UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _____ to _____
Commission File Number 1-16619
KERR-McGEE CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Delaware 73-1612389
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
Kerr-McGee Center, Oklahoma City, Oklahoma 73125
(Address of Principal Executive Offices and Zip Code)
Registrant's telephone number, including area code (405) 270-1313
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Number of shares of common stock, $1.00 par value, outstanding as of July 31,
2004: 150,996,605.
KERR-McGEE CORPORATION
INDEX
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements PAGE
----
Consolidated Statement of Income for the Three and
Six Months Ended June 30, 2004 and 2003 1
Consolidated Balance Sheet at June 30, 2004 and
December 31, 2003 2
Consolidated Statement of Cash Flows for the Six
Months Ended June 30, 2004 and 2003 3
Notes to Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 34
Item 3. Quantitative and Qualitative Disclosures about Market Risk 43
Item 4. Controls and Procedures 46
Forward-Looking Information 46
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 47
Item 4. Submission of Matters to a Vote of Security Holders 47
Item 6. Exhibits and Reports on Form 8-K 47
SIGNATURE 50
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
KERR-McGEE CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
Three Months Six Months
Ended Ended
June 30, June 30,
-------------------- --------------------
(Millions of dollars, except per-share amounts) 2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------------------------------
Revenues $1,097.1 $1,052.6 $2,213.4 $2,152.2
-------- -------- -------- --------
Costs and Expenses
Costs and operating expenses 432.6 439.1 835.6 823.5
Selling, general and administrative expenses 80.1 79.1 163.7 150.0
Shipping and handling expenses 38.4 35.0 76.1 67.0
Depreciation and depletion 191.0 193.0 381.3 382.6
Accretion expense 6.8 6.3 13.4 12.5
Impairments on assets held for use 1.1 - 14.3 5.1
Loss (gain) associated with assets held for sale 3.9 (.5) 7.3 (5.7)
Exploration, including dry holes and amortization of
undeveloped leases 65.5 66.6 116.1 207.1
Taxes, other than income taxes 28.6 21.0 57.0 46.4
Provision for environmental remediation and restoration,
net of reimbursements 7.4 1.9 6.6 19.2
Interest and debt expense 55.7 63.4 112.7 128.4
-------- -------- -------- --------
Total Costs and Expenses 911.1 904.9 1,784.1 1,836.1
-------- -------- -------- --------
186.0 147.7 429.3 316.1
Other Expense (7.0) (26.9) (7.3) (25.2)
-------- -------- -------- --------
Income from Continuing Operations before Income Taxes 179.0 120.8 422.0 290.9
Provision for Income Taxes (68.4) (51.0) (159.2) (116.9)
-------- -------- -------- --------
Income from Continuing Operations 110.6 69.8 262.8 174.0
Income (Loss) from Discontinued Operations
(net of income tax provision) - (.2) - .2
Cumulative Effect of Change in Accounting Principle (net of benefit
for income taxes of $18.2) - - - (34.7)
-------- -------- -------- --------
Net Income $ 110.6 $ 69.6 $ 262.8 $ 139.5
======== ======== ======== ========
Income (Loss) per Common Share
Basic -
Continuing operations $ 1.07 $ .70 $ 2.58 $ 1.73
Discontinued operations - - - -
Cumulative effect of change in accounting principle - - - (.34)
-------- -------- -------- --------
Total $ 1.07 $ .70 $ 2.58 $ 1.39
======== ======== ======== ========
Diluted -
Continuing operations $ 1.01 $ .68 $ 2.42 $ 1.67
Discontinued operations - - - -
Cumulative effect of change in accounting principle - - - (.31)
-------- -------- -------- --------
Total $ 1.01 $ .68 $ 2.42 $ 1.36
======== ======== ======== ========
Dividends Declared per Common Share $ .45 $ .45 $ .90 $ .90
======== ======== ======== ========
The accompanying notes are an integral part of this statement.
KERR-McGEE CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
June 30, December 31,
(Millions of dollars) 2004 2003
- -------------------------------------------------------------------------------------------------------------------
ASSETS
- ------
Current Assets
Cash $ 104.7 $ 142.0
Accounts receivable 717.3 583.3
Inventories 404.7 393.4
Investment in equity securities 556.7 509.8
Deposits, prepaid expenses and other assets 145.9 127.6
Deferred income taxes 206.4 76.0
Current assets associated with properties held for disposal - .4
--------- ---------
Total Current Assets 2,135.7 1,832.5
--------- ---------
Property, Plant and Equipment 18,302.5 14,273.1
Less reserves for depreciation, depletion and amortization (7,486.8) (6,870.2)
--------- ---------
10,815.7 7,402.9
--------- ---------
Investments and Other Assets 653.3 628.9
Goodwill 1,196.9 357.3
Long-Term Assets Associated with Properties Held for Disposal 1.3 28.3
--------- ---------
Total Assets $14,802.9 $10,249.9
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Accounts payable $ 477.2 $ 475.5
Long-term debt due within one year 827.7 574.3
Taxes on income 80.2 126.6
Taxes, other than income taxes 70.1 36.5
Derivative liabilities 820.5 354.2
Accrued liabilities 726.1 664.5
--------- ---------
Total Current Liabilities 3,001.8 2,231.6
--------- ---------
Long-Term Debt 3,528.0 3,081.2
--------- ---------
Deferred Income Taxes 2,056.6 1,334.7
Asset Retirement Obligations 473.5 384.6
Other Liabilities and Deferred Credits 665.7 566.0
Long-Term Liabilities Associated with Properties Held for Disposal .5 16.0
--------- ---------
3,196.3 2,301.3
--------- ---------
Stockholders' Equity
Common stock, par value $1 - 300,000,000 shares
authorized, 150,557,481 shares issued at 6-30-04
and 100,892,354 shares issued at 12-31-03 150.6 100.9
Capital in excess of par value 4,144.4 1,708.3
Preferred stock purchase rights 1.0 1.0
Retained earnings 1,098.9 927.2
Accumulated other comprehensive loss (244.9) (45.4)
Common shares in treasury, at cost - 105,462 shares
at 6-30-04 and 31,924 at 12-31-03 (5.3) (1.6)
Deferred compensation (67.9) (54.6)
--------- ---------
Total Stockholders' Equity 5,076.8 2,635.8
--------- ---------
Total Liabilities and Stockholders' Equity $14,802.9 $10,249.9
========= =========
The "successful efforts" method of accounting for oil and gas exploration and
production activities has been followed in preparing this balance sheet.
The accompanying notes are an integral part of this statement.
KERR-McGEE CORPORATION AND SUBSIDIARY COMPANIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
Six Months Ended
June 30,
-------------------------
(Millions of dollars) 2004 2003
- ------------------------------------------------------------------------------------------
Operating Activities
- --------------------
Net income $ 262.8 $ 139.5
Adjustments to reconcile net income to net cash
provided by operating activities -
Depreciation, depletion and amortization 407.5 419.9
Accretion expense 13.4 12.5
Impairments on assets held for use 14.3 5.1
Loss associated with assets held for sale 7.3 .5
Dry hole costs 26.1 128.2
Deferred income taxes 110.6 80.8
Provision for environmental remediation and
restoration, net of reimbursements 6.6 19.2
Cumulative effect of change in accounting principle - 34.7
Noncash items affecting net income 70.0 69.2
Other net cash used in operating activities (211.2) (144.7)
------- -------
Net Cash Provided by Operating Activities 707.4 764.9
------- -------
Investing Activities
- --------------------
Capital expenditures (432.9) (517.9)
Dry hole costs (26.1) (128.2)
Cash acquired in Westport acquisition (1) 43.0 -
Proceeds from sales of assets 3.3 195.9
Other investing activities 12.9 (14.8)
------- -------
Net Cash Used in Investing Activities (399.8) (465.0)
------- -------
Financing Activities
- --------------------
Issuance of long-term debt 86.0 31.5
Repayment of long-term debt (347.0) (222.3)
Issuance of common stock 7.0 -
Dividends paid (91.0) (90.6)
Other financing activities - (.6)
------- -------
Net Cash Used in Financing Activities (345.0) (282.0)
------- -------
Effects of Exchange Rate Changes on Cash and Cash Equivalents .1 .8
------- -------
Net Increase (Decrease) in Cash and Cash Equivalents (37.3) 18.7
Cash and Cash Equivalents at Beginning of Period 142.0 89.9
------- -------
Cash and Cash Equivalents at End of Period $ 104.7 $ 108.6
======= =======
(1) See Notes B and E for information regarding the business combination and
related noncash investing and financing activities.
The accompanying notes are an integral part of this statement.
KERR-McGEE CORPORATION AND SUBSIDIARY COMPANIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004
A. Basis of Presentation and Accounting Policies
Basis of Presentation
---------------------
The condensed financial statements included herein have been prepared by
the company, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission and, in the opinion of management,
include all adjustments, consisting only of adjustments that are normal and
recurring in nature, necessary to present fairly the resulting operations
for the indicated periods. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States have been
condensed or omitted pursuant to such rules and regulations. Although the
company believes that the disclosures are adequate to make the information
presented not misleading, these condensed financial statements should be
read in conjunction with the financial statements and the notes thereto
included in the company's latest annual report on Form 10-K.
Business Segments
-----------------
The company has three reportable segments: oil and gas exploration and
production, production and marketing of titanium dioxide pigment (chemicals
- pigment), and production and marketing of other chemicals (chemicals -
other). Other chemicals include the company's electrolytic manufacturing
and marketing operations and forest products treatment business.
Employee Stock Option Plans
---------------------------
The company accounts for its stock option plans under the intrinsic-value
method permitted by Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees." Accordingly, no stock-based employee
compensation cost is reflected in net income for the issuance of stock
options under the company's plans, since all options were fixed-price
options with an exercise price equal to the market value of the underlying
common stock on the date of grant.
Statement of Financial Accounting Standards (FAS) No. 123, "Accounting for
Stock-Based Compensation," prescribes a fair-value method of accounting for
employee stock options under which compensation expense is measured based
on the estimated fair value of stock options at the grant date and
recognized over the period of time that the options vest. The following
table illustrates the effect on net income and earnings per share as if the
company had applied the fair-value recognition provisions of FAS 123 to
stock-based employee compensation.
Three Six
Months Ended Months Ended
June 30, June 30,
(Millions of dollars, ----------------- ----------------
except per share amounts) 2004 2003 2004 2003
---------------------------------------------------------------------------------------------------
Net income as reported $110.6 $69.6 $262.8 $139.5
Less stock-based compensation expense determined
using a fair-value method, net of taxes (3.4) (4.1) (6.8) (8.1)
------ ----- ------ ------
Pro forma net income $107.2 $65.5 $256.0 $131.4
====== ===== ====== ======
Net income per share -
Basic -
As reported $ 1.07 $ .70 $ 2.58 $ 1.39
Pro forma 1.03 .65 2.51 1.31
Diluted -
As reported 1.01 .68 2.42 1.36
Pro forma .98 .64 2.36 1.28
Goodwill and Intangible Assets
------------------------------
In accordance with FAS 142, "Goodwill and Other Intangible Assets,"
goodwill and certain indefinite-lived intangibles are not amortized but are
reviewed annually for impairment, or more frequently if impairment
indicators arise. The annual test for impairment was completed in the
second quarter of 2004, with no impairment indicated. The amounts tested
for impairment exclude goodwill and intangible assets recorded in
connection with the company's June 25, 2004 acquisition of Westport
Resources Corporation (Westport).
Reclassifications
-----------------
Certain reclassifications have been made to the prior year financial
statements to conform with the current year presentation. In the third
quarter of 2003, the company began reporting in revenues the net marketing
fee received from sales of nonequity North Sea crude oil marketed on behalf
of other partners. Prior to the 2003 third quarter, the company reported
purchases and sales of nonequity crude oil on a gross basis.
B. Business Combination
On June 25, 2004, Kerr-McGee completed its acquisition of Westport, an
independent oil and gas exploration and production company with operations
in the Rocky Mountain, Mid-Continent and Gulf Coast areas onshore U.S. and
in the Gulf of Mexico. The acquisition increases Kerr-McGee's proved
reserves by approximately 30%, bringing the combined company's total
reserves as of December 31, 2003, to approximately 1.3 billion barrels of
oil equivalent.
On the effective date of the merger, each issued and outstanding share of
Westport common stock was converted into .71 shares of Kerr-McGee common
stock. As a result, Kerr-McGee issued 48.9 million shares of common stock
to Westport's stockholders. The common stock exchanged in the merger was
valued at $2.4 billion based on Kerr-McGee's weighted average stock price
two days before and after April 7, 2004, the date the acquisition was
publicly announced. Kerr-McGee also exchanged 1.9 million stock options for
options held by Westport employees. The fair value of the vested options
exchanged was $33.7 million, determined using the Black-Scholes option
pricing model.
The acquisition price, net of cash acquired of $43 million, totaled $4.5
billion, which includes the value of common stock and stock options
exchanged, plus debt and other liabilities assumed, and merger costs.
Kerr-McGee has reflected Westport's assets and liabilities in the company's
balance sheet at June 30, 2004, and has included Westport's results of
operations in the company's statement of income for the five-day period
ending June 30, 2004. The purchase price was allocated preliminarily to
specific assets and liabilities based on their estimated fair values at the
date of acquisition, with $840 million recorded as goodwill and
approximately $600 million recorded for deferred tax liabilities. Since the
Westport acquisition closed at the end of the second quarter, certain data
necessary to determine the fair values of the acquired assets and
liabilities is not yet available including, but not limited to: final
acquisition-date economic valuations of acquired proved and unproved oil
and gas properties, data necessary for the identification and valuation of
pre-acquisition contingencies, and tax return data providing the underlying
tax bases of Westport's assets and liabilities at June 25, 2004. The
company expects to complete its purchase price allocation later this year,
at which time the preliminary allocation will be revised and goodwill will
be adjusted accordingly.
The strategic benefits of the merger and the principal factors that
contributed to Kerr-McGee recognizing goodwill are as follows:
o Provides complementary high-quality assets in core U.S. onshore and
Gulf of Mexico regions
o Enhances the stability of high-margin production
o Expands low-risk exploitation opportunities
o Increases free cash flow for Kerr-McGee's high-potential exploration
opportunities
o Reduces leverage and enables greater financial flexibility
o Provides opportunities for synergies and related cost savings
The pro forma information presented below has been prepared to give effect
to the Westport acquisition as if it had occurred at the beginning of the
periods presented. The pro forma information is presented for illustrative
purposes only and is based on estimates and assumptions deemed appropriate
by Kerr-McGee. If the Westport acquisition had occurred in the past,
Kerr-McGee's operating results would have been different from those
reflected in the pro forma information below; therefore, the pro forma
information should not be relied upon as an indication of the operating
results that Kerr-McGee would have achieved if the transactions had
occurred on January 1, 2003. The pro forma information also should not be
used as an indication of the future results that Kerr-McGee will achieve
after the Westport acquisition.
Pro Forma Information
--------------------------------------------
Three Months Six Months
Ended Ended
June 30, June 30,
-------------------- --------------------
(Millions of dollars, except per-share amounts) 2004 2003 2004 2003
-----------------------------------------------------------------------------------------------------------
Revenues $1,305.6 $1,227.6 $2,663.9 $2,508.2
Income from Continuing Operations 136.5 78.0 323.7 198.4
Net Income 136.5 77.8 323.7 159.9
Income per Common Share -
Basic $ .91 $ .52 $ 2.17 $ 1.07
Diluted .88 .55 2.08 1.06
C. Derivatives
The company is exposed to risk from fluctuations in crude oil and natural
gas prices, foreign currency exchange rates, and interest rates. To reduce
the impact of these risks on earnings and to increase the predictability of
its cash flow, from time to time, the company enters into certain
derivative contracts, primarily swaps and collars for a portion of its oil
and gas production, forward contracts to buy and sell foreign currencies,
and interest rate swaps.
The following tables summarize the balance sheet presentation of the
company's derivatives as of June 30, 2004 and December 31, 2003:
As of June 30, 2004
--------------------------------------------------------------------
Derivative Fair Value
-------------------------------------------------
Current Long-Term Current Long-Term Deferred Gain
Asset Asset Liability Liability (Loss) in AOCI(1)
--------------------------------------------------------------------
Oil and gas commodity derivatives -
Kerr-McGee positions $16.6 $14.0 $(436.7) $(101.6) $(291.6)
Acquired Westport positions 2.7 3.1 (142.4) (43.9) -
Gas marketing-related derivatives 11.2 2.7 (11.0) (2.7) -
Foreign currency forward contracts 17.4 4.2 (3.6) - 16.3
Interest rate swaps - - - 3.6 -
DECS call option - - (226.8) - -
Other 2.2 1.1 - - 2.1
----- ----- ------- ------- -------
Total derivative contracts $50.1 $25.1 $(820.5) $(144.6) $(273.2)
===== ===== ======= ======= =======
As of December 31, 2003
--------------------------------------------------------------------
Derivative Fair Value
-------------------------------------------------
Current Long-Term Current Long-Term Deferred Gain
Asset Asset Liability Liability (Loss) in AOCI(1)
--------------------------------------------------------------------
Oil and gas commodity derivatives $ 7.7 $14.9 $(181.3) $ - $(106.3)
Gas marketing-related derivatives 8.0 2.1 (6.9) (2.1) -
Foreign currency forward contracts 28.0 - (11.1) - 17.0
Interest rate swaps - - - 15.1 -
DECS call option - - (154.9) - -
Other .3 .5 - - .5
----- ----- ------- ----- -------
Total derivative contracts $44.0 $17.5 $(354.2) $13.0 $ (88.8)
===== ===== ======= ===== =======
(1) Amounts deferred in accumulated other comprehensive income (AOCI) are
reflected net of tax.
The following tables summarize the gain (loss) and classification of the
company's financial derivative instruments in the Statement of Income for
the three and six month periods ending June 30, 2004 and 2003:
Three Months Ended Six Months Ended
June 30, 2004 June 30, 2004
-------------------------------- ----------------------------------
Costs and Other Costs and Other
Revenues Expenses Expense Revenues Expenses Expense
-------------------------------- ----------------------------------
Hedge Activity:
Oil and gas commodity derivatives $(155.4) $ - $ - $(216.8) $ - $ -
Foreign currency contracts .3 4.1 - .3 8.1 -
Interest rate swaps - 5.0 - - 9.3 -
Other - .3 - - .3 -
------- ---- ------ ------- ----- ------
Total hedging contracts (155.1) 9.4 - (216.5) 17.7 -
------- ---- ------ ------- ----- ------
Nonhedge Activity:
Oil and gas commodity derivatives
Kerr-McGee positions (9.8) - 2.6 (9.8) - 2.2
Acquired Westport positions 15.2 - - 15.2 - -
Gas marketing-related derivatives 1.4 - - 3.4 - (.9)
DECS call option - - (65.5) - - (71.9)
Other - - (.2) - - (.8)
------- ---- ------ ------- ----- ------
6.8 - (63.1) 8.8 - (71.4)
Total nonhedge contracts ------- ---- ------ ------- ----- ------
Total derivative contracts $(148.3) $9.4 $(63.1) $(207.7) $17.7 $(71.4)
======= ==== ====== ======= ===== ======
Three Months Ended Six Months Ended
June 30, 2003 June 30, 2003
-------------------------------- ----------------------------------
Costs and Other Costs and Other
Revenues Expenses Expense Revenues Expenses Expense
-------------------------------- ----------------------------------
Hedge Activity:
Oil and gas commodity derivatives $(49.9) $ - $ - $(166.6) $ - $ -
Foreign currency contracts - 3.7 - - 5.0 -
Interest rate swaps - 2.8 - - 5.5 -
------ ----- ------ ------- ----- ------
Total hedging contracts (49.9) 6.5 - (166.6) 10.5 -
------ ----- ------ ------- ----- ------
Nonhedge Activity:
Oil and gas commodity derivatives - - (.7) - - (4.1)
Gas marketing-related derivatives 1.1 - (3.4) (9.7) - (2.4)
DECS call option - - (41.9) - - (58.1)
Other - - (.2) - - (.3)
------ ----- ------ ------- ----- ------
Total nonhedge contracts 1.1 - (46.2) (9.7) - (64.9)
------ ----- ------ ------- ----- ------
Total derivative contracts $(48.8) $ 6.5 $(46.2) $(176.3) $10.5 $(64.9)
====== ===== ====== ======= ===== ======
The company periodically enters into financial derivative instruments that
generally fix the commodity prices to be received for a portion of its oil
and gas production in the future. The fair value of these derivative
instruments was determined based on prices actively quoted, generally NYMEX
and Dated Brent prices. For derivative instruments qualifying as cash flow
hedges, gains and losses are deferred in accumulated other comprehensive
income and reclassified into earnings when the associated hedged production
occurs. The company expects to reclassify deferred losses of $227.2 million
into earnings during the next 12 months (assuming no further changes in the
fair market value of the related contracts). Losses for hedge
ineffectiveness are recognized as a reduction to revenues in the
Consolidated Statement of Income and were not material for the three and
six month periods ending June 30, 2004 and 2003.
Between March 31, 2004 and April 6, 2004, Kerr-McGee entered into
additional financial derivative instruments in the form of fixed-price
swaps and costless collars relating to specified quantities of projected
2004-2006 production that was not already hedged. Certain crude oil and
natural gas swaps covering the period from August to December 2004 were
characterized initially as "nonhedge" derivatives in the second quarter of
2004, since Kerr-McGee's U.S. production (excluding Westport volumes) was
either already hedged or, in the case of Rocky Mountain production, the
company did not have sufficient basis swaps in place to ensure that the
hedges would be highly effective. Consequently, Kerr-McGee recognized
mark-to-market losses of $9.8 million in earnings during the second quarter
associated with these derivatives. In July 2004, after the Westport merger
closed and with sufficient oil and gas production now available, these
swaps were designated as hedges and, as such, future realized gains and
losses will be reflected in earnings when the hedged production is sold.
In connection with the merger, Kerr-McGee recognized a $195.7 million net
liability associated with Westport's existing commodity derivatives at the
merger date (June 25, 2004). Some of these derivative instruments were
designated as hedges in July 2004 in connection with the re-designation of
Kerr-McGee's acquisition-related derivatives described above, while others
do not qualify for hedge accounting treatment. As a result, Kerr-McGee
recognized a mark-to-market gain of $15.2 million in earnings during the
second quarter since the value of the net derivative liability had
decreased to $180.5 million by June 30, 2004.
Westport's derivatives in place at the merger date consisted of fixed-price
oil and gas swaps, natural gas basis swaps, and costless and three-way
collars. The fixed-price oil and gas swaps and natural gas basis swaps
qualify for hedge accounting and were designated as hedges in July 2004.
Accordingly, future realized gains and losses on those derivative
instruments will be reflected in earnings when the hedged production is
sold. However, the costless and three-way collars - each of which is in a
net liability position - do not qualify for hedge accounting treatment
under existing accounting standards because they represent "net written
options" at the merger date. As a result, even though these collars
effectively reduce commodity price risk for the combined company's
production, Kerr-McGee will continue to recognize mark-to-market gains and
losses in future earnings until the collars mature rather than defer such
amounts in accumulated other comprehensive income. The net derivative
liability associated with costless and three-way collars at June 30, 2004
was $71.1 million.
In addition to the company's hedging program, Kerr-McGee Rocky Mountain
Corp. holds certain gas basis swaps settling between 2004 and 2008. Through
December 2003, the company treated these gas basis swaps as nonhedge
derivatives, and changes in fair value were recognized in earnings. The
company has designated those swaps settling in 2004 and 2005 as hedges
since the basis swaps have now been coupled with natural gas fixed-price
swaps, while the remainder settling between 2006 and 2008 will continue to
be treated as nonhedge derivatives.
The company's marketing subsidiary, Kerr-McGee Energy Services Corporation
(KMES) markets natural gas (including equity gas) in the Denver area.
Contracts for the physical delivery of gas at fixed prices have not been
designated as hedges and are marked-to-market through earnings. KMES has
entered into natural gas swaps and basis swaps that offset its fixed-price
risk on physical contracts and lock in the margins associated with the
physical sale. The gains or losses on these derivative contracts, which
also are marked-to-market through earnings, substantially offset the gains
and losses from the fixed-price physical contracts.
From time to time, the company enters into forward contracts to buy and
sell foreign currencies. Certain of these contracts (purchases of
Australian dollars and British pound sterling, and sales of euro) have been
designated and have qualified as cash flow hedges of the company's
anticipated future cash flows related to pigment sales, operating costs,
capital expenditures and raw material purchases. These forward contracts
generally have durations of less than three years. Changes in the fair
value of these contracts are recorded in accumulated other comprehensive
loss and will be recognized in earnings in the periods during which the
hedged forecasted transactions affect earnings (i.e., when the forward
contracts close in the case of a hedge of sales revenues or operating
costs, when the hedged assets are depreciated in the case of a hedge of
capital expenditures and when finished inventory is sold in the case of a
hedged raw material purchase). The company expects to reclassify net gains
of approximately $7.9 million into earnings during the next 12 months,
assuming no further changes in the fair value of the contracts. No hedges
were discontinued during the first six months of 2004, and no
ineffectiveness was recognized.
In connection with the issuance of $350 million 5.375% notes due April 15,
2005, the company entered into an interest rate swap arrangement in April
2002. The terms of the agreement effectively change the interest the
company will pay on the debt until maturity from the fixed rate to a
variable rate of LIBOR plus .875%. During February 2004, the company
reviewed the composition of its outstanding debt and entered into
additional interest rate swaps, converting an aggregate of $566 million in
fixed-rate debt to variable-rate debt. Under the interest rate swaps, $150
million of 6.625% notes due October 15, 2007, will pay a variable rate of
LIBOR plus 3.35%; $109 million of 8.125% notes due October 15, 2005, will
pay a variable rate of LIBOR plus 5.86%; and $307 million of 5.875% notes
due September 15, 2006, will pay a variable rate of LIBOR plus 3.1%. The
company considers these swaps to be a hedge against the change in fair
value of the related debt as a result of interest rate changes. Any gain or
loss on the swaps is offset by a comparable gain or loss resulting from
recording changes in the fair value of the related debt. The critical terms
of the swaps match the terms of the debt; therefore, the swaps are
considered highly effective and no hedge ineffectiveness has been
recognized.
The company issued 5 1/2% notes exchangeable for common stock (DECS) in
August 1999, which allowed each holder to receive between .85 and 1.0 share
of Devon common stock or, at the company's option, an equivalent amount of
cash at maturity in August 2004. Embedded options in the DECS provided the
company a floor price on Devon's common stock of $33.19 per share (the put
option). The company also had the right to retain up to 15% of the shares
if Devon's stock price was greater than $39.16 per share (the DECS holders
had an embedded call option on 85% of the shares). Using the Black-Scholes
valuation model, the company recognized any gains or losses resulting from
changes in the fair value of the put and call options in other income. The
fluctuation in the value of the put and call derivative financial
instruments generally offset the increase or decease in the market value of
the Devon stock classified as trading, which is also recognized in other
income. The company recognized gains of $66.2 million and $43.7 million in
the three month periods ending June 30, 2004 and 2003, respectively,
related to the changes in market value of the Devon stock. In the
corresponding six month periods, the company recognized gains on
revaluation of the Devon stock of $73.7 million and $63.3 million,
respectively. The DECS and the derivative liability associated with the
call option are classified as current liabilities in the Consolidated
Balance Sheet as of June 30, 2004 and December 31, 2003. The DECS were
settled on August 2, 2004, with the distribution of shares of Devon common
stock.
Selected pigment receivables have been sold in an asset securitization
program at their equivalent U.S. dollar value at the date the receivables
were sold. The company is collection agent and retains the risk of foreign
currency rate changes between the date of sale and collection of the
receivables. Under the terms of the asset securitization agreement, the
company is required to enter into forward contracts for the value of the
euro-denominated receivables sold into the program to mitigate its foreign
currency risk.
The company has entered into other forward contracts to sell foreign
currencies that will be collected as a result of pigment sales denominated
in foreign currencies. These contracts have not been designated as hedges
even though they do protect the company from changes in foreign currency
rates.
D. Discontinued Operations and Asset Impairments
On March 31, 2003, the company completed the sale of its Kazakhstan
operations for $168.6 million in cash, recognizing a loss on sale of $6.1
million in results from discontinued operations during the first quarter of
2003. In connection with this sale, the company recorded an $18.6 million
settlement liability for the net cash flow of the Kazakhstan operations
from the effective date of the transaction to the closing date. The
settlement liability was paid during the third quarter of 2003. The net
proceeds received by the company were used to reduce outstanding debt.
Impairment losses totaling $14.3 million and $5.1 million were recognized
during the first six months of 2004 and 2003, respectively, for certain
assets used in operations that are not considered held for sale. The 2004
impairments related primarily to a U.S. Gulf of Mexico field that
experienced premature water breakthrough and ceased production sooner than
expected.
The company continues to review its options with respect to its 100%-owned
Leadon field and, particularly, the associated floating production, storage
and offloading (FPSO) facility. Management presently intends to continue
operating and producing the field until such time as the operating cash
flow generated by the field does not support continued production or until
a higher value option is identified. Given the significant value associated
with the FPSO relative to the size of the entire project, the company will
continue to pursue a long-term solution that achieves maximum value for
Leadon - which may include disposing of the field, monetizing the FPSO by
selling it as a development option for a third-party discovery, or
redeployment in other company operations. As of June 30, 2004, the carrying
value of the Leadon field assets totaled $358 million. Given the
uncertainty concerning possible outcomes, it is reasonably possible that
the company's estimate of future cash flows from the Leadon field and
associated fair value could change in the near term due to, among other
things, (i) unfavorable changes in commodity prices or operating costs,
(ii) a production profile that declines more rapidly than currently
anticipated, and/or (iii) unsuccessful results of marketing activities or
failure to locate a strategic buyer (or suitable redeployment opportunity).
Accordingly, management anticipates that the Leadon field will be subject
to periodic impairment review until such time as the field is abandoned or
sold. If future cash flows or fair value decrease from that presently
estimated, an additional write-down of the Leadon field could occur in the
future.
Capitalized costs associated with exploratory wells may be charged to
earnings in a future period if management determines that commercial
quantities of hydrocarbons have not been discovered. At June 30, 2004, the
company had capitalized costs of approximately $184 million associated with
such ongoing exploration activities, primarily in the deepwater Gulf of
Mexico, Brazil, Alaska and China.
In January 2004, the company announced the temporary idling of one line of
its sulfate-process titanium dioxide pigment production facilities at the
Savannah manufacturing plant, which is one of two sulfate-process trains
operated by the company worldwide. The line was temporarily idled because
of soft demand for sulfate-process titanium dioxide pigment. The sulfate
line has remained idle, as the market conditions have not sufficiently
improved. In addition, unanticipated cost issues associated with
underperforming plant and equipment discovered after the company acquired
the plant in 2000 have increased the cost profile of the plant from that
initially anticipated. The company is currently performing market analyses
and evaluating plant reconfiguration to explore means of best improving
operating results, while also evaluating its strategic options with respect
to the Savannah sulfate operations. During the second quarter, the company
operated its new high-productivity oxidation line for chloride at the
Savannah facility, which produced improved ore yields. The company is
evaluating the performance of this new oxidation line and expects to have a
better understanding of how the Savannah site might be reconfigured to
exploit its capabilities by the latter part of 2004. The possible
reconfiguration of the Savannah site, if any, as well as any decisions
regarding strategic options related to the sulfate operations, could
include redeployment of certain assets, idling of certain assets and
reduction of the future useful life of certain assets, resulting in the
acceleration of depreciation expense and the recognition of other charges.
E. Cash Flow Information
Net cash provided by operating activities reflects cash payments for income
taxes and interest as follows:
Six Months Ended
June 30,
------------------------
(Millions of dollars) 2004 2003
---------------------------------------------------------------------------
Income tax payments $ 89.5 $ 64.9
Less refunds received (3.3) (14.8)
------ ------
Net income tax payments $ 86.2 $ 50.1
====== ======
Interest payments $135.9 $119.0
====== ======
Noncash items affecting net income included in the reconciliation of net
income to net cash provided by operating activities include the following:
Six Months Ended
June 30,
---------------------
(Millions of dollars) 2004 2003
--------------------------------------------------------------------------
Incentive compensation provisions $ 34.4 $ 18.5
Increase in fair value of trading securities (1) (73.7) (63.3)
Increase in fair value of embedded options in
the DECS (1) 71.9 58.1
Net losses on equity method investments 14.7 12.8
Net periodic postretirement expense 13.4 11.2
Net periodic pension credit for qualified plan (10.6) (6.0)
Litigation reserve provisions - 6.5
All other (2) 19.9 31.4
------ ------
Total $ 70.0 $ 69.2
====== ======
Other net cash used in operating activities in the Consolidated Statement
of Cash Flows consists of the following:
Six Months Ended
June 30,
---------------------
(Millions of dollars) 2004 2003
--------------------------------------------------------------------------
Decrease due to changes in working capital accounts $(130.3) $ (83.7)
Environmental expenditures (44.1) (36.4)
All other (2) (36.8) (24.6)
------- -------
Total $(211.2) $(144.7)
======= =======
Information about noncash investing and financing activities not reflected
in the Consolidated Statement of Cash Flows follows:
Six Months Ended
June 30,
------------------
(Millions of dollars) 2004 2003
--------------------------------------------------------------------------
Noncash investing activities
Increase in property, plant and equipment (3) $3,462.0 $ -
Increase in fair value of trading securities (1) 73.7 63.3
Decrease in property related to Gunnison operating
lease agreement (4) (82.6) -
Increase in intangible assets (3) 46.2 -
Noncash financing activities
Issuance of common stock and stock options (3) 2,447.9 -
Long-term debt assumed (3) 1,045.5 -
Reduction in debt related to Gunnison operating
lease agreement (4) (75.3) -
Increase in fair value of embedded options in
the DECS (1) 71.9 58.1
(1) See Note C for a discussion of the accounting for the DECS.
(2) No other individual item is material to total cash flows from
operations.
(3) Noncash transaction related to Westport merger, see Note B.
(4) See Note H for a discussion of the Gunnison Synthetic Trust.
F. Comprehensive Income and Financial Instruments
Comprehensive income for the three and six months ended June 30, 2004 and
2003, is as follows:
Three Months Six Months
Ended Ended
June 30, June 30,
------------------ -------------------
(Millions of dollars) 2004 2003 2004 2003
----------------------------------------------------------------------------------------------------
Net income $110.6 $69.6 $ 262.8 $139.5
Unrealized gains on securities - 5.1 - 7.4
Reclassification of unrealized gains on available
for-sale securities included in net income - - (5.4) -
Change in fair value of cash flow hedges (93.5) 1.9 (184.4) (13.7)
Foreign currency translation adjustment (3.0) 17.1 (10.0) 28.0
Other - - 0.3 0.8
------ ----- ------- ------
Comprehensive income $ 14.1 $93.7 $ 63.3 $162.0
====== ===== ======= ======
The company has certain investments that are considered to be available for
sale. These financial instruments are carried in the Consolidated Balance
Sheet at fair value, which is based on quoted market prices. The company
had no securities classified as held to maturity at June 30, 2004 or
December 31, 2003. At June 30, 2004 and December 31, 2003,
available-for-sale securities for which fair value could be determined were
as follows:
June 30, 2004 December 31, 2003
------------------------------- --------------------------------
Gross Gross
Unrealized Unrealized
Fair Holding Fair Holding
(Millions of dollars) Value Cost Gain Value Cost Gain
-------------------------------------------------------------------------------------------------------------
Equity securities $ - $ - $ - $26.8 $9.8 $8.3(1)
U.S. government obligations 3.8 3.8 - 3.9 3.9 -
--- ----
Total $ - $8.3
=== ====
(1) This amount includes $8.6 million of gross unrealized hedging losses on
15% of the exchangeable debt at the time of adoption of FAS 133.
The equity securities represent the company's investment in Devon Energy
Corporation common stock. During January 2004, the company sold its
remaining Devon shares classified as available for sale for a pretax gain
of $9 million. Proceeds from the January sales totaled $27.4 million. The
cost of the shares sold and the amount of the gain reclassified from
accumulated other comprehensive income were determined using the average
cost of the shares held. The company also received proceeds of $11.5
million in January 2004 related to sales of Devon shares in December 2003,
with a 2004 settlement date.
G. Equity Affiliates
Investments in equity affiliates totaled $118.6 million at June 30, 2004,
and $123.1 million at December 31, 2003. Pretax equity loss related to the
investments is included in other income in the Consolidated Statement of
Income and totaled $6.4 million and $6.7 million for the three months ended
June 30, 2004 and 2003, respectively. For the first six months of 2004, the
loss in equity affiliates totaled $14.7 million, compared with $12.8
million for the same 2003 period.
H. Debt
As of June 30, 2004, long-term debt due within one year consisted of the
following:
June 30,
(Millions of dollars) 2004
---------------------------------------------------------------------------
5.375% Notes due April 15, 2005 $350.0
5.5% Exchangeable Notes (DECS) due August 2, 2004, net
of unamortized discount of $.6 million 329.7
8.375% Notes due July 15, 2004 145.0
Guaranteed Debt of Employee Stock Ownership Plan 9.61% Notes
due in installments through January 2, 2005 3.0
------
Total $827.7
======
Subsequent to June 30, 2004, the company used available cash to fund the
July 15, 2004 maturity of its 8.375% Notes. In addition, the company's 5.5%
Exchangeable Notes were settled on August 2, 2004, with the distribution of
shares of Devon common stock. See Note C for additional information
regarding the DECS.
As discussed in Note B, the company completed its acquisition of Westport
on June 25, 2004. In connection with the merger, Kerr-McGee assumed the
following Westport debt:
(Millions of dollars) Fair Value
---------------------------------------------------------------------------
8.25% Notes due 2011 (face value $700 million) $ 800.5
Revolving credit facility 245.0
--------
Total $1,045.5
========
On June 25, 2004, after completion of the merger, Kerr-McGee paid down all
outstanding borrowings under the Westport revolving credit facility.
Consequently, there were no borrowings outstanding under this credit
facility at June 30, 2004. However, letters of credit totaling $160 million
associated with Westport's derivatives were backed by the credit facility
and remained outstanding as of June 30, 2004. During July, these letters of
credit were cancelled and the Westport revolving credit facility was
terminated on July 13, 2004.
During June 2004, Kerr-McGee purchased Westport 8.25% Notes with an
aggregate principal amount of $14.5 million ($16.1 million fair value). The
fair value of the purchased notes is reflected as a reduction of long-term
debt assumed in the merger in the Consolidated Balance Sheet. On July 1,
2004, Kerr-McGee issued a notice of redemption for the 8.25% Westport notes
and the notes were redeemed on July 31, 2004 at an aggregate redemption
price of $785.5 million. The redemption price consisted of the face value
of $700 million, less the amount previously purchased by Kerr-McGee of
$14.5 million, plus a make-whole premium of $100 million.
On July 1, 2004, Kerr-McGee issued $650 million of 6.95% notes due July 1,
2024, with interest payable semi-annually. The notes were issued at 99.2%,
resulting in a discount of $5 million which will be recognized as
additional interest expense over the term of the notes. The proceeds from
this debt issuance, together with proceeds from borrowings under the
company's revolving credit facilities, were used to redeem the 8.25%
Westport notes discussed above.
During 2001, the company entered into a leasing arrangement with Kerr-McGee
Gunnison Trust (Gunnison Synthetic Trust) for the construction of the
company's share of a platform to be used in the development of the Gunnison
field, in which the company has a 50% working interest. Under the terms of
the agreement, the company financed its share of construction costs for the
platform under a synthetic lease credit facility between the trust and
groups of financial institutions for up to $157 million, with the company
making lease payments sufficient to pay interest at varying rates on the
notes. Construction of the platform was completed in December 2003, with
the company's share of construction costs totaling $149 million. On
December 31, 2003, $65.6 million of the synthetic lease facility was
converted to a leveraged lease structure, whereby the company leases an
interest in the platform under an operating lease agreement from a separate
business trust.
Both the Gunnison Synthetic Trust and the new operating lease trust are
considered variable interest entities under the provisions of FASB
Interpretation No. 46, "Consolidation of Variable Interest Entities - an
Interpretation of ARB No. 51." As such, the company is required to analyze
its relationship with each trust to determine whether the company is the
primary beneficiary and, if so, required to consolidate the trusts. Based
on the analyses performed, the company is not the primary beneficiary of
the operating lease trust; however, the company was considered the primary
beneficiary of the Gunnison Synthetic Trust. Accordingly, the remaining
assets and liabilities of the Gunnison Synthetic Trust were reflected in
the company's Consolidated Balance Sheet at December 31, 2003, which
included $82.6 million in property, plant and equipment, $3.8 million in
accrued liabilities, $75.3 million in long-term debt, and $3.5 million in
minority interest. On January 15, 2004, the remaining $82.6 million of the
synthetic lease facility was converted to a leveraged lease structure, and
the related lessor trust is not subject to consolidation. As a result, the
associated property and debt are not reflected in the company's
Consolidated Balance Sheet at June 30, 2004.
I. Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share (EPS) from continuing operations for the three-month and
six-month periods ended June 30, 2004 and 2003.
For the Three Months Ended June 30,
------------------------------------------------------------------------------
2004 2003
-------------------------------------- -------------------------------------
Income from Income from
(In millions, except Continuing Per-Share Continuing Per-Share
per-share amounts) Operations Shares Income Operations Shares Income
--------------------------------------------------------------------------------------------------------------
Basic EPS $110.6 103.6 $1.07 $69.8 100.1 $.70
===== ====
Effect of dilutive securities:
5 1/4% convertible
debentures 5.3 9.8 5.3 9.8
Restricted stock - 1.1 - .7
Stock options - .3 - .1
------ ----- ----- -----
Diluted EPS $115.9 114.8 $1.01 $75.1 110.7 $.68
====== ===== ===== ===== ===== ====
For the Six Months Ended June 30,
------------------------------------------------------------------------------
2004 2003
-------------------------------------- -------------------------------------
Income from Income from
(In millions, except Continuing Per-Share Continuing Per-Share
per-share amounts) Operations Shares Income Operations Shares Income
--------------------------------------------------------------------------------------------------------------
Basic EPS $262.8 102.0 $2.58 $174.0 100.1 $1.73
===== =====
Effect of dilutive securities:
5 1/4% convertible
debentures 10.7 9.8 10.7 9.8
Restricted stock - 1.0 - .7
Stock options - .3 - -
------ ----- ------ -----
Diluted EPS $273.5 113.1 $2.42 $184.7 110.6 $1.67
====== ===== ===== ====== ===== =====
J. Accounts Receivable Sales
In December 2000, the company began an accounts receivable monetization
program for its pigment business through the sale of selected accounts
receivable with a three-year, credit-insurance-backed asset securitization
program. On July 30, 2003, the company restructured the existing accounts
receivable monetization program to include the sale of receivables
originated by the company's European chemical operations. The company is
currently in the process of renewing the program and expects to have the
renewal completed during the third quarter of 2004. The maximum
availability under the program is $165 million. Under the terms of the
program, selected qualifying customer accounts receivable may be sold
monthly to a special-purpose entity (SPE), which in turn sells an undivided
ownership interest in the receivables to a third-party multi-seller
commercial paper conduit sponsored by an independent financial institution.
The company sells, and retains an interest in, excess receivables to the
SPE as over-collateralization for the program. The company's retained
interest in the SPE's receivables is classified in trade accounts
receivable in the accompanying Consolidated Balance Sheet. The retained
interest is subordinate to, and provides credit enhancement for, the
conduit's ownership interest in the SPE's receivables, and is available to
the conduit to pay certain fees or expenses due to the conduit, and to
absorb credit losses incurred on any of the SPE's receivables in the event
of termination. However, the company believes that the risk of credit loss
is very low since its bad-debt experience has historically been
insignificant. The company retains servicing responsibilities and receives
a servicing fee of 1.07% of the receivables sold for the period of time
outstanding, generally 60 to 120 days. No recourse obligations were
recorded since the company has no obligations for any recourse actions on
the sold receivables. The company also holds preference stock in the
special-purpose entity equal to 3.5% of the receivables sold. The
preference stock is essentially a retained deposit to provide further
credit enhancements, if needed, but otherwise recoverable by the company at
the end of the program.
The company sold $304 million and $155.7 million of its pigment receivables
during the second quarter of 2004 and 2003, respectively and $540.9 million
and $312.5 million during the first six months of 2004 and 2003,
respectively. Losses, though not material, are recorded on the receivable
sales equal to the difference in the book value of the receivables sold and
the total of cash and the fair value of the deposit retained by the
special-purpose entity. The outstanding balance on receivables sold, net of
the company's retained interest in receivables serving as
over-collateralization, totaled $165 million at both June 30, 2004 and
December 31, 2003.
K. Work Force Reduction, Restructuring Provisions and Exit Activities
In connection with the Westport merger, the company recognized liabilities
of $18.9 million associated with severance and relocation costs for certain
former Westport employees. Terminations of 23 employees occurred on June
25, 2004, and 44 employees remaining for transitional purposes will be
terminated no later than June 25, 2005.
In September 2003, the company announced a program to reduce its U.S.
nonbargaining work force through both voluntary retirements and involuntary
terminations. As a result of the program, the company's eligible U.S.
nonbargaining work force was reduced by approximately 9%, or 271 employees.
Qualifying employees terminated under this program became eligible for
enhanced benefits under the company's pension and postretirement plans,
along with severance payments. The program was substantially completed by
the end of 2003, with certain retiring employees staying into the first
half of 2004 for transition purposes. In connection with the work force
reduction, the company recognized a pretax charge of $56.4 million during
the latter half of 2003, of which $34.2 million was for curtailment and
special termination benefits associated with the company's retirement plans
and $22.2 million was for severance-related costs. The remaining provision
for severance-related costs is included in the restructuring reserve table
below. Of the $22.2 million severance-related provision, $18.6 million has
been paid through the second quarter of 2004, with $3.6 million remaining
in the accrual at June 30, 2004.
During 2003, the company's chemical - pigment operating unit provided $60.8
million pretax for costs associated with the closure of its synthetic
rutile plant in Mobile, Alabama. Included in the $60.8 million were $14.1
million for the cumulative effect of change in accounting principle related
to the recognition of an asset retirement obligation, $15.2 million for
accelerated depreciation, $14.9 million for other shut-down related costs,
$10.5 million for severance benefits and $6.1 million for benefit plan
curtailment costs. The provision for severance benefits is included in the
restructuring reserve table below (see Note N for a discussion of the asset
retirement obligation). Of the total $10.5 million severance accrual, $8.6
million has been paid through the second quarter of 2004. Approximately 135
employees will ultimately be terminated in connection with this plant
closure, of which 117 had been terminated as of June 30, 2004.
During 2002, the company's chemical - other operating unit provided $16.5
million for costs associated with its plans to exit the forest products
business. The company provided an additional $5.1 million in 2003 for
severance benefits associated with exiting the forest products business, of
which $3.6 million was recorded during the first six months of 2003. During
the first six months of 2004, the company provided an additional $1.2
million for dismantlement and closure costs. These costs are reflected in
costs and operating expenses in the Consolidated Statement of Income.
Included in the total provision of $22.8 million were $16.7 million for
dismantlement and closure costs, and $6.1 million for severance costs. Of
the total provision, $14 million has been paid through the 2004 second
quarter and $8.2 million remained in the accrual at June 30, 2004. In
connection with the plant closures, 252 employees will be terminated, of
which 202 had been terminated as of June 30, 2004.
In 2001, the company's chemical - pigment operating unit provided $31.8
million pretax related to the closure of a plant in Antwerp, Belgium. Of
this total accrual, $27.1 million had been paid through the 2004 second
quarter and $4.4 million remained in the accrual at June 30, 2004. As a
result of this plant closure, 121 employees were terminated.
The provisions, payments, adjustments and restructuring reserve balances
for the six-month period ended June 30, 2004, are included in the table
below.
Dismantlement
Personnel and
(Millions of dollars) Total Costs Closure
--------------------------------------------------------------------------
December 31, 2003 $ 39.1 $ 26.5 $12.6
Westport severance/relocation 18.9 18.9 -
Provisions 1.2 - 1.2
Payments (21.2) (16.7) (4.5)
Adjustments - (.3) .3
------ ------ -----
June 30, 2004 $ 38.0 $ 28.4 $ 9.6
====== ====== =====
L. Condensed Consolidating Financial Information
On October 3, 2001, Kerr-McGee Corporation issued $1.5 billion of long-term
notes in a public offering. The notes are general, unsecured obligations of
the company and rank in parity with all of the company's other unsecured
and unsubordinated indebtedness. Kerr-McGee Chemical Worldwide LLC and
Kerr-McGee Rocky Mountain Corporation have guaranteed the notes.
Additionally, Kerr-McGee Corporation has guaranteed all indebtedness of its
subsidiaries, including the indebtedness assumed in the purchase of HS
Resources. As a result of these guarantee arrangements, the company is
required to present condensed consolidating financial information. The top
holding company is Kerr-McGee Corporation. The guarantor subsidiaries
include Kerr-McGee Chemical Worldwide LLC and Kerr-McGee Rocky Mountain
Corporation.
The following tables present condensed consolidating financial information
for (a) Kerr-McGee Corporation, the parent company, (b) the guarantor
subsidiaries, and (c) the non-guarantor subsidiaries on a consolidated
basis.
Kerr-McGee Corporation and Subsidiary Companies
Condensed Consolidating Statement of Income
For the Three Months Ended June 30, 2004
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------
Revenues $ - $215.6 $881.5 $ - $1,097.1
------ ------ ------ ------- --------
Costs and Expenses
Costs and operating expenses - 109.2 324.0 (.6) 432.6
Selling, general and administrative expenses .7 .6 78.8 - 80.1
Shipping and handling expenses - 1.9 36.5 - 38.4
Depreciation and depletion - 30.2 160.8 - 191.0
Accretion expense - .6 6.2 - 6.8
Impairments on assets held for use - - 1.1 - 1.1
Loss associated with assets held for sale - .1 3.8 - 3.9
Exploration, including dry holes and
amortization of undeveloped leases - 2.9 62.6 - 65.5
Taxes, other than income taxes .1 9.1 19.4 - 28.6
Provision for environmental remediation
and restoration, net of reimbursements - 7.1 .3 - 7.4
Interest and debt expense 26.6 8.9 70.0 (49.8) 55.7
------ ------ ------ ------- --------
Total Costs and Expenses 27.4 170.6 763.5 (50.4) 911.1
------ ------ ------ ------- --------
(27.4) 45.0 118.0 50.4 186.0
Other Income (Expense) 206.4 16.4 20.2 (250.0) (7.0)
------ ------ ------ ------- --------
Income before Income Taxes 179.0 61.4 138.2 (199.6) 179.0
Provision for Income Taxes (68.4) (22.4) (54.0) 76.4 (68.4)
------ ----- ------ ------- --------
Net Income $110.6 $ 39.0 $ 84.2 $(123.2) $ 110.6
====== ====== ====== ======= ========
Kerr-McGee Corporation and Subsidiary Companies
Condensed Consolidating Statement of Income
For the Three Months Ended June 30, 2003
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------
Revenues $ - $169.3 $887.6 $ (4.3) $1,052.6
------ ------ ------ ------- --------
Costs and Expenses
Costs and operating expenses - 82.1 361.6 (4.6) 439.1
Selling, general and administrative expenses - 3.0 76.1 - 79.1
Shipping and handling expenses - 2.1 32.9 - 35.0
Depreciation and depletion - 30.4 162.6 - 193.0
Accretion expense - .6 5.7 - 6.3
Loss (gain) associated with assets held for sale - 1.7 (2.2) - (.5)
Exploration, including dry holes and
amortization of undeveloped leases - 2.9 63.7 - 66.6
Taxes, other than income taxes .1 3.2 17.7 - 21.0
Provision for environmental remediation
and restoration, net of reimbursements - .7 1.2 - 1.9
Interest and debt expense 28.8 8.3 70.0 (43.7) 63.4
------ ------ ------ ------- --------
Total Costs and Expenses 28.9 135.0 789.3 (48.3) 904.9
------ ------ ------ ------- --------
(28.9) 34.3 98.3 44.0 147.7
Other Income (Expense) 149.7 (25.8) 14.7 (165.5) (26.9)
------ ------ ------ ------- --------
Income from Continuing Operations
before Income Taxes 120.8 8.5 113.0 (121.5) 120.8
Benefit (Provision) for Income Taxes (51.2) 1.4 (45.9) 44.7 (51.0)
------ ------ ------ ------- --------
Income from Continuing Operations 69.6 9.9 67.1 (76.8) 69.8
Income (Loss) from Discontinued Operations,
net of tax - .4 (.6) - (.2)
------ ------ ------ ------- --------
Net Income $ 69.6 $ 10.3 $ 66.5 $ (76.8) $ 69.6
====== ====== ====== ======= ========
Kerr-McGee Corporation and Subsidiary Companies
Condensed Consolidating Statement of Income
For the Six Months Ended June 30, 2004
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------
Revenues $ - $426.5 $1,786.9 $ - $2,213.4
------- ------ -------- ------- --------
Costs and Expenses
Costs and operating expenses - 218.9 617.7 (1.0) 835.6
Selling, general and administrative expenses .7 .7 162.3 - 163.7
Shipping and handling expenses - 3.6 72.5 - 76.1
Depreciation and depletion - 60.2 321.1 - 381.3
Accretion expense - 1.3 12.1 - 13.4
Impairments on assets held for use - .9 13.4 - 14.3
Loss associated with assets held for sale - .1 7.2 - 7.3
Exploration, including dry holes and
amortization of undeveloped leases - 6.5 109.6 - 116.1
Taxes, other than income taxes .1 17.4 39.5 - 57.0
Provision for environmental remediation
and restoration, net of reimbursements - 6.3 .3 - 6.6
Interest and debt expense 54.1 18.1 139.3 (98.8) 112.7
------- ------ -------- ------- --------
Total Costs and Expenses 54.9 334.0 1,495.0 (99.8) 1,784.1
------- ------ -------- ------- --------
(54.9) 92.5 291.9 99.8 429.3
Other Income (Expense) 476.9 9.8 49.3 (543.3) (7.3)
------- ------ -------- ------- --------
Income before Income Taxes 422.0 102.3 341.2 (443.5) 422.0
Provision for Income Taxes (159.2) (36.8) (131.6) 168.4 (159.2)
------- ------ -------- ------- --------
Net Income $ 262.8 $ 65.5 $ 209.6 $(275.1) $ 262.8
======= ====== ======== ======= ========
Kerr-McGee Corporation and Subsidiary Companies
Condensed Consolidating Statement of Income
For the Six Months Ended June 30, 2003
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------
Revenues $ - $323.1 $1,835.5 $ (6.4) $2,152.2
------ ------ -------- ------- --------
Costs and Expenses
Costs and operating expenses - 153.6 677.1 (7.2) 823.5
Selling, general and administrative expenses - 10.1 139.9 - 150.0
Shipping and handling expenses - 4.7 62.3 - 67.0
Depreciation and depletion - 60.3 322.3 - 382.6
Accretion expense - 1.2 11.3 - 12.5
Impairments on assets held for use - - 5.1 - 5.1
Loss (gain) associated with assets held for sale - 1.6 (7.3) - (5.7)
Exploration, including dry holes and
amortization of undeveloped leases - 6.8 200.3 - 207.1
Taxes, other than income taxes .2 8.7 37.5 - 46.4
Provision for environmental remediation
and restoration, net of reimbursements - 5.8 13.4 - 19.2
Interest and debt expense 57.7 16.7 142.8 (88.8) 128.4
------ ------ -------- ------- --------
Total Costs and Expenses 57.9 269.5 1,604.7 (96.0) 1,836.1
------ ------ -------- ------- --------
(57.9) 53.6 230.8 89.6 316.1
Other Income (Expense) 296.3 (25.2) 44.6 (340.9) (25.2)
------ ------ -------- ------- --------
Income from Continuing Operations
before Income Taxes 238.4 28.4 275.4 (251.3) 290.9
Provision for Income Taxes (98.9) (2.8) (107.1) 91.9 (116.9)
------ ------ -------- ------- --------
Income from Continuing Operations 139.5 25.6 168.3 (159.4) 174.0
Income (Loss) from Discontinued Operations,
net of tax - 12.4 (12.2) - .2
Cumulative Effect of Change in Accounting
Principle, net of tax - (1.3) (33.4) - (34.7)
------ ------ -------- ------- --------
Net Income $139.5 $ 36.7 $ 122.7 $(159.4) $ 139.5
====== ====== ======== ======= ========
Kerr-McGee Corporation and Subsidiary Companies
Condensed Consolidating Balance Sheet
June 30, 2004
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------
ASSETS
- ------
Current Assets
Cash $ 1.8 $ - $ 102.9 $ - $ 104.7
Intercompany receivables .1 - 49.8 (49.9) -
Accounts receivable - 116.1 601.2 - 717.3
Inventories - 3.4 401.3 - 404.7
Deposits, prepaid expenses and other assets 16.3 19.7 682.9 (16.3) 702.6
Deferred income taxes .2 21.1 185.1 206.4
-------- -------- --------- --------- ---------
Total Current Assets 18.4 160.3 2,023.2 (66.2) 2,135.7
Property, Plant and Equipment - Net - 1,968.6 8,847.1 - 10,815.7
Investments in Subsidiaries 5,907.0 732.1 - (6,639.1) -
Investments and Other Assets 11.6 73.4 647.9 (79.6) 653.3
Goodwill - 346.3 850.6 - 1,196.9
Long-term Assets Associated with Properties
Held for Disposal - - 1.3 - 1.3
-------- -------- --------- --------- ---------
Total Assets $5,937.0 $3,280.7 $12,370.1 $(6,784.9) $14,802.9
======== ======== ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Intercompany borrowings $ 59.3 $ 772.3 $ 760.6 $(1,592.2) $ -
Accounts payable 45.6 44.9 386.7 - 477.2
Long-term debt due within one year 350.0 - 477.7 - 827.7
Other current liabilities 23.4 200.1 1,476.4 (3.0) 1,696.9
-------- -------- --------- --------- ---------
Total Current Liabilities 478.3 1,017.3 3,101.4 (1,595.2) 3,001.8
Long-Term Debt 1,479.4 - 2,064.7 (16.1) 3,528.0
Other Liabilities and Deferred Credits 8.9 677.1 2,510.8 (1.0) 3,195.8
Long-Term Liabilities Associated with
Properties Held for Disposal - - .5 - .5
Stockholders' Equity 3,970.4 1,586.3 4,692.7 (5,172.6) 5,076.8
-------- -------- --------- --------- ---------
Total Liabilities and Stockholders' Equity $5,937.0 $3,280.7 $12,370.1 $(6,784.9) $14,802.9
======== ======== ========= ========= =========
Kerr-McGee Corporation and Subsidiary Companies
Condensed Consolidating Balance Sheet
December 31, 2003
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------
ASSETS
- ------
Current Assets
Cash $ 2.2 $ - $ 139.8 $ - $ 142.0
Intercompany receivables 7.0 - 58.8 (65.8) -
Accounts receivable - 125.2 458.1 - 583.3
Inventories - 5.4 388.0 - 393.4
Deposits, prepaid expenses and other assets - 17.9 619.5 - 637.4
Deferred income taxes 1.4 17.7 56.9 - 76.0
Current assets associated with properties
held for disposal - - .4 - .4
-------- -------- -------- --------- ---------
Total Current Assets 10.6 166.2 1,721.5 (65.8) 1,832.5
Property, Plant and Equipment - Net - 1,966.6 5,436.3 - 7,402.9
Investments in Subsidiaries 3,181.6 732.4 - (3,914.0) -
Investments and Other Assets 10.2 104.7 593.6 (79.6) 628.9
Goodwill - 346.4 10.9 - 357.3
Long-term Assets Associated with Properties
Held for Disposal - - 28.3 - 28.3
-------- -------- -------- --------- ---------
Total Assets $3,202.4 $3,316.3 $7,790.6 $(4,059.4) $10,249.9
======== ======== ======== ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current Liabilities
Intercompany borrowings $ 68.6 $ 892.9 $1,088.9 $(2,050.4) $ -
Accounts payable 45.4 38.9 391.2 - 475.5
Long-term debt due within one year - - 574.3 - 574.3
Other current liabilities 36.8 173.2 971.8 - 1,181.8
-------- -------- -------- --------- ---------
Total Current Liabilities 150.8 1,105.0 3,026.2 (2,050.4) 2,231.6
Long-Term Debt 1,829.3 - 1,251.9 - 3,081.2
Other Liabilities and Deferred Credits (4.5) 696.0 1,595.7 (1.9) 2,285.3
Long-Term Liabilities Associated with
Properties Held for Disposal - - 16.0 - 16.0
Stockholders' Equity 1,226.8 1,515.3 1,900.8 (2,007.1) 2,635.8
-------- -------- -------- --------- ---------
Total Liabilities and Stockholders' Equity $3,202.4 $3,316.3 $7,790.6 $(4,059.4) $10,249.9
======== ======== ======== ========= =========
Kerr-McGee Corporation and Subsidiary Companies
Condensed Consolidating Statement of Cash Flows
For the Six Months Ended June 30, 2004
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------
Operating Activities
- --------------------
Net income $ 262.8 $ 65.5 $ 209.6 $(275.1) $ 262.8
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities -
Depreciation, depletion and amortization - 63.8 343.7 - 407.5
Accretion expense - 1.3 12.1 - 13.4
Impairments on assets held for use - .9 13.4 - 14.3
Loss associated with assets held for use - .1 7.2 - 7.3
Dry hole costs - (0.1) 26.2 - 26.1
Deferred income taxes 14.6 7.6 88.4 - 110.6
Equity in (earnings) losses of subsidiaries (272.5) (3.7) - 276.2 -
Provision for environmental remediation
and restoration, net of reimbursements - 6.3 .3 - 6.6
Noncash items affecting net income .1 16.9 53.0 - 70.0
Other net cash used in operating activities (29.9) (5.3) (174.9) (1.1) (211.2)
------- ------ ------- ------- -------
Net Cash Provided by (Used in)
Operating Activities (24.9) 153.3 579.0 - 707.4
------- ------ ------- ------- -------
Investing Activities
- --------------------
Capital expenditures - (66.7) (366.2) - (432.9)
Dry hole costs - .1 (26.2) - (26.1)
Westport acquisition - - 43.0 - 43.0
Proceeds from sales of assets - .2 3.1 - 3.3
Other investing activities (16.1) - 29.0 - 12.9
------- ------ ------- ------- -------
Net Cash Used in Investing Activities (16.1) (66.4) (317.3) - (399.8)
------- ------ ------- ------- -------
Financing Activities
- --------------------
Increase (decrease) in intercompany
notes payable 124.6 (86.9) (37.7) - -
Issuance of long-term debt - - 86.0 - 86.0
Repayment of long-term debt - - (347.0) - (347.0)
Issuance of common stock 7.0 - - - 7.0
Dividends paid (91.0) - - - (91.0)
------- ------ ------- ------- -------
Net Cash Provided by (Used in)
Financing Activities 40.6 (86.9) (298.7) - (345.0)
------- ------ ------- ------- -------
Effects of Exchange Rate Changes on Cash
and Cash Equivalents - - .1 - .1
------- ------ ------- ------- -------
Net Decrease in Cash and Cash Equivalents (.4) - (36.9) - (37.3)
Cash and Cash Equivalents at Beginning of
Period 2.2 - 139.8 - 142.0
------- ------ ------- ------- -------
Cash and Cash Equivalents at End of Period $ 1.8 $ - $ 102.9 $ - $ 104.7
======= ====== ======= ======= =======
Kerr-McGee Corporation and Subsidiary Companies
Condensed Consolidating Statement of Cash Flows
For the Six Months Ended June 30, 2003
Non-
Kerr-McGee Guarantor Guarantor
(Millions of dollars) Corporation Subsidiaries Subsidiaries Eliminations Consolidated
- -----------------------------------------------------------------------------------------------------------------------
Operating Activities
- --------------------
Net income $ 139.5 $ 36.7 $ 122.7 $(159.4) $ 139.5
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities -
Depreciation, depletion and amortization - 62.5 357.4 - 419.9
Accretion expense - 1.2 11.3 - 12.5
Impairments on assets held for use - - 5.1 - 5.1
Loss associated with assets held for sale - - .5 - .5
Equity in (earnings) losses of subsidiaries (152.6) 31.9 - 120.7 -
Dry hole costs - - 128.2 - 128.2
Deferred income taxes - 50.8 30.0 - 80.8
Provision for environmental remediation
and restoration, net of reimbursements - 5.8 13.4 - 19.2
Cumulative effect of change in accounting
principle - 1.3 33.4 - 34.7
Noncash items affecting net income .9 14.6 53.7 - 69.2
Other net cash used in operating activities (7.4) (133.6) (3.7) - (144.7)
------- ------- ------- ------- -------
Net Cash Provided by (Used in)
Operating Activities (19.6) 71.2 752.0 (38.7) 764.9
------- ------- ------- ------- -------
Investing Activities
- --------------------
Capital expenditures - (61.2) (456.7) - (517.9)
Dry hole costs - - (128.2) - (128.2)
Proceeds from sales of assets - 7.1 188.8 - 195.9
Other investing activities - - (14.8) - (14.8)
------- ------- ------- ------- -------
Net Cash Used in Investing Activities - (54.1) (410.9) - (465.0)
------- ------- ------- ------- -------
Financing Activities
- --------------------
Issuance of long-term debt - - 31.5 - 31.5
Repayment of long-term debt - - (222.3) - (222.3)
Increase (decrease) in intercompany
notes payable 109.8 (17.1) (92.7) - -
Dividends paid (90.6) - (39.6) 39.6 (90.6)
Other financing activities - - .3 (.9) (.6)
------- ------- ------- ------- -------
Net Cash Provided by (Used in)
Financing Activities 19.2 (17.1) (322.8) 38.7 (282.0)
------- ------- ------- ------- -------
Effects of Exchange Rate Changes on Cash
and Cash Equivalents - - .8 - .8
------- ------- ------- ------- -------
Net Increase (Decrease) in Cash and Cash
Equivalents (.4) - 19.1 - 18.7
Cash and Cash Equivalents at Beginning of
Period 2.5 - 87.4 - 89.9
------- ------- ------- ------- -------
Cash and Cash Equivalents at End of Period $ 2.1 $ - $ 106.5 $ - $ 108.6
======= ======= ======= ======= =======
M. Contingencies
West Chicago, Illinois
In 1973, the company's chemical affiliate (Chemical) closed a facility in
West Chicago, Illinois, that processed thorium ores for the federal
government and for certain commercial purposes. Historical operations had
resulted in low-level radioactive contamination at the facility and in
surrounding areas. The original processing facility is regulated by the
State of Illinois (the State), and four vicinity areas are designated as
Superfund sites on the National Priorities List (NPL).
Closed Facility - Pursuant to agreements reached in 1994 and 1997 among
Chemical, the City of West Chicago (the City) and the State regarding the
decommissioning of the closed West Chicago facility, Chemical has
substantially completed the excavation of contaminated soils and has
shipped the bulk of those soils to a licensed disposal facility. Removal of
the remaining materials is expected to be substantially completed by the
end of 2004, leaving principally surface restoration and groundwater
monitoring and/or remediation for subsequent years. Surface restoration is
expected to be completed in 2004, except for areas designated for use in
connection with the Kress Creek and Sewage Treatment Plant remediation
discussed below. The long-term scope, duration and cost of groundwater
monitoring and/or remediation are uncertain because it is not possible to
reliably predict how groundwater conditions have been affected by the
excavation and removal work.
Vicinity Areas - The Environmental Protection Agency (EPA) has listed four
areas in the vicinity of the closed West Chicago facility on the NPL and
has designated Chemical as a Potentially Responsible Party (PRP) in these
four areas. Chemical has substantially completed remedial work for two of
the areas (known as the Residential Areas and Reed-Keppler Park). The other
two NPL sites, known as Kress Creek and the Sewage Treatment Plant, are
contiguous and involve low levels of insoluble thorium residues,
principally in streambanks and streambed sediments, virtually all within a
floodway. Chemical has reached an agreement in principle with the
appropriate federal and state agencies and local communities regarding the
characterization and cleanup of the sites, past and future government
response costs, and the waiver of natural resource damage claims. The
agreement in principle is expected to be incorporated in a consent decree,
which must be agreed to by the appropriate federal and state agencies and
local communities and then entered by a federal court. It is anticipated
that the consent decree will be filed with the court in 2004 and approved
by the court in due course thereafter. Chemical has already conducted an
extensive characterization of Kress Creek and the Sewage Treatment Plant
and, at the request of EPA, Chemical is conducting limited additional
characterization that is expected to be completed in 2004. The cleanup
work, which is expected to take about four years to complete following
entry of the consent decree, will require excavation of contaminated soils
and stream sediments, shipment of excavated materials to a licensed
disposal facility and restoration of affected areas.
Financial Reserves - As of June 30, 2004, the company had remaining
reserves of $87 million for costs related to West Chicago. Although actual
costs may exceed current estimates, the amount of any increase cannot be
reasonably estimated at this time. The amount of the reserve is not reduced
by reimbursements expected from the federal government under Title X of the
Energy Policy Act of 1992 (Title X) (discussed below).
Government Reimbursement - Pursuant to Title X, the U.S. Department of
Energy (DOE) is obligated to reimburse Chemical for certain decommissioning
and cleanup costs incurred in connection with the West Chicago sites in
recognition of the fact that about 55% of the facility's production was
dedicated to U.S. government contracts. The amount authorized for
reimbursement under Title X is $365 million plus inflation adjustments.
That amount is expected to cover the government's full share of West
Chicago cleanup costs. Through June 30, 2004, Chemical had been reimbursed
approximately $215 million under Title X.
Reimbursements under Title X are provided by congressional appropriations.
Historically, congressional appropriations have lagged Chemical's cleanup
expenditures. As of June 30, 2004, the government's share of costs incurred
by Chemical but not yet reimbursed by the DOE totaled approximately $70
million. The company believes receipt of the remaining arrearage in due
course following additional congressional appropriations is probable and
has reflected the arrearage as a receivable in the financial statements.
The company expects to receive $30 million in reimbursements for this
receivable within the next 12 months and the remainder by the end of 2006,
and will recognize recovery of the government's share of future remediation
costs for the West Chicago sites as Chemical incurs the costs.
Henderson, Nevada
In 1998, Chemical decided to exit the ammonium perchlorate business. At
that time, Chemical curtailed operations and began preparation for the
shutdown of the associated production facilities in Henderson, Nevada, that
produced ammonium perchlorate and other related products. Manufacture of
perchlorate compounds began at Henderson in 1945 in facilities owned by the
U.S. government. The U.S. Navy expanded production significantly in 1953
when it completed construction of a plant for the manufacture of ammonium
perchlorate. The Navy continued to own the ammonium perchlorate plant as
well as other associated production equipment at Henderson until 1962, when
the plant was purchased by a predecessor of Chemical. The ammonium
perchlorate produced at the Henderson facility was used primarily in
federal government defense and space programs. Perchlorate has been
detected in nearby Lake Mead and the Colorado River.
Chemical began decommissioning the facility and remediating associated
perchlorate contamination, including surface impoundments and groundwater
when it decided to exit the business in 1998. In 1999 and 2001, Chemical
entered into consent orders with the Nevada Division of Environmental
Protection that require Chemical to implement both interim and long-term
remedial measures to capture and remove perchlorate from groundwater.
In 1999, Chemical initiated the interim measures required by the consent
orders. Construction of a long-term remediation system is complete, and the
system is operating. It is anticipated that performance testing will be
completed during the third quarter of 2004. The scope, duration and cost of
groundwater remediation will be driven in the long term by drinking water
standards, which to date have not been formally established by state or
federal regulatory authorities. EPA and other federal and state agencies
currently are evaluating the health and environmental risks associated with
perchlorate as part of the process for ultimately setting drinking water
standards. One state agency, the California Environmental Protection Agency
(CalEPA), has set a public health goal for perchlorate, which is a
preliminary step to setting a drinking water standard. The establishment of
drinking water standards could materially affect the scope, duration and
cost of the long-term groundwater remediation that Chemical is required to
perform.
Financial Reserves - Remaining reserves for Henderson totaled $14 million
as of June 30, 2004. As noted above, the long-term scope, duration and cost
of groundwater remediation are uncertain and, therefore, additional costs
may be incurred in the future. However, the amount of any additional costs
cannot be reasonably estimated at this time.
Government Litigation - In 2000, Chemical initiated litigation against the
United States seeking contribution for response costs. The suit is based on
the fact that the government owned the plant in the early years of its
operation, exercised significant control over production at the plant and
the sale of products produced at the plant, and was the largest consumer of
products produced at the plant. The litigation is in the discovery stage.
Although the outcome of the litigation is uncertain, Chemical believes it
is likely to recover a portion of its costs from the government. The amount
and timing of any recovery cannot be estimated at this time and,
accordingly, the company has not recorded a receivable or otherwise
reflected in the financial statements any potential recovery from the
government.
In addition, on July 26, 2004, the company was served with a lawsuit, which
was filed in the United States District Court for the District of Arizona.
The lawsuit, Alan Curtis and Linda Curtis v. City of Bullhead City, et al.,
in which the company is one of several defendants (the Defendants), alleges
various causes of action under a variety of common law theories and federal
environmental laws and seeks recovery for damages allegedly caused by the
exposure to and the migration of various chemical contaminants contained in
the Colorado River. Plaintiffs also seek an order requiring the Defendants
to remediate the contamination. The company intends to vigorously defend
against the lawsuit. The company believes that the litigation will not have
a material adverse effect on its financial position or results of
operations.
Insurance - In 2001, Chemical purchased a 10-year, $100 million
environmental cost cap insurance policy for groundwater and other
remediation at Henderson. The insurance policy provides coverage only after
Chemical exhausts a self-insured retention of approximately $61 million and
covers only those costs incurred to achieve a cleanup level specified in
the policy. As noted above, federal and state agencies have not established
a drinking water standard and, therefore, it is possible that Chemical may
be required to achieve a cleanup level more stringent than that covered by
the policy. If so, the amount recoverable under the policy could be
affected.
Through June 30, 2004, Chemical had incurred expenditures of about $68
million that it believes can be applied to the self-insured retention. In
April 2004, Chemical reached an agreement in principle with one of its
vendors to reimburse Chemical approximately $6 million for a portion of
Chemical's costs. Reimbursement from the vendor will effectively reduce
Chemical's out-of-pocket costs and, therefore, will reduce the amount of
expenditures that qualify under the insurance policy. At June 30, 2004,
Chemical had incurred costs that exceed the self-insured retention by $1
million. The company believes that this excess as well as the remaining
reserve of $14 million will qualify under the insurance policy, which would
result in an insurance reimbursement of about $15 million based on current
cost estimates. The company believes that the reimbursements of $6 million
from Chemical's vendor and $15 million under the insurance policy are
probable and, accordingly, the company has recorded receivables in the
financial statements totaling $21 million.
Milwaukee, Wisconsin
In 1976, Chemical closed a wood-treatment facility it had operated in
Milwaukee, Wisconsin. Operations at the facility prior to its closure had
resulted in the contamination of soil and groundwater at and around the
site with creosote and other substances used in the wood-treatment process.
In 1984, EPA designated the Milwaukee wood-treatment facility as a
Superfund site under CERCLA, listed the site on the NPL and named Chemical
a PRP. Chemical executed a consent decree in 1991 that required it to
perform soil and groundwater remediation at and below the former
wood-treatment area and to address a tributary creek of the Menominee River
that had become contaminated as a result of the wood-treatment operations.
Actual remedial activities were deferred until after the decree was finally
entered in 1996 by a federal court in Milwaukee.
Groundwater treatment was initiated in 1996 to remediate groundwater
contamination below and in the vicinity of the former wood-treatment area.
It is not possible to reliably predict how groundwater conditions will be
affected by the soil remediation and groundwater treatment; therefore, it
is not known how long groundwater treatment will continue. Soil cleanup of
the former wood-treatment area began in 2000 and was completed in 2002.
Also in 2002, terms for addressing the tributary creek were agreed upon
with EPA, after which Chemical began the implementation of a remedy to
reroute the creek and to remediate associated sediment and stream bank
soils, which is expected to take about four more years.
As of June 30, 2004, the company had remaining reserves of $11 million for
the costs of the remediation work described above. This includes $4 million
added to the reserve in the second quarter of 2004 for the excavation and
disposal of additional soil volumes encountered during remediation of the
tributary creek of the Menominee River. Although actual costs may exceed
current estimates, the amount of any increases cannot be reasonably
estimated at this time.
Cushing, Oklahoma
In 1972, an affiliate of the company closed a petroleum refinery it had
operated near Cushing, Oklahoma. Prior to closing the refinery, the
affiliate also had produced uranium and thorium fuel and metal at the site
pursuant to licenses issued by the Atomic Energy Commission (AEC). The
uranium and thorium operations commenced in 1962 and were shut down in
1966, at which time the affiliate decommissioned and cleaned up the portion
of the facility related to uranium and thorium operations to applicable
standards. The refinery also was cleaned up to applicable standards at the
time of closing.
Subsequent regulatory changes required more extensive remediation at the
site. In 1990, the affiliate entered into a consent agreement with the
State of Oklahoma to investigate the site and take appropriate remedial
actions related to petroleum refining and uranium and thorium residuals.
Investigation and remediation of hydrocarbon contamination is being
performed with oversight of the Oklahoma Department of Environmental
Quality. Soil remediation to address hydrocarbon contamination is expected
to continue for about four more years. The long-term scope, duration and
cost of groundwater remediation are uncertain and, therefore, additional
costs may be incurred in the future.
Additionally, in 1993, the affiliate received a decommissioning license
from the Nuclear Regulatory Commission (NRC), the successor to AEC's
licensing authority, to perform certain cleanup of uranium and thorium
residuals. During the second quarter of 2004, all known remaining
radiological contamination was removed from the site and shipped to a
licensed disposal facility. Verification and report preparation will extend
through the end of 2004.
As of June 30, 2004, the company had remaining reserves of $16 million for
the costs of the ongoing remediation and decommissioning work described
above. Included in this amount is $6 million added to the reserves during
the second quarter of 2004 primarily for excavation, transportation, and
disposal of additional soil volumes encountered during the final stages of
the radiological cleanup. Although actual costs may exceed current
estimates, the amount of any increases cannot be reasonably estimated at
this time.
Mobile, Alabama
In June 2003, Chemical ceased operations at its facility in Mobile,
Alabama, which Chemical had used to produce feedstock for its titanium
dioxide plants. Operations prior to closure had resulted in minor
contamination of groundwater adjacent to surface impoundments. A
groundwater recovery system was installed prior to closure and continues in
operation as required under Chemical's National Pollutant Discharge
Elimination System (NPDES) permit. Future remediation work, including
groundwater recovery, closure of the impoundments and other minor work, is
expected to be substantially completed in about five years. As of June 30,
2004, the company had remaining reserves of $11 million. Although actual
costs may exceed current estimates, the amount of any increases cannot be
reasonably estimated at this time.
New Jersey Wood-Treatment Site
In 1999, EPA notified Chemical and its parent company that they were
potentially responsible parties at a former wood-treatment site in New
Jersey that has been listed by EPA as a Superfund site. At that time, the
company knew little about the site as neither Chemical nor its parent had
ever owned or operated the site. A predecessor of Chemical had been the
sole stockholder of a company that owned and operated the site. The company
that owned the site already had been dissolved and the site had been sold
to a third party before Chemical became affiliated with the former
stockholder in 1964. EPA has preliminarily estimated that cleanup costs may
reach $120 million or more.
There are substantial uncertainties about Chemical's responsibility for the
site, and Chemical is evaluating possible defenses to any claim by EPA for
response costs. EPA has not articulated the factual and legal basis on
which EPA notified Chemical and its parent that they are potentially
responsible parties. The EPA notification may be based on a successor
liability theory premised on the 1964 transaction pursuant to which
Chemical became affiliated with the former stockholder of the company that
had owned and operated the site. Based on available historical records, it
is uncertain whether and, if so, under what terms the former stockholder
assumed liabilities of the dissolved company. Moreover, as noted above, the
site had been sold to a third party and the company that owned and operated
the site had been dissolved before Chemical became affiliated with that
company's stockholder. In addition, there appear to be other potentially
responsible parties, though it is not known whether the other parties have
received notification from EPA. EPA has not ordered Chemical or its parent
to perform work at the site and is instead performing the work itself. The
company has not recorded a reserve for the site as it is not possible to
reliably estimate whatever liability Chemical or its parent may have for
the cleanup because of the aforementioned uncertainties and the existence
of other potentially responsible parties.
Los Angeles County, California
During the second quarter of 2004, the company began remediation and
restoration of an oil and gas field in Los Angeles County, California.
Early soil excavation experience indicates that the engineering studies
provided by the property owner may have underestimated actual volumes
requiring remediation. The company has initiated a study to refine the
estimate of work requirements and associated costs. The study will be
completed in the third quarter of 2004. As of June 30, 2004, the company
had environmental reserves of $8 million for this project. Although actual
costs may exceed current estimates, the amount of any increase cannot be
reasonably estimated at this time.
Coal Supply Contract
An affiliate of the company entered into a coal supply contract with
Peabody Coaltrade, Inc. ("PCI") in February 1998. In 1998, the company
exited the coal business and assigned its rights and obligations under the
coal supply contract to a third party. In connection with the assignment,
the company agreed to guarantee performance under the contract. PCI has
notified the company of a threatened default by the assignee under the coal
supply contract and that PCI may seek to hold the company liable under the
1998 guaranty in the event of a default. In addition to other defenses to
the enforceability of the guaranty, the company believes the guaranty
expired in January 2003 when the primary term of the coal supply contract
expired. No reserve has been provided for performance under the guaranty
because the company does not believe a loss is probable and the amount of
any loss is not reasonably estimable.
Forest Products Litigation
Between 1999 and 2001, Chemical and its parent company were named in 22
lawsuits in three states (Mississippi, Louisiana and Pennsylvania) in
connection with present and former forest products operations located in
those states (in Columbus, Mississippi; Bossier City, Louisiana; and Avoca,
Pennsylvania). The lawsuits sought recovery under a variety of common law
and statutory legal theories for personal injuries and property damages
allegedly caused by exposure to and/or release of creosote and other
substances used in the wood-treatment process. Chemical has executed
settlement agreements that are expected to resolve substantially all of the
Louisiana, Pennsylvania and Columbus, Mississippi, lawsuits described
above. Accordingly most of the suits have been, or are expected to be,
dismissed.
Following the adoption by the Mississippi legislature of tort reform,
plaintiffs' lawyers filed many new lawsuits across the state of Mississippi
in advance of the reform's effective date. On December 31, 2002,
approximately 245 lawsuits were filed against Chemical and its affiliates
on behalf of approximately 4,600 claimants in connection with Chemical's
Columbus, Mississippi, operations, seeking recovery on legal theories
substantially similar to those advanced in the litigation described above.
Substantially all of these lawsuits have been removed to the U.S. District
Court for the Northern District of Mississippi, and the Court has
consolidated these lawsuits for pretrial and discovery purposes. Chemical
and its affiliates believe the lawsuits are without substantial merit and
are vigorously defending against them. The company has not provided a
reserve for the lawsuits because it cannot reasonably determine the
probability of a loss, and the amount of loss, if any, cannot be reasonably
estimated.
On December 31, 2002, June 13, 2003, and June 25, 2004, three lawsuits were
filed against Chemical in connection with a former wood-treatment plant
located in Hattiesburg, Mississippi. The lawsuits seek recovery on legal
theories substantially similar to those advanced in the litigation
described above. A total of approximately 3,300 claimants now have asserted
claims in connection with the Hattiesburg plant. Chemical has resolved
approximately 1,490 of these claims pursuant to a settlement reached in
April 2003, which has resulted in aggregate payments by Chemical of
approximately $600,000. Chemical and its affiliates believe that the
remaining claims are without substantial merit and are vigorously defending
against them. The company has not provided a reserve for the lawsuits
because it cannot reasonably determine the probability of a loss, and the
amount of loss, if any, cannot be reasonably estimated.
The company believes that the resolution of the remaining forest products
litigation will not have a material adverse effect on the company's
financial condition or results of operations.
Other Matters
The company and/or its affiliates are parties to a number of legal and
administrative proceedings involving environmental and/or other matters
pending in various courts or agencies. These include proceedings associated
with facilities currently or previously owned, operated or used by the
company's affiliates and/or their predecessors, some of which include
claims for personal injuries and property damages. Current and former
operations of the company's affiliates also involve management of regulated
materials and are subject to various environmental laws and regulations.
These laws and regulations will obligate the company's affiliates to clean
up various sites at which petroleum and other hydrocarbons, chemicals,
low-level radioactive substances and/or other materials have been
contained, disposed of or released. Some of these sites have been
designated Superfund sites by EPA pursuant to CERCLA. Similar environmental
regulations exist in foreign countries in which the company's affiliates
operate.
The company provides for costs related to contingencies when a loss is
probable and the amount is reasonably estimable. It is not possible for the
company to reliably estimate the amount and timing of all future
expenditures related to environmental and legal matters and other
contingencies because, among other reasons:
o some sites are in the early stages of investigation, and other sites
may be identified in the future;
o remediation activities vary significantly in duration, scope and cost
from site to site depending on the mix of unique site
characteristics, applicable technologies and regulatory agencies
involved;
o cleanup requirements are difficult to predict at sites where remedial
investigations have not been completed or final decisions have not
been made regarding cleanup requirements, technologies or other
factors that bear on cleanup costs;
o environmental laws frequently impose joint and several liability on
all potentially responsible parties, and it can be difficult to
determine the number and financial condition of other potentially
responsible parties and their respective shares of responsibility for
cleanup costs;
o environmental laws and regulations, as well as enforcement policies,
are continually changing, and the outcome of court proceedings and
discussions with regulatory agencies are inherently uncertain;
o some legal matters are in the early stages of investigation or
proceeding or their outcomes otherwise may be difficult to predict,
and other legal matters may be identified in the future;
o unanticipated construction problems and weather conditions can hinder
the completion of environmental remediation;
o the inability to implement a planned engineering design or use
planned technologies and excavation methods may require revisions to
the design of remediation measures, which delay remediation and
increase costs; and
o the identification of additional areas or volumes of contamination
and changes in costs of labor, equipment and technology generate
corresponding changes in environmental remediation costs.
As of June 30, 2004, the company had reserves totaling $227 million for
cleaning up and remediating environmental sites, reflecting the reasonably
estimable costs for addressing these sites. This includes $87 million for
the West Chicago sites, $14 million for the Henderson, Nevada, site and $32
million for forest products sites. Additionally, as of June 30, 2004, the
company had litigation reserves totaling approximately $38 million for the
reasonably estimable losses associated with litigation. Management
believes, after consultation with general counsel, that currently the
company has reserved adequately for the reasonably estimable costs of
environmental matters and other contingencies. However, additions to the
reserves may be required as additional information is obtained that enables
the company to better estimate its liabilities, including liabilities at
sites now under review, though the company cannot now reliably estimate the
amount of future additions to the reserves.
N. Asset Retirement Obligations
The company adopted FAS 143, "Accounting for Asset Retirement Obligations,"
on January 1, 2003, which resulted in an increase in net property of $107.9
million, an increase in abandonment liabilities of $160.8 million and a
decrease in deferred income tax liabilities of $18.2 million. The net
impact of these changes resulted in an after-tax charge to earnings of
$34.7 million to recognize the cumulative effect of retroactively applying
the new accounting standard. Additionally in January 2003, the company
announced its plan to close the synthetic rutile plant in Mobile, Alabama,
by the end of 2003. Since the plant had a determinate closure date, the
company also accrued an abandonment liability of $17.6 million associated
with its plans to decommission the Mobile facility.
A summary of the changes in the abandonment liability during the first six
months of 2004 is included in the table below.
(Millions of dollars)
---------------------------------------------------------------------------------
Balance, December 31, 2003 $420.9
New obligations incurred 2.2
Liability assumed in the Westport merger (1) 73.7
Accretion expense 13.4
Abandonment expenditures (6.1)
Abandonment obligations settled through property divestitures (1.9)
Changes in estimates, including timing 13.8
------
Balance, June 30, 2004 516.0
Less: current asset retirement obligation (42.0)
Less: asset retirement obligation classified as held for disposal (.5)
------
Long-term asset retirement obligation $473.5
======
(1) See Note B.
O. Employee Benefit Plans
The company has both noncontributory and contributory defined-benefit
retirement plans and company-sponsored contributory postretirement plans
for health care and life insurance. Most employees are covered under the
company's retirement plans, and substantially all U.S. employees may become
eligible for the postretirement benefits if they reach retirement age while
working for the company.
During the second quarter of 2004, the company contributed $4.1 million to
the U.S. nonqualified and foreign retirement plans, and $8.5 million to its
U.S. postretirement plan. During the first six months of 2004, the company
contributed $7.3 million to the U.S. nonqualified and foreign retirement
plans, and $11 million to its U.S. postretirement plan. Kerr-McGee expects
to contribute approximately $5 million to its U.S. nonqualified retirement
plans, $8.7 million to its foreign retirement plans and $14.4 to its U.S.
postretirement plan during 2004. No contributions are expected in 2004 for
the U.S. qualified retirement plan.
In December 2003, the Medicare Prescription Drug, Improvement and
Modernization Act of 2003 ("the Act") was signed into law. The Act expands
Medicare to include, for the first time, coverage for prescription drugs.
The Act also introduces a federal subsidy to sponsors of retiree health
care benefit plans that provide a benefit that is at least actuarially
equivalent to Medicare Part D. In May 2004, the FASB issued Staff Position
(FSP) FAS 106-2, "Accounting and Disclosure Requirements Related to the
Medicare Prescription Drug, Improvement and Modernization Act of 2003," to
provide guidance on accounting for the effects of the Act. Kerr-McGee will
adopt FSP FAS 106-2 in the third quarter of 2004 and does not anticipate
the adoption will have a material impact on the company's results of
operations. The net periodic postretirement cost included in the tables
below does not reflect any amount associated with the subsidy.
Total costs recognized for employee retirement and postretirement benefit
plans for the second quarter of 2004 and 2003 were as follows:
Postretirement
Retirement Plans Health and Life Plans
------------------------- ------------------------
Three Months Ended Three Months Ended
June 30, June 30,
------------------------- ------------------------
(Millions of dollars) 2004 2003 2004 2003
------------------------------------------------------------------------------------------------------------------
Net periodic cost -
Service cost $ 7.0 $ 6.4 $ .7 $ .5
Interest cost 18.3 18.2 5.0 2.9
Expected return on plan assets (29.3) (30.6) - -
Net amortization -
Prior service cost 2.1 2.3 .4 .1
Net actuarial (gain) loss 1.0 (2.6) .8 -
Special termination benefits,
curtailment loss (1) - 13.4 - 1.1
------ ------ ---- ----
Total net periodic cost $ (.9) $ 7.1 $6.9 $4.6
====== ====== ==== ====
Total costs recognized for employee retirement and postretirement benefit
plans for the first six months of 2004 and 2003 were as follows:
Postretirement
Retirement Plans Health and Life Plans
------------------------ -------------------------
Six Months Ended Six Months Ended
June 30, June 30,
------------------------ -------------------------
(Millions of dollars) 2004 2003 2004 2003
------------------------------------------------------------------------------------------------------------------
Net periodic cost -
Service cost $14.1 $ 12.8 $ 1.4 $ 1.6
Interest cost 36.5 36.4 9.7 8.3
Expected return on plan assets (58.6) (61.0) - -
Net amortization -
Prior service cost 4.2 4.5 .8 .2
Net actuarial (gain) loss 2.0 (5.1) 1.5 -
Special termination benefits,
curtailment loss (1) - 13.4 - 1.1
----- ------ ----- -----
Total net periodic cost $(1.8) $ 1.0 $13.4 $11.2
===== ====== ===== =====
(1) Includes special termination benefit and curtailment costs associated with
the shutdown of the Forest Products operations and the Mobile, Alabama
facility.
The following assumptions were used in estimating the net periodic expense
for the first six months of 2004 and 2003:
Six Months Ended Six Months Ended
June 30, 2004 June 30, 2003
------------------------------- -----------------------------------
United States International United States International
---------------------------------------------------------------------------------------------------------------
Discount rate 6.25% 5.25 - 5.5% 6.75% 5.5 - 5.75%
Expected return on plan assets 8.5 5.75 - 7.25 8.5 5.75 - 7.0
Rate of compensation increases 4.5 2.0 - 5.0 4.5 2.5 - 6.5
P. Business Segments
Following is a summary of sales and operating profit for each of the
company's business segments for the second quarter and first six months of
2004 and 2003.
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- ----------------------
(Millions of dollars) 2004 2003 2004 2003
---------------------------------------------------------------------------------------------------------------
Revenues
Exploration and Production $ 765.1 $ 720.8 $1,598.9 $1,516.7
Chemicals - Pigment 302.8 283.8 555.2 537.1
Chemicals - Other 29.2 48.0 59.2 98.3
-------- -------- -------- --------
1,097.1 1,052.6 2,213.3 2,152.1
All other - - .1 .1
-------- -------- -------- --------
Total Revenues $1,097.1 $1,052.6 $2,213.4 $2,152.2
======== ======== ======== ========
Operating Profit (Loss)
Exploration and Production $ 263.0 $ 272.8 $ 592.9 $ 545.0
Chemicals - Pigment 13.5 (14.2) 20.7 (6.8)
Chemicals - Other (1.3) (8.4) (8.1) (18.4)
-------- -------- -------- --------
Total Operating Profit 275.2 250.2 605.5 519.8
Other Expense (96.2) (129.4) (183.5) (228.9)
-------- -------- -------- --------
Income from Continuing Operations
Before Income Taxes 179.0 120.8 422.0 290.9
Provision for Income Taxes (68.4) (51.0) (159.2) (116.9)
-------- -------- -------- --------
Income from Continuing Operations 110.6 69.8 262.8 174.0
Discontinued Operations, Net of Income Taxes - (.2) - .2
Cumulative Effect of Change in Accounting
Principle, Net of Income Taxes - - - (34.7)
-------- -------- -------- --------
Net Income $ 110.6 $ 69.6 $ 262.8 $ 139.5
======== ======== ======== ========
The acquisition of Westport, as discussed in Note B, materially increased
total assets and net property, plant and equipment within the exploration
and production segment. Information regarding assets by reportable segment
and net property, plant and equipment by geographic region is included
below.
June 30, December 31,
(Millions of dollars) 2004 2003
---------------------------------------------------------------------------
Total assets -
Exploration and production $12,009.3 $ 7,385.4
--------- ---------
Chemicals -
Pigment 1,495.9 1,521.3
Other 195.3 216.4
--------- ---------
Total Chemicals 1,691.2 1,737.7
--------- ---------
Total 13,700.5 9,123.1
Corporate and other assets 1,102.4 1,126.8
--------- ---------
Total $14,802.9 $10,249.9
========= =========
Net property, plant and equipment -
U.S. operations $ 8,435.4 $ 4,977.5
--------- ---------
International operations -
North Sea - exploration and production 1,794.2 1,874.1
China - exploration and production 200.4 165.0
Other - exploration and production 18.6 4.0
Europe - pigment 269.6 280.6
Australia - pigment 97.5 101.7
--------- ---------
2,380.3 2,425.4
--------- ---------
Total $10,815.7 $ 7,402.9
========= =========
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Results of Consolidated Operations
Second-quarter 2004 income from continuing operations totaled $110.6
million, an increase of 58% when compared with income of $69.8 million for
the same 2003 period. Income from continuing operations for the first six
months of 2004 was $262.8 million, an increase of 51% when compared with
income of $174 million for the comparable 2003 period. Net income for the
2004 second quarter was $110.6 million, compared with 2003 second-quarter
net income of $69.6 million. For the first six months of 2004, net income
was $262.8 million, compared with net income of $139.5 million for the same
2003 period. The inclusion of Westport's results of operations for the
five-day period ending June 30, 2004, increased net income by $14.6 million
for the 2004 second quarter and year-to-date periods.
Second-quarter 2004 operating profit was $275.2 million, compared with
second-quarter 2003 operating profit of $250.2 million, an increase of $25
million. Operating results within the exploration and production business
decreased $9.8 million from the prior year, while operating results for the
chemical - pigment and chemical - other operating units improved $34.8
million. The improvement for the chemical operations was primarily
attributable to prior year charges associated with the shut down of the
Mobile synthetic rutile plant and forest products operations.
Operating profit for the first six months of 2004 increased $85.7 million
over the same 2003 period. The increase in operating profit for the
six-month period was primarily attributable to lower exploration expense
(primarily dry hole costs), higher realized sales prices for crude oil and
natural gas, higher natural gas sales volumes, and the 2003 Mobile and
forest products shutdown provisions, partially offset by lower crude oil
sales volumes. These variances are discussed in more detail in the segment
discussion that follows.
Other expense for the second quarter of 2004 totaled $96.2 million,
compared with expense of $129.4 million in the same 2003 period, a $33.2
million decrease between periods. The decrease was primarily due to a
decrease in net interest expense of $7.4 million, lower foreign currency
losses of $14.1 million and lower insurance and departmental general and
administrative costs of $10.3 million.
Other expense for the first six months of 2004 totaled $183.5 million,
compared with expense of $228.9 million in the same 2003 period, for a
decrease of $45.4 million between periods. The decrease resulted primarily
from lower net interest expense of $15.3 million, lower foreign currency
losses of $8.7 million, a 2004 gain on sale of trading securities of $9
million and lower litigation costs of $6.5 million. The decrease in net
interest expense between periods resulted primarily from lower average
outstanding debt balances during the first six months of 2004 (exclusive of
the debt assumed in the Westport acquisition) as compared with the prior
year, together with an increase in interest savings from the company's
interest rate swap agreements.
Income tax expense for the second quarter of 2004 was $68.4 million
resulting in an effective tax rate of 38.2%, compared with income tax
expense of $51 million, or 42.2% in the same 2003 period. For the first six
months of 2004, income tax expense was $159.2 million, or 37.7%, compared
with expense of $116.9 million, or 40.2% in 2003. The reduction in the
effective tax rate between periods was primarily a result of a higher
proportion of income earned in lower tax jurisdictions.
Segment Operations
Exploration and Production
Oil and gas sales revenues, production statistics and average prices from
continuing operations are shown in the following table.
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ----------------------
2004 2003 2004 2003
---------------------------------------------------------------------------------------------------------------
Revenues -
Crude oil and condensate sales $337.4 $363.4 $ 698.7 $ 768.8
Natural gas sales 316.8 273.1 688.1 596.2
Gas marketing activities 87.3 74.1 169.0 133.9
Nonhedge derivative gains 5.4 - 5.4 -
Other 18.2 10.2 37.7 17.8
------ ------ -------- --------
Total $765.1 $720.8 $1,598.9 $1,516.7
====== ====== ======== ========
Production -
Crude oil and condensate
(thousands of bbls per day) 140 155 142 160
Natural gas (MMcf per day) 740 697 751 729
Total equivalent barrels of oil
(thousands of boe per day) 264 271 267 282
Average realized sales prices -
Crude oil and condensate (per barrel) (a) $26.97 $25.28 $27.14 $26.14
Natural gas (per Mcf) (a) $4.70 $4.29 $5.03 $4.51
(a)The effect of the company's oil and gas commodity hedging program is
included in the average sales prices shown above. During the second
quarter of 2004, hedging activity reduced the average sales price of
crude oil and natural gas by $7.43 per barrel and $.93 per Mcf,
respectively. For the second quarter of 2003, hedging activity reduced
the average sales price of crude oil and natural gas by $.92 per barrel
and $.58 per Mcf, respectively. For the six months ended June 30, 2004,
hedging activity reduced the average sales price of crude oil and
natural gas by $5.67 per barrel and $0.52 per Mcf, respectively. For the
same period in 2003, hedging activity reduced the average sales price of
crude oil and natural gas by $2.53 per barrel and $.70 per Mcf,
respectively.
Crude Oil Revenues:
Oil revenues for the second quarter of 2004 totaled $337.4 million, down
$26 million from the same period in 2003. For the six months ended June 30,
2004 and 2003, crude oil revenues totaled $698.7 million and $768.8
million, respectively, a decrease of $70.1 million. The decrease in both
2004 periods resulted from lower oil volumes, partially offset by higher
realized prices. The acquisition of Westport properties in late June
contributed $5.3 million to crude oil revenues (1.6 Mbbls/d) in the second
quarter of 2004.
For the second quarter, the average realized price for oil improved $1.69
per barrel compared to the same period in 2003, resulting in an increase of
$20.8 million in oil revenues, while lower oil production reduced revenues
by $46.8 million. The production decrease was primarily due to declining
production volumes in the North Sea area, combined with the impact of 2003
property divestitures in the South China Sea and U.S. onshore areas.
For the six months ending June 30, 2004, the average realized price
increased $1.00 per barrel compared with the same period in 2003, resulting
in higher oil revenues of $25.7 million, while oil production declined by
12%, reducing oil revenues by $95.8 million. On a divestiture-adjusted
basis, 2004 year-to-date oil production volumes declined by 7%. The
decrease was primarily due to lower production volumes in the North Sea
area.
Natural Gas Revenues:
Natural gas revenues increased by $43.7 million in the second quarter of
2004 compared with the same 2003 period as a result of a 6% increase in gas
production, combined with a $.41 per Mcf increase in the average realized
price for natural gas. Gas production of 740 MMcf per day was 43 MMcf per
day above second quarter 2003 rates. The increase was primarily due to
higher volumes from the Gunnison field in the deepwater Gulf of Mexico,
which began production late in the fourth quarter of 2003. Also
contributing to the increase was production from the Brae fields in the
North Sea and the U.S. onshore Rincon field which was acquired in the third
quarter of 2003. The acquisition of Westport properties in late June
contributed $12 million to natural gas revenues (20.6 MMcf/d) in the second
quarter of 2004.
Natural gas revenues increased by $91.9 million for the six months ending
June 30, 2004, compared with the same 2003 period as a result of an
increase in gas production, combined with a $.52 per Mcf increase in the
average realized price for natural gas. Gas production of 751 MMcf per day
for the six months ending June 30, 2004, was 22 MMcf per day above rates
for the comparable 2003 period, a 3% increase. The increase was primarily
due to higher volumes from the Gunnison field in the deepwater Gulf of
Mexico, North Sea Brae fields and U.S. onshore Rincon field.
Nonhedge Derivative Gains and Losses:
Nonhedge derivative gains (losses) represent mark-to-market gains and
losses related to crude oil and natural gas derivative instruments that
have not been designated as hedges or that do not qualify for hedge
accounting treatment.
In the second quarter of 2004, the company recognized a $9.8 million
mark-to-market loss for certain crude oil and natural gas swaps associated
with the combined company's expected production since Kerr-McGee's U.S.
production (excluding Westport volumes) was either already hedged or, in
the case of Rocky Mountain production, did not have sufficient basis swaps
in place to ensure that the hedges would be highly effective. Kerr-McGee
also recognized a $15.2 million mark-to-market gain associated with
derivative liabilities assumed in the Westport merger for the change in
fair value from the closing date (June 25, 2004) through June 30, 2004.
The Kerr-McGee swaps were designated as hedges in July 2004 after the
merger with Westport closed. In addition, Westport's fixed-price oil and
gas swaps and natural gas basis swaps were designated as hedges in July
2004. However, Westport's costless and three-way collars do not qualify for
hedge accounting treatment even though they effectively reduce commodity
price risk for the combined company's production. As a result, Kerr-McGee
will continue to recognize mark-to-market gains and losses in future
earnings until the collars mature. The net derivative liability associated
with these collars at June 30, 2004 was $71.1 million.
A full description of Kerr-McGee's open derivative positions at June 30,
2004, both hedge and nonhedge, is included below in Item 3, Quantitative
and Qualitative Disclosures about Market Risk.
Operating Profit - Revenues, operating costs and expenses, and marketing
activities associated with the exploration and production segment are shown
in the following table.
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- -----------------------
2004 2003 2004 2003
---------------------------------------------------------------------------------------------------------------
Revenues, excluding marketing revenues $677.8 $646.7 $1,429.9 $1,382.8
------ ------ -------- --------
Operating Costs and Expenses:
Lifting Costs:
Lease Operating Expense 82.0 84.4 170.9 172.3
Production Taxes 18.2 8.3 33.3 22.7
------ ------ -------- --------
Total Lifting Costs 100.2 92.7 204.2 195.0
Depreciation and Depletion 160.3 150.0 322.0 306.7
Accretion Expense 6.8 6.3 13.4 12.5
Impairments on Assets Held for Use 1.1 - 14.3 5.1
Loss (Gain) on Assets Held for Sale 3.9 (0.5) 7.3 (5.7)
General and Administrative Expense 35.0 20.7 66.2 42.7
Transportation Expense 24.8 23.5 51.6 45.2
Exploration Expense 65.5 66.6 116.1 207.1
Gas Gathering, Pipeline and Other Expenses 17.9 18.2 42.8 34.0
------ ------ -------- --------
Total Operating Costs and Expenses 415.5 377.5 837.9 842.6
------ ------ -------- --------
Net, excluding marketing activities 262.3 269.2 592.0 540.2
Marketing - Gas Sales Revenues 87.3 74.1 169.0 133.9
Marketing - Gas Purchase Costs (including
transportation) (86.6) (70.5) (168.1) (129.1)
------ ------ -------- --------
Total Operating Profit $263.0 $272.8 $ 592.9 $ 545.0
====== ====== ======== ========
Lease Operating Expense:
Lease operating expense was $82 million in the second quarter of 2004, a
$2.4 million decrease from the same period of 2003. The decrease was due to
lower operating expenses in the international area due to the divestiture
of the Liuhua field in China, as well as reduced costs in the North Sea and
U.S. onshore areas. The reduction was offset in part by higher lease
operating expenses in the Gulf of Mexico relating primarily to operating
lease payments for platform infrastructure at the Gunnison development. On
a per-unit basis, lease operating expense increased by 2% from $3.39 per
boe in 2003 to $3.45 per boe in 2004.
For the six months ending June 30, 2004, lease operating expense was $170.9
million compared with $172.3 million for the same period of 2003, a $1.4
million decrease. On a per-unit basis, 2004 year-to-date lease operating
expense was $3.52 per boe compared to $3.34 per boe for 2003, an increase
of $.18 per boe. The increase results from higher operating expenses in the
Gulf of Mexico relating primarily to the Gunnison platform, increased
workover activity in the Rocky Mountain area and lower volumes in the North
Sea area. These increases were partially offset by reductions from the
divestiture of the Liuhua field and U.S. onshore properties.
Transportation Costs:
In the second quarter of 2004, transportation costs, representing the costs
paid to third-party providers to transport oil and gas production,
increased $1.3 million from the second quarter of 2003. For the six months
ended June 30, 2004 transportation expense was $51.6 million, an increase
of $6.4 million compared to the same period in 2003. The increase in
transportation expense primarily resulted from higher transportation costs
associated with new deepwater Gulf of Mexico producing fields. In the
second quarter of 2004, this increase was partially offset by lower costs
in the U.K. North Sea.
Depreciation, Depletion and Amortization (DD&A):
DD&A expense increased $10.3 million in the second quarter of 2004 over the
same 2003 period. On a per-unit basis, DD&A increased from $6.02 per boe in
2003 to $6.75 per boe in 2004. For the six months ended June 30, DD&A
expense totaled $322 million, an increase of $15.3 million over 2003.
Higher DD&A unit costs for both periods resulted primarily from increases
in the U.K. North Sea area due to a reduction in the expected life-of-field
facility salvage values on certain fields and lower reserve estimates at
year-end 2003. Overall per-unit DD&A is expected to increase to just over
$8.00 per boe in the third quarter reflecting the higher cost associated
with acquiring Westport's proved reserves as compared to Kerr-McGee's
historical finding and development costs per boe.
General and Administrative Expenses:
General and administrative expenses were higher in the second quarter of
2004, increasing by $14.3 million over the same period in 2003.
Year-to-date general and administrative expenses increased $23.5 million
over the same period in 2003. The increase in both the second-quarter and
six-month periods was a result of higher incentive-based compensation and
pension costs, together with lower overhead charge-outs for U.S. onshore
properties caused by 2003 divestitures. General and administrative expenses
are expected to increase in the third quarter as Kerr-McGee absorbs certain
of Westport's existing administrative responsibilities and personnel.
Exploration Expense:
Exploration expense decreased by $1.1 million in the second quarter of 2004
compared with 2003, primarily as a result of lower dry hole costs of $5.5
million and lower amortization of non-producing leasehold costs of $6.7
million, partially offset by higher geological and geophysical project
costs of $9.6 million and higher lease rental expense of $1.9 million.
For the six months ending June 30, 2004 and 2003, exploration expense
totaled $116.1 million and $207.1 million, respectively, a decrease of $91
million. Lower dry hole costs of $102.1 million and lower amortization of
non-producing leasehold costs of $11 million were partially offset by
higher geological and geophysical project costs of $18 million and
additional exploration staffing of $2.6 million. Exploration staffing
levels and geophysical projects were increased during 2003 in support of
the company's worldwide exploration efforts and continued development of
its high-potential prospect inventory.
Capitalized costs associated with exploratory wells may be charged to
earnings in a future period if management determines that commercial
quantities of hydrocarbons have not been discovered. At June 30, 2004, the
company had capitalized costs of approximately $184 million associated with
such ongoing exploration activities, primarily in the deepwater Gulf of
Mexico, Brazil, Alaska and China.
Asset Impairments and Gain (Loss) on Sale of Assets:
Kerr-McGee records impairment losses when performance analysis indicates
that future net cash flows from production will not be sufficient to
recover the carrying amounts of the related assets. In general, such
write-downs often occur on mature properties that are nearing the end of
their productive lives or cease production sooner than anticipated. Asset
impairment losses recorded in the second quarter of 2004 associated with
assets held for use totaled $1.1 million. Asset impairment losses for the
first six months of 2004 totaled $14.3 million compared with $5.1 million
for 2003. Asset impairment losses in 2004 related primarily to a U.S Gulf
of Mexico field that experienced premature water breakthrough and ceased
production sooner than expected. For a discussion of the company's Leadon
field in the U.K. North Sea, see Note D to the accompanying consolidated
financial statements.
The company recognized a loss on sale of assets of $3.9 million in the
second quarter of 2004 and $7.3 million for the six months ended June 30,
2004. The loss on sale of assets is associated primarily with oil and gas
properties held for sale in the U.S. Gulf of Mexico shelf. From time to
time, the company may identify other oil and gas properties to be disposed
of that are considered noncore or nearing the end of their productive
lives.
Gas Marketing Activities:
In the Rocky Mountain producing area, Kerr-McGee purchases third-party
natural gas for aggregation and sale with the company's own production from
the Wattenberg field in Colorado. In addition, Kerr-McGee has purchased
transportation capacity to markets in the Midwest to facilitate sale of its
natural gas in market regions outside the immediate vicinity of its
production. This activity began with the company's acquisition of HS
Resources in August 2001 and has increased since that time.
Marketing revenue increased $13.2 million in the second quarter of 2004
compared with the same period in 2003. Marketing revenue for the first six
months of 2004 totaled $169 million, or $35.1 million higher than the same
period in 2003. The increase for both periods was primarily the result of
higher purchase and resale of natural gas in the Rocky Mountain area and
higher natural gas prices. Gas purchase costs increased $16.1 million for
the second quarter of 2004 and $39 million for the six months ended June
30, 2004.
Chemicals - Pigment
Operating profit for the second quarter of 2004 was $13.5 million on
revenues of $302.8 million, compared with an operating loss of $14.2
million on revenues of $283.8 million for the same 2003 period. The 2003
operating loss was primarily a result of shutdown provisions totaling $28.9
million for the Mobile, Alabama facility. Average selling prices decreased
2% from prior year, principally due to competitive market conditions in
North America and Europe, while total revenues increased $19 million in the
second quarter of 2004 compared with the prior year. The $19 million
increase in revenues between periods was driven by higher sales volumes
resulting in an increase of $33 million, partially offset by a decrease of
$14 million due to lower average sales prices. Pigment sales volumes
increased by 15,600 tonnes in the second quarter over 2003; however,
manufacturing cost efficiency gains resulting from increased production
volumes were largely offset by higher product transportation costs, raw
material price increases and foreign currency losses.
For the first six months of 2004, operating profit was $20.7 million on
revenues of $555.2 million, compared with an operating loss of $6.8 million
on revenues of $537.1 million in the comparable prior-year period. The
improvement in operating profit for the first six months of 2004 compared
with the same 2003 period was primarily attributable to shutdown provisions
for the Mobile facility totaling $36.3 million in the prior-year period.
Additionally, in the first six months of 2004, a favorable volume variance
of $24.1 million was offset by higher average product costs of $22.5
million, lower revenues of $8.6 million resulting from lower average sales
prices, and higher transportation, selling and administrative costs of $3.7
million compared to the same period in 2003.
For the six months ended June 30, 2004, revenues increased $18.1 million,
or 3%, of which $26.7 million resulted from higher pigment sales volumes,
partially offset by a decrease of $8.6 million due to lower average sales
prices. The lower average sales prices were driven by competitive market
conditions. Pigment sales volumes increased by 18,900 tonnes for the first
six months compared with prior-year levels.
In January 2004, the company announced the temporary idling of one line of
its sulfate-process titanium dioxide pigment production facilities at the
Savannah manufacturing plant, which is one of two sulfate-process trains
operated by the company worldwide. The line was temporarily idled because
of soft demand for sulfate-process titanium dioxide pigment. The sulfate
line has remained idle, as the market conditions have not sufficiently
improved. In addition, unanticipated cost issues associated with
underperforming plant and equipment discovered after the company acquired
the plant in 2000 have increased the cost profile of the plant from that
initially anticipated. The company is currently performing market analyses
and evaluating plant reconfiguration to explore means of best improving
operating results, while also evaluating its strategic options with respect
to the Savannah sulfate operations. During the second quarter, the company
operated its new high-productivity oxidation line for chloride at the
Savannah facility, which produced improved ore yields. The company is
evaluating the performance of this new oxidation line and expects to have a
better understanding of how the Savannah site might be reconfigured to
exploit its capabilities by the latter part of 2004. The possible
reconfiguration of the Savannah site, if any, as well as any decisions
regarding strategic options related to the sulfate operations, could
include redeployment of certain assets, idling of certain assets and
reduction of the future useful life of certain assets, resulting in the
acceleration of depreciation expense and the recognition of other charges.
Chemicals - Other
Operating loss in the 2004 second quarter was $1.3 million on revenues of
$29.2 million, compared with an operating loss of $8.4 million on revenues
of $48 million for the same 2003 period. The decrease in revenues was
primarily due to the ongoing exit of the forest products business. The
decrease in operating loss was primarily due to an $8.8 million provision
made in the second quarter of 2003 related to exiting the forest products
business and increased sales from the company's Henderson, Nevada
electrolytic manganese dioxide (EMD) manufacturing plant, partially offset
by lower forest product sales.
For the six months ended June 30, 2004, operating loss was $8.1 million on
revenues of $59.2 million, compared with an operating loss of $18.4 million
on revenues of $98.3 million in the same 2003 period. The $10.3 million
decrease in operating loss for the six months of 2004 was primarily due to
environmental costs in 2003 of $11 million for remediation of ammonium
perchlorate related to the company's Henderson, Nevada operations (see Note
M). The Henderson EMD facility was temporarily idled in the third quarter
of 2003 and resumed its operations in the first quarter of 2004.
Financial Condition
At June 30, 2004, the company's net working capital position was a negative
$866.1 million, compared with a negative $399.1 million at December 31,
2003. The current ratio was .7 to 1 at June 30, 2004 and .8 to 1 at
December 31, 2003. Included in current liabilities at June 30, 2004, are
derivative liabilities associated with oil and natural gas commodity
contracts of $590.1 million, together with a derivative liability for the
call option associated with the company's notes exchangeable for common
stock (DECS) of $226.8. The commodity contracts generally settle when the
associated sale occurs. Oil and gas revenues, which reflect sales at
prevailing market prices, are recorded net of any gains or losses on the
derivative instruments. As discussed below, the DECS and the associated
call option were settled August 2, 2004, the maturity date of the DECS. The
negative working capital position at June 30, 2004, is not indicative of a
lack of liquidity, as the company maintains sufficient current assets to
settle current liabilities when due. Additionally, the company has
sufficient unused lines of credit and revolving credit facilities to fund
any current cash requirements, as discussed below. Current asset balances
are minimized as one way to finance capital expenditures and lower
borrowing costs.
The company's percentage of net debt (debt less cash) to capitalization was
46% at June 30, 2004, compared with 57% at December 31, 2003, and 58% at
June 30, 2003. The decrease from December 31, 2003, resulted primarily from
the issuance of common stock in connection with the Westport merger
(discussed below). The company had unused lines of credit and revolving
credit facilities of $1.4 billion at June 30, 2004. Of this amount, $870
million can be used to support commercial paper borrowings of Kerr-McGee
Credit LLC and $490 million can be used to support European commercial
paper borrowings of Kerr-McGee (G.B.) PLC, Kerr-McGee Chemical GmbH,
Kerr-McGee Pigments (Holland) B.V. and Kerr-McGee International ApS.
Currently, the capacity of the company's commercial paper program totals
$1.2 billion, available for issuance based on market conditions. As of June
30, 2004, the company had outstanding commercial paper borrowings of $86
million. The company also had available, to issue and sell, a total of
$1.65 billion of debt securities, common or preferred stock, or warrants
under its shelf registration with the Securities and Exchange Commission.
The amount available under the company's shelf registration was reduced to
$1 billion on July 1, 2004, due to the issuance of $650 million in debt
securities as discussed below.
As of June 30, 2004, the company's senior unsecured debt was rated BBB by
Standard & Poor's and Fitch and Baa3 by Moody's. The company believes that
it has the ability to provide for its operational needs and its long- and
short-term capital programs through its operating cash flow (partially
protected by the company's hedging program), borrowing capacity and ability
to raise capital. Should operating cash flow decline, the company may
reduce its capital expenditures program, borrow under its commercial paper
program, draw on its revolving credit facilities and/or consider selective
long-term borrowings or equity issuances. Kerr-McGee's commercial paper
programs are backed by the revolving credit facilities currently in place.
Long-term debt obligations due within one year of $827.7 million consist
primarily of $145 million, 8.375% notes due July 15, 2004; $330.3 million
(face value), 5.5% DECS due August 2, 2004; and $350 million, 5.375% notes
due April 15, 2005. The company used available cash to fund the maturity of
its $145 million notes due on July 15, 2004. In addition, the DECS settled
on August 2, 2004, with the distribution of shares of Devon common stock.
The company holds derivative financial instruments that require margin
deposits if unrealized losses exceed limits established with individual
counterparty institutions. From time to time, the company may be required
to advance cash to its counterparties to satisfy margin deposit
requirements. Between January 1, 2004 and August 5, 2004, margin calls
totaled $35.5 million, all of which had been refunded to the company, with
no margin calls outstanding as of August 5, 2004.
As discussed above, the DECS matured August 2, 2004. At June 30, 2004, the
fair values of the embedded put and call options in the DECS were nil and
$226.8 million, respectively. On December 31, 2003, the fair values of the
embedded put and call options were nil and $154.9 million, respectively.
During the second quarter of 2004, the company recorded a loss of $65.5
million in other income for the changes in the fair values of the put and
call options, compared with a loss of $41.9 million during the second
quarter of 2003. During the first six months of 2004 and 2003, the company
recorded losses of $71.9 million and $58.1 million, respectively, in other
income for the changes in the fair values of the put and call options. The
fluctuation in the value of the put and call derivative financial
instruments will generally offset the increase or decease in the market
value of the Devon stock classified as trading. The fair value of the 8.4
million shares of Devon classified as trading securities was $556.7 million
at June 30, 2004, and $483 million at December 31, 2003, which together
with the call option liability, resulted in a net asset carrying value of
$329.9 million and $328.1 million at June 30, 2004 and December 31, 2003,
respectively. During the second quarter of 2004 and 2003, the company
recorded unrealized gains of $66.2 million and $43.7 million, respectively,
in other income for the changes in fair value of the Devon shares
classified as trading. During the first six months of 2004 and 2003, the
company recorded unrealized gains of $73.7 million and $63.3 million,
respectively, in other income for the changes in fair value of the Devon
shares classified as trading. The DECS and the derivative liability
associated with the call option were classified as current liabilities in
the Consolidated Balance Sheet as of June 30, 2004 and December 31, 2003.
Operating activities provided net cash of $707.4 million in the first six
months of 2004, compared with $764.9 million for the same 2003 period. The
$57.5 million decrease in operating cash flow between periods resulted
primarily from a $53 million increase in taxes and interest paid during the
first six months of 2004. For the first six months of 2004, capital
spending, including dry hole costs, totaled $459 million and dividends paid
totaled $91 million, which compares with $707.4 of net cash provided by
operating activities during the same period. Excess operating cash flow,
together with Westport cash on hand at the merger date of $43 million,
proceeds from the sale of Devon stock of $38.9 million and other cash
inflows were used to fund the company's net reduction in long-term debt of
$261 million in the first six months of 2004.
Capital expenditures for the first six months of 2004, excluding dry hole
costs, totaled $432.9 million, compared with $517.9 million for the
comparable prior-year period. The decrease is primarily attributable to
lower capital spending within the exploration and production operating unit
in the Gulf of Mexico region as compared to the prior year. Exploration and
production expenditures, principally in the Gulf of Mexico and onshore
United States, were 89% of the 2004 total expenditures. Expenditures for
the chemicals - pigment segment were 9% of the 2004 total, while chemicals
- other and corporate incurred the remaining 2% of the year-to-date 2004
expenditures. Management anticipates that the cash requirements for the
next several years can be provided through internally generated funds and
selective borrowings.
On June 25, 2004, Kerr-McGee completed its acquisition of Westport, an
independent oil and gas exploration and production company with operations
in the Rocky Mountain, Mid-Continent and Gulf Coast areas onshore U. S. and
in the Gulf of Mexico. The acquisition increases Kerr-McGee's proved
reserves by approximately 30%, bringing the combined company's total
reserves as of December 31, 2003, to approximately 1.3 billion barrels of
oil equivalent. Kerr-McGee believes the merger will create a more balanced
portfolio of oil and gas assets for future growth by combining Westport's
lower-risk, predominantly U.S. onshore properties with Kerr-McGee's
existing asset portfolio. The merger is also expected to positively impact
the company's cash flow from operations for the last six months of 2004.
The acquisition price totaled $4.5 billion, which includes the value of
common stock and stock options exchanged, plus debt and other liabilities
assumed, and merger costs. As a result of the transaction, Kerr-McGee
issued 48.9 million shares of common stock valued at $2.4 billion to
Westport's stockholders and exchanged 1.9 million stock options with a fair
value of $33.7 million for outstanding Westport options.
In connection with the merger, Kerr-McGee assumed the following Westport
debt:
(Millions of dollars) Fair Value
---------------------------------------------------------------------------
8.25% Notes due 2011 (face value $700 million) $ 800.5
Revolving credit facility 245.0
--------
Total $1,045.5
========
On June 25, 2004, after completion of the merger, Kerr-McGee paid down all
outstanding borrowings under the Westport revolving credit facility.
Consequently, there were no borrowings outstanding under this credit
facility at June 30, 2004. However, letters of credit totaling $160 million
associated with Westport's derivatives were backed by the credit facility
and remained outstanding as of June 30, 2004. During July, these letters of
credit were cancelled and the Westport revolving credit facility was
terminated on July 13, 2004.
During June 2004, Kerr-McGee purchased Westport 8.25% Notes with an
aggregate principal amount of $14.5 million ($16.1 million fair value). The
fair value of the purchased notes is reflected as a reduction of long-term
debt assumed in the merger in the Consolidated Balance Sheet. On July 1,
2004, Kerr-McGee issued a notice of redemption for the 8.25% Westport notes
and the notes were redeemed on July 31, 2004 at an aggregate redemption
price of $785.5 million. The redemption price consisted of the face value
of $700 million, less the amount previously purchased by Kerr-McGee of
$14.5 million, plus a make-whole premium of $100 million.
On July 1, 2004, Kerr-McGee issued $650 million of 6.95% notes due July 1,
2024, with interest payable semi-annually. The notes were issued at 99.2%,
resulting in a discount of $5 million which will be recognized as
additional interest expense over the term of the notes. The proceeds from
this debt issuance, together with proceeds from borrowings under the
company's revolving credit facilities, were used to redeem the 8.25%
Westport notes discussed above.
Obligations and Commitments
In connection with the merger, Kerr-McGee assumed Westport's obligations
under existing firm transportation contracts. The following table shows the
expected future payment commitments associated with these contracts:
(Millions of dollars) Payments due by period
---------------------------------------------------------------------------
2005 2007 After
Total 2004 -2006 -2008 2008
------ ---- ----- ----- -----
Gas transportation contracts $111.3 $2.9 $20.3 $25.6 $62.5
====== ==== ===== ===== =====
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
Commodity Price Risk
The company is exposed to market risk fluctuations in crude oil and natural
gas prices. To increase the predictability of its cash flows and support
capital expenditure plans, the company periodically enters into financial
derivative instruments that generally fix the commodity prices to be
received for a portion of the company's oil and gas production in the
future.
Prior to entering into the merger agreement with Westport, Kerr-McGee
entered into additional financial derivative transactions relating to
specified amounts of projected 2004-2006 crude oil and natural gas
production volumes. In addition, Kerr-McGee assumed Westport's existing
commodity derivatives at the merger date. Westport's derivatives in place
at the merger dated consisted of fixed-price oil and gas swaps, natural gas
basis swaps, and costless and three-way collars. The collars assumed in the
merger do not qualify for hedge accounting treatment, although they
effectively reduce commodity price risk for the combined company's
production.
At June 30, 2004, the following commodity-related derivatives were
outstanding related to (i) the company's 2004 hedging program, (ii) the
incremental derivative transactions described above and (iii) Westport's
derivative positions in place at the merger date.
Average
Daily Average
Contract Type (1) Period Volume Price
----------------------------------------------------------------------------------------------------------------
Natural Gas Hedges MMBtu $/MMBtu
------------------ ----- -------
Fixed-price swaps (NYMEX) Q3 - 2004 807,663 $4.89
Q4 - 2004 870,000 $4.97
2005 55,000 $4.42
Fixed-price swaps (NWPRM) (2) Q3, Q4 - 2004 30,000 $3.33
Costless collars (NYMEX) 2005 280,000 $5.00 - $6.25
2006 340,000 $4.75 - $5.51
Basis swaps (CIG (3) and NWPRM) Q3 - 2004 100,000 $0.59
Q4 - 2004 80,109 $0.55
2005 45,000 $0.41
Crude Oil Hedges Bbl $/Bbl
---------------- --- -----
Fixed-price swaps (WTI) Q3 - 2004 65,882 $27.93
Q4 - 2004 68,015 $28.54
2005 3,000 $29.23
Fixed-price swaps (Brent) Q3 - 2004 46,850 $26.45
Q4 - 2004 52,000 $26.71
Costless collars (WTI) 2005 14,000 $28.50 - $31.89
2006 19,000 $27.00 - $30.58
(1) These contracts may be subject to margin calls above certain limits
established with individual counterparty institutions.
(2) Northwest Pipeline Rocky Mountain index (NWPRM).
(3) Colorado Interstate Gas pipeline.
At June 30, 2004, the following commodity-related derivatives were
outstanding and represent those contracts that have not been designated as
hedges or that do not qualify for hedge accounting treatment in the case of
the collars acquired in the Westport merger.
Average
Daily Three-way Average
Contract Type (1) Period Volume Floor Price
----------------------------------------------------------------------------------------------------------------
Natural Gas (nonhedge contracts) MMBtu $/MMBtu $/MMBtu
-------------------------------- ----- ------- -------
Basis swaps (CIG and NWPRM) 2006 - 2007 35,000 - $0.31
2008 17,473 - $0.25
Costless collars (NYMEX) Q3, Q4 - 2004 44,674 - $3.70 - $4.00
2005 60,000 - $4.09 - $5.57
Three-way collars (NYMEX) (2) Q3, Q4 - 2004 10,000 $3.15 $4.00 - $5.00
2006 20,000 $3.04 $4.00 - $6.00
Crude Oil (nonhedge contracts) Bbl $/Bbl $/Bbl
------------------------------ --- ----- -----
Three-way collars (WTI) (2) Q3, Q4 - 2004 4,000 $19.25 $24.38 - $27.71
2005 5,000 $20.93 $25.00 - $28.23
2006 2,000 $20.88 $25.00 - $28.65
(1) These contracts may be subject to margin calls above certain limits
established with individual counterparty institutions.
(2) These derivatives function similar to a costless collar with the
exception that if the NYMEX price falls below the three-way floor, the
company loses price protection. For example, the company only has
$.85/MMBtu of price protection if the NYMEX price falls below
$3.15/MMBtu in the case of its 2004 natural gas three-way collars
($4.00 - $3.15).
Foreign Currency Exchange Rate Risk
Periodically, the company enters into forward contracts to buy and sell
foreign currencies. Certain of these contracts (purchases of Australian
dollars and British pound sterling) have been designated and have qualified
as cash flow hedges of the company's operating and capital expenditure
requirements. These contracts generally have durations of less than three
years. The resulting changes in fair value of these contracts are recorded
in accumulated other comprehensive income.
Following are the notional amounts at the contract exchange rates,
weighted-average contractual exchange rates and estimated contract values
for contracts to purchase (sell) foreign currencies. Contract values for
contracts open at June 30, 2004, are based on the estimated forward
exchange rates in effect at quarter-end. Contract values for contracts
entered into subsequent to quarter-end are based on July month-end rates.
All amounts are U.S. dollar equivalents.
Estimated
(Millions of dollars, Notional Weighted-Average Contract
except average contract rates) Amount Contract Rate Value
--------------------------------------------------------------------------------------------------------------
Open contracts at June 30, 2004 -
Maturing in 2004 -
British pound sterling $ 124.3 1.6976 $ 132.3
Australian dollar 18.8 .5353 24.3
Euro (112.1) 1.1755 (107.0)
British pound sterling (.8) 1.7753 (.8)
New Zealand dollar (.9) .6198 (.9)
Japanese yen (.5) .0092 (.5)
Maturing in 2005 -
British pound sterling 76.7 1.5995 85.0
Contracts entered into in July 2004 -
Maturing in 2005 -
British pound sterling 109.1 1.7980 107.8
Item 4. Controls and Procedures.
As of the end of the period covered by this report, an evaluation was
carried out under the supervision and with the participation of the
company's management, including its Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
company's disclosure controls and procedures pursuant to Exchange Act Rule
13a-15. Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the company's disclosure controls and
procedures are effective in alerting them in a timely manner to material
information relating to the company (including its consolidated
subsidiaries) required to be included in the company's periodic SEC
filings. Subsequent to the date of evaluation of the company's internal
controls, Kerr-McGee contracted Netherland, Sewell & Associates, Inc.
(NSAI) to review the company's processes for assessing oil and natural gas
reserves. NSAI specializes in reservoir engineering, modeling and
economics, as well as other consulting services. In 2004, NSAI will review
procedures, methodology and reserve calculations for Kerr-McGee's major
domestic fields, covering approximately 50% of the company's existing
proved reserve base prior to the Kerr-McGee and Westport merger. Of
Westport's total estimated proved reserve quantities of 297 million barrels
of oil equivalent as of December 31, 2003, 87% was based upon reserve
reports prepared by NSAI and Ryder Scott Company, L.P.
Forward-Looking Information
Statements in this quarterly report regarding the company's or management's
intentions, beliefs or expectations, or that otherwise speak to future
events, are "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Future results and developments
discussed in these statements may be affected by numerous factors and
risks, such as the accuracy of the assumptions that underlie the
statements, the success of the oil and gas exploration and production
program, drilling risks, the market value of Kerr-McGee's products,
uncertainties in interpreting engineering data, demand for consumer
products for which Kerr-McGee's businesses supply raw materials, the
financial resources of competitors, changes in laws and regulations, the
ability to respond to challenges in international markets, including
changes in currency exchange rates, political or economic conditions, trade
and regulatory matters, general economic conditions, and other factors and
risks identified in the Risk Factors section of the company's Annual Report
on Form 10-K and other SEC filings. Actual results and developments may
differ materially from those expressed in this quarterly report.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
A. In 2002, Tiwest Pty Ltd, an Australian joint venture that produces
titanium dioxide and in which Chemical indirectly has a 50%
interest, received a complaint and notice of violation from the
Department of Environmental Waters and Catchment Protection in
Western Australia (the "Department") alleging violations of the
Environmental Protection Act (1986). This matter concerned an
alleged chlorine release at the facility. Tiwest defended the
proceeding in the Court of Petty Sessions, Perth, Western Australia,
and on March 26, 2004, the Court found in favor of Tiwest. The
Department has appealed the Court's decision. Tiwest is vigorously
defending against the appeal, and the company believes that, should
the Court's ruling be overturned, any fines or penalties related to
the matter will not have a material adverse effect on the company.
B. In addition to the matter described above and those previously
disclosed in the Annual Report on Form 10-K and the Quarterly Report
on Form 10-Q for the first fiscal quarter, a discussion of legal
proceedings and contingencies can be found in Note M to the
Consolidated Financial Statements included in Part I, Item 1 of this
Form 10-Q, which is incorporated herein by reference.
Item 4. Submission of Matters to a Vote of Security Holders.
(a) The 2004 annual meeting of stockholders was held on May 11, 2004.
The following matters were voted upon at the 2004 annual meeting:
(1) The following directors were elected with the following vote
totals.
Votes Votes
In Favor Withheld
-------- --------
William E. Bradford 86,977,664 2,002,742
Luke R. Corbett 86,877,896 2,102,509
David C. Genever-Watling 86,875,178 2,105,227
Farah M. Walters 86,296,045 2,684,361
(2) The stockholders ratified the appointment of Ernst & Young LLP
as the company's independent auditors for 2004. There were
85,874,326 votes for the proposal; 2,530,228 votes against the
proposal; and 575,851 abstentions.
(3) The stockholders voted against a stockholder proposal to
establish an Office of the Board of Directors. There were
34,344,137 votes for the proposal; 39,711,741 votes against the
proposal; and 1,560,458 abstentions.
(b) A special meeting of stockholders was held on June 25, 2004, to
consider and vote on a proposal to approve the issuance of shares of
Kerr-McGee common stock in connection with the merger of Westport
Resources Corporation with and into Kerr-McGee (Nevada) LLC. There
were 74,823,050 votes for the proposal; 1,457,583 votes against the
proposal; and 551,901 abstentions.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits -
Exhibit No
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3.1 Amended and restated Certificate of Incorporation
of Kerr-McGee Corporation, filed as Exhibit 4.1 to
the company's Registration Statement on Form S-4
dated June 28, 2001, and incorporated herein by
reference.
3.2 Amended and restated Bylaws of Kerr-McGee
Corporation.
4.1 The company agrees to furnish to the Securities
and Exchange Commission, upon request, copies of
each of the following instruments, which define
the rights of holders of certain long-term debt of
the company, which debt has been redeemed as of
the date of this filing: Indenture, dated as of
November 5, 2001, among Westport Resources
Corporation, the subsidiary guarantors party
thereto and The Bank of New York, as trustee under
the indenture, as amended by the First
Supplemental Indenture, dated as of December 31,
2001, by the Second Supplemental Indenture
thereto, dated as of December 17, 2002, by the
Third Supplemental Indenture thereto, dated as of
April 3, 2003, and by the Fourth Supplemental
Indenture thereto, dated as of June 25, 2004.
10.1 Westport Resources Corporation 2000 Stock
Incentive Plan effective October 17, 2000.
10.2 Amendment No. 1 to Westport Resources Corporation
2000 Stock Incentive Plan effective August 21,
2001.
31.1 Certification pursuant to Securities Exchange Act
Rule 15d-14(a), as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification pursuant to Securities Exchange Act
Rule 15d-14(a), as adopted pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K -
The following Current Reports on Form 8-K were filed or furnished by
the company during the quarter ended June 30, 2004:
o Current Report dated April 7, 2004, announcing that the
boards of directors of Kerr-McGee Corporation and Westport
Resources Corporation unanimously approved a strategic
merger.
o Current Report dated April 7, 2004, announcing the company
had posted on its website a table containing information
regarding new hedges entered into by Kerr-McGee associated
with the Westport merger.
o Current Report dated April 7, 2004, in which the company
provided fact sheets presenting certain operating and
financial information related to Kerr-McGee and Westport
associated with the proposed merger.
o Current Report dated April 8, 2004, in which the company
furnished as exhibits pursuant to Item 7 of Form 8-K the
Agreement and Plan of Merger, Voting Agreements and a
Registration Rights Agreement entered into in connection with
the merger of Kerr-McGee Corporation and Westport Resources
Corporation, together with the joint press release dated
April 7, 2004 by Kerr-McGee and Westport announcing the
merger.
o Current Report dated April 21, 2004, announcing a conference
call to discuss the company's first-quarter 2004 financial
and operating results, and expectations for the future.
o Current Report dated April 28, 2004, announcing the company
had posted on its website a table providing projected ranges
of 2004 average daily oil and natural gas production and a
table containing a reconciliation of net income determined in
accordance with generally accepted accounting principles to
adjusted net income for the year-to-date and quarterly fiscal
periods ended March 31, 2004.
o Current Report dated April 28, 2004, announcing the company's
first-quarter 2004 earnings.
o Current Report dated May 21, 2004, announcing a conference
call to discuss to company's second-quarter 2004 financial
and operating activities, and expectations for the future.
o Current Report dated May 26, 2004, announcing a security
analyst meeting to discuss the company's financial and
operating outlook for 2004 and certain expectations for oil
and natural gas production volumes for the year 2004.
o Current Report dated May 27, 2004, announcing that the
company would present at the UBS 2004 Global Oil and Gas
Conference on June 3, 2004.
o Current Report dated June 2, 2004, announcing that the
company would present at the RBC Capital Markets North
American Energy and Power Conference on June 8, 2004.
o Current Report dated June 16, 2004, announcing a conference
call to discuss the company's second-quarter 2004 financial
and operating activities, and expectations for the future.
o Current Report dated June 21, 2004, in which Kerr-McGee filed
the audited consolidated financial statements of Westport
included in its Annual Report on Form 10-K for the year ended
December 31, 2003, the unaudited consolidated financial
statements of Westport as of and for the three months ended
March 31, 2004, and unaudited pro forma condensed
consolidated financial statements, together with the consents
of KPMG LLP, Ryder Scott Company, L.P., and Netherland Sewell
& Associates, Inc.
o Current Report dated June 23, 2004, in which Kerr-McGee filed
a consent issued by Ernst & Young LLP associated with the
company's registration statements on Form S-3 (File Nos.
333-81720 and 333-68136) and prospectuses thereunder.
o Current Report dated June 25, 2004, announcing the closing of
the merger of Westport Resources Corporation with and into
Kerr-McGee (Nevada), LLC, a wholly owned subsidiary of
Kerr-McGee.
o Current Report dated June 25, 2004, announcing the offering
of $650 million in aggregate principal amount of Kerr-McGee's
6.95% Notes due 2024.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
KERR-McGEE CORPORATION
Date: August 6, 2004 By: /s/ John M. Rauh
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John M. Rauh
Vice President and Controller
and Chief Accounting Officer