalf of approximately 4,598
claimants in connection with Chemical's Columbus, Mississippi, operations.
Chemical and its affiliates believe the lawsuits are without substantial
merit and intend to vigorously defend the lawsuits. The company has not
provided a reserve for the lawsuits because it cannot reasonably determine
the probability of a loss, and the amount of loss, if any, cannot be
reasonably estimated.
Hattiesburg Litigation - On December 31, 2002, a lawsuit was filed against
Chemical in the Circuit Court of Forrest County, Mississippi. The lawsuit,
Betty Bolton et al. v. Kerr-McGee Chemical Corporation, relates to a former
wood-treatment plant located in Hattiesburg, Mississippi. A second lawsuit,
Pearlina Jones et al. v. Kerr-McGee Chemical Corporation, was filed on June
13, 2003, in the Chancery Court of Forrest County, Mississippi, and relates
to the same wood-treatment plant. The lawsuits seek recovery on legal
theories substantially similar to those advanced in the forest products
litigation described above.
By the end of the third quarter, approximately 1,900 claimants had been
identified in connection with the Hattiesburg litigation, and Chemical had
agreed to settle claims asserted in the Bolton lawsuit and Jones lawsuit as
well as similar other claims. While the precise amount of Chemical's
obligation under the settlements depends on the number of claimants who sign
and deliver valid individual releases, Chemical's ultimate obligation under
the settlements is expected to be less than $800,000. As of September 30,
2003, Chemical had paid approximately $570,000 to settle the claims of about
1,450 claimants who had signed releases. Although the settlements are
expected to resolve the majority of the claims described above, the
settlements will not resolve the claims of claimants who do not sign
releases. As of September 30, 2003, approximately 450 claimants had not
delivered valid releases and it is uncertain if such releases will be
delivered at all. Chemical and its affiliates believe that claims not
resolved pursuant to the settlements are without substantial merit and
intend to vigorously defend against any further action taken with respect to
such claims. The company has not provided a reserve for such claims because
it cannot reasonably determine the probability of a loss, and the amount of
loss, if any, cannot be reasonably estimated.
Other Matters
The company and/or its affiliates are parties to a number of legal and
administrative proceedings involving environmental and/or other matters
pending in various courts or agencies. These include proceedings associated
with facilities currently or previously owned, operated or used by the
company's affiliates and/or their predecessors, and include claims for
personal injuries and property damages. Current and former operations of the
company's affiliates also involve management of regulated materials and are
subject to various environmental laws and regulations. These laws and
regulations will obligate the company's affiliates to clean up various sites
at which petroleum and other hydrocarbons, chemicals, low-level radioactive
substances and/or other materials have been disposed of or released. Some of
these sites have been designated Superfund sites by EPA pursuant to CERCLA.
Similar environmental regulations exist in foreign countries in which the
company's affiliates operate.
The company provides for costs related to contingencies when a loss is
probable and the amount is reasonably estimable. It is not possible for the
company to reliably estimate the amount and timing of all future
expenditures related to environmental and legal matters and other
contingencies because, among other reasons:
o some sites are in the early stages of investigation, and other sites may
be identified in the future;
o cleanup requirements are difficult to predict at sites where remedial
investigations have not been completed or final decisions have not been
made regarding cleanup requirements, technologies or other factors that
bear on cleanup costs;
o environmental laws frequently impose joint and several liability on all
potentially responsible parties, and it can be difficult to determine the
number and financial condition of other potentially responsible parties
and their respective shares of responsibility for cleanup costs;
o environmental laws and regulations are continually changing, and court
proceedings are inherently uncertain;
o some legal matters are in the early stages of investigation or proceeding
or their outcomes otherwise may be difficult to predict, and other legal
matters may be identified in the future;
o unanticipated construction problems and weather conditions can hinder the
completion of environmental remediation;
o the inability to implement a planned engineering design or use planned
technologies and excavation methods may require revisions to the design
of remediation measures, which delay remediation and increase costs; and
o the identification of additional areas or volumes of contamination and
changes in costs of labor, equipment and technology generate
corresponding changes in environmental remediation costs.
As of September 30, 2003, the company had reserves totaling $290 million for
cleaning up and remediating environmental sites, reflecting the reasonably
estimable costs for addressing these sites. This includes $107 million for
the West Chicago sites, $34 million for the Henderson, Nevada, site and $39
million for forest products sites. Cumulative expenditures at all
environmental sites through September 30, 2003, total $1.085 billion (before
considering government reimbursements). Additionally, as of September 30,
2003, the company had litigation reserves totaling approximately $57 million
for the reasonably estimable losses associated with litigation. This
includes $18 million for the forest products litigation described above.
Management believes, after consultation with general counsel, that currently
the company has reserved adequately for the reasonably estimable costs of
environmental matters and other contingencies. However, additions to the
reserves may be required as additional information is obtained that enables
the company to better estimate its liabilities, including liabilities at
sites now under review, though the company cannot now reliably estimate the
amount of future additions to the reserves.
O. Business Segments
Following is a summary of sales and operating profit for each of the
company's business segments for the third quarter and first nine months of
2003 and 2002.
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------------------
(Millions of dollars) 2003 2002 2003 2002
-----------------------------------------------------------------------------------------------------------
Sales
Exploration and production $ 693.8 $645.0 $2,210.5 $1,781.1
Chemicals - Pigment 266.8 266.8 803.9 748.1
Chemicals - Other 45.4 53.0 143.7 152.9
-------- ------ -------- --------
1,006.0 964.8 3,158.1 2,682.1
All other .1 - .2 .1
-------- ------ -------- --------
Total Sales $1,006.1 $964.8 $3,158.3 $2,682.2
======== ====== ======== ========
Operating Profit (Loss)
Exploration and production $ 222.0 $170.7 $ 767.0 $ 333.4
Chemicals - Pigment 7.6 18.9 .8 20.7
Chemicals - Other (3.7) (7.7) (22.1) (5.2)
-------- ------ -------- --------
Total Operating Profit 225.9 181.9 745.7 348.9
Other Expense (175.7) (73.0) (404.6) (433.9)
-------- ------ -------- --------
Income (Loss) from Continuing Operations
before Income Taxes 50.2 108.9 341.1 (85.0)
Provision for Income Taxes (21.1) (195.7) (138.0) (181.2)
-------- ------ -------- --------
Income (Loss) from Continuing Operations 29.1 (86.8) 203.1 (266.2)
Discontinued Operations, Net of Income Taxes (.3) .4 (.1) 127.3
Cumulative Effect of Change in Accounting
Principle, Net of Income Taxes - - (34.7) -
-------- ------ -------- --------
Net Income (Loss) $ 28.8 $(86.4) $ 168.3 $ (138.9)
======== ====== ======== ========
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Comparison of 2003 Results with 2002 Results
Third-quarter 2003 income from continuing operations totaled $29.1 million,
compared with a loss of $86.8 million for the same 2002 period. Income from
continuing operations for the first nine months of 2003 was $203.1 million,
compared with a loss of $266.2 million for the comparable 2002 period. Net
income for the 2003 third quarter was $28.8 million, compared with a 2002
third-quarter net loss of $86.4 million. For the first nine months of 2003,
net income was $168.3 million, compared with a net loss of $138.9 million
for the same 2002 period.
Third-quarter 2003 operating profit increased $44 million over the
comparable prior-year period, to $225.9 million from $181.9 million. The
increase was primarily due to higher realized sales prices for crude oil and
natural gas, lower operating costs within the exploration and production
operating unit and lower asset impairments. Operating profit for the first
nine months of 2003 was $745.7 million, an increase of $396.8 million over
comparable 2002 operating profit of $348.9 million. The increase in
operating profit for the nine-month period is attributable to lower asset
impairments, higher realized sales prices for crude oil, natural gas and
pigment, and lower operating costs within the exploration and production
unit, partially offset by shutdown provisions for the Mobile, Alabama,
synthetic rutile plant and forest products operations, higher exploration
expense, and higher pigment product costs. These variances are discussed in
more detail in the segment discussion that follows.
Other expense for the third quarter of 2003 totaled $175.7 million, compared
with expense of $73 million in the same 2002 period. The increase of $102.7
million between periods resulted primarily from higher environmental expense
related to former plant sites of $72.9 million. Due to findings from the
company's efforts over the spring and summer months, the 2003 third-quarter
review of the company's environmental remediation projects resulted in the
company providing additional reserves totaling $47.1 million for costs
related to activities at former plant sites. During the 2002 third quarter,
the company recorded a net credit to environmental expense of $25.8 million
resulting from the accrual of reimbursements due from the Department of
Energy related to the company's former West Chicago facility. The remaining
increase in other expense was due to $16.7 million in pension curtailment
costs related to a voluntary workforce reduction announced during the 2003
third quarter, higher losses on trading securities and nonoperating
derivative financial instruments of $26.2 million, higher corporate general
and administrative expense of $7.4 million, and higher losses from equity
affiliates of $6.1 million. These increases were partially offset by a net
favorable change of $23.9 million due to foreign currency transaction gains
of $.6 million in the 2003 third quarter versus losses of $23.3 million in
the 2002 third quarter, combined with lower net interest expense of $6.2
million. Lower average outstanding debt balances and lower average interest
rates during the third quarter of 2003 as compared with the same quarter in
the prior year resulted in the decrease in net interest expense. The losses
from equity affiliates in 2003 and 2002 are primarily due to losses from
AVESTOR, a joint venture formed in 2001 to produce a revolutionary
lithium-metal-polymer battery.
Other expense for the first nine months of 2003 totaled $404.6 million,
compared with expense of $433.9 million in the same 2002 period, for a
decrease of $29.3 million between periods. The decrease resulted primarily
from lower litigation costs of $64.2 million, lower foreign currency
transaction losses of $26.4 million and lower net interest expense of $17.5
million. These decreases were partially offset by third-quarter 2003 pension
curtailment costs of $16.7 million, higher corporate general and
administrative costs of $28.8 million, and net losses of $6.8 million from
trading securities and nonoperating derivative financial instruments,
compared with net gains of $19.8 million in the same 2002 period. During the
2002 second quarter, the company provided a $70 million litigation reserve
for the settlement of certain forest products litigation claims, which is
the primary reason for the favorable variance in litigation costs from the
prior year. The increase in corporate general and administrative costs
resulted primarily from higher retirement, deferred compensation and
incentive costs of $11.9 million, higher general liability insurance costs
of $9.3 million, and higher departmental costs of $3.8 million.
In September 2003, the company announced a program to reduce its U.S.
nonbargaining workforce by 7% to 9%, or 200 to 250 employees. The program
consists of both voluntary early retirements and involuntary terminations.
The third-quarter 2003 pension curtailment charge of $16.7 million was
recorded for the cost of the anticipated voluntary early retirements. The
company has estimated the total cost of the program will be approximately
$40 million after-tax. Other costs for severance payments, outplacement
expenses and special termination benefits within the retirement plans will
be recognized in the fourth quarter of 2003 or during 2004, as appropriate.
The company expects to save approximately $30 million annually in salaries
and benefits through the workforce reduction. See Note G for additional
discussion regarding this program.
Income tax expense for the third quarter of 2003 was $21.1 million, compared
with income tax expense of $195.7 million in the same 2002 period. For the
first nine months of 2003, income tax expense was $138.0 million, compared
with income tax expense of $181.2 million in 2002. The income tax expense
for both 2002 periods included $146.4 million resulting from the effects of
U.K. tax law changes. See Note L for a reconciliation between reported
income tax expense and the amount that would be computed using the statutory
U.S. Federal income tax rate.
Segment Operations
Exploration and Production -
Operating profit for the third quarter of 2003 was $222.0 million, a 30%
improvement compared with $170.7 million for the same 2002 period. For the
nine months ended September 30, 2003, operating profit totaled $767 million,
more than double 2002 operating profit for the same period of $333.4
million. The increase in operating profit in both 2003 periods was primarily
due to higher 2003 average realized crude oil and natural gas sales prices,
lower asset impairments on oil and gas properties, gains on sales of oil and
gas properties during 2003, and lower depreciation, depletion and production
costs, partially offset by lower crude oil and natural gas sales volumes and
higher exploration expense. Including the effects of hedging, realized crude
oil and natural gas sales prices for the 2003 third quarter increased 10%
and 51%, respectively, over 2002 levels due to market conditions. For the
first nine months of 2003, realized crude oil and natural gas sales prices
increased 21% and 60%, respectively, over the same 2002 period.
Total revenues for the third quarter of 2003 increased $48.8 million to
$693.8 million from $645 million for the 2002 third quarter. Of the total
increase, $123.3 million resulted from higher oil and gas prices and $67.8
million was due to an increase in other operating revenues, partially offset
by lower crude oil sales volumes of $117.9 million and lower natural gas
sales volumes of $24.4 million. For the nine months ended September 30,
2003, total revenues increased $429.4 million to $2.211 billion from $1.781
billion in 2002. Of the total increase, $514.2 million resulted from higher
oil and gas prices and $178.6 million resulted from an increase in other
operating revenues, partially offset by lower crude oil sales volumes of
$242.4 million and lower natural gas sales volumes of $21 million. The
increase in other operating revenues for both 2003 periods is primarily a
result of increased sales of third-party gas in the Rocky Mountain region.
The decrease in crude oil sales volumes is primarily due to the divestiture
of noncore properties in China, Ecuador, the U.S. and U.K. North Sea regions
during 2002 and 2003, partially offset by higher oil sales in the Gulf of
Mexico.
Operating costs totaled $471.8 million for the third quarter of 2003 and
$474.3 million for the third quarter of 2002, a decrease of $2.5 million.
The decrease resulted primarily from lower oil and gas production costs of
$47.9 million, gains on sales of oil and gas properties of $22.7 million in
2003, lower depreciation and depletion expense of $15.3 million, and lower
asset impairment charges of $5.7 million, partially offset by higher
product, gas gathering and pipeline costs of $65.2 million, higher
exploration expense of $9.7 million, higher general and administrative
expenses of $7 million, and accretion expense of $6.3 million. The decreases
in production costs and depreciation and depletion expense resulted from
lower production volumes between periods. The decrease in production costs
also reflects improvement in the company's cost structure resulting from the
divestiture of certain high-cost properties over the past year.
Third-quarter 2003 production costs per barrel of oil equivalent (BOE)
decreased approximately 20%, to $3.86 from $4.68 in the 2002 third quarter.
Property divestitures were also the primary cause for the decrease in crude
oil production volumes to 141,000 barrels per day from 192,900 barrels per
day in the 2002 third quarter. Higher crude oil production volumes from new
projects in the Gulf of Mexico partially offset the decrease between
periods. The $65.2 million increase in product, gas gathering and pipeline
costs is related to the $67.8 million increase in other operating revenues
discussed above, and resulted primarily from higher product costs for Rocky
Mountain natural gas marketing activities, combined with higher volumes.
For the nine months ended September 30, 2003, operating costs totaled $1.444
billion, compared with $1.448 billion in the same 2002 period. The $4
million decrease between periods resulted primarily from lower asset
impairment charges of $149.6 million, lower oil and gas production costs of
$106.6 million, lower depreciation and depletion expense of $62.9 million,
and 2003 gains on sales of held-for-sale properties of $36.9 million,
partially offset by higher product, gas gathering and pipeline costs of
$171.5 million, higher exploration expense of $138.1 million, higher general
and administrative expenses of $12.9 million, higher transportation costs of
$10.5 million, and accretion expense of $18.8 million. During 2002, the
company initiated a strategic plan to divest noncore oil and gas properties.
As a result of this plan, certain domestic and North Sea assets classified
as held-for-sale were evaluated and deemed impaired during the first nine
months of 2003 and 2002. In addition, asset impairments were recorded during
the first nine months of 2003 and 2002 for certain assets classified as
held-for-use where expectations of future cash flows were less than the
carrying value of the related assets. In total, the company recorded pretax
impairment charges of $31.9 million during the first nine months of 2003,
compared with $181.5 million during the same 2002 period. Consistent with
the 2003 third quarter, the decrease in production costs and depreciation
and depletion expense resulted from lower production volumes between periods
caused primarily by the high-cost property divestitures discussed above,
which also favorably impacted production costs through an overall improved
cost structure. Crude oil production volumes decreased to 153,600 barrels
per day from 195,600 barrels per day in the first nine months of 2002. The
$171.5 million increase in product, gas gathering and pipeline costs is
related to the $178.6 million increase in other operating revenues discussed
above, and resulted primarily from higher product costs for Rocky Mountain
natural gas marketing activities, combined with higher volumes. Higher dry
hole costs accounted for $113.9 million of the total increase in exploration
expense.
The following table shows the company's average crude oil and natural gas
sales prices and volumes for both the third quarter and first nine months of
2003 and 2002.
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
2003 2002 2003 2002
------------------------------------------------------------------------------------------------------------
Crude oil and condensate sales
(thousands of bbls/day)
Domestic
Offshore 55.4 50.5 57.6 52.7
Onshore 18.4 30.1 20.0 29.5
North Sea 65.4 104.9 73.7 104.7
Other international - 8.0 2.9 8.4
------ ------ ------ ------
Total continuing operations 139.2 193.5 154.2 195.3
Discontinued operations - 2.3 .8 5.6
------ ------ ------ ------
Total 139.2 195.8 155.0 200.9
====== ====== ====== ======
Average crude oil sales price (per barrel) (a)
Domestic
Offshore $26.00 $22.95 $25.93 $21.11
Onshore 25.34 23.04 26.31 21.01
North Sea 25.68 23.68 26.04 21.96
Other international - 23.57 29.24 21.37
Average for continuing operations 25.76 23.38 26.09 21.56
Discontinued operations $ - $20.89 $24.47 $19.62
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- -------------------
2003 2002 2003 2002
-------------------------------------------------------------------------------------------------------------
Natural gas sold (MMcf/day)
Domestic
Offshore 265 305 275 267
Onshore 343 389 353 384
North Sea 91 95 92 98
------ ------ ------ ------
Total 699 789 720 749
====== ====== ====== ======
Average natural gas sales price (per Mcf) (a)
Domestic
Offshore $ 4.59 $ 3.20 $ 4.98 $ 3.02
Onshore 4.26 2.70 4.36 2.73
North Sea 2.81 1.85 2.89 2.17
Average $ 4.20 $ 2.79 $ 4.41 $ 2.76
(a) The effects of the company's hedging program during the third quarter
and first nine months of 2003 and 2002 are included in the average
sales prices shown above. Losses on commodity hedges reduced the
average crude oil and condensate sales prices from continuing
operations by $2.16 per barrel and $1.75 per barrel during the third
quarter of 2003 and 2002, respectively, and reduced the average natural
gas sales prices by $.48 per Mcf during the third quarter of 2003.
Losses on commodity hedges reduced the average crude oil and condensate
sales prices from continuing operations by $2.43 per barrel and $.93
per barrel during the first nine months of 2003 and 2002, respectively,
and reduced the average natural gas sales prices by $.63 per Mcf during
the first nine months of 2003. Gains on commodity hedges increased the
average natural gas sales price by $.17 per Mcf and $.04 per Mcf during
the three and nine months ended September 30, 2002, respectively.
The Leadon field was written down to estimated fair value during the fourth
quarter of 2002 due to field performance issues. As of September 30, 2003,
the carrying value of the Leadon field assets totaled $377 million. During
2003, the company has selectively marketed the Leadon field for sale and
has entered into limited negotiations with third parties; however, the
timing of sale, if any, cannot presently be determined. Accordingly, the
Leadon field has not been classified as held for sale in the financial
statements. The company continues to review its options with respect to the
Leadon field, which include sale of the field, tieback of wells to other
fixed infrastructure in the area (allowing the company to monetize the
Leadon floating facility by marketing it as a development option for
another discovery), or continued production from the field until existing
wells are fully depleted; however, a long-term solution has not yet been
determined. Given the uncertainty concerning possible outcomes, it is
reasonably possible that the company's estimate of future cash flows from
the Leadon field and associated fair value could change in the near term.
If future cash flows or fair value decrease significantly from that
presently estimated, an additional write-down of the Leadon field could
occur in the future.
Chemicals - Pigment
Operating profit for the third quarter of 2003 was $7.6 million on revenues
of $266.8 million, compared with operating profit of $18.9 million on
revenues of $266.8 million for the same 2002 period. A net improvement in
the pigment sales price and volume mix of $19 million during the 2003 third
quarter was more than offset by higher average product costs of $15.9
million; an environmental provision reversal of $6.1 million in 2002 related
to the company's Savannah, Georgia, operations; shutdown provisions in 2003
for the Mobile, Alabama, facility of $4.3 million; and higher selling and
administrative costs of $4.1 million. For the first nine months of 2003,
operating profit was $.8 million on revenues of $803.9 million, compared
with operating profit of $20.7 million on revenues of $748.1 million in the
comparable prior-year period. The decrease in operating profit for the first
nine months of 2003 compared with the same 2002 period was primarily due to
shutdown provisions for the Mobile facility totaling $40.6 million, higher
average product costs of $34.4 million, higher selling and administrative
costs of $14.5 million, and the $6.1 million reversal of a Savannah
environmental provision in 2002, partially offset by an increase due to an
improved sales price and volume mix of $72.8 million over the 2002
nine-month period. The year-to-date shutdown provision for the Mobile
operations included $6.1 million for curtailment costs related to pension
and postretirement benefits.
Revenues remained flat for the 2003 third quarter compared to prior year;
however, the chemical - pigment operating unit experienced higher average
sales prices during the 2003 third quarter, which resulted in a $16.2
million increase in revenues for the period. Lower sales volumes for the
period entirely offset the increase due to price. For the nine months ended
September 30, 2003, revenues increased $55.8 million, or 7%, of which $82.1
million resulted from higher average sales prices, partially offset by a
decrease of $26.3 million due to lower pigment sales volumes. Price
increases for pigment products were announced throughout 2002 and into 2003;
however, pigment sales volumes decreased by 9,400 tonnes in the 2003 third
quarter and by 13,500 tonnes for the first nine months compared with
prior-year levels, primarily in the European sector.
In January 2003, Kerr-McGee announced its plans to close the Mobile,
Alabama, facility, and the plant was closed in June 2003. This closure was
part of the company's continuous effort to enhance operating profitability.
The Mobile plant processed and supplied a portion of the feedstock for the
company's titanium dioxide pigment plants in the United States; however,
through Kerr-McGee's ongoing supply-chain initiatives, feedstock is now
being purchased more economically than it could be manufactured at the
Mobile plant. As a result of these steps, the company anticipates annual
savings of approximately $25 million to $30 million beginning in 2004.
Chemicals - Other
Operating loss in the 2003 third quarter was $3.7 million on revenues of
$45.4 million, compared with an operating loss of $7.7 million on revenues
of $53 million in the same 2002 period. Of the $4 million decrease in the
operating loss, $8.7 resulted from the impact of environmental provisions on
the electrolytic operations in the prior-year quarter, partially offset by
lower operating results from the forest products operations of $2.7 million.
Operating loss for the nine months ended September 30, 2003, was $22.1
million on revenues of $143.7 million, compared with an operating loss of
$5.2 million on revenues of $152.9 million in the same 2002 period. The
$16.9 million increase in operating loss for the first nine months of 2003
was primarily due to lower operating results of $15.8 million from the
forest products operations and higher electrolytic product costs of $4.7
million, partially offset by lower environmental costs of $5.1 million.
Environmental provisions for the chemical - other operating unit are related
primarily to ammonium perchlorate remediation associated with the company's
Henderson, Nevada, operations (See Note N). Of the $15.8 million decrease in
operating results for the forest products operations, $8.8 million resulted
from shutdown provisions incurred during the 2002 second quarter, which
included $8.1 million for curtailment costs related to pension and
postretirement benefits.
During the third quarter of 2003, Kerr-McGee Chemical LLC placed its
electrolytic manganese dioxide (EMD) manufacturing operation in Henderson,
Nevada, on standby to reduce inventory levels because of the harmful effect
of low-priced imports on the company's EMD business and the operation is
expected to remain on standby through the first quarter of 2004. In response
to the pricing activities of importing companies, Kerr-McGee Chemical LLC
filed a petition for the imposition of antidumping duties with the U.S.
Department of Commerce International Trade Administration and the U.S.
International Trade Commission on July 31, 2003. In its petition, the
company alleged that manufacturers in certain countries, including
Australia, Greece, Ireland, Japan and South Africa, export EMD to the United
States in violation of the U.S. antidumping laws and requested that the U.S.
Department of Commerce apply substantial antidumping duties to the EMD
imported from such countries. The Department of Commerce found probable
cause to believe that manufacturers in the countries described above have
engaged in dumping and, therefore, has initiated an antidumping
investigation with respect to such manufacturers. However, the outcome of
the proceeding is uncertain. The company intends to resume EMD manufacturing
if and when competitiveness is restored.
Financial Condition
At September 30, 2003, the company's net working capital position was a
negative $361.2 million, compared with a negative $51 million at September
30, 2002, and a negative $319.7 million at December 31, 2002. The current
ratio was .8 to 1 at both September 30, 2003, and December 31, 2002,
compared with 1 to 1 at September 30, 2002. The negative working capital
position at September 30, 2003, is not indicative of a lack of liquidity, as
the company maintains sufficient current assets to settle current
liabilities when due. Additionally, the company has sufficient unused lines
of credit and revolving credit facilities, as discussed below. Current asset
balances are minimized as one way to finance capital expenditures and lower
borrowing costs.
The company's percentage of net debt (debt less cash) to capitalization was
57% at September 30, 2003, compared with 60% at December 31, 2002, and 59%
at September 30, 2002. The decrease from December 31, 2002, resulted
primarily from reduced debt balances of $183.4 million combined with an
increase in stockholders' equity for the period. The company had unused
lines of credit and revolving credit facilities of $1.399 billion at
September 30, 2003. Of this amount, $870 million can be used to support
commercial paper borrowings of Kerr-McGee Credit LLC and $490 million can be
used to support European commercial paper borrowings of Kerr-McGee (G.B.)
PLC, Kerr-McGee Chemical GmbH, Kerr-McGee Pigments (Holland) B.V. and
Kerr-McGee International ApS. Currently, the capacity of the company's
commercial paper program totals $1.2 billion, which can be issued based on
market conditions. Long-term debt obligations due within one year of $672.3
million consist primarily of $100 million, 8% notes due October 15, 2003,
$100 million of floating rate notes due June 28, 2004, $145 million, 8.375%
notes due July 15, 2004, and $330.3 million (face value), 5.5% notes
exchangeable for common stock due August 2, 2004. As discussed below, the
notes exchangeable for common stock may be settled in either Devon stock or,
at the company's option, an equivalent amount of cash. The $100 million, 8%
notes due October 15, 2003, were paid in October using a combination of
internally generated cash flows and commercial paper borrowings. The company
expects to also use internally generated cash flows or short-term borrowings
to fund the payment of the remaining $245 million in debt maturities.
On July 30, 2003, the company amended its existing accounts receivable
monetization program. The new program has been expanded to include the sale
of receivables originated by the company's European chemical operations and
the maximum availability under the program is $168 million.
As of December 31, 2002, the company's senior unsecured debt was rated BBB
by Standard & Poor's and Fitch and the equivalent by Moody's. During May
2003, Moody's downgraded the company's senior unsecured debt from Baa2 to
Baa3 and downgraded the company's commercial paper from Prime-2 to Prime-3.
As a result of the Moody's downgrade, the company's borrowing costs may
increase, and the company may experience a different mix of investor
interest in its debt and/or amounts they are individually willing to invest.
The company believes that it has the ability to provide for its operational
needs and its long- and short-term capital programs through its operating
cash flow (partially protected by the company's hedging program), borrowing
capacity and ability to raise capital. Should operating cash flow decline,
the company may reduce its capital expenditures program, borrow under its
commercial paper program, borrow under existing credit facilities and/or
consider selective long-term borrowings or equity issuances. Kerr-McGee's
commercial paper programs are backed by the revolving credit facilities
currently in place.
The company issued 5-1/2% notes exchangeable for common stock (DECS) in
August 1999, which allow each holder to receive between .85 and 1.0 share of
Devon common stock or, at the company's option, an equivalent amount of cash
at maturity in August 2004. Embedded options in the DECS provide the company
a floor price on Devon's common stock of $33.19 per share (the put option).
The company also retains the right to 15% of the shares if Devon's stock
price is greater than $39.16 per share (the DECS holders have an imbedded
call option on 85% of the shares). If Devon's stock price at maturity is
greater than $33.19 per share but less than $39.16 per share, the company's
right to retain Devon stock will be reduced proportionately. The company is
not entitled to retain any Devon stock if the price of Devon stock at
maturity is less than or equal to $33.19 per share. Using the Black-Scholes
valuation model, the company recognizes in Other Income any gains or losses
resulting from changes in the fair value of the put and call options. At
September 30, 2003, the fair values of the embedded put and call options
were nil and $79.4 million, respectively. On December 31, 2002, the fair
values of the embedded put and call options were nil and $66.6 million
respectively. During the third quarter of 2003, the company recorded a gain
of $45.3 million in Other Income for the changes in the fair values of the
put and call options, compared with a gain of $19.7 million during the third
quarter of 2002. During the first nine months of 2003 and 2002, the company
recorded losses of $12.8 million and $54.5 million, respectively, in Other
Income for the changes in the fair values of the put and call options. The
fluctuation in the value of the put and call derivative financial
instruments will generally offset the increase or decease in the market
value of 85% of the Devon stock owned by the company. The fair value of the
8.4 million shares of Devon classified as trading securities was $406.5
million at September 30, 2003, and $387.2 million at December 31, 2002.
During the third quarter of 2003 and 2002, the company recorded unrealized
losses of $44 million and $8.7 million, respectively, in Other Income for
the changes in fair value of the Devon shares classified as trading. During
the first nine months of 2003 and 2002, the company recorded unrealized
gains of $19.3 million and $81 million, respectively, in Other Income for
the changes in fair value of the Devon shares classified as trading. The
company accounts for the remaining 15% of the Devon shares as
available-for-sale securities in accordance with FAS 115, "Accounting for
Certain Investments in Debt and Equity Securities," with changes in market
value recorded in accumulated other comprehensive income. The fair value of
the Devon shares classified as available for sale was $73.2 million at
September 30, 2003, and $69.7 million at December 31, 2002. The DECS, the
derivative liability associated with the call option and the Devon shares
have been classified as current assets or current liabilities, as
appropriate, in the Consolidated Balance Sheet as of September 30, 2003.
Operating activities provided net cash of $1.192 billion in the first nine
months of 2003. During the first nine months of 2003, cash provided by
operating activities and proceeds of $258.6 million from asset sales were
sufficient to fund the company's net reduction in long-term debt of $193.5
million, capital expenditures (including dry hole costs) of $912.1 million,
dividends of $135.9 million, and a $69.6 million onshore property
acquisition in south Texas.
Capital expenditures for the first nine months of 2003, excluding dry hole
costs, totaled $749.4 million, compared with $886.2 million for the
comparable prior-year period. The decrease is largely attributable to lower
capital spending within the exploration and production operating unit in the
U.K. North Sea, Rocky Mountain and onshore U.S. regions during the first
nine months of 2003 and prior-year capital spending on discontinued
operations, partially offset by higher 2003 spending in the deepwater Gulf
of Mexico and China as compared to the prior year. Exploration and
production expenditures, principally in the Gulf of Mexico and onshore
United States, were 90% of the 2003 total expenditures. Chemical - pigment
expenditures were 8% of the 2003 total, while chemical - other and corporate
incurred the remaining 2% of the year-to-date 2003 expenditures. Management
anticipates that the cash requirements for the next several years can be
provided through internally generated funds and selective borrowings.
New Accounting Standards
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (FAS) No. 143, "Accounting for
Asset Retirement Obligations." FAS 143 requires that an asset retirement
obligation (ARO) associated with the retirement of a tangible long-lived
asset be recognized as a liability in the period in which it is incurred and
becomes determinable (as defined by the standard), with an offsetting
increase in the carrying amount of the associated asset. The cost of the
tangible asset, including the initially recognized ARO, is depreciated such
that the cost of the ARO is recognized over the useful life of the asset.
The ARO is recorded at fair value, and accretion expense will be recognized
over time as the discounted liability is accreted to its expected settlement
value. The fair value of the ARO is measured using expected future cash
outflows discounted at the company's credit-adjusted risk-free interest
rate.
The company adopted FAS 143 on January 1, 2003, which resulted in an
increase in net property of $127.5 million, an increase in abandonment
liabilities of $180.4 million and a decrease in deferred income tax
liabilities of $18.2 million. The net impact of these changes resulted in an
after-tax charge to earnings of $34.7 million to recognize the cumulative
effect of retroactively applying the new accounting principle. In accordance
with the provisions of FAS 143, Kerr-McGee accrues an abandonment liability
associated with its oil and gas wells and platforms when those assets are
placed in service, rather than its past practice of accruing the expected
abandonment costs on a unit-of-production basis over the productive life of
the associated oil and gas field. No market risk premium has been included
in the company's calculation of the ARO for oil and gas wells and platforms
since no reliable estimate can be made by the company. In connection with
the change in accounting principle, abandonment expense of $9.1 million and
$26.7 million for the third quarter and first nine months of 2002,
respectively, has been reclassified from Costs and operating expenses to
Depreciation and depletion in the Consolidated Statement of Operations to be
consistent with the 2003 presentation. In January 2003, the company
announced its plan to close the synthetic rutile plant in Mobile, Alabama,
and closed the plant in June 2003. Since the plant had a determinate closure
date, the company accrued an abandonment liability of $17.6 million
associated with its plans to decommission the Mobile facility.
In January 2003, the FASB issued FASB Interpretation (FIN) No. 46,
"Consolidation of Variable Interest Entities - an Interpretation of ARB No.
51." For variable interest entities in existence as of February 1, 2003, FIN
46, as originally issued, required consolidation by the primary beneficiary
in the third quarter of 2003. In October 2003, the FASB deferred the
effective date of FIN 46 to the fourth quarter. In accordance with the
provisions of FIN 46, the company believes it would be required to
consolidate the business trust created to construct and finance the Gunnison
production platform. The construction is being financed by a synthetic lease
credit facility between the trust and groups of financial institutions for
up to $157 million. The company is required to make lease payments
sufficient to pay interest on the financing over the term of the synthetic
lease credit facility, which terminates in November 2006. Completion of the
Gunnison platform is anticipated to occur in either December 2003, or early
2004. The company is currently in negotiations to convert the Gunnison
synthetic lease to an operating lease agreement, under which different
trusts will become the lessor/owner of the platform and related equipment.
The new agreements are expected to close in December 2003 and/or January
2004; however, the ultimate closing date will be dependent on the completion
of the platform and the timeliness of the negotiation process and may occur
sometime thereafter. If the synthetic lease is converted to an operating
lease before year end, the company believes the variable interest entity
lessor will not be subject to consolidation. However, the ultimate
accounting treatment for the proposed restructured lease agreement or the
lessor trust can not be determined until the significant terms of the
agreement are finalized. If the synthetic lease is not replaced before year
end, the financing trust will be subject to consolidation at December 31,
2003. The company has reviewed the effects of FIN 46 relative to its other
relationships with possible variable interest entities, such as the lessor
trusts that are party to the Nansen and Boomvang operating leases and
certain joint-venture arrangements, and does not believe that consolidation
of these entities is required.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Beginning in March 2002, the company entered into hedging contracts for a
portion of its oil and natural gas production. The company continues to
expand its hedging program and will enter into additional contracts to
increase the hedged volumes associated with its projected 2004 production.
The commodity hedging program was initiated to increase the predictability
of the company's cash flows and support capital projects since hedging
contracts generally fix the commodity prices to be received in the future.
At September 30, 2003, the company had outstanding contracts to hedge a
total of 8.7 million barrels of North Sea crude oil production, 6.6 million
barrels of domestic crude oil production and 50 million MMBtu of domestic
natural gas production for the period from October 2003 through December
2004. The net liability fair value of the hedge contracts outstanding at
September 30, 2003, was $13.1 million for North Sea crude oil, $11.1 million
for domestic crude oil and $24.4 million for domestic natural gas.
At September 30, 2003, the following commodity-related derivative contracts
were outstanding:
Daily Average
Contract Type (1) Period Volume Price
-------------------------------------------------------------------------------------------------------------------
Natural Gas Hedges MMBtu $/MMBtu
------------------ ----- -------
Fixed-price swaps (NYMEX) Q4 - 2003 310,000 $4.00
Q1 - 2004 85,000 $5.04
Costless collars (NYMEX) Q4 - 2003 65,000 $3.50-$5.26
Q1 - 2004 85,000 $4.48-$6.00
Basis swaps (Rockies) Q4 - 2003 64,580 $0.36
Crude Oil Hedges Bbl $/Bbl
---------------- --- -----
Fixed-price swaps (WTI) Q4 - 2003 35,000 $26.01
Q1 - 2004 27,000 $27.50
Q2, 3, 4 - 2004 3,500 $27.12
Fixed-price swaps (Brent) Q4 - 2003 45,000 $25.04
Q1 - 2004 40,000 $26.15
Q2, 3, 4 - 2004 3,500 $25.81
Natural Gas (non-hedge contracts) MMBtu $/MMBtu
--------------------------------- ----- -------
Basis swaps (Rockies) Q4 - 2003 68,300. $0.78
Q1 - 2004 135,000 $0.57
Q2, 3, 4 - 2004 35,000 $0.31
2005 35,000 $0.31
2006 35,000 $0.31
2007 35,000 $0.31
2008 20,000 $0.25
(1) These contracts may be subject to margin calls above certain limits
established with individual counterparty institutions.
From October 1, 2003, through October 17, 2003, the company added the
following derivative contracts, expanding its hedging program to cover a
larger portion of its 2003 and 2004 production.
Daily Average
Contract Type (1) Period Volume Price
---------------------------------------------------------------------------------------------------------------
Natural Gas Hedges MMBtu $/MMBtu
------------------ ----- -------
Fixed-price swaps (NYMEX) Q1 - 2004 110,000 $5.56
Costless collars (NYMEX) Q1 - 2004 150,000 $4.78-$7.08
Crude Oil Hedges Bbl $/Bbl
---------------- --- -----
Fixed-price swaps (WTI) Q4 - 2003 20,100 $31.84
Q1 - 2004 21,000 $29.94
Q2 - 2004 25,000 $27.06
Q3 - 2004 26,500 $27.21
Q4 - 2004 14,000 $27.03
Fixed-price swaps (Brent) Q4 - 2003 12,500 $30.18
Q1 - 2004 5,000 $28.20
Q2 - 2004 36,000 $25.63
Q3 - 2004 23,500 $25.85
Q4 - 2004 12,000 $25.75
(1) These contracts may be subject to margin calls above certain limits
established with individual counterparty institutions.
Periodically, the company enters into forward contracts to buy and sell
foreign currencies. Certain of these contracts (purchases of Australian
dollars and British pound sterling and certain sales of Euro) have been
designated and have qualified as cash flow hedges of the company's operating
and capital expenditure requirements. These contracts generally have
durations of less than three years. The resulting changes in fair value of
these contracts are recorded in accumulated other comprehensive income.
Following are the notional amounts at the contract exchange rates,
weighted-average contractual exchange rates and estimated contract values
for open contracts at September 30, 2003, to purchase (sell) foreign
currencies. Contract values are based on the estimated forward exchange
rates in effect at period-end. All amounts are U.S. dollar equivalents.
Estimated
(Millions of dollars, Notional Weighted-Average Contract
except average contract rates) Amount Contract Rate Value
----------------------------------------------------------------------------------------------------------
Open contracts at September 30, 2003 -
Maturing in 2003 -
British pound sterling $33.6 1.5399 $36.1
Australian dollar 15.6 .5586 18.9
Euro (84.2) 1.1197 (86.2)
British pound sterling (.7) 1.5920 (.7)
Japanese yen (.8) .0088 (.8)
New Zealand dollar (.5) .5684 (.5)
Maturing in 2004 -
Australian dollar 37.7 .5366 46.4
Euro (45.9) 1.1024 (47.5)
Item 4. Controls and Procedures.
As of the end of the period covered by this report, an evaluation was
carried out under the supervision and with the participation of the
company's management, including its Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-15. Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the company's disclosure controls and
procedures are effective in alerting them in a timely manner to material
information relating to the company (including its consolidated
subsidiaries) required to be included in the company's periodic SEC filings.
There were no significant changes in the company's internal controls or in
other factors that could significantly affect these controls subsequent to
the date of their evaluation.
Forward-Looking Information
Statements in this quarterly report regarding the company's or management's
intentions, beliefs or expectations, or that otherwise speak to future
events, are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Future results and developments
discussed in these statements may be affected by numerous factors and risks,
such as the accuracy of the assumptions that underlie the statements, the
success of the oil and gas exploration and production program, drilling
risks, the market value of Kerr-McGee's products, uncertainties in
interpreting engineering data, demand for consumer products for which
Kerr-McGee's businesses supply raw materials, the financial resources of
competitors, changes in laws and regulations, the ability to respond to
challenges in international markets, including changes in currency exchange
rates, political or economic conditions, trade and regulatory matters,
general economic conditions, and other factors and risks identified in the
Risk Factors section of the company's Annual Report on Form 10-K and other
SEC filings. Actual results and developments may differ materially from
those expressed in this quarterly report.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
(a) For a discussion of legal proceedings and contingencies, reference is
made to Note N to the consolidated financial statements included in
Part I, Item 1. of this Form 10-Q, which is incorporated herein by
reference.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits -
Exhibit No
----------
3.1 Amended and Restated Certificate of Incorporation of
Kerr-McGee Corporation, filed as Exhibit 4.1 to the
company's Registration Statement on Form S-4/A dated
June 18, 2001, and incorporated herein by reference.
3.2 Amended and Restated Bylaws of Kerr-McGee Corporation,
filed as Exhibit 3.2 to the company's Annual Report on
Form 10-K for the year ended December 31, 2002, and
incorporated herein by reference.
31.1 Certification Pursuant to Securities Exchange Act Rule
15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification Pursuant to Securities Exchange Act Rule
15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
32.2 Certification Pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(b) Reports on Form 8-K -
The following Current Reports on Form 8-K were filed by the company
during the quarter ended September 30, 2003:
o Current Report dated July 23, 2003, announcing a conference
call to discuss the company's second-quarter 2003 financial
and operating results, and expectations for the future.
o Current Report dated July 29, 2003, announcing a security
analyst meeting to discuss the company's financial and
operating outlook for 2003 and certain expectations for oil
and natural gas production volumes for the year 2003.
o Current Report dated July 30, 2003, announcing the company's
second-quarter 2003 earnings.
o Current Report dated July 30, 2003, announcing the company
had posted on its website a table containing a
reconciliation of GAAP to Adjusted Net Income for the
year-to-date and quarterly fiscal periods ended June 30,
2003.
o Current Report dated August 22, 2003, announcing a
conference call to discuss interim third-quarter 2003
financial and operating activities, and expectations for the
future.
o Current Report dated August 28, 2003, announcing a
presentation discussing the company's oil and gas operations
by Luke Corbett, chairman and chief executive officer, at
the Lehman Brothers CEO Energy/Power Conference.
o Current Report dated September 19, 2003, announcing a
conference call to discuss interim third-quarter 2003
financial and operating activities, and expectations for the
future.
o Current Report dated September 24, 2003, announcing a
security analyst meeting to discuss the company's financial
and operating outlook for 2003 and certain expectations for
oil and natural gas production volumes for the year 2003.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
KERR-McGEE CORPORATION
Date: November 11, 2003 By: /s/ John M. Rauh
----------------- --------------------------------
John M. Rauh
Vice President and Controller
and Chief Accounting Officer