UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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(Mark One) |
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x |
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE |
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FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2007 |
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or |
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o |
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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FOR THE TRANSITION PERIOD FROM TO |
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COMMISSION FILE NUMBER 1-3551 |
EQUITABLE RESOURCES, INC.
(Exact name of registrant as specified in its charter)
PENNSYLVANIA |
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25-0464690 |
(State or other jurisdiction of incorporation or organization) |
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(IRS Employer Identification No.) |
225 North Shore Drive, Pittsburgh, Pennsylvania 15212
(Address of principal executive offices, including zip code)
Registrants telephone number, including area code: (412) 553-5700
(Former name, former address and former fiscal year, if changed since last report)
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 o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ý Accelerated Filer o Non-Accelerated Filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.
Class |
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Outstanding
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Common stock, no par value |
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121,648,466 shares |
EQUITABLE RESOURCES, INC. AND SUBSIDIARIES
Index
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Part I. Financial Information: |
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Item 1. |
Financial Statements (Unaudited): |
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Statements of Consolidated Income for the Three and Six Months Ended June 30, 2007 and 2006 |
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Statements of Condensed Consolidated Cash Flows for the Six Months Ended June 30, 2007 and 2006 |
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Condensed Consolidated Balance Sheets as of June 30, 2007 and December 31, 2006 |
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Notes to Condensed Consolidated Financial Statements |
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Item 2. |
Managements Discussion and Analysis of Financial Condition and Results of Operations |
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Item 3. |
Quantitative and Qualitative Disclosures About Market Risk |
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Item 4. |
Controls and Procedures |
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Part II. Other Information: |
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Item 1. |
Legal Proceedings |
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Item 1A. |
Risk Factors |
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Item 2. |
Unregistered Sales of Equity Securities and Use of Proceeds |
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Item 4. |
Submission of Matters to a Vote of Security Holders |
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Item 6. |
Exhibits |
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Signature |
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Index to Exhibits |
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2
Item 1. Financial Statements
Statements of Consolidated Income (Unaudited)
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Three Months Ended |
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Six Months Ended |
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2007 |
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2006 |
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2007 |
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2006 |
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(Thousands, except per share amounts) |
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Operating revenues |
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$ |
293,240 |
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$ |
251,207 |
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$ |
749,786 |
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$ |
681,326 |
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Cost of sales |
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116,953 |
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86,113 |
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336,965 |
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294,930 |
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Net operating revenues |
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176,287 |
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165,094 |
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412,821 |
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386,396 |
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Operating expenses: |
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Operation and maintenance |
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25,568 |
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25,366 |
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53,012 |
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48,970 |
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Production |
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16,125 |
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15,670 |
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32,637 |
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31,789 |
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Selling, general and administrative |
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45,483 |
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28,050 |
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111,780 |
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57,755 |
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Office consolidation impairment charges |
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(2,908 |
) |
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(2,908 |
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Depreciation, depletion and amortization |
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27,592 |
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24,797 |
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55,019 |
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49,014 |
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Total operating expenses |
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114,768 |
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90,975 |
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252,448 |
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184,620 |
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Operating income |
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61,519 |
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74,119 |
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160,373 |
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201,776 |
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Gain on sale of assets, net |
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119,401 |
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119,401 |
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Gain on sale of available-for-sale securities |
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1,042 |
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Equity in earnings (losses) of nonconsolidated investments |
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666 |
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(124 |
) |
775 |
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50 |
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Interest expense |
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9,483 |
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9,995 |
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21,763 |
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22,952 |
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Income before income taxes |
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172,103 |
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64,000 |
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259,828 |
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178,874 |
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Income taxes |
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64,760 |
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20,091 |
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95,867 |
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62,606 |
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Net income |
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$ |
107,343 |
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$ |
43,909 |
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$ |
163,961 |
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$ |
116,268 |
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Earnings per share of common stock: |
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Basic: |
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Weighted average common shares outstanding |
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121,356 |
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120,128 |
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121,289 |
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119,823 |
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Net income |
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$ |
0.88 |
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$ |
0.37 |
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$ |
1.35 |
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$ |
0.97 |
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Diluted: |
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Weighted average common shares outstanding |
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122,837 |
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122,044 |
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122,806 |
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121,899 |
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Net income |
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$ |
0.87 |
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$ |
0.36 |
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$ |
1.34 |
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$ |
0.95 |
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Dividends declared per common share |
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$ |
0.22 |
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$ |
0.22 |
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$ |
0.44 |
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$ |
0.43 |
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The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
3
EQUITABLE RESOURCES, INC. AND SUBSIDIARIES
Statements of Condensed Consolidated Cash Flows (Unaudited)
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Six Months Ended |
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2007 |
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2006 |
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(Thousands) |
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Cash flows from operating activities: |
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Net income |
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$ |
163,961 |
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$ |
116,268 |
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Adjustments to reconcile net income to cash provided by operating activities: |
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Provision for losses on accounts receivable |
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(1,075 |
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614 |
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Depreciation, depletion, and amortization |
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55,019 |
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49,014 |
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Gain on sale of assets, net |
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(119,401 |
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Gain on sale of available-for-sale securities |
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(1,042 |
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Office consolidation impairment charges |
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(2,908 |
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Deferred income taxes |
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55,823 |
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5,899 |
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Excess tax benefits from share-based payment arrangements |
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(4,180 |
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(5,758 |
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Decrease in accounts receivable and unbilled revenues |
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67,376 |
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158,688 |
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Decrease in inventory |
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42,174 |
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908 |
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(Increase) decrease in margin deposits |
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(10,933 |
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199,837 |
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Decrease in accounts payable |
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(1,373 |
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(78,919 |
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Change in derivative instruments at fair value, net |
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27,375 |
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4,441 |
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Changes in other assets and liabilities |
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40,593 |
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(50,211 |
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Net cash provided by operating activities |
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314,317 |
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397,873 |
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Cash flows from investing activities: |
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Capital expenditures |
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(335,860 |
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(153,416 |
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Proceeds from sale of assets |
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184,576 |
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Restricted cash from sale of assets |
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(95,000 |
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Proceeds from contribution of assets |
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23,262 |
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Proceeds from sale of available-for-sale securities |
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7,295 |
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Investment in available-for-sale securities |
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(9,709 |
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(2,201 |
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Proceeds from sale of discontinued operations, net of purchase price adjustments |
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(724 |
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Net cash used in investing activities |
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(225,436 |
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(156,341 |
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Cash flows from financing activities: |
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Dividends paid |
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(53,531 |
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(51,729 |
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Proceeds from note payable to Nora Gathering, LLC |
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69,786 |
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Repayments of note payable to Nora Gathering, LLC |
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(7,000 |
) |
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Proceeds from exercises under employee compensation plans |
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2,449 |
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16,274 |
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Excess tax benefits from share-based payment arrangements |
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4,180 |
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5,758 |
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Decrease in short-term loans |
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(33,999 |
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(286,801 |
) |
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Net cash used in financing activities |
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(18,115 |
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(316,498 |
) |
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Net increase (decrease) in cash and cash equivalents |
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70,766 |
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(74,966 |
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Cash and cash equivalents at beginning of period |
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74,966 |
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Cash and cash equivalents at end of period |
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$ |
70,766 |
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$ |
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Cash paid during the period for: |
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Interest, net of amount capitalized |
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$ |
21,373 |
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$ |
22,972 |
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Income taxes, net of refund |
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$ |
21,072 |
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$ |
30,448 |
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The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
4
Condensed Consolidated Balance Sheets (Unaudited)
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June 30, |
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December 31, |
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(Thousands) |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
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$ |
70,766 |
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$ |
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Restricted cash |
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95,576 |
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Accounts receivable (less accumulated provision for doubtful accounts: June 30, 2007, $17,003; December 31, 2006, $20,442) |
|
162,018 |
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199,486 |
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Unbilled revenues |
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11,794 |
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40,627 |
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Margin deposits with financial institutions |
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10,944 |
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11 |
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Inventory |
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226,954 |
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269,128 |
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Derivative instruments, at fair value |
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32,336 |
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129,675 |
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Prepaid expenses and other |
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60,770 |
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62,523 |
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Total current assets |
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671,158 |
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701,450 |
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Equity in nonconsolidated investments |
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128,558 |
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35,023 |
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Property, plant and equipment |
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3,730,469 |
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3,617,297 |
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Less: accumulated depreciation and depletion |
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1,239,581 |
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1,239,826 |
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Net property, plant and equipment |
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2,490,888 |
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2,377,471 |
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Investments, available-for-sale |
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35,777 |
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31,270 |
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Other assets |
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113,026 |
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111,697 |
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Total assets |
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$ |
3,439,407 |
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$ |
3,256,911 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current liabilities: |
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Current portion of long-term debt |
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$ |
10,000 |
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$ |
10,000 |
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Short-term loans |
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102,000 |
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135,999 |
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Note payable to Nora Gathering, LLC |
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62,786 |
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Accounts payable |
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211,953 |
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213,326 |
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Derivative instruments, at fair value |
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582,805 |
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570,251 |
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Other current liabilities |
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156,673 |
|
150,203 |
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Total current liabilities |
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1,126,217 |
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1,079,779 |
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Debentures and medium-term notes |
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753,500 |
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753,500 |
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Other non-current liabilities: |
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Deferred income taxes and investment tax credits |
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363,053 |
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338,012 |
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Unrecognized tax benefits |
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36,191 |
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Pension and other post-retirement benefits |
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47,926 |
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50,947 |
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Other credits |
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89,494 |
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88,393 |
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Total other non-current liabilities |
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536,664 |
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477,352 |
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||||||
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Common stockholders equity: |
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Common stock, no par value, authorized 320,000 shares; shares issued: June 30, 2007 and December 31, 2006, 149,008 |
|
369,043 |
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366,856 |
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Treasury stock, shares at cost: June 30, 2007, 27,357; December 31, 2006, 27,405 (net of shares and cost held in trust for deferred compensation of 177, $3,038 and 159, $2,724) |
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(469,385 |
) |
(469,584 |
) |
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Retained earnings |
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1,469,629 |
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1,363,310 |
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Accumulated other comprehensive loss |
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(346,261 |
) |
(314,302 |
) |
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Total common stockholders equity |
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1,023,026 |
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946,280 |
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Total liabilities and stockholders equity |
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$ |
3,439,407 |
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$ |
3,256,911 |
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The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
5
Equitable Resources, Inc. and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
A. Financial Statements
The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with United States generally accepted accounting principles for interim financial information and with the requirements of Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements. In this Form 10-Q, references to we, us, our, Equitable, Equitable Resources, and the Company refer collectively to Equitable Resources, Inc. and its consolidated subsidiaries. In the opinion of management, these statements include all adjustments (consisting of only normal recurring accruals, unless otherwise disclosed in this Form 10-Q) necessary for a fair presentation of the financial position of Equitable Resources, Inc. and subsidiaries as of June 30, 2007, and the results of its operations and cash flows for the three and six month periods ended June 30, 2007 and 2006.
The balance sheet at December 31, 2006 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements.
Due to the seasonal nature of the Companys natural gas distribution and energy marketing businesses and the volatility of natural gas prices, the interim statements for the three and six month periods ended June 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.
For further information, refer to the consolidated financial statements and footnotes thereto included in Equitable Resources Annual Report on Form 10-K for the year ended December 31, 2006, as well as in Information Regarding Forward Looking Statements on page 17 of this document.
B. Segment Information
The Company reports its operations in two segments, which reflect its lines of business. The Equitable Supply segments activities comprise the development, production, gathering, marketing and sale of natural gas and a small amount of associated oil and the extraction and sale of natural gas liquids. The Equitable Utilities segments operations comprise the sale and transportation of natural gas to customers at state-regulated rates, interstate pipeline transportation, storage and gathering of natural gas subject to federal regulation, the unregulated marketing of natural gas and limited trading activities.
Operating segments are evaluated on their contribution to the Companys consolidated results based on operating income, equity in earnings (losses) of nonconsolidated investments and other income. Interest expense and income taxes are managed on a consolidated basis. Headquarters costs are billed to the operating segments based upon a fixed allocation of the headquarters annual operating budget. Differences between budget and actual headquarters expenses are not allocated to the operating segments.
Substantially all of the Companys operating revenues, income from operations and assets are generated or located in the United States.
6
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Three Months Ended |
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Six Months Ended |
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||||||||||
|
|
2007 |
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2006 |
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2007 |
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2006 |
|
||||||
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|
||||||
Revenues from external customers: |
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|
|
|
|
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|
||||||
Equitable Supply |
|
$ |
127,884 |
|
$ |
119,327 |
|
$ |
253,141 |
|
$ |
241,776 |
|
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Equitable Utilities |
|
172,112 |
|
139,027 |
|
515,224 |
|
473,725 |
|
||||||
Less: intersegment revenues (a) |
|
(6,756 |
) |
(7,147 |
) |
(18,579 |
) |
(34,175 |
) |
||||||
Total |
|
$ |
293,240 |
|
$ |
251,207 |
|
$ |
749,786 |
|
$ |
681,326 |
|
||
Total operating expenses: |
|
|
|
|
|
|
|
|
|
||||||
Equitable Supply |
|
$ |
56,707 |
|
$ |
53,884 |
|
$ |
127,104 |
|
$ |
104,350 |
|
||
Equitable Utilities |
|
37,544 |
|
31,900 |
|
79,602 |
|
69,731 |
|
||||||
Unallocated expenses (b) |
|
20,517 |
|
5,191 |
|
45,742 |
|
10,539 |
|
||||||
Total |
|
$ |
114,768 |
|
$ |
90,975 |
|
$ |
252,448 |
|
$ |
184,620 |
|
||
Operating income: |
|
|
|
|
|
|
|
|
|
||||||
Equitable Supply |
|
$ |
71,177 |
|
$ |
65,443 |
|
$ |
126,037 |
|
$ |
137,426 |
|
||
Equitable Utilities |
|
10,859 |
|
13,867 |
|
80,078 |
|
74,889 |
|
||||||
Unallocated expenses |
|
(20,517 |
) |
(5,191 |
) |
(45,742 |
) |
(10,539 |
) |
||||||
Total |
|
$ |
61,519 |
|
$ |
74,119 |
|
$ |
160,373 |
|
$ |
201,776 |
|
||
|
|
|
|
|
|
|
|
|
|
||||||
Reconciliation of operating income to net income: |
|
|
|
|
|
|
|
|
|
||||||
|
|
|
|
|
|
|
|
|
|
||||||
Equity in earnings (losses) of nonconsolidated investments: |
|
|
|
|
|
|
|
|
|
||||||
Equitable Supply |
|
$ |
633 |
|
$ |
(124 |
) |
$ |
706 |
|
$ |
(18 |
) |
||
Unallocated |
|
33 |
|
|
|
69 |
|
68 |
|
||||||
Total |
|
$ |
666 |
|
$ |
(124 |
) |
$ |
775 |
|
$ |
50 |
|
||
|
|
|
|
|
|
|
|
|
|
||||||
Gain on sale of assets, net Equitable Supply |
|
119,401 |
|
|
|
119,401 |
|
|
|
||||||
Gain on sale of available-for-sale securities |
|
|
|
|
|
1,042 |
|
|
|
||||||
Interest expense |
|
9,483 |
|
9,995 |
|
21,763 |
|
22,952 |
|
||||||
Income taxes |
|
64,760 |
|
20,091 |
|
95,867 |
|
62,606 |
|
||||||
Net income |
|
$ |
107,343 |
|
$ |
43,909 |
|
$ |
163,961 |
|
$ |
116,268 |
|
||
|
|
June 30, |
|
December 31, |
|
|||
|
|
2007 |
|
2006 |
|
|||
|
|
(Thousands) |
|
|||||
Segment Assets: |
|
|
|
|
|
|||
Equitable Supply |
|
$ |
1,971,136 |
|
$ |
1,794,485 |
|
|
Equitable Utilities |
|
1,293,537 |
|
1,407,024 |
|
|||
Total operating segments |
|
3,264,673 |
|
3,201,509 |
|
|||
Headquarters assets and intersegment eliminations, net |
|
174,734 |
|
55,402 |
|
|||
Total assets |
|
$ |
3,439,407 |
|
$ |
3,256,911 |
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|||||||||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
|||||||
|
|
(Thousands) |
|
|||||||||||||
Expenditures for segment assets: |
|
|
|
|
|
|
|
|
|
|||||||
Equitable Supply |
|
$ |
159,462 |
|
$ |
68,615 |
|
$ |
297,455 |
|
$ |
122,527 |
|
|||
Equitable Utilities |
|
18,616 |
|
13,626 |
|
38,207 |
|
29,080 |
|
|||||||
Unallocated expenditures |
|
112 |
|
541 |
|
198 |
|
1,809 |
|
|||||||
Total |
|
$ |
178,190 |
|
$ |
82,782 |
|
$ |
335,860 |
|
$ |
153,416 |
|
|||
(a) Intersegment revenues primarily represent sales from Equitable Supply to the unregulated marketing affiliate of Equitable Utilities.
(b) Unallocated expenses for the three and six months ended June 30, 2007 are primarily related to executive compensation.
7
C. Derivative Instruments
Natural Gas Hedging Instruments
The Companys overall objective in its hedging program is to assure a return on capital invested in long-lived assets in excess of the Companys cost of capital. The various derivative commodity instruments used by the Company to hedge its exposure to variability in expected future cash flows associated with the fluctuations in the price of natural gas related to the Companys forecasted sale of equity production and forecasted natural gas purchases and sales have been designated and qualify as cash flow hedges. Futures contracts obligate the Company to buy or sell a designated commodity at a future date for a specified price and quantity at a specified location. Swap agreements involve payments to or receipts from counterparties based on the differential between a fixed and variable price for the commodity. Collar agreements require the counterparty to pay the Company if the index price falls below the floor price and the Company to pay the counterparty if the index price rises above the cap price. Exchange-traded instruments are generally settled with offsetting positions. Over the counter arrangements require settlement in cash.
The fair value of the Companys derivative commodity instruments designated as cash flow hedges is presented below:
|
|
As of |
|
||||
|
|
June 30, 2007 |
|
December 31, 2006 |
|
||
|
|
(Thousands) |
|
||||
Asset |
|
$ |
31,908 |
|
$ |
129,675 |
|
Liability |
|
(544,919 |
) |
(544,444 |
) |
||
Net liability |
|
$ |
(513,011 |
) |
$ |
(414,769 |
) |
These amounts are included in the Condensed Consolidated Balance Sheets as derivative instruments, at fair value. The net fair value of derivative instruments changed during the first six months of 2007 primarily as a result of an increase in natural gas prices. The absolute quantities of the Companys derivative commodity instruments that have been designated and qualify as cash flow hedges totaled 335.9 Bcf and 392.6 Bcf as of June 30, 2007 and December 31, 2006, respectively, and primarily related to natural gas swaps. The open positions at June 30, 2007 had maturities extending through December 2013.
The Company deferred net losses of $319.8 million and $286.2 million in accumulated other comprehensive loss, net of tax, as of June 30, 2007 and December 31, 2006, respectively, associated with the effective portion of the change in fair value of its derivative instruments designated as cash flow hedges. Assuming no change in price or new transactions, the Company estimates that approximately $107.1 million of net unrealized losses on its derivative commodity instruments reflected in accumulated other comprehensive loss, net of tax, as of June 30, 2007 will be recognized in earnings during the next twelve months due to the physical settlement of hedged transactions. This recognition occurs through a reduction in the Companys net operating revenues resulting in the average hedged price becoming the realized sales price.
Ineffectiveness associated with the Companys derivative instruments designated as cash flow hedges increased earnings by approximately $1.3 million and $0.2 million for the three month periods ended June 30, 2007 and 2006, respectively. These amounts are included in operating revenues in the Statements of Consolidated Income.
The Company conducts trading activities through its unregulated marketing group. The function of the Companys trading business is to contribute to the Companys earnings by taking market positions within defined limits subject to the Companys corporate risk management policy. The absolute notional quantities of the futures and swaps held for trading purposes at June 30, 2007 totaled 9.9 Bcf and 23.8 Bcf, respectively.
Below is a summary of the activity of the fair value of the Companys derivative commodity contracts with third parties held for trading purposes during the six months ended June 30, 2007 (in thousands).
Fair value of contracts outstanding as of December 31, 2006 |
|
$ |
581 |
|
Contracts realized or otherwise settled |
|
(723 |
) |
|
Other changes in fair value |
|
57 |
|
|
Fair value of contracts outstanding as of June 30, 2007 |
|
$ |
(85 |
) |
8
The following table presents maturities and the fair valuation source for the Companys derivative commodity instruments that are held for trading purposes as of June 30, 2007.
Net Fair Value of Third Party Contract (Liabilities) Assets at Period-End
Source of Fair Value |
|
Maturity |
|
Maturity |
|
Maturity |
|
Maturity in |
|
Total Fair |
|
|||||
|
|
(Thousands) |
|
|||||||||||||
Prices actively quoted (NYMEX) (1) |
|
$ |
(103 |
) |
$ |
|
|
$ |
|
|
$ |
|
|
$ |
(103 |
) |
Prices provided by other external sources (2) |
|
18 |
|
|
|
|
|
|
|
18 |
|
|||||
Net derivative liabilities |
|
$ |
(85 |
) |
$ |
|
|
$ |
|
|
$ |
|
|
$ |
(85 |
) |
(1) Contracts include futures and fixed price swaps
(2) Contracts include basis swaps
In May 2007, the Company sold a portion of its interest in certain gas properties in the Nora Field, as discussed in Note J. As part of this transaction, the Company closed out certain cash flow hedges associated with forecasted production at this location by purchasing offsetting positions. The fair value of these derivative instruments was a $27.3 million liability at June 30, 2007. In addition, the fair value of derivative instruments associated with forecasted production at non-core gas properties sold in May 2005 was a $10.6 million liability at June 30, 2007. The Company does not treat these derivatives as hedging instruments under Statements of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133). These amounts are included in the Condensed Consolidated Balance Sheet as derivative instruments, at fair value.
When the net fair value of any of the Companys swap agreements represents a liability to the Company which is in excess of the agreed-upon threshold between the Company and the financial institution acting as counterparty, the counterparty requires the Company to remit funds to the counterparty as a margin deposit for the derivative liability which is in excess of the threshold amount. The Company recorded such deposits in the amount of $4.0 million in its Condensed Consolidated Balance Sheet as of June 30, 2007.
When the Company enters into exchange-traded natural gas contracts, exchanges require participants, including the Company, to remit funds to the corresponding broker as good-faith deposits to guard against the risks associated with changing market conditions. Participants must make such deposits based on an established margin requirement as well as the net liability position, if any, of the fair value of the associated contracts. In the case where the fair value of such contracts is in a net asset position, the broker may remit funds to the Company, in which case the Company records a current liability for such amounts received. The margin requirements are established by the exchanges based on prices, volatility and the time to expiration of the related contract and are subject to change at the exchanges discretion. The Company recorded margin deposits in the amount of $6.9 million in its Condensed Consolidated Balance Sheet as of June 30, 2007.
D. Investments, Available-For-Sale
As of June 30, 2007, the investments classified by the Company as available-for-sale consist of approximately $35.8 million of debt and equity securities intended to fund plugging and abandonment and other liabilities for which the Company self-insures. Any unrealized gains or losses with respect to investments classified as available-for-sale are recognized within the Condensed Consolidated Balance Sheets as a component of equity, accumulated other comprehensive loss.
During the first quarter of 2007, the Company reviewed its investment portfolio including its investment allocation and as a result sold equity securities with a cost basis of $6.3 million for total proceeds of $7.3 million, resulting in the Company recognizing a gain of $1.0 million. The Company used the proceeds from these sales and other available cash to purchase other debt and equity securities with a cost basis totaling $9.7 million during the first quarter of 2007. These investments are classified as available-for-sale in the Condensed Consolidated Balance Sheet. The Company utilizes the specific identification method to determine the cost of all investment securities sold.
9
E. Comprehensive Income
Total comprehensive income, net of tax, was as follows:
|
|
Three Months Ended |
|
Six Months Ended |
|
||||||||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||||
|
|
(Thousands) |
|
||||||||||||
Net income |
|
$ |
107,343 |
|
$ |
43,909 |
|
$ |
163,961 |
|
$ |
116,268 |
|
||
Other comprehensive income (loss): |
|
|
|
|
|
|
|
|
|
||||||
Net change in cash flow hedges: |
|
|
|
|
|
|
|
|
|
||||||
Natural gas (Note C) |
|
58,935 |
|
49,563 |
|
(33,598 |
) |
248,954 |
|
||||||
Interest rate |
|
29 |
|
29 |
|
58 |
|
58 |
|
||||||
Unrealized gain (loss) on investments, available-for-sale |
|
932 |
|
(389 |
) |
468 |
|
366 |
|
||||||
Pension and other post-retirement benefit plans: |
|
|
|
|
|
|
|
|
|
||||||
Prior service cost |
|
(14 |
) |
|
|
(118 |
) |
|
|
||||||
Net loss |
|
352 |
|
|
|
914 |
|
|
|
||||||
Settlement loss |
|
238 |
|
|
|
317 |
|
|
|
||||||
Total comprehensive income |
|
$ |
167,815 |
|
$ |
93,112 |
|
$ |
132,002 |
|
$ |
365,646 |
|
||
The components of accumulated other comprehensive loss, net of tax, are as follows:
|
|
June 30, |
|
December 31, |
|
||
|
|
2007 |
|
2006 |
|
||
|
|
(Thousands) |
|
||||
Net unrealized loss from hedging transactions |
|
$ |
(320,411 |
) |
$ |
(286,871 |
) |
Unrealized gain on available-for-sale securities |
|
4,437 |
|
3,969 |
|
||
Pension and other post-retirement benefits adjustment |
|
(30,287 |
) |
(31,400 |
) |
||
Accumulated other comprehensive loss |
|
$ |
(346,261 |
) |
$ |
(314,302 |
) |
F. Share-Based Compensation
The Company adopted SFAS No. 123 (revised 2004), Share-Based Payment (SFAS No. 123R) as of January 1, 2006. Under SFAS No. 123R, the compensation cost of a share-based award is recorded in the Companys income statement and is generally measured based on the grant-date fair value of the award.
Share-based compensation expense recorded by the Company was as follows:
|
|
Three Months Ended |
|
Six Months Ended |
|
||||||||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||||
|
|
(Thousands) |
|
||||||||||||
2005 Executive Performance Incentive Program units |
|
$ |
20,830 |
|
$ |
5,431 |
|
$ |
46,379 |
|
$ |
10,122 |
|
||
Restricted stock awards |
|
626 |
|
896 |
|
1,513 |
|
1,587 |
|
||||||
Nonqualified stock options |
|
29 |
|
129 |
|
212 |
|
685 |
|
||||||
Director stock units |
|
887 |
|
446 |
|
1,412 |
|
447 |
|
||||||
Total share-based compensation expense |
|
$ |
22,372 |
|
$ |
6,902 |
|
$ |
49,516 |
|
$ |
12,841 |
|
||
2005 Executive Performance Incentive Program
The vesting of the units granted under the 2005 Executive Performance Incentive Program (2005 Program) will occur contingent upon a combination of the level of total shareholder return relative to a fixed group of peer companies and the Companys average absolute return on total capital during the four year performance period ending December 31, 2008. The Company continually monitors its stock price and performance in order to assess the impact on the ultimate payouts under the 2005 Program. The Company modified its assumptions during the
10
first six months of 2007 and increased its assumptions for both the ultimate share price and the payout multiple at the vesting date to $60.00 and 225% of the units awarded, respectively. As a result, the Company recognized an increase in long-term incentive plan expense associated with the 2005 Program of $15.6 million and $35.7 million for the three and six month periods ended June 30, 2007, respectively. The 2005 Program expense is classified as selling, general and administrative expense in the Statements of Consolidated Income. A portion of the 2005 Program expense is included as an unallocated expense in deriving total operating income for segment reporting purposes. See Note B. The Company recorded a total accrual for the 2005 Program of $90.0 million in other current liabilities in its Condensed Consolidated Balance Sheet as of June 30, 2007.
Restricted Stock Awards
The Company granted 72,600 and 88,200 restricted stock awards during the six months ended June 30, 2007 and 2006, respectively, to key executives from the Companys 1999 Long-Term Incentive Plan (the Plan). The shares granted under the Plan will be fully vested at the end of the three-year period commencing the date of grant. The fair value of each share is equal to the market price of the Companys common stock on the date of grant. The weighted average fair value of these restricted stock grants, based on the grant date fair value of the Companys stock, was $43.61 and $35.75, for the six months ended June 30, 2007 and 2006, respectively.
As of June 30, 2007, there was $6.2 million of total unrecognized compensation cost related to nonvested restricted stock awards. That cost is expected to be recognized over a weighted average period of approximately 20 months.
Stock Options
The Company granted 20,123 and 56,257 stock options during the six months ended June 30, 2007 and 2006, respectively, all of which comprised options granted for reload rights associated with previously-awarded options. The weighted average grant date fair value of these reload option grants was $10.51 and $9.07 for the six month periods ended June 30, 2007 and 2006, respectively.
The fair value of the Companys option grants was estimated at the dates of grant using a Black-Scholes option-pricing model with the assumptions indicated in the table below for the six month periods ended June 30, 2007 and 2006.
|
|
Six Months Ended June 30, |
|
||
|
|
2007 |
|
2006 |
|
Risk-free interest rate (range) |
|
4.59% to 5.02% |
|
4.59% to 5.04% |
|
Dividend yield |
|
2.06% to 2.29% |
|
2.34% to 2.38% |
|
Volatility factor |
|
.212 to .213 |
|
.212 to .226 |
|
Expected term |
|
7 years |
|
7 years |
|
As of June 30, 2007, there was no unrecognized compensation cost related to outstanding nonvested stock options as all outstanding options were fully vested.
Nonemployee Directors Stock Incentive Plans
The Company has historically granted to non-employee directors stock units which vested upon award. The value of the stock units will be paid in cash on the earlier of the directors death or retirement from the Companys Board of Directors. The Company accounts for these stock units as liability awards and as such records compensation expense for the remeasurement of the fair value of the stock units based on the Companys stock price at the end of each reporting period. A total of 88,530 non-employee director stock units were outstanding as of June 30, 2007. A total of 15,570 and 18,000 stock units were granted to non-employee directors during the six month periods ended June 30, 2007 and 2006, respectively. The weighted average fair value of these director stock units, based on the grant date fair value of the Companys stock, was $49.88 and $35.12, for the six months ended June 30, 2007 and 2006, respectively.
As of June 30, 2007, 152,404 options were outstanding under the 1999 Nonemployee Directors Stock Incentive Plan. No options were granted to non-employee directors during the six month periods ended June 30, 2007 and 2006.
11
G. Income Taxes
The consolidated Federal income tax liability of the Company has been settled with the Internal Revenue Service (IRS) through 1997. The IRS has completed its review of the Companys Federal income tax filings for the 1998 through 2000 years and the Company believes that only minor issues remain to be resolved. The IRS is expected to survey the 2001 and 2002 Federal income tax filings. During the second quarter of 2007, the IRS began an examination of the Companys Federal income tax filings for 2003 through 2005. As of June 30, 2007, no significant issues have been raised relating to these filings.
The Company is also subject to various routine state income tax examinations. The Company mainly operates in four states which have statutes of limitations that expire between three to four years from the date of filing of the income tax return.
The Company estimates an annual effective income tax rate based on projected results for the year and applies this rate to income before taxes to calculate income tax expense. Refinements made due to subsequent information that affects the estimated annual effective income tax rate are reflected as adjustments in the current period. Separate effective income tax rates are calculated for net income from continuing operations and any separately reported net income items, such as discontinued operations and extraordinary items.
On April 4, 2007, West Virginia enacted legislation, effective for the Companys tax year beginning January 1, 2009, that mandates unitary combined reporting, changes certain apportionment provisions for tax partnerships, changes certain definitions for financial organizations and makes miscellaneous changes to other corporate net income tax statutes. As a result of this law change, the Company recorded additional tax expense of $2.9 million to reflect an overall increase in the Companys expected deferred tax liability as of the effective date. This charge is included in the annual income tax expense and the entire amount is reflected in the second quarter of 2007. The effective income tax rate for the three months ending June 30, 2007 is 37.6%. The Company currently estimates the annual effective income tax rate to be approximately 36.5%. The estimated annual effective income tax rate as of June 30, 2006 was 35.0%.
In June 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109, (FIN 48) which applies to all open tax positions accounted for in accordance with SFAS No. 109, Accounting for Income Taxes. This Interpretation is intended to result in increased relevance and comparability in financial reporting of income taxes and to provide more information about the uncertainty in income tax assets and liabilities.
The Company adopted the provisions of FIN 48 on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized a $4.1 million increase in the liability for unrecognized tax benefits which was accounted for as a reduction to the January 1, 2007 balance of retained earnings. Additionally, as a result of the implementation of FIN 48, the Company recorded $29.7 million of unrecognized tax benefits related to a balance sheet reclassification that did not impact retained earnings. A total of $16.9 million of this reclassification relates to the gross up of certain tax positions that were previously recorded net of tax benefit, tax positions which relate to temporary differences that were previously part of deferred taxes and tax positions that were previously offset against deferred tax assets. The remaining $12.8 million relates to tax positions previously categorized as current liabilities. After the recognition of these items in connection with the implementation of FIN 48, the total liability for unrecognized tax benefits at January 1, 2007 was $33.8 million. Of this total, $16.9 million of tax benefits would reduce the Companys effective tax rate if the tax benefits were recognized in the financial statements.
The Company recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense. The total amount of accrued interest included in the FIN 48 liability above as of January 1, 2007 was $11.0 million. No amounts were accrued for penalties as of January 1, 2007.
There were no material changes to unrecognized tax benefits, interest or penalties during the second quarter of 2007. As of June 30, 2007, the Company is not aware of any positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within the next 12 months.
12
H. Pension and Other Postretirement Benefit Plans
The Companys costs related to its defined benefit pension and other postretirement benefit plans for the three and six months ended June 30, 2007 and 2006 were as follows:
|
|
Pension Benefits |
|
Other Benefits |
|
||||||||
|
|
Three Months Ended June 30, |
|
||||||||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||
|
|
(Thousands) |
|
||||||||||
Components of net periodic benefit cost |
|
|
|
|
|
|
|
|
|
||||
Service cost |
|
$ |
63 |
|
$ |
108 |
|
$ |
123 |
|
$ |
138 |
|
Interest cost |
|
1,093 |
|
1,097 |
|
636 |
|
725 |
|
||||
Expected return on plan assets |
|
(1,403 |
) |
(1,533 |
) |
|
|
|
|
||||
Amortization of prior service cost |
|
41 |
|
93 |
|
(215 |
) |
(34 |
) |
||||
Recognized net actuarial loss |
|
363 |
|
267 |
|
574 |
|
536 |
|
||||
Settlement loss |
|
697 |
|
(109 |
) |
|
|
|
|
||||
Net periodic benefit cost |
|
$ |
854 |
|
$ |
(77 |
) |
$ |
1,118 |
|
$ |
1,365 |
|
|
|
Pension Benefits |
|
Other Benefits |
|
||||||||||
|
|
Six Months Ended June 30, |
|
||||||||||||
|
|
2007 |
|
2006 |
|
2007 |
|
2006 |
|
||||||
|
|
(Thousands) |
|
||||||||||||
Components of net periodic benefit cost |
|
|
|
|
|
|
|
|
|
||||||
Service cost |
|
$ |
126 |
|
$ |
216 |
|
$ |
246 |
|
$ |
276 |
|
||
Interest cost |
|
2,186 |
|
2,194 |
|
1,272 |
|
1,450 |
|
||||||
Expected return on plan assets |
|
(2,806 |
) |
(3,066 |
) |
|
|
|
|
||||||
Amortization of prior service cost |
|
82 |
|
186 |
|
(430 |
) |
(68 |
) |
||||||
Recognized net actuarial loss |
|
726 |
|
534 |
|
1,148 |
|
1,072 |
|
||||||
Settlement loss |
|
1,130 |
|
(18 |
) |
|
|
|
|
||||||
Net periodic benefit cost |
|
$ |
1,444 |
|
$ |
46 |
|
$ |
2,236 |
|
$ |
2,730 |
|
||
The Company made a cash contribution of $1.3 million to the pension plan in the first quarter of 2007 to fund an early retirement program which was settled during the fourth quarter of 2006.
I. Recently Issued Accounting Standards
The Fair Value Option for Financial Assets and Financial Liabilities
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an amendment of FASB Statement No. 115, (SFAS No. 159) which provides entities with an option to report selected financial assets and liabilities at fair value. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. This Statement is effective as of the beginning of the first fiscal year that begins after November 15, 2007. The Company is currently evaluating the impact that SFAS No. 159 will have on its consolidated financial statements.
Fair Value Measurements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, (SFAS No. 157) which establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company is currently evaluating the impact that SFAS No. 157 will have on its consolidated financial statements.
13
J. Gain on Sale of Assets
On April 13, 2007, the Company and Range Resources Corporation (Range) agreed to a development plan for the Nora Field, a gas field located in Southwestern Virginia. The Company entered into a Purchase and Sale Agreement (Purchase Agreement) with Pine Mountain Oil and Gas, Inc. (PMOG), a subsidiary of Range, pursuant to which the Company agreed to sell to PMOG a portion of the Companys interests in certain gas properties in the Nora Field. Additionally, the Company entered into a Contribution Agreement (Contribution Agreement) with PMOG relating to the contribution of certain Nora Field gathering facilities and pipelines to Nora Gathering, LLC (Nora LLC), a newly formed entity that is equally owned by the Company and PMOG. This gathering system will service production of the Company and Range.
On May 17, 2007, the Company completed a majority of the transactions contemplated by the Purchase Agreement by selling proved reserves of approximately 70 Bcf, including developed reserves of approximately 64 Bcf, to PMOG for proceeds of $184.6 million. Proceeds of $95.0 million from the sale were placed into an escrow account pursuant to a deferred exchange agreement, which allows for the use of the funds in a potential like-kind exchange for certain identified assets. The Company is evaluating the potential purchase of eligible replacement properties within the statutory time period. As of June 30, 2007, the balance of restricted cash was $95.6 million.
Additionally, on May 17, 2007, the Company completed a substantial majority of the transactions contemplated by the Contribution Agreement by contributing Nora Field gathering property with a net book value of $120.0 million to Nora LLC in exchange for a 50% interest in Nora LLC and cash of $23.3 million. PMOG contributed cash of $93.1 million to Nora LLC in exchange for its 50% interest. The Company and Nora LLC also entered into a demand note agreement whereby Nora LLC loaned to the Company $69.8 million on the closing date. The balance of this note as of June 30, 2007 was $62.8 million, and was classified as note payable to Nora Gathering, LLC in the Companys Condensed Consolidated Balance Sheet. The Company is accounting for its interest in Nora LLC under the equity method of accounting, as the Company determined that it has the ability to exert significant influence over the operating and financial policies of Nora LLC through its 50%, non-controlling interest. The Company recorded an equity investment in Nora LLC of $93.1 million in its Condensed Consolidated Balance Sheet as of May 17, 2007.
The Company recorded a gain on these transactions of $147.8 million, net of costs to sell, in accordance with SFAS No. 19, Financial Accounting and Reporting by Oil and Gas Producing Companies. As a result of the working interest sale, the Company reduced its hedge position by approximately 7.3 Bcf, resulting in the Companys recording a hedge loss of $28.4 million as of the date of sale. These items are recorded in gain on sale of assets, net in the Companys Statements of Consolidated Income for the three and six month periods ended June 30, 2007.
As a result of these transactions, the Company and Range have equalized their interest in the Nora Field, including their interest in the producing wells, undrilled acreage and gathering system. These transactions are subject to various post-closing purchase price adjustments which may result in the Company recording additional gain or loss on these transactions upon finalization of the adjustments, which is expected to occur during the second half of 2007.
A second closing covering the remainder of the gas properties and related remaining gathering assets included in the above transactions would reduce the Companys proved reserves by a maximum of approximately 11 Bcf, including developed reserves of up to 10 Bcf. The Company is currently working with all parties involved to obtain the remaining required consents.
K. Office Consolidation / Impairment Charges
In May 2005, the Company completed the relocation of its corporate headquarters and other operations to a newly constructed office building located at the North Shore in Pittsburgh. The relocation resulted in the early termination of several operating leases and the early retirement of assets and leasehold improvements at several locations. During the second quarter of 2006, the Company began to utilize certain of the leased space previously deemed to have no economic benefit to the Company, to make space available for the pending acquisition of The Peoples Natural Gas Company and Hope Gas, Inc. transition planning activities. The Company reversed approximately $2.4 million of the associated early termination liability for these leases during the three months ended June 30, 2006.
14
Additionally, the Company recorded a $0.5 million reduction in the early termination liability during the three months ended June 30, 2006 resulting from a revision of the amount of estimated cash flows for one of its operating leases.
L. Other Events
Pending Acquisition of The Peoples Natural Gas Company and Hope Gas, Inc.
On March 1, 2006, the Company entered into a definitive agreement to acquire Dominion Resources, Inc.s (Dominion) natural gas distribution assets in Pennsylvania and in West Virginia for approximately $970 million, subject to adjustments, in a cash transaction for the stock of The Peoples Natural Gas Company (Peoples) and Hope Gas, Inc. (Hope). The Company agreed on July 3, 2007 not to exercise its termination right under the Stock Purchase Agreement prior to September 1, 2007 pending further discussions regarding an amendment to the Stock Purchase Agreement which would allow the sale of Peoples to close in advance of the sale of Hope if the injunction described below is lifted. Dominion has agreed not to exercise its termination right under the Stock Purchase Agreement prior to November 1, 2007. No assurance can be given that the parties will be able to negotiate an amendment providing for the sale of Peoples to close in advance of the sale of Hope or that the remaining regulatory issues will be resolved.
On May 14, 2007, the Public Service Commission of West Virginia (WV PSC) issued an order in the Companys proposed acquisition of Hope, which case has been consolidated with four other cases, to initiate a focused management audit regarding two Hope applications to adjust purchased gas costs. On July 24, 2007, the WV PSC issued another order bifurcating the acquisition case from the cases involving the focused management audit and soliciting comment from the parties as to, among other things, how to proceed with the acquisition case and the amount and form of an escrow proposed to be posted by Hope in connection with alleged wrong doing. The Company continues to engage in settlement negotiations with the interveners and with Dominion to resolve the open issues.
On April 13, 2007, the Pennsylvania Public Utility Commission (PA PUC) issued an Opinion and Order approving the stock acquisition consistent with the terms and conditions of a Joint Petition for Settlement which includes, among other things, an agreement by the Company that Equitable Gas Company and Peoples will not make base rate case filings prior to January 1, 2009.
On March 14, 2007, the Federal Trade Commission (FTC) issued an administrative complaint challenging the Companys acquisition of Peoples. On April 13, 2007, the FTC filed a complaint in the U.S. District Court for the Western District of Pennsylvania seeking a preliminary injunction to enjoin the proposed acquisition. On May 14, 2007, the District Court dismissed the FTCs request for a preliminary injunction. The FTC appealed the dismissal to the United States Court of Appeals for the Third Circuit on the basis that the state action immunity doctrine barred the FTCs claim. On June 1, 2007, the Third Circuit issued an injunction pending appeal preventing the Company from closing the transaction pending further order of the Third Circuit. The appeal is currently in the briefing phase. Pursuant to an amended notice received after the Company's July 26, 2007 earnings call, oral argument, if required by the Third Circuit, is scheduled for the week of October 1, 2007.
The transaction is also under review by the Pennsylvania Attorney General (PA AG). The PA AG has filed an amicus brief in the Third Circuit case arguing that the state action immunity doctrine does not apply, which is contrary to the Companys position. The PA PUC has filed an amicus brief in the Third Circuit case supporting the Companys position.
The assets to be acquired are expected to approximately increase: customers in the distribution operations by 475,000 or 173%; total storage capacity by 33 Bcf or 60%; miles of gathering pipelines by 936 miles; gathered volumes by 40%; and miles of high pressure transmission by 466 miles or 42%. Transition planning activities have continued at Equitable Utilities to plan for the integration of the assets, resources, and business processes of Peoples and Hope into Equitable Resources. The Company has deferred certain costs in conjunction with the pending acquisition of Peoples and Hope. In the event that the acquisition does not close or the likelihood becomes remote, the Company will expense these deferred costs which may result in a charge of $10 million to $15 million.
15
West Virginia Royalty Dispute
In June 2006, the West Virginia Supreme Court of Appeals issued a decision involving interpretation of certain types of oil and gas leases of an unrelated party, in which a class of royalty owners in the state of West Virginia filed a lawsuit claiming that the defendant in the case underpaid royalties by deducting certain post-production costs not permitted by such types of leases and not paying a fair value for the gas produced from the royalty owners leases. In January 2007, the jury in the aforementioned case returned a verdict in favor of the plaintiff royalty owners, awarding the plaintiffs significant compensatory and punitive damages for the alleged underpayment of royalties. While the defendant plans to appeal the verdict, this decision may ultimately impact other royalty interest rights in West Virginia. Claims have been brought against others in the oil and gas industry, including the Company. The proceedings against the Company are in the early stages and the plaintiffs have sought class certification. The Company believes that the claims and facts decided in the unrelated lawsuit can be differentiated from those asserted against the Company. Nevertheless, the Company has reviewed its West Virginia royalty agreements and established a reserve it believes to be appropriate.
16
Managements Discussion and Analysis of Financial Condition and Results of Operations
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
INFORMATION REGARDING FORWARD LOOKING STATEMENTS
Disclosures in this Quarterly Report on Form 10-Q contain certain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. Statements that do not relate strictly to historical or current facts are forward-looking and usually identified by the use of words such as anticipate, estimate, should, may, will, forecasts, approximate, expect, project, intend, plan, believe and other words or phrases of similar meaning in connection with any discussion of future operating or financial matters. Without limiting the generality of the foregoing, forward-looking statements contained in this report include the matters discussed in the sections captioned Outlook in this Managements Discussion and Analysis of Financial Condition and Results of Operations, and the expectations of plans, strategies, objectives, and growth and anticipated financial and operational performance of the Company and its subsidiaries, including guidance regarding the Companys drilling and infrastructure programs, production and sales volumes, liquidity, reserves, capital expenditures, executive compensation, hedging risks, the pending acquisition of The Peoples Natural Gas Company and Hope Gas, Inc., the financing of that acquisition and the Companys move to a holding company structure. A variety of factors could cause the Companys actual results to differ materially from the anticipated results or other expectations expressed in the Companys forward-looking statements. The risks and uncertainties that may affect the operations, performance and results of the Companys business and forward-looking statements include, but are not limited to, those set forth under Item 1A, Risk Factors of the Companys Form 10-K for the year ended December 31, 2006.
Any forward-looking statement speaks only as of the date on which such statement is made and the Company does not intend to correct or update any forward-looking statements, whether as a result of new information, future events or otherwise.
CORPORATE OVERVIEW
Three Months Ended June 30, 2007
vs. Three Months Ended June 30, 2006
Equitable Resources consolidated net income for the three months ended June 30, 2007 totaled $107.3 million, or $0.87 per diluted share, compared to $43.9 million, or $0.36 per diluted share, reported for the same period a year ago. This $63.4 million increase in net income from 2006 to 2007 was due to several factors. In the second quarter of 2007, the Company recorded a $119.4 million net gain on the sale of assets in the Nora Field. The impact of higher realized sales prices at Equitable Supply ($6.8 million), reserves established in connection with West Virginia royalty disputes and other legal expenses at Equitable Supply in 2006 ($2.1 million), and higher production sales volumes at Equitable Supply ($1.4 million) also contributed to the increase between years. These increases between years were partially offset by increased incentive compensation expense ($15.5 million) and other operating cost increases.
Six Months Ended June 30, 2007
vs. Six Months Ended June 30, 2006
Equitable Resources consolidated net income for the six months ended June 30, 2007 totaled $164.0 million, or $1.34 per diluted share, compared to $116.3 million, or $0.95 per diluted share, reported for the same period a year ago. This $47.7 million increase in net income from 2006 to 2007 was due to several factors, including the second quarter of 2007 gain on the sale of assets. The impact of favorable storage asset optimization at Equitable Utilities ($10.8 million), higher production sales volumes at Equitable Supply ($6.4 million), colder weather in Equitable Gas service territory in 2007 ($8.1 million), and higher gathering revenues at Equitable Supply ($5.3 million) also contributed to the increase. These increases between years were partially offset by increased incentive compensation expense ($38.0 million), increased reserves for West Virginia royalty disputes and other legal expenses at Equitable Supply ($9.9 million), increased transition planning expenses related to the pending acquisition of The Peoples Natural Gas Company and Hope Gas, Inc. ($6.5 million), higher depreciation, depletion and amortization expense at Equitable Supply ($5.8 million), a positive impact in 2006 for previously deferred amounts from the approval and settlement of the Equitrans, L.P. rate case ($5.4 million) and higher gathering and compression expense at Equitable Supply ($4.2 million).
17
The Company has reported the components of each segments operating income and various operational measures in the sections below, and where appropriate, has provided information describing how a measure was derived. Equitables management believes that presentation of this information provides useful information to management and investors regarding the financial condition, operations and trends of each of Equitables segments without being obscured by the financial condition, operations and trends for the other segment or by the effects of corporate allocations of interest and income taxes. In addition, management uses these measures for budget planning purposes.
EQUITABLE SUPPLY
OVERVIEW
During the second quarter of 2007, the Equitable Supply segment sold to Pine Mountain Oil and Gas, Inc. (PMOG) a portion of the Companys interests in certain gas properties in the Nora Field totaling approximately 70 Bcf of proved reserves. Also during the second quarter of 2007, the Equitable Supply segment contributed certain Nora Field gathering facilities and pipelines to Nora Gathering, LLC, a newly formed entity that is equally owned by the Company and PMOG, in exchange for a 50% equity interest in the LLC and cash. These transactions resulted in a net gain of $119.4 million. See Note J to the Companys Condensed Consolidated Financial Statements for further discussion of these transactions. As a result of the gathering asset contribution, gathered volumes, gathering revenues and gathering-related expenses related to the Nora Field gathering activities are no longer included in Equitable Supplys operating results. However, Equitable Supply records its 50% equity interest in the earnings of Nora Gathering, LLC in equity in earnings of nonconsolidated investments.
Excluding the impact of the sale of interests in the Nora Field, sales volumes increased approximately 5% from 2006 to 2007, primarily as a result of increased production from the 2006 and 2007 drilling programs. Equitable Supply drilled 267 gross operated wells, including 16 horizontal wells, in the six months ended June 30, 2007, compared to 214 gross operated wells in 2006, a 25% increase.
18
RESULTS OF OPERATIONS
EQUITABLE SUPPLY
|
|
Three Months Ended |
|
Six Months Ended |
|
|||||||||||||||||||
|
|
2007 |
|
2006 |
|
% |
|
2007 |
|
2006 |
|
% |
|
|||||||||||
OPERATIONAL DATA |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
Production: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
Natural gas and oil production (MMcfe) |
|
21,024 |
|
20,381 |
|
3.2 |
|
41,440 |
|
39,963 |
|
3.7 |
|
|||||||||||
Company usage, line loss (MMcfe) |
|
(1,621 |
) |
(1,266 |
) |
28.0 |
|
(2,699 |
) |
(2,519 |
) |
7.1 |
|
|||||||||||
Total sales volumes (MMcfe) |
|
19,403 |
|
19,115 |
|
1.5 |
|
38,741 |
|
37,444 |
|
3.5 |
|
|||||||||||
Average (well-head) sales price ($/Mcfe) |
|
$ |
5.07 |
|
$ |
4.71 |
|
7.6 |
|
$ |
4.88 |
|
$ |
4.90 |
|
(0.4 |
) |
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
Lease operating expenses (LOE), excluding production taxes ($/Mcfe) |
|
$ |
0.31 |
|
$ |
0.31 |
|
|
|
$ |
0.32 |
|
$ |
0.30 |
|
6.7 |
|
|||||||
Production taxes ($/Mcfe) |
|
$ |
0.46 |
|
$ |
0.46 |
|
|
|
$ |
0.47 |
|
$ |
0.50 |
|
(6.0 |
) |
|||||||
Production depletion ($/Mcfe) |
|
$ |
0.70 |
|
$ |
0.62 |
|
12.9 |
|
$ |
0.70 |
|
$ |
0.62 |
|
12.9 |
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
Gathering: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
Gathered volumes (MMcfe) |
|
24,068 |
|
26,268 |
|
(8.4 |
) |
53,110 |
|
53,550 |
|
(0.8 |
) |
|||||||||||
Average gathering fee ($/Mcfe) |
|
$ |
1.12 |
|
$ |
1.01 |
|
10.9 |
|
$ |
1.11 |
|
$ |
1.00 |
|
11.0 |
|
|||||||
Gathering and compression expense ($/Mcfe) |
|
$ |
0.49 |
|
$ |
0.40 |
|
22.5 |
|
$ |
0.46 |
|
$ |
0.38 |
|
21.1 |
|
|||||||
Gathering and compression depreciation ($/Mcfe) |
|
$ |
0.16 |
|
$ |
0.15 |
|
6.7 |
|
$ |
0.15 |
|
$ |
0.14 |
|
7.1 |
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
(in thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
Production operating income |
|
$ |
63,277 |
|
$ |
56,655 |
|
11.7 |
|
$ |
107,224 |
|
$ |
118,667 |
|
(9.6 |
) |
|||||||
Gathering operating income |
|
7,900 |
|
8,788 |
|
(10.1 |
) |
18,813 |
|
18,759 |
|
0.3 |
|
|||||||||||
Total operating income |
|
$ |
71,177 |
|
$ |
65,443 |
|
8.8 |
|
$ |
126,037 |
|
$ |
137,426 |
|
(8.3 |
) |
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
Production depletion |
|
$ |
14,737 |
|
$ |
12,594 |
|
17.0 |
|
$ |
29,069 |
|
$ |
24,731 |
|
17.5 |
|
|||||||
Gathering and compression depreciation |
|
3,894 |
|
3,821 |
|
1.9 |
|
8,227 |
|
7,588 |
|
8.4 |
|
|||||||||||
Other depreciation, depletion and amortization |
|
1,469 |
|
1,034 |
|
42.1 |
|
2,801 |
|
1,976 |
|
41.8 |
|
|||||||||||
Total depreciation, depletion and amortization |
|
$ |
20,100 |
|
$ |
17,449 |
|
15.2 |
|
$ |
40,097 |
|
$ |
34,295 |
|
16.9 |
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
Capital expenditures (thousands) |
|
$ |
159,462 |
|
$ |
68,615 |
|
132.4 |
|
$ |
297,455 |
|
$ |
122,527 |
|
142.8 |
|
|||||||
19
|
|
Three Months Ended |
|
Six Months Ended |
|
|||||||||||||
|
|
2007 |
|
2006 |
|
% |
|
2007 |
|
2006 |
|
% |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
FINANCIAL DATA (Thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Production revenues |
|
$ |
100,954 |
|
$ |
92,671 |
|
8.9 |
|
$ |
194,241 |
|
$ |
188,192 |
|
3.2 |
|
|
Gathering revenues |
|
26,930 |
|
26,656 |
|
1.0 |
|
58,900 |
|
53,584 |
|
9.9 |
|
|||||
Total operating revenues |
|
127,884 |
|
119,327 |
|
7.2 |
|
253,141 |
|
241,776 |
|
4.7 |
|
|||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
LOE, excluding production taxes |
|
6,471 |
|
6,360 |
|
1.7 |
|
13,286 |
|
11,790 |
|
12.7 |
|
|||||
Production taxes |
|
9,655 |
|
9,310 |
|
3.7 |
|
19,351 |
|
19,999 |
|
(3.2 |
) |
|||||
Gathering and compression (O&M) |
|
11,797 |
|
10,582 |
|
11.5 |
|
24,621 |
|
20,424 |
|
20.5 |
|
|||||
Selling, general and administrative (SG&A) |
|
8,684 |
|
10,183 |
|
(14.7 |
) |
29,749 |
|
17,842 |
|
66.7 |
|
|||||
Depreciation, depletion and amortization (DD&A) |
|
20,100 |
|
17,449 |
|
15.2 |
|
40,097 |
|
34,295 |
|
16.9 |
|
|||||
Total operating expenses |
|
56,707 |
|
53,884 |
|
5.2 |
|
127,104 |
|
104,350 |
|
21.8 |
|
|||||
Operating income |
|
$ |
71,177 |
|
$ |
65,443 |
|
8.8 |
|
$ |
126,037 |
|
$ |
137,426 |
|
(8.3 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||
Gain on sale of assets, net |
|
$ |
119,401 |
|
$ |
|
|
100.0 |
|
$ |
119,401 |
|
$ |
|
|
100.0 |
|
|
Equity in earnings (losses) of nonconsolidated investments |
|
$ |
633 |
|
$ |
(124 |
) |
610.5 |
|
$ |
706 |
|
$ |
(18 |
) |
4,022.2 |
|
|
Three Months Ended June 30, 2007
vs. Three Months Ended June 30, 2006
Equitable Supplys operating income totaled $71.2 million for the three months ended June 30, 2007 compared to $65.4 million for the three months ended June 30, 2006. The $5.8 million increase in operating income was primarily the result of an increase in the average well-head sales price, reserves established in connection with West Virginia royalty disputes and other legal expenses in 2006 and increased sales volumes. These factors were partially offset by increased DD&A and increased gathering and compression expenses.
Total operating revenues were $127.9 million for the three months ended June 30, 2007 compared to $119.3 million for the three months ended June 30, 2006. The $8.6 million increase in total operating revenues was primarily due to an 8% increase in the average well-head sales price and a 2% increase in production sales volumes. The $0.36 per Mcfe increase in the average well-head sales price was primarily attributable to increased market prices on unhedged volumes. The 2% increase in production sales volumes was primarily the result of increased production from the 2006 and 2007 drilling programs, partially offset by the normal production decline in the Companys wells and the sale of 583 MMcfe in the Nora Field to PMOG. Gathering revenues were essentially flat, as an 11% increase in the average gathering fee was offset by an 8% decrease in gathered volumes. The increase in the average gathering fee, primarily charged to affiliates, is reflective of the Companys commitment to an increased infrastructure program as well as operating cost increases. The decrease in gathered volumes is due to the contribution of gathering facilities and pipelines to Nora Gathering, LLC, partially offset by increased Company production.
Operating expenses totaled $56.7 million for the three months ended June 30, 2007 compared to $53.9 million for the three months ended June 30, 2006. The increase in DD&A was primarily due to increased depletion expense resulting from both increases in the unit rate and volume, as well as increased depreciation on a higher asset base. The $0.08 increase in the depletion rate is primarily attributable to the increased investment in the oil and gas producing properties. Gathering and compression expense increased approximately 12% due to electricity charges on newly installed electric compressors, increased field line and compressor maintenance related to the Companys infrastructure investments, increased field labor and related employment costs and increased property taxes. In addition, the per unit gathering and compression rate increased as the per unit rate for the Nora Field properties contributed in 2007 was significantly lower than the rate for the Companys remaining properties. These expense increases were partially offset by a decrease in expenses due to the sale of assets in the Nora Field as well as a reduction due to reserves established in 2006 for certain West Virginia royalty disputes and other legal expenses.
20
Equity in earnings of nonconsolidated investments totaled $0.6 million for the three months ended June 30, 2007 compared to an equity loss of $0.1 million for the three months ended June 30, 2006. The $0.7 million increase was primarily due to equity earnings of $0.6 million recorded in the second quarter of 2007 for Equitable Supplys investment in Nora Gathering, LLC.
Capital expenditures totaled $159.5 million for the three months ended June 30, 2007 compared to $68.6 million for the three months ended June 30, 2006. The $90.9 million increase was primarily due to increased capital spending for midstream infrastructure projects, including the construction of the Big Sandy Pipeline, and an increased drilling and development plan in 2007.
Six Months Ended June 30, 2007
vs. Six Months Ended June 30, 2006
Equitable Supplys operating income for the six months ended June 30, 2007 was $126.0 million compared to $137.4 million for the six months ended June 30, 2006. The $11.4 million decrease in operating income was primarily the result of reserves established in connection with West Virginia royalty disputes and other legal expenses, increased operating expenses and decreased average well-head sales prices. These factors were partially offset by increased sales volumes and gathering revenues.
Total operating revenues were $253.1 million for the six months ended June 30, 2007 compared to $241.8 million for the six months ended June 30, 2006. The $11.3 million increase in total operating revenues was primarily due to a 4% increase in production sales volumes and a 10% increase in gathering revenues, partially offset by a slight decline in the average well-head sales price. The 4% increase in production sales volumes was primarily the result of increased production from the 2006 and 2007 drilling programs, partially offset by the normal production decline in the Companys wells and the sale of 583 MMcfe in the Nora Field to PMOG. The 10% increase in gathering revenues was due to an 11% increase in the average gathering fee partially offset by a 1% decrease in gathered volumes. The increase in the average gathering fee, primarily charged to affiliates, is reflective of the Companys commitment to an increased infrastructure program as well as operating cost increases. The decrease in gathered volumes is due to the contribution of gathering facilities and pipelines to Nora Gathering, LLC, partially offset by increased Company production.
Operating expenses were $127.1 million for the six months ended June 30, 2007, compared to $104.4 million for the six months ended June 30, 2006. The increase in SG&A was primarily due to increased reserves for certain West Virginia royalty disputes and other legal expenses, adjustments to the allowance for doubtful accounts, and increased insurance costs. The increase in DD&A was primarily due to increased depletion expense resulting from both increases in the unit rate and volume, as well as increased depreciation on a higher asset base. The $0.08 increase in the depletion rate is primarily attributable to the increased investment in the oil and gas producing properties. Gathering and compression expense increased approximately 21% due to electricity charges on newly installed electric compressors, increased field line and compressor maintenance related to the Companys infrastructure investments, increased field labor and related employment costs and increased property taxes. The increase in LOE is attributable to increased direct operating costs, personnel costs and environmental costs. These increases were partially offset by a decrease in expenses due to the sale of assets in the Nora Field as previously discussed.
Capital expenditures totaled $297.5 million for the six months ended June 30, 2007 compared to $122.5 million for the six months ended June 30, 2006. The $175.0 million increase was primarily due to increased capital spending for midstream infrastructure projects, including the construction of the Big Sandy Pipeline, and an increased drilling and development plan in 2007.
OUTLOOK
Equitable Supplys Appalachian Basin business strategy is focused on growing through expansion of its drilling program and midstream gathering and processing systems. The Company will continue to emphasize operational excellence, including cost control in all areas of its operations.
21
Equitable Supply is on track to drill at least 650 gross operated wells in 2007, which includes at least 70 horizontal wells, and to sell between 77 and 78 Bcfe of gas. The 650 gross operated wells is a 16% increase over the 560 gross operated wells drilled in 2006.
Since September 2006, the Company has drilled 30 horizontal wells. The Companys engineering projections and cost estimates have been revised to incorporate experience to date, reflecting an 8% reduction in estimated cost per well to $1.2 million, a 17% increase in the expected reserve recovery and a higher expected after-tax return of 17%, up from 15%. Based on the encouraging results of the horizontal program, the Company decided in the second quarter of 2007 to exclusively drill Kentucky shale wells horizontally. Horizontal wells typically require longer lead time for permitting and implementation of capital commitments. The decision not to drill some permitted vertical shale wells reduced the number of wells drilled and associated volumes, compared to the Companys previous drilling plan. Ultimately, volumes from the Kentucky shale drilling locations are expected to be higher as a result of using horizontal drilling technology.
Through its Equitrans affiliate, the Company is constructing the Big Sandy Pipeline, which will provide for a significant increase in midstream throughput capacity in the Appalachian region. This project is targeted for completion later in 2007. The Company is also upgrading the Company-operated hydrocarbon processing plant in Langley, Kentucky, targeted for completion in early 2008. The projects are projected to cost an aggregate of $255 million, up from the Companys previous estimate of $191 million primarily due to scope changes and cost increases.
EQUITABLE UTILITIES
OVERVIEW
On March 1, 2006, the Company entered into a definitive agreement to acquire Dominion Resources, Inc.s (Dominion) natural gas distribution assets in Pennsylvania and in West Virginia for approximately $970 million, subject to adjustments, in a cash transaction for the stock of The Peoples Natural Gas Company (Peoples) and Hope Gas, Inc. (Hope). The Company agreed on July 3, 2007 not to exercise its termination right under the Stock Purchase Agreement prior to September 1, 2007 pending further discussions regarding an amendment to the Stock Purchase Agreement which would allow the sale of Peoples to close in advance of the sale of Hope if the injunction described below is lifted. Dominion has agreed not to exercise its termination right under the Stock Purchase Agreement prior to November 1, 2007. No assurance can be given that the parties will be able to negotiate an amendment providing for the sale of Peoples to close in advance of the sale of Hope or that the remaining regulatory issues will be resolved.
On May 14, 2007, the Public Service Commission of West Virginia (WV PSC) issued an order in the Companys proposed acquisition of Hope, which case has been consolidated with four other cases, to initiate a focused management audit regarding two Hope applications to adjust purchased gas costs. On July 24, 2007, the WV PSC issued another order bifurcating the acquisition case from the cases involving the focused management audit and soliciting comment from the parties as to, among other things, how to proceed with the acquisition case and the amount and form of an escrow proposed to be posted by Hope in connection with alleged wrong doing. The Company continues to engage in settlement negotiations with the interveners and with Dominion to resolve the open issues.
On April 13, 2007, the Pennsylvania Public Utility Commission (PA PUC) issued an Opinion and Order approving the stock acquisition consistent with the terms and conditions of a Joint Petition for Settlement which includes, among other things, an agreement by the Company that Equitable Gas Company and Peoples will not make base rate case filings prior to January 1, 2009.
On March 14, 2007, the Federal Trade Commission (FTC) issued an administrative complaint challenging the Companys acquisition of Peoples. On April 13, 2007, the FTC filed a complaint in the U.S. District Court for the Western District of Pennsylvania seeking a preliminary injunction to enjoin the proposed acquisition. On May 14, 2007, the District Court dismissed the FTCs request for a preliminary injunction. The FTC appealed the dismissal to the United States Court of Appeals for the Third Circuit on the basis that the state action immunity doctrine barred the FTCs claim. On June 1, 2007, the Third Circuit issued an injunction pending appeal preventing the
22
Company from closing the transaction pending further order of the Third Circuit. The appeal is currently in the briefing phase. Pursuant to an amended notice received after the Company's July 26, 2007 earnings call, oral argument, if required by the Third Circuit, is scheduled for the week of October 1, 2007.
The transaction is also under review by the Pennsylvania Attorney General (PA AG). The PA AG has filed an amicus brief in the Third Circuit case arguing that the state action immunity doctrine does not apply, which is contrary to the Companys position. The PA PUC has filed an amicus brief in the Third Circuit case supporting the Companys position.
The Company has filed applications with the PA PUC and WV PSC to reorganize as a holding company. The Company expects to complete the reorganization upon receipt of the required approvals.
RESULTS OF OPERATIONS
EQUITABLE UTILITIES
|
|
Three
Months Ended |
|
Six
Months Ended |
|
|||||||||||||||
|
|
2007 |
|
2006 |
|
% |
|
2007 |
|
2006 |
|
% |
|
|||||||
OPERATIONAL DATA |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
Heating degree days (30 year normal average: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
Qtr - 705; YTD - 3,635) |
|
617 |
|
565 |
|
9.2 |
|
3,465 |
|
3,103 |
|
11.7 |
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
Residential sales and transportation volumes (MMcf) |
|
3,301 |
|
2,656 |
|
24.3 |
|
15,251 |
|
12,861 |
|
18.6 |
|
|||||||
Commercial and industrial volumes (MMcf) |
|
5,632 |
|
4,667 |
|
20.7 |
|
15,638 |
|
13,750 |
|
13.7 |
|
|||||||
Total throughput (MMcf) Distribution Operations |
|
8,933 |
|
7,323 |
|
22.0 |
|
30,889 |
|
26,611 |
|
16.1 |
|
|||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
Net operating revenues (thousands): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
Distribution Operations (regulated): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
Residential |
|
$ |
19,093 |
|
$ |
16,648 |
|
14.7 |
|
$ |
60,268 |
|
$ |
53,167 |
|
13.4 |
|
|||
Commercial & industrial |
|
7,553 |
|
6,589 |
|
14.6 |
|
25,510 |
|
22,668 |
|
12.5 |
|
|||||||
Other |
|
2,115 |
|
1,697 |
|
24.6 |
|
3,991 |
|
3,204 |
|
24.6 |
|
|||||||
Total Distribution Operations |
|
28,761 |
|
24,934 |
|
15.3 |
|
89,769 |
|
79,039 |
|
13.6 |
|
|||||||
Pipeline Operations (regulated) |
|
14,327 |
|
13,868 |
|
3.3 |
|
32,443 |
|
38,937 |
|
(16.7 |
) |
|||||||
Energy Marketing |
|
5,315 |
|
6,965 |
|
(23.7 |
) |
37,468 |
|
26,644 |
|
40.6 |
|
|||||||
Total net operating revenues |
|
$ |
48,403 |
|
$ |
45,767 |
|
5.8 |
|
$ |
159,680 |
|
$ |
144,620 |
|
10.4 |
|
|||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||
Operating income (thousands): |
|
|
|
|
|
|
|
|
|
|
|
|