ITEM 1: BUSINESS _________________
As used in this report, the term "K N" means K N Energy, Inc. and the term "Company" means collectively K N Energy, Inc. and its subsidiaries, unless the context requires a different meaning. (See "Subsidiaries of the Registrant" in Exhibit 22.)
(A) General Development of Business _______________________________
K N was incorporated in Kansas on May 18, 1927. The Company's principal operations are the sale, marketing, transportation, processing and gathering of natural gas and the exploration, development and production of oil and natural gas. The Company has operated as a natural gas pipeline and utility since 1937 and has been involved in oil and gas exploration and development since 1951.
Since 1989, K N subsidiaries have engaged in nonregulated gas marketing and gathering activities. This segment is experiencing significant growth through acquisitions, joint ventures and the transfer of substantially all of K N's existing gathering and processing facilities to this nonregulated segment as part of its restructuring. (See "Restructuring and Reorganization" below.)
On October 1, 1993, K N implemented its unbundling of pipeline services in response to the Federal Energy Regulatory Commission's Order No. 636 ("Order 636"). The Order is designed to stimulate competition in the interstate transportation and sale of natural gas. Of the many elements that make up Order 636, the central feature involves the unbundling of gas sales and transportation services. Unbundling means that traditional pipeline customers, such as wholesale customers, direct end- users and shippers, have new options when contracting for various pipeline services such as transportation and storage.
In response to Order 636, K N no longer operates its interstate operations as a single entity that purchases, gathers, processes, transports, stores and sells natural gas at retail and wholesale. Instead, K N has restructured its operations and now operates its interstate transmission pipeline as a separate subsidiary business unit, K N Interstate Gas Transmission Co. ("KNI").
K N's local distribution operation is being operated as a separate business unit ("K N Retail") within the parent company. K N also provides retail natural gas services through two intrastate divisions, Rocky Mountain Natural Gas in Colorado and Northern Gas of Wyoming.
Substantially all of the gathering and processing facilities that were previously part of K N's regulated transmission operation are now being operated as nonregulated facilities by K N Gas Gathering, Inc. ("KNGG"), a wholly-owned subsidiary which also operates a number of other gathering and processing facilities acquired during the past two years.
On April 1, 1993, the Company completed the $48 million acquisition of the Wattenberg natural gas gathering and transportation system. The
transmission segment of the system is a Federal Energy Regulatory Commission ("FERC")-regulated interstate pipeline system operated by K N Wattenberg Transmission Limited Liability Company ("KNWTLLC"), a second- tier subsidiary of K N. The nonregulated gathering portion of the system is operated by K N Front Range Gathering Company ("KNFRGC"), a wholly-owned subsidiary of KNGG.
(B) Financial Information About Industry Segments _____________________________________________
The Business Segment Information in Note 13 of Notes to Consolidated Financial Statements of the 1993 Annual Report to Shareholders as shown on pages 52 and 53 provides the operating profit, identifiable assets and other information for each segment. The Consolidated Statements of Income in the 1993 Annual Report to Shareholders as shown on page 32 show sales to unaffiliated customers (operating revenues) for each segment.
(C) Narrative Description of Business _________________________________
(1) Regulated Gas Services ______________________
Markets and Sales _________________
The Company's FERC-regulated interstate pipeline systems (operated by KNI and KNWTLLC) provide transportation and storage services to K N Retail and other local natural gas distribution utilities and shippers. K N Retail provides retail natural gas services to residential, commercial, agricultural and industrial customers in Kansas, Nebraska, Colorado and Wyoming. Approximately 151,000 retail customers are served by K N Retail. The interstate pipeline systems provide transportation and storage services for a portion of the system supply of Public Service Company of Colorado ("PSCo"), Western Resources, Inc. and the City of Colorado Springs, Colorado, as well as for other local utilities serving 92,000 gas consumers in Colorado, Kansas and Nebraska.
As of December 31, 1993, the interstate systems provided transportation and storage services to utilities serving 293 communities, as follows:
(1) Principal cities served by K N Retail include: Alliance, Chadron, Holdrege, McCook, Ogallala, Scottsbluff, Sidney and a portion of Kearney, Nebraska; Colby, Phillipsburg and Scott City, Kansas; Julesburg and Wray, Colorado; and Douglas and Torrington, Wyoming.
(2) Principal cities served by other local distribution utilities include: Grand Island, Hastings, Norfolk, North Platte, and Kearney, Nebraska; Hays, Kansas; and Sterling and the metropolitan areas of Colorado Springs and Denver, Colorado.
The Company operates intrastate gas pipeline systems serving industrial customers and K N's distribution divisions in Wyoming and Colorado. The Northern Gas of Wyoming Division of K N provides retail gas
service to approximately 50,000 customers in 25 communities in central, south central and northeastern Wyoming. Principal cities served at retail by the Wyoming intrastate system include Casper, Gillette, Lander, Laramie, Rawlins and Riverton, Wyoming. The Rocky Mountain Natural Gas Division of K N ("RMNG") serves approximately 31,500 retail customers in 26 communities in western Colorado. Aspen, Delta, Glenwood Springs, Montrose, Snowmass Village and Telluride are the principal cities served.
RMNG continues to experience significant growth in the resort areas of Colorado. During 1993, the division experienced a six percent growth in the number of residential and commercial customers.
Because of the demands of this continued growth, RMNG and an affiliate, in conjunction with PSCo, have received a favorable order from the Colorado Public Utilities Commission to build a 90-mile transmission pipeline from Rifle to Avon, Colorado. The pipeline will connect natural gas production areas near Rifle to K N's Colorado intrastate pipeline system.
Agriculture is the dominant factor in the economies of the Company's historical service areas. The Company supplies natural gas for irrigation, crop drying, processing of agricultural products and the manufacture of agriculture-related goods.
The following table sets forth the percentage of total natural gas sales revenues for each class of customer for each of the three years in the period ended December 31, 1993, as follows:
(1) Regulated sales of natural gas to other gas utilities ended on September 30, 1993, due to the Company's implementation of Order 636.
Natural gas sales accounted for 51.6, 69.4 and 78.0 percent of consolidated revenues for the years ended December 31, 1993, 1992 and 1991, respectively.
The transfer of substantially all of K N's gathering and processing facilities to KNGG effective January 1, 1994, will result in a significant shift in operating revenues, expenses and operating income. The cessation of the merchant function as a FERC-regulated service will substantially reduce this segment's operating revenues and gas purchase expenses; however, this will not impact operating income.
Results of this business segment have historically been seasonal in nature due to fluctuating needs for natural gas for space heating and irrigation. However, Order 636 mandated the use of straight fixed-variable rate design ("SFV") for FERC-regulated services. This rate methodology will result in this business segment collecting a significant portion of
its revenues from customers through demand charges collected evenly throughout the year. Accordingly, fluctuations in operating revenues resulting from seasonal variations in weather temperatures should be reduced.
Transportation ______________
KNI, under its menu of services, provides not only firm and interruptible transportation, but also storage and no-notice services to its customers. Under no-notice service, customers are able to meet their peak day requirements without making specific nominations as required by firm and interruptible transportation services tariffs.
Under Order 636, the local distribution companies ("LDCs") and other shippers may release their unused firm transportation capacity rights to other shippers. It is anticipated that this released capacity will, to a large extent, replace interruptible transportation on the Company's system. Interruptible transportation is charged on the basis of volumes shipped.
The Company's Wyoming and Colorado intrastate systems have blanket certificates which allow them to transport gas to be delivered in interstate commerce, and both systems also provide intrastate transportation services.
Marketing _________
The Company is continuing its efforts to expand its transportation business through expanded capacity and new interconnects, as well as by adding new transportation services. While there is considerable competition for this business, the Company has certain strategic advantages to enable it to be a successful competitor. These include favorable geographic pipeline locations providing access to both major gas supply areas and potential new markets. The Company will continue developing its role as an operator of transportation hubs, facilitating market-center services.
A K N subsidiary is a one-third joint venture partner in the TransColorado Gas Transmission Pipeline Project. This pipeline is expected to provide increased flexibility in accessing multiple natural gas basins in the Rocky Mountain region. TransColorado is in its final preconstruction stage and regulatory work is nearing completion. To focus marketing activities, the partner companies have opened a TransColorado marketing office to secure supply and transportation commitments. Construction is anticipated to begin in 1995.
Gas Supply __________
With the implementation of Order 636, gas purchasing is now the responsibility of each LDC. To meet this new responsibility, K N Retail formed a new Gas Supply Department. K N Retail has contracted with KNI and other pipelines for transportation and storage services required to serve its markets. K N Retail's gas supply requirements are being met through
a combination of purchases from a wholly-owned subsidiary, K N Gas Supply Services, Inc. ("KNGSSI"), and third party suppliers.
K N Retail's gas supply comes from five major geological areas, as follows:
(1) Anadarko Basin, including the Hugoton, Bradshaw and Panoma fields in Kansas;
(2) Barton Arch area of central Kansas;
(3) Denver-Julesburg Basin in northeast Colorado, northwest Kansas and western Nebraska;
(4) Wind River Basin in central Wyoming; and
(5) Bowdoin area in north central Montana.
The Company's intrastate system in Wyoming purchases its gas supply principally from producers in the Wind River Basin in central Wyoming. The Company's Colorado intrastate system purchases approximately 12 percent of its system supply from a K N oil and gas subsidiary and the remainder from a number of western Colorado fields.
Underground storage facilities are used to provide deliverabilities for peak system demand. Four underground storage facilities are located on the interstate systems, five are on the Wyoming intrastate system and one is on the Colorado intrastate system.
In connection with Order 636, K N received FERC approval to reclassify, as of October 1, 1993, 54.9 billion cubic feet ("Bcf") of working gas to cushion gas. As part of the corporate restructuring, all cushion gas (88.1 Bcf) was transferred to KNI at that time. The remaining working gas of 11.1 Bcf at October 1, 1993, was purchased in-place by K N's former wholesale customers; K N Retail retained 4.3 Bcf of this working gas. On the interstate systems, a net injection of 2.7 Bcf in 1993 increased the total year-end gas inventory owned by all parties to 95.1 Bcf. The approximate unused working gas capacity at December 31, 1993, was 9.7 Bcf.
On the Wyoming intrastate system, 11.3 Bcf of working gas was available in storage at year-end after a net withdrawal of 2.5 Bcf during the year. On the Colorado intrastate system, 2.3 Bcf of working gas was available in storage at year-end after a net withdrawal of 98 million cubic feet ("MMcf") during the year.
Restructuring and Reorganization ________________________________
As authorized by FERC, K N implemented Order 636 restructured services on October 1, 1993. K N requested FERC approval, as a result of Order 636, to transfer all of its interstate transmission and storage facilities to KNI, a wholly-owned jurisdictional subsidiary of K N, and substantially all of its gathering and processing facilities to KNGG, a nonjurisdictional wholly-owned subsidiary of K N. In its May 5, 1993 order, FERC approved the transfer of K N's gathering, processing, transmission and storage facilities to KNI effective October 1, 1993. On
November 1, 1993, FERC authorized the transfer of substantially all gathering and processing facilities from KNI to KNGG.
Through discussions with its former wholesale customers, K N was able to formulate and implement a plan which resulted in the transition to Order 636 services and which avoided the necessity of any Gas Supply Realignment ("GSR") cost recovery filings with FERC. As a part of its action on K N's restructuring proposal, on January 13, 1994, FERC approved the offer of settlement which implemented K N's GSR crediting mechanism.
Regulation __________
KNI's and KNWTLLC's facilities for the transportation of natural gas in interstate commerce, and in the case of KNI, for storage services in interstate commerce, are subject to regulation by FERC. In addition, KNI is subject to the requirements of FERC Order Nos. 497, et al., the Marketing Affiliate Rules, which govern the provision of information by an interstate pipeline to its marketing affiliates. The subsidiaries of K N currently identified as marketing affiliates are K N Gas Marketing, Inc. and KNGSSI.
The Company's distribution facilities and retail sales in Kansas, Colorado and Wyoming are under the regulatory authority of each state's utility commission. The Wyoming and Colorado commissions also may review the Company's issuance of securities. In Nebraska, retail gas sales rates for residential and commercial customers are regulated by each municipality served since there is no state utility commission.
In the incorporated communities in which K N sells natural gas at retail, K N operates under franchises granted by the applicable municipal authorities. K N is seeking to renew its franchises in: Casper and Laramie, Wyoming; Eagle and Wellington, Colorado; and Atkinson and Gothenburg, Nebraska. Sales are currently being made during the renewal process. In Colorado, these franchises must also be approved by the state regulatory commission. The duration of franchises varies with applicable law. In unincorporated areas, K N's direct sales of natural gas are not subject to franchise, but, in all states except Nebraska, are "certificated" by the state regulatory commissions.
Regulatory Matters __________________
See Note 3 of Notes to Consolidated Financial Statements of the 1993 Annual Report to Shareholders as shown on pages 39 and 40.
In March 1994, RMNG filed an application for a "make whole" rate change with the Colorado Public Utilities Commission ("CPUC") proposing to increase annual revenues $2.5 million effective April 2, 1994. This matter is currently pending before the CPUC.
In February and March 1994, K N filed suits for injunctive relief against 20 municipalities in Nebraska, seeking the Court to enjoin the effectiveness of ordinances which attempt to make certain gas utility rates retroactive for the period of October 1, 1990, through May 1, 1993. These lawsuits are currently pending in the District Court of Lancaster County, Nebraska.
Purchased Gas Adjustment Clauses ________________________________
K N Retail has gas supply cost adjustment clauses in its Kansas, Colorado and Wyoming tariffs and in its rate ordinances for Nebraska residential and commercial customers. These gas supply cost adjustment clauses provide for the pass-on of increases or decreases in upstream delivery costs and the recovery of under- or refund of over-collected purchased gas costs (including carrying charges thereon in certain jurisdictions) from prior periods. Order 636 eliminated the gas supply cost adjustment clause in KNI's FERC tariff. K N's Wyoming and Colorado intrastate regulated utilities' tariffs also contain purchased gas adjustment clauses.
Competition ___________
The Company's pipeline systems face competition from other transporters. In addition, natural gas competes with fuel oil, coal, propane and electricity in the areas served by the Company's pipeline systems and local distribution businesses.
(2) Gas Marketing and Gathering ___________________________
K N Gas Marketing, Inc. ("KNGM") was formed in March 1989 to provide gas marketing and supply services to various natural gas resellers and end-users on K N pipeline systems. KNGM works with producers and end- users on the pipeline systems to arrange the purchase and transportation of producers' excess or uncommitted gas to end-users, acting as shipper or agent for the end-users, administering nominations and providing balancing assistance when needed.
During 1993, KNGM continued efforts to expand its markets both on and off K N's pipelines through the reorganization of its existing staff and K N's former gas supply staff. These growth activities are expected to continue under K N's post Order 636 reorganization activities.
KNGSSI began operations in September 1993 to facilitate K N's transition from a provider of bundled pipeline sales service to a provider of Order 636 restructured services. In performing this function, KNGSSI buys gas from K N's former gas suppliers, aggregates these supplies and sells gas to former wholesale customers.
K N Trading, Inc. ("KNTI"), another wholly-owned subsidiary of K N, was formed in November 1991 to engage in risk management activities in the gas commodities futures market. KNTI buys and sells gas commodity futures positions on the New York Mercantile Exchange ("NYMEX") and through the use of over-the-counter gas commodity derivatives for the purpose of reducing adverse price exposure for gas supply costs or specific market margins.
KNGG was formed in November 1989 to provide gathering and mainline connection services for existing and new gas supply customers. KNGG operates gathering systems whose operations and rates of return are not currently regulated by FERC.
Acquisitions and Capital Expenditures _____________________________________
On April 1, 1993, the Company completed its acquisition of the Wattenberg natural gas gathering and transportation system. KNFRGC is the operator of the gathering portion of the system. This system gathers and transports gas from approximately 1,800 receipt points in northeast Colorado, and transports up to 250,000 million British thermal units ("MMBtus") of gas per day.
On June 1, 1993, Wind River Gathering Company acquired approximately 110 miles of natural gas pipeline and facilities in Wyoming's Wind River Basin. Wind River Gathering Company is a joint venture between KNGG and a subsidiary of Tom Brown, Inc., a Wind River Basin producer. This system connects area producers with major markets served by K N and other interstate pipeline systems. KNGG manages the operations of the gathering system. The system gathers and transports up to 30,000 MMBtus of gas per day.
KNGM and KNGG incurred 1993 capital expenditures of $7.0 million. 1994 capital expenditures are budgeted at $4.7 million.
Restructuring and Reorganization ________________________________
In conjunction with its Order 636 reorganization filing, K N applied for and received FERC permission to transfer substantially all of its regulated gathering and processing assets to KNGG. This transfer was effective January 1, 1994. The assets are located in K N's traditional gas supply areas in Kansas, Wyoming, Colorado, Texas and Oklahoma.
Regulation __________
To the extent the gas marketing subsidiaries make sales for resale in interstate commerce, they are subject to FERC regulations and rulemaking related to affiliated marketers.
Under the Natural Gas Act, facilities used for and operations involving the production and gathering of natural gas are exempt from FERC jurisdiction, while facilities used for and operations involving interstate transmission are not. However, FERC's determination of what constitutes exempt gathering facilities as opposed to jurisdictional transmission facilities has evolved over time. Under current law, facilities which otherwise are classified as gathering may be subject to ancillary FERC rate and service jurisdiction when owned by an interstate pipeline company and used in connection with interstate transportation or jurisdictional sales. Respecting facilities owned by noninterstate pipeline companies, such as KNGG and KNFRGC's gathering facilities, FERC has historically distinguished between these types of activities on a very fact-specific basis. FERC has initiated a rulemaking to consider issues relating to gathering services performed by interstate pipelines or their affiliates. FERC intends to use information obtained to reevaluate the appropriateness of its traditional gathering criteria in light of Order 636, and to establish consistent policies for gathering rates and services for both interstate pipelines and their affiliates. It is not possible at this time to predict the outcome of this proceeding and its potential effect on KNGG and KNFRGC.
As part of its corporate reorganization, K N requested and was granted authority to transfer substantially all of its gathering facilities to KNGG. The Commission determined that after the transfer, the gathering facilities would be nonjurisdictional, but FERC reserved the right to reassert jurisdiction if KNGG was found to be operating the facilities in an anti-competitive manner or contrary to open access principles.
Competition ___________
The gas marketing and gathering subsidiaries operate in a competitive environment for the purchase, sale and gathering of natural gas. The general availability of competitively priced gas supplies, the availability and price of alternative fuels and the availability and price of gathering and transportation services in their market areas all have an impact on these subsidiaries' competitive position for new markets.
(3) Oil and Gas Production ______________________
K N owns and participates in the development and production of oil and gas reserves through two wholly-owned subsidiaries, K N Production Company ("KNPC") and GASCO, Inc. ("Gasco").
KNPC was formed in 1983 and currently owns oil and gas properties mainly in Colorado, Oklahoma, Texas and Wyoming. All KNPC production is sold either to unaffiliated purchasers or nonjurisdictional affiliated purchasers. Gasco was formed in 1966 and acquired by K N in 1986. Gasco owns properties in Colorado and Wyoming, selling much of its production to affiliated purchasers.
During 1993, KNPC participated in the drilling and completion of 16 development wells in the Denver-Julesburg Basin, and in the drilling and completion of one exploratory well in the Oklahoma panhandle. Gasco participated in working over ten wells on the Western Slope and in the drilling and completion of one development well in Colorado.
At December 31, 1993, KNPC had approximately 30,000 net undeveloped acres under lease and owned interests in 84 producing wells (35 net), of which it operated 20 (14 net). Gasco had approximately 140,000 net undeveloped acres under lease and owned interests in 139 producing wells (107 net), operating 117 (105 net). In addition to oil and gas properties, Gasco owns the Wolf Creek gas storage field in Colorado, and also owns interests in three small gathering systems, all in Colorado.
Acquisitions and Capital Expenditures _____________________________________
In February 1994, KNPC and Gasco finalized the acquisition of gas reserves and production from Fuel Resources Development Company, a wholly- owned subsidiary of PSCo. The properties are located near existing K N operations in western Colorado and in the Moxa Arch region of southwestern Wyoming. Total net reserves approximate 50 billion cubic feet equivalent of natural gas. The Company is discussing the possible sharing of ownership interests and non-recourse financing with other parties.
The Company will continue to focus on the acquisition and development of natural gas reserves in the Mid-Continent and Rocky Mountain
regions, emphasizing areas contiguous to current and future Company pipeline operations.
Capital expenditures in 1993 were $4.8 million. Capital expenditures for 1994 are budgeted at $6.7 million.
Regulation __________
Oil and gas operations are primarily subject to the regulation of the Minerals Management Service ("MMS") and the Bureau of Land Management on the Federal level. Each state in which the Company's oil and gas subsidiaries operate regulates the volume and manner of production of natural gas in that state under laws directed toward conservation and the prevention of waste of natural resources.
Competition ___________
Oil and gas exploration and development are subject to competition from not only numerous other companies in the industry, but also from alternative fuels, including coal and nuclear energy.
(4) General _______
Gas Purchases _____________
Prior to Order 636, gas was purchased by the interstate pipeline for resale to its wholesale customers. As a result of the restructuring and reorganization pursuant to Order 636, each LDC, including K N Retail, now has the responsibility for its gas purchases. Under K N's Supply Transition Program, KNGSSI administers purchases from a portfolio of gas purchase contracts that existed prior to the reorganization. Order 636 has not significantly impacted gas purchasing for K N's intrastate systems.
Gas purchase prices for certain categories of gas have been deregulated over a period of time beginning January 1, 1985, pursuant to the Natural Gas Policy Act of 1978 ("NGPA"). The final total deregulation of all gas at the wellhead occurred on January 1, 1993, under terms of the Natural Gas Wellhead Decontrol Act of 1989. The deregulation of gas at the wellhead is intended to bring the prices paid for gas to a "market clearing" level. Those contracts which have a deregulation clause allow the purchaser to redetermine the price to a competitive level and the Company has exercised these rights as deregulation has occurred.
The natural gas futures contract, actively traded on the NYMEX, has brought significant price discovery to the natural gas market. Various indices and regional natural gas hubs have changed the method of pricing from long-term annual redeterminations to short-term, daily or monthly, pricing of gas at current market levels. As such, gas prices now quickly react to supply and demand as any other commodity market.
Gas purchase contracts also may contain a take-or-pay clause which requires that a certain purchase level be attained each contract year, or the purchaser must make a payment equal to the contract price multiplied by the deficient volume. At December 31, 1993, the level of outstanding payments was $11.7 million. All such payments are fully recoupable under the terms of the gas purchase contracts and the existing regulatory rules
and regulations. To date, the Company has not made any buy-out or buy-down payments relating to take-or-pay contracts.
Certain gas purchase contracts containing market-out clauses were redetermined to a competitive price for 1993, reflecting an increase in gas prices from the 1992 redetermined price.
Environmental Regulation ________________________
The Company's operations and properties are subject to extensive and changing Federal, state and local laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. Numerous governmental departments issue rules and regulations to implement and enforce such laws which are often difficult and costly to comply with and which carry substantial penalties for failure to comply. Moreover, the recent trends toward stricter standards in environmental legislation and regulation are likely to continue.
The United States Oil Pollution Act of 1990 (the "OPA") and regulations promulgated thereunder by the MMS impose a variety of requirements on persons who are or may be responsible for oil spills in waters of the United States. The term "waters of the United States" has been broadly defined to include inland waterbodies, including wetlands, playa lakes and intermittent streams. The Company has oil and gas facilities that could affect "waters of the United States." The Federal Water Pollution Control Act, also known as the Clean Water Act, and regulations promulgated thereunder, require containment of potential discharges of oil or hazardous substances and preparation of oil spill contingency plans. The Company currently is implementing programs that address containment of potential discharges and spill contingency planning. The failure to comply with ongoing requirements or inadequate cooperation during a spill event may subject a responsible party to civil or criminal enforcement actions.
The Comprehensive Environmental Response, Compensation and Liability Act, as amended ("Superfund"), imposes liability, without regard to fault or the legality of the original conduct, on certain classes of persons who are considered to have contributed to the release of a "hazardous substance" into the environment. Under Superfund, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources. Furthermore, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment.
Federal and state regulations have recently been changed as a result of the 1990 Amendments to the Clean Air Act. This affects the Company's operations in several ways. Natural gas compressors for both gathering and transmission activity are now required to meet stricter air emission standards. Additionally, states in which the Company operates are adopting new regulations under the authority of the "Operating Permit Program" under Title V of these 1990 Amendments. These Operating Permits will require operators of certain facilities to obtain individual site- specific air permits containing stricter operational and technological
standards of operation in order to achieve compliance with this section of the 1990 Clean Air Act Amendments and associated state air regulations.
Compliance with Federal, state and local provisions with respect to the protection of the environment has had no material effect upon capital expenditures, earnings, or the competitive position of the Company, except as described in Item 3 "Mystery Bridge Road Environmental Matters" and "Other Environmental Matters."
Safety Regulation _________________
The operations of certain of the Company's gas pipelines are subject to regulation by the United States Department of Transportation (the "DOT") under the Natural Gas Pipeline Safety Act of 1968 (the "NGPSA"), as amended. The NGPSA establishes safety standards with respect to the design, installation, testing, construction, operation and management of natural gas pipelines, and requires entities that own or operate pipeline facilities to comply with the applicable safety standards, to establish and maintain inspection and maintenance plans and to comply with such plans.
The NGPSA was amended by the Pipeline Safety Act of 1992 to require the DOT's Office of Pipeline Safety to consider, among other things, protection of the environment when developing minimum pipeline safety regulations. Management believes the Company's operations, to the extent they may be subject to the NGPSA, comply in all material respects with the NGPSA.
The Company is also subject to laws and regulations concerning occupational health and safety.
Although the Company is unable to predict the ultimate cost of compliance, it is not anticipated that the Company will be required in the near future to expend material amounts to comply with these laws and regulations.
Other _____
Amounts spent by the Company during 1993, 1992 and 1991 on research and development activities were not material.
Sales were not made to any individual customer in 1993 in an amount which equaled ten percent or more of the Company's consolidated revenues.
At December 31, 1993, the Company had 1,735 employees.
(D) Financial Information About Foreign and Domestic Operations and _______________________________________________________________ Export Sales ____________
All of the Company's operations are in the contiguous 48 states.
ITEM 2:


ITEM 2: PROPERTIES ___________________
(A) Location and Character of Property __________________________________
The Registrant maintains its principal place of business in Lakewood, Colorado. Other major offices are in: Hastings, Nebraska; Phillipsburg, Kansas; Casper, Wyoming; and Glenwood Springs, Colorado. At December 31, 1993, the principal properties of the Company were as set forth below.
Gas Service ___________
As of December 31, 1993, the Company's gas service properties included transmission, gathering and storage lines of 8,239 miles in the interstate systems, 675 miles in the Wyoming intrastate system and 766 miles in the Colorado intrastate system. (Effective January 1, 1994, 1,691 miles of gathering lines were transferred to KNGG as part of the corporate reorganization. See "Restructuring and Reorganization" on pages 9 and 10.) Distribution lines totaling 6,159 miles were in the interstate system, 1,072 miles in the Wyoming intrastate system and 1,423 miles in the Colorado intrastate system at December 31, 1993.
The Company has four underground gas storage facilities in operation in the interstate systems, five in the Wyoming intrastate system and one in the Colorado intrastate system. Its major interstate facilities are the Huntsman Storage Field in Cheyenne County, Nebraska and the Big Springs Storage Field in Deuel County, Nebraska.
The interstate systems also included two products extraction plants and 185 compressor units with an aggregate 175,171 rated compressor horsepower at December 31, 1993. (Effective January 1, 1994, 29 compressor units with an aggregate 5,482 rated compressor horsepower and the Scott City products extraction plant were transferred to KNGG as part of the corporate reorganization.) The Wyoming intrastate system included eight compressor units and the Colorado intrastate system included 13 compressor units with aggregate rated compressor horsepower of 3,204 and 5,995, respectively, at December 31, 1993. The Company's other gas service properties include measuring and regulating stations, garages, warehouses and other land and buildings necessary and useful in the conduct of its business.
Gas Marketing and Gathering ___________________________
The Company's gas marketing and gathering properties are discussed in Item 1 (C)(2). As of December 31, 1993, KNGG and its subsidiaries operated gathering systems with 2,918 miles of gathering lines and 75 compressors with an aggregate 43,150 rated compressor horsepower. (Effective January 1, 1994, 1,691 miles of gathering lines, 29 compressor units with an aggregate 5,482 rated compressor horsepower and the Scott City products extraction plant were transferred to KNGG as part of the corporate reorganization.) For additional information relating to gas marketing and gathering properties see Notes 1(H), 2, 4 and 13 of Notes to Consolidated Financial Statements of the 1993 Annual Report to Shareholders as shown on pages 37, 39, 40-41 and 52-53.
Oil and Gas Production ______________________
The Company's oil and gas producing properties are discussed in Item 1(C)(3). For additional information relating to oil and gas production properties see Notes 1(I), 4 and 13 of Notes to Consolidated Financial Statements of the 1993 Annual Report to Shareholders as shown on pages 37, 40-41 and 52-53.
(B) Oil and Gas Reserves, Properties and Activities _______________________________________________
Not material.
ITEM 3:
ITEM 3: LEGAL PROCEEDINGS __________________________
Mystery Bridge Road Environmental Matters _________________________________________
K N is named as one of four potentially responsible parties ("PRPs") at a U.S. Environmental Protection Agency ("EPA") Superfund site, pursuant to Superfund. The site is known as the Mystery Bridge Road/U.S. Highway 20 site located near Casper, Wyoming (the "Brookhurst Subdivision"). The EPA's remedy consists of two parts, "Operating Unit One," which addresses the groundwater cleanup and "Operating Unit Two," which addresses cleanup procedures for the soil and free-phase petroleum product.
A Consent Decree between the Company, the EPA and another PRP was entered on October 2, 1991, in the Wyoming Federal District Court. Groundwater cleanup under Operating Unit One has been proceeding since 1990. On September 14, 1993, the EPA certified that the remedial action for Operating Unit One was "operational and functional." This is the last step in the Superfund process prior to remedy completion.
In July 1992, the EPA approved the Company's Operating Unit Two workplan and the Company received an EPA "Statement of Work." The work required to be performed for Operating Unit Two commenced during the third quarter of 1992 and is expected to continue through 1995. (United States _____________ of America v. Dow Chemical Company, Dowell Schlumberger, Inc., and K N ______________________________________________________________________ Energy, Inc., Civil Action No. 91CV1042, United States District Court for ____________ the District of Wyoming; formerly reported as Administrative Orders for Removal Action on Consent, October 15, 1987, and Amendment to Administrative Order for Removal Order on Consent, October 10, 1989, Docket No. CERCLA VII-88-01, United States Environmental Protection Agency; Judicial Entry of Consent Decree, United States v. Dow Chemical Company, ______________________________________ et al. (D. Wyo) USDC-WY-91CV1042B, Superfund Site Number 8T83, Natrona _________________________________ County, Wyoming; EPA Docket Number CERCLA-VIII.)
With regard to this same Superfund site, in 1987 the State of Wyoming filed suit against several parties (including K N) for injunctive relief, penalties and unquantified damages claimed to have resulted from alleged pollution of groundwater and soils in the Brookhurst Subdivision. On April 1, 1993, the Wyoming District Court dismissed the lawsuit, finding that K N had diligently remedied the alleged pollution. (Wyoming v. Little _________________ America Refining Co., K N Energy, Inc. and Dowell Schlumberger, Civil ______________________________________________________________ Action No. 62325, Wyoming District Court [Natrona County].)
On October 20, 1989, a lawsuit was filed against the Company and 18 other defendants on behalf of a group of 268 individuals who reside or resided in the Brookhurst Subdivision, seeking damages for alleged releases of certain chemicals to the soil, groundwater and air. On February 5, 1993, the Company reached agreement to settle the above-described dispute. The settlement, which was approved by the Wyoming District Court, resolved all disputes between the parties and closed the lawsuit. A reserve for the settlement amount and related matters had been established in the Company's financial statements prior to 1993 and, accordingly, such settlement did not have any material adverse impact on the Company's financial position or results of operations. (Albertson, et al., v. Dow Chemical Co., K N ___________________________________________ Energy, Inc., et al., Civil Action No. 65212, 7th Judicial District, ____________________ Natrona County District Court, State of Wyoming.)
On November 30, 1990, the Company initiated an action against a number of its insurance carriers for a declaration of the carriers' contractual obligations to provide insurance coverage for all sums associated with the alleged losses under the state, Federal and toxic tort claims related to the Brookhurst Subdivision. The Company entered into formal settlements with all of the defendants in the lawsuit in 1993, and received settlement proceeds associated therewith. (K N v. Allianz ______________ Insurance Company, et al., Civil Action No. 90CV301-J, United States ________________________ District Court for the District of Wyoming.)
Other Environmental Matters ___________________________
An environmental audit performed by the Company in autumn 1991 revealed that a grease known as Rockwell 860 had been used as a valve sealant at several of the Company's locations in Nebraska. Rockwell 860 is a solid clay-like material which does not easily spill into the environment, but contains approximately ten percent polychlorinated biphenyls ("PCBs"). Based on the Company's initial studies, the PCBs are contained within the pipeline and valves at the subject locations. PCBs are regulated by the EPA under the Toxic Substances Control Act. On March 31, 1993, the Company filed suit against Rockwell International Corporation manufacturer of the valve sealant; and two other related defendants, claiming under contractual, statutory, tort and strict liability theories that the defendants share responsibility for the Company's environmental expenses and commercial losses resulting from any EPA or state required PCB cleanup or mitigation. The Company reached a settlement in principal with Rockwell, et al. in March 1994.
The Company submitted a proposed PCB remediation plan to the EPA in November 1991. To date, no enforcement action or penalties have been issued or discussed by the EPA. The Company currently cannot estimate the extent of the remediation nor costs, though such costs are not expected to exceed the settlement amounts or to have any material adverse impact on the Company's financial position or results of operations. The PCB cleanup program is not expected to interrupt or diminish K N's operational ability to gather or transport natural gas.
Certain used pipe reclaimed at the Company's Holdrege, Nebraska pipeyard was wrapped with asphalt-saturated asbestos felt, which was commonly removed in accordance with Company practices. The removed wrap contains friable asbestos fibers above the regulatory standard. The Nebraska Department of Environmental Control ("DEC"), the agency having
jurisdiction over this matter, was notified and approved the Company's remediation plan. Remediation is effectively complete, at a total cost not to exceed $600,000. The asbestos cleanup program did not interrupt or diminish K N's operational ability to gather or transport natural gas.
Grynberg v. K N et al. ______________________
On October 9, 1992, Jack J. Grynberg filed suit in the United States District Court for the District of Colorado against the Company, Rocky Mountain Natural Gas Company and Gasco (the "K N Entities") alleging that the K N Entities as well as KNPC and KNGG, have violated Federal and state antitrust laws. In essence, Grynberg asserts that the companies have engaged in an illegal exercise of monopoly power, have illegally denied him economically feasible access to essential facilities to transport and distribute gas produced from fewer than 20 wells located in northwest Colorado, and illegally have attempted to monopolize or to enhance or maintain an existing monopoly. Grynberg also asserts certain causes of action relating to a gas purchase contract.
No specific monetary damages have been claimed, although Grynberg has requested that any actual damages awarded be trebled. In addition, Grynberg has requested that the K N Entities be ordered to divest all interests in natural gas exploration, development and production properties, all interests in distribution and marketing operations, and all interests in natural gas storage facilities, separating these interests from the Company's natural gas gathering and transportation system in northwest Colorado.
On August 13, 1993, the United States District Court, District of Colorado, stayed this proceeding pending exhaustion of appeals in a related state court action involving the same plaintiff. (Grynberg v. K N, et al., _______________________ Civil Action No. 92-2000, United States District Court for the District of Colorado.)
ITEM 4:
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ____________________________________________________________
None.
EXECUTIVE OFFICERS OF THE REGISTRANT ____________________________________
(A) Identification and Business Experience of Executive Officers ____________________________________________________________
Name Age Position and Business Experience __________________________ _____ _________________________________
Charles W. Battey. . . . . 62 Chairman and Chief Executive Offi- cer since January 1989 and Director since 1971.
Larry D. Hall. . . . . . . 51 President and Chief Operating Offi- cer since May 1988 and Director since 1984.
Leland L. Hurst. . . . . . 63 Senior Vice President since May 1993. Previously Senior Vice President, Operations from June 1988 to May 1993.
Judith A. Aden . . . . . . 52 Vice President and Treasurer since March 1991, Treasurer since January 1981 and Assistant Secretary since March 1989.
William E. Asbury. . . . . 41 Vice President, Gas Service since 1988.
Eugene B. Bade . . . . . . 47 Vice President and Controller since May 1993. Previously Vice Pres- ident K N Gas Marketing from January 1990 to May 1993, Vice President from April 1989 to January 1990 and Director of Internal Audit from November 1985 to April 1989.
Richard M. Buxton. . . . . 45 Vice President, Strategic Planning and Financial Services since March 1991. Director, Financial Services from 1986 to March 1991.
William S. Garner, Jr. . . 44 Vice President, General Counsel and Secretary since April 1992. Vice President and General Counsel since January 1991. Previously Vice Pres- ident and Deputy General Counsel from September 1989 through 1990 and Vice President, Law from June 1988 to September 1989.
S. Wesley Haun . . . . . . 46 Vice President, Marketing and Supply since May 1993. Previously Vice President, Gas Supply from March 1990 to May 1993 and Vice President, Gas Acquisition from November 1988 to March 1990.
E. Wayne Lundhagen . . . . 57 Vice President, Finance and Accounting since May 1988.
Arnold R. Madigan. . . . . 55 Vice President, Interstate Transportation since May 1993. Previously Vice President, Marketing and Transportation from September 1989 to May 1993 and Vice President and General Counsel from June 1988 to September 1989.
John W. Simonton . . . . . 48 Vice President, Administration and Human Resources since May 1988.
H. Rickey Wells. . . . . . 37 Vice President, Operations since June 1988.
These officers generally serve until March of each year.
(B) Involvement in Certain Legal Proceedings ________________________________________
None.
PART II
ITEM 5:
ITEM 5: MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER _________________________________________________________________________ MATTERS _______
The Company's common stock is listed for trading on the New York Stock Exchange under the symbol KNE. Dividends paid and the price range of the Company's common stock by quarters for the last two years, restated for an October 1993 three-for-two stock split, are provided below.
ITEM 6:
ITEM 6: SELECTED FINANCIAL DATA ________________________________
FIVE-YEAR REVIEW
Selected Financial Data (Dollars in Thousands Except Per Share Amounts)
(1) Restated to reflect a three-for-two common stock split in 1993.
ITEM 7:
ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND ________________________________________________________________________ RESULTS OF OPERATIONS _____________________
CONSOLIDATED FINANCIAL RESULTS
Continuing Operations
Income from continuing operations and the applicable earnings per share and return on beginning of year common equity for the three years ended December 31, 1993, were as follows:
Earnings per share for 1993 exceeded 1992 results by 23 percent, despite the negative effects of record low gas sales to irrigation customers. The impact of lower irrigation sales was more than offset by positive contributions from acquisitions of natural gas facilities, expense controls, favorable resolution of rate cases, and insurance settlements. In addition, 1993 first quarter gas sales, transportation and natural gas liquids revenues were significantly greater than those in the first quarter of 1992 due to colder weather.
The decline in 1992 earnings, in comparison with 1991, reflected the impact of unfavorable weather on natural gas sales and natural gas liquids revenues, and higher interest expense which resulted, in part, from reduced operating cash flows. These negative earnings factors were partially offset by increased transportation revenues, rate increases, lower operating costs as a result of expense controls and reduced litigation expense provisions.
Discontinued Operations
In 1991, the Company recorded an after-tax loss of $17.3 million resulting from the sale of its coal subsidiaries and the discontinuance of this business segment.
RESULTS OF CONTINUING OPERATIONS
Discussion of operating results by business segment and consolidated other income and (deductions) and income taxes follows. Segment operating revenues, gas purchases, operations and maintenance expenses, and volumetric data cited here are before intersegment eliminations (dollars in millions).
Revenues and expenses of the Federal Energy Regulatory Commission ("FERC")-regulated Wattenberg transmission system, acquired on April 1, 1993, are included in this segment's 1993 operating results.
The decline in gas sales and transportation revenues (and related gas purchases) primarily reflects FERC Order No. 636 ("Order 636") implementation and the resultant elimination of the gas cost component from FERC-regulated service revenues. An additional cause for the decline in 1993 gas sales and transportation revenues was the record low sales to irrigation customers due to the abnormally wet summer. Irrigation sales were 3.1 Bcf below 1992 volumes. However, revenues from the Wattenberg transmission system, rate increases in essentially all K N retail jurisdictions (including resolution of the 1990 rate case in Nebraska), and increases in 1993 residential and commercial sales volumes (4.3 Bcf above 1992 due to colder weather) substantially offset the decline in irrigation sales.
Greater systems throughput, costs and expenses of the Wattenberg transmission system and higher costs related to increased natural gas liquids recoveries impacted 1993 operations and maintenance expenses. These increases were partially mitigated by insurance settlements related to the Brookhurst Subdivision Superfund site near Casper, Wyoming.
Gas service's 1992 operating revenues were ten percent below 1991 as a result of unfavorable weather. Most notably impacted by the adverse 1992 weather were gas sales to irrigation customers, which were 7.2 Bcf below 1991. Gas sales revenues were positively affected in 1992 by rate increases, including $3.8 million collected in prior years but reserved from earnings for the 1990 eastern and central Nebraska rate case. Transportation revenues in 1992 were $3.4 million higher than 1991 as off-system transport volumes increased by 13.3 Bcf. Natural gas liquids revenues in 1992 were $2.9 million below 1991 as the unfavorable weather affected both prices and volumes.
Operating costs and expenses for 1992 were 11 percent below 1991 due principally to reduced on-system throughput and expense controls. Gas purchases declined significantly as a result of lower 1992 gas sales and processing of volumes for natural gas liquids recoveries. In addition, 1992 operations and maintenance expenses were affected by lower provisions for litigation issues. The increase in 1992 taxes, other than income taxes, primarily results from state property tax legislation in Nebraska.
In addition to continued growth in nonregulated gas marketing activities, this segment's 1993 and 1992 operating results reflect the Douglas gathering and processing acquisition beginning in October 1992 and the Wattenberg gathering facilities acquisition beginning in April 1993. Additionally, with Order 636 restructuring effective October 1, 1993, this segment assumed the gas sales function previously provided by K N for its wholesale customers as part of its bundled services.
The increases in 1993 and 1992 oil and gas revenues and production result from the July 1992 acquisition of producing properties in western Colorado and successful drilling in the Denver-Julesburg Basin in northeastern Colorado.
The increase in interest expense primarily reflects the Company's issuance of $195 million of long-term debt during the last three years. The majority of the net proceeds from these debt issues were used to fund capital expenditures and acquisitions; however, $65 million was used to refund higher coupon debt in 1993 and 1992. As a result, the Company's year end 1993 weighted-average embedded cost of long-term debt was 8.3 percent compared with a cost of 9.6 percent at December 31, 1990.
The effect of the one percent increase in the Federal tax rate, resulting from enactment of the Revenue Reconciliation Act of 1993, was more than offset by increased 1993 tax credits on gas production from wells qualifying for non-conventional fuel credit under Section 29 of the Internal Revenue Code. The 1991 effective tax rate reflects higher state income tax provisions.
LIQUIDITY AND CAPITAL RESOURCES
The primary sources of cash during 1993 included cash generated from operations, short-term borrowings and the issuance of long-term debt. Principal cash outflows were capital expenditures and acquisitions, redemptions of long-term debt and preferred stock, and payment of interest and dividends.
Cash Flows from Operating Activities
Net cash flows from continuing operations were $43.3 million, $33.2 million and $72.1 million for 1993, 1992 and 1991, respectively. In addition to the factors discussed previously, which affect cash generation as well as operating results, net cash flows have been impacted by litigation settlements (including recoupable take-or-pay payments) and environmental costs. In both 1993 and 1992, actual cash disbursements exceeded expense provisions for litigation and environmental issues. Net operating cash flows for 1993 were also reduced by repayments to gas service customers for previous years' over-recovery of gas costs.
Capital Expenditures and Commitments
Excluding acquisitions, 1993 capital expenditures were $63.1 million compared with expenditures of $60.1 million in 1992 and $59.4 million in 1991. (Refer to Note 13 of Notes to Consolidated Financial Statements for business segment expenditures.) The increased 1993 spending includes approximately $9.0 million of Order 636 transition costs (measurement facilities and systems) and $11.0 million for construction of a new corporate office building. The regulated portion of the Wattenberg system and the Company's portion of the Wind River gathering system primarily account for the $26.8 million of capital expenditures for acquisitions in 1993.
Consolidated 1994 capital expenditures are budgeted at $54.5 million, excluding acquisitions. This includes $7.6 million for the first phase of the Rifle to Avon pipeline being jointly constructed by the Company's subsidiary, Rocky Mountain Natural Gas Company, and Public Service Company of Colorado. The second phase of this pipeline will be constructed in 1995; the Company's portion of estimated costs is approximately $5.0 million. In February 1994, K N's oil and gas subsidiaries completed the acquisition of gas reserves and production in western Colorado and southwestern Wyoming. During the first half of 1994, the Company plans to bring in one or more partners to participate in this acquisition and to assist in further development of the properties.
The Company has no substantial disagreements related to take-or-pay matters. The Company monitors contractual obligations, including obligations to pay above-market prices under certain contracts, and at the end of each contract year pays those producers to whom take-or-pay amounts are payable. All amounts paid by the Company for take-or-pay are fully recoupable from future gas production.
Statement of Financial Accounting Standards No. 112 ("SFAS 112"), "Employers' Accounting for Postemployment Benefits," establishes standards of financial accounting and reporting for the estimated cost of benefits provided by an employer to former or inactive employees after employment but before retirement. SFAS 112 is effective for fiscal years beginning after December 15, 1993. Implementation of SFAS 112 is not expected to have a material effect on the Company's financial position or results of operations.
Capital Resources
Short-term debt was $47.0 million at December 31, 1993, compared with $2.0 million of borrowings at December 31, 1992. The Company has credit agreements with eight banks to either borrow or use as commercial paper support up to $90 million. In November 1993, K N filed a shelf registration statement with the Securities and Exchange Commission for the sale of $200 million of debt securities in anticipation of long-term financing needs over the next three years.
In January 1994, the Company received $41.0 million from the sale of contract demand receivables to a financial institution. The demand receivables resulted from gas sales contracts between some of K N's former wholesale customers and a K N subsidiary. Proceeds were used to reduce short-term debt.
The Company expects that 1994 cash requirements for debt service, preferred stock redemptions, dividends and capital expenditures will be provided by internal cash flows, short-term borrowings, and the issuance of common stock for dividend reinvestment and employee benefit plans.
OUTLOOK
Restructuring and Reorganization
The Company's implementation of Order 636 and the related corporate reorganization are discussed in other sections of this annual report. This discussion will focus on the expected 1994 financial implications of these events. As a result of recent acquisitions and the transfer of substantially all of K N interstate's gathering and processing facilities to a nonregulated subsidiary, the composition of 1994's operating income will differ significantly from the past. Historically, the Company's gas service segment has accounted for more than 90 percent of consolidated operating income. The expectation for 1994 is that this segment will account for approximately 65 to 70 percent of operating income.
Secondly, Order 636 mandated the use of SFV rate design for FERC- regulated services. Accordingly, fluctuations in operating revenues resulting from significant variations in weather temperatures should be reduced. Revenues from the Company's important summer irrigation load will remain vulnerable to abnormal weather patterns, such as those experienced in 1993 and 1992.
Finally, the effect of both of the above items is expected to change the Company's historical quarterly earnings distribution. The 1994 first and fourth quarters will account for a smaller percentage of annual earnings, while the second and third quarters will be higher.
Gas Service
The Company's Order 636 implementation and reorganization will significantly impact this business segment's future operating results. The transfer of substantially all of K N interstate's gathering facilities and the principal processing plant to a subsidiary within the gas marketing and gathering segment will result in a significant shift in operating revenues, expenses and operating income. Additionally, with the elimination of the merchant function from FERC-regulated services, this segment's operating revenues and gas purchases will be substantially lower than prior periods; however, this elimination should not impact operating income.
Operating results for 1994 should benefit from a full year's operation of the Wattenberg transmission system and from rate increases placed into effect during 1993.
As a result of the unbundling and the diverse services offered under the post-Order 636 environment, competition will increase. The Company believes that its interstate and intrastate systems are well-positioned to capitalize on opportunities resulting from future development of natural gas reserves in the Rocky Mountain region. The Company expects continued moderate growth in its retail distribution operations due, principally, to the continued customer additions being realized by its Colorado intrastate system.
Gas Marketing and Gathering
On January 1, 1994, substantially all of the gathering facilities and the principal processing plant, which were previously a part of the K N interstate system, were transferred to a subsidiary within the gas marketing and gathering business segment. This segment's 1993 operating results included only partial year activity of the Wattenberg nonregulated gathering system and the Wind River gas gathering joint venture. Accordingly, this segment's 1994 operating revenues, expenses and operating income are expected to be significantly higher than in 1993.
Oil and Gas Production
The February 1994 acquisition of producing properties and undeveloped gas reserves in western Colorado and southwestern Wyoming is expected to have a positive impact on 1994 operating results of this business segment. The Company also believes that its involvement in oil and gas development and production provides opportunities to enhance the value of its associated gas service, gathering and processing businesses.
Litigation
During the last three years, the Company has resolved or settled four major cases or environmental matters -- three cases related to the Brookhurst Subdivision Superfund site near Casper, Wyoming, and long-standing litigation with FM Properties Inc. and other parties. Refer to Note 5 of Notes to Consolidated Financial Statements for additional information on the Company's pending litigation. Management believes it has established adequate reserves such that resolution of pending litigation or environmental matters will not have a material adverse effect on the Company's financial position or results of operations.
INFLATION
Current ratemaking practices allow the Company to recover through revenues the historical cost, rather than the current replacement cost, of utility plant and equipment. In the past three years, the rate of inflation has not had a material impact on the Company's costs.
ITEM 8:

ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ____________________________________________________
Report of Independent Public Accountants
To K N Energy, Inc.:
We have audited the accompanying consolidated balance sheets of K N Energy, Inc. (a Kansas corporation) and subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, common stockholders' equity and cash flows for each of the three years in the period ended December 31, 1993. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of K N Energy, Inc. and subsidiaries as of December 31, 1993 and 1992, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1993, in conformity with generally accepted accounting principles.
As explained in Notes 1(D) and 9 of Notes to Consolidated Financial Statements, the Company changed its method of accounting for income taxes effective January 1, 1992, and its method of accounting for postretirement benefits other than pensions effective January 1, 1993.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the index of financial statements are presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
Denver, Colorado, February 10, 1994.
The accompanying notes are an integral part of these statements.
The accompanying notes are an integral part of these balance sheets.
The accompanying notes are an integral part of these statements.
The accompanying notes are an integral part of these statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
(A) Principles of Consolidation
The consolidated financial statements include the accounts of K N Energy, Inc. ("K N") and all of its subsidiaries (the "Company"). All material intercompany items and transactions have been eliminated.
(B) Basis of Accounting
The accounting policies of the Company conform to generally accepted accounting principles. For the regulated public utilities in the Company, these accounting principles are applied in accordance with Statement of Financial Accounting Standards No. 71, which prescribes the circumstances in which the application of generally accepted accounting principles is affected by the economic effect of regulation.
(C) Gas Service Revenues
Natural gas revenues are recorded on the basis of gas delivered to customers to the end of each accounting period. This includes unbilled revenues representing the estimated amount customers will be billed for gas delivered from the time meters were last read to the end of the accounting period, net of cost of gas where applicable. Gas transportation revenues are recorded on the basis of capacity reserved on and gas transported through the pipeline systems. The Company receives a fee for its transportation services; however, there are no purchased gas expenses associated with the transportation function.
(D) Income Taxes
The Company implemented Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes," effective as of January 1, 1992. SFAS 109 requires recognition of deferred income tax assets and liabilities based on enacted tax laws for all temporary differences between financial reporting and tax bases of assets and liabilities. Deferred tax assets are reduced by a valuation allowance for the amount of any tax benefit that, more likely than not, is expected to not be realized. The adoption of SFAS 109 had an insignificant effect on the Company's financial position and results of operations, since the Company had already adopted the liability method of accounting under Statement of Financial Accounting Standards No. 96.
(E) Earnings Per Share
Earnings per share are computed based on the monthly weighted average number of common shares outstanding during the periods. There are no other securities or common stock equivalents which have a material dilutive effect on earnings per share. On August 10, 1993, K N's Board of Directors declared a three-for-two common stock split
which was distributed on October 4, 1993, to common shareholders of record on September 15, 1993. The par value of the common stock did not change. All weighted average and per share amounts in the accompanying financial statements have been restated to reflect the stock split. The weighted average number of common shares outstanding was 14,913,000 in 1993, 14,580,000 in 1992 and 14,459,000 in 1991.
(F) Nonutility Gas Marketing Subsidiaries
Gas marketing subsidiaries' revenues are included in "Gas Marketing and Gathering," and their gas purchase costs are included in "Gas Purchases."
(G) Prepaid Gas
Prepaid gas represents payments made in lieu of taking delivery of (and purchasing) natural gas under the take-or-pay provisions of the Company's gas purchase contracts, net of any subsequent recoupments in kind from producers. All funds paid by the Company for take-or-pay are fully recoupable from future production, and are recorded as an asset (Prepaid Gas). When recoupment is made in kind in a subsequent contract year, natural gas purchase expense is recorded and the asset is reduced.
(H) Property, Plant and Equipment
Utility plant is stated at the original cost of construction, which includes indirect costs such as payroll taxes, fringe benefits, administrative and general costs and an allowance for funds used during construction.
Expenditures which increase capacities or extend useful lives are capitalized. Routine maintenance, repairs and renewal costs are expensed as incurred. The cost of depreciable utility property, plant and equipment retired, plus the cost of removal less salvage, is deducted from accumulated depreciation with no effect on current period earnings.
(I) Exploration and Development Costs
K N's oil and gas subsidiaries follow the "successful efforts" method of accounting. Under this method, acquisition costs, successful exploration costs and development costs are capitalized and unsuccessful exploration costs, lease rentals and evaluation costs are expensed.
(J) Depreciation, Depletion and Amortization
Depreciation is computed based on the straight-line method over the estimated useful life for most utility property, plant and equipment. The unit-of-production method is used for computing depreciation, depletion and amortization for oil and gas properties.
(K) Gas in Underground Storage
K N's regulated interstate retail distribution business and Northern Gas Company record storage injections at the average cost of purchased gas for the year. Storage withdrawals are priced on the last-in first-out ("LIFO") method. K N Gas Supply Services, Inc., a nonjurisdictional subsidiary, prices storage injections at the average cost of purchased gas each month. Storage withdrawals are priced at the average cost of storage gas at the beginning of each month. Rocky Mountain Natural Gas Company prices storage injections at the average cost of purchased gas for the year. Storage withdrawals are priced on the first-in first-out ("FIFO") method.
The Company also maintains gas in its underground storage facilities on behalf of certain third parties. The Company receives a fee for its storage services but does not reflect the value of third party gas in the accompanying financial statements.
(L) Deferred Revenues
In January 1994, contract demand receivables with a face amount of $41 million were sold to a financial institution. No gain or loss was recorded on the sale. The Company is deferring revenues from certain gas sales agreements associated with these receivables pending final disposition of related gas purchase contracts.
(M) Reclassification of Prior Year Amounts
Certain prior year amounts have been reclassified to conform with the 1993 presentation.
(N) Cash Flow Information
The Company considers all highly-liquid investments purchased with an original maturity of three months or less to be cash equivalents.
Changes in Other Working Capital Items Summary, Supplemental Disclosures of Cash Flow Information and Supplemental Schedule of Noncash Investing and Financing Activities are as follows:
(B) In connection with the exchange and lease of gathering and processing facilities described in Note 4(D), the Company exchanged its interest in the Tyrone Gas Gathering system as a portion of the consideration.
2. Restructuring and Reorganization
On April 8, 1992, the Federal Energy Regulatory Commission ("FERC") issued Order No. 636 ("Order 636") which requires a fundamental restructuring of interstate natural gas pipelines.
A separate restructuring docket was established for each interstate pipeline, including K N (Docket No. RS92-19-000). On November 2, 1992, K N made its compliance filing reflecting K N's proposal for its restructured services to implement Order 636. K N's proposal was revised in response to subsequent FERC orders. As authorized by FERC, K N implemented Order 636 restructured services on October 1, 1993. As a part of its action on K N's restructuring proposal, FERC approved implementation of K N's gas supply realignment ("GSR") crediting mechanism.
K N requested FERC approval, as a result of Order 636, to transfer all of its interstate transmission and storage facilities to K N Interstate Gas Transmission Co. ("KNI"), a wholly-owned jurisdictional subsidiary of K N, and substantially all of its gathering and processing facilities to K N Gas Gathering, Inc. ("KNGG"), a nonjurisdictional wholly-owned subsidiary of K N. In its May 5, 1993 order, FERC approved the transfer of K N's interstate gas transmission and storage facilities to KNI effective October 1, 1993. On November 1, 1993, FERC authorized the transfer of gathering and processing facilities from KNI to KNGG. The transfer was effective January 1, 1994, and included approximately $70 million of gross property, plant and equipment.
Order 636 required pipelines to unbundle sales and transportation services. KNI has complied with FERC's directive to mitigate its GSR costs caused by this restructuring. KNI's GSR process allows for the assignment of its above-market contracts. Under KNI's tariff, every shipper has a right to take assignment of these above- market contracts. Shippers may either take assignment of these above- market contracts or enter into a negotiated exit fee. This should obviate the need to make any GSR cost recovery filing with FERC.
3. Regulatory Matters
On December 30, 1993, KNI made a rate filing with FERC requesting a $12.0 million annual increase in revenues. The new rates will become effective July 1, 1994, subject to refund.
In February 1992, K N filed a rate restatement with FERC pursuant to FERC's purchased gas adjustment regulations. The filing
proposed no change in K N's current rates. K N submitted an offer of Settlement and Stipulation ("Settlement") in August 1993. FERC approved the Settlement on November 17, 1993. Terms of the Settlement did not have a material effect on K N's financial position or results of operations.
In February 1993, K N filed general rate applications in all 177 retail Nebraska communities it serves, requesting an increase in aggregate annual revenues of $2.2 million. Pursuant to Nebraska statute, the new rates became effective May 2, 1993, subject to refund. An agreement was reached in August 1993, between the Company and representatives of the 10 rate areas in Nebraska. Under the terms of the agreement, K N received a $1.4 million annual rate increase. Revenues collected above the settlement rates were refunded to the customers in December 1993.
In June 1990, K N filed general rate applications in 147 central and eastern Nebraska communities requesting an increase in aggregate annual revenues of $6.7 million. Pursuant to Nebraska statute, the new rates were put into effect on October 1, 1990, subject to refund. The majority of the communities adopted a lower rate increase. K N filed for injunctions against these communities. On August 27, 1993, the Nebraska Supreme Court ruled that natural gas rates placed into effect by K N as interim rates on October 1, 1990, were properly justified and should be allowed to stand. In 1992, K N reduced the deferred portion of the increased revenues resulting from these rate applications and recorded as revenue $3.8 million of amounts previously deferred in 1990 and 1991. The remaining deferred revenues relating to this matter, totaling $1.6 million, were recorded as revenue in 1993.
In June 1992, K N filed an application for a "make whole" rate increase with the Colorado Public Utilities Commission ("CPUC"). The new rates, which resulted in increased annual revenues of $0.7 million, were approved by the CPUC and became effective August 1, 1992.
In December 1992, K N filed an application with the Wyoming Public Service Commission ("WPSC") for an annualized general rate increase of $1.2 million. In April 1993, the WPSC issued an order granting K N a $1.1 million annual rate increase effective May 1, 1993.
In March 1993, K N filed an application with the Kansas Corporation Commission ("KCC") for an annualized general rate increase of $3.3 million. On October 28, 1993, the KCC issued an order approving a settlement agreement between K N and the interested parties which granted K N a $2.4 million annual rate increase effective October 1, 1993.
4. Acquisitions
(A) Wattenberg
On April 1, 1993, the Company completed the $48 million acquisition of the Wattenberg natural gas gathering and transmission system. The system has both regulated and nonregulated components. The regulated transmission segment, approximately $18 million of the
acquisition, was financed with corporate funds, and the balance of the system was financed through an operating lease. The system gathers and transports gas from approximately 1,800 receipt points in northeastern Colorado.
(B) Oil and Gas Reserve Acquisition
On February 1, 1994, the Company's oil and gas development subsidiaries, K N Production Company and GASCO, Inc., acquired gas reserves and production properties located near existing K N operations in western Colorado and in the Moxa Arch region of southwestern Wyoming for a total purchase price of approximately $30 million. The acquired properties have total net reserves of approximately 50 billion cubic feet equivalent of natural gas. The Company is discussing the possible sharing of ownership interests and non-recourse financing with other parties.
(C) Wind River
Effective June 1, 1993, Wind River Gathering Company acquired approximately 110 miles of natural gas pipeline and facilities in Wyoming's Wind River Basin. Wind River Gathering Company is a joint venture between KNGG and a subsidiary of Tom Brown, Inc., a Wind River Basin producer. KNGG manages the operations of the gathering system. KNGG paid approximately $2 million for its interest in the joint venture.
(D) Exchange and Lease of Gathering and Processing Facilities
On October 1, 1992, K N exchanged its Tyrone gas gathering system located in the Oklahoma panhandle for a natural gas processing plant and gathering system located near Douglas, Wyoming. KNGG is operator of the Douglas system, and entered into an operating lease for the facilities with a financial institution.
(E) Distribution Systems
On March 31, 1992, K N acquired the stock of two corporations for $3.7 million in net cash. The acquired corporations owned two gas utility distribution systems serving approximately 7,000 customers, mainly in northeastern Wyoming. The acquisition was accounted for as a purchase, and the corporations were merged into K N effective April 1, 1992.
5. Litigation
K N is named as one of four potentially responsible parties ("PRPs") at a U.S. Environmental Protection Agency ("EPA") Superfund site, pursuant to the Comprehensive Environmental Response, Compensation and Liability Act ("Superfund"). The site is known as the Mystery Bridge Road/U.S. Highway 20 site located near Casper, Wyoming (the "Brookhurst Subdivision"). The EPA's remedy consists of two parts, "Operating Unit One," which addresses the groundwater cleanup and "Operating Unit Two," which addresses cleanup procedures for the soil and free-phase petroleum product.
A Consent Decree between the Company, the EPA and another PRP was entered on October 2, 1991, in the Wyoming Federal District Court. Groundwater cleanup under Operating Unit One has been proceeding since 1990. On September 14, 1993, the EPA certified that the remedial action for Operating Unit One was "operational and functional." This is the last step in the Superfund process prior to remedy completion.
In July 1992, the EPA approved the Company's Operating Unit Two workplan and the Company received an EPA "Statement of Work." The work required to be performed for Operating Unit Two commenced during the third quarter of 1992 and is expected to continue through 1995 at a total cost estimated not to be more than $1.0 million.
With regard to this same Superfund site, in 1987 the State of Wyoming filed suit against several parties (including K N) for injunctive relief, penalties and unquantified damages claimed to have resulted from alleged pollution of groundwater and soils in the Brookhurst Subdivision. On April 1, 1993, the Wyoming District Court dismissed the lawsuit, finding that K N had diligently remedied the alleged pollution.
On October 20, 1989, a lawsuit was filed against the Company and 18 other defendants on behalf of a group of 268 individuals who reside or resided in the Brookhurst Subdivision, seeking damages for alleged releases of certain chemicals to the soil, groundwater and air. On February 5, 1993, the Company reached agreement to settle the above- described dispute. The settlement, which was approved by the Wyoming District Court, resolved all disputes between the parties and closed the lawsuit. A reserve for the settlement amount and related matters had been established in the Company's financial statements prior to 1993 and, accordingly, such settlement did not have any material adverse impact on the Company's financial position or results of operations.
On November 30, 1990, the Company initiated an action against a number of its insurance carriers for a declaration of the carriers' contractual obligations to provide insurance coverage for all sums associated with the alleged losses under the state, Federal and toxic tort claims related to the Brookhurst Subdivision. The Company entered into formal settlements with all of the defendants in the lawsuit in 1993, and received settlement proceeds associated therewith.
On October 9, 1992, Jack J. Grynberg filed suit in the United States District Court for the District of Colorado against the Company, Rocky Mountain Natural Gas Company and GASCO, Inc. (the "K N Entities") alleging that the K N Entities as well as K N Production Company and KNGG, have violated Federal and state antitrust laws. In essence, Grynberg asserts that the companies have engaged in an illegal exercise of monopoly power, have illegally denied him economically feasible access to essential facilities to transport and distribute gas produced from fewer than 20 wells located in northwest Colorado, and illegally have attempted to monopolize or to enhance or maintain an existing monopoly. Grynberg also asserts certain causes of action relating to a gas purchase contract.
No specific monetary damages have been claimed, although Grynberg has requested that any actual damages awarded be trebled. In addition, Grynberg has requested that the K N Entities be ordered to divest all interests in natural gas exploration, development and production properties, all interests in distribution and marketing operations, and all interests in natural gas storage facilities, separating these interests from the Company's natural gas gathering and transportation system in northwest Colorado.
On August 13, 1993, the United States District Court, District of Colorado, stayed this proceeding pending exhaustion of appeals in a related state court action involving the same plaintiff.
The Company believes it has meritorious defenses to all lawsuits and legal proceedings in which it is a defendant and will vigorously defend against them. Based on its evaluation of the above matters, and after consideration of reserves established, management believes that the resolution of such matters will not have a material adverse effect on the Company's financial position or results of operations.
6. Income Taxes
See Note 1(D) regarding the method of accounting for income taxes.
Components of the income tax provision applicable to Federal and state income taxes are as follows (in thousands):
The difference between the statutory Federal income tax rate and the Company's effective income tax rate is summarized as follows:
The Company has recorded deferred regulatory assets of $1.5 million and $2.1 million, and deferred regulatory liabilities of $4.4 million and $7.3 million at December 31, 1993 and 1992, respectively, which are expected to result in cost-of-service adjustments. These amounts reflect the "gross of tax" presentation required under SFAS 109. T he Company reduced its deferred regulatory liability by $2.2 million as a result of the Federal tax rate increase from 34 percent to 35 percent. The deferred tax assets and liabilities and deferred regulatory assets and liabilities for rate-regulated entities computed according to SFAS 109 at December 31, 1993 and 1992 result from the following (in thousands):
7. Financing
(A) Notes Payable
The Company has credit agreements with eight banks to either borrow or use as commercial paper support, up to a total of $90.0 million at December 31, 1993. At December 31, 1993, $10.0 million was outstanding under the credit agreements at an interest rate of 3.27 percent. No amounts were outstanding under the credit agreements at December 31, 1992. Borrowings are made at prime or a rate less than prime negotiated on the borrowing date and for a term of not more than one year. The Company pays the banks a fee of one quarter of one percent per annum of the unused commitment.
Commercial paper issued by the Company represents unsecured short-term notes with maturities up to 270 days from the date of issue. Rates at which commercial paper was issued during the year ranged from 3.2 percent to 3.7 percent. At December 31, 1993 and 1992, $37.0 million and $2.0 million of commercial paper, respectively, were outstanding.
(B)Long-Term Debt
Long-term debt at December 31, 1993 and 1992 was as follows (in thousands):
Maturities of long-term debt for the five years ending December 31, 1998, are as follows (in thousands):
(A) Class A $8.50 Preferred Stock
The Class A $8.50 Preferred Stock is subject to mandatory redemption through a sinking fund (at $100 per share, plus accrued and unpaid dividends) of $500,000 in 1994. At the option of the Company, this stock is redeemable, in whole or in part, at $100.85 per share during 1994. In each of the years 1993 and 1992, the Company redeemed 10,000 shares subject to mandatory redemption. In 1991, the Company redeemed 10,000 shares subject to mandatory redemption and an additional 25,000 shares at $102.13 per share.
(B) Class B $8.30 Preferred Stock
The Class B $8.30 Preferred Stock is subject to mandatory redemption through a sinking fund (at $100 per share, plus accrued and unpaid dividends) of $571,400 annually from 1995 through 1998 and $572,000 in 1999. At the option of the Company, this stock is redeemable, in whole or in part, at $101.74 per share prior to January 2, 1995; such redemption price is reduced annually thereafter until January 2, 1998, when it becomes $100 per share. Also, at the option of the Company, 5,714 shares of this stock may be redeemed in each of the years 1994 through 1998, inclusive, at $100 per share. In each of the years 1993, 1992 and 1991, the Company redeemed 5,714 shares subject to mandatory redemption, and an additional 5,714 shares at $100 per share.
(C) Class A $5.00 Preferred Stock
The Class A $5.00 Preferred Stock is redeemable, in whole or in part, at the option of the Company at any time on 30 days' notice at
$105 per share plus accrued dividends. This series has no sinking fund requirements.
(D) Rights of Preferred Shareholders
All outstanding series of preferred stock have voting rights.
If, for any class of preferred stock, the Company (i) is in arrears on dividends, (ii) has failed to pay or set aside any amounts required to be paid or set aside for all sinking funds, or (iii) is in default on any of its redemption obligations, then no dividends shall be paid or declared on any junior stock nor shall any junior stock be purchased or redeemed by the Company. Also, if dividends on any class of preferred stock are sufficiently in arrears, the holders of that stock may elect one-third of the Company's Board of Directors.
(E) Combined Aggregate Redemption Requirements
The combined aggregate amount of mandatory redemption requirements for all preferred issues for the five years ending December 31, 1998, are as follows (in thousands):
(F) Fair Value
At December 31, 1993, both the carrying amount and the estimated fair value of K N's outstanding preferred stock subject to mandatory redemption were $3.4 million, compared with $5.5 million and $5.6 million, respectively, at December 31, 1992. The fair value of K N's preferred stock is estimated based on an evaluation made by an independent security analyst.
9. Employee Benefits
(A) Retirement Plans
The Company has defined benefit pension plans covering substantially all full-time employees. These plans provide pension benefits that are based on the employees' compensation during the period of employment. These plans are tax qualified subject to the minimum funding requirements of ERISA. The Company's funding policy is to contribute annually the recommended contribution using the actuarial cost method and assumptions used for determining annual funding requirements. Plan assets consist primarily of pooled fixed income and equity funds.
Net pension cost for 1993, 1992 and 1991 included the following components (in thousands):
The following table sets forth the plans' funded status and amounts recognized in the Company's financial statements at December 31, 1993 and 1992 (in thousands):
The rate of increase in future compensation and the expected long-term rate of return on assets were 4.5 percent and 8.5 percent, respectively, for 1993, and 5.0 percent and 9.25 percent, respectively, for 1992 and 1991. The weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 7.5 percent for all three periods.
The Company also contributes the lesser of ten percent of the Company's net income or ten percent of normal employee compensation to the Employees Retirement Fund Trust Profit Sharing Plan (a defined contribution plan). Contributions by the Company were $2,588,000, $2,090,000 and $464,000 for 1993, 1992 and 1991, respectively.
(B) Other Postretirement Employee Benefits
The Company has a defined benefit postretirement plan providing medical care benefits upon retirement for all eligible employees with at least five years of credited service as of January 1, 1993, and their eligible dependents. Retired employees are required to contribute monthly amounts which depend upon the retired employee's age, years of service upon retirement and date of retirement.
This plan also provides life insurance benefits upon retirement for all employees with at least ten years of credited service who are age 55 or older when they retire. The Company pays for a portion of the life insurance benefit; employees may at their option increase the benefit by making contributions from age 55 until age 65 or retirement, whichever is earlier. In 1993, the Company began funding the future expected postretirement benefit costs under the plan by making payments to Voluntary Employee Benefit Association trusts. The Company's
funding policy is to contribute amounts within the deductible limits imposed on Internal Revenue Code Sec. 501(c)(9) trusts. Plan assets consist primarily of pooled fixed income funds.
Effective January 1, 1993, the Company prospectively adopted Statement of Financial Accounting Standards No. 106 ("SFAS 106") which requires the accrual of the expected costs of postretirement benefits other than pensions during the years that employees render service. The Accumulated Postretirement Benefit Obligation ("APBO") of the plan at January 1, 1993, was approximately $18.8 million. The Company has elected to amortize this transition obligation to expense over a 20- year period.
Net postretirement benefit cost for the defined benefit plan in 1993 included the following components (in thousands):
Prior to 1993, the cost of providing medical care benefits to retired employees was recognized as expense as claims were paid, and the cost of life insurance benefits for retirees was not accrued. Instead, life insurance claims were paid from a trust fund resulting from termination of third party coverage. The Company's net cost of medical care claims for retirees was approximately $1.2 million and $1.1 million in 1992 and 1991, respectively. In 1993, the incremental effect on postretirement cost as a result of adopting SFAS 106 was a $1.3 million increase.
The following table sets forth the plan's funded status and the amounts recognized in the Company's financial statements at December 31, 1993(in thousands):
The weighted average discount rate used in determining the actuarial present value of the APBO was 7.5 percent; the assumed health care cost trend rate was 11 percent for 1993, nine percent for 1994 and seven percent for 1995 and beyond. A one-percentage-point increase in the assumed health care cost trend rate for each future year would have increased the aggregate of the service and interest cost components of the 1993 net periodic postretirement benefit cost by
$0.1 million and would have increased the APBO as of December 31, 1993, by $0.1 million.
K N's interstate retail distribution business, in connection with rate filings described in Note 3 for Kansas, Nebraska and Wyoming, has received regulatory approval to include in the cost-of-service component of its rates the cost of postretirement benefits as measured by application of SFAS 106. In addition, KNI has requested similar regulatory treatment from FERC in connection with its rate filing, also described in Note 3. At December 31, 1993, no SFAS 106 costs were deferred as regulatory assets.
(C) Other Postemployment Benefits
In November 1992, FASB issued SFAS 112, which establishes standards of financial accounting and reporting for the estimated cost of benefits provided by an employer to former or inactive employees after employment but before retirement. SFAS 112 is effective for fiscal years beginning after December 15, 1993. Implementation of SFAS 112 is not expected to have a material effect on the Company's financial position or results of operations.
10. Common Stock Option and Purchase Plans
The Company has incentive stock option plans for key employees and nonqualified stock option plans for its nonemployee directors. Under the plans, options are granted at not less than 100 percent of the market value of the stock at the date of grant. Pursuant to amendments to the plans' provisions, options granted after 1989 vest over three to five years and expire ten years after date of grant. Under earlier grants, all options vested immediately or within three years and are exercisable for ten years from date of grant.
At December 31, 1993, 91 employees, officers and directors held options under the plans. The changes in stock options outstanding during 1993, 1992 and 1991 are as follows, restated to reflect the three-for-two common stock split described in Note 1(E):
Unexercised options outstanding at December 31, 1993, expire at various dates between 1994 and 2003.
Effective April 1, 1990, and for each succeeding year, the Company established an Employee Stock Purchase Plan under which eligible employees may purchase the Company's common stock through voluntary payroll deductions at a 15 percent discount from the market value of the common stock, as defined in the plan.
Under the Company's Stock Option, Dividend Reinvestment, Employee Stock Purchase and Employee Benefit Plans, 2,111,299 shares were reserved for issuance at December 31, 1993.
11. Commitments and Contingent Liabilities
(A) Leases
In 1993, K N Front Range Gathering Company began to lease gas gathering equipment and facilities under a ten-year operating lease. Also in 1993, K N and certain subsidiaries began to lease various furniture, fixtures and vehicles under various operating leases with terms from three to seven years. In 1992, KNGG began to lease gas gathering facilities and processing equipment under a seven-year operating lease. All of these operating leases contain purchase options at the end of their lease terms.
Payments made under operating leases were $5.2 million in 1993, $2.4 million in 1992 and $1.9 million in 1991.
Future minimum commitments under major operating leases for the five years ending December 31, 1998 and thereafter are as follows (in thousands):
(B) Capital Expenditure Budget
The consolidated capital expenditure budget for 1994 is approximately $54.5 million, excluding acquisitions. Approximately $2.0 million had been committed for the purchase of plant and equipment at December 31, 1993.
12. Discontinued Operations
On June 1, 1991, K N sold its wholly-owned coal mining subsidiaries, Wyoming Fuel Company and North Central Energy Company. The Company received cash proceeds of $7.2 million, and receives a royalty interest on all future coal mined and sold from the southern Colorado properties.
The results of operations of the coal mining subsidiaries have been accounted for as discontinued operations in the financial statements. Following is a summary of revenues, loss from operations and loss on sale of this discontinued business (in thousands):
13. Business Segment Information
The Company's principal operations are the sale and transportation of natural gas ("Gas Service"), nonregulated gas marketing and gathering ("Gas Marketing and Gathering") and exploration, development and production of oil and gas ("Oil and Gas Production").
Total revenues by segment include sales to unaffiliated customers. General corporate income and expenses, interest expense and income taxes are not included in the computation of operating income. Identifiable assets by segment are those assets used in the Company's operations in each segment. Corporate assets are principally cash and investments.
(1) Restated to reflect a three-for-two common stock split in 1993.
ITEM 9:
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING _____________________________________________________________________ AND FINANCIAL DISCLOSURE ________________________
There were no such matters during 1993.
PART III
ITEM 10:


ITEM 10: DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ____________________________________________________________
(A) Identification of Directors ___________________________
For information regarding the Directors, see pages 2-3 of the 1994 Proxy Statement.
(B) Identification of Executive Officers ____________________________________
See Executive Officers of the Registrant under Part I.
(C) Identification of Certain Significant Employees _______________________________________________
None.
(D) Family Relationships ____________________
None.
(E) Business Experience ___________________
See Executive Officers of the Registrant under Part I.
(F) Involvement in Certain Legal Proceedings ________________________________________
See Executive Officers of the Registrant under Part I.
(G) Promoters and Control Persons _____________________________
None.
ITEM 11:
ITEM 11: EXECUTIVE COMPENSATION ________________________________
See "Executive Compensation", "Stock Options", "Pension Benefits" and "Director Compensation" on pages 4-5, 8-10, 12 and 13 of the 1994 Proxy Statement.
ITEM 12:
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ________________________________________________________________________
See the following pages of the 1994 Proxy Statement: (i) pages 2-3 relating to common stock owned by directors; (ii) page 11, "Executive Stock Ownership"; and (iii) pages 18-19, "Principal Shareholders".
ITEM 13:
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ________________________________________________________
(A) Transactions with Management and Others _______________________________________
See "Relationship Between Certain Directors and the Company" on page 4 of the 1994 Proxy Statement.
(B) Certain Business Relationships ______________________________
See "Relationship Between Certain Directors and the Company" on page 4 of the 1994 Proxy Statement.
(C) Indebtedness of Management __________________________
None.
(D) Transactions with Promoters ___________________________
Not applicable.
PART IV
ITEM 14:
ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON ________________________________________________________________ FORM 8-K ________
(a) See the index for a listing and page numbers of financial statements, financial statement schedules and exhibits included herein or incorporated by reference.
Executive Compensation Plans and Arrangements _____________________________________________
Form of Key Employee Severance Agreement (Exhibit 10.2, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*
1982 Stock Option Plan for Nonemployee Directors of the Company with Form of Grant Certificate (Exhibit 10.3, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*
1982 Incentive Stock Option Plan for key employees of the Company (Exhibit 10.4, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*
1986 Incentive Stock Option Plan for key employees of the Company (Exhibit 10.5, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*
1988 Incentive Stock Option Plan for key employees of the Company (Exhibit 10.6, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*
Form of Grant Certificate for Employee Stock Option Plans (Exhibit 10.7, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*
Directors' Deferred Compensation Plan Agreement (Exhibit 10.8, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*
1987 Directors' Deferred Fee Plan and Form of Participation Agreement regarding the Plan (Exhibit 10.9, Amendment No. 1 on Form 8 dated September 2, 1988 to the Annual Report on Form 10-K for the year ended December 31, 1987)*
1992 Stock Option Plan for Nonemployee Directors of the Company with Form of Grant Certificate (Exhibit 4.1, File No. 33-46999)*
K N Energy, Inc. 1993 Executive Incentive Plan (Exhibit 10(k) to the Annual Report on Form 10-K for the Year Ended December 31, 1992)*
K N Energy, Inc. 1994 Executive Incentive Plan (attached hereto as Exhibit 10(k))**
1994 K N Energy, Inc. Long-Term Incentive Plan (Attachment A to the K N Energy, Inc. 1994 Proxy Statement on Schedule 14-A)*
(b) Reports on Form 8-K
On February 3, 1994, the Company filed a Form 8-K which disclosed that on February 1, 1994, K N's gas reserves development subsidiaries, K N Production Company and GASCO, Inc., acquired gas reserves and production properties located near existing K N operations in western Colorado and in the Moxa Arch region of southwestern Wyoming from Fuel Resources Development Co., a subsidiary of Public Service Co. of Colorado.*
* Incorporated herein by reference. ** Included in SEC and NYSE copies only.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
K N ENERGY, INC. (Registrant)
March 23, 1994 By /s/ E. Wayne Lundhagen ______________________________________ E. Wayne Lundhagen Vice President - Finance and Accounting
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Chairman, Chief Executive Officer and Director /s/ Charles W. Battey (Principal Executive Officer) March 23, 1994 ___________________________ Charles W. Battey
/s/ Stewart A. Bliss Director March 23, 1994 ___________________________ Stewart A. Bliss
/s/ David W. Burkholder Director March 23, 1994 ___________________________ David W. Burkholder
/s/ Robert H. Chitwood Director March 23, 1994 ___________________________ Robert H. Chitwood
/s/ Howard P. Coghlan Director March 23, 1994 ___________________________ Howard P. Coghlan
/s/ Robert B. Daugherty Director March 23, 1994 ___________________________ Robert B. Daugherty
/s/ Jordan L. Haines Director March 23, 1994 ___________________________ Jordan L. Haines
/s/ Larry D. Hall Director March 23, 1994 ___________________________ Larry D. Hall
/s/ William J. Hybl Director March 23, 1994 ___________________________ William J. Hybl Vice President - Finance and Accounting (Principal Financial and Accounting /s/ E. Wayne Lundhagen Officer) March 23, 1994 ___________________________ E. Wayne Lundhagen
/s/ H. A. True, III Director March 23, 1994 ___________________________ H. A. True, III
SCHEDULE VI
SCHEDULE IX
K N ENERGY, INC. AND SUBSIDIARIES
SHORT-TERM BORROWINGS
THREE YEARS ENDED DECEMBER 31, 1993
The Company has credit agreements with eight banks to either borrow or use as commercial paper support, up to a total of $90.0 million at December 31, 1993. Borrowings are made at prime or a rate less than prime negotiated on the borrowing date and for a term of not more than one year. The Company pays the banks a fee of one-quarter of one percent per annum of the unused commitment.
Commercial paper issued by the Company represents unsecured short-term notes with maturities up to 270 days from the date of issue. Rates at which commercial paper was issued during the year ranged from 3.2 percent to 3.7 percent.
Amounts outstanding during the year and at year-end, and related interest rates, were as follows:
(A) The average borrowings were determined based on the total of daily outstanding principal balances divided by the number of days in the year.
(B) The weighted average interest rates during the period were computed by dividing the actual interest expense by the average short-term debt outstanding.
SCHEDULE X
K N ENERGY, INC. AND SUBSIDIARIES
SUPPLEMENTARY INCOME STATEMENT INFORMATION
THREE YEARS ENDED DECEMBER 31, 1993
The amounts of depreciation and amortization of intangible assets, preoperating costs and similar deferrals, and advertising costs are not considered to be significant. The amount of taxes, other than payroll and income taxes, maintenance and repairs, and royalties for 1993, 1992 and 1991, are as follows:
EXHIBIT 12
EXHIBIT 13
K N ENERGY, INC. ________________
1993 ANNUAL REPORT TO SHAREHOLDERS __________________________________
Interested persons may receive a copy of the Company's 1993 Annual Report to Shareholders without charge by forwarding a written request to: K N Energy, Inc., Securities Services Department, P. O. Box 281304, Lakewood, Colorado 80228-8304.
EXHIBIT 22
K N ENERGY, INC. AND SUBSIDIARIES
SUBSIDIARIES OF THE REGISTRANT
State of Name of Company Incorporation __________________________________________________ _____________
Colorado Gasmark, Inc. (inactive). . . . . . . . . Colorado GASCO, Inc.. . . . . . . . . . . . . . . . . . . . Colorado KNE Acquisition Corporation. . . . . . . . . . . . Delaware K N Dakota Company (inactive). . . . . . . . . . . Colorado K N Front Range Operating Company. . . . . . . . . Colorado K N Gas Gathering, Inc.. . . . . . . . . . . . . . Colorado *K N Front Range Gathering Company . . . . . . . Colorado K N Gas Marketing, Inc.. . . . . . . . . . . . . . Colorado K N Gas Supply Services, Inc.. . . . . . . . . . . Colorado K N Interstate Gas Transmission Co.. . . . . . . . Colorado K N Optima Company (inactive). . . . . . . . . . . Colorado K N Production Company . . . . . . . . . . . . . . Delaware K N Trading, Inc.. . . . . . . . . . . . . . . . . Delaware K N TransColorado, Inc.. . . . . . . . . . . . . . Colorado K N Wattenberg Company . . . . . . . . . . . . . . Colorado *K N Wattenberg Transmission Limited Liability Company . . . . . . . . . . . . . . . . . . . . Colorado Midlands Transportation Company. . . . . . . . . . Kansas Northern Gas Company . . . . . . . . . . . . . . . Wyoming R M N G Gathering Co.. . . . . . . . . . . . . . . Colorado Rocky Mountain Natural Gas Company . . . . . . . . Colorado *T C P Gathering Co. . . . . . . . . . . . . . . Colorado Slurco Corporation . . . . . . . . . . . . . . . . Colorado Slurco, Inc. (inactive). . . . . . . . . . . . . . Kansas Sunflower Pipeline Company . . . . . . . . . . . . Kansas Wyoming Gasmark, Inc. (inactive) . . . . . . . . . Delaware
*Second tier subsidiary of K N; subsidiary of entity listed directly above.
All of the subsidiaries named above are included in the consolidated financial statements of the Registrant included herein.
EXHIBIT 24
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS _________________________________________
As independent public accountants, we hereby consent to the incorporation by reference in (i) Registration Statements on Form S-16, File Nos. 2-51894, 2-55664, 2-63470 and 2-75654; (ii) Registration Statements on Form S-8, File Nos. 2-77752, 33-10747, 33-24934 and 33- 33018; and (iii) Registration Statements on Form S-3, File Nos. 2-84910, 33-26314, 33-23880, 33-42698, 33-44871, 33-45091, 33-46999 and 33-51115 of our report dated February 10, 1994, on the consolidated financial statements of K N Energy, Inc. and subsidiaries and on supplemental Schedules V, VI, IX and X included in this Form 10-K for the year ended December 31, 1993.
/s/ Arthur Andersen & Co.
Denver, Colorado. March 23, 1994.