-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Qahlgj3O94gctIfIWbY2nI3nhUxtFeGBmiFanuqvmSffRw1W3CY/RSwIMJJOjO9O uHPCYRarUK4HISG76ilTYg== 0000950144-99-003080.txt : 19990325 0000950144-99-003080.hdr.sgml : 19990325 ACCESSION NUMBER: 0000950144-99-003080 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 16 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990324 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SONAT INC CENTRAL INDEX KEY: 0000092236 STANDARD INDUSTRIAL CLASSIFICATION: NATURAL GAS TRANSMISSION [4922] IRS NUMBER: 630647939 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-07179 FILM NUMBER: 99571630 BUSINESS ADDRESS: STREET 1: 1900 FIFTH AVENUE NORTH STREET 2: AMSOUTH SONAT TOWER CITY: BIRMINGHAM STATE: AL ZIP: 35203 BUSINESS PHONE: 2053253800 MAIL ADDRESS: STREET 1: PO BOX 2563 CITY: BIRMINGHAM STATE: AL ZIP: 35202 FORMER COMPANY: FORMER CONFORMED NAME: SOUTHERN NATURAL RESOURCES INC DATE OF NAME CHANGE: 19820305 10-K 1 SONAT INC. 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED, EFFECTIVE OCTOBER 7, 1996] FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED, EFFECTIVE OCTOBER 7, 1996] FOR THE TRANSITION PERIOD FROM ________________ TO _________________ Commission file number 1-7179 --------------------- SONAT INC. (Exact name of registrant as specified in its charter) DELAWARE 63-0647939 (State or other jurisdiction of incorporation (I.R.S. Employer Identification No.) or organization)
AMSOUTH-SONAT TOWER BIRMINGHAM, ALABAMA 35203 TELEPHONE 205-325-3800 (Address of principal executive offices) SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE ON TITLE OF EACH CLASS WHICH REGISTERED ------------------- ------------------------ Common Stock, $1.00 par value New York Stock Exchange, Inc. Pacific Stock Exchange, Inc.
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None 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 Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] AGGREGATE MARKET VALUE OF THE VOTING STOCK HELD BY NON-AFFILIATES OF THE REGISTRANT, AS OF JANUARY 31, 1999 -- $2,230,348,507. NUMBER OF SHARES OF COMMON STOCK, $1.00 PAR VALUE, OUTSTANDING ON JANUARY 31, 1999 -- 110,038,562 DOCUMENTS INCORPORATED BY REFERENCE PORTIONS OF THE PROXY STATEMENT OF THE REGISTRANT DATED AS OF MARCH 22, 1999, ARE INCORPORATED BY REFERENCE INTO PART III OF THIS REPORT ON FORM 10-K. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 SONAT INC. INDEX TO REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998
ITEM PAGE - ---- ------ PART I Item 1. Business.................................................... I-1 I-1 Proposed Merger with El Paso Energy Corporation........... I-2 Exploration and Production................................ I-2 Sonat Exploration Company.............................. I-4 Consolidated Oil and Gas Reserves.................... I-5 Consolidated Wells and Acreage....................... I-9 Consolidated Exploratory and Development Wells....... I-9 Consolidated Net Production, Unit Prices, and Production Costs.................................... I-10 Consolidated Development, Exploration, and Acquisition Expenditures............................ I-10 Competition and Current Business Conditions............ I-11 Natural Gas Transmission.................................. I-11 Southern Natural Gas Company........................... I-11 Florida Gas Transmission Company....................... I-11 Sea Robin Pipeline Company............................. I-11 South Georgia Natural Gas Company...................... I-12 Destin Pipeline Company, L.L.C......................... I-12 Etowah LNG Company, L.L.C.............................. I-12 Southern LNG Inc....................................... I-13 Markets -- Transportation.............................. I-15 Markets -- System Expansions........................... I-17 Gas Sales and Supplies................................. I-17 Rate and Regulatory Proceedings........................ I-18 Storage Fields......................................... I-18 Competition and Current Business Conditions............ I-20 Energy Services........................................... I-20 Sonat Energy Services Company.......................... I-20 Sonat Marketing Company L.P.......................... I-20 Sonat Public Service Company L.L.C................... I-20 Unicom Gas Services LLC.............................. I-20 Stone & Webster Sonat Energy Resources, LLC.......... I-21 Sonat Power Marketing L.P............................ I-21 Sonat Power Inc...................................... I-21 West Georgia Generating Company L.P.................. I-21 Sonat Intrastate-Alabama Inc......................... I-22 Sonat Power Systems Inc................................ I-22 Competition and Current Business Conditions............ I-24 Governmental Regulation................................... I-24 Exploration and Production............................. I-24 Natural Gas Transmission............................... I-25 Energy Services........................................ I-25 Environmental Matters..................................... I-25 Year 2000 Project......................................... I-25 Cautionary Statement Concerning Forward-Looking Statements............................................. Item 2. Properties.................................................. I-26 Item 3. Legal Proceedings........................................... I-26 Item 4. Submission of Matters to a Vote of Security Holders......... I-27
3
ITEM PAGE - ---- ------ Executive Officers of the Registrant..................................... I-27 PART II Item 5. Market for Registrant's Common Equity and Related II-33 Stockholder Matters......................................... Item 6. Selected Financial Data..................................... II-44 Item 7. Management's Discussion and Analysis of Financial Condition II-2 and Results of Operations.................................................. Item 7A. Quantitative and Qualitative Disclosures About Market II-10 Risk........................................................ Item 8. Financial Statements and Supplementary Data................. II-16 Item 9. Changes in and Disagreements with Accountants on Accounting II-45 and Financial Disclosure.................................................. PART III Item 10. Directors and Executive Officers of the Registrant.......... III-1 Item 11. Executive Compensation...................................... III-1 Item 12. Security Ownership of Certain Beneficial Owners and III-1 Management.................................................. Item 13. Certain Relationships and Related Transactions.............. III-1 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form IV-1 8-K.........................................................
4 PART I ITEM 1. BUSINESS Sonat Inc. ("Sonat" or the "Company") is a diversified energy holding company. It is engaged through Sonat Exploration Company and Sonat Exploration GOM Inc. (collectively "Exploration") in domestic oil and natural gas exploration and production, through Southern Natural Gas Company ("Southern") and Citrus Corp. ("Citrus") in the transmission and storage of natural gas, and through Sonat Energy Services Company ("Sonat Energy Services") in natural gas and electric power marketing and electric generation. Exploration operates primarily in Texas, Oklahoma, Louisiana, Arkansas, Alabama, and the Gulf of Mexico. In January 1998 Sonat completed a $1.3 billion merger, accounted for as a pooling-of-interests, with Zilkha Energy Company ("Zilkha"), a privately owned oil and gas exploration, development, and production company operating primarily offshore in the shallow waters of the Gulf of Mexico. Following the merger, Zilkha was renamed Sonat Exploration GOM Inc. Southern is a major transporter of natural gas to the southeastern United States. Its natural gas pipeline system extends primarily from gas producing areas of Texas, Louisiana, and the Gulf of Mexico to markets in a seven-state area of the Southeast. Sonat and Enron Corp., an unaffiliated company, each owns a one-half interest in Citrus, a holding company that owns 100 percent of Florida Gas Transmission Company ("Florida Gas"). Florida Gas is an interstate natural gas pipeline that serves the State of Florida. Sonat Energy Services' largest subsidiary, Sonat Marketing Company L.P. ("Sonat Marketing"), sells natural gas throughout much of the United States, principally the area east of the Rocky Mountains. Another subsidiary of Sonat Energy Services, Sonat Power Marketing L.P. ("Power Marketing"), markets electric power throughout the area of the United States east of the Rocky Mountains. Sonat Energy Services owns 65 percent and subsidiaries of AGL Resources, Inc., an unaffiliated company ("AGL Resources"), own 35 percent of Sonat Marketing and Power Marketing. Sonat was incorporated under the laws of Delaware in 1973 in connection with a reorganization of Southern. At March 1, 1999, Sonat and its subsidiaries employed approximately 1,890 people. Sonat's principal executive offices are located at 1900 Fifth Avenue North, AmSouth-Sonat Tower, Birmingham, Alabama 35203, and its telephone number is (205) 325-3800. Additional business information is contained in Management's Discussion and Analysis of Financial Condition and Results of Operations and in the Notes to Consolidated Financial Statements in Part II of this report, which are incorporated herein by reference. Reference is made to Note 13 of the Notes to Consolidated Financial Statements contained in Part II of this report for further information with respect to the portions of Sonat's revenues, operating profit, capital expenditures, and identifiable assets attributable to each of its business segments. PROPOSED MERGER WITH EL PASO ENERGY CORPORATION On March 13, 1999, Sonat and El Paso Energy Corporation ("El Paso") entered into an Agreement and Plan of Merger (the "Merger Agreement"), providing for, among other things, the merger of El Paso and the Company. Under the terms of the Merger Agreement, the Company's shareholders will receive one share of El Paso common stock, par value $3.00 per share ("El Paso Common Stock"), for each share of common stock, par value $1.00 per share, of the Company ("Company Common Stock"), they own. The merger is subject to certain customary conditions, including, among others, approval by the stockholders of the Company and receipt of certain required government approvals. In the event El Paso stockholder approval for the issuance of El Paso Common Stock in the merger is not obtained, El Paso has agreed to issue an amount of El Paso Common Stock not to exceed, in the aggregate, 19.9 percent of the outstanding El Paso Common Stock, with the balance of the merger consideration to be paid in the form of non-convertible long-term preferred stock (the "Preferred Stock"). The Preferred Stock will bear a dividend rate designed to cause the stock to have a value equal to the greater of $32 or the value of the El Paso Common Stock as of the time of I-1 5 the Company's shareholder vote, subject to a cap of $44.50. The Preferred Stock will be redeemable in 21 years and will not be convertible. In connection with the Merger Agreement, on March 13, 1999, the Company and El Paso also entered into cross option agreements, pursuant to which, among other things, (i) El Paso has been granted an option to purchase up to 19.9 percent of the Company Common Stock, exercisable if the Merger Agreement is terminated under certain circumstances as set forth therein and (ii) the Company has been granted an option to purchase up to 19.9 percent of the El Paso Common Stock, exercisable if the Merger Agreement is terminated under certain circumstances as set forth therein. EXPLORATION AND PRODUCTION Sonat is engaged in the exploration for and the acquisition, development, and production of oil and natural gas through its wholly owned subsidiary, Sonat Exploration Company, and its subsidiary companies and Sonat Exploration GOM Inc. On January 30, 1998, Sonat closed the merger of one of its wholly owned subsidiaries with Zilkha, a privately owned oil and gas exploration, development, and production company operating primarily offshore in the shallow waters of the Gulf of Mexico, for $1.3 billion. Following the merger, Zilkha was renamed Sonat Exploration GOM Inc. ("Sonat GOM"), which is a wholly owned subsidiary of Sonat. See Note 3 of the Notes to Consolidated Financial Statements in Part II of this report for additional details regarding the merger. Unless the context specifically indicates otherwise, the term "Exploration" as used below shall include both Sonat Exploration Company and its subsidiary companies and Sonat GOM and all numbers shall be consolidated numbers for Exploration as so defined. SONAT EXPLORATION COMPANY Exploration's principal office is located in Houston, Texas. Exploration also has offices in Tyler and Midland, Texas, and Oklahoma City, Oklahoma. The oil and gas properties of Exploration are principally located onshore in the Southern coastal states, in various states in the Southwest, and in federal waters offshore Louisiana and Texas. Exploration holds the industry's largest net leasehold position in the shallow water area (less than 600 feet) of the Gulf of Mexico. As of December 31, 1998, Exploration had operations or properties in 12 states. Exploration had working interests in approximately 1.7 million gross acres or 1.1 million net acres onshore as of December 31, 1998. Of this onshore acreage, approximately 570,000 gross or 332,000 net acres were producing oil or gas. In addition, as of such date (but excluding properties sold on January 15, 1999), Exploration had a working interest in 397 federal offshore blocks in the Gulf of Mexico and 26 state offshore blocks, totaling approximately 1.9 million gross acres or 1.8 million net acres, of which 41 were located in deep water areas. Of these blocks, 85 were producing oil or gas and 338 lease blocks (covering approximately 1.6 million net acres) were undeveloped. Exploration has licensed or contracted to license three dimensional ("3-D") seismic data covering 6,232 lease blocks in both shallow and deep water areas of the Gulf of Mexico. Following the merger with Zilkha, Sonat undertook a comprehensive review of its exploration and production business and determined that its return on invested capital would fall short of its goals. At that time, Exploration undertook a thorough review of each producing area to determine which properties were earning an acceptable financial return and which were not. Exploration also reviewed its cost structure and looked at ways to operate more efficiently. As a consequence, a major restructuring program was announced in April 1998. Program steps, which have been completed, included the sale of certain oil and gas properties, consolidation of certain business units, and a substantial work force reduction. Oil and gas properties sold, including its Austin Chalk properties, had proved reserves of approximately 430 billion cubic feet ("Bcf") of natural gas equivalent ("Bcfe"), or approximately 17 percent of Exploration's proved reserves as of December 31, 1997, and daily net production of approximately 170 million cubic feet ("MMcf") of natural gas equivalent ("MMcfe"). Proceeds of approximately $317 million from these sales were used to reduce debt. Production fell to 276 Bcfe in 1998 from 318 Bcfe in 1997, due primarily to these property sales. I-2 6 Business units were consolidated from seven to three. This action, together with related staff reductions, reduced Exploration's workforce by approximately 25 percent. In addition, Exploration reviewed all of its oil and natural gas reserves in 1998. Proved reserves were adjusted downward by a net 426 Bcfe from year-end 1997 proved reserves in addition to the 430 Bcfe reduction as a result of the property sales. As a result of these revisions and the property sales, Exploration's total proved reserves were approximately 1.6 trillion cubic feet ("Tcf") of natural gas equivalent at the end of 1998, compared to approximately 2.6 Tcf at the end of 1997. Approximately 89 percent of Exploration's proved reserves are natural gas. In 1998 Exploration participated in the drilling of 291 development wells, of which 92 percent were successful. Exploration also participated in the drilling of a total of 40 exploratory wells in 1998 (18 offshore and 22 onshore), 19 of which were successful (eight offshore and 11 onshore). Of the total of 331 wells in which Exploration participated in drilling in 1998, it operated 275. Exploration failed to replace the reserves it produced during 1998. During 1999 Exploration has budgeted to drill approximately 25 exploratory wells and 11 development wells on its acreage positions in the Gulf of Mexico. Exploration also added to its deep-water holdings in the Gulf of Mexico by successfully bidding on 28 deep-water blocks during 1998. Exploration intends to continue to acquire prospective deep-water blocks to add to its inventory of drillable prospects. Exploration's restructuring program particularly impacted its onshore operations since almost all of the properties sold in 1998 were onshore. The most significant of these were Exploration's Austin Chalk and Arkoma Basin properties. Exploration had maintained an active drilling program in the Austin Chalk Trend in East Texas and West Louisiana from 1993 through 1997, but the economics of continued development were not attractive. The Arkoma Basin properties were nearing completion of Exploration's development program for them and continued exploration and development entailed more risk than Exploration thought was justified. Exploration's onshore exploration effort over the past few years had been dominated by the Cotton Valley Pinnacle Reef trend in East Texas. Its drilling success rate and the initial flow rates from the reef wells were encouraging, but during 1998 the production rates from these wells dropped substantially, and Exploration has significantly curtailed its reef exploration program. Strategically, Exploration is now emphasizing a disciplined onshore exploration program to capitalize on its excellent land position and seismic holdings. Exploration anticipates drilling approximately 34 exploratory wells, plus a coalbed methane pilot project in Sheridan, Wyoming, and 244 development wells on its onshore acreage during 1999. Exploration will pursue producing property acquisitions that can be integrated efficiently into its existing operations and that offer development drilling opportunities. Exploration is also interested in expanding its coalbed methane drilling operations following its success in Alabama's Black Warrior Basin, where its daily production has risen from 18 to 55 MMcf per day in the past three years. Exploration recently acquired 38,000 acres in Wyoming's Powder River Basin and has begun a pilot program there to test the feasibility of what could become a significant coalbed methane drilling program. PennzEnergy Company, an unaffiliated company ("PennzEnergy"), and Exploration recently announced that they have formed a joint venture to develop mineral interests underlain by coalbed methane at the 700,000 - acre Vermejo Park Ranch in northeast New Mexico. Under the terms of the definitive joint venture agreement, Exploration will pay up to $10 million in cash and fund a substantial development program to earn a 36-year lease covering part of PennzEnergy's mineral interest in Vermejo Park Ranch and adjacent holdings. PennzEnergy will initially participate with a 25-percent working interest in the venture, and will increase its working interest incrementally to 50 percent as the project reaches defined milestones. In addition to its working interest, PennzEnergy will retain a 25-percent royalty in its lease to Exploration. Closing of the transaction is subject to certain preferential rights held by the landowner. I-3 7 In 1999 PennzEnergy and Exploration expect to drill a minimum of 35 wells. Plans call for drilling 80 wells in 2000 and 150 wells each year thereafter. Reserves associated with the joint venture properties are estimated to exceed one Tcf of coalbed methane. To accommodate near-term gas sales generated by the development program, Exploration has agreed to construct at its own expense during 1999 a gathering line north from Vermejo Park Ranch to interconnect with a regional transportation pipeline. Longer-term plans call for Exploration to arrange for transportation on a newly constructed natural gas pipeline that will connect to the national pipeline grid. Exploration has an option to discontinue participation in the joint venture beyond September 1, 2000. In that event, however, Exploration's interest in the project, including any related improvements made, would be assigned to PennzEnergy at no cost. Changes in Exploration's capital program may occur during the year since the number, type, and timing of prospects drilled are subject to continual revision as a result of many factors, including the number of new prospects identified and secured through exploration and joint ventures with others, the number of prospects identified through ongoing geologic evaluation or seismic reprocessing efforts, rig availability and cost, lease expiration dates, the availability of capital to fund such projects, initial test results, the price of oil and gas, weather, and other general and economic conditions. While maintaining an active drilling program, Exploration has also continued its cost control and productivity improvement efforts. Exploration's business is subject to all of the operating risks normally associated with the exploration for and production of oil and gas, including blowouts, cratering, pollution, and fires, each of which could result in damage to or destruction of oil and gas wells, formations, production facilities, or properties or in personal injury. Sonat maintains broad insurance coverage on behalf of Exploration with respect to losses resulting from these operating hazards. See "Governmental Regulation -- Exploration and Production" below for information concerning the effect of various laws and governmental regulations on Exploration's operations. CONSOLIDATED OIL AND GAS RESERVES. As of December 31, 1998, Exploration's net proved reserves totaled 30 million barrels of crude oil, condensate, and natural gas liquids and 1,422 Bcf of natural gas. As of December 31, 1997, Exploration's net proved reserves amounted to 73 million barrels of crude oil, condensate, and natural gas liquids and 2,161 Bcf of natural gas. For additional information concerning reserves, see Note 14 of the Notes to Consolidated Financial Statements in Part II of this report. The following table sets forth certain information on the total proved reserves for Exploration as of December 31, 1998. Information in the following table is based upon the reserve report prepared by Exploration dated January 1, 1999. Ryder Scott Company Petroleum Engineers ("Ryder Scott") has issued its report dated March 10, 1999, in which it reviewed certain of Exploration's onshore properties, which account for approximately 62 percent of Exploration's total net proved reserves. William M. Cobb & Associates, Inc. ("Cobb") has issued its report dated January 14, 1999, in which it reviewed all of Sonat GOM's offshore properties (the former Zilkha acreage), which account for approximately 15 percent of Exploration's total net proved reserves. All of such reserve reports were done in accordance with the rules and regulations of the Securities and Exchange Commission.
NET PROVED RESERVES ------------------------------- GAS LIQUIDS TOTAL --------- ------- --------- (MMCF) (MBBL) (MMCFE) Producing................................................... 931,600 17,552 1,036,900 Non-Producing............................................... 191,000 7,191 234,200 Undeveloped................................................. 299,700 4,974 329,500 --------- ------ --------- Total Proved...................................... 1,422,300 29,717 1,600,600 ========= ====== =========
There are numerous uncertainties inherent in estimating quantities of proved reserves, including many factors beyond the control of Exploration. The reserve data set forth herein represents only estimates. Reservoir engineering is a subjective process of estimating underground accumulations of crude oil and natural gas that cannot be measured in an exact manner, and the accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretations and judgment. As a result, estimates I-4 8 of different engineers often vary. In addition, results of drilling, testing, and production subsequent to the date of an estimate may justify revision of such estimate. Accordingly, reserve estimates are often different from the quantities of crude oil and natural gas that are ultimately recovered. The meaningfulness of such estimates is highly dependent upon the accuracy of the assumptions upon which they were based. In general, the volume of production from oil and gas properties owned by Exploration declines as reserves are depleted. Except to the extent Exploration conducts successful exploration and development activities or acquires additional properties containing proved reserves, or both, the proved reserves of Exploration will decline as reserves are produced. Exploration relies on its own technical staff for the selection of its drilling prospects. Leases on desirable, nonproducing offshore prospects are typically acquired in federal and state waters by acquisition or through a competitive bidding process from the federal or state governments. Exploration has, and may in the future, bid with other companies for leases on prospective offshore acreage. Onshore leases are acquired by Exploration and by independent lease brokers at the direction of Exploration's staff, through farmouts, through participation in prospects developed by others, or by acquisition. Exploration may, as it has in the past, enter into joint venture arrangements where exploration and development activity is performed on behalf of the joint venture by whichever company is designated as operator. Drilling for Exploration is conducted by independent drilling contractors. There have been no oil or gas reserve estimates filed or included in any reports to any federal agency within the last twelve months, except Form EIA-23 Annual Survey of Domestic Oil and Gas Reserves filed with the Federal Energy Regulatory Commission (the "FERC") and Form 9-1866 (Request for Reservoir Maximum Efficient Rate) filed with the Minerals Management Service of the U.S. Department of the Interior (the "MMS"). There are no material differences in the reserves reflected in such reports and the estimated reserves as reflected in Note 14 of the Notes to Consolidated Financial Statements in Part II of this report, except for differences resulting from actual production, acquisitions, property sales, and necessary reserve revisions and additions to reflect actual experience. CONSOLIDATED WELLS AND ACREAGE. The following tables detail the gross lease acreage of both producing and nonproducing onshore properties and offshore lease blocks in which Exploration had an interest at December 31, 1998 (excluding properties sold on January 15, 1999). The map on page I-8 following the tables generally depicts the areas in which Exploration had significant lease interests as of December 31, 1998. SONAT EXPLORATION COMPANY ONSHORE GROSS LEASE ACREAGE
NON- STATE PRODUCING PRODUCING TOTAL - ----- --------- ------------- --------- Alabama..................................................... 10,670 33,057 43,727 Arkansas.................................................... 19,933 28,048 47,981 Louisiana................................................... 125,504 334,379 459,883 Montana..................................................... 9,392 -- 9,392 New Mexico.................................................. 6,450 648 7,098 Oklahoma.................................................... 209,447 56,399 265,846 Texas....................................................... 185,169 643,559 828,728 Wyoming..................................................... 1,673 -- 1,673 Other....................................................... 1,637 160 1,797 ------- --------- --------- Total............................................. 569,875 1,096,250 1,666,125 ======= ========= =========
I-5 9 OFFSHORE GROSS LEASE BLOCKS*
AREA PRODUCING NON-PRODUCING TOTAL ---- --------- ------------- ----- Alaminos Canyon............................................. -- 4 4 Atwater Valley 402.......................................... -- 1 1 Brazos...................................................... 1(1) 7 8 East Breaks................................................. -- 28 28 East Cameron................................................ 8(2) 15 23 Eugene Island............................................... 10 9 19 Galveston................................................... 2 6 8 Grand Isle.................................................. 2 14 16 Green Canyon................................................ -- 1 1 High Island................................................. 3(3) 26 29 Main Pass................................................... 4 6 10 Matagorda................................................... -- 1 1 Mississippi Canyon.......................................... 3(4) 6 9 Mobile...................................................... -- 1 1 Mustang Island.............................................. 3 1 4 Sabine Pass................................................. 3 -- 3 Ship Shoal.................................................. 2 17 19 South Marsh Island.......................................... 6 9 15 South Pass.................................................. -- 3 3 South Pelto................................................. 5(5) 6 11 South Timbalier............................................. 3(6) 32 35 Vermilion................................................... 2(7) 26 28 Viosca Knoll................................................ -- 18 18 West Cameron................................................ 20(8) 66 86 West Delta.................................................. 2 15 17 -- --- --- Federal........................................... 79 318 397 LOUISIANA Atchafalaya Bay............................................. 1 3 4 Grand Isle.................................................. 3(9) 10 13 Sabine Pass................................................. 1 -- 1 West Cameron................................................ -- 1 1 -- --- --- Louisiana......................................... 5 14 19 TEXAS High Island................................................. 1(10) 4 5 Sabine Pass................................................. -- 2 2 -- --- --- Texas............................................. 1 6 7 -- --- --- State............................................. 6 20 26 -- --- --- TOTAL............................................. 85 338 423 == === ===
- --------------- * Excludes blocks sold to Energy Resource Technology, Inc. on January 15, 1999. (1) Sonat GOM has a 3.887429% working interest and Sonat Exploration Development I Company, its wholly owned subsidiary ("SEDCO"), has a 12.310191% working interest in Brazos 491. The SEDCO interest is subject to the UBS Asset Management 90% net profit interest. (2) Sonat GOM has a 15% back-in override in East Cameron 328 when, commencing September 15, 1996, one million barrels of oil has been produced; and, Exploration has a 40.73% working interest below 10,500 feet in East Cameron 223; and a 31.23% working interest below 10,500 feet in East Cameron 231. I-6 10 (3) Exploration only has a 3% override in High Island 139; and Sonat GOM has a back-in 8.2875% override in High Island 116 when, commencing July 1, 1996, 45 Bcf of gas has been produced. High Island 355A has been included in the lease count; however, the lease was released on January 31, 1999. (4) Exploration is not a lessee of one of the four producing blocks, Mississippi Canyon 150, but this block has been unitized with the three producing lease blocks in the area in which Exploration has a working interest. (5) Sonat GOM has a 7.58333% before payout overriding royalty interest ("BPO ORRI")/8.5% after payout overriding royalty interest ("APO ORRI") or 25% after payout working interest in South Pelto 18 (operating rights from surface to 20,000 feet). Sonat GOM owns 100% in the remaining lease. (6) Sonat GOM has a 7.613333% BPO/10.893333% APO ORRI in the South Timbalier 11 (operating rights from surface to 25,000 feet). Sonat GOM owns 100% in the remaining lease. (7) Sonat GOM has a 7.583333% BPO/6.8333333% APO ORRI only in the Vermilion 87 (operating rights from surface to 6,780 feet). Sonat GOM owns 100% in the remaining lease. (8) Exploration has a 12.5% working interest below 9,500 feet in West Cameron 290, which is one of the producing blocks; and Exploration only has an overriding royalty interest in West Cameron 421. (9) Sonat GOM owns a 70% working interest below the Q-60 Sand, and does not own an interest in the producing well. (10) High Island 11-L (State Lease) -- This well has been categorized as producing; however, it is shut-in. The following table sets forth information concerning Exploration's consolidated working interests in oil and gas properties as of December 31, 1998 (excluding properties sold on January 15, 1999).
TOTAL NUMBER OF PRODUCTIVE WELLS NUMBER OF ---------------- DEVELOPED UNDEVELOPED WELLS BEING OIL GAS ACRES ACRES DRILLED ---- ------ --------- ----------- ----------- Gross.................................. 150 2,112(1) 861,540 2,727,737 35 Net.................................... 106 1,317 512,386 2,365,707 24
- --------------- (1) Twenty of these wells are multiple completions. I-7 11 SONAT EXPLORATION INTERESTS (SONAT EXPLORATION MAP) SONAT GOM INTERESTS (SONAT INTERESTS MAP) I-8 12 CONSOLIDATED EXPLORATORY AND DEVELOPMENT WELLS. The following table sets forth certain consolidated information regarding exploratory and development wells drilled during the years 1996 through 1998.
NET EXPLORATORY NET DEVELOPMENT WELLS DRILLED WELLS DRILLED ------------------ --------------------- 1996 1997 1998 1996 1997 1998 ---- ---- ---- ----- ----- ----- Productive.............................................. 24.4 19.4 14.9 210.7 296.1 204.2 Dry..................................................... 6.0 14.9 18.6 5.4 19.3 18.1
For information concerning Exploration's (i) capitalized costs of oil and gas producing activities, (ii) costs incurred in oil and gas producing activities, (iii) net revenues from oil and gas production, (iv) estimated proved oil and gas reserves, (v) estimated future oil and gas net revenues, and (vi) present value of estimated future net revenues from estimated production of proved oil and gas reserves, see Note 14 of the Notes to Consolidated Financial Statements in Part II of this report. The standardized measures of discounted future net cash flows relating to Exploration's oil (including condensate) and gas reserves are calculated as prescribed by Statement of Financial Accounting Standards No. 69. The standardized measures of Exploration's proved oil and gas reserves presented in Part II of this report do not represent Sonat's estimate of their fair market value and are not otherwise representative of the value thereof, but rather, as stipulated and required by the Financial Accounting Standards Board, are intended solely to assist financial statement users in making comparisons between companies. The information contained in the foregoing table should not be considered indicative of future drilling performance, nor should it be assumed that there is any necessary correlation between the number of productive wells drilled and the amount of oil and gas that may ultimately be recovered from such wells. CONSOLIDATED NET PRODUCTION, UNIT PRICES, AND PRODUCTION COSTS. As of December 31, 1998, Exploration had an ownership interest in 2,262 gross (1,423 net) productive wells, including 2,112 gross (1,317 net) productive natural gas wells and 150 gross (106 net) productive oil wells. Of these wells, 2,122 producing wells were onshore and 140 producing wells were offshore. Reference is made to the table in Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II of this report showing the consolidated net production (sales volumes) of oil and condensate, natural gas liquids, and natural gas for 1996 to 1998 and the average sales prices for those years (including transfers). The average production (lifting) costs per unit of oil and gas was $.33 in 1998, $.37 in 1997, and $.30 in 1996. The average production cost is calculated by converting all units of production to the equivalent thousand cubic feet ("Mcf") of gas using the relative energy content method. Exploration sells its crude oil production generally at posted prices, subject to adjustments for gravity and transportation. Exploration sells its natural gas primarily to Sonat Marketing at spot-market prices. Exploration also sells some of its gas under long-term contracts directly to pipelines, distribution companies, and end-users. Exploration sells natural gas liquids at market prices under monthly or long-term contracts. Sales of natural gas by Exploration to affiliates accounted for approximately 68 percent of Exploration's revenues in 1998, 54 percent in 1997, and 56 percent in 1996. During 1993 Sonat Marketing entered into agreements with Exploration pursuant to which Sonat Marketing purchases substantially all of Exploration's natural gas production that is not sold under pre-existing term dedications. The purchase prices for natural gas covered by these agreements is based on representative index prices agreed upon by Exploration and Sonat Marketing as representing the market value of the gas. A portion of Exploration's production is hedged by entering into intercompany swaps with Sonat Marketing to reduce the risks associated with spot-market price volatility. See Note 4 of the Notes to Consolidated Financial Statements contained in Part II of this report. I-9 13 The following table sets forth certain information regarding the net production volumes, average sales prices received, and average production costs associated with Exploration's sales of oil and natural gas for the periods indicated.
YEARS ENDED DECEMBER 31, --------------------- 1998 1997 1996 ----- ----- ----- Net Production: Gas (Bcf)................................................. 226 266 268 Oil and Condensate (MMBbls)............................... 6.5 6.8 6.8 Natural Gas Liquids (MMBbls).............................. 1.8 1.8 2.2 Total (Bcfe)...................................... 276 318 322 Average Sales Price: Gas ($/Mcf)............................................... 1.95 2.26 2.19 Oil and Condensate ($/Bbl)................................ 13.14 19.57 18.48 Natural Gas Liquids ($/Bbl)............................... 8.83 11.90 12.03 Average Production Cost: ($/Mcfe)(1)............................................... 0.33 0.37 0.30
- --------------- (1) Includes direct lifting costs (labor, repairs and maintenance, materials, and supplies) and the administrative costs of production offices, insurance, and property and severance taxes. CONSOLIDATED DEVELOPMENT, EXPLORATION, AND ACQUISITION EXPENDITURES. The following table sets forth certain information regarding the costs incurred by Exploration in its development, exploration, and acquisition activities during the periods indicated.
YEARS ENDED DECEMBER 31, ------------------------------ 1998 1997 1996 -------- -------- -------- ($ THOUSANDS) Development Costs........................................... $375,296 $490,979 $308,755 Exploration Costs: Proved Acquisitions....................................... 1,592 5,811 61,441 Lease Acquisitions and Delay Rentals...................... 58,809 86,789 73,602 Seismic Acquisition and Reprocessing...................... 52,998 102,450 48,301 Drilling.................................................. 92,364 176,580 128,001 -------- -------- -------- Total Capital Expenditures........................ $581,059 $862,609 $620,100 ======== ======== ========
COMPETITION AND CURRENT BUSINESS CONDITIONS The oil and gas business is highly competitive in the search for and acquisition of additional reserves and in the marketing of oil and natural gas. Exploration's competitors include the major and intermediate size oil companies, independent oil and gas concerns, and individual producers or operators. Exploration's realized natural gas prices averaged $1.95 per thousand cubic feet in 1998, down from $2.26 in 1997. Oil and condensate prices averaged $13.14 per barrel in 1998 versus $19.57 per barrel in 1997. Exploration hedged a portion of its 1998 production, which reduced its realized price for natural gas by $.02 per Mcf. See Part II of this report in Note 4 of the Notes to Consolidated Financial Statements and in Management's Discussion and Analysis of Financial Condition and Results of Operations following the caption "Hedging Activities" for a discussion of oil and gas production hedged in the future. Exploration has a 1999 capital budget of $335 million; however, given Sonat's debt levels, Exploration will limit its expenditures to the total of operating cash flow and the proceeds of any property sales. Exploration expects to sell its West Texas and other non-strategic properties in 1999. Due to the decline in oil field services costs, the 1999 drilling program should be comparable to Exploration's 1998 program. Given the I-10 14 many opportunities emerging in the Gulf of Mexico and in coalbed methane areas onshore, Exploration will increase exploration while reducing its onshore development program. This could result in lower near-term production, but Exploration believes it will result in greater long-term production and profitability. Actual expenditures for such activities may vary from these estimates for a number of reasons, including those discussed under the caption Cautionary Statement Concerning Forward-Looking Statements contained below in this Part I of this report. NATURAL GAS TRANSMISSION Sonat owns interests in approximately 14,000 miles of natural gas pipelines extending across the southeastern United States from Texas to South Carolina and Florida. The principal business of Sonat's pipelines is the transmission and storage of natural gas in interstate commerce. Sonat's interstate pipeline businesses are subject to regulation by the FERC and the U.S. Department of Transportation under the terms of the Natural Gas Policy Act of 1978 ("NGPA"), the Natural Gas Act ("NGA"), and various pipeline safety and environmental laws. See "Governmental Regulation -- Natural Gas Transmission" below for information concerning the regulation of natural gas transmission operations. SOUTHERN NATURAL GAS COMPANY Sonat's principal operating company in the pipeline group is Southern, a wholly owned subsidiary of Sonat, which owns approximately 7,300 miles of interstate natural gas pipelines. Southern's interstate pipeline system extends from gas fields in Texas, Louisiana, Mississippi, Alabama, and the Gulf of Mexico to markets in Louisiana, Mississippi, Alabama, Florida, Georgia, South Carolina, and Tennessee. Southern is the principal pipeline supplier to the growing Southeastern markets of Alabama and Georgia. Southern's interstate pipeline system has a firm daily delivery capacity of 2.5 Bcf of natural gas. A map of Southern's pipeline system, including pipelines of its subsidiaries and joint ventures, as well as of the pipeline system of Florida Gas, appears on page I-19. FLORIDA GAS TRANSMISSION COMPANY Florida Gas is the primary pipeline transporter of natural gas in the State of Florida and the sole pipeline transporter to peninsular Florida. Florida Gas is operated by a subsidiary of Enron Corp., an unaffiliated company, which owns the other 50 percent of Citrus. Florida Gas owns approximately 4,800 miles of interstate natural gas pipelines that extend from south Texas to a point near Miami, Florida. Its system has a firm daily delivery capacity of 1.5 Bcf of natural gas. See the map on page I-19. For additional information regarding Citrus, see Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II of this report, and the Consolidated Financial Statements of Citrus contained in Part IV of this report. SEA ROBIN PIPELINE COMPANY Sea Robin Pipeline Company ("Sea Robin"), a wholly owned subsidiary of Southern, owns an approximately 430-mile interstate natural gas pipeline system located in the Gulf of Mexico. Sea Robin gathers natural gas and condensate for others and delivers those products to shore for condensate removal and gas processing and redelivery to one independent storage company and five downstream transmission pipelines, including Southern. See the system map on page I-19. Sea Robin transported approximately 238 Bcf of natural gas in 1998 compared to 278 Bcf in 1997. These Sea Robin volumes are included within the Southern transportation volumes discussed below. SOUTH GEORGIA NATURAL GAS COMPANY South Georgia Natural Gas Company ("South Georgia"), a wholly owned subsidiary of Southern, owns an approximately 910-mile interstate natural gas transmission system located in eastern Alabama, southern Georgia, and the Florida Panhandle. See the system map on page I-19. South Georgia transported I-11 15 approximately 39 Bcf of natural gas in 1998 compared to 38 Bcf in 1997. These South Georgia volumes are included within the Southern transportation volumes discussed below. DESTIN PIPELINE COMPANY, L.L.C. Destin Pipeline Company, L.L.C. ("Destin"), is owned one-third each by Southern and subsidiaries of Shell Oil Company ("Shell") and BP Amoco Corporation ("BP Amoco"). Destin owns a 223-mile interstate pipeline system that transports natural gas from the growing eastern Gulf of Mexico production area, with an additional 31-mile extension scheduled to go in service in the second quarter of 1999. Destin's pipeline system extends northward into Mississippi, where it connects with five other interstate pipelines, including Southern and Florida Gas. See the system map on page I-19. The pipeline has a firm daily delivery capacity of 1.0 Bcf of natural gas. Southern is the operator of the system. Destin's pipeline system was partially completed and in service in September 1998 and was fully in service in March 1999. As of March 1999, the total capital to be expended by Destin is estimated to be $475 million, including two substantial extensions of the original mainline system that were constructed in late 1998 and early 1999. Destin's FERC Gas Tariff includes a flexible firm transportation service, which provides for levels of firm transportation capacity that may vary quarterly, with the transportation provided at a volumetric rate provided certain minimum throughput levels are maintained. Under the flexible firm service, Destin's transportation revenue will fluctuate based on the levels of gas production from its shippers. To be eligible for Destin's flexible firm service, a shipper must make a life-of-reserves commitment of production from offshore leases with estimated proven recoverable reserves of 100 Bcf or more. Shell, BP Amoco, and other shippers have dedicated their production from certain leases in the eastern Gulf of Mexico to Destin for transportation under Destin's flexible firm rate schedule. Discussions are underway with other prospective shippers. ETOWAH LNG COMPANY, L.L.C. In December 1997 an affiliate of AGL Resources and Southern formed a new entity, Etowah LNG Company, L.L.C. ("Etowah"), to jointly construct, own, and operate a new liquefied natural gas ("LNG") peaking facility in Polk County, Georgia. Peaking services provide supplemental gas supplies on days when demand is highest, typically during the winter. Under the agreement, AGL Resources and Southern each will own 50 percent of Etowah, which will be regulated by the FERC. The proposed plant will connect directly into AGL Resources' principal natural gas distribution subsidiary, Atlanta Gas Light Company ("AGLC"), and Southern's pipeline. Etowah will provide natural gas storage and peaking services to AGLC and the city of Austell, Georgia. The new facility will cost approximately $90 million. AGLC has subscribed for 200 MMcf per day of deliverability capacity from Etowah, which represents two-thirds of its anticipated available capacity, for a term of 20 years. The agreement for Etowah to provide services to AGLC includes, however, provisions allowing AGLC to terminate the agreement in the event it does not receive, with respect to the agreement, a satisfactory order from the Georgia Public Service Commission ("Georgia PSC") or if AGLC determines it should not proceed with the agreement. In September 1998 the Georgia PSC issued an order approving the agreement, but allowed for further review of it. The parties extended the time period during which AGLC may terminate the agreement. AGLC has advised Southern that it is reevaluating the timing and extent of its needs for firm peaking services and will advise Southern whether it will proceed with this project during the third quarter of 1999. If AGLC exercises its option to terminate its service agreement with Etowah, the project would not go forward and AGLC would be obligated to reimburse Etowah for all of its costs incurred in the project. SOUTHERN LNG INC. Southern LNG Inc. ("Southern LNG"), formerly known as Southern Energy Company, a wholly owned subsidiary of Southern, owns an LNG receiving and regasification terminal near Savannah, Georgia, which was constructed for a project, now terminated, to import LNG from Algeria. The terminal has been inactive since the early 1980s. In 1992 the FERC approved a settlement relating to Southern LNG's facilities. The I-12 16 settlement resolved a number of outstanding rate and accounting issues. Southern LNG must determine by the end of 1999 whether to file with the FERC to abandon its facility. If it abandons the facility, Southern LNG would nevertheless be allowed to recover most of its remaining investment in the facility pursuant to the settlement. MARKETS -- TRANSPORTATION Sonat's pipelines provide natural gas transportation services for their distribution customers, primarily for residential and commercial end use, industrial customers, electric generation companies, gas producers, other gas pipelines, and gas marketing and trading companies. Southern provides transportation service in both its gas supply and market areas. The principal industries served directly by Sonat's pipeline systems and indirectly through their customers' distribution systems include the electric generation, fertilizer, chemical, pulp and paper, textile, primary metals, stone, clay, and glass industries. Transportation volumes in 1998 for Southern and all of its subsidiaries were 984 Bcf, compared with transportation volumes in 1997 of 1,007 Bcf. Sales to distribution customers, including municipalities and gas districts, accounted for most of 1998 sales of 12 Bcf and 1997 sales of 65 Bcf. In each of 1998 and 1997, the volumes associated with the 1998 and 1997 sales are not accounted for as sales volumes, but rather are included in transportation volumes because all sales are made at the receipt points where the gas enters Southern's pipeline system. In 1998 Florida Gas transported 465 Bcf of natural gas, compared to 471 Bcf in 1997. Sonat's pipelines provide transportation service under rate schedules that are subject to FERC regulatory authority. Rates for transportation service depend on whether service is on a firm or interruptible basis and the location of the service on Southern's pipeline system. Firm service is transportation service for which the shipper pays a fixed monthly fee to reserve capacity in the pipeline system (the "Reservation Fee"). The shipper may not use this capacity it has reserved at all times, but the firm transportation customers of Southern and Florida Gas (with the exception of certain small customers) must pay the monthly Reservation Fee regardless of the volumes shipped. Shippers are able to resell their unused firm capacity pursuant to FERC rules and regulations. Interruptible service is only available when pipeline capacity is available and may be interrupted by the pipeline as needed when use of the pipeline is at its greatest, typically during winter periods. For most pipelines, including Southern and Florida Gas, FERC requires a rate design, known as straight-fixed-variable ("SFV"), that is designed to allow pipelines to recover substantially all of their fixed costs, a return on their equity investment in facilities, and income taxes in the Reservation Fee. Pipelines charge transportation rates for interruptible service for actual volumes transported. Rates for transportation service are discounted by Southern and Florida Gas in individual instances to respond to competition in the markets they serve. I-13 17 Southern's and Florida Gas' contracts to provide firm transportation service for their customers are for varying amounts and periods of time. The following chart describes the expiration dates and amounts of service covered under the various firm transportation agreements of Southern and Florida Gas with their firm transportation customers. EXPIRATION DATES OF FIRM TRANSPORTATION CONTRACTS (MCF/D)
YEAR SOUTHERN FLORIDA GAS - ---- --------- ----------- 1999........................................................ 162,022 30,764 2000........................................................ 190,433 380,012 2001........................................................ 21,994 -0- 2002........................................................ 771,125 -0- 2003........................................................ 281,341 12,416 2004........................................................ 35,504 7,121 2005........................................................ 165,198 429,378 2006........................................................ 45,108 216 2007........................................................ 309,523 31,048 2008........................................................ 356,254 -0- 2009........................................................ 13,000 6,931 Beyond 2009................................................. 98,783 586,752 --------- --------- Total............................................. 2,450,285 1,484,638 ========= =========
Substantially all of the firm transportation capacity currently available in Southern's two largest market areas is fully subscribed. Nearly all of Southern's firm transportation contracts contain evergreen provisions that automatically extend the term for additional months or years unless notice of termination is given by one of the parties. There can be no assurance that the existing customers of Southern or Florida Gas will extend their firm service agreements at the same levels when their current service agreements expire. Transportation capacity reservation fees to Southern, combined with sales by Sonat Marketing, from one distribution customer, AGLC, and its subsidiary, Chattanooga Gas Company ("Chattanooga"), accounted for approximately four percent of Sonat's 1998 consolidated revenues. Reservation fees to Southern from AGLC and Chattanooga accounted for approximately 34 percent of Southern's 1998 consolidated revenues. Transportation capacity reservation fees to Southern, combined with sales by Sonat Marketing, from another distribution customer, Alabama Gas Corporation ("Alabama Gas"), accounted for approximately four percent of Sonat's 1998 consolidated revenues. Reservation fees to Southern from Alabama Gas accounted for approximately 12 percent of Southern's 1998 consolidated revenues. No other customer accounted for as much as ten percent of Southern's consolidated revenues for 1998. Sonat's pipelines hold easements acquired through either purchase or condemnation for all of their pipeline rights-of-way. Such easements remain valid until the pipeline traversing it is abandoned. Each company has the power to eminent domain if needed in connection with acquiring additional rights-of-way for expansion projects. Sonat's pipeline businesses are subject to operating risks associated with the transmission of natural gas through a pipeline system, which could result in property damage and personal injury. Sonat has a comprehensive safety program to address these risks. Southern has consistently ranked at or near the top of its industry peer group in safety performance. Sonat maintains broad insurance coverage on behalf of Southern and its other subsidiaries insuring against financial loss resulting from these operating risks. For additional information regarding Southern's transportation and sales of gas, see Management's Discussion and Analysis of Financial Condition and Results of Operations contained in Part II of this report. I-14 18 MARKETS -- SYSTEM EXPANSIONS Southern continually seeks to expand its pipeline system (i) to reach new markets, (ii) to increase delivery capacity to existing markets to serve the increasing gas demands in its market area, and (iii) to connect new gas supplies, principally in the Gulf of Mexico, to deliver gas not only into Southern's system but also into the interstate pipeline grid. Demand for natural gas in the six Southeastern states that comprise Southern's principal market area, Alabama, Florida, Georgia, Mississippi, South Carolina, and Tennessee, has grown at an annual average rate of 3.5 percent in the last ten years, compared to the national annual average growth rate for gas demand of 2.6 percent during such period. Natural gas demand in peninsular Florida, the principal market served by Florida Gas, has grown even faster, at an annual rate of 5.2 percent in the last ten years. In November 1998 Southern placed in service an expansion to its pipeline system that will serve firm transportation commitments totaling 65 million cubic feet of natural gas per day from customers in eastern Tennessee, Georgia, and Alabama. Another expansion to North Alabama, which originally received FERC approval in May 1997, has now received the necessary FERC and other regulatory authorizations to change the route of the pipeline as it crosses the Wheeler National Wildlife Refuge, although the certificate order from the FERC is on appeal for judicial review and the permit from the U.S. Fish & Wildlife Service is on administrative appeal. Barring further unforeseen delays, it is expected that the pipeline will be completed and ready for service for the 1999-2000 winter heating season. The 122-mile expansion will provide 78 million cubic-feet-per-day capacity to the participating customers. In addition to the general growth in gas demand throughout the Southeast, the use of natural gas to generate electric power represents a significant growth prospect in the market areas of Southern and Florida Gas. Since 1994, electric utilities served by Southern have added 23 gas-fired combustion turbine generation units with generating capacity of 1,980 megawatts. These units, which have consumed in excess of 200 MMcf of natural gas on a peak day, are used primarily to meet the utilities' peak generation loads in the summer and winter months. In late 1998 Southern completed a $10 million, 34 million cubic-feet-per-day expansion in Alabama that primarily provides firm service to a 100-megawatt base load gas-fired electric generation plant operated by Alabama Power Company, a subsidiary of Southern Company. Units of Southern Company had previously installed 19 natural gas-fired peaking turbines that are served by Southern's pipeline, but this is the first natural gas-fired electric generation facility in Southern's market designed for year-round use. On March 3, 1999, Carolina Power & Light Company ("CP&L") and Southern announced plans to form a 50/50 joint venture to construct, own, and operate a 175-mile, 30-inch, natural gas pipeline from the terminus of Southern's pipeline system in Aiken, South Carolina, to an interconnect with the pipeline system of North Carolina Natural Gas Corporation ("NCNG") in Robeson County, North Carolina. The new Palmetto Interstate Pipeline ("Palmetto") will provide a significant interstate natural gas pipeline connection in eastern North Carolina. Palmetto has a planned initial capacity of 200 million to 300 million cubic feet of natural gas per day and will be expanded to accommodate future growth. CP&L plans to subscribe for a substantial portion of the capacity in Palmetto to fuel new electric generation being developed for its customers in the Carolinas, with the remainder to be used to increase the region's natural gas availability. An open season will start soon for customers to subscribe to firm capacity on the pipeline. Depending upon the resulting firm subscription, the capital cost for Palmetto is expected to be $200 million to $250 million. The proposed schedule calls for the new pipeline to be operational in April 2002. Construction is scheduled to begin in the summer of 2001, following the completion of engineering and environmental preparation and federal and state permitting. The exact route of the pipeline has not yet been determined, but the pipeline route likely will cross portions of Aiken, Lexington, Richland, Sumter, Lee, Darlington, Marlboro, and Dillon counties in South Carolina and Robeson County, North Carolina. A detailed environmental analysis is under way to establish the most environmentally sound path. I-15 19 As part of the project Southern will undertake a major expansion of its existing interstate pipeline system, consisting of extensive pipeline looping and additional compression at points from Mississippi to Aiken. The extent of Southern's pipeline expansion, which is expected to cost in excess of $200 million, will depend on capacity requirements. This expansion will provide significant rate and operational benefits to Southern's existing customers. CP&L is considering sites in North Carolina and northeastern South Carolina for new electric generation to be fueled by the new pipeline. CP&L plans to build about 4,000 megawatts of natural gas-fueled generation by 2007. Some of the new electric generation will be served in conjunction with NCNG, a natural gas distribution company headquartered in Fayetteville, North Carolina, which owns natural gas pipelines that currently serve eastern North Carolina. CP&L is in the process of acquiring NCNG. The construction of Palmetto and expansion of the Southern system require approval by the FERC as well as other federal and state agencies and is likely to be challenged on both environmental grounds and economic grounds by certain of its competitors, environmental groups, or landowners. Construction is also subject to execution of definitive agreements between CP&L and Southern. In November 1998 Florida Gas filed with the FERC for approval of a Phase IV expansion that will increase system firm capacity by 272 MMcf per day, or 19 percent. More than 90 percent of this new capacity is for Florida's growing electric generation requirements. This $351 million expansion includes 205 miles of pipeline that will extend the Florida Gas system to the Fort Myers area. Subject to regulatory approval, Phase IV is scheduled to be placed into service in mid-2001. Another growth area for Sonat's pipeline business is in expanding production area pipeline capacity to receive and transport projected increases in gas production from the Gulf of Mexico, driven by deep water developments. In March 1997 Southern placed in service a $14 million expansion project that allows producers to transport, under 10-year contracts, 140 MMcf per day of natural gas from offshore Louisiana to interconnections between Southern and other pipelines in South Louisiana. In addition, as described above, the initial construction of the Destin pipeline system has been completed. Destin, which connects with five interstate pipelines in Mississippi, including Southern and Florida Gas, enables producers to deliver gas from the eastern deepwater Gulf of Mexico to interstate markets. In June 1998 the FERC approved Destin's application to extend its pipeline system approximately 12 miles to transport additional gas reserves committed by other producers to Destin's system. This extension was partially completed and in service in December 1998 and was placed fully in service in January 1999. In July 1998 the FERC also approved another Destin application to extend its pipeline by approximately 31 miles to transport additional gas reserves committed by other producers to Destin's system. This extension is expected to be in service in the second quarter of 1999. Under FERC regulations, a pipeline is allowed to charge rates that are designed to recover fully its cost of providing service to the pipeline's customers, including a reasonable rate of return on its investment in the facilities it uses to provide its service, which is referred to as the rate base of the pipeline. The allowed rate of return includes both a cost of debt component and a return on equity component. The cumulative effect of capital investment required to serve the existing and pending projects in the three growth segments of Sonat's pipeline business described above - market area, electric generation, and production area demand -- together I-16 20 with capital investment for necessary pipeline repair and replacements, has resulted in the growth in rate base for Sonat's pipeline businesses as shown in the table below. RATE BASE ($ MILLION)
SOUTHERN AND FLORIDA YEAR SUBSIDIARIES(1) GAS(2) - ---- --------------- ------- 1994........................................................ $ 735 $ 239 1995........................................................ 735 1,250 1996........................................................ 768 1,237 1997........................................................ 843 1,223 1998........................................................ 1,146 1,193 1999 (Estimated)............................................ 1,329 1,234 2000 (Estimated)............................................ 1,334 1,214
- --------------- (1) Includes proportionate shares of the rate bases of Destin, Etowah, and other joint ventures attributable to Southern's ownership interests. (2) 100 percent of the rate base of Florida Gas, which is 50-percent owned by Sonat. The amounts estimated for 1999 and 2000 in the foregoing table include (i) currently planned capital expenditures for those years for maintenance, repair, and replacement of the pipeline system, (ii) projects that have received FERC approval and are currently under construction, and (iii) projects that have been agreed to but for which FERC approval has not yet been obtained. The above numbers include no amounts for Palmetto or for the related expansion capital to be spent by Southern. No assurance can be given that such projects, which are subject to protest by customers, competitors, the staff of the FERC, and other interested parties, such as environmental groups and landowners, will be approved by the FERC or, if approved, that such construction will not be delayed for environmental, weather, or other reasons. A pipeline cannot reflect a change in its rate base in its rates until it files a new rate case and a pipeline's rate of return is subject to change every time it files a new rate case. Consequently, there can also be no assurance that the rate of return a pipeline is permitted by the FERC to earn on its rate base in the future will be equal to the returns effectively earned in the past. Thus, the changes in rate base projected above do not necessarily equate to an expected change in earnings. GAS SALES AND SUPPLIES As a result of its restructuring pursuant to FERC directive, Southern terminated or renegotiated to market pricing substantially all of its gas supply contracts through which it had historically obtained its long-term gas supply. At December 31, 1998, Southern had five remaining long-term gas supply contracts. Pending the termination or expiration of the few remaining supply contracts, Southern's remaining gas supply is being sold on a month-to-month basis. Except for such sales, Southern's participation in gas supply activities will be limited to the purchase and sale of volumes of gas from time to time as may be required for system management purposes. RATE AND REGULATORY PROCEEDINGS Periodically, Southern and its subsidiaries and Florida Gas make general rate filings with the FERC to provide for the recovery of cost of service and a return on equity. The FERC normally allows the filed rates to become effective, subject to refund, until it rules on the approved level of rates. Southern and its subsidiaries and Florida Gas provide reserves relating to such amounts collected subject to refund, as appropriate, and make refunds upon establishment of the final rates. At December 31, 1998, Southern's currently effective rates are established by a settlement that was approved by a FERC order issued in 1995, which order is now final and nonappealable. All of Southern's customers are parties to the settlement. Under the terms of the settlement, Southern is required to file a new rate case no later than September 1, 1999, to become effective, after normal suspension by the FERC, by March 1, 2000. I-17 21 The current effective rates of Florida Gas were established by an uncontested settlement that was approved by the FERC in September 1997. The settlement provides that, except in certain limited circumstances, Florida Gas will not file a general rate case to be effective prior to October 1, 2000, but it must file a new rate case no later than October 1, 2001. STORAGE FIELDS Southern owns and operates Muldon Storage Field ("Muldon"), a large underground natural gas storage field in Mississippi connected to its pipeline system. The certificated working storage capacity of Muldon is 31 Bcf of gas. Southern and Tennessee Gas Pipeline Company ("Tennessee"), a subsidiary of El Paso, each owns 50-percent of the Bear Creek Storage Field ("Bear Creek"), an underground natural gas storage field located in Louisiana. Southern operates Bear Creek, which provides storage service to Southern, Tennessee, and their customers. Bear Creek has a total certificated working storage capacity of 65 Bcf of gas, half of which is committed to Southern. COMPETITION AND CURRENT BUSINESS CONDITIONS The natural gas transmission industry, although regulated, is very competitive. Customers purchase gas supply from producers and gas marketing companies in unregulated transactions and contract with Southern for transportation and storage services to deliver such gas supply to their markets. Southern's three largest customers are each able to obtain a significant portion of their natural gas requirements through transportation by other pipelines. In addition, Southern competes with several pipelines for the transportation and storage business of many of its other customers. The competition with such pipelines is intense, and Southern and Florida Gas must at times discount their transportation rates in order to maintain market share and revenues. Recently, two other pipeline companies announced their intent to create new pipeline systems to serve Florida markets. Natural gas is sold in competition principally with fuel oil, coal, liquefied petroleum gases, electricity, and heavy crude oil. An important consideration in the markets of Southern and Florida Gas is the ability of natural gas to compete with alternate fuels, which are fuels to which a potential end user of gas may switch depending on the price of the fuel and other factors. Residual fuel oil, the principal competitive alternate fuel in the market area of Southern and Florida Gas, has been at certain times in the past, and may be at times in the future, priced at or below the comparable price of natural gas in industrial and electric generation markets. Some parts of Southern's market area are also served by one or more other pipeline systems that can provide transportation service in competition with Southern. As described above, for most pipelines the FERC requires the SFV rate design that permits pipelines to recover substantially all of their fixed costs, a return on equity, and income taxes in the capacity reservation component of their rates. The firm transportation customers of Southern and Florida Gas (with the exception of certain small customers) must pay these reservation charges regardless of the volumes shipped. Accordingly, the SFV rate design should result in relative stability in the revenues, earnings, and cash flows of interstate pipelines, including Southern and Florida Gas, compared to other rate design methodologies. This is particularly true at Florida Gas, which faces intense competition in the Florida market from residual fuel oil that affects the volumes of gas it transports. There can be no assurance, however, that the existing customers of Southern or Florida Gas will extend their firm service agreements at the same levels when their current service agreements expire. As described above, Destin's rates are designed to recover all of its fixed and variable costs, including a return on equity and income taxes, through a volumetric rate design. In order to receive firm service at a volumetric rate, Destin's customers must commit to Destin all of their gas production from certain specified areas. Sea Robin's customers principally subscribe for interruptible service, so its revenues are highly dependent on the volumes of gas it transports. I-18 22 SONAT PIPELINE SYSTEMS (SONAT PIPELINE SYSTEMS) I-19 23 ENERGY SERVICES SONAT ENERGY SERVICES COMPANY Sonat Energy Services, which is a wholly owned subsidiary of Sonat, acts as a holding company for Sonat's companies engaged in natural gas and electric power marketing, power generation, and intrastate natural gas transmission. SONAT MARKETING COMPANY L.P. Sonat Marketing's principal offices are in Birmingham, Alabama and Houston, Texas. It also has regional offices in Tyler, Texas, Oklahoma City, Oklahoma, and Atlanta, Georgia. It purchases natural gas principally from gas producers and other marketing companies and resells the gas to industrial and commercial users, gas distribution companies, gas pipelines, and other marketing companies throughout much of the United States, principally the area east of the Rocky Mountains. Sonat Marketing also offers a variety of risk-management, transportation, and storage services to its customers. Sonat Marketing's total natural gas trading volumes rose sharply in 1998 as financial volumes more than doubled. In response to the increasing price risk management requirements of its customers, Sonat Marketing makes a market in financial instruments used to hedge gas prices and regional pricing differences ("basis differences"). Physical trading volumes declined by approximately five percent in 1998 reflecting primarily movement of certain basis transactions from physical to financial markets. Sonat Marketing sold 1,225 Bcf of natural gas in 1998 compared to sales of 1,288 Bcf in 1997. Its daily physical natural gas sales volumes were 3.4 Bcf per day at the end of 1998 compared to 4.2 Bcf per day at the end of 1997. Its daily derivative settlement volumes were 18.5 Bcf per day at the end of 1998 compared to 6.8 Bcf per day at the end of 1997. A map showing Sonat Marketing's areas of operations appears on page I-23. Sonat Marketing purchases at index-based prices all of the natural gas production of Exploration that is not sold under pre-existing term dedications. Sonat Marketing remarkets this gas as part of its marketing operations. Sonat Marketing uses derivative financial instruments as a market maker to manage the risks associated with its purchase and sale activities and to hedge the price volatility associated with Exploration's natural gas and oil production. See Part II of this report in Notes 1 and 4 of the Notes to Consolidated Financial Statements and in Management's Discussion and Analysis of Financial Condition and Results of Operations under the caption "Market Risk" for additional information regarding its derivatives activities. SONAT PUBLIC SERVICE COMPANY L.L.C. Sonat Public Service Company L.L.C. ("Sonat Public Service") was formed in late 1996 as a joint venture of Sonat Marketing and PSNC Production Corporation, a wholly owned subsidiary of Public Service Company of North Carolina, Inc., an unaffiliated company. Sonat Public Service, which is headquartered in Gastonia, North Carolina, markets natural gas and related services to small industrial and large commercial customers throughout the Mid-Atlantic region, including the District of Columbia and the states of North Carolina, South Carolina, Maryland, and Virginia. In addition, Sonat Public Service provides gas supply management services to Public Service Company of North Carolina as well as municipalities in the Mid-Atlantic region. Sonat Public Service sold 30 Bcf of natural gas in 1998 compared to sales of 17 Bcf in 1997. UNICOM GAS SERVICES LLC. Unicom Gas Services LLC ("Unicom Gas Services") was formed in August 1997 as a joint venture of Sonat Marketing and Unicom Energy Services Inc., a wholly owned subsidiary of Unicom Corporation, an unaffiliated company. Unicom Gas Services, which is headquartered in Chicago, Illinois, markets natural gas and related services to industrial and commercial customers in the Midwest region. Unicom Gas Services sold 14 Bcf of natural gas in 1998 compared to sales of 0.2 Bcf in 1997. STONE & WEBSTER SONAT ENERGY RESOURCES LLC. Stone & Webster Sonat Energy Resources LLC ("S&W Sonat") was formed in September 1998 as a joint venture of Sonat Marketing and Stone & Webster Engineers & Constructors, Inc., a wholly owned subsidiary of Stone & Webster, Inc., an unaffiliated company. S&W Sonat, which is headquartered in Boston, Massachusetts, focuses on providing large industrial, commercial, and governmental customers in North America with a variety of bundled energy management services. These services include building or upgrading power and steam generation equipment, commodity I-20 24 supply (natural gas, fossil fuels, and electricity), risk management, metering, billing, and operations and maintenance, as well as selected asset ownership. SONAT POWER MARKETING L.P. Power Marketing, which is headquartered in Birmingham, Alabama, markets electric power throughout the area of the United States east of the Rocky Mountains. Significant changes are underway in the electric industry that create new opportunities for marketing companies. The FERC has initiated, and more than half of the states are considering, regulatory changes to promote competition and give purchasers of electricity choices other than their traditional utilities, similar to the unbundling that occurred in the natural gas industry. Power Marketing was created to take advantage of these opportunities through the expected growth of wholesale power marketing. A map showing Power Marketing's areas of operations appears on page I-23. Power Marketing continued to grow during 1998. Its sales volumes increased from 8.8 million megawatt hours in 1997 to 10.5 million megawatt hours in 1998. It became profitable in 1998 as both sales volumes and margins increased over 1997 levels. Its financial results also benefited from volatility in electricity prices. Power Marketing utilizes derivative instruments in managing commodity price risk. See Part II of this report in Notes 1 and 4 of the Notes to Consolidated Financial Statements and in Management's Discussion and Analysis of Financial Condition and Results of Operations under the caption "Market Risk" for additional information regarding its derivatives activities. SONAT POWER INC. Sonat Power Inc. ("Sonat Power") is a wholly owned subsidiary of Sonat Energy Services. In February 1998 Sonat Mid-Georgia L.L.C. ("Sonat Mid-Georgia"), a wholly owned subsidiary of Sonat Power, acquired a fifty-percent limited partnership interest in Mid-Georgia Cogen L.P. ("Mid-Georgia Cogen"), which owns and operates an approximate 300-megawatt electric power plant in Georgia. The remaining fifty percent is owned by NCP Perry Incorporated, as a limited partner, and NCP Houston Power Incorporated, as both a limited and a general partner, both of which are wholly owned subsidiaries of GPU, Inc., an unaffiliated company. Sonat Power's equity investment is approximately $28 million as of December 31, 1998. The plant began commercial operation in June 1998. This project is supported by a long-term power sales agreement as well as a long-term fuel purchase agreement. Sonat Power is also the joint owner, with The AES Corporation, an unaffiliated company, of a project to construct a natural gas-fueled power plant near San Francisco, California. Because of regulatory and other developments, the current outlook for and timing of this project are uncertain. WEST GEORGIA GENERATING COMPANY L.P. West Georgia Generating Company L.P. ("West Georgia"), formerly Cataula Generating Company, L.P., is a wholly owned subsidiary of Sonat Energy Services. It was acquired in September 1998 from affiliates of U.S. Generating Company, an unaffiliated company. At that time it acquired the right to develop a 680-megawatt peaking plant in western Georgia and an associated contract to sell a significant portion of the plant's output to Georgia Power Company ("Georgia Power"). This plant is expected to have a total capital cost of approximately $230 million, approximately $26 million of which had been expended through December 31, 1998. West Georgia originally planned to develop the plant in Harris County, Georgia, but as a result of the revocation by the Harris County Board of Commissioners of the previously issued special-use permit, West Georgia will develop the plant in Upson County, Georgia. If the project experiences additional delays in permitting or construction, it could result in an inability to have the plant available in time to meet its obligation to make 205 megawatts of electric capacity available to Georgia Power beginning June 1, 2000. In that event, West Georgia would be required to source electric capacity from the market at prices potentially in excess of the prices received from Georgia Power. West Georgia anticipates, however, that it will begin commercial operations in time to meet its contractual commitments to Georgia Power. See Note 10 of the Notes to Consolidated Financial Statements contained in Part II of this report. SONAT INTRASTATE-ALABAMA INC. Sonat Intrastate-Alabama Inc. ("SIA"), a wholly owned subsidiary of Sonat Energy Services, owns an approximately 450-mile intrastate pipeline system extending from natural gas fields and coal seam gas production areas in the Black Warrior Basin in northwest and central Alabama to connections with customers in Alabama, as well as interconnections with three other pipelines, including I-21 25 Southern. SIA's throughput in 1998, which includes both transportation and sales, was approximately 52 Bcf of natural gas compared to 42 Bcf in 1997. SONAT POWER SYSTEMS INC. Sonat Power Systems Inc. ("Sonat Power Systems"), a wholly owned subsidiary of Sonat, formed a strategic alliance in 1997 with AlliedSignal Power Systems Inc. ("AlliedSignal"), a wholly owned subsidiary of AlliedSignal Inc., an unaffiliated company, to market and support AlliedSignal's TurboGenerator(TM) products. The TurboGenerator(TM) unit is a small, self-contained 75-kilowatt power source fueled by natural gas. The size is ideal for smaller commercial establishments, but these units can also be used together to meet the power needs for larger applications. Through this alliance, Sonat Power Systems is the exclusive distributor of the TurboGenerator(TM) unit in 13 Southern states from Texas to Maryland, plus the District of Columbia. In December 1998 Sonat Power Systems acquired an option from AlliedSignal to become the exclusive distributor in Mexico of TurboGenerator(TM) units outside the oil and gas industry. During 1998 AlliedSignal tested and further enhanced the TurboGenerator(TM) unit. Sonat Power Systems anticipates placing a number of prototype TurboGenerator(TM) units with significant regional customers in the third quarter of 1999. AlliedSignal expects to begin commercial production in mid-1999 and Sonat Power Systems' sales could increase to 50 units per month after the commencement of commercial production. The success of Sonat Power Systems will substantially depend on the ability of AlliedSignal to produce a commercially viable TurboGenerator(TM) unit and the market demand for such units. COMPETITION AND CURRENT BUSINESS CONDITIONS Competition in the gas marketing and power marketing businesses is intense and is expected to remain so due to the large number of industry participants, although there is a trend toward consolidation in the gas marketing industry. By acquiring an interest in an electric power plant, acquiring the rights to develop another power plant, and forming a new energy marketing joint venture, Sonat Energy Services continued to expand the scope of its businesses in 1998. In addition, total volumes increased at both Sonat Marketing and Power Marketing. Power marketing margins improved substantially as increasingly open markets and a volatile summer environment created good opportunities. Margins in the natural gas marketing business remained low, however, as declining prices and increased storage inventories created a difficult environment. In addition, Sonat Marketing took charges in order to reconcile gas imbalance and other accounts with various pipelines, storage facilities, and customers. At Sonat Energy Services earnings before interest and taxes declined from $7 million in 1997 to a loss of $7 million in 1998. Both Sonat Marketing and Power Marketing expect margins to remain under intense pressure in 1999. I-22 26 SONAT ENERGY SERVICES AREAS OF OPERATIONS (AREA OF OPERATIONS) I-23 27 GOVERNMENTAL REGULATION EXPLORATION AND PRODUCTION The federal government and the states in which Exploration has oil and gas production and owns interests in producing properties regulate various matters affecting Exploration's oil and gas production, including the drilling and spacing of wells, conservation, forced pooling, and protection of correlative rights among interest owners. The operations of Exploration under federal oil and gas leases are subject to certain statutes and regulations of the U.S. Department of the Interior that currently impose liability upon lessees for the cost of clean-up of pollution resulting from their operations. Royalty obligations on all federal leases are regulated by the MMS, which has promulgated valuation guidelines for the payment of royalty by producers. To the extent the MMS finally determines valuation based on a method other than actual sales proceeds received, producers could be required to pay royalties at a rate higher than actual sales proceeds. Other federal, state, and local laws and regulations relating to the protection of the environment may affect Exploration's oil and gas operations, both directly and indirectly, through their effect on the construction and operation of facilities, drilling operations, production, or the delay or prevention of future offshore lease sales. Sonat maintains substantial insurance on behalf of Exploration for oil pollution liability. Exploration is also subject to various governmental safety regulations in the jurisdictions in which it operates. NATURAL GAS TRANSMISSION Southern, its interstate transmission subsidiaries, and Florida Gas are subject to regulation by the FERC under the NGA and the NGPA. The NGA grants to the FERC authority to regulate the construction and operation of pipeline and related facilities utilized in the transportation and sale of natural gas in interstate commerce, including the extension, enlargement, or abandonment of such facilities. Southern, its interstate transmission subsidiaries, and Florida Gas hold required certificates of public convenience and necessity issued by the FERC authorizing them to construct and operate all pipelines, facilities, and properties now in operation for which certificates are required, and to transport and sell natural gas in interstate commerce. The FERC regulates rates for the transportation of natural gas in interstate commerce. The maximum transportation rates for gas delivered by SIA into interstate commerce are also regulated by the FERC. As necessary, Southern, its interstate transmission subsidiaries, Florida Gas, and SIA file with the FERC applications for changes in their transportation rates and charges designed to allow them to recover fully their costs of providing such service to their customers, including a reasonable rate of return on their investment in facilities. These rates are normally allowed to become effective, subject to refund, until such time as the FERC rules on the actual level of rates. See "Rate and Regulatory Proceedings" above. In July 1998 FERC issued a Notice of Proposed Rulemaking ("NOPR") in which it seeks comments on a wide range of initiatives to change the manner in which short-term (less than one year) transportation markets are regulated. Among other things, the NOPR proposes the following: (i) removing the price cap for the short-term capacity market; (ii) establishing procedures to make pipeline and shipper-owned capacity more comparable; (iii) auctioning all available short-term pipeline capacity on a daily basis with the pipeline unable to set a reserve price above variable costs; (iv) changing policies on pipeline penalties, nomination procedures, and services; (v) permitting the negotiation of terms and conditions of service; and (vi) potentially modifying the procedures for certificating new pipeline construction. Also in July 1998 FERC issued a Notice of Inquiry ("NOI") seeking comments on FERC's policy for pricing long-term capacity. Comments on the NOPR and NOI are due in April 1999. It is unclear when and what action, if any, FERC will take in connection with the NOPR and NOI and the comments received in response to them, but the resulting regulatory changes could have a significant impact on the businesses of Southern and its natural gas transmission subsidiaries and Florida Gas. I-24 28 Southern, its natural gas transmission subsidiaries, Florida Gas, and SIA are subject to the Natural Gas Pipeline Safety Act of 1968, as amended, which regulates pipeline and LNG plant safety requirements, and to the National Environmental Policy Act and other environmental legislation. Each of them has a continuing program of inspection designed to keep all of their facilities in compliance with pollution control and pipeline safety requirements and believe that they are in substantial compliance with applicable requirements. Southern's capital expenditures to comply with environmental and pipeline safety regulations were approximately $23 million in 1998 and $23 million in 1997. Southern anticipates that such expenditures will be approximately $4 million in 1999. ENERGY SERVICES Gas sold by Sonat Marketing and other natural gas marketing companies is not regulated by the FERC. Power Marketing, Mid-Georgia Cogen, and West Georgia are subject to the regulatory jurisdiction of the FERC under the Federal Power Act with respect to rates, terms, and conditions of service, and certain reporting requirements, including sales in the wholesale power market. Each of those companies sells or will sell wholesale power under its market-based rate schedule, which has been approved by and is on file with the FERC. ENVIRONMENTAL MATTERS Various environmental matters relating to, or that could affect, Sonat or one or more of its subsidiaries are described in Part II of this report in Management's Discussion and Analysis of Financial Condition and Results of Operations under the caption "Environmental Issues," which is incorporated herein by reference. YEAR 2000 PROJECT The year 2000 issues as they relate to Sonat are discussed in Part II of this report in Management's Discussion and Analysis of Financial Condition and Results of Operations under the caption "Year 2000 Project," which is incorporated herein by reference. CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS This report, including the information incorporated by reference herein, contains forward-looking statements regarding the Company's business plans and prospects, objectives, future drilling plans, expansion projects, proposed capital expenditures, and expected performance or results. These forward-looking statements are based on assumptions that the Company believes are reasonable, but are subject to a wide range of risks and uncertainties and, as a result, actual results may differ materially from those expressed in such forward-looking statements. Such statements are made in reliance on the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Important factors that could cause actual results to differ include changes in oil and gas prices and underlying demand, which would affect profitability and might cause the Company to alter its plans; the timing and success of the Company's exploration and development drilling programs, which would affect production levels and reserves; the results of the Company's hedging activities; risks incident to the drilling and operation of oil and gas wells; future drilling, production and development costs, including drilling rig rates; the success of the Company's internal cost reduction activities; and the requirements to receive various governmental approvals to proceed with pipeline, storage, and power generation projects, and unanticipated construction delays in connection with such projects. Realization of the Company's objectives and expected performance can also be adversely affected by the actions of customers and competitors, changes in governmental regulation of the Company's businesses, and changes in general economic conditions and the state of domestic capital markets. I-25 29 ITEM 2. PROPERTIES A description of Sonat's and its subsidiaries' principal properties is included under Item 1. Business above and is hereby incorporated by reference herein. ITEM 3. LEGAL PROCEEDINGS For information regarding various environmental matters relating to, or that could affect, Sonat or one or more of its subsidiaries, see Management's Discussion and Analysis of Financial Condition and Results of Operations in Part II of this report under the caption "Environmental Issues." Aline Moye v. Exxon Corporation, et al., CV No. 98-20, is a class action lawsuit filed in state court in Monroe County, Alabama in January 1998 on behalf of royalty owners in the Big Escambia Creek Gas Field ("Field") in Alabama, against Exxon Corporation, a gas producer in the Field, Southern, which purchased or transported gas from the Field, and five other named defendants, alleging that the methods used by the defendants to measure the heating content and volume of natural gas produced from the Field have caused the producer(s) of this gas to underpay royalties owed to the royalty owners. The complaint seeks recovery of actual damages based upon the allegedly unpaid royalties as well as punitive damages, the amount of which are not specified in the complaint. Although it cannot predict the outcome, Southern believes that the methods of measurement were appropriate and intends to defend the suit vigorously. United States of America ex rel. Jack J. Grynberg v. Southern Natural Gas Company, et al., U.S. District Court, E.D. La., CV No. 97-2087. Southern received a letter from the United States Department of Justice on August 31, 1998, enclosing a copy of a complaint that was filed, but not served, by Jack J. Grynberg in 1997 against Southern, its wholly owned subsidiary, Sea Robin, and a number of affiliated companies in the United States District Court for the Eastern District of Louisiana. Grynberg filed the suit on behalf of the United States Government under 31 U.S.C. sec.3729, et seq., commonly known as the False Claims Act, alleging that the methods used by the defendants to measure the heating content and volume of gas purchased or transported by them have caused producers of natural gas to underpay royalties owed by the producers to the United States. The complaint also alleges that the defendants deprived the United States of appropriate royalties by selling gas to affiliated companies at artificially low prices, which were the basis for payment of royalties to the United States, and that the affiliates resold the gas to third parties at higher prices. The complaint seeks recovery of actual damages based upon the unpaid royalties owed, the amount of which is not specified in the complaint. Such damages may be trebled under the False Claims Act. The Complaint is similar to 76 other complaints that Grynberg has filed in various federal district courts against virtually every firm that has purchased gas from federal leases in the past ten years. The complaint makes allegations similar to those in a 1995 complaint that Grynberg filed under the False Claims Act against Southern, Sea Robin, and 68 other defendants in the United States District Court for the District of Columbia, which was dismissed on procedural grounds. The Justice Department has requested Southern and the defendants in the other 76 cases to address the allegations in the complaints in order for the Justice Department to determine whether to intervene and take over the cases as provided by the False Claims Act, which Southern and the other defendants have done. Southern believes that its and Sea Robin's measurement practices conformed to Department of Interior regulations, industry standards, and the terms of the applicable tariffs, which are filed with the FERC. Southern also believes that the prices its affiliates paid were equal to the prices paid in comparable arms-length transactions and are in compliance with applicable Department of Interior regulations. As a result, Southern believes that it and its affiliates have meritorious defenses to the complaint and intends to defend the suit vigorously whenever it is served and the suit goes forward. Southern Natural Gas Company v. O. D. Chafin, et al., Circuit Court of Cullman County, CV No. 96-217. Southern initiated a proceeding in 1996 to obtain a right-of-entry to the subject property in order to perform pipeline surveys. In September 1997, Chafin, et al., filed a class-action counterclaim against Southern that seeks (i) to keep any condemnation action in state court (Southern had filed condemnation actions in federal court), (ii) to enjoin construction of the North Alabama pipeline project, and (iii) unspecified compensatory and punitive damages. Chafin, et al. also filed a motion for conditional class certification, which I-26 30 the Court granted ex parte. In October 1997, Southern filed to dismiss the counterclaim and to reconsider the class certification. The court did not rule on Southern's motion, but placed the case on its administrative (inactive) docket, where it remains. Southern believes that it is procedurally incorrect for a counterclaim to be filed to a right-of-entry action and that Southern has meritorious defenses to the counterclaim and class certification. Since the filing of the motion for conditional class certification, the Alabama Supreme Court has decided several cases that would prevent the type of ex parte action taken by the Cullman County Circuit Court. Sonat and its subsidiaries are involved in a number of other lawsuits, all of which have arisen in the ordinary course of business. Sonat does not believe that any ultimate liability resulting from any of these other pending lawsuits will have a material adverse effect on it. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Sonat did not submit any matter to a vote of its security holders during the fourth quarter of 1998. EXECUTIVE OFFICERS OF THE REGISTRANT
OFFICER OFFICE AGE - ------- ------ --- Ronald L. Kuehn, Jr........................ Chairman of the Board, President, and Chief Executive Officer........................ 63 James A. Rubright.......................... Executive Vice President................... 52 William A. Smith........................... Executive Vice President and General Counsel.................................. 54 Richard B. Bates........................... Senior Vice President...................... 45 John B. Holmes, Jr......................... Senior Vice President...................... 51 James E. Moylan, Jr........................ Senior Vice President and Chief Financial Officer.................................. 48 Thomas W. Barker, Jr....................... Vice President-Finance..................... 54 Beverley T. Krannich....................... Vice President-Human Resources and Secretary................................ 48 John M. Musgrave........................... Vice President-Planning and Treasurer...... 48
There is no family relationship between any of the above-named executive officers. The officers of Sonat are elected annually by the Board of Directors. The identification of an individual as an executive officer in this report does not constitute a determination by Sonat or its Board of Directors that such individual is an officer of Sonat for purposes of Section 16 of the Securities Exchange Act of 1934. Ronald L. Kuehn, Jr. was elected Chairman of the Board of Sonat effective March 28, 1986. Mr. Kuehn has served as Director of Sonat since April 30, 1981, as President of Sonat since January 1, 1982, and as Chief Executive Officer of Sonat since June 1, 1984, and currently serves in those capacities. Mr. Kuehn also serves as Director of various Sonat subsidiaries. James A. Rubright was elected Executive Vice President of Sonat effective May 1, 1998, and currently serves in that capacity. Mr. Rubright has executive oversight responsibility for Sonat's natural gas transmission businesses and Sonat Energy Services. During the past five years Mr. Rubright has served as an officer of Southern, Sonat Exploration, and Sonat Energy Services. William A. Smith was elected Executive Vice President of Sonat effective March 1, 1991, and General Counsel effective July 1, 1997, and currently serves in those capacities. Mr. Smith also serves as Executive Vice President and General Counsel of Exploration and Sonat Energy Services. Richard B. Bates was elected Senior Vice President of Sonat effective May 1, 1995, and currently serves in that capacity. Mr. Bates has served as President of Sonat Energy Services and Sonat Marketing since January 1, 1994, Power Marketing and Sonat Power since June 1, 1996, and Sonat Power Systems since September 23, 1997. I-27 31 John B. Holmes, Jr. was elected Senior Vice President of Sonat effective May 1, 1998, and currently serves in that capacity. Mr. Holmes also serves as President of Exploration. Prior to his election as Senior Vice President, Mr. Holmes was President of Zilkha. James E. Moylan, Jr. was elected Chief Financial Officer of Sonat effective July 1, 1997, and Senior Vice President of Sonat effective May 1, 1995, and currently serves in those capacities. Mr. Moylan has served as Senior Vice President and Chief Financial Officer of Exploration and Executive Vice President and Chief Financial Officer of Sonat Energy Services since January 1, 1999. Thomas W. Barker, Jr. was elected Vice President-Finance of Sonat effective June 15, 1984, and currently serves in that capacity. Mr. Barker also serves as Vice President-Finance of Exploration and Southern. Beverley T. Krannich was elected Vice President-Human Resources of Sonat effective June 1, 1987, and Secretary of Sonat effective May 11, 1984, and currently serves in those capacities. Ms. Krannich also serves as Vice President-Human Resources of Exploration and Southern. John M. Musgrave was elected Vice President-Planning of Sonat effective May 1, 1998, and Treasurer of Sonat effective July 1, 1997, and currently serves in those capacities. Mr. Musgrave also serves as Treasurer of Southern and Sonat Energy Services and Assistant Treasurer of Exploration. During the past five years Mr. Musgrave has served as an officer of Sonat, Exploration, Southern, and Sonat Energy Services. I-28 32 PART II
ITEM PAGE ---- ----- Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters....................................... II-33 Item 6. Selected Financial Data..................................... II-44 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................. II-2 Item 7A. Quantitative and Qualitative Disclosures About Market Risk...................................................... II-10 Item 8. Financial Statements and Supplementary Data................. II-16 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................. II-45
--------------------- The financial data following on pages II-2 through II-44 is reproduced from, and the Table of Contents below is taken from, the Sonat Inc. Annual Report to Stockholders for 1998. An index to the financial statements and financial statement schedules may be found under Item 14. "EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K" in Part IV of this report. --------------------- FINANCIAL INFORMATION CONTENTS
PAGE ----- Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 23 Report of Management........................................ 36 Report of Ernst & Young LLP, Independent Auditors........... 37 Consolidated Financial Statements Consolidated Balance Sheets............................ 38 Consolidated Statements of Operations.................. 40 Consolidated Statements of Changes in Stockholders' Equity................................................ 41 Consolidated Statements of Cash Flows.................. 42 Notes to Consolidated Financial Statements.................. 43 Selected Consolidated Financial Data........................ 65
II-1 33 Management's Discussion and Analysis of Financial Condition and Results of Operations Sonat Inc. and Subsidiaries PROPOSED MERGER WITH EL PASO ENERGY CORPORATION On March 13, 1999, Sonat and El Paso Energy Corporation ("El Paso") entered into an Agreement and Plan of Merger (the "Merger Agreement"), providing for, among other things, the merger of El Paso and the Company. Under the terms of the Merger Agreement, the Company's shareholders will receive one share of El Paso common stock, par value $3.00 per share ("El Paso Common Stock"), for each share of common stock, par value $1.00 per share, of the Company ("Company Common Stock"), they own. The merger is subject to certain customary conditions, including, among others, approval by the stockholders of the Company and receipt of certain required government approvals. In the event El Paso stockholder approval for the issuance of El Paso Common Stock in the merger is not obtained, El Paso has agreed to issue an amount of El Paso Common Stock not to exceed, in the aggregate, 19.9 percent of the outstanding El Paso Common Stock, with the balance of the merger consideration to be paid in the form of non-convertible long-term preferred stock (the "Preferred Stock"). The Preferred Stock will bear a dividend rate designed to cause the stock to have a value equal to the greater of $32 and the value of the El Paso Common Stock as of the time of the Company's shareholder vote, subject to a cap of $44.50. The Preferred Stock will be redeemable in 21 years and will not be convertible. In connection with the Merger Agreement, on March 13, 1999, the Company and El Paso also entered into cross option agreements, pursuant to which, among other things, (i) El Paso has been granted an option to purchase up to 19.9 percent of the Company Common Stock, exercisable if the Merger Agreement is terminated under certain circumstances as set forth therein and (ii) the Company has been granted an option to purchase up to 19.9 percent of the El Paso Common Stock, exercisable if the Merger Agreement is terminated under certain circumstances as set forth therein. RESULTS OF OPERATIONS Earnings Before Interest and Taxes Business segment operating results for Sonat Inc. and its subsidiaries (the Company) are presented in the table below. The table also shows significant unusual items in 1998 and 1997 that affect earnings before interest and taxes (EBIT) and net income comparisons. Each significant unusual item is discussed in the respective segment discussions in the following pages. The table is presented because management believes this information enhances the analysis of results of operations.
(In Millions) -------------------------------------- Years Ended December 31, 1998 1997 1996 - --------------------------------------------------------------------------- Earnings (Loss) Before Interest and Taxes: Exploration and Production $ (936.2) $ 181.0 $ 252.8 Natural Gas Transmission 233.3 225.9 204.8 Energy Services (6.8) 7.1 5.8 Other 7.7 6.9 4.5 - --------------------------------------------------------------------------- (702.0) 420.9 467.9 - --------------------------------------------------------------------------- Unusual Items (Expense) Income Included Above: Exploration and Production Ceiling test charges (1,035.2) -- -- Restructuring costs (15.0) -- -- Merger expenses -- (50.4) -- - --------------------------------------------------------------------------- (1,050.2) (50.4) -- Earnings Before Interest and Taxes, Excluding Unusual Items $ 348.2 $ 471.3 $ 467.9 ===========================================================================
(In Millions, Except Per-Share Amounts) -------------------------------------- Years Ended December 31, 1998 1997 1996 - --------------------------------------------------------------------------- Net Income (Loss) As Reported $(530.5) $218.0 $255.8 - --------------------------------------------------------------------------- Unusual Items (Expense) Income Included Above: Exploration and Production Ceiling test charges (672.9) -- -- Restructuring costs (9.7) -- -- Merger expenses -- (32.7) -- - --------------------------------------------------------------------------- (682.6) (32.7) -- - --------------------------------------------------------------------------- Net Income Excluding Unusual Items $ 152.1 $250.7 $255.8 =========================================================================== Earnings (Loss) Per Share of Common Stock $ (4.82) $ 1.98 $ 2.32 =========================================================================== Earnings (Loss) Per Share of Common Stock - Assuming Dilution $ (4.82) $ 1.95 $ 2.29 =========================================================================== Earnings Per Share of Common Stock Excluding Unusual Items $ 1.38 $ 2.28 $ 2.32 =========================================================================== Earnings Per Share of Common Stock Excluding Unusual Items - Assuming Dilution $ 1.38 $ 2.24 $ 2.29 ===========================================================================
23 II-2 34 Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) EXPLORATION AND PRODUCTION The Company is engaged in the exploration for and the acquisition, development and production of oil and natural gas in the United States through Sonat Exploration Company and Sonat Exploration GOM (Sonat Exploration). Most of Sonat Exploration's natural gas production is sold to Sonat Marketing Company L.P. (Sonat Marketing), the Company's majority-owned affiliate operating in the Energy Services segment. In January 1998, the Company completed its merger with Zilkha Energy Company (see Note 3 of the Notes to Consolidated Financial Statements) and in September 1998, the Company changed its method of accounting for oil and gas operations from successful efforts to full cost (see Note 2 of the Notes to Consolidated Financial Statements). The financial statements and other information for all periods presented have been restated to reflect the results of the merger with Zilkha Energy Company, accounted for on a pooling-of-interests basis, and the change in accounting. Following the merger with Zilkha Energy, the Company undertook a comprehensive review of its exploration and production business to improve its overall financial performance. As a consequence, a major restructuring program was announced in April 1998. Program steps, which have been completed, included the sale of certain oil and gas properties, consolidation of certain business units and a substantial work force reduction. In 1998, oil and gas properties sold, including the Company's Austin Chalk properties, had proved reserves of approximately 430 billion cubic feet of natural gas equivalent (Bcfe) and daily net production of approximately 170 million cubic feet (MMcf) of natural gas equivalent. Business units were consolidated from seven to three. This action, together with related staff reductions, reduced Sonat Exploration's work force by approximately 220 people, or one-fourth. In addition, the Company reviewed all of its oil and natural gas reserves in 1998. Proved reserves were revised downward by a net 426 Bcfe from year-end 1997 proved reserves. During 1998, 40 onshore and offshore exploratory wells were completed, 19 of which were successful. Sonat Exploration had very good drilling results in the Gulf of Mexico during the fourth quarter, as it was successful on all four of the exploratory wells drilled. In response to significantly lower day rates for offshore drilling rigs, Sonat Exploration has increased its Gulf of Mexico activity substantially to a five- to six-rig program, from the one- to two-rig program that was maintained for most of 1998. Proved reserves at December 31,1998, were 1.6 trillion cubic feet of natural gas equivalent. Exploration and Production
(In Millions) ----------------------------------------- Years Ended December 31, 1998 1997 1996 - -------------------------------------------------------------------------------- Revenues $ 535.2 $755.1 $730.3 - -------------------------------------------------------------------------------- Costs and Expenses: Operating and maintenance 72.7 82.6 77.3 General and administrative 35.0 107.7 39.9 Depreciation, depletion and amortization 291.6 341.3 332.1 Ceiling test charges 1,035.2 -- -- Restructuring costs 15.0 -- -- Taxes and other 24.6 45.7 28.3 - -------------------------------------------------------------------------------- 1,474.1 577.3 477.6 - -------------------------------------------------------------------------------- Operating Income (Loss) (938.9) 177.8 252.7 Other Income 2.7 3.2 .1 - -------------------------------------------------------------------------------- Earnings (Loss) Before Interest and Taxes as Reported (936.2) 181.0 252.8 Unusual Items 1,050.2 50.4 -- - -------------------------------------------------------------------------------- Earnings Before Interest and Taxes Excluding Unusual Items $ 114.0 $231.4 $252.8 ================================================================================ Proved Reserves (Bcfe) 1,601 2,598 2,402 Net Sales Volumes: Gas (Bcf) 226 266 268 Oil and condensate (MBbls) 6,560 6,760 6,817 Natural gas liquids (MBbls) 1,767 1,805 2,161 ================================================================================ Average Sales Prices: Gas ($/Mcf) $ 1.95 $ 2.26 $ 2.19 Oil and condensate ($/Bbl) 13.14 19.57 18.48 Natural gas liquids ($/Bbl) 8.83 11.90 12.03 ================================================================================
1998 VERSUS 1997. EBIT decreased $117.4 million after excluding the recognition of ceiling test charges of $1,035.2 million in 1998 (see Notes 2 and 16 of the Notes to Consolidated Financial Statements), $15.0 million of restructuring costs in 1998 and $50.4 million of expenses in 1997 associated with Sonat's merger with Zilkha Energy Company (see Note 3 of the Notes to Consolidated Financial Statements). The decrease in EBIT was primarily due to lower energy prices and production volumes, partly offset by lower costs and expenses. Natural gas production decreased to 226 billion cubic feet (Bcf) from 266 Bcf in 1997. Average realized natural gas prices decreased 14 percent to $1.95 per thousand cubic feet (Mcf) in 1998 from $2.26 per Mcf in 1997. Realized oil and condensate prices decreased 33 percent to an average of $13.14 per barrel from $19.57 per barrel in 1997. 24 II-3 35 Costs and expenses were $103.0 million lower after excluding the unusual items in 1998 and 1997. General and administrative expense decreased 48 percent primarily as a result of executive compensation expense for Sonat Exploration GOM, which was included in the 1997 period. Depreciation, depletion and amortization expense decreased 15 percent due to property sales and lower volumes. Taxes and other expenses, after excluding merger-related expenses in 1997, decreased 30 percent due to a contract termination fee incurred by Sonat Exploration GOM in 1997 and lower production related severance taxes. 1997 VERSUS 1996. EBIT decreased $21.4 million, after excluding expenses of $50.4 million in 1997 associated with Sonat's merger with Zilkha Energy Company. The decrease in EBIT was attributable to higher operating expenses partially offset by increased revenues resulting from higher gas and oil and condensate prices. Natural gas prices increased 3 percent to $2.26 per Mcf and oil and condensate prices increased 6 percent to $19.57 per barrel on average for the year. Costs and expenses increased 21 percent in 1997 as compared to the 1996 period. Operating and maintenance expense increased $5.3 million as a result of a higher level of drilling activity. General and administrative expense increased primarily due to higher executive compensation and severance bonuses of $54.3 million at Zilkha Energy. Taxes and other expenses include $10.5 million of merger expenses and a contract termination fee in 1997. The increase in Other Income resulted from a gain on the sale of marketable securities. HEDGING ACTIVITIES. Sonat Exploration, through Sonat Marketing, uses derivative financial instruments to manage the risks associated with price volatility for its production, which it sells in the spot market. (See Market Risk and Notes 1 and 4 of the Notes to Consolidated Financial Statements.) Gains or losses experienced on Sonat Exploration's hedging transactions offset the changes in revenue recognized on the sale of the commodity. Natural gas revenues were reduced by $4.3 million, $49.3 million and $47.7 million in the 1998, 1997 and 1996 periods, respectively, as a result of hedging activities. There were no oil hedging activities reflected in the 1998 period. Hedging activities decreased oil revenues by $.5 million and $19.2 million in 1997 and 1996, respectively. A portion of Sonat Exploration's future gas production is hedged through the year 2012 as follows:
Volumes Weighted Average Price (Bcf) (per Mcf) - ---------------------------------------------------------------------- 1999 52.2 $2.01 2000 34.9 $2.05 2001 4.2 $2.31 2002-2012 43.7 $3.31 - ---------------------------------------------------------------------- 135.0 $2.45 ======================================================================
NATURAL GAS TRANSMISSION The Company is engaged in the natural gas transmission business through Southern Natural Gas Company and its subsidiaries (Southern) and Citrus Corp. (a 50 percent-owned company). Southern and Citrus Corp. (Citrus) are actively pursuing opportunities to expand their pipeline systems in their traditional market areas and to connect new gas supplies. In April 1997, units of Shell Oil Company and BP Amoco Corporation joined with Southern Natural Gas in the ownership of Destin Pipeline Company L.L.C. (Destin), a 1 billion-cubic-feet-per-day pipeline designed to transport natural gas from deep-water areas in the eastern Gulf of Mexico. Southern Natural Gas has a one-third interest in this pipeline. Shell, BP Amoco and other shippers have made substantial firm transportation commitments to Destin. Construction of the pipeline began in December 1997. The pipeline was partially completed and in service in September 1998 and was fully in service in March 1999. In June 1998, the Federal Energy Regulatory Commission (FERC) approved Destin's application to extend its pipeline system approximately 12 miles to transport additional gas reserves committed by other producers to Destin's system. This extension was partially completed and in service in December 1998 and was placed fully in service in January 1999. In July 1998 the FERC also approved another Destin application to extend its pipeline by approximately 31 miles to transport additional gas reserves committed by other producers to Destin's system. This extension is expected to be in service in the second quarter of 1999. The total capital to be expended by Destin is now estimated to be $467 million. Southern Natural Gas placed in service two expansions to its pipeline system during 1998 and expects to place a 122-mile, 78 million-cubic-foot-per-day expansion to North Alabama in service this year. The two expansions placed in service during 1998 include firm transportation commitments totaling 65 million cubic feet of natural gas per day from customers in eastern 25 II-4 36 Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Tennessee, Georgia and Alabama and 34 million cubic feet per day from Alabama Power Company and two other customers. In December 1998, Florida Gas Transmission Company (Florida Gas) filed with the FERC for approval of a Phase IV expansion that will increase system firm capacity by 272 MMcf per day, or 19 percent. More than 90 percent of this new capacity is for Florida's growing electric generation requirements. This $351 million expansion includes 205 miles of pipeline that will extend the Florida Gas system to the Fort Myers area. Subject to regulatory approval, Phase IV is scheduled to be placed into service in mid-2001. Southern Natural Gas Company and Subsidiaries
(In Millions) ---------------------------------- Years Ended December 31, 1998 1997 1996 - -------------------------------------------------------------------------- Revenues: Market transportation and storage $326.0 $313.2 $323.2 Supply transportation 43.3 48.5 46.6 Other 24.9 31.6 29.0 - -------------------------------------------------------------------------- Total Revenues 394.2 393.3 398.8 - -------------------------------------------------------------------------- Costs and Expenses: Operating and maintenance 84.4 75.4 74.9 General and administrative 57.0 71.3 91.6 Depreciation and amortization 46.3 47.8 48.3 Taxes, other than income 21.3 19.9 18.1 - -------------------------------------------------------------------------- 209.0 214.4 232.9 - -------------------------------------------------------------------------- Operating Income 185.2 178.9 165.9 Other Income: Equity in earnings of unconsolidated affiliates 19.7 11.8 9.6 Other 5.1 7.1 6.7 - -------------------------------------------------------------------------- 24.8 18.9 16.3 - -------------------------------------------------------------------------- Earnings Before Interest and Taxes $210.0 $197.8 $182.2 ========================================================================== (Billion Cubic Feet) - -------------------------------------------------------------------------- Volumes: Market transportation 612 611 630 Supply transportation 372 396 315 Intrastate (1) - - 38 - -------------------------------------------------------------------------- Total Volumes 984 1,007 983 ========================================================================== Transition gas sales 12 65 69 ==========================================================================
(1)Southern's investment in Sonat Intrastate-Alabama Inc., a small intrastate pipeline subsidiary, was transferred to Sonat Inc. on January 1, 1997. Citrus Corp.
(In Millions) --------------------------------- Years Ended December 31, 1998 1997 1996 - -------------------------------------------------------------------------- Allocated Expenses Included in EBIT $ 1.1 $ 0.5 $ 0.3 ========================================================================== Equity in Earnings of Citrus Corp. $24.4 $28.7 $22.9 ========================================================================== (Billion Cubic Feet) - -------------------------------------------------------------------------- Florida Gas Volumes (100%): Market transportation 424 443 428 Supply transportation 41 28 29 - -------------------------------------------------------------------------- Total Volumes 465 471 457 ==========================================================================
1998 VERSUS 1997. Southern - EBIT was $210.0 million in 1998 compared with $197.8 million in 1997. EBIT improved primarily due to lower general and administrative expenses and higher equity in earnings of unconsolidated affiliates. System expansions also increased operating results, partly offset by declining results at Sea Robin Pipeline Company (Sea Robin) as a result of lower interruptible throughput. The market transportation and storage revenue increase was due to higher firm transportation revenues associated with expansion projects completed in 1998. Supply transportation revenues decreased primarily due to lower interruptible throughput on the Sea Robin system. Operating and maintenance expense increased primarily due to the difference in proceeds recognized on the disposition of assets between 1997 and 1998, offset by favorable fuel expenses in 1998. Both 1998 and 1997 periods include positive effects related to the sale of assets. General and administrative expenses decreased primarily due to lower stock-based compensation, employee benefit, insurance and professional services expenses. Equity in earnings of unconsolidated affiliates increased primarily due to the inclusion of Southern's share of earnings in Destin, slightly offset by lower earnings from Bear Creek Storage Company. Destin's earnings increase was the result of higher allowance for funds used during construction (AFUDC) capitalized in 1998 as compared with 1997 levels. The Company expects Destin's 1999 earnings will be lower than 1998 as operating revenues are adversely affected by currently anticipated delays in the development of the substantial offshore discoveries of Shell and BP Amoco that are dedicated to the Destin system. Other, net decreased in 1998 compared with 1997 primarily due 26 II-5 37 to a non-recurring gain in 1997 on the termination of Southern's interest rate forward agreement of $2.4 million. This decrease was slightly offset by higher AFUDC. Citrus - Equity in earnings of Citrus declined by $4.3 million to $24.4 million in 1998. This decline is due primarily to a gain recognized in 1997 on the restructuring of the marketing arrangement for Citrus Trading Company between Sonat and Enron Corp. and a favorable adjustment to estimated state income taxes in 1997. Partially offsetting these items were the recognition of supply credits on a gas supply agreement in 1998, lower net interest expense and lower operating expenses. 1997 VERSUS 1996. Southern - EBIT for Southern was $197.8 million in 1997 compared with $182.2 million in 1996. EBIT improved primarily due to lower general and administrative expenses. Also favorably impacting EBIT were expansions and improved results at Sea Robin. Partly offsetting was warmer winter weather during 1997 which negatively affected operating results. Market transportation revenues decreased primarily due to lower volumes resulting from warmer weather and the transfer of Southern's ownership of a small intrastate pipeline to Sonat, which was immaterial to operating results, partially offset by increased revenues from expansions. Supply transportation revenues increased due to higher volumes. Operating and maintenance expense increased slightly primarily due to higher fuel expense. Operating and maintenance expense in both periods included positive effects related to the disposition of assets. General and administrative expenses decreased primarily due to lower stock-based compensation and employee benefit expenses in 1997 and a $9.0 million donation to the Sonat Foundation in 1996. Equity in earnings of unconsolidated affiliates increased primarily due to the inclusion of Southern's share of earnings in the Destin Pipeline joint venture and slightly higher earnings from Bear Creek Storage Company. Other, net increased in 1997 compared with 1996 primarily due to higher levels of AFUDC at Southern recognized during construction of its expansions, offset slightly by lower gains recognized on the termination of an interest rate forward agreement associated with an anticipated financing that did not occur. Citrus - Equity in earnings of Citrus increased $5.8 million over 1996 to $28.7 million. 1997 results reflect a gain recognized on the restructuring of the marketing arrangement for Citrus Trading Company between Sonat and Enron Corp. and a favorable adjustment to estimated state income taxes. The effect of higher revenues at Florida Gas from higher rates in conjunction with its rate filing that was effective in March 1997 and higher interruptible transportation volumes was offset by a gain on sale of assets recognized in 1996, lower trading margins at Citrus Trading and higher operating expenses. NATURAL GAS SALES AND SUPPLY Sales by Southern of natural gas are anticipated to continue only until Southern's remaining supply contracts expire, are terminated or are assigned. As a result of its restructuring pursuant to FERC directives in past years, Southern terminated or renegotiated to market pricing substantially all of its gas supply contracts through which it had historically obtained its long-term gas supply. Pending the termination or expiration of the few remaining supply contracts, Southern's remaining gas supply is being sold on a month-to-month basis. Because Southern is primarily a gas transporter and does not realize significant margins on gas sales, the net of gas sales revenues and natural gas cost is included in other revenue. Except for the sale of its remaining gas supply described above, Southern's participation in gas supply activities will be limited to the purchase and sale of gas from time to time as may be required for system management purposes. Southern's annual purchase commitments total less than $21 million per year for 1999 and subsequent years. Based on Southern's current expectations with respect to natural gas prices in 1999 and the years following, an immaterial volume of gas is expected to be at prices above market. RATE MATTERS Under terms of a settlement approved by the FERC, all of Southern Natural Gas' previously pending rate proceedings and proceedings to recover gas supply realignment and other transition costs associated with the implementation of FERC Order No. 636 were resolved. The settlement requires Southern Natural Gas to file a new rate case no later than September 1, 1999. Southern expects the rates filed in that rate case to become effective after normal suspension by the FERC on March 1, 2000, subject to refund upon conclusion of the rate case. 27 II-6 38 Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) In September 1997, the FERC approved a rate case settlement between Florida Gas and its customers. The terms of the settlement provide for tiered rates effective beginning March 1, 1997, which, for a two-year period, reflect an increase over the rates in effect prior to the rate filing for transportation through both the pre-expansion and Phase III expansion systems. The settlement resolved all issues related to Phase III construction and the construction cost audit. The settlement terms require Florida Gas to file a new rate case no later than October 1, 2001. ENERGY SERVICES Sonat Energy Services, through its majority-owned subsidiaries, Sonat Marketing and Sonat Power Marketing L.P. (Sonat Power Marketing), conducts marketing activities in the natural gas and electric industries, respectively. Sonat Marketing purchases and resells substantially all of Sonat Exploration's natural gas production, as well as purchasing and reselling gas for other customers. Sonat Power Marketing has executed electric power purchase, sales and transmission agreements with numerous companies and is focused on expanding its wholesale electric marketing business. Both of these subsidiaries use derivative instruments. (See Market Risk and Note 4 of the Notes to Consolidated Financial Statements.) In 1998 a subsidiary of Sonat Energy Services acquired a 50 percent interest in a natural gas-fired power plant in Georgia (the Mid-Georgia Cogen plant) for an equity investment of approximately $28 million. The power plant began operations in June 1998. In September 1998, a subsidiary of Sonat Energy Services acquired the rights to develop a 680-megawatt natural gas-fired peaking power plant in west central Georgia. This power plant, which will have a total capital cost of approximately $230 million, is scheduled to begin commercial operation in June 2000. The plant will provide energy to serve the growing Georgia and Southeast power markets during peak power demand periods. Sonat Energy Services is pursuing additional power plant opportunities. Sonat Intrastate-Alabama Inc. (SIA), a wholly owned subsidiary of Sonat Energy Services, owns an approximately 450-mile intrastate pipeline system extending from natural gas fields and coal seam gas production areas in the Black Warrior Basin in northwest and central Alabama to connections with customers in Alabama, as well as interconnections with three other pipelines, including Southern. SIA's throughput (including sales and transportation) for 1998 was 52 Bcf compared with 42Bcf in 1997. Sonat Power Systems Inc., a wholly owned subsidiary of Sonat, formed a strategic alliance in 1997 with AlliedSignal Power Systems Inc., an unaffiliated company, to market and support its onsite electric power systems in 13 Southern states from Texas to Virginia, and the District of Columbia. On December 28,1998, Sonat Power Systems executed an amendment to its existing development and distribution agreement with AlliedSignal granting Sonat Power Systems the option to become the exclusive distributor of the power generator group of products in Mexico. Energy Services
(In Millions) ---------------------------------------- Years Ended December 31, 1998 1997 1996 - ----------------------------------------------------------------------------- Revenues $3,192.4 $3,725.2 $2,592.7 ============================================================================== Operating Margin $ 35.4 $ 50.1 $ 36.2 ============================================================================== Operating Income (Loss) $ (13.8) $ 10.6 $ 10.2 ============================================================================== Earnings (Loss) Before Interest and Taxes $ (6.8) $ 7.1 $ 5.8 ============================================================================== (Billion Cubic Feet) ---------------------------------------- Sonat Marketing Gas Sales Volumes (100%) 1,225 1,288 968 ============================================================================== (Thousands of Megawatt Hours) ---------------------------------------- Sonat Power Marketing Sales Volumes (100%) 10,533 8,768 2,969 ============================================================================== (Billion Cubic Feet) ---------------------------------------- Financial Volumes Notional Settlements Third Parties - -- -- -- Natural Gas 3,939 1,560 -- ==============================================================================
1998 VERSUS 1997. EBIT decreased in the 1998 period compared to the 1997 period due to lower margins at Sonat Marketing and a $5.6 million revision of accounting estimate recognized to reconcile gas imbalance and other accounts with various natural gas pipelines, storage facilities and customers. Sonat Marketing's physical sales volumes were down slightly compared with 1997. However, notional volumes from natural gas derivative settlements increased 153 percent in 1998, reflecting an increase in Sonat Marketing's financial transactions on behalf of customers and an increase in market making of derivative products for its own account and to manage its basis positions. Sonat Power Marketing became profitable in 1998, as both sales volumes and margins increased over 1997 levels. Sonat Power Marketing's financial results also benefited from volatility 28 II-7 39 in electricity prices. Operating costs increased in 1998, as Sonat Energy Services continued to expand its scope of business. The 1998 period also includes the contribution from the 50 percent-owned Mid-Georgia Cogen plant. 1997 VERSUS 1996. EBIT increased $1.3 million to $7.1 million in 1997. The principal reason for the increase was the recognition of mark-to-market income from origination activities in the fourth quarter of 1997, which more than offset a decrease in unit margins. At the end of 1997, Sonat Marketing's gas sales volumes reached 4.2 Bcf per day, up from 3.3 Bcf per day at the end of 1996. Sonat Power Marketing also increased its sales volumes sharply, but was not profitable in the extremely competitive power marketing business. Operating costs increased due to business growth. OTHER STATEMENTS OF OPERATIONS ITEMS
(In Millions) --------------------------- Years Ended December 31, 1998 1997 1996 - ------------------------------------------------------------------- Interest Expense, Net $126.3 $97.2 $88.9 ===================================================================
1998 VERSUS 1997. Net interest expense increased in 1998 compared with 1997 due to higher average debt levels, slightly offset by the effect of lower average interest rates. Additional interest on taxes caused an increase in other interest expense. Interest capitalized decreased due to lower interest capitalized at Sonat Exploration. 1997 VERSUS 1996. Net interest expense increased in 1997 compared with 1996 due to higher average debt levels. The effect of lower interest rates on debt and average regulatory reserve balances slightly offset the effect of higher average debt levels.
(In Millions) ------------------------------ Years Ended December 31, 1998 1997 1996 - ------------------------------------------------------------------- Income Tax Expense (Benefit) $(297.7) $105.8 $123.2 ===================================================================
1998 VERSUS 1997. Income tax expense decreased in 1998 compared with 1997 due to lower pretax earnings primarily related to the ceiling test charges in 1998. Excluding these charges, the effective tax rate decreased slightly due to the effect of tax preference items on lower pretax earnings. 1997 VERSUS 1996. Income tax expense decreased in 1997 compared with 1996 due to lower pretax earnings. LIQUIDITY AND CAPITAL RESOURCES Cash Flows
(In Millions) ----------------------------- Years Ended December 31, 1998 1997 1996 - ------------------------------------------------------------------- Operating Activities $509.9 $633.6 $656.7 ===================================================================
1998 VERSUS 1997. Cash flows from operations decreased $123.7 million compared with the 1997 period primarily due to lower operating results at Sonat Exploration. Operating results for the Company's segments were discussed earlier. Depreciation, depletion and amortization and deferred income taxes include a charge of $1,035.2 million and a benefit of $362.3 million, respectively, for ceiling test charges related to Sonat Exploration's oil and gas properties in 1998. Absent the ceiling test charges, the change in deferred income taxes and accrued interest and income taxes primarily reflects the capitalization of intangible drilling costs for income tax purposes in the current period. The change in accounts receivable and accounts payable is primarily attributable to lower natural gas prices and volumes. The change in inventory primarily represents the purchase of natural gas inventory by Sonat Energy Services in 1997 as well as purchases of material for Sonat Exploration's Cotton Valley Pinnacle Reef trend drilling program in the 1997 period. The change in restricted cash, accrued long-term compensation and other current liabilities primarily represents the payment of certain expenses associated with the merger between the Company and Zilkha Energy in January 1998 (see Note 3 of the Notes to Consolidated Financial Statements). 1997 VERSUS 1996. Cash flows from operations decreased compared with the 1996 period due to the funding of a $116.0 million liability for transaction and other costs in connection with the merger with Zilkha Energy (see Note 3 of the Notes to Consolidated Financial Statements). Absent this item, cash flows from operations improved compared with the 1996 period due to improved cash flows at both Sonat Exploration and Southern. Partly offsetting the increase was a decrease in Energy Services' cash flows due to the impact of higher energy prices on working capital, including broker deposits. The 1996 period included $34.0 million in cash refunds paid to customers at Southern. Other than those refunds, the change in gas supply realignment costs and the change in reserves for regulatory matters were attributable to the recording of a customer settlement by Southern in the second quarter of 1996 (the Customer Settlement). Deferred income taxes and accrued income taxes reflect the impact of higher deductions for intangible drilling costs at Sonat Exploration in 1997 and the Customer 29 II-8 40 Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Settlement in 1996. The change in accounts receivable and accounts payable is primarily attributable to high receivable and payable balances in December 1996 reflecting higher natural gas prices. The change in inventory primarily reflects the purchase of material for Sonat Exploration's Cotton Valley Pinnacle Reef trend drilling program and the purchase of natural gas inventory under an asset management agreement at Sonat Marketing. The change in Other, net is primarily due to $41.2 million of accrual reversals related to the Customer Settlement and a decrease in interruptible transportation revenue credits of $13.5 million, both of which occurred in 1996.
(In Millions) ---------------------------------- Years Ended December 31, 1998 1997 1996 - ----------------------------------------------------------------------- Investing Activities $(646.9) $(1,019.6) $(621.0) =======================================================================
1998 VERSUS 1997. Net cash used in investing activities was $372.7 million lower in 1998 compared with 1997. The decrease was primarily attributable to proceeds from the sale of certain oil and gas properties. The sale of those properties also contributed to lower capital expenditures at Sonat Exploration in the current period. Higher investments in the Destin and the Mid-Georgia Cogen joint ventures partially offset these decreases. 1997 VERSUS 1996. Net cash used in investing activities was $398.6 million higher in 1997 compared with 1996, primarily due to higher capital expenditures (see table following) resulting from increased developmental drilling at Sonat Exploration. The increase in investments in unconsolidated affiliates primarily reflects Southern's investment of $39.1 million in Destin during 1997. Capital expenditures for the Company's business segments (excluding unconsolidated affiliates) were as follows:
(In Millions) -------------------------------- Years Ended December 31, 1998 1997 1996 - -------------------------------------------------------------------- Exploration and Production $581.1 $ 862.6 $620.1 Natural Gas Transmission 222.1 144.3 130.4 Energy Services 10.0 11.0 4.7 Other 5.9 4.5 6.0 - -------------------------------------------------------------------- Total $819.1 $1,022.4 $761.2 ====================================================================
The Company's investments in unconsolidated affiliates were as follows:
(In Millions) ------------------------------------ Years Ended December 31, 1998 1997 1996 - ------------------------------------------------------------------ Natural Gas Transmission $ 89.5 $ 44.8 $ 0.3 Energy Services 57.7 0.4 5.0 - ------------------------------------------------------------------ Total $147.2 $ 45.2 $ 5.3 ================================================================== (In Millions) ------------------------------------ Years Ended December 31, 1998 1997 1996 - ------------------------------------------------------------------ Financing Activities $116.8 $365.3 $(38.4) ==================================================================
1998 VERSUS 1997. Financing activities provided $116.8 million in 1998 compared with $365.3 million in 1997. Increased borrowings helped finance capital and other corporate expenditures. The $325.3 million net proceeds from the disposal of assets, principally oil and gas properties, were primarily used to repay borrowings under the Company's floating rate facilities in the current period. 1997 VERSUS 1996. Financing activities provided $365.3 million in 1997 compared with requiring $38.4 million in 1996. The change was primarily attributable to increased borrowings, which helped finance higher capital expenditures, the Company's stock repurchase program and the funding of the liability for transaction and other costs in connection with the merger with Zilkha Energy in 1997. 30 II-9 41 Capital Resources At December 31, 1998, the Company had bank lines of credit and a revolving credit agreement with banks with a total capacity of $1.25 billion. The Company's bank and commercial paper borrowings in the aggregate are not authorized to exceed the maximum amount available under its lines of credit and revolving credit agreement. As a result, after giving effect to the $696.1 million of commercial paper and $24.3 million of borrowings from the short-term lines of credit outstanding at December 31, 1998, $529.6 million was available to the Company under such lines of credit and revolving credit agreement at December 31, 1998. In late January 1999, Sonat completed a new 364-day $400.0 million revolving credit facility with 11 banks. In connection with this new credit facility, the Company terminated existing lines of credit providing for up to $700.0 million of borrowings. Sonat and Southern Natural Gas have shelf registration statements with the Securities and Exchange Commission which provide for the issuance of up to $500 million in debt securities by both companies. Southern Natural Gas issued $100.0 million in debt under its registration statement in the third quarter of 1998. The Company's capital expenditures and other investing requirements for 1999 are expected to total $529 million. This amount reflects investments in unconsolidated affiliates and proposed expenditures for oil and gas property acquisitions, exploration and development, pipeline expansion and other projects. The Company completed the Zilkha Energy merger on January 30, 1998, issuing $1.04 billion of common stock to the Zilkha Energy shareholders (see Note 3 of the Notes to Consolidated Financial Statements). The Company's cash requirements relating to the Zilkha Energy merger totaled approximately $290 million, principally for repayment of debt and certain other liabilities of Zilkha Energy and transaction expenses. The Company believes that cash flow from operations and borrowings in either the private or public market will provide the Company with the means to fund operations and currently planned investment and capital expenditures. MARKET RISK Financial instruments of the Company expose it to both commodity price risk and interest rate risk. Commodity Price Risk - The Company's primary market risk exposure is the volatility of energy commodity prices, relating to the portfolio position of its financial instruments and physical commitments, which can affect the operating results of Sonat Exploration and Sonat Energy Services. The Company uses commodity futures contracts, options and price swap agreements as well as offsetting physical positions to hedge its commodity price risk on crude oil, natural gas and electricity. Sonat Energy Services performs all hedging activity (non-trading) for both its own operations and for the operations of Sonat Exploration. Sonat Energy Services, through its subsidiary, Sonat Marketing, also uses derivative instruments as a market maker (trading activity) by maintaining active trading positions in natural gas and crude oil commodity futures, swap and option contracts. Sonat Marketing limits its risk to changes in the value of its outstanding positions through the use of Value-at-Risk models, establishment of offsetting positions and limit and monitoring procedures. The Company's non-trading (hedging) and trading activities are implemented under a set of policies approved by the Board of Directors. Established procedures and processes are employed to manage and monitor these activities and all derivative activities are internally reviewed by a Risk Oversight Committee to ensure compliance with all policies. The Company's use of derivative instruments to reduce the effect of market volatility is described in Note 4 of the Notes to Consolidated Financial Statements. Sonat Energy Services manages its commodity price risks through its subsidiaries, Sonat Marketing Company and Sonat Power Marketing. Sonat Marketing and Sonat Power Marketing each manage commodity risks at a portfolio level by utilizing Value-at-Risk models for natural gas and electricity commodities, respectively. Each Value-at-Risk model includes energy commodity transactions, both physical and derivative (commodity futures, swaps and options) for both trading and non-trading activities. The Value-at-Risk models use historical or variance co-variance simulation methods to determine commodity risk exposure (the loss that could occur over a two-day period) due to changes in natural gas, electricity or crude oil commodity prices within a 95 percent confidence level. Value-at-Risk models are routinely backtested against market prices and volatilities to assess the quality of Value-at-Risk measures. The Risk Oversight Committee and management monitor the portfolio Value-at-Risk to ensure compliance with Board limits. 31 II-10 42 Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) The Value-at-Risk data for Energy Services for 1998 and 1997 is as follows:
(In Thousands) ------------------------------ Average Maximum Minimum - ------------------------------------------------------- 1998 $973 $1,792 $685 ======================================================= 1997 $593 $ 752 $473 =======================================================
The Value-at-Risk for non-trading activities was immaterial. Interest Rate Risk - The Company's entire portfolio of interest rate risk instruments is classified as non-trading. The Company's interest income and expense are sensitive to changes in the level of short-term interest rates in the United States. In general, the Company uses excess funds to reduce short-term debt levels and therefore has minimal cash equivalent investments. Short-term debt averaged $661.3 million in 1998. Excess cash generated by or contributed to joint venture projects is invested on a short-term basis pending distribution or expenditure on capital projects. Such short-term investments averaged $18.2 million in 1998. To mitigate the impact of fluctuations in interest rates, the Company maintains a balance among components of its capital structure, providing a mix of maturities and pricing methods for its debt obligations. At December 31, 1998, 37 percent of the Company's debt had variable rates compared with 38 percent in 1997. The effects of changes in the fixed and variable components of debt essentially offset. Fixed rate long-term debt which was $923.7 million (fair value of $966.4 million) at December 31, 1997, increased 31 percent. Additionally, variable rate debt increased due to a 56 percent increase in commercial paper which was $446.6 million at December 31, 1997. The Company's amount of variable rate long-term debt decreased from $130.0 million at December 31, 1997, which slightly offset the effect of the increase in variable rate commercial paper. Overall the Company's debt increased primarily due to the merger with Zilkha Energy. The Company used restricted cash deposits of $116.0 million at December 31, 1997, to pay certain merger-related expenses. In the past the Company has used derivative instruments to aid in its management of interest rate risk, although it is not currently doing so. The following table provides information about the Company's financial instruments that are sensitive to changes in interest rates. The table presents principal cash flows and related weighted-average interest rates by expected maturity dates. The weighted-average variable rate is the current effective rate. Municipal bonds are used to satisfy obligations under various non-qualified benefit plans of the Company. Broker deposits of $29.9 million with a return of 4.1 percent at December 31, 1998, were excluded from the table. Interest Rate Risk Instruments Principal Amount by Expected Maturity and Average Interest Rate
(Dollars in Millions) -------------------------------------------------------------------------------------- Fair There- Value 1999 2000 2001 2002 2003 after Total 12/31/98 - ---------------------------------------------------------------------------------------------------------------------------- Assets: Notes Receivable $ 50.4 $ -- $ -- $ -- $ -- $ -- $ 50.4 $ 50.4 Average Interest Rate 7.9% Municipal Bonds $ 1.5 $3.3 $ 4.4 $ .9 $7.0 $ 26.9 $ 44.0 $ 47.2 Average Interest Rate 4.9% 4.9% 4.8% 4.8% 4.8% 4.7% Liabilities: Commercial Paper $696.1 $ -- $ -- $ -- $ -- $ -- $ 696.1 $ 696.1 Average Interest Rate 6.0% Long-term Debt, including Current Portion: Fixed Rate $109.8 $2.8 $200.2 $200.0 $ -- $700.0 $1,212.8 $1,258.4 Average Interest Rate 7.5% 7.4% 7.1% 6.8% 6.7% 6.8% Variable Rate $ 24.3 $ -- $ -- $ -- $ -- $ -- $ 24.3 $ 24.3 Average Interest Rate 5.9% =============================================================================================================================
32 II-11 43 INFLATION AND THE EFFECT OF CHANGING ENERGY PRICES The rate of inflation in the United States has been moderate over the past several years and has not significantly affected the profitability of the Company. In prior periods of high general inflation, oil and gas prices generally increased at comparable rates; however, there is no assurance that this will be the case in the current environment or in possible future periods of high inflation. In addition, inflation can affect the day rates that Sonat Exploration pays for drilling rigs. Margins in the Energy Services segment are highly sensitive to competitive pressures and may not reflect the effects of inflation. The results of operations in the Company's three major business segments will be affected by future changes in oil and gas prices and the interrelationship between oil, gas and other energy prices. ENVIRONMENTAL ISSUES The operations and properties of Sonat Exploration, Southern, Energy Services, and their subsidiaries are subject to extensive and changing federal, state and local laws and regulations relating to environmental protection, including the generation, storage, handling, emission, transportation and discharge of materials into the environment, and relating to safety and health. The recent trend in environmental legislation and regulation generally is toward stricter standards, and this trend will likely continue. These laws and regulations may require the acquisition of a permit or other authorization before construction or drilling commences and for certain other activities, limit or prohibit construction, drilling and other activities on certain lands lying within wilderness or wetlands and other protected areas, and impose substantial liabilities for pollution resulting from operations. The permits required for various operations are subject to revocation, modification and renewal by issuing authorities. The Company believes that its operations currently are in substantial compliance with applicable environmental regulations. Governmental authorities have the power to enforce compliance with their regulations, and violations are subject to fines or injunction, or both. The Company does not expect environmental compliance matters to have a material adverse effect on its financial position or results of operations. It is also not anticipated that the Company will be required in the near future to expend amounts that are material to its financial condition or operations by reason of environmental laws and regulations, but because such laws and regulations are frequently changed and may impose increasingly stricter requirements, the Company is unable to predict the ultimate cost of complying with such laws and regulations. Southern has been notified that it is or may be a potentially responsible party (PRP) under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) in connection with one Superfund site for which the amount of its liability has not been settled. The Company has determined that the aggregate maximum amount of loss reasonably likely to be attributed to it, after giving effect to likely contributions by other PRPs, would not be material to its financial position or results of operations. However, liability for PRPs under CERCLA (and applicable state law) is joint and several among all PRPs. Although volumetric allocation is a factor in assessing liability, it is not necessarily determinative; thus, the ultimate liability at this site could be substantially greater than the maximum amount estimated by the Company. In the operation of their natural gas pipeline systems, Southern and its wholly owned subsidiaries, South Georgia Natural Gas Company (South Georgia) and Sea Robin, have used, and continue to use at several locations, gas meters containing elemental mercury. Southern, South Georgia and Sea Robin plan to remove all remaining mercury meters during the course of regularly scheduled facilities upgrades. Mercury and mercury meters are handled pursuant to procedures that are designed to protect employees and the environment and to comply with Occupational Safety and Health Administration standards. It is generally believed in the natural gas pipeline industry that, in the course of normal maintenance and replacement operations, elemental mercury may have been released from mercury meters. Based on its previous determination that its pipeline meters may in the past have been the source of small releases of elemental mercury, Southern and Sea Robin have completed the characterization of their sites in Alabama, Georgia, Louisiana and Mississippi. Characterization of potential sites on the pipeline system of South Georgia has not yet commenced. At this time, only the State of Georgia has issued formal guidelines for remediation of mercury sites, although the State of Louisiana has issued informal guidance. Southern filed copies of the characterization reports with the State of Georgia and the State is evaluating what remediation actions, if any, are necessary. Southern is unable to estimate the cost of mercury remediation because costs will vary based on a number of factors particular to each site and because regulatory guidance is still uncertain for all sites. Based on its experience with other remediation projects, industry experience to date with 33 II-12 44 Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) remediation of mercury and its preliminary characterization data, Southern believes that the cost of its characterization and remediation of any mercury contamination will not be material to the Company's financial position or results of operations. The Company generally considers environmental assessment and remediation costs and costs associated with compliance with environmental standards incurred by Southern, South Georgia and Sea Robin to be recoverable through rates since they are prudent costs incurred in the ordinary course of business and, accordingly, generally will seek recovery of such costs through rate filings, although no assurance can be given with regard to their ultimate recovery. RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 133 requires the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income as changes occur. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives are either offset against the change in fair value of assets, liabilities or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. SFAS No. 133 becomes effective for fiscal years beginning after June 15, 1999. As a result, calendar year-end companies have until January 1, 2000, to adopt. Early application is encouraged, but only permitted as of the beginning of any fiscal quarter. Retroactive application to previous periods, even previous quarters within the same fiscal year, is not permitted. The Company has not yet determined what the effect of SFAS No. 133 will be on the earnings and financial position of the Company. In November 1998, the Emerging Issues Task Force (EITF) reached a consensus on EITF Issue 98-10- Accounting for Contracts Involved in Energy Trading and Risk Management Activities. The EITF consensus establishes guidance on the accounting for energy trading contracts prior to the adoption of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. It requires energy trading contracts to be marked-to-market, with gains and losses included in earnings and separately disclosed in the financial statements or footnotes. The consensus is to be applied to financial statements issued for fiscal years beginning after December 15, 1998. The effect of initial application should be reported as the cumulative effect of a change in an accounting principle in accordance with Opinion No. 20. The consensus will require energy contracts that qualify as energy trading contracts under this consensus to be marked-to-market at the Company's subsidiaries, Sonat Marketing and Sonat Power Marketing. Sonat Marketing currently accounts for its energy contracts at market value. Sonat Power Marketing will be required to value its energy trading contracts at market value. The impact to the Company will not be material. YEAR 2000 PROJECT The following disclosure contains forward-looking statements. The Company's ability to meet its objectives identified below is dependent upon several factors that could cause actual results to differ materially from those set forth below, including the timely provision of necessary upgrades and modifications by suppliers. In addition, the Company cannot guarantee that third parties on whom it depends for essential services will convert their critical systems and processes in a timely manner. Each of the phases of the Company's Year 2000 project is progressing, and the Company believes that it is taking all reasonable and appropriate steps necessary to be able to operate in the Year 2000 and beyond. To answer the Year 2000 challenge, the Sonat Board of Directors directed that a corporate-wide initiative be undertaken. A consulting firm was engaged to assist in this effort. The Company has divided its Year 2000 project into assessment, remediation, testing and contingency planning phases. During the assessment phase, the Company completed a comprehensive inventory of IT systems, embedded systems, equipment, computer hardware and software that rely on a computer chip as well as service providers that could be impacted by the Year 2000 problem. For vendor-supplied items, the Company has contacted its vendors seeking written verification of Year 2000 readiness. In addition, the Company continues to contact entities with whom 34 II-13 45 it has a material relationship, such as natural gas suppliers, pipelines, electric utilities, telecommunication service providers, banks and other suppliers of goods and services, to determine the extent to which the Company is vulnerable to the failure of those third parties to remediate their Year 2000 issue. The Company is currently engaged in the remediation and testing phases of the Year 2000 project. The remediation phase includes completing the replacement of mainframe systems with Year 2000-ready vendor packages on new client/server platforms and performing any required modifications and upgrades identified during the assessment phase. The testing phase involves testing systems for Year 2000 readiness. The Company has completed remediation and testing for approximately 80 percent of its critical systems. The remaining critical systems and non-critical systems are scheduled to be remediated and tested by June 30, 1999. The Company relies on producers of natural gas, natural gas pipelines, natural gas distribution companies, natural gas marketing companies and electric transmission providers to conduct its basic operations. External infrastructure, such as electric, telecommunication and water service is also necessary for the Company's basic operations. Should any third party with which the Company has a material relationship fail, the impact could become a significant challenge to the Company's ability to perform its basic operations. Due to the nature of the Company's business, extensive contingency plans are already in place, including plans to provide pipeline system reliability. Because of the additional uncertainties caused by the Year 2000 problem, the Company is developing additional contingency plans as practicable for critical systems, service providers and business partners. A consulting firm has been engaged to assist in this effort. These plans involve developing contingencies for failures that may result from the Year 2000 problem, and include plans to establish control centers to facilitate communications in the event of a telecommunications failure and staffing at selected locations on the Company's pipeline system. The Company is scheduled to have these plans completed by June 30, 1999. The estimated cost to the Company of the Year 2000 project for capital as well as general and administrative costs is expected to be less than $10 million. As of December 31, 1998, the Company has incurred approximately $4.5 million in Year 2000 project costs. The Company expects to fund Year 2000 expenditures from normal operations. The timing of expenditures is not indicative of readiness efforts or progress to date. CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS This Annual Report contains certain forward-looking statements regarding the Company's business plans and prospects, objectives, future drilling plans, expansion projects, proposed capital expenditures and expected performance or results. These forward-looking statements are based on assumptions that the Company believes are reasonable, but are subject to a wide range of risks and uncertainties and, as a result, actual results and experience may differ materially from the anticipated results or other expectations expressed in such forward-looking statements. Such statements are made in reliance on the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Important factors that could cause actual results to differ include changes in oil and gas prices and underlying demand, which would affect profitability and might cause the Company to alter its plans; the timing and success of the Company's exploration and development drilling programs, which would affect production levels and reserves; the results of the Company's hedging activities; risks incident to the drilling and operation of oil and gas wells; future drilling, production and development costs, including drilling rig rates; the success of the Company's cost-reduction activities; and the requirements to receive various governmental approvals to proceed with pipeline, storage and power generation projects, and unanticipated construction delays in connection with such performance can also be adversly affected by the actions of customers and competitors, changes in governmental regulation of the Company's businesses, and changes in general economic conditions and the state of domestic capital markets. 35 II-14 46 Report of Management Sonat Inc. and Subsidiaries Management of the Company is responsible for the preparation and integrity of all financial data included in this annual report. The Consolidated Financial Statements have been prepared in conformity with generally accepted accounting principles and necessarily include amounts based on estimates and judgments of management. The Company's accounting systems include controls designed to provide reasonable assurance that assets are safeguarded against loss or unauthorized use and that the financial records are adequate and reliable for preparation of financial statements and other financial data. The concept of reasonable assurance is based on the recognition that the cost of internal controls should not exceed the related benefits. An integral part of the internal controls is the selection, training and development of qualified accounting and internal audit personnel. The Company engages the firm of Ernst & Young LLP as independent auditors to audit the Company's Consolidated Financial Statements and express their opinion thereon. Their audit is conducted in accordance with generally accepted auditing standards and includes a review and evaluation of the Company's internal controls and other procedures as they consider appropriate. The Report of Ernst & Young LLP, Independent Auditors, appears on the facing page. Internal audit activities are coordinated with the independent auditors to maximize audit effectiveness. The Audit Committee of the Board of Directors is composed solely of directors who are not active or retired officers or employees of the Company. It recommends a firm to serve as independent auditors of the Company, subject to nomination by the Board of Directors and election by the stockholders, approves all audit and other professional services rendered by the independent auditors and regularly reviews their independence. The Audit Committee reviews and reports on significant accounting decisions and transactions and the scope and results of audits by the Company's internal auditing staff and the independent auditors. It reviews with management compliance with the Company's business ethics and conflict of interest policies and reviews with independent auditors the adequacy of the Company's internal controls. The internal auditors and the independent auditors have free access to the Audit Committee, without management's presence, to discuss the Company's internal controls and the results of their audits. /s/ James E. Moylan, Jr. James E. Moylan, Jr. Senior Vice President and Chief Financial Officer February 25,1999 36 II-15 47 Report of Ernst & Young LLP, Independent Auditors Sonat Inc. and Subsidiaries The Board of Directors and Stockholders Sonat Inc. We have audited the accompanying consolidated balance sheets of Sonat Inc. and Subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the 1996 financial statements of Zilkha Energy Company, a wholly owned subsidiary, which statements reflect net income constituting approximately 17 percent of the related consolidated totals. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to data included for Zilkha Energy Company, is based solely on the report of the other auditors. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, based on our audits and, for 1996, the report of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sonat Inc. and Subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. As discussed in Note 2 to the consolidated financial statements, in 1998 the Company changed its method of accounting for oil and gas operations. /s/ Ernst & Young LLP Birmingham, Alabama January 19, 1999 37 II-16 48 Consolidated Balance Sheets Consolidated Financial Statements Sonat Inc. and Subsidiaries
(In Thousands) ---------------------------- December 31, 1998 1997(*) - --------------------------------------------------------------------------- ASSETS Current Assets: Cash and cash equivalents $ 7,104 $ 27,278 Restricted cash (Note 1) -- 115,956 Notes receivable from affiliates 50,359 64 Accounts receivable 388,075 619,517 Inventories (Note 5) 69,093 65,161 Gas imbalance receivables 7,673 16,644 Assets from trading activities (Note 4) 229,801 92,150 Other 48,404 44,037 - --------------------------------------------------------------------------- Total Current Assets 800,509 980,807 - --------------------------------------------------------------------------- Investments and Advances: Unconsolidated affiliates (Note 6) 635,692 495,234 Other investments 61,316 58,384 - --------------------------------------------------------------------------- 697,008 553,618 - --------------------------------------------------------------------------- Plant, Property and Equipment, including $148,615,000 in 1998 and $201,208,000 in 1997, excluded from full-cost amortization base used for oil and gas properties (Notes 7 and 14) 8,399,934 7,830,697 Less Accumulated Depreciation, Depletion and Amortization 5,703,767 4,264,917 - --------------------------------------------------------------------------- 2,696,167 3,565,780 - --------------------------------------------------------------------------- Deferred Charges and Other: Assets from trading activities (Note 4) 25,694 9,638 Other 141,716 142,271 - --------------------------------------------------------------------------- 167,410 151,909 - --------------------------------------------------------------------------- Total Assets $4,361,094 $5,252,114 ===========================================================================
(*) Restated, See Note 2 See accompanying notes. 38 II-17 49 Consolidated Balance Sheets Consolidated Financial Statements Sonat Inc. and Subsidiaries
(In Thousands) --------------------------- December 31, 1998 1997(*) - -------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Long-term debt due within one year (Note 8) $ 109,835 $ 14,508 Unsecured notes (Note 8) 720,361 446,721 Accounts payable 401,357 615,322 Accrued income taxes 21,700 18,274 Accrued interest 47,864 37,242 Accrued long-term compensation -- 73,799 Gas imbalance payables 11,497 14,320 Liabilities from trading activities (Note 4) 223,628 85,398 Other 40,357 75,299 - -------------------------------------------------------------------------------- Total Current Liabilities 1,576,599 1,380,883 - -------------------------------------------------------------------------------- Long-Term Debt (Note 8) 1,099,484 1,235,984 - -------------------------------------------------------------------------------- Deferred Credits and Other: Deferred income taxes (Note 9) 163,964 485,950 Liabilities from trading activities (Note 4) 12,564 5,014 Other 179,232 182,507 - -------------------------------------------------------------------------------- 355,760 673,471 - -------------------------------------------------------------------------------- Commitments and Contingencies (Note 10) Stockholders' Equity: Common stock, $1.00 par; 400,000,000 shares authorized, 111,387,520 and 111,385,858 shares issued in 1998 and 1997, respectively (Note 11) 111,388 111,385 Other capital 68,804 56,401 Retained earnings 1,209,527 1,858,871 - -------------------------------------------------------------------------------- 1,389,719 2,026,657 - -------------------------------------------------------------------------------- Less treasury stock at cost, 1,345,673 and 1,438,793 shares in 1998 and 1997, respectively (Note 11) 60,468 64,881 - -------------------------------------------------------------------------------- Total Stockholders' Equity 1,329,251 1,961,776 - -------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $4,361,094 $5,252,114 ================================================================================
(*) Restated, See Note 2 See accompanying notes. 39 II-18 50 Consolidated Statements of Operations Consolidated Financial Statements Sonat Inc. and Subsidiaries
(In Thousands, Except Per-Share Amounts) ---------------------------------------------------- Years Ended December 31, 1998 1997(*) 1996(*) - ---------------------------------------------------------------------------------------------------- Revenues (Notes 1 and 13) $ 3,709,818 $ 4,372,497 $ 3,203,610 - ---------------------------------------------------------------------------------------------------- Costs and Expenses: Natural gas cost 2,393,027 2,949,766 1,973,147 Electric power cost 351,942 224,294 65,699 Operating and maintenance 163,386 181,911 155,781 General and administrative 117,749 202,754 145,571 Depreciation, depletion and amortization 349,465 397,955 383,903 Ceiling test charges (Note 2) 1,035,178 -- -- Restructuring costs (Note 3) 15,017 -- -- Taxes, other than income 47,418 43,800 47,447 - ---------------------------------------------------------------------------------------------------- 4,473,182 4,000,480 2,771,548 - ---------------------------------------------------------------------------------------------------- Operating Income (Loss) (763,364) 372,017 432,062 - ---------------------------------------------------------------------------------------------------- Other Income (Loss), Net: Equity in earnings of unconsolidated affiliates (Note 6) 48,777 43,021 34,211 Minority interest 4,082 (4,395) (4,907) Other income, net 8,495 10,296 6,525 - ---------------------------------------------------------------------------------------------------- 61,354 48,922 35,829 - ---------------------------------------------------------------------------------------------------- Earnings (Loss) Before Interest and Taxes (702,010) 420,939 467,891 - ---------------------------------------------------------------------------------------------------- Interest: Interest income 5,459 4,908 4,874 Interest expense (136,837) (109,548) (101,403) Interest capitalized 5,123 7,448 7,642 - ---------------------------------------------------------------------------------------------------- (126,255) (97,192) (88,887) - ---------------------------------------------------------------------------------------------------- Income (Loss) Before Income Taxes (828,265) 323,747 379,004 Income Tax Expense (Benefit) (Note 9) (297,748) 105,751 123,164 - ---------------------------------------------------------------------------------------------------- Net Income (Loss) $ (530,517) $ 217,996 $ 255,840 ==================================================================================================== Earnings (Loss) Per Share of Common Stock (Note 11) $ (4.82) $ 1.98 $ 2.32 Earnings (Loss) Per Share of Common Stock - Assuming Dilution (Note 11) (4.82) 1.95 2.29 ==================================================================================================== Weighted Average Shares Outstanding 110,020 110,099 110,370 Weighted Average Shares Outstanding - Assuming Dilution 110,020 111,669 111,722 ==================================================================================================== Dividends Paid Per Share $ 1.08 $ 1.08 $ 1.08 ====================================================================================================
(*) Restated, See Note 2 See accompanying notes. 40 II-19 51 Consolidated Statements of Changes in Stockholders' Equity Consolidated Financial Statements Sonat Inc. and Subsidiaries
(In Thousands) -------------------------------------------------------------------------------- 1998 1997(*) 1996(*) -------------------------------------------------------------------------------- Years Ended December 31, Shares Amount Shares Amount Shares Amount - ------------------------------------------------------------------------------------------------------------------------------------ Common Stock, $1.00 Par; 400,000,000 Shares Authorized (Note 11): Balance at beginning of year 111,385 $ 111,385 111,391 $ 111,391 111,402 $ 111,402 Issued (canceled) 3 3 (6) (6) (11) (11) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of year 111,388 111,388 111,385 111,385 111,391 111,391 - ------------------------------------------------------------------------------------------------------------------------------------ Accumulated Other Comprehensive Income: Balance at beginning of year 3,222 10,140 6,614 Realized net (gains)/losses in value of securities (net of tax expense/(benefit) of $683,000, $1,216,000, and $(86,000)) (1,269) (2,259) 160 Change in unrealized gains (losses) on securities, (net of tax expense/ (benefit) of $(202,000), $(2,509,000), and $1,812,000) (376) (4,659) 3,366 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of year 1,577 3,222 10,140 - ------------------------------------------------------------------------------------------------------------------------------------ Other Capital: Balance at beginning of year 53,179 50,522 58,643 Tax benefit from utilization of NOL carryforward 11,505 -- -- Other 2,543 2,657 (8,121) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of year 67,227 53,179 50,522 - ------------------------------------------------------------------------------------------------------------------------------------ Retained Earnings: Balance at beginning of year 1,858,871 1,733,653 1,371,757 Adjustment to beginning balance for Sonat Exploration's change to full cost (Note 2) -- -- 199,196 Net income (loss) (530,517) 217,996 255,840 Cash dividends paid by Sonat at $1.08 per share (118,827) (92,778) (93,140) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of year 1,209,527 1,858,871 1,733,653 - ------------------------------------------------------------------------------------------------------------------------------------ Treasury Stock, at cost: Balance at beginning of year (1,438) (64,881) (831) (29,703) (1,077) (31,534) Additions (56) (2,284) (1,058) (54,056) (775) (30,966) Issued 148 6,697 451 18,878 1,021 32,797 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of year (1,346) (60,468) (1,438) (64,881) (831) (29,703) - ------------------------------------------------------------------------------------------------------------------------------------ Total Stockholders' Equity 110,042 $1,329,251 109,947 $1,961,776 110,560 $1,876,003 ==================================================================================================================================== Comprehensive Income (Loss) $ (532,162) $ 211,078 $ 259,366 ====================================================================================================================================
(*) Restated, See Note 2 See accompanying notes. 41 II-20 52 Consolidated Statements of Cash Flows Consolidated Financial Statements Sonat Inc. and Subsidiaries
(In Thousands) --------------------------------------------------- Years Ended December 31, 1998 1997(*) 1996(*) - ------------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net income (loss) $ (530,517) $ 217,996 $ 255,840 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation, depletion and amortization, including ceiling test charges 1,384,643 397,955 383,903 Deferred income taxes (321,986) 85,249 100,302 Equity in earnings of unconsolidated affiliates, less distributions (38,255) (31,914) (23,040) Reserves for regulatory matters (4,237) (10,212) (167,154) Gas supply realignment costs 1,067 7,514 187,929 Change in: Accounts receivable 231,442 (7,781) (261,932) Inventories (3,932) (34,111) (7,002) Accounts payable (213,965) 79,947 226,370 Accrued interest and income taxes, net 14,319 (2,248) 30,695 Accrued long-term compensation (73,799) 57,493 1,266 Other current assets 4,333 (4,256) (3,589) Other current liabilities (37,765) 13,452 6,534 Net change from trading activities (7,927) (11,376) -- Net change in restricted cash 115,956 (115,956) -- Other, net (9,515) (8,114) (73,385) - ------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 509,862 633,638 656,737 - ------------------------------------------------------------------------------------------------------------- Cash Flows from Investing Activities: Plant, property and equipment additions (819,135) (1,022,353) (761,211) Net proceeds from disposal of assets 325,333 49,842 149,367 Investments in unconsolidated affiliates and other (153,048) (47,127) (9,143) - ------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (646,850) (1,019,638) (620,987) - ------------------------------------------------------------------------------------------------------------- Cash Flows from Financing Activities: Proceeds from issuance of long-term debt 500,000 2,025,041 987,088 Payments of long-term debt (539,500) (1,812,023) (862,877) Changes in short-term borrowings 273,640 288,691 (60,870) - ------------------------------------------------------------------------------------------------------------- Net changes in debt 234,140 501,709 63,341 Dividends paid (118,827) (92,778) (93,140) Treasury stock purchases (1,289) (53,176) (30,914) Other 2,790 9,514 22,264 - ------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities 116,814 365,269 (38,449) - ------------------------------------------------------------------------------------------------------------- Net Decrease in Cash and Cash Equivalents (20,174) (20,731) (2,699) Cash and Cash Equivalents at Beginning of Year 27,278 48,009 50,708 - ------------------------------------------------------------------------------------------------------------- Cash and Cash Equivalents at End of Year $ 7,104 $ 27,278 $ 48,009 ============================================================================================================= Supplemental Disclosures of Cash Flow Information Cash Paid For: Interest, net of amount capitalized $ 119,898 $ 99,426 $ 75,870 Income taxes paid (refunds received), net 7,408 20,124 (4,914) =============================================================================================================
(*) Restated, See Note 2 See accompanying notes. 42 II-21 53 Notes to Consolidated Financial Statements Sonat Inc. and Subsidiaries NOTE 1 Business Description and Significant Accounting Policies Business Description - The Consolidated Financial Statements of Sonat Inc. (Sonat) and its subsidiaries (the Company) reflect operations in the Exploration and Production, Natural Gas Transmission and Energy Services segments. The Exploration and Production segment is engaged in exploration, development and production of domestic oil and natural gas. The Natural Gas Transmission segment is primarily engaged in the interstate transmission and storage of natural gas. The Energy Services segment is primarily engaged in the marketing of natural gas and electric power and in power generation. For further description of business segments, see Note 13. For a description of financial instruments, credit risk and contingencies, see Notes 4 and 10. Principles of Consolidation - The Consolidated Financial Statements include the accounts of Sonat and its subsidiaries. The Consolidated Financial Statements have been restated for a change to the full cost method of accounting for the Company's oil and gas operations (see Note 2). Intercompany transactions and accounts have been eliminated in consolidation. The equity method of accounting is used for investments in affiliates owned 50 percent or less. Use of Estimates in the Preparation of Financial Statements - In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash Equivalents - Cash equivalents are typically money-market investments in the form of repurchase agreements, certificates of deposit and time deposits with maturities of three months or less at the time of purchase. These investments are accounted for at cost. Restricted Cash - At December 31, 1997, the Company had $116.0 million of restricted cash. The restricted cash was held in trust by the issuing bank, was restricted as to withdrawal and use, and was invested in cash equivalents. The restricted cash was used to pay certain merger expenses in 1998 (see Note 3). Inventories - Inventories consist primarily of materials and supplies and gas stored underground. Gas stored underground is carried at fair value, which approximates average cost. Inventories of materials and supplies utilized for ongoing replacements and expansions are reviewed regularly and adjusted to their net realizable value. Gas Imbalance Receivables and Payables - For the Natural Gas Transmission segment, gas imbalances represent the difference between gas receipts from and gas deliveries to the Company's transportation and storage customers. Gas imbalances arise when these customers deliver more or less gas into the pipeline than they take out. Imbalances incurred prior to implementation of Order No. 636 are settled through exchange of gas. Imbalances incurred after implementation of Order No. 636 are settled monthly. For the Energy Services segment, imbalances are subject to the terms of the various pipelines. Plant, Property and Equipment and Depreciation - Plant, property and equipment is carried at cost. The Company provides for depreciation on a composite or straight-line basis, except for oil and gas properties. (See Notes 7 and 14.) The Company reviews its long-lived assets for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Other than for oil and gas properties no impairment was required in any of the three years in the period ended December 31, 1998. See Notes 2 and 16 for ceiling test charges related to oil and gas properties. Oil and Gas Properties - The Company utilizes the full cost method of accounting for its oil and gas properties. Under the full cost method, all productive and non-productive costs incurred in connection with the acquisition, exploration and development of oil and gas reserves are capitalized and amortized on the unit-of-production method using proved reserves. Certain unevaluated properties are excluded from the amortization base until a determination has been made as to the existence of proved reserves. Since the Company's operations are limited to the United States, it utilizes a single cost center for amortization purposes. Capitalized costs are subject to a ceiling test which limits such costs to the aggregate of the present value of future net revenues plus the lower of cost or fair market value of unproved properties. Any conveyances of properties are treated as adjustments to the cost of oil and gas properties with no gain or loss recognized. Accounting for Regulated Operations - The regulated operations of the Company are subject to the provisions of Statement of Financial Accounting Standards (SFAS) No. 71, Accounting for the Effects of Certain Types of Regulation. Accordingly, the Company records certain assets and liabilities that result from the effects of the rate-making process that would not be recorded under generally accepted accounting principles for non-regulated entities. The regulatory assets and regulatory liabilities of the Company are primarily classified as Deferred Charges and Other 43 II-22 54 Notes to Consolidated Financial Statements Note 1 (continued) and Deferred Credits and Other, respectively, in the Consolidated Balance Sheets. Revenue Recognition - Revenue is recognized in the Exploration and Production segment when deliveries of oil and natural gas are made. The Company's Natural Gas Transmission segment recognizes revenue from natural gas transportation in the period the service is provided. Reserves are provided on revenues collected subject to refund when appropriate. Revenues are recognized in the Energy Services segment when deliveries of the physical commodities are made and, for the segment's trading portfolio, as changes in the fair value of items in the portfolio occur. Commodity Price-Risk Management Activities - The Company uses derivative instruments (commodity futures contracts, options and price swap agreements) both to hedge its commodity price risk on natural gas, crude oil and electricity, and as a market maker (trading activity) in natural gas and crude oil. Natural gas, crude oil and electricity futures contracts are traded on the New York Mercantile Exchange (NYMEX). Natural gas contracts are for fixed units of 10,000 MMBtu and are available for up to 36 months in the future. Crude oil contracts are for fixed units of 1,000 barrels and are available for periods up to 30 months in the future. Electricity contracts are for 736 megawatt hours and are available for up to 18 months in the future. Price swap agreements call for one party to make monthly payments to (or receive payments from) another party based upon the differential between a fixed and a variable price (fixed-price swap) or two variable prices (basis swap) for a notional volume specified by the contract. Options can be exchange traded on the NYMEX or traded over-the-counter. Exchange traded and over-the-counter options give the owner the right, but not the obligation, to a futures contract or to buy or sell an underlying commodity at a given price, respectively. Non-Trading Activities - Derivative positions taken specifically to mitigate market price risk associated with significant physical transactions are accounted for using hedge accounting provided they meet hedge accounting criteria. Under hedge accounting, gains and losses from futures are deferred in the Consolidated Balance Sheets in Deferred Credits and Other and recognized in earnings in conjunction with the earnings recognition of the underlying physical. Each net payment/receipt due or owed under the swap agreement is recognized in earnings during the period to which the payment/receipt relates, and there is no recognition in the Consolidated Balance Sheets for changes in the swap's fair value. Gains or losses resulting from settlement of swaps are amortized over their original terms. Cash flows from hedging activities are recognized in the same section of the Consolidated Statements of Cash Flows as the hedged transaction. The derivative instruments used to hedge commodity transactions have historically had high correlation with commodity prices and are expected to continue to do so. In the event that correlation is not maintained, the gains or losses associated with the hedging instruments are immediately recognized to the extent that correlation is lost. Trading Activities - The Company's trading portfolio consists of short- and long-term energy-related purchase and sale commitments (physical and derivative). All of these trading positions are reported at fair value and recorded under the heading of Assets and Liabilities from Trading Activities (current and long-term) in the Consolidated Balance Sheets. The change in fair value is recognized in revenues as it occurs. Fair value is subject to change and reflects an estimate of market prices considering various factors including closing exchange and over-the-counter quotations, time value and volatility factors underlying the commitments. These market prices are adjusted to reflect the potential impact of liquidating Sonat Marketing's position in an orderly manner over a reasonable period of time under present market conditions (see Note 4). Environmental Expenditures - The Company provides for environmental liabilities when environmental assessments and/or remediation are probable and such costs to the Company can be reasonably estimated. Accruals for environmental remediation liabilities are not material and have not been discounted. Stock-Based Compensation - The Company follows the provisions of Accounting Principles Board Opinion (APB) No. 25 for its stock-based compensation awards (see Note 11). Capitalized Interest - The Company capitalizes interest costs associated with non-producing leases and exploration and major development projects until the related properties are evaluated and subject to depletion. The Company also capitalizes interest costs on major projects during construction. Interest is capitalized on borrowed funds and, where regulation by the Federal Energy Regulatory Commission (FERC) exists, on internally generated funds. The weighted average rate used by regulated subsidiaries is calculated in accordance with FERC rules. Rates used by unregulated subsidiaries approximate the average interest rate on related debt. Interest capitalized on internally generated funds is included in Other income, net. Income Taxes - The Company follows a liability and asset approach in accounting for income taxes. Deferred tax liabilities 44 II-23 55 and assets are determined using the tax rate for the period in which those amounts are expected to be paid or received. (See Note 9.) Gas Supply Realignment Costs - Included in the Consolidated Statements of Cash Flows are gas supply realignment costs that were incurred by the Company to amend or terminate, or to purchase gas at above-market prices under its gas purchase contracts as a result of the separation of its sales, transportation and storage services mandated by FERC directive. Recent Accounting Pronouncements - In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 130, Reporting Comprehensive Income, which establishes standards for reporting and display of income and its components (revenue, expenses, gains, and losses) in a full set of general-purpose financial statements. The Company adopted SFAS No. 130 on January 1, 1998, and has presented comprehensive income for all periods presented in the Consolidated Statements of Changes in Stockholders' Equity. In June 1997, the FASB issued SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information, which establishes standards for the way public companies report information about operating segments in annual financial statements. SFAS No. 131, which is based on the management approach to segment reporting, also establishes requirements to report selected segment information quarterly and to report entity-wide disclosures about products and services, major customers and the countries in which the entity holds assets and reports revenue. The Company adopted SFAS No. 131 on January 1, 1998. (See Note 13.) NOTE 2 Change in Method of Accounting for Oil and Gas Operations In September 1998, the Company changed its accounting method for oil and gas operations as conducted by its subsidiaries, Sonat Exploration Company and Sonat Exploration GOM (Sonat Exploration), from the successful efforts method to the full cost method because its capital spending is focused significantly more on exploration activity than in the past. Full cost accounting, which amortizes rather than expenses dry-hole exploration and other related costs, provides a more appropriate method of matching revenues and expenses for the Company's exploration strategy. The Company has restated all prior consolidated financial statements as a result of the conversion to full cost accounting. As a part of this process, all previous charges related to the impairment of Sonat Exploration's assets, including those taken in 1998, were reversed, which significantly raised the book value of those properties as well as the Company's stockholders' equity. The full cost method, however, requires quarterly ceiling tests to ensure that the carrying value of oil and gas properties is not overstated. Sonat Exploration performed ceiling tests for each of the 1998 quarters. At March 31, 1998, June 30, 1998, and September 30, 1998, it was determined that capitalized costs exceeded the ceiling test limits by $39.7 million, $540.5 million and $455.0 million, respectively, which are included as ceiling test charges in the Consolidated Statement of Operations. Future quarterly full cost ceiling tests will be based on the then-current NYMEX prices for both natural gas and oil, after adjustments. Since the net carrying value of the Company's oil and natural gas properties has been reduced due to the full cost ceiling limitation such that the present value of the Company's proved oil and gas reserves does not exceed the Company's net oil and natural gas properties recorded on its balance sheet, there is an increased risk of future property write-downs due to factors that negatively affect the estimated present value of proved oil and gas reserves, including volatile oil and natural gas prices, downward revisions in estimated proved oil and natural gas quantities and unsuccessful exploratory operations (see Note 16). The effect of the accounting change on net income (loss) is as follows:
(In Thousands, Except Per-Share Amounts) ----------------------------------------- Years Ended December 31, 1998 1997 1996 - ---------------------------------------------------------------------------- Effect on: Net income $(258,351) $130,584 $18,006 Earnings (loss) per share of common stock (2.35) 1.19 .16 Earnings (loss) per share of common stock - assuming dilution (2.35) 1.17 .16 - ----------------------------------------------------------------------------
The effect of the accounting change on earnings by quarter for 1998 and 1997 is as follows (per-share amounts are on a diluted basis):
(In Thousands, Except Per-Share Amounts) ------------------------------------------------ Amount Per Share Amount Per Share 1998 1997 - ------------------------------------------------------------------- First $ (10,063) $ (.09) $17,672 $.16 Second (57,317) (.52) 19,454 .17 Third (250,164) (2.27) 57,732 .52 Fourth 59,193 .54 35,726 .32 - -------------------------------------------------------------------
45 II-24 56 Notes to Consolidated Financial Statements NOTE 3 Changes in Operations Business Combination - On January 30, 1998, following a special shareholders' meeting, the Company completed the merger with Zilkha Energy Company by exchanging approximately 24.2 million common shares for all of the outstanding shares of Zilkha Energy. Zilkha Energy was a privately owned exploration and production company. Immediately thereafter Zilkha Energy's name was changed to Sonat Exploration GOM Inc. The merger constituted a tax-free reorganization and has been accounted for as a pooling-of-interests under APB No. 16. Accordingly, all prior period consolidated financial statements and notes have been restated to include Sonat Exploration GOM in the Company's consolidated financial statements for all periods presented. There were no transactions between Sonat and Sonat Exploration GOM prior to the combination. Certain changes were made to the Sonat Exploration GOM financial statements to conform to Sonat's basis of accounting presentation. The following are the revenues and net income (loss) for the previously separate companies and the combined amounts presented in these consolidated financial statements.
(In Thousands) ----------------------------------------------- Month of Years Ended December 31, January 1998 1997 1996 - ------------------------------------------------------------------------- Revenues: Sonat Inc. $380,302 $4,175,218 $3,038,425 Sonat Exploration GOM 14,186 197,279 165,185 - ------------------------------------------------------------------------- Combined $394,488 $4,372,497 $3,203,610 ========================================================================= Net Income (Loss): Sonat Inc. $ 13,459 $ 219,011 $ 213,409 Sonat Exploration GOM 3,492 (1,015) 42,431 - ------------------------------------------------------------------------- Combined $ 16,951 $ 217,996 $ 255,840 =========================================================================
In connection with the merger, Sonat Exploration GOM recorded charges of $50.4 million ($32.7 million after taxes) to operating expenses in 1997 for direct and other merger-related costs pertaining to the merger transaction. At December 31, 1997, Sonat Exploration GOM had accrued $73.8 million, which represented compensation due to certain employees under deferred compensation plans. The liability was estimated based on the fair market value of Sonat Exploration GOM as of December 31, 1997. The Company's restricted cash deposit at December 31, 1997, reflected on the Consolidated Balance Sheet was used to settle this liability and certain other merger-related expenses. During the years ended December 31, 1997 and 1996, $61.8 million and $12.0 million, respectively, were expensed related to the deferred compensation plans. All debt of Sonat Exploration GOM was paid off in connection with the merger. Sonat Exploration Restructuring - On April 23, 1998, the Company announced a restructuring of Sonat Exploration. The restructuring included significant property sales and certain cost-reduction activities associated with a reduction in work force. Oil and natural gas properties having approximately 430 billion cubic feet of natural gas equivalent reserves and daily net production of approximately 170 million cubic feet of natural gas equivalent were sold. A pretax restructuring charge of $15.0 million for restructuring expenses primarily associated with a reduction in work force was recognized in the second quarter of 1998. All work force reductions have been completed. NOTE 4 Financial Instruments Derivative Commodity Instruments Held or Issued for Trading Purposes The Company maintains active trading positions in natural gas and crude oil commodity futures, swap and option contracts. The Company manages its trading positions with strict policies and procedures and limits its risk to changes in the value of its outstanding positions through the use of Value-at-Risk models and the establishment of offsetting positions. The trading operation also enters into natural gas commodity purchase and sale commitments. These activities constitute its trading business and are essential to provide customers with market products at competitive prices. At December 31, 1998 and 1997, the Company's trading portfolio had outstanding energy commodity futures, swaps and options. In the table below, buys of swaps represent either 1) payment of fixed price and receipt of NYMEX or index; or 2) payment of NYMEX or index and receipt of index. The absolute notional volumes and terms are:
1998 ------------------------------------- Notional Volume Maximum ---------------- Commodity Buy Sell Term - --------------------------------------------------------------------------- Natural Gas (TBtu) 1,506 1,454 60 months Crude Oil (Thousands of Barrels) 5,640 2,310 60 months - ---------------------------------------------------------------------------
The 60-month term deals begin in 2002 and end in 2006.
1997 ------------------------------------- Notional Volume Maximum ---------------- Commodity Buy Sell Term - --------------------------------------------------------------------------- Natural Gas (TBtu) 372 284 33 months - ---------------------------------------------------------------------------
46 II-25 57 The 33-month term deals were ongoing at December 31, 1997, and end in 2000. The amounts disclosed in the following table represent the end-of-period fair value and the average fair value of the natural gas trading portfolio.
In Thousands) ----------------------------------------------------- Fair Value (Carrying Amount) Average Fair Value as of for the Year Ended ----------------------------------------------------- December 31, 1998 1997 1998 1997 - -------------------------------------------------------------------------- Assets $255,495 $101,788 $140,774 $52,899 Liabilities 236,192 90,412 126,236 49,848 - --------------------------------------------------------------------------
Net trading gains for 1998 and 1997 are $13.1 million and $15.0 million, respectively. Derivative Commodity Instruments Held or Issued for Purposes Other Than Trading In certain cases derivative positions are taken specifically to mitigate market price risk associated with significant physical transactions and are accounted for using hedge accounting provided they meet hedge accounting criteria. Sonat Exploration hedges a portion of its production by entering into intercompany swaps with Sonat Marketing Company L.P. (Sonat Marketing). The exposure that Sonat Marketing assumes from Sonat Exploration is then hedged by entering into derivative instruments with third parties. Sonat Marketing and Sonat Power Marketing also hedge third-party purchases and sales by entering into commodity futures, swaps and options. At December 31, 1998 and 1997, the Company had outstanding energy commodity futures, swaps and options for purposes other than trading. In the table below, buys of swaps represent either 1) payment of fixed price and receipt of NYMEX or index; or 2) payment of NYMEX or index and receipt of index. The absolute notional volumes and terms are:
1998 ------------------------------------- Notional Volume Maximum ---------------- Commodity Buy Sell Term - --------------------------------------------------------------------------- Natural Gas (TBtu) 17 103 24 months Electricity (Thousands of MWh) 39 45 4 months - ---------------------------------------------------------------------------
The 24-month term deals were ongoing at December 31, 1998 and end in 2000.
1997 ------------------------------------- Notional Volume Maximum ---------------- Commodity Buy Sell Term - --------------------------------------------------------------------------- Natural Gas (TBtu) 38 214 58 months Crude Oil (Thousands of Barrels) -- 480 12 months - ---------------------------------------------------------------------------
The 58-month term deals were ongoing at December 31, 1997 and end in 2002. The information in the following table represents the fair value of outstanding financial derivative positions held for purposes other than trading. Not included are the related physical positions that these derivative positions hedge.
(In Thousands) --------------------------- Fair Value as of December 31, 1998 1997 - --------------------------------------------------------------------------- Natural Gas: Futures $ (439) $ (873) Swaps (7,158) (27,458) Options -- (516) Electricity: Futures 1 -- Options 12 -- - ---------------------------------------------------------------------------
Deferred amounts on open futures positions will mature over 1999 and 2000. Credit Risk from Derivative Activities NYMEX traded futures are guaranteed by the NYMEX and have nominal credit risk. On all other transactions described above, the Company is exposed to credit risk in the event of nonperformance by the counterparties. The Company has established policies and procedures to evaluate potential counterparties for creditworthiness before entering into over-the-counter swap and option agreements. The credit risk resulting from in-the-money swaps is monitored on a regular basis against established collateralization limits and credit limits established by the Company. Due to changes in market conditions, the market value of swaps and options and the associated credit exposure with the counterparties can change significantly. At December 31, 1998, the market value of the Company's in-the-money swaps and options was $21.0 million, and two counterparties posted additional collateral in the amount of $.5 million. Reserves for credit risk are established as necessary. Financial Risk On January 22, 1996, the Company entered into a forward rate agreement to hedge the interest rate risk of an anticipated future borrowing under an existing shelf registration statement. In September 1996, due to revised expectations of external financing requirements, 50 percent of the forward rate agreement was liquidated resulting in a gain of $3.9 million. A gain of $2.4 million was recognized upon final settlement of this agreement in 1997. 47 II-26 58 Notes to Consolidated Financial Statements Note 4 (continued) Other Financial Instruments The carrying amounts and fair values of the Company's financial instruments, other than derivative instruments, are as follows:
(In Thousands) -------------------------------------- December 31, 1998 Carrying Amounts Fair Value - -------------------------------------------------------------------------- Cash and Cash Equivalents $ 7,104 $ 7,104 Notes Receivable 50,359 50,359 Investment in Debt and Equity Securities 47,130 47,511 Gas Supply Realignment Costs 2,562 2,562 Unsecured Notes 720,361 720,361 Long-Term Debt 1,209,319 1,258,370 - --------------------------------------------------------------------------
(In Thousands) -------------------------------------- December 31, 1997 Carrying Amounts Fair Value - -------------------------------------------------------------------------- Cash and Cash Equivalents $ 27,278 $ 27,278 Restricted Cash 115,956 115,956 Investment in Debt and Equity Securities 52,231 53,101 Gas Supply Realignment Costs 3,630 3,630 Unsecured Notes 446,721 446,721 Long-Term Debt 1,250,492 1,294,854 - -------------------------------------------------------------------------------
The following methods and assumptions were used by the Company in estimating its fair value disclosures for balance sheet financial instruments: Cash and cash equivalents, restricted cash, notes receivable, gas supply realignment (GSR) costs and unsecured notes - The carrying amount reported in the Consolidated Balance Sheets approximates its fair value. Investment in debt and equity securities - The fair values for marketable debt and equity securities are based on quoted market prices. Long-term debt - The fair values of the Company's long-term debt are based on quoted market values or estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. All of the Company's financial instruments, other than certain derivative instruments, are held for purposes other than trading. The Company's financial instruments that are exposed to concentrations of credit risk consist primarily of cash equivalents, investments and accounts receivable. The Company's cash equivalents, restricted cash deposits and short-term investments represent securities placed with various high investment grade institutions. This investment practice limits the Company's exposure to concentrations of credit risk. Accounts receivable of the Exploration and Production segment are primarily from joint-interest partners, oil and gas marketing companies and pipeline companies. A majority of its revenues are from Sonat Marketing, which is headquartered in the Southeast. Accounts receivable of the Natural Gas Transmission segment relate to business conducted with gas distribution companies, municipalities, gas districts, industrial customers and interstate pipeline companies in the Southeast. Accounts receivable of the Energy Services segment primarily relate to trading with other marketing companies, industrial end users and local distribution companies, with primary concentration in the Gulf Coast, Southeastern, Northeastern and Midwestern markets. The Company performs ongoing credit evaluations of its customers' financial condition and, in some circumstances, requires collateral from its customers. Accounts receivable are stated net of valuation allowances of $9.3 million in 1998 and $8.2 million in 1997. NOTE 5 Inventories The table below shows the values of various categories of the Company's inventories by segment.
(In Thousands) --------------------------- December 31, 1998 1997 - ---------------------------------------------------------------- Exploration and Production: Materials and supplies $15,560 $16,954 Natural Gas Transmission: Materials and supplies 20,190 21,529 Energy Services: Materials and supplies 210 247 Gas stored underground 33,125 26,418 Other 8 13 - ---------------------------------------------------------------- $69,093 $65,161 ================================================================
NOTE 6 Unconsolidated Affiliates At December 31, 1998, the Company's investments in unconsolidated affiliates totaled $635.7 million, and the Company's share of underlying equity in net assets of the investees was $691.3 million. The difference is primarily due to the excess over cost of the Company's share of the underlying equity in net assets of Citrus Corp., which is being amortized over the depreciable life of Citrus' assets. Through December 31, 1998, the Company's cumulative equity in earnings of these unconsolidated affiliates was $377.9 million and cumulative dividends received from them totaled $182.8 million. 48 II-27 59 The following table presents the components of equity in earnings of unconsolidated affiliates:
(In Thousands) --------------------------------------------- Years Ended December 31, 1998 1997 1996 - ------------------------------------------------------------------------------------ COMPANY'S SHARE OF REPORTED EARNINGS (LOSSES) Exploration and Production $ 455 $ 445 $ 408 - ------------------------------------------------------------------------------------ Natural Gas Transmission: Citrus Corp. (including $1,383,000 of amortization of basis difference each year) 24,371 28,676 22,902 Bear Creek Storage 9,531 10,679 10,184 Destin 9,968 1,276 -- Other 167 (106) (554) - ------------------------------------------------------------------------------------ 44,037 40,525 32,532 - ------------------------------------------------------------------------------------ Energy Services 2,885 817 9 - ------------------------------------------------------------------------------------ Other 1,400 1,234 1,262 - ------------------------------------------------------------------------------------ $48,777 $ 43,021 $ 34,211 ====================================================================================
Natural Gas Transmission Affiliates - Sonat owns 50 percent of Citrus, the parent company of Florida Gas Transmission Company. Southern owns a one-third interest in Destin Pipeline Company, L.L.C. (Destin) and a subsidiary of Southern owns 50 percent of Bear Creek Storage Company, an underground gas storage company. The following is summarized financial information for Citrus:
(In Thousands) ---------------------------------------------- Years Ended December 31, 1998 1997 1996 - -------------------------------------------------------------------------------- Revenues $591,005 $735,402 $769,860 Expenses: Natural gas cost 269,818 416,953 429,367 Operating expenses 102,001 107,370 94,573 Depreciation and amortization 51,771 60,470 83,563 Interest and other 92,715 78,563 92,079 Income taxes 28,726 17,460 27,240 - -------------------------------------------------------------------------------- Income Reported $ 45,974 $ 54,586 $ 43,038 ================================================================================
(In Thousands) --------------------------------- December 31, 1998 1997 - -------------------------------------------------------------------------------- Assets: Current $ 81,133 $ 79,390 Net transmission plant and property 2,342,641 2,346,123 Other 83,629 67,671 - -------------------------------------------------------------------------------- $2,507,403 $2,493,184 ================================================================================ Liabilities and Equity: Current $ 300,368 $ 132,134 Long-term debt and other liabilities 1,296,735 1,496,724 Stockholders' equity 910,300 864,326 - -------------------------------------------------------------------------------- $2,507,403 $2,493,184 ================================================================================
The following is summarized financial information for Bear Creek. No provision for income taxes has been included since its income taxes are paid directly by the joint venture participants.
(In Thousands) ------------------------------------------- Years Ended December 31, 1998 1997 1996 - ----------------------------------------------------------------------------- Revenues $35,744 $36,226 $36,258 Expenses: Operating expenses 6,819 4,440 4,817 Depreciation 5,441 5,430 5,415 Other expenses, net 4,422 4,997 5,657 - ----------------------------------------------------------------------------- Income Reported $19,062 $21,359 $20,369 =============================================================================
(In Thousands) ---------------------------- December 31, 1998 1997 - ------------------------------------------------------------- Assets: Current $ 11,687 $ 6,503 Net plant and property 144,519 149,334 Other -- 296 - ------------------------------------------------------------- $156,206 $156,133 ============================================================= Liabilities and Equity: Current $ 7,968 $ 8,298 Long-term debt and other liabilities 43,140 48,799 Participants' equity 105,098 99,036 - ------------------------------------------------------------- $156,206 $156,133 =============================================================
In 1995, Southern executed a Capital Contribution Agreement in connection with the project financing for Bear Creek from The Prudential Insurance Company of America. In the event that Bear Creek does not refinance the remaining principal, this agreement provides that Southern and its partner will contribute $21.0 million each to Bear Creek on October 31, 2000, to provide funds to enable Bear Creek to make a principal payment due under the financing. In April 1997, units of Shell Oil Company and BP Amoco Corporation joined with Southern Natural Gas in the ownership of Destin, a 1 billion-cubic-foot-per-day pipeline designed to transport natural gas from deep-water areas in the eastern Gulf of Mexico. Construction of the pipeline began in December 1997. Destin was partially completed and placed in service in September 1998 and was fully in service in March 1999. The FERC has approved two extensions of Destin which extend its pipeline by 49 II-28 60 Notes to Consolidated Financial Statements Note 6 (continued) 43 miles. The following is summarized financial information for Destin.
(In Thousands) ---------------------------- Years Ended December 31, 1998 1997 - -------------------------------------------------------------------- Revenues $ 11,978 $1,049 Expenses (Income): Operating expenses 820 -- Depreciation and amortization 641 -- Interest and other (19,388) 2,778 - -------------------------------------------------------------------- Income Reported $ 29,905 $3,827 ====================================================================
(In Thousands) ----------------------------- December 31, 1998 1997 - ---------------------------------------------------------------------------- Assets: Current $ 23,867 $ 54,885 Net transmission plant and property 417,102 81,864 Other 12,626 1,429 - ---------------------------------------------------------------------------- $453,595 $138,178 ============================================================================ Liabilities and Equity: Current $140,792 $ 4,315 Long-term debt and other liabilities 19,571 2,236 Stockholders' equity 293,232 131,627 - ---------------------------------------------------------------------------- $453,595 $138,178 ============================================================================
In November 1998 Destin issued bonds to the Mississippi Business Finance Corporation (MBFC) in the amount of $135.0 million. The three members of Destin each purchased $45.0 million of these bonds from the MBFC, which loaned the proceeds from the sale of the bonds to Destin. Destin used the proceeds from this loan to finance the construction of its pipeline project, which allowed it to return invested capital to its three members. NOTE 7 Plant, Property and Equipment and Depreciation Plant, property and equipment, by business segment, is shown in the following table:
(In Thousands) -------------------------------- December 31, 1998 1997 - ---------------------------------------------------------------------------- Exploration and Production: Costs subject to amortization $5,420,473 $5,022,140 Costs not subject to amortization 148,615 201,208 - ---------------------------------------------------------------------------- 5,569,088 5,223,348 - ---------------------------------------------------------------------------- Natural Gas Transmission: Mainline transmission property 1,642,291 1,295,247 Gas supply 506,965 660,700 Gas gathering 10,261 16,568 Underground storage facilities 61,494 60,684 Liquefied natural gas facilities 154,076 154,076 Other 297,138 269,498 - ---------------------------------------------------------------------------- 2,672,225 2,456,773 - ---------------------------------------------------------------------------- Energy Services: Intrastate pipeline 56,012 55,834 Other 32,168 22,334 - ---------------------------------------------------------------------------- 88,180 78,168 - ---------------------------------------------------------------------------- Other 70,441 72,408 - ---------------------------------------------------------------------------- $8,399,934 $7,830,697 ============================================================================
Plant, property and equipment includes construction work in progress of $142.6 million and $137.1 million at December 31, 1998 and 1997, respectively. Plant, property and equipment also includes $142.1 million and $130.1 million of gas stored underground at December 31, 1998 and 1997, respectively. The accumulated depreciation, depletion and amortization amounts, by business segment, are as follows:
(In Thousands) --------------------------------- December 31, 1998 1997 - ---------------------------------------------------------------------------- Exploration and Production $4,093,898 $2,700,122 - ---------------------------------------------------------------------------- Natural Gas Transmission: Mainline transmission property 866,198 844,885 Gas supply 449,485 434,205 Gas gathering 6,206 11,072 Underground storage facilities 47,850 45,869 Liquefied natural gas facilities 123,802 118,981 Other 40,449 42,815 - ---------------------------------------------------------------------------- 1,533,990 1,497,827 - ---------------------------------------------------------------------------- Energy Services: Intrastate pipeline 29,727 26,819 Other 10,570 6,435 - ---------------------------------------------------------------------------- 40,297 33,254 - ---------------------------------------------------------------------------- Other 35,582 33,714 - ---------------------------------------------------------------------------- $5,703,767 $4,264,917 ============================================================================
50 II-29 61 The annual depreciation rates or useful productive lives, by business segment, are as follows:
1998 1997 1996 - ---------------------------------------------------------------------------------------- Natural Gas Transmission: Mainline transmission property 2.0% 2.0% 2.0% Gas supply 2.9% 2.9% 2.9% Gas gathering 2.8% 2.8% 2.8% Underground storage facilities 3.3% 3.3% 3.3% Liquefied natural gas facilities 3.2% 3.2% 3.2% Energy Services Intrastate pipeline 20 yrs. 20 yrs. -- Other 5 yrs. 5 yrs. 5 yrs. Other 5-38 yrs. 5-38 yrs. 5-38 yrs. ========================================================================================
Under the full cost method, all productive and non-productive costs incurred in connection with the acquisition, exploration and development of oil and gas reserves are capitalized and amortized on the unit-of-production method using proved reserves. Certain unevaluated properties are excluded from the amortization base until a determination has been made as to the existence of proved reserves. Also included in amortization on a unit-of-production basis are the estimated future dismantlement and abandonment costs and estimated future development costs for proved undeveloped reserves. During the first quarter of 1998, the Company recognized the effect of a change in salvage values, including reversal of excess depreciation expense, relating to certain fixed assets, primarily aircraft and vehicles. The change, which was to comply with FERC directives, reduced the loss for the year ended December 31, 1998, by approximately $4.6 million. NOTE 8 Debt and Lines of Credit Long-Term Debt - Long-term debt consists of:
(In Thousands) ------------------------------------- December 31, 1998 1997 - ----------------------------------------------------------------------------------------- Sonat Inc. Revolving Credit Agreement at rates based on prime, international or money-market lending rates (an effective rate of 6.14% at December 31, 1997) expiring on June 30, 2001 $ -- $ 130,000 6.75% Notes due October 1, 2007 100,000 100,000 6 7/8% Notes due June 1, 2005 200,000 200,000 9 1/2% Notes due August 15, 1999 100,000 100,000 6 5/8% Notes due February 1, 2008 100,000 -- 7% Notes due February 1, 2018 100,000 -- 9% Notes due May 1, 2001 100,000 100,000 8.24% Senior Notes due through December 31, 2000 4,100 6,200 Sonat Exploration GOM Inc. Senior Revolving Credit Facility (an effective rate of 7.22% at December 31, 1997) expiring on October 31, 1999 -- 145,000 10.6% Senior Subordinated Notes due July 26, 2001 -- 50,000 Southern Natural Gas Company 6.125% Notes due September 15, 2008 100,000 -- 6.70% Notes due October 1, 2007 100,000 100,000 7.85% Notes due January 15, 2002 100,000 100,000 8 5/8% Notes due May 1, 2002 100,000 100,000 8 7/8% Notes due February 15, 2001 100,000 100,000 Southern LNG Inc. Promissory Note (an effective rate of 6.75% at December 31, 1998 and 1997) due through April 1, 1999 5,000 10,000 Capital Leases and Other 3,754 11,042 - ----------------------------------------------------------------------------------------- Total Outstanding 1,212,854 1,252,242 Less Long-Term Debt Due Within One Year (109,835) (14,508) Less Unamortized Debt Discount (3,535) (1,750) - ----------------------------------------------------------------------------------------- $ 1,099,484 $ 1,235,984 =========================================================================================
51 II-30 62 Notes to Consolidated Financial Statements Note 8 (continued) Annual maturities of long-term debt at December 31, 1998, are as follows:
Years (In Thousands) - -------------------------------------------------------------------- 1999 $ 109,835 2000 2,805 2001 200,214 2002 200,000 2003 -- 2004-2018 700,000 - -------------------------------------------------------------------- $1,212,854 ====================================================================
Sonat has a bank revolving credit agreement that provides for periodic borrowings and repayments of up to $500.0 million through June 30, 2001. Borrowings are supported by unsecured promissory notes that, at the option of the Company, will bear interest at the banks' prevailing prime or international lending rate, or such rates as the banks may competitively bid. During 1998, $200.0 million was borrowed and $330.0 million was repaid under the revolving credit agreement, resulting in no balance outstanding at December 31, 1998. In January 1998, Sonat made two public offerings of Notes pursuant to a shelf registration statement. In one offering, Sonat issued $100.0 million of 6 5/8 percent Notes due February 1, 2008, at 99.531 percent to yield 6.69 percent. In the other offering, Sonat issued $100.0 million of 7 percent Notes due February 1, 2018, at 99.787 percent to yield 7.02 percent. The net proceeds from the offerings were used for general corporate purposes, including capital expenditures, working capital and repayment of debt. In September 1998, Southern Natural Gas made a public offering of $100.0 million of its 6.125 percent Notes due September 15, 2008, at 99.531 percent to yield 6.189 percent. The net proceeds from the offering were used for general corporate purposes, including capital expenditures. Unsecured Notes - Loans under all short-term credit facilities are for a duration of less than three months. At December 31, 1998, Sonat had short-term lines of credit of $700.0 million available through January 25, 1999. Southern Natural Gas had short-term lines of credit of $50.0 million available through May 31, 1999. Borrowings are available for a period of not more than 364 days and are in the form of unsecured promissory notes that bear interest at rates based on the banks' prevailing prime, international or money-market lending rates. At December 31, 1998, Sonat had $24.3 million outstanding under its agreement at a rate of 5.87 percent. No amounts were outstanding under Southern Natural Gas' agreement. In late January 1999, Sonat completed a new 364-day $400.0 million revolving credit facility with 11 banks. In connection with this new credit facility, the Company terminated existing lines of credit providing for up to $700.0 million of borrowings. Sonat had $696.1 million and $446.6 million, respectively, in commercial paper outstanding at average rates of 5.96 percent and 6.31 percent at December 31, 1998 and 1997, respectively. NOTE 9 Income Taxes An analysis of the Company's income tax expense (benefit) is as follows:
(In Thousands) -------------------------------------------------- Years Ended December 31, 1998 1997 1996 - ---------------------------------------------------------------------------------------- Current: Federal $ 18,548 $ 12,435 $ 18,841 State 5,690 8,067 4,021 - ---------------------------------------------------------------------------------------- 24,238 20,502 22,862 - ---------------------------------------------------------------------------------------- Deferred: Federal (325,663) 82,777 94,911 State 3,677 2,472 5,391 - ---------------------------------------------------------------------------------------- (321,986) 85,249 100,302 - ---------------------------------------------------------------------------------------- Income Tax Expense (Benefit) $(297,748) $105,751 $123,164 ========================================================================================
Net deferred tax liabilities are comprised of the following:
(In Thousands) ------------------------------- December 31, 1998 1997 - -------------------------------------------------------------------------- Deferred Tax Liabilities: Depreciation $240,098 $ 585,314 Inventories 11,130 11,573 Other 17,078 10,468 - -------------------------------------------------------------------------- Total deferred tax liabilities 268,306 607,355 - -------------------------------------------------------------------------- Deferred Tax Assets: GSR and other transition costs 8,531 10,210 Employee benefits 7,708 36,607 Net operating loss carryforwards 33,098 46,065 Tax credit carryforwards 22,859 14,713 Other accounting accruals 12,066 7,954 Other 20,080 17,361 - -------------------------------------------------------------------------- 104,342 132,910 Less valuation allowance -- (11,505) - -------------------------------------------------------------------------- Total deferred tax assets 104,342 121,405 - -------------------------------------------------------------------------- Net Deferred Tax Liabilities $163,964 $ 485,950 ==========================================================================
52 II-31 63 In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. During 1998, the Company removed its valuation allowance related to net operating loss carryforwards because based on the weight of available evidence, it is more likely than not that the remaining deferred tax assets will be realized. At December 31, 1998, the Company had available net operating loss carryforwards of approximately $94.6 million for income tax purposes which expire between 2001 and 2017. The Company has tax credit carryforwards of approximately $22.9 million which can be carried forward indefinitely. Consolidated income tax expense (benefit) is different from the amount computed by applying the U.S. federal income tax rate to income (loss) before income tax. The reasons for this difference are as follows:
(In Thousands) ------------------------------------------------- Years Ended December 31, 1998 1997 1996 - ------------------------------------------------------------------------------------------ Income Tax Expense (Benefit) at Statutory Federal Income Tax Rates $(289,893) $ 113,311 $ 132,651 Increases (Decreases) Resulting From: State income taxes, net of federal income tax benefit 6,089 6,851 6,118 Non-conventional fuel tax credits (6,844) (7,220) (9,465) Refunds and adjustment of accrued tax position (110) 47 880 Dividend exclusion (6,824) (8,029) (6,413) Other (166) 791 (607) - ------------------------------------------------------------------------------------------ Income Tax Expense (Benefit) $(297,748) $ 105,751 $ 123,164 ==========================================================================================
NOTE 10 Commitments and Contingencies Rate Matters - Periodically, Southern makes general rate filings with the FERC to provide for the recovery of cost of service and a return on equity. The FERC normally allows the filed rates to become effective, subject to refund, until it rules on the approved level of rates. Southern provides reserves relating to such amounts collected subject to refund, as appropriate, and makes refunds upon establishment of the final rates. At December 31, 1998, Southern's rates are established by a settlement that was approved by FERC orders issued in 1995 and 1996. All of its customers are parties to the settlement, and all revenue is based on the final settlement rates and therefore is not being collected subject to refund. Other Matters - In September 1998, West Georgia Generating Company L.P., formerly Cataula Generating Company, L.P. (West Georgia), acquired the right to develop a 680-megawatt peaking plant in west central Georgia and an associated contract to sell a significant portion of the plant's output to Georgia Power Company. Although West Georgia originally planned to develop the plant in Harris County, Georgia, as a result of the revocation by the Harris County Board of Commissioners of the previously issued special-use permit, West Georgia is in the process of finalizing alternate sites for the location of the plant. If the project experiences additional delays in site finalization, permitting or construction, it could result in an inability to have the plant available in time to meet its obligation to make 205 megawatts of electric capacity available to Georgia Power beginning June 1, 2000. In that event, West Georgia would be required to source electric capacity from the market at prices in excess of the prices received from Georgia Power. However, West Georgia anticipates that it will be successful in relocating the plant to one of its alternative sites and commencing construction in time to meet its contractual commitments to Georgia Power. 53 II-32 64 Notes to Consolidated Financial Statements Note 10 (continued) Sonat Marketing was formed in September 1995 and is jointly owned by a subsidiary of the Company and a subsidiary of AGL Resources, Inc. Sonat's wholly owned subsidiary, Sonat Marketing Company, contributed all of its assets and liabilities except $32.0 million of accounts receivable in exchange for a 65 percent ownership interest in Sonat Marketing, and a subsidiary of AGL Resources, contributed $32.0 million in cash to Sonat Marketing in exchange for a 35 percent ownership interest. AGL Resources has certain rights to resell to the Company its interest in Sonat Marketing, including a right until August 31, 2000, to receive the greater of fair market value or a formula price. The pretax gain on the transaction of approximately $23 million, which is included in Other Deferred Credits in the Consolidated Balance Sheets, has been deferred. Leases - The Company has operating lease commitments expiring at various dates, principally for office space and equipment. The Company has no significant capital leases. Rental expense for all operating leases is summarized below. Rental Expense
(In Thousands) ----------------------------- Years Ended December 31, 1998 1997 1996 - ----------------------------------------------------------------- Non-Affiliated Operating Leases $19,904 $20,377 $18,444 Affiliated Operating Leases 3,950 3,544 3,680 - ----------------------------------------------------------------- $23,854 $23,921 $22,124 =================================================================
At December 31, 1998, future minimum payments for non-cancelable operating leases for the years 1999 through 2003 are $12 million or less per year. Future minimum rentals to be received under subleases for the years 1999 and 2000 are less than $2 million per year. NOTE 11 Capital Stock and Stock-Based Compensation Per-share prices of the Company's common stock, based on the New York Stock Exchange listing of composite transactions, and dividends paid per common share for the last two years are summarized below. Price Range and Dividends Paid Per Common Share
(Unaudited) --------------------------------------------- Quarter 1998 1997 - ----------------------------------------------------------------------- Price Range High-Low First $45 5/8 - $38 7/8 $57 - $45 1/2 Second 44 13/16 - 36 59 1/8 - 50 5/8 Third 38 9/16 - 25 7/8 54 1/4 - 45 3/8 Fourth 31 3/8 - 26 5/16 51 5/16 - 42 1/4 ======================================================================= Dividend Rate (Note) First $ .27 $ .27 Second .27 .27 Third .27 .27 Fourth .27 .27 - ----------------------------------------------------------------------- $ 1.08 $ 1.08 ======================================================================= Shareholders of Record at Year-End 10,589 11,258 =======================================================================
Note: The dividend rate is the actual rate paid per common share of Sonat stock, exclusive of shares issued for the merger in January 1998 (see Note 3). The Company had no restrictions on the payment of dividends at December 31, 1998. The Company has a Preference Share Rights Plan (the Plan) designed to protect the interest of stockholders in the event of a hostile attempt to take over the Company and to make it more difficult for a person to gain control of the Company in a manner or on terms not approved by the Board of Directors. The Plan provides for the issuance of one right with respect to each outstanding share of common stock. The rights issued under the Plan are redeemable at any time by the Company before their expiration on February 3, 2006, unless certain triggering events have occurred. The rights outstanding under the Plan are exercisable for one one-hundredth of a share of Series A Participating Preference Stock, par value $1.00, with each share having substantially the rights and preferences of 100 shares of common stock. As of December 31, 1998, 1,000,000 shares of Series A Participating Preference Stock were reserved for issuance under this Plan. 54 II-33 65 Earnings Per Share - The following table presents the computation of basic and diluted earnings (loss) per share of common stock:
(In Thousands, Except Per-Share Amounts) ----------------------------------------- Years Ended December 31, 1998 1997 1996 - --------------------------------------------------------------------------- Numerator: Net income (loss) $(530,517) $217,996 $255,840 =========================================================================== Denominator: Denominator for Basic Earnings (Loss) Per Share: Weighted average number of shares of common stock outstanding 110,020 110,099 110,370 Effect of Dilutive Securities: Common stock equivalents applicable to outstanding stock options (Note) -- 1,570 1,352 - --------------------------------------------------------------------------- Denominator for Earnings (Loss) Per Share - Assuming Dilution: Adjusted weighted average shares using treasury stock method for assumed conversions 110,020 111,669 111,722 =========================================================================== Earnings (Loss) Per Share of Common Stock $ (4.82) $ 1.98 $ 2.32 =========================================================================== Earnings (Loss) Per Share of Common Stock - Assuming Dilution $ (4.82) $ 1.95 $ 2.29 ===========================================================================
Note: The addition of 1,002,000 potential common shares for the 1998 period would be antidilutive in the computation of diluted earnings per share and are therefore not included. Executive Award Plan - The Company has an Executive Award Plan that provides awards to certain key employees in the form of stock options, restricted stock and stock appreciation rights (SARs) in tandem with any or all stock options. In years prior to 1991, tax offset payments were generally provided in conjunction with these awards. SARs permit the holder of an exercisable option to surrender that option for an amount equal to the excess of the market price of the common stock on the date of exercise over the option price (appreciation). The appreciation is payable in cash, common stock or a combination of both. SARs are subject to the same terms and conditions as the options to which they are related. Commencing in November 1995, the Company has issued, in tandem with its regular stock options, SARs that are exercisable only in the event of a change in control (limited SARs). In November 1995, the Company also issued limited SARs to certain key employees with respect to all of their then outstanding options. No other SARs have been issued since 1990. At December 31, 1998, 89,000 SARs relating to the earlier periods were outstanding. All options granted since December 1992 have 10-year terms and vest and become fully exercisable at the end of five years of continued employment. Options issued after 1992 also contain an acceleration provision dependent upon a specified increase in the Company's stock price. Options granted prior to December 1992 vested over three years and had no accelerated vesting provisions. The Company issued 18,400 shares of restricted stock with a $35.48 per share market value to employees during 1998, 80,100 shares with a $43 13/16 per share market value during 1997 and 97,000 shares with a $52.00 per share market value during 1996. At December 31, 1998, 229,798 of the 550,200 cumulative restricted shares issued have vested. A new plan was authorized during 1995 which made an additional four million shares available for issuance. The Company has elected to follow APB No. 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for its employee stock options. Under APB No. 25, compensation expense is recognized for the difference between the option price and market value on the measurement date for variable stock option awards and restricted stock grants. No compensation expense is recognized for options the Company issued after 1990 because the exercise price of the stock options equals the market price of the underlying stock on the date of grant. Stock-based compensation increased pretax income by $5.8 million in 1998 and $2.0 million in 1997 and decreased it by $13.2 million in 1996. Pro forma information regarding net income and earnings per share is required by SFAS No. 123, Accounting for Stock-Based Compensation, and has been determined as if the Company had 55 II-34 66 Notes to Consolidated Financial Statements Note 11 (continued) accounted for its employee stock options under the fair value method of the Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 1998, 1997 and 1996, respectively: interest rates (zero-coupon U.S. government issues with a remaining life of six years) of 4.95 percent, 5.93 percent and 6.10 percent; dividend yields of 3.54 percent, 2.47 percent and 2.35 percent; volatility factors of the expected market price of the Company's common stock of .292, .266 and .255; and a weighted-average expected life of the options of six years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. The Company's pro forma information follows:
(In Thousands, Except Per-Share Amounts) -------------------------------------------- Years Ended December 31, 1998 1997 1996 - ---------------------------------------------------------------------------- Net Income (Loss): As reported $ (530,517) $ 217,996 $ 255,840 Pro forma (533,027) 216,773 253,173 Earnings (Loss) Per Share: As reported $ (4.82) $ 1.98 $ 2.32 Pro forma (4.84) 1.97 2.29 Earnings (Loss) Per Share - Assuming Dilution: As reported $ (4.82) $ 1.95 $ 2.29 Pro forma (4.84) 1.94 2.27 ============================================================================
For purposes of the pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period, which is five years for the awards. However, since all of the 1995 stock option grants vested under an accelerated vesting clause in 1996, the entire remaining cost for that award is reflected in 1996. Because the Company's stock options vest generally over five years and additional awards are typically made each year, the above pro forma disclosures are not likely to be representative of the effects on pro forma net income or loss for future years. A summary of the Company's stock option activity and related information follows:
Years Ended December 31, 1998 - --------------------------------------------------------------------------- Weighted-Avg. Options Exercise Price - --------------------------------------------------------------------------- Outstanding - Beginning of Year 4,416,219 $32.74 Granted 1,323,100 30.48 Exercised (190,424) 19.80 Forfeited (68,480) 45.79 - --------------------------------------------------------------------------- Outstanding - End of Year 5,480,415 32.48 =========================================================================== Exercisable - End of Year 3,444,075 30.25 =========================================================================== Shares Authorized for Future Grants 1,561,000 =========================================================================== Fair Value of Options Granted During the Year $ 7.53 =========================================================================== 1997 - --------------------------------------------------------------------------- Weighted-Avg. Options Exercise Price - --------------------------------------------------------------------------- Outstanding - Beginning of Year 4,178,226 $30.16 Granted 712,400 43.81 Exercised (453,907) 25.69 Forfeited (20,500) 46.90 - --------------------------------------------------------------------------- Outstanding - End of Year 4,416,219 32.74 =========================================================================== Exercisable - End of Year 3,217,419 27.38 =========================================================================== Shares Authorized for Future Grants 2,884,700 =========================================================================== Fair Value of Options Granted During the Year $ 12.50 =========================================================================== 1996 - --------------------------------------------------------------------------- Weighted-Avg. Options Exercise Price - --------------------------------------------------------------------------- Outstanding - Beginning of Year 4,578,600 $25.24 Granted 633,700 52.00 Exercised (1,013,954) 21.58 Forfeited (20,120) 31.81 - --------------------------------------------------------------------------- Outstanding - End of Year 4,178,226 30.16 =========================================================================== Exercisable - End of Year 3,544,526 26.26 =========================================================================== Shares Authorized for Future Grants 3,597,100 =========================================================================== Fair Value of Options Granted During the Year $ 14.87 ===========================================================================
The following table summarizes information about stock options outstanding at December 31, 1998:
Options Outstanding ----------------------------------------- Weighted-Avg. Number Remaining Range of Exercise Outstanding Contractual Weighted-Avg. Prices 12/31/98 Life Exercise Price - ------------------------------------------------------------------- $ 13.625 - $17.4375 365,050 2.9 $16.31 $ 21.125 - $ 29.125 2,345,130 7.1 26.42 $ 30.00 - $ 32.25 1,266,815 5.8 30.99 $43.8125 - $ 52.00 1,503,420 8.6 47.14 - ------------------------------------------------------------------- 5,480,415 Options Exercisable --------------------------- Number Range of Exercise Exercisable Weighted-Avg. Prices 12/31/98 Exercise Price - --------------------------------------------------- $ 13.625 - $17.4375 365,050 $16.31 $ 21.125 - $ 29.125 1,262,630 25.54 $ 30.00 - $ 32.25 1,266,815 30.99 $43.8125 - $ 52.00 549,580 48.64 - --------------------------------------------------- 3,444,075 ===================================================
56 II-35 67 Directors' Restricted Stock Plan - The Company has a Restricted Stock Plan for non-employee members of the Board of Directors. Full rights vest over a maximum of five years. The Company issued 24,000 shares under this plan in 1998. The Company did not issue any shares under this plan during 1997 and 1996. At December 31, 1998, 35,860 of the 61,460 cumulative shares granted have vested. Treasury Stock - Shares held in treasury are being reissued in connection with employee stock options and restricted stock programs. Serial Preference Stock - At December 31, 1998 and 1997, there were 10,000,000 shares of $1.00 par value Serial Preference Stock authorized, with none issued. NOTE 12 Retirement Plans and Other Postemployment Benefits Retirement Plans - The Company has a trusteed, non-contributory, tax qualified defined benefit retirement plan (the Retirement Plan) covering substantially all employees of the Company. A supplemental benefit plan (the Supplemental Plan) that provides retirement benefits in excess of those allowed under the Company's tax qualified retirement plan is also in effect for the Company. Amounts are being placed in a trust established to provide benefits under the Supplemental Plan. However, this trust is not subject to any funding requirements. At December 31, 1998, this trust had assets with a fair market value of $47.5 million available to pay benefits. These assets are not considered plan assets under SFAS No. 87, Employers' Accounting for Pensions. The following tables set forth the benefit obligation and assets of the plans and the changes in the benefit obligation and plan assets:
(In Thousands) ------------------------ Years Ended December 31, 1998 1997 - -------------------------------------------------------------------- Change in Benefit Obligation: Benefit obligation at January 1, $ 372,687 $ 386,825 Service cost 10,892 7,848 Interest cost 28,209 26,858 Amendments (341) -- Actuarial loss (gain) 31,351 (25,959) Effect of curtailment (5,518) (3,096) Effect of special termination benefits 4,121 3,252 Benefits paid (24,020) (23,041) - -------------------------------------------------------------------- Benefit obligation at December 31, $ 417,381 $ 372,687 ==================================================================== Change in Plan Assets: Fair value at January 1, $ 550,982 $ 459,033 Return on plan assets 76,312 111,983 Contributions 3,395 3,007 Benefits paid (24,020) (23,041) - -------------------------------------------------------------------- Fair value at December 31, $ 606,669 $ 550,982 ====================================================================
The following table sets forth the funded status of the plans and the amount of the net pension asset or liability recognized in the Company's Consolidated Balance Sheets:
(In Thousands) ------------------------ December 31, 1998 1997 - -------------------------------------------------------------------- Funded Status $ 189,288 $ 178,295 Unrecognized Net Assets at Transition (7,612) (9,292) Unrecognized Net Gain (166,188) (172,566) Unrecognized Prior Service Cost 5,516 7,088 Net Unamortized Deferred Charge from Early Retirement Termination Benefits 453 598 - -------------------------------------------------------------------- Net Pension Asset Recognized in the Consolidated Balance Sheets $ 21,457 $ 4,123 ==================================================================== Total Recognized Amounts in the Consolidated Balance Sheets Consist of: Prepaid benefit cost $ 53,642 $ 33,170 Accrued benefit liability (33,893) (29,887) Intangible asset 1,255 242 Net unamortized deferred charge from early retirement termination benefits 453 598 - -------------------------------------------------------------------- $ 21,457 $ 4,123 ====================================================================
57 II-36 68 Notes to Consolidated Financial Statements Note 12 (continued) The projected benefit obligation and accumulated benefit obligation for the pension plan with accumulated benefit obligations in excess of plan assets were $51.1 million and $33.9 million, respectively, as of December 31, 1998, and $40.4 million and $29.9 million, respectively, as of December 31, 1997. The assumed rates used to measure the projected benefit obligations and the expected earnings of plan assets are:
Years Ended December 31, 1998 1997 1996 - ------------------------------------------------------------------ Discount Rate 7.0% 7.5% 7.0% Long-Term Rate of Return 10.5% 9.5% 9.5% Increase in Future Compensation Levels (Composite Rate): Retirement and Supplemental Plans 5.0% 5.0% 5.0% ==================================================================
The Company's net periodic pension income consists of the following components:
(In Thousands) ------------------------------------ Years Ended December 31, 1998 1997 1996 - -------------------------------------------------------------------- Service Cost $ 10,892 $ 7,848 $ 8,818 Interest Cost 28,209 26,858 26,550 Expected Return (48,586) (40,107) (37,795) Amortization of Prior Service Cost 816 868 868 Amortization of Net Asset at Transition (1,679) (1,679) (1,679) Amortization of Net Gain (3,054) (2,379) 76 Curtailment Gain (4,803) (2,959) -- Special Termination Benefits Loss 4,121 3,252 -- - -------------------------------------------------------------------- Net Periodic Pension Income $(14,084) $ (8,298) $ (3,162) ====================================================================
Other Postemployment Benefits - The Company has plans that provide for postretirement health care and life insurance benefits to substantially all of its employees when they retire. The Company accrues the cost of postretirement health care and life insurance benefits within the employees' active service periods. The Company has elected to amortize the transition obligation over a 20-year period. The following tables set forth the benefit obligation and assets of the Company's postretirement health care and life insurance plans and the changes in the benefit obligation and plan assets:
(In Thousands) ---------------------- Years Ended December 31, 1998 1997 - ------------------------------------------------------------------ Change in Benefit Obligation: Benefit obligation at January 1, $ 82,956 $ 95,027 Service cost 2,005 2,137 Interest cost 5,870 6,575 Plan participants' contributions 987 904 Actuarial loss (gain) 1,695 (14,833) Effect of curtailment (1,389) 233 Effect of special termination benefits 1,824 100 Benefits paid (6,836) (7,187) - ------------------------------------------------------------------ Benefit obligation at December 31, $ 87,112 $ 82,956 ================================================================== Change in Plan Assets: Fair value at January 1, $ 38,923 $ 32,595 Return on plan assets 6,276 4,109 Employer's contribution 9,614 8,502 Plan participants' contributions 987 904 Benefits paid (6,836) (7,187) - ------------------------------------------------------------------ Fair value at December 31, $ 48,964 $ 38,923 ==================================================================
The following table sets forth the funded status and amount of the net pension asset or liability at December 31, 1998 and 1997, for the Company's postretirement health care and life insurance plans:
(In Thousands) ---------------------- December 31, 1998 1997 - ------------------------------------------------------------------ Funded Status $(38,148) $(44,033) Unrecognized Net Obligation at Transition 43,151 51,994 Unrecognized Net Gain (32,918) (31,649) Net Unamortized Deferred Charge From Early Retirement Termination Benefit 1,442 1,980 - ------------------------------------------------------------------ Accrued Postretirement Benefit Liability $(26,473) $(21,708) ================================================================== Total Recognized Amounts in the Consolidated Balance Sheets Consist of: Prepaid benefit cost $ -- $ 204 Accrued benefit liability (27,915) (23,892) Net unamortized deferred charge from early retirement termination benefit 1,442 1,980 - ------------------------------------------------------------------ $(26,473) $(21,708) ==================================================================
58 II-37 69 The assumed rates used to measure the projected benefit obligation and the expected earnings of plan assets are:
Years Ended December 31, 1998 1997 1996 - -------------------------------------------------------- Discount Rate 7.0% 7.5% 7.0% Long-Term Rate of Return: Medical assets (after tax) 6.5% 5.5% 5.5% Life insurance assets 10.5% 7.5% 7.5% ========================================================
The rate of increase in the per capita costs of covered health care benefits is assumed to be 4.5 percent in 1999 and for all future years. The Company's net periodic cost for postretirement health care and life insurance benefits consists of the following components:
(In Thousands) ------------------------------------ Years Ended December 31, 1998 1997 1996 - --------------------------------------------------------------------------- Service Cost $ 2,005 $ 2,137 $ 2,161 Interest Cost 5,870 6,575 6,387 Expected Return on Plan Assets (2,772) (2,069) (1,617) Amortization of Net Obligation at Transition 3,469 3,597 3,597 Amortization of Net Gain (1,722) (820) (367) Curtailment Loss 4,180 1,866 -- Special Termination Benefits Loss 1,824 100 -- - --------------------------------------------------------------------------- $ 12,854 $ 11,386 $ 10,161 ===========================================================================
A one-percentage-point change in assumed health care cost trend rates would have the following effects:
(In Thousands) ---------------------------- 1-Percentage- 1-Percentage- Point Point Increase Decrease - ------------------------------------------------------------------------- Effect on total of service and interest cost components $1,156 $ (939) Effect on postretirement benefit obligation 8,964 (7,684) =========================================================================
NOTE 13 Business Segment Analysis The Company's consolidated financial statements reflect operations in three segments: Exploration and Production, Natural Gas Transmission and Energy Services. The Company is engaged in the exploration for and the acquisition, development and production of oil and natural gas through its Exploration and Production segment. The oil and gas properties of the Exploration and Production segment are located principally onshore in the Southern coastal states, in various states in the Southwest, and in federal waters offshore Louisiana and Texas. It derives a significant portion of its revenues from sales to Sonat Marketing (included in the Energy Services segment). The principal business of the Natural Gas Transmission segment is the transmission and storage of natural gas in interstate commerce. Its transmission systems are located in the Southeastern United States. Transportation service is provided for its distribution customers primarily for residential and commercial end use; industrial customers; electric generation companies; gas producers; other gas pipelines; and gas marketing and trading companies. It provides transportation service in both its gas supply and market areas. The principal industries served directly by the natural gas transmission segment's pipeline system and indirectly through its distribution customers' systems include the electric generation, fertilizer, chemical, pulp and paper, textile, primary metals, stone, clay and glass industries. The Energy Services segment is engaged primarily in natural gas and electric power marketing for industrial and commercial users, gas distribution companies and gas producers throughout the Gulf Coast, Southeastern, Midwestern and Northeastern United States and development of power systems and power plants. The Company's results of operations, revenues from major customers, capital expenditures and assets by business segment are shown in the following tables. Intersegment sales are primarily gas sales by the Exploration and Production segment and transportation revenue by the Natural Gas Transmission segment and are priced at market rates. The Company has no foreign operations. 59 II-38 70 Notes to Consolidated Financial Statements Note 13 (continued) Business Segment Analysis
(In Thousands) ------------------------------------------------------------ Exploration Natural and Gas Energy Year Ended December 31, 1998 Production Transmission Services Total - ---------------------------------------------------------------------------------------------------------------- Revenues from External Customers $ 173,874 $ 357,678 $ 3,191,320 $ 3,722,872 Intersegment Revenues 361,380 36,538 1,048 398,966 Interest Income 80 3,494 3,023 6,597 Interest Expense 78,071 40,114 4,255 122,440 Interest Capitalized 2,371 2,506 246 5,123 Depreciation, Depletion and Amortization 291,586 46,281 7,032 344,899 Unusual Items 1,050,195 -- -- 1,050,195 Equity in Earnings of Unconsolidated Affiliates 455 44,037 2,885 47,377 Earnings (Loss) Before Interest and Taxes (936,230) 233,268 (6,820) (709,782) Investment in Unconsolidated Affiliates 6,090 549,520 69,212 624,822 Segment Assets 1,635,597 1,961,994 762,547 4,360,138 Capital Expenditures 581,059 222,165 9,971 813,195 ================================================================================================================
(In Thousands) ------------------------------------------------- Exploration Natural and Gas Energy Year Ended December 31, 1997 Production Transmission Services Total - -------------------------------------------------------------------------------------------------------- Revenues from External Customers $ 345,520 $ 359,163 $3,725,186 $4,429,869 Intersegment Revenues 409,555 34,129 -- 443,684 Interest Income 1,261 2,233 2,670 6,164 Interest Expense 64,540 30,612 1,874 97,026 Interest Capitalized 5,599 1,849 -- 7,448 Depreciation, Depletion and Amortization 341,278 47,769 5,557 394,604 Unusual Items 50,374 -- -- 50,374 Equity in Earnings of Unconsolidated Affiliates 445 40,525 817 41,787 Earnings Before Interest and Taxes 180,972 225,905 7,063 413,940 Investment in Unconsolidated Affiliates 5,679 467,453 9,192 482,324 Segment Assets 2,764,381 1,757,851 744,626 5,266,858 Capital Expenditures 862,609 144,269 10,978 1,017,856 ========================================================================================================
(In Thousands) ----------------------------------------------------- Exploration Natural and Gas Energy Year Ended December 31, 1996 Production Transmission Services Total - ------------------------------------------------------------------------------------------------------------ Revenues from External Customers $319,730 $ 362,194 $2,589,468 $3,271,392 Intersegment Revenues 410,520 36,634 3,234 450,388 Interest Income 1,092 5,077 5,008 11,177 Interest Expense 57,059 38,060 984 96,103 Interest Capitalized 6,658 984 -- 7,642 Depreciation, Depletion and Amortization 332,129 48,292 1,729 382,150 Equity in Earnings of Unconsolidated Affiliates 408 32,532 9 32,949 Earnings Before Interest and Taxes 252,845 204,782 5,841 463,468 Capital Expenditures 620,100 130,418 4,736 755,254 ============================================================================================================
60 II-39 71 The following table reconciles the total of the Company's reportable segments' revenues to the Company's consolidated revenues:
(In Thousands) --------------------------------------------- Years Ended December 31, 1998 1997 1996 - -------------------------------------------------------------------------- Total Revenues for Reportable Segments $ 4,121,838 $ 4,873,553 $ 3,721,780 Other Revenues 17 15 (524) Elimination of Intersegment Revenues (398,966) (443,684) (450,388) Other Reclassifications (13,071) (57,387) (67,258) - -------------------------------------------------------------------------- Total Consolidated Revenues $ 3,709,818 $ 4,372,497 $ 3,203,610 ==========================================================================
The following table reconciles the total of the Company's reportable segments' earnings before interest and taxes (EBIT) to the Company's consolidated EBIT:
(In Thousands) ------------------------------------ Years Ended December 31, 1998 1997 1996 - ------------------------------------------------------------------- Total EBIT for Reportable Segments $(709,782) $413,940 $463,468 Other EBIT 7,772 6,999 4,423 - ------------------------------------------------------------------- Total Consolidated EBIT $(702,010) $420,939 $467,891 ===================================================================
The following table reconciles the total of the Company's reportable segments' assets to the Company's consolidated assets:
(In Thousands) ---------------------------- December 31, 1998 1997 - --------------------------------------------------------------------- Total Assets for Reportable Segments $ 4,360,138 $ 5,266,858 Other Assets 2,874,572 2,885,865 Elimination of Intercompany Receivables and Payables (2,850,311) (2,867,051) Other Eliminations (23,305) (33,558) - --------------------------------------------------------------------- Total Consolidated Assets $ 4,361,094 $ 5,252,114 =====================================================================
Revenues from Major Customers
(In Thousands) ---------------------------------- Years Ended December 31, 1998 1997 1996 - ------------------------------------------------------------------ Enron and affiliates: Exploration and production $ 63,265 $181,206 $167,843 Natural gas transmission 3 180 156 Energy services 157,950 264,399 202,130 - ------------------------------------------------------------------ $221,218 $445,785 $370,129 ================================================================== Atlanta Gas Light: Natural gas transmission $134,045 $130,425 $134,062 Energy services 17,303 51,069 54,191 - ------------------------------------------------------------------ $151,348 $181,494 $188,253 ================================================================== Alabama Gas Corporation: Natural gas transmission $ 47,956 $ 48,300 $ 38,662 Energy services 105,134 87,994 86,062 - ------------------------------------------------------------------ $153,090 $136,294 $124,724 ==================================================================
All of the major customers or their affiliates participate with the Company in certain joint venture operations. NOTE 14 Oil and Gas Operations (Unaudited) At December 31, 1998, the Company had interests in oil and gas properties that are located primarily in Texas, Louisiana, Oklahoma, Arkansas, Alabama, and offshore Louisiana and Texas in the Gulf of Mexico. The Company does not own or lease any oil and gas properties outside the United States. Capitalized costs relating to oil and gas producing activities and related accumulated depreciation, depletion and amortization were as follows: Capitalized Costs
(In Thousands) ------------------------- December 31, 1998 1997 - --------------------------------------------------------------- Oil and Gas Properties: Costs subject to amortization $5,420,473 $5,022,140 Costs not subject to amortization 148,615 201,208 - --------------------------------------------------------------- 5,569,088 5,223,348 Less Accumulated Depreciation, Depletion and Amortization 4,093,898 2,700,122 - --------------------------------------------------------------- $1,475,190 $2,523,226 ===============================================================
61 II-40 72 Notes to Consolidated Financial Statements Note 14 (continued) Costs incurred in oil and gas producing activities, whether capitalized or expensed, were as follows: Costs Incurred
(In Thousands) ---------------------------------- Years Ended December 31, 1998 1997 1996 - ----------------------------------------------------------------------- Property Acquisition Costs: Proved properties $ 1,592 $ 5,811 $ 61,441 Unproved properties 48,292 77,935 72,705 Exploration Costs 155,879 287,884 177,199 Development Costs 371,500 488,724 295,821 - ----------------------------------------------------------------------- Total Costs $577,263 $860,354 $607,166 =======================================================================
An analysis of the capitalized costs by year of expenditure of oil and gas properties that are not being amortized as of December 31, 1998, pending determination of proved reserves follows: Capitalized Costs Not Being Amortized
(In Thousands) --------------------------------------------------------------- Cumulative Costs Excluded for Cumulative Balance Years Ended Dec.31, Balance --------------------------------------------------------------- DEC. 31, 1998 1998 1997 1996 Dec. 31, 1995 - ---------------------------------------------------------------------------- Acquisition $ 93,931 $39,559 $24,220 $18,386 $11,766 Exploration 54,684 41,573 12,644 467 -- - ---------------------------------------------------------------------------- $148,615 $81,132 $36,864 $18,853 $11,766 ============================================================================
Projects presently excluded from amortization are in various stages of evaluation. The majority of these costs are expected to be included in the amortization calculation in the years 1999 through 2003. Total amortization expense, including ceiling test charges, per unit of production was $4.81, $1.41, and $1.03 per thousand cubic feet equivalent in 1998, 1997 and 1996, respectively. Net quantities of proved developed and undeveloped reserves of natural gas and crude oil, including condensate and natural gas liquids, and changes in such quantities were as follows: Reserve Data
Liquids Gas Liquids Gas Liquids Gas (MBbls) (Bcf) (MBbls) (Bcf) (MBbls) (Bcf) -------------------------------------------------------------------------- December 31, 1998 1997 1996 - -------------------------------------------------------------------------------------------------------------------------------- Proved (Developed and Undeveloped) Reserves, Net: Beginning of year 72,882 2,160.6 65,984 2,006.4 55,304 1,711.7 Revisions of previous estimates (12,816) (349.4) 4,506 156.6 4,134 58.0 Extensions, discoveries and other additions 1,688 118.5 10,540 287.1 21,307 457.2 Purchases of reserves in place -- 5.9 850 20.6 2,158 151.3 Sales of reserves in place (23,710) (287.6) (433) (43.7) (7,941) (103.5) Production (8,327) (225.7) (8,565) (266.4) (8,978) (268.3) - -------------------------------------------------------------------------------------------------------------------------------- End of Year 29,717 1,422.3 72,882 2,160.6 65,984 2,006.4 ================================================================================================================================ Proved Developed Reserves: Beginning of year 45,225 1,557.5 33,327 1,395.8 30,455 1,184.1 End of year 24,743 1,122.6 45,225 1,557.5 33,327 1,395.8 ================================================================================================================================
MBbls-Thousands of barrels Bcf-Billion cubic feet 62 II-41 73 The significant changes to reserves, other than acquisitions, dispositions or production, are due to reservoir performance in existing fields and drilling of additional wells in existing fields. There were no major discoveries or other events, favorable or adverse, that may be considered to have caused a significant change in the estimated proved reserves since December 31, 1998. Results of operations from producing activities by fiscal year were as follows: Results of Operations
(In Thousands) ----------------------------------------- Years Ended December 31, 1998 1997 1996 - ----------------------------------------------------------------------- Net Revenues: Sales $ 179,258 $ 347,219 $ 331,757 Affiliated sales 361,380 409,555 410,520 - ----------------------------------------------------------------------- Total 540,638 756,774 742,277 Production Costs (91,470) (116,112) (96,235) Depreciation, Depletion and Amortization (1,326,765) (341,278) (332,129) - ----------------------------------------------------------------------- (877,597) 299,384 313,913 Income Tax (Expense) Benefit 313,497 (97,603) (100,488) - ------------------------ ---------------------------------------------- Results of Operations from Producing Activities (Excluding Corporate Overhead and Interest Costs) $ (564,100) $ 201,781 $ 213,425 =======================================================================
The standardized measure of discounted future net cash flows relating to proved oil and gas reserves follows: Standardized Measure of Discounted Future Net Cash Flows
(In Thousands) ------------------------------------------ December 31, 1998 1997 1996 - ----------------------------------------------------------------------- Future Cash Inflows $ 3,124,205 $ 6,059,477 $ 8,551,630 Future Production and Development Costs (1,027,931) (1,889,348) (1,881,447) Future Income Tax Expenses (317,572) (912,059) (1,776,403) - ----------------------------------------------------------------------- Future Net Cash Flows 1,778,702 3,258,070 4,893,780 - ----------------------------------------------------------------------- 10% Annual Discount for Estimated Timing of Cash Flows (616,435) (1,058,622) (1,499,656) - ----------------------------------------------------------------------- Standardized Measure of Discounted Future Net Cash Flows $ 1,162,267 $ 2,199,448 $ 3,394,124 =======================================================================
For the calculations in the preceding table, estimated future cash inflows from estimated future production of proved reserves were computed using realized oil and gas prices for the month of December of each respective year. The following are the principal sources of change in the standardized measure of discounted future net cash flows: Changes in Standardized Measure of Discounted Future Net Cash Flows
(In Thousands) ------------------------------------------ Years Ended December 31, 1998 1997 1996 - ----------------------------------------------------------------------- Sales and Transfers of Oil and Gas Produced, Net of Production Costs $ (449,168) $ (640,662) $ (646,042) Net Changes in Prices and Production Costs (389,252) (1,858,640) 1,583,674 Extensions, Discoveries and Improved Recovery, Less Related Costs 71,557 328,665 1,156,729 Changes in Estimated Future Development Costs 36,269 (83,805) 28,320 Development Costs Incurred During the Period 182,447 228,798 60,259 Revisions of Previous Quantity Estimates (413,484) 175,081 164,214 Accretion of Discount 268,797 449,400 185,091 Net Change in Income Taxes 379,228 611,352 (891,355) Purchases of Reserves in Place 4,441 23,628 318,084 Sales of Reserves in Place (468,770) (47,170) (256,706) Changes in Production Rates (Timing) and Other (259,246) (381,323) 49,465 - ---------------------------------------------------------------------- $(1,037,181) $(1,194,676) $1,751,733 ======================================================================
63 II-42 74 Notes to Consolidated Financial Statements NOTE 15 Quarterly Results (Unaudited) Selected unaudited quarterly data is shown below:
(In Thousands, Except Per-Share Amounts) ------------------------------------------------------------- 1st 2nd 3rd 4th Quarter Quarter Quarter Quarter - ------------------------------------------------------------------------------------------------------------------------- 1998(1)(2) Revenues $1,109,143 $ 925,132 $ 874,497 $ 801,046 Operating Income (Loss) 59,474 (474,888) (389,322) 41,372 Earnings (Loss) Before Interest and Taxes 69,298 (457,199) (368,801) 54,692 Net Income (Loss) 27,950 (315,296) (258,416) 15,245 ========================================================================================================================= Earnings (Loss) Per Share of Common Stock $ .25 $ (2.87) $ (2.35) $ .14 ========================================================================================================================= Earnings (Loss) Per Share of Common Stock - Assuming Dilution $ .25 $ (2.87) $ (2.35) $ .14 =========================================================================================================================
(In Thousands, Except Per-Share Amounts) ------------------------------------------------------------- 1st 2nd 3rd 4th Quarter Quarter Quarter Quarter - ------------------------------------------------------------------------------------------------------------------------- 1997(2)(3) Revenues $1,123,529 $ 855,925 $1,073,715 $1,319,328 Operating Income 138,220 67,153 91,507 75,137 Earnings Before Interest and Taxes 153,637 78,011 100,994 88,297 Net Income 87,538 36,306 52,348 41,804 ========================================================================================================================= Earnings Per Share of Common Stock $ .79 $ .33 $ .48 $ .38 ========================================================================================================================= Earnings Per Share of Common Stock - Assuming Dilution $ .78 $ .32 $ .47 $ .38 =========================================================================================================================
(1) See Note 2 for information on quarterly ceiling test charges recorded in 1998. (2) In September 1998, the Company changed its accounting method for its oil and gas operations (see Note 2). (3) Net income for the fourth quarter of 1997 includes a charge of $32.7 million, or $.29 per share (diluted), related to merger expenses (see Note 3) NOTE 16 Subsequent Event (Unaudited) The Company recognized a $1,035.2 Million non-cash write-down of its oil and natural gas properties as a result of its change to the full cost method of accounting during the third quarter of 1998. Due to the substantial recent volatility in oil and gas prices and their effect on the carrying value of the Company's proved oil and gas reserves, there can be no assurance that future write-downs will not be required as a result of factors that may negatively affect the present value of proved oil and natural gas reserves and the carrying value of oil and natural gas properties, including volatile oil and natural gas prices, downward revisions in estimated proved oil and natural gas reserve quantities and unsuccessful drilling activities. Based on current market prices and current estimates, the Company anticipates a first quarter ceiling test write-down of approximately $200 million. This estimate is based upon a number of assumptions that are subject to change dependent on future events, however, including changes in oil and gas prices and the impact of reserve changes during the quarter. 64 II-43 75 Selected Consolidated Financial Data (Unaudited) Sonat Inc. and Subsidiaries
(In Millions, Except Per-Share Amounts) -------------------------------------------------------------------------- 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------------------- Revenues $ 3,709.8 $ 4,372.5 $ 3,203.6 $ 1,902.4 $ 1,481.9 Costs and Expenses 4,473.2 4,000.5 2,771.5 1,626.7 1,281.3 - ------------------------------------------------------------------------------------------------------------------------------- Operating Income (Loss) (763.4) 372.0 432.1 275.7 200.6 Other Income, Net 61.4 48.9 35.8 226.1 55.9 - ------------------------------------------------------------------------------------------------------------------------------- EBIT (702.0) 420.9 467.9 501.8 256.5 Interest Expense, Net (126.2) (97.2) (88.9) (97.1) (77.3) - ------------------------------------------------------------------------------------------------------------------------------- Income (Loss) Before Income Taxes (828.2) 323.7 379.0 404.7 179.2 Income Tax Expense (Loss) (297.7) 105.7 123.2 136.2 23.5 - ------------------------------------------------------------------------------------------------------------------------------- Net Income (Loss) $ (530.5) $ 218.0 $ 255.8 $ 268.5 $ 155.7 =============================================================================================================================== Earnings (Loss) Per Share $ (4.82) $ 1.98 $ 2.32 $ 2.43 $ 1.40 Earnings (Loss) Per Share - Assuming Dilution $ (4.82) $ 1.95 $ 2.29 $ 2.41 $ 1.39 Weighted Average Shares Outstanding (thousands) 110,020 110,099 110,370 110,428 111,278 Weighted Average Shares Outstanding - Assuming Dilution (thousands) 110,020 111,669 111,722 111,261 112,228 Dividend Rate $ 1.08 $ 1.08 $ 1.08 $ 1.08 $ 1.08 =============================================================================================================================== Assets $ 4,361.1 $ 5,252.1 $ 4,362.8 $ 4,013.3 $ 3,885.1 Debt Maturing within One Year 830.2 461.2 215.7 241.7 225.3 Long-Term Debt 1,099.5 1,236.0 979.7 804.6 993.4 Stockholders' Equity 1,329.3 1,961.8 1,876.0 1,716.1 1,548.9 - ------------------------------------------------------------------------------------------------------------------------------- Total Capitalization $ 3,259.0 $ 3,659.0 $ 3,071.4 $ 2,762.4 $ 2,767.6 ===============================================================================================================================
Note: The 1994-1997 periods have been restated to reflect the change to the full cost method of accounting for the Company's oil and gas operations (see Note 2). 65 II-44 76 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Sonat has not had a change in accountants within twenty-four months prior to the date of its most recent financial statements or in any period subsequent to such date. II-45 77 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information regarding the Directors and nominees for Director of Sonat required by Item 401 of Regulation S-K is presented under the heading "Election of Directors" in the Proxy Statement of Sonat Inc. dated as of March 22, 1999 (the "Proxy Statement"), which information is hereby incorporated by reference herein. A copy of the Proxy Statement is filed as an exhibit to this report on Form 10-K. Information regarding the executive officers of Sonat is presented following Item 4 of this report, as permitted by General Instruction G(3) to Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K. ITEM 11. EXECUTIVE COMPENSATION The information required by Item 402 of Regulation S-K regarding executive compensation is presented under the headings "Compensation of Outside Directors" and "Compensation of Executive Officers" in the Proxy Statement, which information is hereby incorporated by reference herein. Notwithstanding the foregoing, the information provided under the headings "Report of the Executive Compensation Committee" and "Performance Graph" in the Proxy Statement are not incorporated by reference herein. A copy of the Proxy Statement is filed as an exhibit to this report on Form 10-K. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information regarding the security ownership of certain beneficial owners and management required by Item 403 of Regulation S-K is presented under the heading "Ownership of Common Stock by Directors and Executive Officers" in the Proxy Statement, which information is hereby incorporated by reference herein. A copy of the Proxy Statement is filed as an exhibit to this report on Form 10-K. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information regarding certain relationships and related transactions required by Item 404 of Regulation S-K is presented on pages 1 and 2 of in the Proxy Statement, which information is hereby incorporated by reference herein. A copy of the Proxy Statement is filed as an exhibit to this report on Form 10-K. III-1 78 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Index to Financial Statements, Financial Statement Schedules, and Exhibits 1. FINANCIAL STATEMENTS
PAGE ---- Included in Part II of this report: Report of Ernst & Young LLP, Independent Auditors......... II-16 Consolidated Balance Sheets at December 31, 1998 and 1997................................................... II-17 Consolidated Statements of Operations for the years ended December 31, 1998, 1997, and 1996...................... II-19 Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 1998, 1997, and 1996................................................... II-20 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997, and 1996...................... II-21 Notes to Consolidated Financial Statements................ II-22
2. FINANCIAL STATEMENT SCHEDULES
PAGE ---- Included in Part IV of this report: Consolidated Schedules for each of the three years in the period ended December 31, 1998: II. Valuation and Qualifying Accounts.................. IV-9 Consolidated Financial Statements of Citrus Corp. (50-percent-owned joint venture) at December 31, 1998.................................................. IV-10
All other financial statement schedules have been omitted as not applicable or because the subject matter is either not present or is not present in amounts sufficient to require submission of the schedule, in accordance with the instructions contained in Regulation S-X, or the required information is included in the financial statements or notes thereto. Financial statements of 50-percent-or-less-owned companies and joint ventures, other than Citrus Corp., are not presented herein because such companies and joint ventures do not meet the significance test. IV-1 79 3. EXHIBITS(1)
EXHIBIT NUMBER EXHIBITS - ------- -------- RESTATED CERTIFICATE OF INCORPORATION AND BY-LAWS 3 (a) Restated Certificate of Incorporation of Sonat Inc. (Restating the Certificate of Incorporation as in effect as of April 28, 1994) filed as Exhibit 3(a) to Form 10-Q of Sonat Inc. for the quarter ended March 31, 1994 3 (b) By-Laws of Sonat Inc. as amended and in effect December 1, 1995, filed as Exhibit 3-(b) to Form 10-K of Sonat Inc. for the year 1995 INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS 4.1 Rights Agreement dated as of January 8, 1996, between Sonat Inc. and Chemical Mellon Shareholder Services, L.L.C., as Rights Agent, with exhibits, and (1) Amendment No. 1 dated as of November 22, 1998, filed as Exhibit 99 to Form 8-A of Sonat Inc. dated January 10, 1996, except (1), which was filed as Exhibit 4.1 to Form 8-K of Sonat Inc. dated January 30, 1998 4.2 Registration Rights Agreement, dated as of January 30, 1998, by and between Sonat Inc., Selim K. Zilkha, Michael Zilkha, the Selim K. Zilkha Trust and the Selim K. Zilkha (1996) Annuity Trust, filed as Exhibit 10.1 to Form 8-K of Sonat Inc. dated January 30, 1998 4.3 Form of Indenture dated June 1, 1986, from Sonat Inc. to Manufacturers Hanover Trust Company, Trustee, as amended by (1) First Supplemental Indenture dated June 1, 1995, between Sonat Inc. and Chemical Bank, successor by merger to Manufacturers Hanover Trust Company, as Trustee, filed as Exhibit 4-(1) to Amendment No. 1 to Registration Statement No. 33-5947 dated June 4, 1986, except(1), which was filed as Exhibit 4-(1) to Form 8-K of Sonat Inc. dated June 6, 1995 4.4 Specimen Note of Sonat Inc. for the $200 million 6 7/8% Notes due June 1, 2005, issued under Registration Statement No. 33-62166, filed as Exhibit 4-(2) to Form 8-K of Sonat Inc. dated June 6, 1995 4.5 Specimen Note of Sonat Inc. for the $100 million 9 1/2% Notes due August 15, 1999, issued under Registration Statement No. 33-5947, filed as Exhibit 4-2(c) to Form 10-K of Sonat Inc. for the year 1996 4.6 Specimen Note of Sonat Inc. for the $100 million 9% Notes due May 1, 2001, issued under Registration Statement No. 33-5947, filed as Exhibit 4-(2) to Form 8-K of Sonat Inc. dated April 30, 1991 4.7 Specimen Note of Sonat Inc. for the $100 million 6.75% Notes due October 1, 2007, issued under Registration Statement No. 33-62166, filed as Exhibit 4-(3) to Form 8-K of Sonat Inc. dated September 25, 1997 4.8 Specimen Note of Sonat Inc. for the $100 million 6 5/8% Notes due February 1, 2008, issued under Registration Statement No. 33-62166, filed as Exhibit 4-(3) to Form 8-K of Sonat Inc. dated January 27, 1998 4.9 Specimen Note of Sonat Inc. for the $100 million 7% Notes due February 1, 2018, issued under Registration Statement No. 33-62166, filed as Exhibit 4-(3) to Form 8-K of Sonat Inc. dated January 29, 1998
- --------------- (1) Sonat will furnish to requesting security holders any exhibit on this list upon the payment of a fee of $.10 per page up to a maximum of $5.00 per exhibit. Requests must be made in writing and should be addressed to Beverley T. Krannich, Secretary, Sonat Inc., P. O. Box 2563, Birmingham, Alabama 35202. IV-2 80
EXHIBIT NUMBER EXHIBITS - ------- -------- 4.10 Form of Indenture dated June 1, 1987, from Southern Natural Gas Company to Manufacturers Hanover Trust Company, Trustee, as amended by (1) First Supplemental Indenture, dated as of September 30, 1997, between Southern Natural Gas Company and The Chase Manhattan Bank (formerly Chemical Bank, successor by merger to Manufacturers Hanover Trust Company), filed as Exhibit 4-(1) to Registration Statement No. 33-47266 of Southern Natural Gas Company dated April 16, 1992, except (1) which was filed as Exhibit 4-(2) to Form 8-K of Southern Natural Gas Company dated September 25, 1997 4.11 Specimen Note of Southern Natural Gas Company for the $100 million 8 7/8% Notes due February 15, 2001, issued under Registration Statement No. 33-16190, filed as Exhibit 4-(2) to Form 8-K of Southern Natural Gas Company dated February 7, 1991 4.12 Specimen Note of Southern Natural Gas Company for the $100 million 7.85% Notes due January 15, 2002, issued under Registration Statement No. 33-16190, filed as Exhibit 4-(2) to Form 8-K of Southern Natural Gas Company dated January 14, 1992 4.13 Specimen Note of Southern Natural Gas Company for the $100 million 8 5/8% Notes due May 1, 2002, issued under Registration Statement No. 33-47266, filed as Exhibit 4.3(d) to Form 10-K of Sonat Inc. for the year 1996 4.14 Specimen Note of Southern Natural Gas Company for the $100 million 6.70% Notes due October 1, 2007, issued under Registration Statement No. 33-47266, filed as Exhibit 4-(3) to Form 8-K of Southern Natural Gas Company dated September 25, 1997 4.15 Specimen Note of Southern Natural Gas Company for the $100 million 6.125% Notes due September 15, 2008, issued under Registration Statement No. 333-47959, filed as Exhibit 4-(3) to Form 8-K of Southern Natural Gas Company dated September 24, 1998 4.16 $400 Million Note Agreement dated November 3, 1986, between Citrus Corp. and the Purchasers named therein, filed as Exhibit 4-(5) to Form 10-K of Sonat Inc. for the year 1990 4.17 Credit Agreement dated as of June 1, 1996, among Sonat Inc., the Banks named therein, and The Chase Manhattan Bank (National Association), and Morgan Guaranty Trust Company of New York, as Co-Agents, filed as Exhibit 4 to Form 10-Q of Sonat Inc. for the quarter ended June 30, 1996 4.18 Credit Agreement dated as of January 20, 1999, among Sonat Inc., the Banks named therein, The Chase Manhattan Bank, as Administrative Agent, Bank of America National Trust and Savings Association, as Syndication Agent, and SunTrust Bank, Atlanta, as Documentation Agent, filed herewith 4.19 Certificate of Designations of Series A Participating Preference Stock of Sonat Inc. dated January 8, 1996, as filed with the Secretary of State of the State of Delaware January 16, 1996, filed as Exhibit 4.6 to Form 10-K of Sonat Inc. for the year 1995 COMPENSATION PLANS AND MANAGEMENT CONTRACTS 10.1 Supplemental Benefit Plan of Sonat Inc. as Amended and Restated effective January 1, 1997, filed herewith 10.2 Executive Award Plan of Sonat Inc. as Amended and Restated as of July 23, 1998, filed as Exhibit 10.1 to Form 10-Q of Sonat Inc. for the quarter ended September 30, 1998 10.3 Restricted Stock Plan for Directors of Sonat Inc. (as Amended and Restated as of February 26, 1998), filed as Exhibit 10.3 to Form 10-K of Sonat Inc. for the year 1997 10.4 Performance Award Plan of Sonat Inc. effective as of January 27, 1994, (1) amendment dated December 1, 1995, and (2) amendment dated July 23, 1998, filed as Exhibit 10-(7) to Form 10-K of Sonat Inc. for the year 1993, except (1), which was filed as Exhibit 10.7 to Form 10-K of Sonat Inc. for the year 1995, and (2), which was filed as Exhibit 10.2 to Form 10-Q of Sonat Inc. for the quarter ended September 30, 1998
IV-3 81
EXHIBIT NUMBER EXHIBITS - ------- -------- 10.5 Cash Bonus Plan of Sonat Inc. effective as of January 27, 1994, (1) amendment dated December 1, 1995, and (2) amendment dated July 23, 1998, filed as Exhibit 10-(8) to Form 10-K of Sonat Inc. for the year 1993, except (1), which was filed as Exhibit 10.8 to Form 10-K of Sonat Inc. for the year 1995, and (2), which was filed as Exhibit 10.4 to Form 10-Q of Sonat Inc. for the quarter ended September 30, 1998 10.6 Sonat Inc. Retirement Plan for Directors as Amended and Restated as of December 2, 1994, and (1) amendment dated December 1, 1995, filed as Exhibit 10.9 to Form 10-K of Sonat Inc. for the year 1994, except (1), which was filed as Exhibit 10.9 to Form 10-K of Sonat Inc. for the year 1995 10.7 Executive Severance Agreement dated July 23, 1998, between Sonat Inc. and Thomas W. Barker, Jr. and schedule identifying substantially identical Executive Severance Agreements between Sonat Inc. and other parties, filed as Exhibit 10.6 to Form 10-Q of Sonat Inc. for the quarter ended September 30, 1998 10.8 Executive Severance Agreement dated July 23, 1998, between Sonat Inc. and Ronald L. Kuehn, Jr., filed as Exhibit 10.5 to Form 10-Q of Sonat Inc. for the quarter ended September 30, 1998 10.9 Directors' Fees Deferral Plan of Sonat Inc. as Amended and Restated as of January 1, 1997, filed as Exhibit 10.9 to Form 10-K of Sonat Inc. for the year 1997 10.10 Indemnity Agreement dated December 4, 1987, between Sonat Inc. and Ronald L. Kuehn, Jr. and schedule identifying substantially identical indemnity agreements between Sonat Inc. and other directors of Sonat Inc. and (1) Indemnity Agreement dated September 1, 1994, between Sonat Inc. and Adrian M. Tocklin, (2) Indemnity Agreement dated November 1, 1995, between Sonat Inc. and Max L. Lukens, (3) Indemnity Agreement dated January 30, 1998, between Sonat Inc. and Michael S. Zilkha, and (4) Indemnity Agreement dated January 30, 1998, between Sonat Inc. and Selim K. Zilkha, filed as Exhibit 10-(11) to Form 10-K of Sonat Inc. for the year 1992, except (1), which was filed as Exhibit 10.3 to Form 10-Q of Sonat Inc. for the quarter ended September 30, 1994, (2), which was filed as Exhibit 10.12 to Form 10-K of Sonat Inc. for the year 1995, and (3) and (4), which were filed as Exhibit 10.11 to Form 10-K of Sonat Inc. for the year 1997 10.11 Trust Agreement dated December 19, 1986, between Sonat Inc. and AmSouth Bank N.A. for Section 415 Retirement Plan Benefits and Vesting Benefits under the Supplemental Benefit Plan and Early Retirement Benefits under the Executive Severance Agreements, filed as Exhibit 10-(15) to Form 10-K of Sonat Inc. for the year 1991 10.12 Trust Agreement dated December 19, 1986, between Sonat Inc. and AmSouth Bank N.A. for Section 415 Stock Purchase Plan Benefits under the Supplemental Benefit Plan, filed as Exhibit 10-(16) to Form 10-K of Sonat Inc. for the year 1991 10.13 Trust Agreement dated December 19, 1986, between Sonat Inc. and AmSouth Bank N.A. for Benefits under the Retirement Plan for Directors, filed as Exhibit 10-(17) to Form 10-K of Sonat Inc. for the year 1991 10.14 Form of Sonat Inc. Executive Life Insurance Program Split Dollar Agreement, Collateral Assignment Agreement, and Program Description, each dated as of July 1, 1990, with (1) schedule identifying the persons participating in such Programs, filed as Exhibit 10-(20) to Form 10-K of Sonat Inc. for the year 1990, except (1), which was filed as Exhibit 10-15 to Form 10-K of Sonat Inc. for the year 1997 10.15 Sonat Inc. Deferred Compensation Plan -- Plan Summary dated November 1998, filed herewith OTHER MATERIAL CONTRACTS 10.16 Capital Stock Agreement among Sonat Inc., Enron Corp., Houston Natural Gas Corporation, and Citrus Corp. dated June 30, 1986, filed as Exhibit 10-(26) to Form 10-K of Sonat Inc. for the year 1991
IV-4 82
EXHIBIT NUMBER EXHIBITS - ------- -------- 10.17 Agreement and Plan of Merger dated as of March 13, 1999, between El Paso Energy Corporation and Sonat Inc., filed as Exhibit 2.1 to Form 8-K of Sonat Inc. dated March 15, 1999 10.18 Form of Certificate of Designation, Preferences and Rights of the % Senior Cumulative Exchangeable Preferred Stock of El Paso Energy Corporation (incorporated by reference, filed as Exhibit E to Exhibit 2.1 of the Form 8-K of Sonat Inc. dated March 15, 1999) 10.19 El Paso Energy Corporation Stock Option Agreement, dated March 13, 1999, filed as Exhibit 99.1 to Form 8-K of Sonat Inc. dated March 15, 1999 10.20 Sonat Inc. Stock Option Agreement, dated March 13, 1999, filed as Exhibit 99.2 to Form 8-K of Sonat Inc. dated March 15, 1999 10.21 Voting Agreement, dated March 13, 1999, between El Paso Corporation and Selim K. Zilkha, in his individual capacity and in his capacity as trustee of the Selim K. Zilkha Trust, and Michael Zilkha, filed as Exhibit 99.3 to Form 8-K of Sonat Inc. dated March 15, 1999 10.22 Voting Agreement, dated March 13, 1999 between El Paso Energy Corporation and Ronald L. Kuehn, Jr., filed as Exhibit 99.4 to Form 8-K of Sonat Inc. dated March 15, 1999 OTHER EXHIBITS 12 Computation of Ratio of Earnings to Fixed Charges, filed herewith 21 Subsidiaries of Sonat Inc., filed herewith 22 Proxy Statement of Sonat Inc. dated as of March 22, 1999, which is not to be deemed "filed" as part of this Form 10-K, except to the extent incorporated by reference under Items 10, 11, 12 and 13 of Part III of this Form 10-K, filed herewith 23.1 Consent of Ernst & Young LLP, Independent Auditors, dated March 19, 1999, filed herewith 23.2 Consent of William M. Cobb & Associates, Inc., Independent Petroleum Engineers, dated March 4, 1999, filed herewith 23.3 Consent of Ryder Scott Company, Petroleum Engineers, dated March 8, 1999, filed herewith 23.4 Consent of KPMG LLP, Independent Auditors, dated March 19, 1999, filed herewith 23.5 Consent of KPMG LLP, Independent Auditors, dated March 19, 1999, filed herewith. 24 Powers of Attorney authorizing Ronald L. Kuehn, Jr.; Thomas W. Barker, Jr.; James E. Moylan, Jr.; William A. Smith; and John C. Griffin to sign the Sonat Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1998, on behalf of certain directors and officers of the registrant, filed herewith 27 Financial Data Schedule for the period ended December 31, 1998, filed herewith, electronically only 99.1 Report of Ryder Scott Company, Petroleum Engineers, dated March 10, 1999, filed herewith 99.2 Report of William M. Cobb & Associates, Inc. dated January 14, 1999, filed herewith
Exhibits listed above that have heretofore been filed with the Securities and Exchange Commission, which were physically filed as noted above, are hereby incorporated herein by reference pursuant to Rule 12b-32 under the Securities Exchange Act of 1934 and made a part hereof with the same effect as if filed herewith. Certain instruments relating to long-term debt of Sonat and its subsidiaries have not been filed as exhibits since the total amount of securities authorized under any such instrument does not exceed ten percent of the total assets of Sonat and its subsidiaries on a consolidated basis. Sonat agrees to furnish a copy of each such instrument to the Commission upon request. IV-5 83 (b) Reports on Form 8-K The Company filed a report on Form 8-K on October 22, 1998, reporting certain information under Item 5 with respect to the Company's third quarter results that reflected the adoption of the full cost method of accounting for its exploration and production business segment. The Company filed a report on Form 8-K on January 7, 1999, reporting certain information under Item 5 restating the Company's financial statements for the years 1997, 1996, and 1995 as a result of the conversion to full cost accounting for its exploration and production business segment. The Company filed a report on Form 8-K on March 3, 1999, reporting certain information under Item 5 relating to the Company's announcement of a joint venture to build a pipeline to North Carolina and the current estimate of an expected first quarter ceiling test charge under full cost accounting provisions for exploration and production operations of approximately $200 million, after tax. The Company filed a report on Form 8-K on March 15, 1999, reporting certain information under Item 5 relating to the announcement regarding the proposed merger of the Company with El Paso Energy Corporation. (c) Exhibits Exhibits required by Item 601 of Regulation S-K have been filed electronically with this report on Form 10-K. IV-6 84 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SONAT INC. By: /s/ RONALD L. KUEHN, JR. ------------------------------------ RONALD L. KUEHN, JR. CHAIRMAN OF THE BOARD, PRESIDENT, AND CHIEF EXECUTIVE OFFICER Dated: March 24, 1999 PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE CAPACITY DATE --------- -------- ---- (i) Principal Executive Officer: /s/ RONALD L. KUEHN, JR. Chairman of the Board, March 24, 1999 - ----------------------------------------------------- President, and Chief (RONALD L. KUEHN, JR.) Executive Officer (ii) Principal Financial and Accounting Officer: /s/ JAMES E. MOYLAN, JR. Senior Vice President and Chief March 24, 1999 - ----------------------------------------------------- Financial Officer (JAMES E. MOYLAN, JR.) (iii) Directors:* William O. Bourke Jerome J. Richardson Ronald L. Kuehn, Jr. Adrian M. Tocklin Robert J. Lanigan James B. Williams Max L. Lukens Joe B. Wyatt Charles Marshall Michael S. Zilkha Benjamin F. Payton Selim K. Zilkha John J. Phelan, Jr. * Signed on behalf of each of these persons and on his behalf: By: /s/ WILLIAM A. SMITH ------------------------------------------------- WILLIAM A. SMITH EXECUTIVE VICE PRESIDENT AND GENERAL COUNSEL AS AUTHORIZED BY CERTAIN POWERS OF ATTORNEY DATED FEBRUARY 25, 1999, AND MARCH 1, 1999, FILED HEREWITH AS EXHIBIT 24
IV-7 85 (This page intentionally left blank) IV-8 86 SONAT INC. AND SUBSIDIARIES SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (IN THOUSANDS)
CHARGED BALANCE AT TO COSTS BALANCE BEGINNING AND AT END DESCRIPTION OF YEAR EXPENSES OTHER(a) OF YEAR - ----------- ---------- -------- -------- ------- 1998 Allowance for doubtful accounts.................... $ 8,160 $ 2,145 $ (1,005) $ 9,300 Valuation allowance on deferred tax assets......... 11,505 -- (11,505)(b) -- Valuation allowance on assets from trading activities...................................... 18,048 4,487 -- 22,535 Actualization Reserve on Accounts Receivable....... 1,050 13,988 (10,750) 4,288 Allowance for restructuring activities............. -- 15,017 (9,197) 5,820 1997 Allowance for doubtful accounts.................... 9,679 116 (1,635) 8,160 Valuation allowance on deferred tax assets......... 11,505 -- -- 11,505 Valuation allowance on assets from trading activities...................................... -- 18,048 -- 18,048 Actualization Reserve on Accounts Receivable....... -- 2,191 (1,141) 1,050 1996 Allowance for doubtful accounts.................... 10,198 3,615 (4,134) 9,679 Valuation allowance on deferred tax assets......... 11,505 -- -- 11,505
- --------------- (a) Accounts charged off net of recoveries, except as otherwise noted. (b) Tax benefit from utilization of NOL carryforward. IV-9 87 CITRUS CORP. AND SUBSIDIARIES TABLE OF CONTENTS
PAGE REPORT OF INDEPENDENT AUDITORS NO. - ------------------------------ -------- Report of Independent Auditors IV-12 AUDITED CONSOLIDATED FINANCIAL STATEMENTS Consolidated Balance Sheets - Assets IV-13 Consolidated Balance Sheets - Liabilities and Stockholders' Equity IV-14 Consolidated Statements of Income and Retained Earnings IV-15 Consolidated Statements of Cash Flows IV-16 Notes to Consolidated Financial Statements IV-17
IV-10 88 (This page intentionally left blank) IV-11 89 Report of Independent Auditors Board of Directors Citrus Corp. We have audited the accompanying consolidated balance sheets of Citrus Corp. and Subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income and retained earnings and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Citrus Corp. and Subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ ERNST & YOUNG LLP Ernst & Young LLP Birmingham, Alabama February 26, 1999 IV-12 90 CITRUS CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
- ------------------------------------------------------------------------------------------------- December 31, ------------------------------------ (In Thousands) 1998 1997 - ------------------------------------------------------------------------------------------------- ASSETS Current Assets Cash and cash equivalents $ 4,495 $ 17,274 Trade and other receivables Customers, net 52,767 43,724 Affiliated companies 227 28 Income taxes 6,145 818 Commodity adjustment costs 3,940 5,399 Materials and supplies 3,489 2,730 Other 10,070 9,417 ------------------------------------ Total Current Assets 81,133 79,390 ------------------------------------ Deferred Charges Unamortized debt expense 5,580 6,241 Commodity adjustment costs 25,520 29,419 Other 52,529 32,011 ------------------------------------ Total Deferred Charges 83,629 67,671 ------------------------------------ Property, Plant and Equipment, at cost 2,850,007 2,810,061 Less -- accumulated depreciation and amortization 507,366 463,938 ------------------------------------ Net Property, Plant and Equipment 2,342,641 2,346,123 ------------------------------------ TOTAL ASSETS $ 2,507,403 $ 2,493,184 - -------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. IV-13 91 CITRUS CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
- ------------------------------------------------------------------------------------------------ December 31, ---------------------------------- (In Thousands, Except Share Data) 1998 1997 - ------------------------------------------------------------------------------------------------ LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Notes payable to banks $ -- $ 20,000 Notes payable to Enron 10,300 -- Long-term debt due within one year 225,750 44,250 Accounts payable Trade 23,796 26,650 Affiliated companies 12,651 13,857 Accrued liabilities Interest 16,121 16,996 Income taxes 518 -- Other taxes 7,850 6,662 Other 3,382 3,719 ---------------------------------- Total Current Liabilities 300,368 132,134 ---------------------------------- Long-Term Debt 755,000 980,750 ---------------------------------- Deferred Credits Deferred income taxes 506,585 483,190 Other 35,150 32,784 ---------------------------------- Total Deferred Credits 541,735 515,974 ---------------------------------- Commitments and Contingencies (Notes 8 and 9) Stockholders' Equity Common stock, $1 par value; 1,000 shares authorized, issued and outstanding 1 1 Additional paid-in capital 634,271 634,271 Retained earnings 276,028 230,054 ---------------------------------- Total Stockholders' Equity 910,300 864,326 ---------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $2,507,403 $2,493,184 - ------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. IV-14 92 CITRUS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME AND RETAINED EARNINGS
- ----------------------------------------------------------------------------------------------------- Years Ended December 31, ------------------------------------------------- (In Thousands) 1998 1997 1996 - ----------------------------------------------------------------------------------------------------- Revenues Gas sales $ 284,831 $ 426,559 $ 445,148 Gas transportation and other, net 306,174 308,843 324,712 ------------------------------------------------- 591,005 735,402 769,860 ------------------------------------------------- Costs and Expenses Natural gas purchased 269,818 416,953 429,367 Operations and maintenance 78,061 82,653 74,413 Depreciation 26,349 26,103 26,651 Amortization 25,422 34,367 56,912 Taxes - other than income taxes 23,940 24,717 20,160 ------------------------------------------------- 423,590 584,793 607,503 ------------------------------------------------- Operating Income 167,415 150,609 162,357 ------------------------------------------------- Other Income (Expense) Interest expense, net (88,289) (93,471) (97,363) Allowance for funds used during construction 1,241 599 (153) Other, net (5,667) 14,309 5,437 ------------------------------------------------- (92,715) (78,563) (92,079) ------------------------------------------------- Income Before Income Taxes 74,700 72,046 70,278 Income Tax Expense 28,726 17,460 27,240 ------------------------------------------------- Net Income 45,974 54,586 43,038 Retained Earnings, Beginning of Year 230,054 175,468 132,430 ------------------------------------------------- Retained Earnings, End of Year $ 276,028 $ 230,054 $ 175,468 - -----------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. IV-15 93 CITRUS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------------------------------- Years Ended December 31, ---------------------------------------------- (In Thousands) 1998 1997 1996 - --------------------------------------------------------------------------------------------------------- Cash Flows From Operating Activities Net income $ 45,974 $ 54,586 $ 43,038 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 51,771 60,470 83,563 Deferred income taxes 23,395 8,621 8,539 Allowance for funds used during construction (1,241) (599) 153 Gain on sale of assets (720) (504) (7,387) Changes in assets and liabilities Trade and other receivables (14,569) 25,127 (6,963) Materials and supplies (759) (173) (178) Accounts payable (4,060) (17,764) 7,380 Accrued liabilities 831 667 (543) Other current assets and liabilities (990) (8,208) (2,547) Contract reformation settlements and adjustments -- (1,826) (4,931) Other, net (16,606) 12,244 (2,225) ---------------------------------------------- Net Cash Provided by Operating Activities 83,026 132,641 117,899 ---------------------------------------------- Cash Flows From Investing Activities Additions to property, plant and equipment (44,639) (31,261) (29,000) Allowance for funds used during construction 1,241 599 (153) Net proceeds from sale of assets 720 504 7,387 Disposition of property, plant and equipment, net 823 (16) 3,081 ---------------------------------------------- Net Cash Used in Investing Activities (41,855) (30,174) (18,685) ---------------------------------------------- Cash Flows From Financing Activities Short-term bank borrowings, net (9,700) 5,000 (55,000) Payment on long-term debt (44,250) (100,000) -- TCR remittances -- (6,256) (31,136) ---------------------------------------------- Net Cash Used in Financing Activities (53,950) (101,256) (86,136) ---------------------------------------------- Increase (Decrease) in Cash and Cash Equivalents (12,779) 1,211 13,078 Cash and Cash Equivalents, Beginning of Year 17,274 16,063 2,985 ---------------------------------------------- Cash and Cash Equivalents, End of Year $ 4,495 $ 17,274 $ 16,063 - ---------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial statements. Additional cash flow information: The Company made the following interest and income tax payments: Interest paid $ 94,187 $ 103,363 $ 106,206 Income taxes paid 10,150 9,708 20,766
IV-16 94 CITRUS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) REPORTING ENTITY Citrus Corp. (the Company), a holding company formed in 1986, owns 100% of the stock of Florida Gas Transmission Company (Transmission), Citrus Trading Corp. (Trading) and Citrus Energy Services, Inc. (CESI). The stock of the Company is owned 50% by Sonat Inc. (Sonat) and 50% by Houston Pipe Line Company, a subsidiary of Enron Corp. (Enron). Transmission, an interstate gas pipeline extending from South Texas to South Florida, is engaged in the interstate transmission of natural gas and is subject to the jurisdiction of the Federal Energy Regulatory Commission (FERC). Trading is engaged in the sale of natural gas primarily to Florida Power& Light Co., a large electric utility in the state of Florida, to local distribution customers, and to end users, the majority of which are in the State of Florida. CESI began operations in February 1996 and provides construction, operations and maintenance services primarily to affiliates and customers of Transmission and Trading. (2) SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions and accounts have been eliminated in consolidation. CASH AND CASH EQUIVALENTS - The Company considers as cash equivalents all highly liquid short-term investments with maturities of three months or less at the time of purchase. These investments are accounted for at cost, which approximates estimated fair value. MATERIALS AND SUPPLIES - Materials and supplies are valued at actual cost. Materials transferred out of warehouses are priced out at average cost. REVENUE RECOGNITION - Gas sales revenue is recognized when gas is sold. Gas transportation revenue is recognized when the service is provided. ACCOUNTING FOR PRICE RISK MANAGEMENT ACTIVITIES - To manage the risks of price fluctuations, Trading, from time to time, has entered into swap agreements in certain energy products. All related gains and losses are recognized currently in income as adjustments to costs and expenses. Trading uses the settlement method of accounting for its commodity swaps. Commodity swaps are settled monthly and gains and losses are recognized immediately. The effects of commodity swaps, none of which has been material for any of the periods presented, are recorded as an adjustment to natural gas purchased. ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION - The allowance for funds used during construction consists, in general, of the net cost of borrowed and equity funds used for construction purposes and a reasonable rate on other funds when so used (the AFUDC rate). The allowance is determined by applying the AFUDC rate to construction work orders. Capitalization begins at the time the Company begins the continuous accumulation of costs in a construction work order on a planned progressive basis and ends when the facilities are placed in service. IV-17 95 CITRUS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (2) SIGNIFICANT ACCOUNTING POLICIES (continued) DEPRECIATION, AMORTIZATION AND MAINTENANCE POLICIES - Property, Plant and Equipment consists primarily of natural gas pipeline. The Company amortizes that portion of its investment in Transmission and other subsidiaries which is in excess of historical cost (acquisition adjustment) on a straight-line basis at an annual rate of 1.9% based upon the estimated remaining useful life of the pipeline system. Transmission has provided for depreciation of assets on a straight-line basis at an annual composite rate of 1.42%, 1.42% and 1.45% for 1998, 1997 and 1996, respectively. Depreciation rates are based on the estimated useful lives of the individual assets. In 1994, Trading entered into an agreement with a major customer, which provides significant future benefits over previous gas sales contracts. The agreement required Trading to make approximately $55 million in deposits on the customers' behalf over sixteen months. Trading is amortizing the total amounts paid on a volumetric basis over the term of the new agreement. Amortization of these payments is included in amortization expense. Transmission amortized contract reformation costs based on firm contract quantities and volume deliveries, and FERC-approved recovery rates. Such amortization is included in amortization expense. Transmission charges to maintenance the costs of repairs and renewal of items determined to be less than units of property. Costs of replacements and renewals of units of property are capitalized. The original costs of units of property retired are charged to the depreciation reserves, net of salvage and removal costs. ACCOUNTING FOR REGULATED OPERATION - The regulated operations of Transmission are subject to the provisions of Statement of Financial Standards (SFAS) No. 71, "Accounting for the Effects of Certain Types of Regulation." Accordingly, Transmission records certain assets and liabilities that result from the effects of the rate-making process that would not be recorded under generally accepted accounting principles for non-regulated entities. The regulated assets and regulatory liabilities of Transmission are primarily classified as Deferred Charges and Deferred Credits, respectively, in the Consolidated Balance Sheets. INCOME TAXES - The Company accounts for income taxes under the provisions of SFAS No. 109, "Accounting for Income Taxes." SFAS No. 109 provides for an asset and liability approach to accounting for income taxes. Under this approach, deferred tax assets and liabilities are recognized based on anticipated future tax consequences attributable to differences between financial statement carrying amounts of assets and liabilities and their respective tax bases. USE OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. RECLASSIFICATIONS - Certain amounts in the consolidated financial statements have been reclassified in 1997 and 1996 to conform with the 1998 presentation. COMPREHENSIVE INCOME - The Company has not recognized any items of comprehensive income for the year ended December 31, 1998. IV-18 96 CITRUS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (3) LONG-TERM DEBT AND OTHER FINANCING ARRANGEMENTS Long-term debt outstanding at December 31, 1998 and 1997 was as follows (in thousands):
1998 1997 ----------------- ----------------- Citrus Corp. 11.10% Notes due 1998-2006 $ 155,750 $ 175,000 8.49% Notes due 2007-2009 90,000 90,000 ----------------- ----------------- 245,750 265,000 ----------------- ----------------- Transmission 9.30% Notes due 1998 -- 25,000 8.14% Notes due 1999 200,000 200,000 9.75% Notes due 1999-2008 65,000 65,000 8.63% Notes due 2004 250,000 250,000 10.11% Notes due 2009-2013 70,000 70,000 9.19% Notes due 2005-2024 150,000 150,000 ----------------- ----------------- 735,000 760,000 ----------------- ----------------- Total Outstanding 980,750 1,025,000 Less Long-Term Debt Due Within One Year 225,750 44,250 ----------------- ----------------- $ 755,000 $ 980,750 ================= =================
Annual maturities and sinking fund requirements on long-term debt outstanding as of December 31, 1998 were as follows (in thousands):
Year Amount ---- ------ 1999 $ 225,750 2000 25,750 2001 25,750 2002 25,750 2003 25,750 Thereafter 652,000 ----------------- $ 980,750 =================
The Company has a note agreement that contains certain restrictions, which among other things limit the incurrence of additional debt, the sale of assets and the payment of dividends. The agreements relating to Transmission's promissory notes include, among other things, restrictions as to the payment of dividends. The Company had no committed lines of credit at December 31, 1998. Transmission has a committed line of credit of $70.0 million, which was available at December 31, 1998, and uncommitted facilities for up to $20.0 million, which were available at December 31, 1998. Transmission had an additional line of credit with Enron of $50 million of which $10.3 million was outstanding with a rate of 5.21% at December 31, 1998, and was repaid on January 4, 1999. IV-19 97 CITRUS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (3) LONG-TERM DEBT AND OTHER FINANCING ARRANGEMENTS (continued) The Company entered into a series of interest rate swap transactions in 1998. The agreements, which terminate in 1999, hedge changes in interest rates related to a debt issue forecasted for the fourth quarter of 1999. The swaps qualify for hedge accounting and are not reflected in the Company's Consolidated Balance. The aggregate notional amount of the swaps is $160 million. The unrealized loss at December 31, 1998 related to the swaps was $1.2 million. Gains or losses will be recognized over the life of the debt issued. The Company is exposed to credit risk in the event of nonperformance by counterparties. There are no collateral requirements related to the agreements. (4) INCOME TAXES The principal components of the Company's net deferred income tax liabilities at December 31, 1998 and 1997 are as follows (in thousands):
1998 1997 ---------------- ---------------- Deferred income tax assets Alternative minimum tax credit $ 23,230 $ 20,360 Other 8,150 5,588 ---------------- ---------------- 31,380 25,948 ---------------- ---------------- Deferred income tax liabilities Depreciation and amortization 515,748 492,629 Contract reformation costs 17,611 13,167 Other 4,606 3,342 ---------------- ---------------- 537,965 509,138 ---------------- ---------------- Net deferred income tax liabilities $ 506,585 $ 483,190 ================ ================
Total income tax expense for the years ended December 31, 1998, 1997 and 1996 is summarized as follows (in thousands):
1998 1997 1996 ---------------- ---------------- ---------------- Payable currently Federal $ 4,963 $ 6,441 $ 15,445 State 368 2,398 3,256 ---------------- ---------------- ---------------- 5,331 8,839 18,701 ---------------- ---------------- ---------------- Payment deferred Federal 19,908 23,300 7,847 State 3,487 (14,679) 692 ---------------- ---------------- ---------------- 23,395 8,621 8,539 ---------------- ---------------- ---------------- Total income tax expense $ 28,726 $ 17,460 $ 27,240 ================ ================ ================
The 1997 income tax provision includes benefits of approximately $10 million from the reduction of the deferred income tax liability due to the reevaluation of state tax requirements. IV-20 98 CITRUS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (4) INCOME TAXES (continued) The differences between taxes computed at the U.S. federal statutory rate and the Company's effective tax rate for the years ended December 31, 1998, 1997 and 1996 are as follows (in thousands):
1998 1997 1996 ---------------- ---------------- ---------------- Statutory federal income tax provision $ 26,145 $ 25,216 $ 24,597 Net state income taxes 2,506 (7,983) 2,566 Other 75 227 77 ---------------- ---------------- ---------------- Income tax expense $ 28,726 $ 17,460 $ 27,240 ================ ================ ================
The Company has an alternative minimum tax (AMT) credit which can be used to offset regular income taxes payable in future years. The AMT credit has an indefinite carry-forward period. For financial statement purposes, the Company has recognized the benefit of the AMT credit carry-forward as a reduction of deferred tax liabilities. (5) EMPLOYEE BENEFIT PLANS The employees of the Company and its subsidiaries are covered under Enron's employee benefit plans. Enron maintains a retirement plan (the Enron Plan) which is a noncontributory defined benefit plan covering substantially all employees in the United States and certain employees in foreign countries. The benefit accrual is in the form of a cash balance of 5% of annual base pay. Pension expenses charged by Enron were immaterial in 1998, 1997 and 1996. As of December 31, 1998, the plan net assets for the Enron Plan in which the employees of the Company participate was greater than the actuarial present value of projected plan benefit obligations by approximately $87 million. Included in this amount are assets from a defined benefit plan for an acquired company. The assumed discount rate was 6.75%. The rate of return on plan assets used in determining the actuarial present value of projected plan benefits was 9.0% to 10.5%. The assumed rate of increase in wages was 4.0% to 9.5%. The Company accounts for post-retirement benefit costs over the service lives of the employees expected to be eligible to receive such benefits. The Company is amortizing the transition obligation, which existed at January 1, 1993, over a period of approximately 19 years. The Company's net periodic post-retirement benefit cost charged by Enron was $1.4, $1.4 and $1.5 million for 1998, 1997 and 1996, respectively, substantially all of which relates to Transmission and are being recovered through rates. The measurement of the accumulated post-retirement benefit obligation (APBO) assumes a 6.75% discount rate and a health care cost trend rate of 7% in 1998 decreasing to 5% by 2003. The APBO exceeded plan assets by $74 million as of its most recent valuation date of December 31, 1998. IV-21 99 CITRUS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (6) MAJOR CUSTOMERS Revenues from individual customers exceeding 10% of total revenues for the years ended December 31, 1998, 1997 and 1996 were approximately as follows (in millions):
Customers 1998 1997 1996 --------- ----------------- ----------------- ----------------- Florida Power & Light Company $ 283.3 $ 424.1 $ 465.5 Enron Capital and Trade Resources 68.8 51.4 19.3
At December 31, 1998 and 1997, the Company's subsidiaries had receivables of approximately $29.9 and $19.8 million from Florida Power & Light Company and receivables of approximately $6.1 and $6.9 million from Enron Capital and Trade Resources, respectively. (7) RELATED PARTY TRANSACTIONS The Company incurs certain corporate administrative expenses including employee benefit costs from Enron and its affiliates. The Company was charged approximately $11.9, $11.8 and $11.9 million for these expenses for the years ended December 31, 1998, 1997 and 1996, respectively. The Company's subsidiaries provide natural gas sales and transport services to Enron and Sonat affiliates at rates equal to rates charged to non-affiliated customers in the same class of service. Revenues related to these services amounted to approximately $68.9, $51.5 and $19.8 million for the years ended December 31, 1998, 1997 and 1996, respectively. The Company's subsidiaries purchased gas from affiliates of Sonat of approximately $73.7, $121.8 and $139.8 million for the years ended December 31, 1998, 1997 and 1996, respectively. The Company's subsidiaries also purchased gas from affiliates of Enron of approximately $135.0, $219.1 and $252.6 million for the years ended December 31, 1998, 1997 and 1996, respectively. The Company had an agreement with an affiliate of Enron in which the affiliate managed the operations of Trading in exchange for a $1.2 million annual fee from November 1, 1993 to October 31, 1997. Effective November 1, 1997, the operations of the contracts held by Trading were divided between affiliates of Enron and Sonat. Additionally, the Enron affiliate made a payment of $20 million in 1997 to Trading to compensate it for lost future business. The fee charged is now based on a volumetric payment of $.005/MMBtu, or approximately 50% of the prior arrangement. Under this agreement, Trading is guaranteed an earnings stream based on all firm long-term contracts in place at November 1, 1997. (8) RATE MATTERS Transmission has been authorized by the FERC to recover certain transition costs incurred through the reformation of gas purchase contracts related to Transmission's former jurisdictional sales services. Transmission's Order No. 636 restructuring settlement, effective November 1, 1993, allows Transmission to recover 100% of any transition costs from $106 million up to $160 million, and 75% of payments exceeding $160 million. Transmission has no gas purchase contracts with accrued take-or-pay obligations that have not yet been terminated. All transition costs eligible for recovery have been fully recovered. Transmission's currently effective rates were established pursuant to a Stipulation and Agreement Settlement ("Rate Case Settlement") which resolved all issues in Transmission's IV-22 100 CITRUS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (8) RATE MATTERS (continued) Section 4 rate filing in FERC Docket No. 96-366. The Rate Case Settlement, approved by FERC Order issued September 24, 1997, provided that Transmission cannot file a general rate case to increase its base tariff rates prior to October 1, 2000 (except in certain limited circumstances) and must file no later than October 1, 2001. The Rate Case Settlement also provided that the rate charged pursuant to Transmission's rate schedule FTS-2 will decrease effective March 1, 1999 and March 1, 2000. On December 1, 1998, Transmission filed an application with the FERC to construct 205 miles of pipeline in order to extend the pipeline to Ft. Meyers, Florida and to expand capacity by 272,000 MMBtu/day. Expansion costs are currently estimated at $351 million. Transmission requested that expansion costs be rolled in to the FTS-2 (Phase III Expansion) service. Settlement proceedings with shippers and the FERC are currently ongoing. (9) COMMITMENTS AND CONTINGENCIES The FERC's Division of Audits (DOA) completed a compliance review of Transmission's books and records for the period of January 1, 1991 through December 31, 1994. Among other things, the FERC auditors questioned certain aspects of Transmission's procedures for accounting for the costs of financing Transmission's Phase III expansion facilities and proposed adjustments to the amount of AFUDC capitalized during construction of its Phase III expansion facilities. Pursuant to an agreement among Transmission, FERC staff and customer intervenors, Transmission filed a settlement agreement on July 30, 1996, which was approved by FERC order issued September 27, 1996. The settlement provided for a reduction of $18.75 million in its Gas Plant in Service account. In addition, the settlement provided that Transmission would restructure its capital accounts by removing approximately $348 million of excess donated capital on its books related to the Phase III construction. The settlement was without prejudice to Transmission seeking Commission approval to recover the $18.75 million, required to be removed from its plant account, in the rate case filed by Transmission on August 30, 1996. As a result of the Rate Case Settlement, Transmission will amortize the $18.75 million over a period not to exceed fifty-five months commencing March 1, 1997. The $18.75 million will be recovered over the amortization period. The DOA conducted a review of Transmission's books and records as to the construction costs of the Phase III expansion. The FERC's Division of Enforcement (DOE) conducted an informal investigation as to the possible non-compliance with certain environmental conditions attached to the FERC certificate authorizing the Phase III expansion. By order issued November 27, 1996, the FERC consolidated the Phase III cost audit and the DOE informal investigation with Transmission's rate case in Docket No. RP96-366-000. Pursuant to the Rate Case Settlement, the DOA review and DOE investigations have been terminated with no disallowance of any Phase III project costs. (10) CONCENTRATIONS OF CREDIT RISK AND OTHER FINANCIAL INSTRUMENTS The Company and its subsidiaries have a concentration of customers in the electric and gas utility industries. These concentrations of customers may impact the Company's overall exposure to credit risk, either positively or negatively, in that the customers may be similarly affected by changes in economic or other conditions. Credit losses incurred on receivables in these industries compare favorably to losses experienced in the Company's receivable portfolio as a whole. The IV-23 101 CITRUS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (10) CONCENTRATIONS OF CREDIT RISK AND OTHER FINANCIAL INSTRUMENTS (continued) Company and its subsidiaries also have a concentration of customers located in the southeastern United States, primarily within the State of Florida. Receivables are generally not collateralized. The Company's management believes that the portfolio of receivables, which includes local distribution companies and municipalities, is well diversified and that such diversification minimizes any potential credit risk. The carrying amounts and fair value of the Company's financial instruments at December 31, 1998 and 1997 are as follows (in thousands):
1998 1997 ----------------------------------- ----------------------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value ---------------- ---------------- ---------------- ---------------- Cash and cash equivalents $ 4,495 $ 4,495 $ 17,274 $ 17,274 Notes payable to banks -- -- 20,000 20,000 Notes payable to Enron 10,300 10,300 -- -- Long-term debt 980,750 1,116,250 1,025,000 1,176,389
The carrying amount of cash and cash equivalents and notes payable reasonably approximate their fair value. The fair value of long-term debt is based upon market quotations of similar debt at interest rates currently available. (11) YEAR 2000 PROJECT (UNAUDITED) The Company continues to assess and modify its computer systems to ensure they will operate properly in 2000. The Company has not incurred material Year 2000 costs to date, and management anticipates that the costs which will be incurred in the future will not have a material impact on the Company's financial position or results of operations. (12) SUBSEQUENT EVENT (UNAUDITED) On March 15, 1999, Sonat announced the execution of definitive agreements for a merger with El Paso Energy Corporation. It is expected that the merger will be completed during the third or fourth quarter of 1999, subject to certain required governmental approvals. IV-24 102 APPENDIX TO ANNUAL REPORT ON FORM 10-K OF SONAT INC. FOR THE YEAR ENDED DECEMBER 31, 1998 In compliance with Section 304 of Regulation S-T, the following information describes pictorial and/or graphic materials contained herein:
PAGE DESCRIPTION I-8 Map of the Southwestern and Southcentral United States (Montana, Wyoming, Colorado, Kansas, New Mexico, Texas, Oklahoma, Arkansas, Louisiana, Mississippi, and Alabama) generally showing the gas reserve basins and areas in which Exploration has significant lease interest. These leases are described on pages I-2 through I-5 and in the chart on page I-5. I-8 Map of the Gulf of Mexico, offshore Texas, Louisiana and Mississippi, showing the location of leases and seismic data held by Sonat GOM as described on pages I-2 through I-5 and in the chart on page I-6. I-18 Map of the Southeastern United States showing the approximate location of Sonat's pipeline systems as described on pages I-11 and I-12, the underground storage facilities of Southern as described on page I-18, and the proposed projects as described on pages I-15 through I-17. I-23 Map of the United States showing areas of operations of Sonat Energy Services as described on pages I-20 and I-21.
103 EXHIBIT INDEX
EXHIBIT NUMBER EXHIBITS - ------- -------- RESTATED CERTIFICATE OF INCORPORATION AND BY-LAWS 3 (a) Restated Certificate of Incorporation of Sonat Inc. (Restating the Certificate of Incorporation as in effect as of April 28, 1994) filed as Exhibit 3(a) to Form 10-Q of Sonat Inc. for the quarter ended March 31, 1994 3 (b) By-Laws of Sonat Inc. as amended and in effect December 1, 1995, filed as Exhibit 3-(b) to Form 10-K of Sonat Inc. for the year 1995 INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS 4.1 Rights Agreement dated as of January 8, 1996, between Sonat Inc. and Chemical Mellon Shareholder Services, L.L.C., as Rights Agent, with exhibits, and (1) Amendment No. 1 dated as of November 22, 1998, filed as Exhibit 99 to Form 8-A of Sonat Inc. dated January 10, 1996, except (1), which was filed as Exhibit 4.1 to Form 8-K of Sonat Inc. dated January 30, 1998 4.2 Registration Rights Agreement, dated as of January 30, 1998, by and between Sonat Inc., Selim K. Zilkha, Michael Zilkha, the Selim K. Zilkha Trust and the Selim K. Zilkha (1996) Annuity Trust, filed as Exhibit 10.1 to Form 8-K of Sonat Inc. dated January 30, 1998 4.3 Form of Indenture dated June 1, 1986, from Sonat Inc. to Manufacturers Hanover Trust Company, Trustee, as amended by (1) First Supplemental Indenture dated June 1, 1995, between Sonat Inc. and Chemical Bank, successor by merger to Manufacturers Hanover Trust Company, as Trustee, filed as Exhibit 4-(1) to Amendment No. 1 to Registration Statement No. 33-5947 dated June 4, 1986, except(1), which was filed as Exhibit 4-(1) to Form 8-K of Sonat Inc. dated June 6, 1995 4.4 Specimen Note of Sonat Inc. for the $200 million 6 7/8% Notes due June 1, 2005, issued under Registration Statement No. 33-62166, filed as Exhibit 4-(2) to Form 8-K of Sonat Inc. dated June 6, 1995 4.5 Specimen Note of Sonat Inc. for the $100 million 9 1/2% Notes due August 15, 1999, issued under Registration Statement No. 33-5947, filed as Exhibit 4-2(c) to Form 10-K of Sonat Inc. for the year 1996 4.6 Specimen Note of Sonat Inc. for the $100 million 9% Notes due May 1, 2001, issued under Registration Statement No. 33-5947, filed as Exhibit 4-(2) to Form 8-K of Sonat Inc. dated April 30, 1991 4.7 Specimen Note of Sonat Inc. for the $100 million 6.75% Notes due October 1, 2007, issued under Registration Statement No. 33-62166, filed as Exhibit 4-(3) to Form 8-K of Sonat Inc. dated September 25, 1997 4.8 Specimen Note of Sonat Inc. for the $100 million 6 5/8% Notes due February 1, 2008, issued under Registration Statement No. 33-62166, filed as Exhibit 4-(3) to Form 8-K of Sonat Inc. dated January 27, 1998 4.9 Specimen Note of Sonat Inc. for the $100 million 7% Notes due February 1, 2018, issued under Registration Statement No. 33-62166, filed as Exhibit 4-(3) to Form 8-K of Sonat Inc. dated January 29, 1998
- --------------- (1) Sonat will furnish to requesting security holders any exhibit on this list upon the payment of a fee of $.10 per page up to a maximum of $5.00 per exhibit. Requests must be made in writing and should be addressed to Beverley T. Krannich, Secretary, Sonat Inc., P. O. Box 2563, Birmingham, Alabama 35202. 104
EXHIBIT NUMBER EXHIBITS - ------- -------- 4.10 Form of Indenture dated June 1, 1987, from Southern Natural Gas Company to Manufacturers Hanover Trust Company, Trustee, as amended by (1) First Supplemental Indenture, dated as of September 30, 1997, between Southern Natural Gas Company and The Chase Manhattan Bank (formerly Chemical Bank, successor by merger to Manufacturers Hanover Trust Company), filed as Exhibit 4-(1) to Registration Statement No. 33-47266 of Southern Natural Gas Company dated April 16, 1992, except (1) which was filed as Exhibit 4-(2) to Form 8-K of Southern Natural Gas Company dated September 25, 1997 4.11 Specimen Note of Southern Natural Gas Company for the $100 million 8 7/8% Notes due February 15, 2001, issued under Registration Statement No. 33-16190, filed as Exhibit 4-(2) to Form 8-K of Southern Natural Gas Company dated February 7, 1991 4.12 Specimen Note of Southern Natural Gas Company for the $100 million 7.85% Notes due January 15, 2002, issued under Registration Statement No. 33-16190, filed as Exhibit 4-(2) to Form 8-K of Southern Natural Gas Company dated January 14, 1992 4.13 Specimen Note of Southern Natural Gas Company for the $100 million 8 5/8% Notes due May 1, 2002, issued under Registration Statement No. 33-47266, filed as Exhibit 4.3(d) to Form 10-K of Sonat Inc. for the year 1996 4.14 Specimen Note of Southern Natural Gas Company for the $100 million 6.70% Notes due October 1, 2007, issued under Registration Statement No. 33-47266, filed as Exhibit 4-(3) to Form 8-K of Southern Natural Gas Company dated September 25, 1997 4.15 Specimen Note of Southern Natural Gas Company for the $100 million 6.125% Notes due September 15, 2008, issued under Registration Statement No. 333-47959, filed as Exhibit 4-(3) to Form 8-K of Southern Natural Gas Company dated September 24, 1998 4.16 $400 Million Note Agreement dated November 3, 1986, between Citrus Corp. and the Purchasers named therein, filed as Exhibit 4-(5) to Form 10-K of Sonat Inc. for the year 1990 4.17 Credit Agreement dated as of June 1, 1996, among Sonat Inc., the Banks named therein, and The Chase Manhattan Bank (National Association), and Morgan Guaranty Trust Company of New York, as Co-Agents, filed as Exhibit 4 to Form 10-Q of Sonat Inc. for the quarter ended June 30, 1996 4.18 Credit Agreement dated as of January 20, 1999, among Sonat Inc., the Banks named therein, The Chase Manhattan Bank, as Administrative Agent, Bank of America National Trust and Savings Association, as Syndication Agent, and SunTrust Bank, Atlanta, as Documentation Agent, filed herewith 4.19 Certificate of Designations of Series A Participating Preference Stock of Sonat Inc. dated January 8, 1996, as filed with the Secretary of State of the State of Delaware January 16, 1996, filed as Exhibit 4.6 to Form 10-K of Sonat Inc. for the year 1995 COMPENSATION PLANS AND MANAGEMENT CONTRACTS 10.1 Supplemental Benefit Plan of Sonat Inc. as Amended and Restated effective January 1, 1997, filed herewith 10.2 Executive Award Plan of Sonat Inc. as Amended and Restated as of July 23, 1998, filed as Exhibit 10.1 to Form 10-Q of Sonat Inc. for the quarter ended September 30, 1998 10.3 Restricted Stock Plan for Directors of Sonat Inc. (as Amended and Restated as of February 26, 1998), filed as Exhibit 10.3 to Form 10-K of Sonat Inc. for the year 1997 10.4 Performance Award Plan of Sonat Inc. effective as of January 27, 1994, (1) amendment dated December 1, 1995, and (2) amendment dated July 23, 1998, filed as Exhibit 10-(7) to Form 10-K of Sonat Inc. for the year 1993, except (1), which was filed as Exhibit 10.7 to Form 10-K of Sonat Inc. for the year 1995, and (2), which was filed as Exhibit 10.2 to Form 10-Q of Sonat Inc. for the quarter ended September 30, 1998
105
EXHIBIT NUMBER EXHIBITS - ------- -------- 10.5 Cash Bonus Plan of Sonat Inc. effective as of January 27, 1994, (1) amendment dated December 1, 1995, and (2) amendment dated July 23, 1998, filed as Exhibit 10-(8) to Form 10-K of Sonat Inc. for the year 1993, except (1), which was filed as Exhibit 10.8 to Form 10-K of Sonat Inc. for the year 1995, and (2), which was filed as Exhibit 10.4 to Form 10-Q of Sonat Inc. for the quarter ended September 30, 1998 10.6 Sonat Inc. Retirement Plan for Directors as Amended and Restated as of December 2, 1994, and (1) amendment dated December 1, 1995, filed as Exhibit 10.9 to Form 10-K of Sonat Inc. for the year 1994, except (1), which was filed as Exhibit 10.9 to Form 10-K of Sonat Inc. for the year 1995 10.7 Executive Severance Agreement dated July 23, 1998, between Sonat Inc. and Thomas W. Barker, Jr. and schedule identifying substantially identical Executive Severance Agreements between Sonat Inc. and other parties, filed as Exhibit 10.6 to Form 10-Q of Sonat Inc. for the quarter ended September 30, 1998 10.8 Executive Severance Agreement dated July 23, 1998, between Sonat Inc. and Ronald L. Kuehn, Jr., filed as Exhibit 10.5 to Form 10-Q of Sonat Inc. for the quarter ended September 30, 1998 10.9 Directors' Fees Deferral Plan of Sonat Inc. as Amended and Restated as of January 1, 1997, filed as Exhibit 10.9 to Form 10-K of Sonat Inc. for the year 1997 10.10 Indemnity Agreement dated December 4, 1987, between Sonat Inc. and Ronald L. Kuehn, Jr. and schedule identifying substantially identical indemnity agreements between Sonat Inc. and other directors of Sonat Inc. and (1) Indemnity Agreement dated September 1, 1994, between Sonat Inc. and Adrian M. Tocklin, (2) Indemnity Agreement dated November 1, 1995, between Sonat Inc. and Max L. Lukens, (3) Indemnity Agreement dated January 30, 1998, between Sonat Inc. and Michael S. Zilkha, and (4) Indemnity Agreement dated January 30, 1998, between Sonat Inc. and Selim K. Zilkha, filed as Exhibit 10-(11) to Form 10-K of Sonat Inc. for the year 1992, except (1), which was filed as Exhibit 10.3 to Form 10-Q of Sonat Inc. for the quarter ended September 30, 1994, (2), which was filed as Exhibit 10.12 to Form 10-K of Sonat Inc. for the year 1995, and (3) and (4), which were filed as Exhibit 10.11 to Form 10-K of Sonat Inc. for the year 1997 10.11 Trust Agreement dated December 19, 1986, between Sonat Inc. and AmSouth Bank N.A. for Section 415 Retirement Plan Benefits and Vesting Benefits under the Supplemental Benefit Plan and Early Retirement Benefits under the Executive Severance Agreements, filed as Exhibit 10-(15) to Form 10-K of Sonat Inc. for the year 1991 10.12 Trust Agreement dated December 19, 1986, between Sonat Inc. and AmSouth Bank N.A. for Section 415 Stock Purchase Plan Benefits under the Supplemental Benefit Plan, filed as Exhibit 10-(16) to Form 10-K of Sonat Inc. for the year 1991 10.13 Trust Agreement dated December 19, 1986, between Sonat Inc. and AmSouth Bank N.A. for Benefits under the Retirement Plan for Directors, filed as Exhibit 10-(17) to Form 10-K of Sonat Inc. for the year 1991 10.14 Form of Sonat Inc. Executive Life Insurance Program Split Dollar Agreement, Collateral Assignment Agreement, and Program Description, each dated as of July 1, 1990, with (1) schedule identifying the persons participating in such Programs, filed as Exhibit 10-(20) to Form 10-K of Sonat Inc. for the year 1990, except (1), which was filed as Exhibit 10-15 to Form 10-K of Sonat Inc. for the year 1997 10.15 Sonat Inc. Deferred Compensation Plan -- Plan Summary dated November 1998, filed herewith OTHER MATERIAL CONTRACTS 10.16 Capital Stock Agreement among Sonat Inc., Enron Corp., Houston Natural Gas Corporation, and Citrus Corp. dated June 30, 1986, filed as Exhibit 10-(26) to Form 10-K of Sonat Inc. for the year 1991
106
EXHIBIT NUMBER EXHIBITS - ------- -------- 10.17 Agreement and Plan of Merger dated as of March 13, 1999, between El Paso Energy Corporation and Sonat Inc., filed as Exhibit 2.1 to Form 8-K of Sonat Inc. dated March 15, 1999 10.18 Form of Certificate of Designation, Preferences and Rights of the % Senior Cumulative Exchangeable Preferred Stock of El Paso Energy Corporation (incorporated by reference, filed as Exhibit E to Exhibit 2.1 of the Form 8-K of Sonat Inc. dated March 15, 1999) 10.19 El Paso Energy Corporation Stock Option Agreement, dated March 13, 1999, filed as Exhibit 99.1 to Form 8-K of Sonat Inc. dated March 15, 1999 10.20 Sonat Inc. Stock Option Agreement, dated March 13, 1999, filed as Exhibit 99.2 to Form 8-K of Sonat Inc. dated March 15, 1999 10.21 Voting Agreement, dated March 13, 1999, between El Paso Corporation and Selim K. Zilkha, in his individual capacity and in his capacity as trustee of the Selim K. Zilkha Trust, and Michael Zilkha, filed as Exhibit 99.3 to Form 8-K of Sonat Inc. dated March 15, 1999 10.22 Voting Agreement, dated March 13, 1999 between El Paso Energy Corporation and Ronald L. Kuehn, Jr., filed as Exhibit 99.4 to Form 8-K of Sonat Inc. dated March 15, 1999 OTHER EXHIBITS 12 Computation of Ratio of Earnings to Fixed Charges, filed herewith 21 Subsidiaries of Sonat Inc., filed herewith 22 Proxy Statement of Sonat Inc. dated as of March 22, 1999, which is not to be deemed "filed" as part of this Form 10-K, except to the extent incorporated by reference under Items 10, 11, 12 and 13 of Part III of this Form 10-K, filed herewith 23.1 Consent of Ernst & Young LLP, Independent Auditors, dated March 19, 1999, filed herewith 23.2 Consent of William M. Cobb, Independent Petroleum Engineers, dated March 4, 1999, filed herewith 23.3 Consent of Ryder Scott Company, Petroleum Engineers, dated March 8, 1999, filed herewith 23.4 Consent of KPMG LLP, Independent Auditors, dated March 19, 1999, filed herewith 23.5 Consent of KPMG LLP, Independent Auditors, dated March 19, 1999, filed herewith 24 Powers of Attorney authorizing Ronald L. Kuehn, Jr.; Thomas W. Barker, Jr.; James E. Moylan, Jr.; William A. Smith; and John C. Griffin to sign the Sonat Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1998, on behalf of certain directors and officers of the registrant, filed herewith 27 Financial Data Schedule for the period ended December 31, 1998, filed herewith, electronically only 99.1 Report of Ryder Scott Company, Petroleum Engineers, dated March 10, 1999, filed herewith 99.2 Report of William M. Cobb & Associates, Inc. dated January 14, 1999, filed herewith
EX-4.18 2 CREDIT AGREEMENT DATED AS OF JANUARY 20, 1999 1 EXHIBIT 4.18 CREDIT AGREEMENT dated as of January 20, 1999 among SONAT INC., THE BANKS NAMED HEREIN, and THE CHASE MANHATTAN BANK, as Administrative Agent, BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, as Syndication Agent and SUNTRUST BANK, ATLANTA, as Documentation Agent 2 TABLE OF CONTENTS
Article Page - ------- ---- I. LOANS............................................................................................ 1 ss.1.01 Syndicated Loans............................................................... 1 ss.1.02 Money Market Loans............................................................. 1 ss.1.03 Swingline Commitment........................................................... 4 ss.1.04 Change of Commitments.......................................................... 5 ss.1.05 Borrowings of Syndicated Loans................................................. 6 ss.1.06 Several Commitments; Remedies Independent...................................... 8 ss.1.07 Availability of Funds.......................................................... 8 ss.1.08 Borrowings of Swingline Loans.................................................. 8 ss.1.09 Lending Offices................................................................ 9 ss.1.10 Notes.......................................................................... 9 II. PAYMENTS, INTEREST AND CERTAIN FEES.............................................................. 10 ss.2.01 Repayment of Loans............................................................. 10 ss.2.02 Interest....................................................................... 10 ss.2.03 Interest Periods............................................................... 11 ss.2.04 Prepayments.................................................................... 11 ss.2.05 Payments, etc.................................................................. 12 ss.2.06 Pro Rata Treatment; Sharing.................................................... 12 ss.2.07 Computations................................................................... 13 ss.2.08 Facility Fee................................................................... 14 ss.2.09 Administration Fee............................................................. 14 III. PROVISIONS RELATING TO FIXED RATE LOANS.......................................................... 14 ss.3.01 Additional Costs............................................................... 14 ss.3.02 Limitation on Types of Loans................................................... 17 ss.3.03 Illegality..................................................................... 17 ss.3.04 Treatment of Affected Loans.................................................... 17 ss.3.05 Compensation................................................................... 17 ss.3.06 Survival....................................................................... 18 IV. CONDITIONS....................................................................................... 18 ss.4.01 Conditions to Effectiveness.................................................... 18 ss.4.02 Conditions Precedent to Loans.................................................. 19 V. COVENANTS........................................................................................ 19 ss.5.01 Financial Statements........................................................... 19 ss.5.02 Access to Books and Inspection................................................. 20
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Article Page - ------- ---- ss.5.03 Litigation..................................................................... 21 ss.5.04 Maintenance of Existence....................................................... 21 ss.5.05 Merger; Sale of Assets......................................................... 21 ss.5.06 Default; Investment Rating..................................................... 22 ss.5.07 ERISA.......................................................................... 22 ss.5.08 Liens.......................................................................... 22 ss.5.09 Total Indebtedness to Consolidated Capitalization.............................. 23 ss.5.10 [Intentionally Omitted.]....................................................... 23 ss.5.11 Insurance...................................................................... 23 ss.5.12 Maintenance of Properties...................................................... 23 ss.5.13 Public Utility Holding Company Act............................................. 24 VI. REPRESENTATIONS AND WARRANTIES................................................................... 24 ss.6.01 Corporate Existence and Powers................................................. 24 ss.6.02 Corporate Authority, etc....................................................... 24 ss.6.03 Financial Condition............................................................ 24 ss.6.04 Litigation..................................................................... 25 ss.6.05 Taxes.......................................................................... 25 ss.6.06 Approvals...................................................................... 25 ss.6.07 ERISA.......................................................................... 25 ss.6.08 Margin Regulations............................................................. 25 ss.6.09 Certain Subsidiaries........................................................... 26 ss.6.10 Investment Company Act......................................................... 26 ss.6.11 Environmental Laws............................................................. 26 ss.6.12 Year 2000 Problem.............................................................. 26 VII. EVENTS OF DEFAULT................................................................................ 26 VIII. MISCELLANEOUS.................................................................................... 28 ss.8.01 Waiver......................................................................... 28 ss.8.02 Notices and Delivery of Documents.............................................. 29 ss.8.03 Governing Law.................................................................. 29 ss.8.04 Offsets, etc................................................................... 29 ss.8.05 Disposition of Loans........................................................... 29 ss.8.06 Expenses....................................................................... 30 ss.8.07 Amendments, Waivers, etc....................................................... 30 ss.8.08 Definitions.................................................................... 31 ss.8.09 Successors and Assigns......................................................... 31 ss.8.10 Counterparts................................................................... 31 ss.8.11 Confidentiality................................................................ 32 IX. THE AGENTS....................................................................................... 32
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Article Page - ------- ---- ss.9.01 Appointment, Power and Immunities.............................................. 32 ss.9.02 Reliance by Agents............................................................. 32 ss.9.03 Default........................................................................ 33 ss.9.04 Rights as a Lender............................................................. 33 ss.9.05 Indemnification................................................................ 33 ss.9.06 Reports........................................................................ 34 ss.9.07 Non-Reliance on Agents and Other Banks......................................... 34 ss.9.08 Failure to Act................................................................. 34 ss.9.09 Resignation or Removal of Agents............................................... 34 ss.9.10 Documentation Agent............................................................ 35 ss.9.11 Syndication Agent.............................................................. 35
SCHEDULE 1 Definitions SCHEDULE 2 Lending Offices and/or Addresses for Notices SCHEDULE 3 Commitments EXHIBIT A-1 Form of Note for Syndicated Loans EXHIBIT A-2 Form of Note for Money Market Loans EXHIBIT A-3 Form of Note for Swingline Loans EXHIBIT B Form of Opinion of Counsel to the Company EXHIBIT C Form of Opinion of Special New York Counsel to the Banks EXHIBIT D Form of Money Market Quote Request EXHIBIT E Form of Money Market Quote iii 5 CREDIT AGREEMENT dated as of January 20, 1999 among SONAT INC., a Delaware corporation (the "Company"); the undersigned banks (each herein called a "Bank"); and THE CHASE MANHATTAN BANK, as Administrative Agent, BANK OF AMERICA National Trust AND Savings Association, as Syndication Agent and SUNTRUST BANK, ATLANTA, as Documentation Agent (in such capacities, each such agent being herein called an "Agent" and collectively the "Agents"); and CREDIT LYONNAIS, NEW YORK BRANCH, as Managing Agent. The Company has requested the Banks to extend credit to the Company for the general corporate purposes of the Company. The Banks are prepared to do so on the terms hereof. Accordingly, the Company, each Bank and the Agents hereby agree as follows: I. LOANS ss.1.01 Syndicated Loans. Each Bank severally agrees, on the terms of this Agreement, to make loans to the Company in Dollars during the period from and including the date hereof to but not including the Commitment Termination Date in an aggregate principal amount at any one time outstanding up to but not exceeding the amount of such Bank's Commitment as then in effect. Subject to the terms of this Agreement, during such period the Company may borrow, repay and reborrow the amount of the Commitments; provided that the sum of (i) the aggregate principal amount of all Money Market Loans, plus (ii) the aggregate principal amount of all Syndicated Loans plus (iii) the aggregate principal amount of all Swingline Loans, at any one time outstanding shall not exceed the aggregate amount of the Commitments at such time except that, notwithstanding the foregoing, Money Market Loans outstanding at the time of any termination or reduction of the Commitments pursuant to ss.1.04 hereof need not be prepaid on account of this proviso. ss.1.02 Money Market Loans. (a) In addition to borrowings of Syndicated Loans, the Company may, as set forth in this ss.1.02, request the Banks to make offers to make Money Market Loans to the Company in Dollars. The Banks may, but shall have no obligation to, make such offers and the Company may, but shall have no obligation to, accept any such offers in the manner set forth in this ss.1.02. Money Market Loans shall be Set Rate Loans, provided that: (i) there may be no more than fifteen different Interest Periods for both Syndicated Loans (other than Domestic Loans) and Money Market Loans outstanding at the same time (for which purpose Interest Periods described in different lettered clauses of the definition of the term "Interest Period" in ss.2.03 hereof shall be deemed to be different Interest Periods even if they are coterminous); and (ii) the sum of (x) aggregate principal amount of all Money Market Loans, plus (y) the aggregate principal amount of all Syndicated Loans plus (z) the aggregate principal amount of all Swingline Loans, at any one time outstanding shall not 6 2 exceed the aggregate amount of the Commitments at such time except that, notwithstanding the foregoing, Money Market Loans outstanding at the time of any termination or reduction of the Commitments pursuant to ss.1.04 hereof need not be prepaid on account of this proviso. (b) When the Company wishes to request offers to make Money Market Loans, it shall give each Bank notice (a "Money Market Quote Request") so as to be received no later than 11:00 a.m. New York time on the Business Day next preceding the date of borrowing proposed therein or such other time and date as the Company and the Majority Banks may agree. The Company may request offers to make Money Market Loans for up to three different Interest Periods in a single notice (for which purpose Interest Periods in different lettered clauses of the definition of the term "Interest Period" shall be deemed to be different Interest Periods even if they are coterminous); provided that the request for each separate Interest Period shall be deemed to be a separate Money Market Quote Request for a separate borrowing (a "Money Market Borrowing"). Each such notice shall be substantially in the form of Exhibit D hereto and shall specify as to each Money Market Borrowing: (i) the proposed date of such borrowing, which shall be a Business Day; (ii) the aggregate amount of such Money Market Borrowing, which shall be at least $25,000,000 (or in larger multiples of $5,000,000) but shall not cause the limits specified in ss.1.02 hereof to be violated (without giving effect to any other Money Market Borrowing subject to a simultaneous Money Market Quote Request); (iii) the duration of the Interest Period applicable thereto; and (iv) the date on which the Money Market Quotes are to be submitted if it is before the proposed date of borrowing (the date on which such Money Market Quotes are to be submitted is called the "Quotation Date"). Except as otherwise provided in this ss.1.02, no Money Market Quote Request shall be given within five Business Days (or such other number of days as the Company and the Majority Banks may agree) of any other Money Market Quote Request. (c) (i) Each Bank may submit one or more Money Market Quotes, each containing an offer to make a Money Market Loan in response to any Money Market Quote Request; provided that, if the Company's request under ss.1.02(b) hereof specified more than one Interest Period, such Bank may make a single submission containing one or more Money Market Quotes for each such Interest Period. Each Money Market Quote must be submitted to the Company not later than 10:00 a.m. New York time on the Quotation Date or such other time and date as the Company and the Majority Banks may agree. Subject to ss.3.02(b), ss.3.03, ss.4.02 and Article VII hereof, any Money Market Quote so made shall be irrevocable except with the written consent of the Company. 7 3 (ii) Each Money Market Quote shall be substantially in the form of Exhibit E hereto and shall specify: (A) the proposed date of borrowing and the Interest Period therefor; (B) the principal amount of the Money Market Loan for which each such offer is being made, which principal amount shall be at least $5,000,000 or a larger multiple of $1,000,000; provided that the aggregate principal amount of all Money Market Loans for which a Bank submits Money Market Quotes (x) may be greater or less than the Commitment of such Bank but (y) may not exceed the principal amount of the Money Market Borrowing for a particular Interest Period for which offers were requested; (C) the rate of interest per annum (rounded upwards, if necessary, to the nearest 1/10,000th of 1%) offered for each Money Market Loan (the "Money Market Rate"); and (D) the identity of the quoting Bank. Unless otherwise agreed by the Company, no Money Market Quote shall contain qualifying, conditional or similar language or propose terms other than or in addition to those set forth in the applicable Money Market Quote Request and, in particular, no Money Market Quote may be conditioned upon acceptance by the Company of all (or some specified minimum) of the principal amount of the Money Market Loan for which such Money Market Quote is being made. (d) Not later than 11:30 a.m. New York time on the Quotation Date or such other time and date as the Company and the Majority Banks may agree, the Company shall notify each Bank of its acceptance or nonacceptance of the offers so notified to it pursuant to ss.1.02(c)(i) hereof (and the failure of the Company to give such notice by such time shall constitute nonacceptance). In the case of acceptance, such notice shall specify the aggregate principal amount of offers for each Interest Period that are accepted. The Company may accept any Money Market Quote in whole or in part (provided that any Money Market Quote accepted in part shall be at least $5,000,000 or in larger multiples of $1,000,000); provided that: (i) the aggregate principal amount of each Money Market Borrowing may not exceed the applicable amount set forth in the related Money Market Quote Request; (ii) the aggregate principal amount of each Money Market Borrowing shall be at least $25,000,000 (or in larger multiples of $5,000,000) but shall not cause the limits specified in ss.1.02 hereof to be violated; (iii) acceptance of offers may be made only in ascending order of Money Market Rates, in each case commencing with the lowest rate so offered; and 8 4 (iv) the Company may not accept any offer that fails to comply with ss.1.02(c)(ii) hereof or otherwise fails to comply with the requirements of this Agreement (including, without limitation, ss.1.02(a) hereof). If offers are made by two or more Banks with the same Money Market Rates for a greater aggregate principal amount than the amount in respect of which offers are accepted for the related Interest Period, the principal amount of Money Market Loans in respect of which such offers are accepted shall be allocated by the Company among such Banks as nearly as possible (in multiples of $1,000,000) in proportion to the aggregate principal amount of such offers. Determinations by the Company of the amounts of Money Market Loans shall be conclusive in the absence of manifest error. Promptly after the acceptance by the Company of any Money Market Quote, the Company shall give Chase notice of the principal amount of each Money Market Loan to be made pursuant to such Money Market Quote, the rate of interest per annum and the duration of the Interest Period applicable thereto and the name of the Bank making such Loan. (f) Any Bank whose offer to make any Money Market Loan has been accepted shall, not later than 1:00 p.m. New York time on the date specified for the making of such Loan, make the amount of such Loan available to Chase at account number 323-506909 maintained by Chase with The Chase Manhattan Bank at its Principal Office in immediately available funds, for account of the Company. The amount so received by Chase shall, subject to the terms and conditions of this Agreement, be made available to the Company on such date by depositing the same, in immediately available funds, in an account of the Company maintained with The Chase Manhattan Bank at its Principal Office designated by the Company. (g) The amount of any Money Market Loan made by any Bank shall not constitute a utilization of such Bank's Commitment. ss.1.03 Swingline Commitment. Subject to the terms and conditions hereof, the Swingline Bank agrees to make a portion of the credit otherwise available to the Company under the Commitments by making swingline loans ("Swingline Loans") in Dollars to the Company during the period from and including the date hereof to but not including the Commitment Termination Date; provided that (a) the aggregate principal amount of Swingline Loans outstanding at any time shall not exceed the Swingline Commitment then in effect, (b) the aggregate principal amount of Swingline Loans plus the aggregate principal amount of Syndicated Loans made by the Swingline Bank outstanding at any time shall not exceed the Swingline Bank's Commitment then in effect, and (c) the Company shall not request, and the Swingline Bank shall not make, any Swingline Loan if, after giving effect to the making of such Swingline Loan, the sum of (i) the aggregate principal amount of all Money Market Loans, plus (ii) the aggregate principal amount of all Syndicated Loans plus (iii) the aggregate principal amount of all Swingline Loans, at any one time outstanding shall exceed the aggregate amount of the Commitments at such time except that, notwithstanding the foregoing, Money Market Loans outstanding at the time of any termination or reduction of the Commitments pursuant to ss.1.04 hereof need not be prepaid on account of this proviso. During such period, the Company may use the Swingline Commitment by borrowing, repaying and reborrowing, all in accordance with the terms and conditions hereof. 9 5 ss.1.04 Change of Commitments. (a) The Company shall have the right at any time or from time to time upon not less than three Business Days' prior notice to Chase (specifying the date and the aggregate amount of each such reduction or termination) to terminate in whole, or to reduce in part, (i) the aggregate unused amount of the Commitments (and, in accordance with ss.1.02(g) hereof, outstanding Money Market Loans shall not constitute a utilization of the Commitments) and/or (ii) the aggregate unused amount of the Swingline Commitment. Each such reduction of the Commitments shall be in an aggregate amount of at least $25,000,000 and a multiple of $1,000,000 and each such reduction of the Swingline Commitment shall be in an aggregate amount of at least $5,000,000 and a multiple of $1,000,000. Chase shall promptly notify each Bank of its proportionate share and the date of each such reduction. (b) If either (i) during any period of 12 consecutive months, individuals who were directors of the Company at the beginning of such period cease to constitute a majority of the board of directors of the Company (except for changes due to the retirement or death of any such individuals) or (ii) any Person (or group of Persons which has an agreement, arrangement or understanding for the purpose of acquiring the shares of the Company) shall acquire, directly or indirectly, beneficial ownership or control of more than 50% of the then outstanding voting shares of the Company (either such event being hereinafter referred to as a "Change in Control"), then each Bank (through Chase) may, by notice to the Company not later than the date 20 Business Days after the Company shall have notified the Agents of any such Change in Control, reduce the Commitment of such Bank in an amount equal to the unused amount of such Bank's Commitment (and, in accordance with ss.1.02(g) hereof, outstanding Money Market Loans shall not constitute a utilization of such Bank's Commitment) and the Swingline Bank, by such notice, may reduce the Swingline Commitment in an amount equal to the unused amount thereof. The Company agrees, as soon as it shall become known to one of its senior officers, to notify the Agents of any such Change in Control (and Chase shall promptly notify the Banks thereof), but the failure to so notify shall not preclude any Bank from reducing the unused amount of such Bank's Commitment as aforesaid. (c) Provided that no Default shall have occurred and be continuing, the Company may at any time terminate the Commitment of any Bank (and, in the case of the Swingline Bank, the Swingline Commitment) that has claimed any compensation under ss.3.01(a) or ss.3.01(c) hereof at any time during the preceding one-month period, in whole but not in part, by (i) giving Chase (which shall promptly notify such Bank) not less than five Business Days' prior notice thereof, which notice shall be irrevocable and effective only upon receipt by Chase and shall specify the identity of such Bank and the effective date of such termination, and (ii) paying to such Bank (and there shall become due and payable) on such date the outstanding principal amount of all Loans made by such Bank, interest on such principal amount accrued to such date, any amounts payable to such Bank pursuant to Article III hereof in connection therewith and all other amounts owing to such Bank by the Company hereunder (provided that the obligations of the Company under Article III and ss.8.06 hereof to such Bank shall survive such termination). (d) Provided that no Default shall have occurred and be continuing, the Company may at any time replace any Bank that has claimed any compensation under ss.3.01(a) or 10 6 ss.3.01(c) hereof at any time during the preceding one-month period, in whole but not in part, by giving Chase not less than five Business Days' prior notice (and Chase shall promptly notify such Bank), that it intends to replace such Bank with one or more banks (which may include any other Bank under this Agreement) selected by the Company and acceptable to Chase (which shall not unreasonably withhold its consent). Any such replacement shall be accomplished pursuant to documentation in form and substance satisfactory to Chase. Upon the effective date of any replacement under this ss.1.04(d) (and as a condition thereto), the Company shall repay to the Bank being replaced the principal of and interest on each Loan then outstanding from such Bank together with all other amounts owing to such Bank hereunder and such replacement bank (or banks, as the case may be) shall make a loan (or loans) to the Company in the (aggregate) principal amount of each such Loan so repaid which loan (or loans) shall be of the same type and have the same maturity and interest rate as the respective Loan so repaid), whereupon such replacement bank (or banks) shall become a "Bank" (or "Banks") for all purposes of this Agreement having a Commitment (or Commitments in the aggregate) (and, in the case of the Swingline Bank, the Swingline Commitment) in the amount of such Bank being replaced and such loan (or loans) shall be deemed a Loan (or Loans) hereunder. (e) The Swingline Bank may terminate in its sole discretion the Swingline Commitment by giving the Company written notice thereof at least 30 days in advance of the date of such termination. (f) The Commitments (and, in the case of the Swingline Bank, the Swingline Commitment) once terminated or reduced may not be reinstated, except that the Swingline Commitment may be reinstated by agreement of the Swingline Bank and the Company. ss.1.05 Borrowings of Syndicated Loans. (a) Each Syndicated Loan shall be either a Domestic Loan or Eurodollar Loan. Syndicated Loans on the occasion of any borrowing thereof hereunder may be Domestic Loans or Eurodollar Loans (each a "type" of Loan) or any combination thereof; provided that there may be no more than ten Interest Periods for Eurodollar Loans outstanding at the same time; and provided, further, that there may be no more than fifteen different Interest Periods for both Eurodollar Loans and Money Market Loans outstanding at the same time (for which purpose Interest Periods described in different lettered clauses of the definition of the term "Interest Period" in ss.2.03 hereof shall be deemed to be different Interest Periods even if they are coterminous). (b) The Company shall give Chase (which shall promptly notify the Banks) notice of each borrowing hereunder of Syndicated Loans, which notice shall be irrevocable and effective only upon receipt by Chase, shall specify with respect to the Syndicated Loans to be borrowed (i) the aggregate amount (which shall be at least $10,000,000 or a multiple of $1,000,000 in excess thereof), (ii) the type or types of Loans to be borrowed and the aggregate amount of each type, (iii) the date of such borrowing (which shall be a Business Day), and (iv) (in the case of Eurodollar Loans) the duration of the Interest Period therefor and shall be given not later than 11:00 a.m. New York time, in the case of Domestic Loans, on the same day as the date 11 7 of such borrowing and, in the case of Eurodollar Loans, on the day which is not less than three Business Days prior to the date of such borrowing. (c) If at any time during which Syndicated Loans are outstanding under this Agreement the Company shall fail to give a notice of the type referred to in ss.1.05(b) or otherwise to advise Chase in writing by 11:00 a.m. New York time on the day which is not less than one Business Day prior to the maturity date of any such Syndicated Loans that it does not intend to reborrow an amount at least equal to the aggregate amount of such Syndicated Loans (or, if less, the aggregate amount of the Commitments) on such maturity date, the Company shall be deemed to have given on such first Business Day preceding such maturity date a notice of borrowing hereunder for Domestic Loans to be made on such date in an amount equal to the lesser of (i) the aggregate principal amount of the Syndicated Loans which are maturing on such date or (ii) the aggregate amount of the Commitments to be outstanding on such date (after giving effect to any reductions of the Commitments to be effected on such date), and Chase shall notify the Banks of such borrowing. (d) Subject to Chase's receipt or deemed receipt of a notice of borrowing as provided in ss.1.05(b) or ss.1.05(c) hereof and to Chase's receipt of notice from the Swingline Bank of the outstanding principal amount of the Swingline Loans as of the Swingline Business Day next preceding the date of such notice of borrowing, Chase shall give each Bank not less than three Business Days' prior notice (with respect to each borrowing of Eurodollar Loans) or same-day notice by noon (with respect to each borrowing of Domestic Loans), as the case may be, of each such borrowing specifying (i) the aggregate amount to be borrowed, (ii) the date of borrowing, (iii) the type or types of Loans to be borrowed, (iv) in the case of any Fixed Rate Loans to be borrowed, the duration of the Interest Period therefor and (v) such Bank's pro rata portion thereof. Each Bank's (other than the Swingline Bank's) pro rata portion of each Syndicated Loan shall equal a fraction, the numerator of which shall be the amount of such Bank's Commitment as of the date the notice of borrowing is given for such Syndicated Loan and the denominator of which shall be (i) the aggregate Commitments of all Banks as of the date such notice of borrowing is given minus (ii) the outstanding principal amount of the Swingline Loans as of the next preceding Swingline Business Day. The Swingline Bank's pro rata portion of each Syndicated Loan shall equal a fraction, the numerator of which shall be (i) the amount of the Swingline Bank's Commitment as of the date the notice of borrowing is given with respect to such Syndicated Loan minus (ii) the outstanding principal amount of the Swingline Loans as of the next preceding Swingline Business Day and the denominator of which shall be (i) the aggregate Commitment of all Banks as of the date such notice of borrowing is given minus (ii) the outstanding principal amount of the Swingline Loans as of the next preceding Swingline Business Day. From and including the date that notice of a borrowing of a Syndicated Loan is given to but excluding the date that such Syndicated Loan is made, the principal amount of such Syndicated Loan required to be made by the Swingline Bank shall be deemed to be outstanding for purposes of clause (b) of ss.1.03. (e) Not later than 1:00 p.m. New York time on the date specified for each borrowing of Syndicated Loans, each Bank shall make available to Chase, at account number 323-506909 maintained by The Chase Manhattan Bank at its Principal Office in immediately available funds the amount of the Syndicated Loan or Syndicated Loans to be made by it on such 12 8 date, for account of the Company. The amount so received by Chase shall, subject to the terms and conditions of this Agreement, be made available to the Company on such date by depositing the same, in immediately available funds, in an account of the Company maintained with The Chase Manhattan Bank at its Principal Office designated by the Company. If any Bank shall (i) be obligated but fail to make available the amount of the Syndicated Loan to be made by it on the date specified for a borrowing hereunder and (ii) have any Syndicated Loans which are maturing on such date, such maturing Syndicated Loans shall automatically be extended in an amount equal to (but not in excess of) the amount of the Syndicated Loan to be made and in the type and for the Interest Period of such Loan to be made (and such Loan which would otherwise mature on such date shall not be considered to be past due hereunder). ss.1.06 Several Commitments; Remedies Independent. The failure of any Bank to make any Loan to be made by it shall not relieve any other Bank of its obligation to make its Loan on such date, but neither any other Bank nor any Agent shall be responsible for such failure. The amounts payable at any time by the Company hereunder and under the Notes to each Bank shall be a separate and independent debt and each Bank shall be entitled to protect and enforce its rights arising out of this Agreement and the Notes, and it shall not be necessary for any other Bank or any Agent to consent to, or to be joined as an additional party in, any proceedings for such purposes. ss.1.07 Availability of Funds. Unless Chase shall have been notified by a Bank prior to the date of any borrowing hereunder that such Bank does not intend to make available to Chase such Bank's Loans to be made on such day, Chase may assume that such Bank has made the amount of such Loans to be made available to Chase on such date and Chase may in reliance upon such assumption (but shall not be required to) make available to the Company a corresponding amount. If such proceeds are not in fact made available to Chase by such Bank, Chase shall be entitled to recover such corresponding amount on demand from such Bank (or, if such Bank fails to pay such corresponding amount forthwith upon such demand, from the Company) together with interest thereon in respect of each day during the period commencing on the date such corresponding amount was made available to the Company and ending on (but excluding) the date Chase recovers such corresponding amount at a rate per annum equal to the Federal Funds Rate for such day (or if such day is not a Business Day, the next preceding Business Day). ss.1.08 Borrowings of Swingline Loans. (a) If on any Swingline Business Day prior to the Commitment Termination Date the aggregate disbursements authorized by the Company and made from the Swingline Account exceed the aggregate cash on hand and deposits received in the Swingline Account on such Swingline Business Day, the Swingline Bank shall make a Swingline Loan to the Company in an amount equal to such excess (subject to the provisions of ss.1.03 hereof), unless otherwise instructed by the Company. Each Swingline Loan shall be credited to the Swingline Account as of the date made. The outstanding Swingline Loans shall bear interest at such rate per annum as the Company and the Swingline Bank shall agree. Accrued interest on the outstanding Swingline Loans shall be paid on each date on which the outstanding Swingline Loans are paid in full and on the first Swingline Business Day of each month if there are any outstanding Swingline Loans on the Swingline Business Day next preceding such day. The Company shall have the right to prepay the outstanding Swingline 13 9 Loans, in whole or in part, at any time. All payments with respect to Swingline Loans shall be made at the Lending Office of the Swingline Bank. Upon request of the Company made on any Swingline Business Day, the Swingline Bank shall give Chase notice as promptly as practicable but in any event by no later than 11:00 a.m. New York time on the next Swingline Business Day of the outstanding principal amount of the Swingline Loans as of the close of business on the Swingline Business Day next preceding the date that such notice is given to Chase. (b) In the case of any of the Events of Default specified in paragraphs A through I of Article VII hereof, (i) the Swingline Bank may, by notice to the Company, terminate the Swingline Commitment hereunder and it shall thereupon terminate, and (ii) the Swingline Bank may, by notice to the Company, declare the outstanding Swingline Loans and Swingline Note and all other obligations of the Company thereunder to be due and payable, whereupon the same shall become forthwith due and payable, without further protest, presentment, notice or demand, all of which are expressly waived by the Company. In case of any of the Events of Default specified in paragraph J or K of Article VII hereof, without any notice to the Company or any act by the Swingline Bank, the Swingline Commitment hereunder shall terminate forthwith and the principal of and interest accrued on the outstanding Swingline Loans and the Swingline Note and all other obligations of the Company thereunder shall become and be due and payable. ss.1.09 Lending Offices. The Loans of each type made by each Bank shall be made and maintained at such Bank's Applicable Lending Office for Loans of such type. ss.1.10 Notes. (a) The Syndicated Loans made by each Bank shall be evidenced by a single promissory note (a "Syndicated Note") of the Company substantially in the form of Exhibit A-1 hereto, dated the Effective Date, payable to such Bank in a principal amount equal to the amount of its Commitment as originally in effect and otherwise duly completed. The date, amount, type, interest rate and maturity date of each Syndicated Loan made by each Bank to the Company, and each payment made on account of the principal thereof, shall be recorded by such Bank on its books and, prior to any transfer of such Note held by it, endorsed by such Bank on the schedule attached to such Note or any continuation thereof. The failure of any Bank to make any notation or entry or any error in such a notation or entry shall not, however, limit or otherwise affect any obligation of the Company under this Agreement or the Notes. (b) The Money Market Loans made by any Bank shall be evidenced by a single promissory note (a "Money Market Note") of the Company substantially in the form of Exhibit A-2 hereto, dated the date of the delivery of such Note to Chase under this Agreement, payable to such Bank and otherwise duly completed. The date, amount, interest rate and maturity date of each Money Market Loan made by each Bank to the Company, and each payment made on account of the principal thereof, shall be recorded by such Bank on its books and, prior to any transfer of such Note held by it, endorsed by such Bank on the schedule attached to such Note or any continuation thereof. The failure of any Bank to make any notation or entry or any error in such a notation or entry shall not, however, limit or otherwise affect any obligation of the Company under this Agreement or the Notes. 14 10 (c) The Loans made by the Swingline Bank shall be evidenced by a single promissory note (a "Swingline Note") of the Company substantially in the form of Exhibit A-3 hereto, dated the Effective Date, payable to the Swingline Bank in a principal amount equal to the amount of the Swingline Commitment as originally in effect and otherwise duly completed. The date, amount, type, interest rate and maturity date of each Swingline Loan made by the Swingline Bank to the Company, and each payment made on account of the principal thereof, shall be recorded by the Swingline Bank on its books and, prior to any transfer of such Note held by it, endorsed by the Swingline Bank on the schedule attached to such Note or any continuation thereof. The failure of the Swingline Bank to make any notation or entry or any error in such a notation or entry shall not, however, limit or otherwise affect any obligation of the Company under this Agreement or the Notes. II. PAYMENTS, INTEREST AND CERTAIN FEES ss.2.01 Repayment of Loans. The Company hereby promises to pay to Chase for account of each Bank, the principal amount of each Loan made by such Bank (except for the Swingline Loan, as to which payments shall be made to the Swingline Bank pursuant to ss.1.08), and such Loan shall mature, on the last day of the Interest Period therefor. ss.2.02 Interest. The Company hereby promises to pay to Chase for account of each Bank, interest on the unpaid principal amount of each Loan made by such Bank (except for the Swingline Loans, as to which payments shall be made to the Swingline Bank pursuant to ss.1.08) for the period from and including the date of such Loan to but excluding the date such Loan shall be paid in full, at the following rates per annum: (a) if such Loan is a Domestic Loan, the Base Rate (as in effect from time to time) plus the Applicable Margin (if any); (b) if such Loan is a Eurodollar Loan, the Fixed Rate for such Loan for the Interest Period for such Loan plus the Applicable Margin (as in effect from time to time during the Interest Period for such Loan); and (c) if such Loan is a Set Rate Loan, the Money Market Rate for such Loan for the Interest Period therefor quoted by the Bank making such Loan and accepted by the Company in accordance with ss.1.02 hereof. Notwithstanding the foregoing, the Company hereby promises to pay to Chase for account of each Bank, interest at the applicable Post-Default Rate on any principal of any Loan made by such Bank, and on any other amount payable by the Company hereunder or under the Notes held by such Bank to or for account of such Bank, which shall not be paid in full when due (whether at stated maturity, by acceleration or otherwise), for the period from and including the due date thereof to but excluding the date the same is paid in full. Accrued interest on each Loan shall be payable on each Interest Payment Date for such Loan, except that interest payable at the Post-Default Rate shall be payable from time to time on demand and interest on any Eurodollar Loan that is converted into a Domestic Loan (pursuant to ss.3.04 hereof) shall be payable on the date of conversion (but only to the extent so converted). Promptly after the determination of any 15 11 interest rate provided for herein or any change therein, Chase shall give notice thereof to the Banks, to which such interest is payable and to the Company. ss.2.03 Interest Periods. As used in this Agreement, "Interest Period" shall mean: (a) With respect to any Eurodollar Loan, the period commencing on the date such Eurodollar Loan is made and ending on the numerically corresponding day in the first, second, third or sixth calendar month thereafter, as the Company may select as provided in ss.1.05(b) hereof, except that each Interest Period which commences on the last Business Day of a calendar month (or on any day for which there is no numerically corresponding day in the appropriate subsequent calendar month) shall end on the last Business Day of the appropriate subsequent calendar month; (b) With respect to any Domestic Loan, the period commencing on the date such Domestic Loan is made and ending on the date such Loan is repaid; (c) With respect to any Set Rate Loan, the period commencing on the date such Set Rate Loan is made and ending on any Business Day up to 180 days thereafter, as the Company may select as provided in ss.1.02(b) hereof; and (d) With respect to a Swingline Loan, the period commencing on the Swingline Business Day on which such Swingline Loan is made and ending on the date such Swingline Loan is repaid. Notwithstanding the foregoing: (i) no Interest Period may commence before and end after the Commitment Termination Date; (ii) each Interest Period which would otherwise end on a day which is not a Business Day shall end on the next succeeding Business Day (or, in the case of an Interest Period for Eurodollar Loans, if such next succeeding Business Day falls in the next succeeding calendar month, on the next preceding Business Day); and (iii) notwithstanding clause (i) above, no Interest Period for any Eurodollar Loans shall have a duration of less than one month and, if the Interest Period for any Eurodollar Loans would otherwise be a shorter period, such Loans shall not be available hereunder. ss.2.04 Prepayments. (a) The Company shall have the right, at any time or from time to time, to prepay Syndicated Loans in whole or in part, provided that (i) the Company shall give Chase notice of each such prepayment not less than three Business Days' prior to the date of such prepayment (which notice shall be effective upon receipt), (ii) each partial prepayment shall be in an aggregate principal amount which is at least $1,000,000 or a multiple thereof, (iii) interest on the principal prepaid, accrued to the prepayment date, shall be paid on the prepayment date and (iv) in the case of prepayment of a Eurodollar Loan other than on the last day of the Interest Period applicable thereto, the Company shall pay compensation, if any, due in accordance with ss.3.05(a) with respect thereto. The Company may not prepay any Money Market Loans. Notwithstanding the foregoing, upon not less than four Business Days' prior notice (which shall be effective upon receipt) the Company may simultaneously prepay all Loans then outstanding hereunder and terminate in whole the Commitments (in which case interest on the principal 16 12 prepaid, accrued to the prepayment date, together with all other amounts owing hereunder, including without limitation under ss.3.05, shall be paid on such prepayment date). (b) If, after giving effect to any termination or reduction of the Commitment of any Bank pursuant to ss.1.04(a) or (b) hereof, the outstanding aggregate principal amount of the Syndicated Loans held by such Bank exceeds the amount of such Bank's Commitment, the Company shall prepay or pay such Syndicated Loans (of a type to be designated by the Company by notice to Chase not less than four Business Days prior to the date of such termination or reduction and, failing such notice, such prepayment or repayment shall be applied, first, to the outstanding Domestic Loans and, next, to the extent necessary, to the outstanding Fixed Rate Loans with the fewest number of days remaining in the Interest Periods therefor on such termination or reduction date) in an aggregate principal amount equal to such excess, together with interest thereon accrued to the date of such prepayment or payment and any other amounts payable pursuant to ss.3.05 hereof in connection therewith. ss.2.05 Payments, etc. (a) Except to the extent otherwise provided herein, all payments of principal, interest and other amounts to be made by the Company under this Agreement and the Notes shall be made in Dollars, in immediately available funds, without deduction, set-off or counterclaim, to Chase at its Principal Office, not later than 11:00 a.m. New York time on the date on which such payment shall become due; provided that, if a new Loan is to be made by any Bank on a date the Company is to repay any principal of an outstanding Loan of such Bank, such Bank shall apply the proceeds of such new Loan to the payment of the principal to be repaid and only an amount equal to the difference (if any) between the principal to be borrowed and the principal to be repaid shall be made available by such Bank to Chase as provided in ss.1.02 or ss.1.05 hereof (if such principal to be borrowed exceeds such principal to be repaid) or paid by the Company to Chase pursuant to this ss.2.05 (if such principal to be repaid exceeds such principal to be borrowed). (b) Each payment received by Chase under this Agreement or any Note for account of a Bank shall be paid promptly to such Bank, in immediately available funds, for account of such Bank's Applicable Lending Office for the Loan in respect of which such payment is made. (c) If the due date of any payment under this Agreement or any Note would otherwise fall on a day which is not a Business Day (or, in the case of any Swingline Loan or Swingline Note, a Swingline Business Day) such date shall be extended to the next succeeding Business Day (or, in the case of any Swingline Loan or Swingline Note, the next succeeding Swingline Business Day) and interest shall be payable for any principal so extended for the period of such extension. ss.2.06 Pro Rata Treatment; Sharing. (a) Except to the extent otherwise provided herein: (i) each borrowing from the Banks under ss.1.01 hereof shall be made from the Banks and each termination or reduction of the amount of the Commitments under ss.1.04 hereof shall be applied to the Commitments of the 17 13 Banks, pro rata according to the amounts of their respective Commitments; (ii) each payment of principal of Syndicated Loans by the Company shall be made for account of the Banks pro rata in accordance with the respective unpaid principal amounts of the Syndicated Loans held by the Banks; and (iii) each payment of interest on Syndicated Loans by the Company shall be made for account of the Banks pro rata in accordance with the amounts of interest on Syndicated Loans due and payable to the respective Banks. (b) If any Bank shall obtain payment of any principal of or interest on any Loan made by it to the Company under this Agreement through the exercise of any right of set-off, banker's lien or counterclaim or similar right or otherwise, and, as a result of such payment, such Bank shall have received a greater percentage of the principal or interest then due to such Bank hereunder than the percentage received by any other Banks, it shall promptly purchase from such other Banks participations in (or, if and to the extent specified by such Bank, direct interests in) the Loans made by such other Banks (or in interest due thereon, as the case may be) in such amounts, and make such other adjustments from time to time as shall be equitable, to the end that all the Banks shall share the benefit of such excess payment (net of any expenses which may be incurred by such Bank in obtaining or preserving such excess payment) pro rata in accordance with the unpaid principal of and/or interest on the Loans held by each of the Banks before giving effect to such payment. To such end all the Banks shall make appropriate adjustments among themselves (by the resale of participations sold or otherwise) if such payment is rescinded or must otherwise be restored. (c) The Company agrees that any Bank so purchasing a participation (or direct interest) in the Loans made by other Banks (or in interest due thereon, as the case may be) may exercise all rights of set-off, bankers' lien, counterclaim or similar rights with respect to such participation as fully as if such Bank were a direct holder of Loans in the amount of such participation. (d) Nothing contained herein shall require any Bank to exercise any such right or shall affect the right of any Bank to exercise, and retain the benefits of exercising, any such right with respect to any other indebtedness or obligation of the Company. (e) If, under any applicable bankruptcy, insolvency or other similar law, any Bank receives a secured claim in lieu of a set-off to which this ss.2.06 applies, such Bank shall, to the extent practicable, exercise its rights in respect of such secured claim in a manner consistent with the rights of the Banks entitled under this ss.2.06 to share in the benefits of any recovery on such secured claim. (f) Notwithstanding the foregoing, this ss.2.06 shall not be applicable to the Swingline Bank with respect to Swingline Loans. ss.2.07 Computations. Interest on Money Market Loans and Eurodollar Loans shall be computed on the basis of a year of 360 days and actual days elapsed (including the first day but excluding the last day) occurring in the period for which payable, and interest on Domestic Loans, Swingline Loans and facility fees shall be computed on the basis of a year of 365 18 14 or 366 days, as the case may be, and actual days elapsed (including the first day but excluding the last day) occurring in the period for which payable. ss.2.08 Facility Fee. The Company shall pay to Chase for account of each Bank a facility fee on such Bank's Commitment (whether used or not) for the period commencing on the Effective Date and ending on the Commitment Termination Date (or such earlier date on which such Bank's Commitment shall have terminated in full pursuant to ss.1.04 hereof) at a rate per annum for each day during such period equal to the Applicable Facility Fee Rate in effect on such day. Accrued facility fees shall be payable quarterly on the last Business Day in March, June, September and December in each year, commencing the first such date after the Effective Date and on the date the Commitments are terminated in full. ss.2.09 Administration Fee. The Company agrees to pay to Chase for its own account a non-refundable fee in the amount of $5,000 for each Quarterly Period commencing on or prior to the date on which the Commitments are terminated in full. Such fee shall not be pro-rated and shall be paid in arrears on the last Business Day of each Quarterly Period in each year, commencing with the first such Business Day after the Effective Date, and on the date the Commitments are terminated in full. III. PROVISIONS RELATING TO FIXED RATE LOANS. The following provisions shall apply to all Fixed Rate Loans: ss.3.01 Additional Costs. (a) The Company shall pay directly to each Bank from time to time on request pursuant to paragraph (d) of this ss.3.01 such amounts as such Bank may determine to be necessary to compensate it for any costs which such Bank determines are attributable to its making or maintaining of any Fixed Rate Loans or its obligation to make any Fixed Rate Loans hereunder, or any reduction in any amount receivable by such Bank hereunder in respect of any of such Loans or such obligation (such increases in costs and reductions in amounts receivable being herein called "Additional Costs"), resulting from any Regulatory Change which: (i) changes the basis of taxation of any amounts payable to such Bank under this Agreement or its Notes in respect of any of such Loans (other than taxes imposed on or measured by the overall net income of such Bank or of its Applicable Lending Office for any of such Loans by the jurisdiction in which such Bank has its principal office or such Applicable Lending Office); or (ii) imposes or modifies any reserve, special deposit or similar requirements (other than in the case of any Bank for any period as to which the Company is required to pay any amount under paragraph (e) below, the reserves against "Eurocurrency liabilities" under Regulation D therein referred to) relating to any extensions of credit or other assets of, or any deposits with or other liabilities of, such Bank (including any of such Loans or any deposits referred to in the definition of "Fixed Base Rate" in Schedule 1 hereof), or any commitment of such Bank (including the Commitment of such Bank hereunder); or 19 15 (iii) imposes any other condition affecting this Agreement or its Notes (or any of such extensions of credit or liabilities) or its Commitment. If any Bank requests compensation from the Company under this ss.3.01(a), the Company may, by notice to such Bank (with a copy to Chase), suspend the obligation of such Bank to make additional Loans of the type with respect to which such compensation is requested (in which case the provisions of ss.3.04 hereof shall be applicable) until either (A) the Regulatory Change giving rise to such request ceases to be in effect or (B) such Bank gives notice to the Company that it will no longer require the Company to pay Additional Costs arising from such Regulatory Change. (b) Without limiting the effect of the provisions of paragraph (a) of this ss.3.01, in the event that, by reason of any Regulatory Change, any Bank either (i) incurs Additional Costs based on or measured by the excess above a specified level of the amount of a category of deposits or other liabilities of such Bank which includes deposits by reference to which the interest rate on Eurodollar Loans is determined as provided in this Agreement or a category of extensions of credit or other assets of such Bank which includes Eurodollar Loans or (ii) becomes subject to restrictions on the amount of such a category of liabilities or assets which it may hold, then, if such Bank so elects by notice to the Company (with a copy to Chase), the obligation of such Bank to make additional Loans of such type hereunder shall be suspended until such Regulatory Change ceases to be in effect (in which case the provisions of ss.3.04 hereof shall be applicable). (c) Without limiting the effect of the foregoing provisions of this ss.3.01 (but without duplication), the Company shall pay directly to each Bank from time to time on request pursuant to paragraph (d) of this ss.3.01 such amounts as such Bank may determine to be necessary to compensate such Bank for any costs which it determines are attributable to the maintenance by such Bank (or any Applicable Lending Office), pursuant to any law or regulation or any interpretation, directive or request (whether or not having the force of law) of any court or governmental or monetary authority (i) following any Regulatory Change or (ii) implementing any risk-based capital guideline or requirement (whether or not having the force of law and whether or not the failure to comply therewith would be unlawful) heretofore or hereafter issued by any government or governmental or supervisory authority implementing at the national level the Basle Accord (including, without limitation, the Final Risk Based Capital Guidelines of the Board of Governors of the Federal Reserve System (12 CFR Part 208, Appendix A; 12 CFR Part 225, Appendix A) and the Final Risk-Based Capital Guidelines of the Office of the Comptroller of the Currency (12 CFR Part 3, Appendix A)), of capital in respect of its Commitment or Loans (such compensation to include, without limitation, an amount equal to any reduction of the rate of return on assets or equity of such Bank (or any Applicable Lending Office) to a level below that which such Bank (or any Applicable Lending Office) could have achieved but for such law, regulation, interpretation, directive or request). For purposes of this ss.3.01(c), "Basle Accord" shall mean the proposals for risk-based capital framework described by the Basle Committee on Banking Regulations and Supervisory Practices in its paper entitled "International Convergence of Capital Measurement and Capital Standards" dated July 1988, as amended, modified and supplemented and in effect from time to time or any replacement thereof. 20 16 (d) Each Bank will notify the Company of any event occurring after the date of this Agreement that will entitle such Bank to compensation under paragraph (a) or (c) of this ss.3.01 as promptly as practicable, but in any event within 90 days, after such Bank obtains actual knowledge thereof; provided, however, that if any Bank fails to give such notice within 90 days after it obtains actual knowledge of such an event, such Bank shall, with respect to compensation payable pursuant to this ss.3.01 in respect of any costs resulting from such event, only be entitled to payment under this ss.3.01 for costs incurred from and after the date 90 days prior to the date that such Bank does give such notice; and provided, further, that each Bank will designate a different Applicable Lending Office for the Loans of such Bank affected by such event or by the matters requiring compensation pursuant to paragraph (e) of this ss.3.01, and take other measures in its sole discretion, if such designation or other measures will avoid the need for, or reduce the amount of, such compensation and will not, in the sole opinion of such Bank, result in a material cost to, or be otherwise disadvantageous to, such Bank, except that such Bank shall have no obligation to designate an Applicable Lending Office located in the United States of America. Each Bank will furnish to the Company a certificate setting forth the basis and amount of each request by such Bank for compensation under paragraph (a) or (c) of this ss.3.01. Determinations and allocations by any Bank for purposes of this ss.3.01 of the effect of any Regulatory Change pursuant to paragraph (a) or (b) of this ss.3.01, or of the effect of capital maintained pursuant to paragraph (c) of this ss.3.01, on its costs or rate of return of maintaining Loans or its obligation to make Loans, or on amounts receivable by it in respect of Loans, and of the amounts required to compensate such Bank under this ss.3.01, shall be conclusive, provided that such determinations and allocations are made on a reasonable basis. (e) Without limiting the effect of the foregoing (but without duplication), the Company shall pay to each Bank on the last day of each Interest Period so long as such Bank is maintaining reserves against "Eurocurrency liabilities" under Regulation D (or, unless the provisions of paragraph (b) above are applicable, so long as such Bank is, by reason of any Regulatory Change, maintaining reserves against any other category of liabilities which includes deposits by reference to which the interest rate on Eurodollar Loans is determined as provided in this Agreement or against any category of extensions of credit or other assets of such Bank which includes any Eurodollar Loans) an additional amount (determined by such Bank and notified, not less than five Business Days prior to the end of the applicable Interest Period, to the Company through Chase) equal to the product of the following for each Eurodollar Loan made by such Bank for each day during such Interest Period: (i) the principal amount of such Eurodollar Loan outstanding on such day; and (ii) the remainder of (x) a fraction the numerator of which is the annual rate (expressed as a decimal) at which interest accrues on such Eurodollar Loan for such Interest Period as provided in this Agreement (less the Applicable Margin) and the denominator of which is one minus the effective annual rate (expressed as a decimal) at which such reserve requirements are imposed on such Bank on such day minus (y) such numerator; and (iii) 1/360. 21 17 ss.3.02 Limitation on Types of Loans. Anything herein to the contrary notwithstanding, if, on or prior to the determination of any Fixed Base Rate for any Interest Period in accordance with the terms hereof: (a) Chase determines, which determination shall be conclusive, that quotations of interest rates for the relevant deposits referred to in the definition of "Fixed Base Rate" in Schedule 1 hereof are not being provided in the relevant amounts or for the relevant maturities for purposes of determining rates of interest for any type of Fixed Rate Loans as provided herein; or (b) the Majority Banks determine, which determination shall be conclusive, and notify (or notifies, as the case may be) Chase that the relevant rates of interest referred to in the definition of "Fixed Base Rate" in Schedule 1 hereof upon the basis of which the rate of interest for Eurodollar Loans for such Interest Period is to be determined are not likely adequately to cover the cost to such Banks (or to such quoting Bank) of making or maintaining such type of Loans; then Chase shall give the Company and each Bank prompt notice thereof, and so long as such condition remains in effect, the Banks (or such quoting Bank) shall be under no obligation to make additional Loans of such type. ss.3.03 Illegality. Notwithstanding any other provision of this Agreement, in the event that it becomes unlawful for any Bank or its Applicable Lending Office to honor its obligation to make or maintain Eurodollar Loans hereunder, then such Bank shall promptly notify the Company thereof (with a copy to Chase) and such Bank's obligation to make Eurodollar Loans shall be suspended until such time as such Bank may again make and maintain Eurodollar Loans (in which case the provisions of ss.3.04 hereof shall be applicable). ss.3.04 Treatment of Affected Loans. If the obligation of any Bank to make a particular type of Fixed Rate Loans shall be suspended pursuant to ss.3.01 or ss.3.03 hereof (Loans of such type being herein called "Affected Loans" and such type being herein called the "Affected Type"), all Loans (other than Money Market Loans) which would otherwise be made by such Bank as Loans of the Affected Type shall be made instead as Domestic Loans and, if an event referred to in ss.3.01(b) or ss.3.03 hereof has occurred and such Bank so requests by notice to the Company with a copy to Chase, all Affected Loans of such Bank then outstanding shall be automatically converted into Domestic Loans on the date specified by such Bank in such notice and, to the extent that Affected Loans are so made (or converted), all payments of principal which would otherwise be applied to such Bank's Affected Loans shall be applied instead to such Loans. ss.3.05 Compensation. The Company shall pay to Chase for account of each Bank, upon the request of such Bank through Chase, such amount or amounts (the basis for which shall be set forth in reasonable detail in such request) as shall be sufficient (in the reasonable opinion of such Bank) to compensate it for any loss, cost or expense which such Bank determines is attributable to: 22 18 (a) any payment or conversion of a Fixed Rate Loan or a Set Rate Loan made by such Bank for any reason (including, without limitation, the acceleration of the Loans pursuant to Article VII hereof) on a date other than the last day of the Interest Period for such Loan; or (b) any failure by the Company for any reason (including, without limitation, the failure of any of the conditions precedent specified in Article IV hereof to be satisfied, but excluding the failure of such Bank to make a Loan when so obligated hereunder) to borrow a Fixed Rate Loan or a Set Rate Loan (with respect to which, in the case of a Money Market Loan, the Company has accepted a Money Market Quote) from such Bank on the date for such borrowing specified in the relevant notice of borrowing given pursuant to ss.1.05 or ss.1.02 hereof. Without limiting the effect of the preceding sentence, such compensation shall include an amount equal to the excess, if any, of (i) the amount of interest which otherwise would have accrued on the principal amount so paid or converted or not borrowed for the period from the date of such payment, conversion or failure to borrow to the last day of the Interest Period for such Loan (or, in the case of a failure to borrow, the Interest Period for such Loan which would have commenced on the date specified for such borrowing) at the applicable rate of interest for such Loan provided for herein minus the Applicable Margin for such Loan over (ii) the interest component of the amount such Bank would have bid in the London interbank market (if such Loan is a Eurodollar Loan) or the United States secondary certificate of deposit market (if such Loan is a Set Rate Loan) for Dollar deposits of leading banks in amounts comparable to such principal amount and with maturities comparable to such period (as reasonably determined by such Bank). ss.3.06 Survival. The obligations of the Company under this Article III shall survive the repayment of the Loans and the cancellation of the Notes. IV. CONDITIONS ss.4.01 Conditions to Effectiveness. The Agreement herein contemplated shall become effective on January 20, 1999 (the "Effective Date"), provided that on the Effective Date, Chase has received each of the following documents (with a copy for each Bank delivered to Chase), in form and substance satisfactory to Chase: (i) one or more counterparts of this Agreement executed by each of the parties hereto; (ii) certified copies of all corporate action taken by the Company to authorize the execution and delivery of this Agreement and the Notes and the borrowings hereunder; (iii) a certificate of a duly authorized officer of the Company as to the incumbency, and setting forth a specimen signature, of each of the persons (a) who has signed this Agreement on behalf of 23 19 the Company, (b) who will sign the Notes on behalf of the Company, and (c) who will, until replaced by other persons duly authorized for that purpose, act as the representatives of the Company for the purpose of signing documents in connection with this Agreement and the transactions contemplated hereby; (iv) the Syndicated Note and the Money Market Note for each Bank and the Swingline Note for the Swingline Bank, all as provided in ss.1.10 hereof, in each case duly completed and executed by the Company; (v) an opinion of Hughes Hubbard & Reed LLP, counsel for the Company, substantially in the form of Exhibit B hereto, which (except as to matters of New York or Federal law) may rely as to certain matters upon an opinion of the Executive Vice President and General Counsel of the Company substantially in the form attached to said Exhibit B; (vi) an opinion of Simpson Thacher & Bartlett, special counsel to the Banks and the Agents, substantially in the form of Exhibit C hereto; and (vii) such other statements, documents, reports or certificates as any Bank or Agent may reasonably request. ss.4.02 Conditions Precedent to Loans. The obligation of any Bank to make any Loan hereunder (including any Money Market Loan and such Bank's initial Syndicated Loan on or after the Effective Date) is subject to the further conditions precedent that, both immediately prior to such Loan and also after giving effect thereto: (a) either (i) if such borrowing is a Money Market Loan or will increase the outstanding aggregate principal amount of the Syndicated Loans, no Default shall have occurred and be continuing or (ii) in the case of any other borrowing, no Event of Default shall have occurred and be continuing; and (b) the representations and warranties made by the Company in Article VI (other than, if such borrowing is not a Money Market Loan and will not increase the outstanding aggregate principal amount of the Syndicated Loans, the last sentence of ss.6.03, ss.6.04, ss.6.05, ss.6.07, ss.6.09 and ss. 6.11 hereof) shall be true on and as of the date of the notice or deemed notice of borrowing for such Loans and on the date of the making of such Loans with the same force and effect as if made on and as of each such date. The obligation of any Bank to make a Eurodollar Loan hereunder is subject to the further condition precedent that, both immediately prior to such Loan and also after giving effect thereto, no Default shall have occurred and be continuing. Each notice or deemed notice of borrowing by the Company hereunder shall constitute a certification by the Company to the effect set forth in the two preceding sentences to the extent applicable to the borrowing that is the subject of such notice (both as of the date of such borrowing notice and, unless the Company otherwise notifies Chase in such borrowing notice or prior to the date of such borrowing, as of the date of such borrowing). V. COVENANTS. So long as any Loan or any other amount owing by the Company to any Agent or Bank hereunder remains outstanding or any Bank's Commitment remains in effect: ss.5.01 Financial Statements. The Company shall deliver to each Bank: 24 20 (a) As soon as available and in any event within 60 days after the end of each of the first three quarterly accounting periods in each fiscal year, the 10-Q report of the Company for such period; (b) As soon as available and in any event within 120 days after the end of each fiscal year, the 10-K report of the Company for such fiscal year, accompanied by (A) an opinion as to the financial statements contained in such 10-K report of independent certified public accountants of recognized national standing, and (B) a statement by said accountants that in the course of their regular examination of the Company and its Consolidated Subsidiaries for purposes of their opinion they obtained no knowledge, except as specifically stated, of the occurrence and continuance of any Default; (c) With each report delivered under ss.5.01(a) or (b) hereof, (A) a statement signed by an Appropriate Officer of the Company certifying and, where calculations are necessary, demonstrating compliance by the Company with the provisions of ss.5.09 hereof, and (B) a statement of an Appropriate Officer of the Company that such officer has no knowledge, except as specifically stated, of the occurrence and continuance of any Default. (d) Promptly after their becoming available: (i) Copies of all financial statements, reports and proxy statements which the Company shall have sent to its stockholders generally. (ii) Copies of all regular and periodic reports, if any, which the Company or any Restricted Subsidiary shall have filed with the Securities and Exchange Commission, or any governmental agency substituted therefor, or with any national securities exchange. (e) From time to time, with reasonable promptness, such further information regarding the business, affairs and financial position of the Company and each Subsidiary as any Bank may reasonably request. ss.5.02 Access to Books and Inspection. The Company shall, upon reasonable request by any Bank, give any representative of such Bank access, at the Company's principal office, during normal business hours to, and permit such representative to examine, copy or make excerpts from, any and all books, records and documents in the possession of the Company relating to its affairs and the affairs of its Subsidiaries, excluding, however, any privileged and confidential communications or other materials, and to inspect any of the properties of the Company or such Subsidiaries; provided that all information (other than publicly available information) delivered by the Company to any Bank pursuant to this ss.5.02 is strictly confidential, and each Bank agrees that it shall (or shall cause the persons referred to in clause (ii) below to) maintain the confidentiality of any such information, subject to: (i) the obligation to disclose such information pursuant to subpoena or other legal process, or to regulatory or examining authorities or other governmental agencies having jurisdiction, or otherwise as may be required by law; (ii) the right to disclose such information to the independent auditors and counsel of such Bank, or to 25 21 the Agents or any other Bank; and (iii) the right to disclose such information to assignees and participants (including prospective assignees and participants) as provided in ss.8.05 hereof. ss.5.03 Litigation. Notwithstanding any other provision of this Agreement, the Company shall, promptly after its becoming available, furnish to each Bank a copy of any report filed by the Company with the Securities and Exchange Commission which contains a statement, description or disclosure as to any litigation or proceeding before any governmental or regulatory agencies affecting the Company or any of its Subsidiaries. ss.5.04 Maintenance of Existence. The Company will preserve and maintain, and cause each of its Restricted Subsidiaries to preserve and maintain, its corporate existence, provided that the foregoing shall not prevent a merger or consolidation, or sale or other disposition of assets, of the Company or any Restricted Subsidiary unless otherwise prohibited by this Agreement. ss.5.05 Merger; Sale of Assets. The Company shall not: (a) merge into or consolidate with any corporation if (i) the Company is not the surviving corporation, (ii) the Company is the surviving corporation and a majority of the board of directors of the Company for a period of three months after the effective date of such merger does not consist of individuals who were directors of the Company 12 months prior to such effective date (except for changes due to the retirement or death of any such individuals) or (iii) after giving effect to such merger or consolidation, a Default has occurred and is continuing; or (b) permit any Restricted Subsidiary to be a party to any merger or consolidation or to transfer all or substantially all of its assets, except that any such Restricted Subsidiary may merge or consolidate with, or transfer all or substantially all of its assets to, the Company or any of the Company's other Subsidiaries provided that (i) the surviving entity of such merger or consolidation or the transferee of such assets (if it is not the Company or another Restricted Subsidiary) shall thereafter be treated as a Restricted Subsidiary for all purposes of this Agreement and (ii) after giving effect to such merger, consolidation or transfer of assets, no Default shall have occurred and be continuing; or (c) sell, assign, transfer or otherwise dispose of all or substantially all of its assets or, in any case, any stock of or other equity interest in any of the Restricted Subsidiaries, except that (i) stock of or other equity interest in any such Restricted Subsidiary may be sold, assigned or transferred by the Company to any of its wholly-owned Subsidiaries provided that thereafter such Subsidiary shall be treated as a Restricted Subsidiary for all purposes of this Agreement and the Company shall not permit such Subsidiary to sell, assign, transfer or otherwise dispose of any such stock or other equity interest except to the Company or otherwise in accordance with this clause (c), (ii) stock of or other equity interest in any Restricted Subsidiary may be sold, assigned, transferred or disposed of (whether by the Company or any of its wholly-owned Subsidiaries) so long as immediately after giving effect to such transaction the Company 26 22 and/or one or more of its wholly-owned Subsidiaries owns stock of or other equity interests in such Restricted Subsidiary (x) representing, in the case of a partnership, not less than 80% of the outstanding capital and profit interests in such partnership or, in the case of any other entity, not less than 80% of the fair market value of the outstanding stock of or other equity interests in such Restricted Subsidiary (excluding Mandatory Preferred Stock of such Restricted Subsidiary) and (y) representing not less than 80% of the ordinary voting power for the election of directors or other persons performing similar functions of such Restricted Subsidiary (other than stock or other equity interests having such power only by reason of the happening of a contingency) and (iii) Mandatory Preferred Stock of any Restricted Subsidiary may be sold, assigned, transferred or disposed of (whether by the Company or any of its Subsidiaries). ss.5.06 Default; Investment Rating. The Company shall: (a) as soon as it shall become known to a senior officer of the Company, forthwith notify each Agent if any Default shall have occurred; and (b) if Moody's or S&P (or any successor thereto) shall have assigned a new rating to the senior debt securities of the Company, notify each Agent of such new rating within 30 days after it is first announced by the applicable rating agency. ss.5.07 ERISA. The Company will furnish to the Banks: (a) as soon as possible and in any event within 15 days after the Company knows or has reason to know that any Termination Event has occurred, a statement of a senior officer of the Company describing such Termination Event and the action, if any, which the Company proposes to take with respect thereto; (b) from time to time promptly after the request of any Bank, copies of each annual report filed pursuant to Section 104 of ERISA with respect to each Plan (including, to the extent required by Section 103 of ERISA, the related financial and actuarial statements and opinions and other supporting statements, certifications, schedules and information referred to in Section 103) and each annual report filed with respect to each Plan under Section 4065 of ERISA; (c) promptly after receipt thereof by the Company from the PBGC, copies of each notice received by the Company of PBGC's intention to terminate any Plan or to have a trustee appointed to administer any Plan; and (d) promptly after such request, such other documents and information relating to Plans as any Bank may reasonably request from time to time. ss.5.08 Liens. The Company will not, and will not permit any Subsidiary to, grant a security interest in any stock of any of the Restricted Subsidiaries or Citrus Corp. The Company will not grant a security interest in any of its other assets to secure Indebtedness (except as provided in the next sentence) unless the Company simultaneously grants to any Designated Agent for the benefit of the Banks an equal and ratable security interest in the assets subject to 27 23 such security interest. The provisions of the preceding sentence shall not apply to the grant by the Company of: (a) Any purchase money mortgage or purchase money security interest created to secure all or part of the purchase price of any property (or to secure a loan made to enable the Company to acquire the property described in such mortgage or in any applicable security agreement); provided that such mortgage or security interest shall extend only to the property so acquired, fixed improvements thereon, replacements thereof and the income and profits therefrom; (b) Any security interest on any property acquired or constructed by the Company, and created not later than twelve months after (i) such acquisition or completion of such construction or (ii) commencement of operation of such property, whichever is later; provided that such security interest shall extend only to the property so acquired or constructed, fixed improvements thereon, replacements thereof and income and profits therefrom; (c) Any security interest deemed to be created as a result of the deposit of cash or securities for the purpose of defeasance of Indebtedness; and (d) Any security interest in any of its cash or cash equivalents (within the meaning of generally accepted accounting principles) created by the Company for the purpose of securing Derivative Obligations of the Company, provided that the aggregate amount of all cash or cash equivalents secured by security interests permitted by this clause (d) shall not exceed $25,000,000. (e) Any security interest not otherwise permitted under the preceding clauses (a) through (d) in any of its assets created by the Company for the purpose of securing Indebtedness of the Company, provided that the aggregate amount of all Indebtedness of the Company secured by security interests permitted by this clause (e) shall not exceed $10,000,000. ss.5.09 Total Indebtedness to Consolidated Capitalization. The Company will not at any time permit Total Indebtedness of the Company to exceed 65% of the Consolidated Capitalization of the Company. ss.5.10 [Intentionally Omitted.] ss.5.11 Insurance. The Company will, and will cause each of its Subsidiaries to, keep insured with financially sound and reputable insurers or through self-insurance conforming with practices of similar corporations maintaining systems of self-insurance all property of a character usually insured by corporations engaged in the same or similar business similarly situated against loss or damage of the kinds and in the amounts customarily insured against by such corporations and carry such other insurance as is usually carried by such corporations. ss.5.12 Maintenance of Properties. The Company will, and will cause each of its Subsidiaries to, keep all of its material properties necessary in its business in good working order 28 24 and condition appropriate for the use being made thereof, ordinary wear and tear excepted; except, in every case, as and to the extent that the Company or its Subsidiaries may be prevented from maintaining their respective properties by fire, strikes, lockouts, acts of God, inability to obtain labor or materials, governmental (including judicial) restrictions, enemy action, civil commotion or unavoidable casualty or similar causes beyond the control of the Company; provided, however, that nothing in this ss.5.12 shall prevent the Company or any of its Subsidiaries from discontinuing the use, operation or maintenance of any of such properties if such discontinuance is, in the judgment of the Company or its applicable Subsidiary, desirable in the conduct of the business of the Company or such Subsidiary and if such discontinuance is not disadvantageous in any material respect to the Banks; and provided, further, that nothing in this ss.5.12 shall prohibit any sale, assignment, transfer or other disposition permitted by ss.5.05 hereof. ss.5.13 Public Utility Holding Company Act. The Company will not, and will not permit any of its Subsidiaries to, be subject to regulation under the Public Utility Holding Company Act of 1935, as amended. VI. REPRESENTATIONS AND WARRANTIES. The Company represents and warrants as follows: ss.6.01 Corporate Existence and Powers. The Company and each of its Restricted Subsidiaries is a corporation duly incorporated and validly existing and in good standing under the laws of the jurisdiction of its incorporation (or, in case of any Restricted Subsidiary not a corporation, such Restricted Subsidiary is duly organized and validly existing under the laws of the jurisdiction of its organization) and is duly licensed or qualified to do business and is in good standing in all states in which the Company believes the conduct of its business or the ownership of its assets requires such qualification, and the Company has corporate power to make this Agreement and the Notes and to borrow hereunder. ss.6.02 Corporate Authority, etc. The making and performance by the Company of this Agreement and the Notes and each borrowing hereunder have been duly authorized by all necessary corporate action and do not and will not contravene any provision of law applicable to the Company or of the certificate of incorporation or by-laws of the Company or result in the material breach of, or constitute a material default or require any consent under, or result in the creation of any material lien, charge or other security interest or encumbrance not permitted by ss.5.08 hereof upon any property or assets of the Company or any of its Restricted Subsidiaries pursuant to, any indenture or other agreement or instrument to which the Company or any of its Restricted Subsidiaries is a party or by which the Company or any of its Restricted Subsidiaries or any of their respective properties may be bound or affected (or, if any such consent is so required, the Company has obtained such consent, which is sufficient for the purpose and remains in full force and effect, and copies thereof have been furnished to Chase). This Agreement has been duly and validly executed and delivered by the Company and constitutes, and each of the Notes when executed and delivered will constitute, its legal, valid and binding obligation, enforceable in accordance with its terms. ss.6.03 Financial Condition. The consolidated balance sheets of the Company and its Consolidated Subsidiaries as at December 31, 1997 and September 30, 1998 and the related 29 25 statements of consolidated income and cash flows of the Company and its Consolidated Subsidiaries for the 12 months and nine months ended on said dates, respectively, heretofore furnished by the Company to the Banks, fairly present in all material respects the financial condition of the Company and its Consolidated Subsidiaries as at said dates and the results of their operations and cash flows for the 12 months and nine months, respectively, then ended in accordance with generally accepted accounting principles (except that (i) the financial statements as of September 30, 1998 and for the nine months then ended were prepared in accordance with the rules of the Securities and Exchange Commission applicable to interim financial statements and they are subject to normal year-end audit adjustments and (ii) the financial statements as of December 31, 1997 and for the 12 months then ended are subject to the accounting developments as disclosed in the Company's Report on Form 10-Q for the quarter ended September 30, 1998). Except as disclosed in a letter dated January 20, 1999, from the Treasurer of the Company, a copy of which has been furnished to each Bank, since December 31, 1997 there has heretofore been no material adverse change in the financial condition or operating results of the Company and its Consolidated Subsidiaries, taken as a whole, from that set forth in the consolidated balance sheet and related statements as at and for the period ended on said date. ss.6.04 Litigation. Except as disclosed in a letter dated January 20, 1999, from the Executive Vice President and General Counsel of the Company, a copy of which has heretofore been furnished to each Bank, there are no actions, suits or proceedings, and no proceedings before any arbitrator or by or before any governmental commission, board, bureau or other administrative agency, pending, or to the knowledge of the Company threatened, against or affecting the Company or any Subsidiary which are reasonably likely to have a material adverse effect on the financial condition, properties or operations of the Company and its Subsidiaries, taken as a whole. ss.6.05 Taxes. Each of the Company and each Restricted Subsidiary has filed all material tax returns required to be filed and paid all material taxes shown thereon to be due, including interest and penalties, or provided adequate reserves for payment thereof, except to the extent the same have become due and payable but are not yet delinquent, and except for any taxes and assessments of which the amount, applicability or validity is currently being contested in good faith by appropriate proceedings. ss.6.06 Approvals. No approval, license or consent of any governmental regulatory body is requisite to the making and performance by the Company of this Agreement, or the execution, delivery and payment of the Notes (or, if any such approval, license or consent is so requisite, the Company has obtained the same, which is sufficient for the purpose and remains in full force and effect, and copies thereof have been furnished to Chase). ss.6.07 ERISA. The Company, and each Subsidiary, has met its minimum funding requirements under ERISA with respect to all its Plans and has not incurred any material liabilities to PBGC or to such Plan under ERISA in connection with any such Plan. ss.6.08 Margin Regulations. The Company is not engaged principally, or as one of its important activities, in the business of extending credit for the purpose of purchasing or carrying margin stock (within the meaning of Regulation U of the Board of Governors of the 30 26 Federal Reserve System), and no part of the proceeds of any Loan will be used to purchase or carry any such margin stock or to extend credit to others for the purpose of purchasing or carrying any such margin stock. ss.6.09 Certain Subsidiaries. Except as a consequence of a transaction or transactions permitted by this Agreement, the Company directly or indirectly owns all of the outstanding shares of common stock of each of the Restricted Subsidiaries (except for directors' qualifying shares), and all shares of stock of such corporations are validly issued, fully paid and non-assessable. ss.6.10 Investment Company Act. The Company is not an "investment company" or a company "controlled" by an "investment company", within the meaning of the Investment Company Act of 1940, as amended. ss.6.11 Environmental Laws. The Company and its Subsidiaries are in compliance in all material respects with the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, the Superfund Amendments and Reauthorization Act of 1986, the Resource Conservation and Recovery Act, the Toxic Substances Control Act, as amended, the Clean Air Act, as amended, the Clean Water Act, as amended, and each other federal, state or local statute, law, ordinance, code, rule or regulation, regulating or imposing liability or standards of conduct concerning, any hazardous, toxic or dangerous waste, substance or material, except for any noncompliance that is not reasonably likely to have a material adverse effect on the financial condition, properties or operations of the Company and its Subsidiaries, taken as a whole. ss.6.12 Year 2000 Problem. The Company has (i) undertaken a detailed review and assessment of all areas within its business and operations that could reasonably be affected by the Year 2000 Problem, (ii) developed a detailed plan and timeline for addressing the Year 2000 Problem on a timely basis and (iii) implemented that plan to date in accordance with such plan and timeline. To the best of Company's knowledge, all computer applications that are material to the Company's business and operations will on a timely basis be able to perform date-sensitive functions for all dates on and after January 1, 2000. All representations and warranties made herein shall survive the making of the Loans and the delivery of the Notes hereunder. VII. EVENTS OF DEFAULT. If any of the following "Events of Default" shall occur and shall not have been remedied: A. default by the Company in the payment of any principal of any of the Notes when the same becomes due and payable; B. default by the Company in the payment of interest on any of the Notes or any other amounts payable under ss.1.03 or ss.2.08 hereof which shall remain unremedied for ten days after the same becomes due and payable; 31 27 C. any representation or warranty made by the Company in Article VI hereof or in any certificate furnished to the Agents or to the Banks hereunder (or deemed to have been given at the time of any borrowing hereunder) shall prove to have been incorrect when made or deemed made, in any material respect; D. default by the Company in the due performance or observance of ss.5.05, ss.5.08 or ss.5.09 hereof; E. default by the Company in the due performance or observance of ss.5.06(a) hereof which shall remain unremedied for a period of ten days; F. default by the Company in the due performance or observance of ss.5.03 or ss.5.06(b) hereof which shall remain unremedied for a period of 30 days after such default shall have become known to an executive officer of the Company; G. default by the Company in the due performance or observance of any other covenant or agreement herein contained which shall remain unremedied for a period of 30 days after written notice thereof shall have been given to the Company by any Bank (through any Designated Agent); H. default by the Company or any Restricted Subsidiary (i) in the payment of any Indebtedness of the Company and/or one or more Restricted Subsidiaries in an aggregate unpaid principal amount of at least $25,000,000, beyond the period or periods of grace (if any) provided with respect thereto, or (ii) in the performance or observance of any other provisions in indentures, credit or loan agreements or other agreements or instruments under which such Indebtedness in such aggregate unpaid principal amount of the Company and/or one or more Restricted Subsidiaries is outstanding or by which such Indebtedness is evidenced and, in the case of clause (ii) only, if the effect of such default is to cause, or permit the holder or holders of such Indebtedness (or a trustee or an agent on behalf of such holder or holders) to cause, such Indebtedness to become due prior to its stated maturity; I. any Termination Event shall have occurred and shall have continued under circumstances which result in an uninsured payment or repayment liability of the Company or any of its Subsidiaries to PBGC in an amount which is material in relation to the financial position of the Company and its Subsidiaries, on a consolidated basis; J. either the Company or one or more Restricted Subsidiaries (taken as a group) with total assets of at least $10,000,000 in the aggregate (such Restricted Subsidiary or Subsidiaries being hereinafter called the "Restricted Group") shall (1) apply for or consent to the appointment of, or taking possession by, a receiver, trustee, custodian, liquidator or other similar official of itself or of all or a substantial part of its assets, (2) admit in writing its inability to pay its 32 28 debts, or generally become unable to pay its debts, as they become due, (3) make a general assignment for the benefit of its creditors, (4) commence a voluntary case under the federal bankruptcy laws (as now or hereafter in effect), (5) file a petition seeking to take advantage of any other laws relating to bankruptcy, reorganization, insolvency, winding-up or composition or readjustment of debts, or (6) acquiesce in writing to, or fail to controvert in a timely and appropriate manner, any petition filed against it or in any involuntary case under the aforesaid federal bankruptcy laws; or corporate action shall be taken by the Company or the Restricted Group for the purpose of effecting any of the foregoing; or K. a proceeding or case shall be commenced, without the application or consent of the Company or the Restricted Group (as defined in paragraph J above), in any court of competent jurisdiction, seeking (1) its liquidation, reorganization, dissolution, winding-up, or composition or readjustment of debts, (2) the appointment of a receiver, trustee, custodian, liquidator or any similar official of itself of all or a substantial part of its assets, (3) similar action with respect to the Company or the Restricted Group under the federal bankruptcy laws (as now or hereafter in effect) or any other laws relating to bankruptcy, insolvency, reorganization, liquidation or winding-up, or composition or adjustment of debts, and such proceeding or case shall continue undismissed, or an order, judgment or decree approving or ordering any of the foregoing shall be entered and continued unstayed and in effect, for any period of 60 consecutive days; or an order for relief against the Company or the Restricted Group shall be entered in an involuntary case under such federal bankruptcy laws, THEREUPON, (in addition to the rights and remedies of the Swingline Bank pursuant to ss.1.08(b)) (1) in the case of any of the Events of Default specified in paragraphs A through I above, (i) any Designated Agent may and, upon being directed so to do by the Majority Banks, shall, by notice to the Company, terminate all Commitments hereunder and they shall thereupon terminate, and (ii) any Designated Agent may and, upon being directed by Banks holding at least 66-2/3% of the aggregate unpaid principal amount of the Loans shall, by notice to the Company, declare all outstanding Loans and Notes and all other obligations of the Company hereunder to be due and payable, whereupon the same shall become forthwith due and payable, without further protest, presentment, notice or demand, all of which are expressly waived by the Company, and (2) in case of any of the Events of Default specified in paragraph J or K above, without any notice to the Company or any act by any Designated Agent or the Majority Banks or any Bank, all Commitments hereunder shall terminate forthwith and the principal of and interest accrued on all the Loans and the Notes and all other obligations of the Company hereunder shall become and be due and payable. VIII. MISCELLANEOUS ss.8.01 Waiver. No failure on the part of any Agent, Bank or holder of a Note to exercise and no delay in exercising and no course of dealing with respect to any right, power or privilege under this Agreement or the Notes shall operate as a waiver thereof; nor shall any single or partial exercise of any right, power, or privilege under this Agreement or the Notes preclude 33 29 any other or further exercise thereof or the exercise of any other right, power, or privilege. The remedies herein provided are cumulative and not exclusive of any remedies provided by law. ss.8.02 Notices and Delivery of Documents. Except as otherwise specified herein, all notices and other communications hereunder shall be in writing or by telex or telecopy, and shall be deemed to have been duly given when transmitted by telex or telecopier or personally delivered or, in the case of a mailed notice or other communication, three Business Days after the date deposited in the mails, certified and postage prepaid, addressed to any party hereto at its address given on Schedule 2 hereto or on the signature pages of, or any schedule to, any amendment hereto, or at such other address of which any party hereto shall have notified in writing the party giving such notice or (in the case of a telex message) addressed to any party at any telex number which is published as belonging to the addressee. Except as otherwise expressly provided herein, all Notes and other documents to be delivered to any Agent under this Agreement shall be delivered to it at its Principal Office. ss.8.03 Governing Law. This Agreement and the Notes hereunder shall be construed in accordance with and governed by the law of the State of New York. ss.8.04 Offsets, etc. Upon the occurrence and during the continuance of an Event of Default, each Bank is hereby authorized at any time and from time to time, without notice to the Company except as required by law (any such notice being expressly waived by the Company), to set off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held and other indebtedness at any time owing by such Bank to or for the credit or the account of the Company against any and all of the obligations of the Company now or hereafter existing under this Agreement and the Notes held by such Bank. Each Bank agrees promptly to notify the Company after any such set-off and application made by such Bank, provided that the failure to give such notice shall not affect the validity of such set-off and application. The rights of the Banks under this ss.8.04 are in addition to other rights and remedies (including, without limitation, other rights of set-off) which the Banks may have. ss.8.05 Disposition of Loans. Each Bank may at any time, at its own expense, assign (but only with the prior written consent of the Company, which it may refuse or grant in its sole discretion), or sell participations in, all or any portion of any Loans made by it to another bank or other entity; provided that no such assignment shall be in a principal amount less than $10,000,000. Any Bank making an assignment hereunder shall pay to Chase an administrative fee of $2,500 with respect to each assignment. In the case of an assignment, upon notice thereof by such Bank to the Company and the Agents, to the extent of such assignment and the Loans so assigned, the assignee shall have the same rights and benefits as it would have if it were a Bank hereunder and the assignor shall cease to have the rights and benefits of a Bank hereunder (provided that the obligations of the Company under Article III to such Bank shall survive such assignment). In the case of a participation, except as otherwise provided in ss.2.06(c) hereof, the participant shall not have any rights under this Agreement or such Bank's Notes (the participant's rights against such Bank in respect of such participations to be those set forth in the agreement executed by such Bank in favor of the participant relating thereto) and all amounts payable by the Company under Article III hereof shall be determined as if such Bank had not sold such participation. The granting of any such participation shall not relieve the grantor of its 34 30 Commitment hereunder. Each Bank may furnish any information concerning the Company or any of its Subsidiaries in the possession of such Bank from time to time to assignees and participants (including prospective assignees and participants) under this ss.8.05, provided that, if any such information is confidential information consisting of or based upon information provided by the Company, prior to furnishing any such information such Bank shall obtain the agreement of any such assignee or participant, in favor of the Company, to maintain the confidentiality of such information, subject to the same requirements and exceptions as specified in ss.5.02 hereof (and such Bank shall promptly furnish a copy of each such agreement to the Company). Any Bank may at any time pledge or assign a security interest in all or any portion of its rights under this Agreement to secure obligations of such Bank to a Federal Reserve Bank, and this Section shall not apply to any such pledge or assignment of a security interest; provided that no such pledge or assignment of a security interest shall release a Bank from any of its obligations hereunder or substitute any such pledgee or assignee for such Bank as a party hereto. ss.8.06 Expenses. All statements, reports, certificates, opinions and other documents or information furnished by the Company to the Agents or the Banks under this Agreement shall be supplied without cost to the Agents or the Banks. Further, the Company hereby agrees that it shall pay, on demand, whether or not any Loan is made hereunder, (a) all reasonable out-of-pocket costs and expenses of the Banks and the Agents incurred in connection with the preparation, execution and delivery of this Agreement, or any amendment or supplement thereto, and the Notes and the making of the Loans hereunder, (b) the reasonable fees and disbursements of Simpson Thacher & Bartlett, special counsel to the Banks, in connection therewith, and (c) all costs and expenses of collection (including, without limitation, reasonable legal fees) incident to the enforcement, protection or preservation of any right of any Bank under this Agreement or the Notes. ss.8.07 Amendments, Waivers, etc. This Agreement and the Notes may not be amended, supplemented or modified, nor any of its terms be waived, except by written instruments signed by the Company and the Majority Banks (and, in the case of any amendment, supplement, modification or waiver affecting Article IX hereof, each of the Agents); provided, however, that no such amendment, supplement, modification or waiver shall, without the written consent of all of the Banks: (i) extend the term of, or change the amount of, or change any of the provisions of ss.1.04 hereof with respect to the reduction or increase of, the Commitment of any Bank, or change the rate at which commitment or facility fees accrue hereunder or extend the time for payment thereof, (ii) extend the maturity of any Loan, change the rate of interest thereon, or affect in any way the terms of payment thereof, (iii) alter the definition of "Majority Banks", (iv) affect any provisions relating to Fixed Rate Loans, (v) alter this ss.8.07 or ss.8.09(a), (vi) waive any condition specified in Article IV, (vii) waive an Event of Default under paragraph J or K of Article VII or modify the effect thereof or (viii) waive or amend any representation contained in Article VI; provided, further, that ss.1.03 and ss.1.08 hereof may be amended, supplemented or modified, and any of the terms thereof waived, by written instrument signed only by the Company and the Swingline Bank. Any such amendment, supplement, modification or waiver so entered into shall apply equally to all of the Banks and any holder of the Notes and shall be binding upon all parties hereto. Any waiver hereunder shall be for such period and subject to such conditions as shall be specified in such written instrument. In the case of any waiver of an Event of Default, such Event of Default shall be deemed to be cured and not continuing, but no such waiver shall 35 31 extend to any subsequent or other Event of Default or any right, power or privilege of the Banks hereunder in connection therewith. ss.8.08 Definitions. Certain terms are defined in Schedule 1 hereto and as used herein shall have meanings as so defined. ss.8.09 Successors and Assigns. (a) This Agreement shall be binding upon and inure to the benefit of the Banks, the Agents, the Company and their respective successors and assigns, except that Company may not assign or transfer any of its respective rights or obligations hereunder without the prior written consent of all the Banks. (b) Notwithstanding anything to the contrary contained herein, any Bank (a "Granting Lender") may grant to a special purpose funding vehicle (an "SPC") of such Granting Lender, identified as such in writing from time to time by the Granting Lender to the Agents and the Company, the option to provide to the Company all or any part of any Loan that such Granting Lender would otherwise be obligated to make to the Borrower pursuant to Section 1.01 or 1.02, provided that (i) nothing herein shall constitute a commitment to make any Loan by any SPC and (ii) if an SPC elects not to exercise such option or otherwise fails to provide all or any part of such Loan, the Granting Lender shall be obligated to make such Loan pursuant to the terms hereof. The making of a Syndicated Loan by an SPC hereunder shall utilize the Commitment of the Granting Lender to the same extent, and as if, such Loan were made by the Granting Lender. Each party hereto hereby agrees that no SPC shall be liable for any payment under this Agreement for which a Bank would otherwise be liable, for so long as, and to the extent, the related Granting Lender makes such payment. In furtherance of the foregoing, each party hereto hereby agrees that, prior to the date that is one year and one day after the later of (i) the payment in full of all outstanding senior indebtedness of any SPC and (ii) the Commitment Termination Date, it will not institute against, or join any other person in instituting against, such SPC any bankruptcy, reorganization, arrangement, insolvency or liquidation proceedings or similar proceedings under the laws of the United States or any State thereof. In addition, notwithstanding anything to the contrary contained in this Section 8.09(b), any SPC may (i) with notice to, but without the prior written consent of, the Company or any Agent and without paying any processing fee therefor, assign all or a portion of its interests in any Loans to its Granting Lender or to any financial institutions providing liquidity and/or credit facilities to or for the account of such SPC to fund the Loans made by such SPC or to support the securities (if any) issued by such SPC to fund such Loans and (ii) disclose on a confidential basis any non-public information relating to its Loans to any rating agency, commercial paper dealer or provider of a surety, guarantee or credit or liquidity enhancement to such SPC. In no event shall the Company be obligated to pay to an SPC that has made a Loan any greater amount than the Company would have been obligated to pay under this Agreement if the Granting Lender had made such Loan. Each Granting Lender shall indemnify and hold harmless the Company and its directors, officers, employees and agents from and against any and all losses, liabilities, claims, damages and expenses arising from or attributable to the making of a Loan by an SPC of such Granting Lender. ss.8.10 Counterparts. This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one instrument and any of the parties hereto may execute this Agreement by signing any such counterpart. 36 32 ss.8.11 Confidentiality. Each of the Agents and the Banks agree to maintain the confidentiality of the Information (as defined below), except that Information may be disclosed (a) to its Affiliates and its Affiliates' directors, officers, employees and agents, including accountants, legal counsel and other advisors (it being understood that the Persons to whom such disclosure is made will be informed of the confidential nature of such Information and instructed to keep such Information confidential), (b) to the extent requested by any regulatory authority, (c) to the extent required by applicable laws or regulations or by any subpoena or similar legal process, (d) to any other party to this Agreement, (e) in connection with the exercise of any remedies hereunder or any suit, action or proceeding relation to this Agreement or the enforcement of rights hereunder, (f) subject to any agreement containing provisions substantially the same as those of this Section, to any assignee of or participant in, or any prospective assignee of or participant in, any of its rights or obligations under this Agreement, (g) with the consent of the Company or (h) to the extent such Information (i) becomes publicly available other than as a result of a breach of this Section or (ii) becomes available to any Agent or any Bank on a nonconfidential basis from a source other than the Company. For the purposes of this Section, "Information" means all information received from the Company, its Subsidiaries or its agents relating to the Company or its business, other than any such information that is available to any Agent or any Bank on a nonconfidential basis prior to disclosure by the Company. IX. THE AGENTS ss.9.01 Appointment, Power and Immunities. Each Bank hereby irrevocably appoints and authorizes each Designated Agent to act as its agent hereunder with such powers as are specifically delegated to such Agent by the terms of this Agreement, together with such other powers as are reasonably incidental thereto. No Agent shall have any duties or responsibilities except those expressly set forth in this Agreement, nor shall any Agent, by reason of this Agreement, have a fiduciary relationship with any Bank. No Agent shall be responsible to the Banks for any recitals, statements, representations or warranties contained in this Agreement or in any information memorandum pertaining to the Company or in any certificate or other document referred to or provided for in, or received by any of them under, this Agreement, for the value, validity, effectiveness, genuineness, enforceability or sufficiency of this Agreement or the Notes or any other document referred to or provided for herein or for any failure by the Company to perform its obligations under any thereof. Each Designated Agent may employ agents and attorneys-in-fact and shall not be answerable, except as to money or securities received by it or its authorized agents, for the negligence or misconduct of any such agents or attorneys-in-fact selected by it with reasonable care. Neither the Agents nor any of their directors, officers, employees or agents shall be liable or responsible for any action taken or omitted to be taken by them hereunder or in connection herewith, except for their own gross negligence or willful misconduct. ss.9.02 Reliance by Agents. Each Agent shall be entitled to rely upon any certificate, notice or other document (including any cable, telegram, telecopy or telex) believed by it to be genuine and correct and to have been signed or sent by or on behalf of the proper person or persons, and upon advice and statements of legal counsel, independent accountants and other experts selected by Chase. Chase may deem and treat the payee of any Note as the owner thereof for all purposes hereof unless and until a notice of the assignment thereof satisfactory to Chase 37 33 signed by such payee shall have been filed with it. As to any matters not expressly provided for by this Agreement, each Agent shall in all cases be fully protected in acting, or in refraining from acting, hereunder in accordance with written instructions signed by the Majority Banks, and such instructions of the Majority Banks and any action taken or failure to act pursuant thereto shall be binding on all of the Banks. ss.9.03 Default. No Agent shall be deemed to have knowledge of the occurrence of a Default or an Event of Default (other than nonpayment of principal, interest or commitment or other fees) unless such Agent has received written notice from a Bank or the Company specifying such Default or Event of Default and stating that such notice is a "Notice of Default". In the event that any Designated Agent receives such a notice of the occurrence of a Default or an Event of Default, such Agent shall give prompt written notice thereof to the other Agents and the Banks. The Designated Agents shall take such action with respect to such Default or Event of Default as shall be reasonably directed in writing by the Majority Banks provided that (i) unless and until the Designated Agents shall have received such directions, the Designated Agents may take such action, or refrain from taking such action, with respect to such Default or Event of Default as they shall deem advisable in the best interests of the Banks and (ii) in no event shall any Agent be required to institute any action, suit or other proceeding in connection herewith. ss.9.04 Rights as a Lender. With respect to its Commitment and the Loans made by it or any collateral therefor, each of Chase, Bank of America and SunTrust (and any successor Agent hereunder) in its capacity as a Bank under this Agreement shall have the same rights and powers hereunder as any other Bank and may exercise the same as though it were not acting as an Agent, and the term "Bank" or "Banks" shall, unless the context otherwise indicates, include each of Chase, Bank of America and SunTrust (and any successor Agent hereunder) in its individual capacity. Each of Chase, Bank of America and SunTrust (and any successor Agent hereunder) and their affiliates may (without having to account therefor to any Bank) accept deposits from, lend money to and generally engage in any kind of banking, trust or other business with the Company (and any of its related companies) as if it were not acting as an Agent and may accept fees and other consideration from the Company for services in connection with this Agreement and otherwise without having to account for the same to the other Agent and the Banks. ss.9.05 Indemnification. The Banks severally agree to indemnify each Agent (to the extent requested by such Agent as provided in ss.9.08 hereof and/or to the extent not reimbursed by the Company), pro rata according to the amounts of their respective Commitments, for any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind and nature whatsoever which may be imposed on, incurred by or asserted against such Agent in any way relating to or arising out of this Agreement or any other documents referred to herein or the transactions contemplated hereby (including, without limitation, the costs and expenses which the Company is obligated to pay under ss.8.06 hereof but excluding, unless a Default has occurred and is continuing, normal administrative costs and expenses incident to the performance of its agency duties hereunder) or the enforcement of any of the terms hereof or of any such other documents, provided that (a) such Agent shall have given the Banks notice thereof and an opportunity to defend against the same at the expense of the Banks and with counsel selected by the Majority Banks, (b) no Bank shall be liable to an Agent for any of the foregoing to the extent they arise from such Agent's gross negligence or willful 38 34 misconduct and (c) no Bank shall be liable for any amount in respect of any compromise or settlement of any of the foregoing unless such compromise or settlement is approved by the Majority Banks. ss.9.06 Reports. Promptly after its receipt thereof, each Agent (or, if all Agents shall have received the same, Chase) will forward to each Bank a copy of each report, notice or other document required by this Agreement to be delivered to such Agent for such Bank. ss.9.07 Non-Reliance on Agents and Other Banks. Each Bank agrees that it has, independently and without reliance on any Agent or any other Bank, and based on such documents and information as it has deemed appropriate, made its own credit analysis of the Company and decision to enter into this Agreement and that it will, independently and without reliance upon any Agent or any other Bank, and based on such documents and information as it shall deem appropriate at the time, continue to make its own analysis and decisions in taking or not taking such action under this Agreement. No Agent shall be required to keep itself informed as to the performance or observance by the Company of this Agreement or any other document referred to or provided for herein or to make inquiry of or to inspect the properties or books of the Company. Except for notices, reports and other documents and information expressly required to be furnished to the Banks by any Agent hereunder, no Agent shall have any duty or responsibility to provide any Bank with any credit or other information concerning the affairs, financial condition or business of the Company (or any of its related companies) which may come into the possession of such Agent or any of its affiliates. ss.9.08 Failure to Act. Except for action expressly required of any Agent under this Agreement, such Agent shall in all cases be fully justified in failing or refusing to act unless it shall be indemnified to its satisfaction by the Banks against any and all liability and expense which may be incurred by it by reason of taking or continuing to take any such action. ss.9.09 Resignation or Removal of Agents. Subject to the appointment and acceptance of a successor Agent as provided below, any Agent may resign at any time by giving written notice thereof to the Banks and the Company and any Agent may be removed at any time with or without cause by the Majority Banks. Upon any such resignation or removal, the Majority Banks shall have the right to appoint a successor Agent. If no successor Agent shall have been so appointed by the Majority Banks and shall have accepted such appointment within 30 days after the retiring Agent's giving of notice of resignation or the Majority Banks' removal of the retiring Agent, then the retiring Agent may, on behalf of the Banks, appoint a successor Agent, which shall be a bank which has an office (or an affiliate or a Subsidiary with an office) in New York, New York. Upon the acceptance of any appointment as Agent hereunder by a successor Agent, such successor Agent shall thereupon succeed to and become vested with all the rights, powers, privileges and duties of the retiring Agent, and the retiring Agent shall be discharged from its duties and obligations hereunder. After any retiring Agent's resignation or removal hereunder as Agent, the provisions of this Agreement shall continue in effect for its benefit in respect of any actions taken or omitted to be taken by it while it was acting as the Agent. 39 35 ss.9.10 Documentation Agent. Nothing in this Agreement shall impose on SunTrust, in its capacity as Documentation Agent, any duties or obligations whatsoever. ss.9.11 Syndication Agent. Nothing in this Agreement shall impose on Bank of America, in its capacity as Syndication Agent, any duties or obligations whatsoever. 40 36 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed as of the date first above written. SONAT INC. By: ------------------------------- Name: Title: AMSOUTH BANK, as a Bank By: -------------------------------- Name: Title: BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, as a Bank By: ------------------------------- Name: Title: THE BANK OF NEW YORK, as a Bank By: -------------------------------- Name: Title: 41 37 THE BANK OF NOVA SCOTIA, as a Bank By: -------------------------------- Name: Title: THE CHASE MANHATTAN BANK, as a Bank By: -------------------------------- Name: Title: CREDIT LYONNAIS, NEW YORK BRANCH, as a Bank By: -------------------------------- Name: Title: MELLON BANK, N.A., as a Bank By: -------------------------------- Name: Title: NORTHERN TRUST, as a Bank By: -------------------------------- Name: Title: 42 38 REGIONS BANK, as a Bank By: -------------------------------- Name: Title: SOUTHTRUST BANK N.A., as a Bank By: -------------------------------- Name: Title: SUNTRUST BANK, ATLANTA, as a Bank By: -------------------------------- Name: Title: By: -------------------------------- Name: Title: Agents THE CHASE MANHATTAN BANK, as Administrative Agent By: -------------------------------- Name: Title: 43 39 BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, as Syndication Agent By: -------------------------------- Name: Title: SUNTRUST BANK, ATLANTA, as Documentation Agent By: -------------------------------- Name: Title: 44 SCHEDULE 1 DEFINITIONS As used in this Agreement, the following terms shall have the following respective meanings: "Additional Costs" shall have the meaning attributed thereto in ss.3.01(a) hereof. "Affected Loans" shall have the meaning attributed thereto in ss.3.04 hereto. "Affected Type" shall have the meaning attributed thereto in ss.3.04 hereto. "Agents" shall have the meaning attributed thereto in the preamble to this Agreement. "Annual Dates" shall mean the Quarterly Date in December of each year. "Applicable Facility Fee Rate" shall mean, with respect to any day, the percentage indicated below opposite the Rating Level in effect on such day:
Rating Level Percentage ------------ ---------- I 0.080% II 0.100% III 0.125% IV 0.150% V 0.200%
"Applicable Lending Office" shall mean, with respect to each Bank, with respect to each type of Loan, the Lending Office designated for such type of Loan on Schedule 2 hereof, or on the signature pages of, or any schedule to, any amendment hereto, or such other office or affiliate of such Bank as such Bank may from time to time specify to Chase and the Company as the office at which its Loans of such type are to be made and maintained. "Applicable Margin" shall mean: (a) with respect to Domestic Loans, zero; and (b) with respect to any Eurodollar Loan on any day, the percentage indicated below opposite the Rating Level in effect on such day:
Rating Level Percentage ------------ ---------- I 0.320% II 0.350% III 0.375% IV 0.475% V 0.500%
45 2 provided, that if on such day the aggregate principal amount of the Loans outstanding equals or exceeds 33% of the Commitments in effect on such day, 0.125% shall be added to the foregoing percentage otherwise applicable on such day. "Appropriate Officer" shall mean the chief executive officer, the chief operating officer, the chief financial officer, the Vice President - Comptroller, the Vice President - Finance or the Treasurer. "Bank of America" shall mean Bank of America National Trust and Savings Association, in its capacity as Syndication Agent. "Banks" shall have the meaning attributed thereto in the preamble to this Agreement, and which shall include the Swingline Bank in its capacity as such. "Base Rate" shall mean, for any day, the higher of (a) the Federal Funds Rate for such day plus 1/2 of 1% per annum and (b) the Prime Rate for such day. Each change in any interest rate provided for herein based upon the Base Rate resulting from a change in the Base Rate shall take effect at the time of such change in the Base Rate. "Basle Accord" shall have the meaning attributed thereto in ss.3.01(c) hereto. "Business Day" shall mean any day on which commercial banks are not authorized or required to close in New York City and, if such day relates to a borrowing of, a payment or prepayment of principal of or interest on, or the Interest Period for, a Eurodollar Loan or a notice by the Company with respect to any such borrowing, payment, prepayment or Interest Period, which is also a day on which dealings in Dollar deposits are carried out in the London interbank market. "Change in Control" shall have the meaning attributed thereto in ss.1.04(b) hereto. "Chase" shall mean The Chase Manhattan Bank in its capacity as the Administrative Agent. "Commitment" shall mean, as to each Bank, the obligation of such Bank to make Syndicated Loans pursuant to ss.1.01 hereof in an aggregate amount at any one time outstanding up to but not exceeding the amount set opposite such Bank's name on Schedule 3 to this Agreement under the caption "Commitment" (as the same may be reduced at any time or from time to time pursuant to ss.1.04 hereof). "Commitment Termination Date" shall mean the 363rd day after the Effective Date. "Company" shall have the meaning attributed thereto in the preamble to this Agreement. "Consolidated Capitalization" shall mean, for any Person, the sum of Total Indebtedness and Equity of such Person and its Consolidated Subsidiaries. 46 3 "Consolidated Subsidiary" shall mean any Subsidiary of a Person which was or shall be consolidated with such Person in any consolidated financial statement furnished to the Banks under this Agreement. "Default" shall mean an Event of Default or an event which, with the notice or lapse of time or both specified in Article VII hereof, would become such an Event of Default. "Derivative Obligations" shall mean any transaction which is a rate swap transaction, basis swap, forward rate transaction, commodity swap, commodity option, equity or equity index swap, equity or equity index option, bond option, interest rate option, foreign exchange transaction, cap transaction, floor transaction, collar transaction, currency swap transaction, cross-currency rate swap transaction, currency option or any other similar transaction (including any option with respect to any of these transactions). "Designated Agents" shall mean Chase and Bank of America. "Dollars" and "$" shall mean lawful money of the United States of America. "Domestic Loans" shall mean Syndicated Loans which bear interest at rates based upon the Base Rate. "Effective Date" shall have the meaning attributed thereto in ss.4.01 hereof. "Equity" means at any time the sum of the following, for any Person and its Consolidated Subsidiaries: (i) the amount of share capital liability, including common and preferred shares (less cost of treasury shares), plus (ii) the amount of surplus and retained earnings (or, in the case of a surplus or retained earnings deficit minus the amount of such deficit). "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended from time to time, including (unless the context otherwise requires) any rules or regulations promulgated thereunder. "Eurodollar Loans" shall mean Syndicated Loans, the interest rates on which are determined on the basis of rates referred to in the definition of "Fixed Base Rate". "Event of Default" shall mean any of the Events of Default specified in Article VII hereof. "Federal Funds Rate" shall mean, for any day, the rate per annum (rounded upwards, if necessary, to the nearest 1/100 of 1%) equal to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers on such day, as published by the Federal Reserve Bank of New York on the Business Day next succeeding such day, provided that (i) if the day for which such rate is to be 47 4 determined is not a Business Day, the Federal Funds Rate for such day shall be such rate on such transactions on the next preceding Business Day as so published on the next succeeding Business Day, and (ii) if such rate is not so published for any day, the Federal Funds Rate for such day shall be the average rate charged to The Chase Manhattan Bank on such day on such transactions as determined by Chase. "Fixed Base Rate" shall mean, with respect to any Fixed Rate Loan, the arithmetic mean (rounded upwards, if necessary, to the nearest 1/100 of 1%), as determined by Chase, of the rate per annum quoted by each Reference Bank at approximately 11:00 a.m. London time (or as soon thereafter as practicable) on the date two Business Days prior to the first day of the Interest Period for such Loan for the offering by such Reference Bank to leading banks in the London interbank market of Dollar deposits having a term comparable to such Interest Period and in an amount comparable to the principal amount of the Eurodollar Loan to be made by such Reference Bank for such Interest Period. If any Reference Bank is not participating in any Fixed Rate Loan, the Fixed Base Rate for such Loan shall be determined by reference to the amount of the Loan which such Reference Bank would have made had it been participating in such Loan. If any Reference Bank does not timely furnish such information for determination of any Fixed Base Rate, Chase shall determine such Fixed Base Rate on the basis of information timely furnished by the remaining Reference Bank. "Fixed Rate" shall mean, for any Fixed Rate Loan, a rate per annum (rounded upwards, if necessary, to the nearest 1/100 of 1%) determined by Chase to be equal to the Fixed Base Rate for such Loan for the Interest Period for such Loan. "Fixed Rate Loans" shall mean Eurodollar Loans. "Indebtedness" shall mean, for any Person, all obligations for borrowed money or purchase money obligations of such Person which in accordance with generally accepted accounting principles would be shown on the balance sheet of such Person as a liability; all obligations under leases required to be capitalized under generally accepted accounting principles at the time of entering into such lease; all guarantees of such Person in respect of Indebtedness of others; Indebtedness of others secured by any mortgage, pledge, security interest, encumbrance, lien or charge upon property owned by such Person, whether or not assumed; Operating Lease Obligations; and, only as to any Consolidated Subsidiary of the Company, any Mandatory Preferred Stock of such Consolidated Subsidiary; provided that Indebtedness shall not include: (i) any Indebtedness evidence of which is held in treasury (but the subsequent resale of such Indebtedness shall be deemed to constitute the creation thereof); or (ii) any particular Indebtedness if, upon or prior to the maturity thereof, there shall have been deposited with the proper depositary, in trust, money or United States government securities (or evidences of such Indebtedness as permitted by the instrument creating such Indebtedness) in the necessary amount to pay, redeem or satisfy such Indebtedness; or (iii) only as to the Company, any Indebtedness of the Company to any of its Subsidiaries provided that such Indebtedness is subordinated in right of payment to the prior payment in full of the obligations of the Company to the Banks and the Agents under this Agreement and the termination in full of the Commitments hereunder (including interest accruing on such obligations after the date of any filing by the Company of any petition in bankruptcy or the commencement of any bankruptcy, insolvency or similar proceeding with 48 5 respect to the Company) in the event that any Default under this Agreement shall have occurred and be continuing and in the event of any insolvency, bankruptcy or similar proceeding affecting the Company; or (iv) any indirect guarantees or other contingent obligations in respect of Indebtedness of other Persons, including agreements, contingent or otherwise, with such other persons or with third persons with respect to, or to permit or assure the payment of, obligations of such other persons, including, without limitation, agreements to purchase or repurchase obligations of such other persons, to advance or supply funds to, or to invest in, such other persons or to pay for properties, products or services of such other persons (whether or not conveyed, delivered or rendered); demand charge contracts, through-put, take-or-pay, keep-well, make-whole or maintenance of working capital or similar agreements; or guarantees with respect to rental or other similar periodic payments to be made by such other Persons, including, but without limiting the generality of the foregoing, the Guaranty Agreement dated as of June 1, 1968, as amended as of August 1, 1968, May 1, 1970, April 13, 1973, May 26, 1973 and November 30, 1984, between Boise Cascade Corporation, the Company and Parish of Beauregard, Louisiana; or (v) any capitalized leases for space and/or equipment in respect of oil and gas production platforms not in excess of $25,000,000 in the aggregate; or (vi) any Indebtedness of Bear Creek Storage Company or Citrus Corp. that is shown on the balance sheet of the Company as a liability and which would not be required to be treated as Indebtedness of the Company or any of its Subsidiaries under generally accepted accounting principles as in effect on the date hereof but which is required to be treated as Indebtedness of the Company or any of its Subsidiaries as a result of a change in generally accepted accounting principles after the date hereof. For purposes of this Agreement, the principal amount of any Indebtedness of any Person (excluding Operating Lease Obligations and Mandatory Preferred Stock of a Consolidated Subsidiary) shall mean the amount required in accordance with generally accepted accounting principles to be shown as a liability on the balance sheet of such Person (or, in the case of Indebtedness of another Person required to be treated as Indebtedness of such Person under this Agreement, the balance sheet of such other Person) prepared as of the applicable date. "Interest Payment Date" shall mean, as to any Loan, the last day of the Interest Period for such Loan and (i) with respect to a Set Rate Loan with an Interest Period longer than 90 days, the last day of each consecutive 90 day period (other than such last day if such last day occurs within two Business Days of the last day of such Interest Period) occurring during such Interest Period commencing with the first day of such Interest Period, (ii) with respect to a Eurodollar Loan with an Interest Period longer than three months, the last day of each consecutive three month period (other than such last day if such last day occurs within two Business Days of the last day of such Interest Period) occurring during such Interest Period commencing with the first day of such Interest Period and (iii) with respect to a Domestic Loan, each Quarterly Date that occurs prior to the end of the Interest Period for such Loan. "Interest Period" shall mean, for any Loan, the period provided for such Loan pursuant to ss.2.03 hereof. "Loans" shall mean Money Market Loans, Syndicated Loans and Swingline Loans. "Majority Banks" shall mean Banks having at least 66-2/3% of the aggregate amount of the Commitments; provided that, if the Commitments shall have terminated, Majority 49 6 Banks shall mean Banks and SPCs holding at least 66-2/3% of the aggregate unpaid principal amount of the Loans. "Mandatory Preferred Stock" shall mean, for any Person, the aggregate stated liquidation value of any outstanding preferred stock issued by such Person which is required to be redeemed, in whole or in part, by sinking fund or other mandatory payments at any time prior to the Commitment Termination Date. "Moody's" shall mean Moody's Investor Service, Inc. "Money Market Borrowing" shall have the meaning assigned to such term in ss.1.02(b) hereof. "Money Market Loans" shall mean the loans provided for by ss.1.02 hereof. "Money Market Note" shall have the meaning assigned to such term in ss.1.10(b) hereof. "Money Market Quote" shall mean an offer in accordance with ss.1.02(c) hereof by a Bank to make a Money Market Loan with one single specified interest rate. "Money Market Quote Request" shall have the meaning assigned to such term in ss.1.02(b) hereof. "Money Market Rate" shall have the meaning assigned to such term in ss.1.02(c)(ii)(C) hereof. "Note" shall mean a Syndicated Note, a Money Market Note or a Swingline Note. "Operating Lease Obligations" shall mean, for the Company at any date, if the minimum annual rental commitments of the Company and its Consolidated Subsidiaries as lessee under leases (other than capital leases and mineral leases) in effect on such date for the fiscal year in which such date occurs shall exceed $30,000,000, the minimum rental commitments of the Company and its Consolidated Subsidiaries as lessee over the remaining terms of such leases that cause such minimum annual rental commitments to exceed $30,000,000, discounted to present value at the rate of 10% per annum. For purposes of this definition, rental payments under leases having the longest terms and which cannot be canceled by the Lessee without the incurrence of a substantial penalty shall be deemed to be those leases that cause such aggregate minimum rental commitments to exceed $30,000,000. "PBGC" shall mean the Pension Benefit Guaranty Corporation and any entity succeeding to any or all of its functions under ERISA. "Person" shall mean an individual, a corporation, a company, a voluntary association, a partnership, a trust, an unincorporated organization or a government or any agency, instrumentality or political subdivision thereof. 50 7 "Plan" shall mean any employee benefit or other plan maintained by the Company or any Subsidiary of the Company for its employees and covered by Title IV of ERISA. "Post-Default Rate" shall mean, in respect of any amount payable under this Agreement which is not paid when due (whether at stated maturity, by acceleration or otherwise), a rate per annum for each day during the period from the due date of such amount until such amount shall be paid in full equal to 2% above the Base Rate in effect on such day (provided that, if the amount so in default is principal of a Fixed Rate Loan or a Money Market Loan and the due date thereof is a day other than the last day of the Interest Period therefor, the "Post-Default Rate" for such principal shall be, for the period from and including such due date to but excluding the last day of the Interest Period for such Loan, 2% above the interest rate for such Loan as provided in ss.2.02 hereof and, thereafter, the rate provided for above in this definition). "Prime Rate" shall mean the rate of interest from time to time announced by Chase at its Principal Office as its prime commercial lending rate. "Principal Office" shall mean (i) with respect to Chase or The Chase Manhattan Bank, its principal office in New York, New York, presently located at 1 Chase Manhattan Plaza, New York, N.Y. and (ii) with respect to Bank of America, its principal office in Concord California, presently located at 1850 Gateway Boulevard, Concord, CA. "Quarterly Dates" shall mean the last day of each March, June, September and December, commencing on the first such date after the Effective Date. "Quarterly Period" shall mean the period of three consecutive calendar months ending on each Quarterly Date. "Quotation Date" shall have the meaning attributed thereto in ss.1.02(b)(iv) hereof. "Rating Level" shall mean, as of any day, the level indicated below opposite the statement that is correct with respect to the ratings of the Company's senior unsecured long-term debt securities as of such day, provided, that if the ratings of S&P and Moody's on such day fall within different levels, the level shall be the level which is one level above the level with the lower rating unless there is a difference of more than two levels, in which case the level shall be the level which is one level below the level with the higher rating: 51 8
Rating Level ------ ----- A- or better by S&P or A3 or better by Moody's I BBB+ by S&P or Baa1 by Moody's II BBB by S&P or Baa2 by Moody's III BBB- by S&P or Baa3 by Moody's IV Below BBB- by S&P and below Baa3 by Moody's V
For purposes of this definition, "I" shall be the highest level and "V" shall be the lowest level. If any rating established or deemed to have been established by Moody's or S&P shall be changed, such change shall be effective as of the date on which it is first announced by the applicable rating agency. Each change in the Rating Level shall apply during the period commencing on the effective date of such change and ending on the date immediately preceding the effective date of the next such change. If the rating system of Moody's or S&P shall change so as to make the above ratings inapplicable, or if either such rating agency shall cease to be in the business of rating corporate debt obligations or shall no longer have in effect a rating for any reason, the Company and the Banks shall negotiate in good faith to amend the references to specific ratings in this definition to reflect such changed rating system or the non-availability of ratings from such rating agency or to select a substitute rating agency and pending or in the absence of any agreement the Rating Level will be determined by reference to the single available rating, if any, or, in the absence of any rating, then such rating agencies will be deemed to have established a rating in Level V. "Reference Banks" shall mean The Chase Manhattan Bank and Bank of America National Trust and Savings Association (or their Applicable Lending Offices, as the case may be). "Regulation D" shall mean Regulation D of the Board of Governors of the Federal Reserve System (or any successor), as the same may be amended or supplemented from time to time. "Regulatory Change" shall mean, with respect to any Bank, any change after the date of this Agreement in United States Federal, state or foreign law or regulations (including, without limitation, Regulation D) or the adoption or making after such date of any interpretation, directive or request applying to a class of banks including such Bank of or under any United States Federal, state or foreign law or regulations (whether or not having the force of law) by any court or governmental or monetary authority charged with the interpretation or administration thereof. 52 9 "Restricted Subsidiaries" shall mean SNG, Sonat Exploration and any other Subsidiary of the Company which shall acquire or succeed to all or any substantial part of the assets or the stock of any such Restricted Subsidiary (in which case any references to any such Restricted Subsidiary in this Agreement shall, mutatis mutandis, be deemed to refer to such other Subsidiary). "Set Rate Auction" shall mean a solicitation of Money Market Quotes setting forth Money Market Rates pursuant to ss.1.02 hereof. "Set Rate Loans" shall mean Money Market Loans the interest rates on which are determined on the basis of Money Market Rates pursuant to a Set Rate Auction. "SNG" shall mean Southern Natural Gas Company, a wholly-owned Subsidiary of the Company (except for directors' qualifying shares). "Sonat Exploration" shall mean Sonat Exploration Company, a wholly-owned Subsidiary of the Company (except for directors' qualifying shares). "S&P" shall mean Standard & Poor's Ratings Services, a division of The Mc-Graw Hill Companies. "SPC" shall have the meaning provided in ss.8.09(b). "Subsidiary" shall mean, as to any Person, any corporation, partnership or other entity at least a majority of whose securities or other ownership interests having ordinary voting power for the election of directors or other persons performing similar functions of such corporation, partnership or entity (other than securities or other ownership interests having such power only by reason of the happening of a contingency) are at the same time owned by such Person and/or one or more of its other Subsidiaries. "SunTrust" shall mean SunTrust Bank, Atlanta, in its capacity as the Documentation Agent. "Swingline Account" shall mean the account of the Company maintained with the Swingline Bank at its Lending Office which the Company and the Swingline Lender shall designate as the Swingline Account for purposes of this Agreement. "Swingline Bank" shall mean SunTrust Bank, Atlanta, in its capacity as the lender of Swingline Loans. "Swingline Business Day" shall mean any day on which commercial banks are not authorized or required to close in Atlanta, Georgia. "Swingline Commitment" shall mean the obligation of the Swingline Bank to make Swingline Loans pursuant to ss.1.03 hereof in an aggregate principal amount at any one time outstanding up to but not exceeding $60,000,000. 53 10 "Swingline Loans" shall have the meaning assigned to such term in ss.1.03 hereof. "Swingline Note" shall have the meaning assigned to such term in ss.1.10(c) hereof. "Syndicated Loans" shall mean the loans provided for by ss.1.01 hereof. "Syndicated Note" shall have the meaning assigned to such term in ss.1.10(a) hereof. "Termination Event" shall mean any event or condition which would constitute grounds under ss.4042 of ERISA for the termination of, or for the appointment of a trustee to administer, any Plan. "Total Indebtedness" shall mean, for any Person, the aggregate unpaid principal amount of the Indebtedness of such Person and its Consolidated Subsidiaries (excluding Indebtedness of any Consolidated Subsidiary to such Person or another such Consolidated Subsidiary and, except for the Company, Indebtedness of such Person to any of its Consolidated Subsidiaries). "Year 2000 Problem" shall mean for any Person the risk that computer applications used by such Person may be unable to perform properly date-sensitive functions involving certain dates after December 31, 1999. 54 SCHEDULE 2 LENDING OFFICES AND/OR ADDRESSES FOR NOTICES 1. SONAT INC. Address for Notices: AmSouth-Sonat Tower 1900 Fifth Avenue North Birmingham, Alabama 35202-2563 Attention: Treasurer Fax: 205-325-7490 Telex: 4955644 Answerback: SNGC UI 2. The Chase Manhattan Bank (as a Bank and as Administrative Agent) Lending Office for All Types of Loans: The Chase Manhattan Bank 1 Chase Manhattan Plaza New York, New York 10081 Address for Notices: The Chase Manhattan Bank 1 Chase Manhattan Plaza New York, New York 10081 Attention: Loan and Agency Services Lisa Pucciarelli Telephone: 212-552-7886 Fax: 212-552-5777 With copies to: The Chase Manhattan Bank 270 Park Avenue, 21st Floor New York, New York 10017 Attention: Oil & Gas Group Steven Wood Carlos Morales Chase Securities Inc. 270 Park Avenue New York, New York 10017-2070 55 2 Attention: Financial Products Money Market Management 6th Floor Chase Securities Inc. 707 Travis, 8th Floor Houston, Texas 77002 3. Bank of America National Trust and Savings Association (as a Bank and as Syndication Agent) Lending Office for All Types of Loans: Bank of America National Trust and Savings Association 1850 Gateway Boulevard Concord, CA 94520 Address for Notices: Bank of America National Trust and Savings Association 1850 Gateway Boulevard Concord, CA 94520 Attention: Camille Gibby Telephone: 925-675-7759 Fax: 925-975-7531 with copies to: Bank of America National Trust and Savings Association Three Allen Center, 333 Clay St. Houston, TX 77002 Attention: Michael J. Dillon Telephone: 713-651-4903 Fax: 713-651-4808 Robert R. Ingersoll Telephone: 713-651-4922 Fax: 713-651-4904 56 3 4. SunTrust Bank, Atlanta (as a Bank, as the Swingline Bank and as Documentation Agent) Lending Office for All Types of Loans: SunTrust Bank, Atlanta 25 Park Place Atlanta, Georgia 30303 Attention: John Frazer Telephone: 404-575-2841 Fax: 404-588-8833 Address for Notices: SunTrust Bank, Atlanta P.O. Box 4418, Mail Code 120 Atlanta, Georgia 30303 Attention: Gina Muncus Telephone: 404-658-4624 Fax: 404-827-6270 Telex: 54220 Answerback: TruscoIntAtl 5. The Bank of Nova Scotia Lending Office for All Types of Loans: The Bank of Nova Scotia 600 Peachtree Street, N.E. Suite 2700 Atlanta, Georgia 30308 Address for Notices: The Bank of Nova Scotia 600 Peachtree Street, N.E. Suite 2700 Atlanta, Georgia 30308 Attention: Donna Gardner Telephone: 404-877-1559 Fax: 404-888-8998 Address for Loan Documentation Matters: The Bank of Nova Scotia 1100 Louisiana, Suite 3000 Houston, Texas 77002 Attention: Jean Paul Purdy Telephone: 713-759-3433 Fax: 713-752-2425 57 4 6. Credit Lyonnais, New York Branch Lending Office for All Types of Loans Credit Lyonnais, New York Branch c/o Credit Lyonnais Houston Representative Office 1000 Louisiana, Suite #5360 Houston, Texas 77002 Address for Notices: Credit Lyonnais, New York Branch c/o Credit Lyonnais Houston Representative Office 1000 Louisiana, Suite #5360 Houston, Texas 77002 Attention: Robert LaRocque Telephone: (713) 751-8721 Fax: (713) 751-0307 Telex: 6868674 Answerback: CL HOU UN 7. Mellon Bank, N.A. Lending Office for All Types of Loans: Mellon Bank, N.A. Three Mellon Bank Center Loan Administration Room 1203 Pittsburgh, PA 15259 Attention: Supervisor Telephone: 412-234-4087 Fax: 412-236-2027 Address for notices: Mellon Bank, N.A. One Mellon Bank Center Room 4425 Pittsburgh, PA 15258 Attention: Roger Howard Telephone: 412-234-5606 Fax: 412-236-1840 58 5 Address for Notices Regarding Money Market Loans Mellon Bank, N.A. One Mellon Bank Center Capital Markets, Room 151-0400 Pittsburgh, PA 15258-0001 Attention: Marilyn Wagner Telephone: (412) 234-1693 Fax: (412) 234-7834 8. AmSouth Bank Lending Office for All Types of Loans: AmSouth Bank 1900 Fifth Avenue North Birmingham, Alabama 35203 Address for Notices: AmSouth Bank 1900 Fifth Avenue North Birmingham, Alabama 35203 Attention: David A. Simmons Senior Vice President Telephone: 205-326-5924 Fax: 205-801-0157 9. Regions Bank Lending Office for All Types of Loans Regions Bank (Birmingham) 417 20th Street North Birmingham, AL 35202 Address for Notices: Regions Bank (Birmingham) 417 North 20th Street Birmingham, AL 35202 Attention: Chuck Allen Telephone: (205) 326-7003 Fax: (205) 326-7739 59 6 10. The Bank of New York Lending Office for All Types of Loans The Bank of New York One Wall Street, 19th Floor New York, NY 10286 Address for Notices: The Bank of New York One Wall Street New York, NY 10286 Attention: Steven Kalachman Telephone: (212) 635-7881 Fax: (212) 635-7923 11. Northern Trust Lending Office for All Types of Loans Northern Trust 50 South LaSalle Street Chicago, IL 60675 Attention: Telephone: Fax: Address for Notices: Northern Trust 50 South LaSalle Street Chicago, IL 60675 Attention: Christina Jakuc Telephone: (312) 444-3455 Fax: (312) 6630-6062 12. SouthTrust Bank N.A. Lending Office for All Types of Loans SouthTrust Bank N.A. 420 N. 20th Street, 6th Floor Birmingham, AL 35203 Attention: Telephone: Fax: 60 7 Address for Notices: SouthTrust Bank N.A. 420 N. 20th Street, 6th Floor Birmingham, AL 35203 Attention: John A. Lotz, Jr. Telephone: (205) 254-5795 Fax: (205) 254-5911 61 SCHEDULE 3
BANKS COMMITMENT THE CHASE MANHATTAN BANK $ 45,000,000.00 BANK OF America National Trust and Savings Association 45,000,000.00 SUNTRUST BANK, ATLANTA 60,000,000.00 CREDIT LYONNAIS, NEW YORK BRANCH 45,000,000.00 THE BANK OF NOVA SCOTIA 30,000,000.00 MELLON BANK, N.A. 35,000,000.00 AMSOUTH BANK 30,000,000.00 THE BANK OF NEW YORK 30,000,000.00 REGIONS BANK 30,000,000.00 NORTHERN TRUST 25,000,000.00 SOUTHTRUST BANK N.A. 25,000,000.00 --------------- $400,000,000.00
62 EXHIBIT A-1 [Form of Note for Syndicated Loans] PROMISSORY NOTE $ , 19 -------------------- ----------- --- New York, New York FORVALUE RECEIVED, SONAT INC., a Delaware corporation (the "Company"), hereby promises to pay to ___________ (the "Bank"), for account of its respective Applicable Lending Offices provided for by the Credit Agreement referred to below, at the principal office of The Chase Manhattan Bank at 1 Chase Manhattan Plaza, New York, New York 10081, the principal sum of _______ Dollars (or such lesser amount as shall equal the aggregate unpaid principal amount of the Syndicated Loans made by the Bank to the Company under the Credit Agreement), in lawful money of the United States of America and in immediately available funds, on the dates and in the principal amounts provided in the Credit Agreement, and to pay interest on the unpaid principal amount of each such Syndicated Loan, at such office, in like money and funds, for the period commencing on the date of such Syndicated Loan until such Syndicated Loan shall be paid in full, at the rates per annum and on the dates provided in the Credit Agreement. The date, amount, type, interest rate and maturity date of each Syndicated Loan made by the Bank to the Company, and each payment made on account of the principal thereof, shall be recorded by the Bank on its books and, prior to any transfer of this Note, endorsed by the Bank on the schedule attached hereto or any continuation thereof. The failure of the Bank to make any notation or entry or any error in such a notation or entry shall not, however, limit or otherwise affect any obligation of the Company under the Credit Agreement or this Note. This Note is one of the Notes referred to in the Credit Agreement (as modified and supplemented and in effect from time to time, the "Credit Agreement") dated as of January 20, 1999, among the Company, the banks named therein and The Chase Manhattan Bank, as Administrative Agent, Bank of America National Trust and Savings Association, as Syndication Agent, and SunTrust Bank, Atlanta, as Documentation Agent, and evidences Syndicated Loans made by the Bank thereunder. Capitalized terms used in this Note have the respective meanings assigned to them in the Credit Agreement. The Credit Agreement provides for the acceleration of the maturity of this Note upon the occurrence of certain events and for prepayments of Loans upon the terms and conditions specified therein. 63 2 This Note shall be governed by, and construed in accordance with, the law of the State of New York. SONAT INC. By ------------------------------- Title: 64 SCHEDULE OF LOANS This Note evidences Loans made under the within-described Credit Agreement to the Company, on the dates, in the principal amounts, of the types, bearing interest at the rates and maturing on the dates set forth below, subject to the payments and prepayments of principal set forth below:
Principal Date Amount Type Maturity Amount Unpaid of of of Interest Date of Paid or Principal Notation Loan Loan Loan Rate Loan Prepaid Amount Made by ---- -------- ---- -------- -------- ------- -------- --------
65 EXHIBIT A-2 [Form of Note for Money Market Loans] PROMISSORY NOTE , 19 ----------------- --- New York, New York FOR VALUE RECEIVED, SONAT INC., a Delaware corporation (the "Company"), hereby promises to pay to (the "Bank"), for account of its respective Applicable Lending Offices provided for by the Credit Agreement referred to below, at the principal office of The Chase Manhattan Bank at 1 Chase Manhattan Plaza, New York, New York 10081, the aggregate unpaid principal amount of the Money Market Loans made by the Bank to the Company under the Credit Agreement, in lawful money of the United States of America and in immediately available funds, on the dates and in the principal amounts provided in the Credit Agreement, and to pay interest on the unpaid principal amount of each such Money Market Loan, at such office, in like money and funds, for the period commencing on the date of such Money Market Loan until such Money Market Loan shall be paid in full, at the rates per annum and on the dates provided in the Credit Agreement. The date, amount, interest rate and maturity date of each Money Market Loan made by the Bank to the Company, and each payment made on account of the principal thereof, shall be recorded by the Bank on its books and, prior to any transfer of this Note, endorsed by the Bank on the schedule attached hereto or any continuation thereof. The failure of the Bank to make any notation or entry or any error in such a notation or entry shall not, however, limit or otherwise affect any obligation of the Company under the Credit Agreement or this Note. This Note is one of the Notes referred to in the Credit Agreement (as modified and supplemented and in effect from time to time, the "Credit Agreement") dated as of January 20, 1999, among the Company, the banks named therein and The Chase Manhattan Bank, as Administrative Agent, Bank of America National Trust and Savings Association, as Syndication Agent, and SunTrust Bank, Atlanta, as Documentation Agent, and evidences Money Market Loans made by the Bank thereunder. Capitalized terms used in this Note have the respective meanings assigned to them in the Credit Agreement. The Credit Agreement provides for the acceleration of the maturity of this Note upon the occurrence of certain events and for prepayments of Loans upon the terms and conditions specified therein. 66 2 This Note shall be governed by, and construed in accordance with, the law of the State of New York. SONAT INC. By ---------------------------------- Title: 67 SCHEDULE OF LOANS This Note evidences Loans made under the within-described Credit Agreement to the Company, on the dates, in the principal amounts, bearing interest at the rates and maturing on the dates set forth below, subject to the payments and prepayments of principal set forth below:
Principal Date Amount Maturity Amount Unpaid of of Interest Date of Paid or Principal Notation Loan Loan Rate Loan Prepaid Amount Made by ---- --------- -------- -------- ------- --------- --------
68 EXHIBIT A-3 [Form of Note for Swingline Loans] PROMISSORY NOTE $ , 19 -------------------------- ----------- --- New York, New York FOR VALUE RECEIVED, SONAT INC., a Delaware corporation (the "Company"), hereby promises to pay to SUNTRUST BANK, ATLANTA (the "Bank"), for account of its respective Applicable Lending Offices provided for by the Credit Agreement referred to below, at the principal office of The Chase Manhattan Bank at 1 Chase Manhattan Plaza, New York, New York 10081, the principal sum of Dollars (or such lesser amount as shall equal the aggregate unpaid principal amount of the Swingline Loans made by the Bank to the Company under the Credit Agreement), in lawful money of the United States of America and in immediately available funds, on the dates and in the principal amounts provided in the Credit Agreement, and to pay interest on the unpaid principal amount of each such Swingline Loan, at such office, in like money and funds, for the period commencing on the date of such Swingline Loan until such Swingline Loan shall be paid in full, at the rates per annum and on the dates provided in the Credit Agreement. The date, amount, type, interest rate and maturity date of each Swingline Loan made by the Bank to the Company, and each payment made on account of the principal thereof, shall be recorded by the Bank on its books and, prior to any transfer of this Note, endorsed by the Bank on the schedule attached hereto or any continuation thereof. The failure of the Bank to make any notation or entry or any error in such a notation or entry shall not, however, limit or otherwise affect any obligation of the Company under the Credit Agreement or this Note. This Note is one of the Notes referred to in the Credit Agreement (as modified and supplemented and in effect from time to time, the "Credit Agreement") dated as of January 20, 1999, among the Company, the banks named therein and The Chase Manhattan Bank, as Administrative Agent, Bank of America National Trust and Savings Association, as Syndication Agent, and SunTrust Bank, Atlanta, as Documentation Agent, and evidences Swingline Loans made by the Bank thereunder. Capitalized terms used in this Note have the respective meanings assigned to them in the Credit Agreement. The Credit Agreement provides for the acceleration of the maturity of this Note upon the occurrence of certain events and for prepayments of Loans upon the terms and conditions specified therein. 69 2 This Note shall be governed by, and construed in accordance with, the law of the State of New York. SONAT INC. By ---------------------------------- Title: 70 SCHEDULE OF LOANS This Note evidences Loans made under the within-described Credit Agreement to the Company, on the dates, in the principal amounts, of the types, bearing interest at the rates and maturing on the dates set forth below, subject to the payments and prepayments of principal set forth below:
Principal Date Amount Type Maturity Amount Unpaid of of of Interest Date of Paid or Principal Notation Loan Loan Loan Rate Loan Prepaid Amount Made by ---- --------- ---- -------- -------- ------- -------- --------
71 EXHIBIT B [Form of Opinion of Special Counsel to the Company] January , 1999 --- To the Banks party to the Agreement referred to below and The Chase Manhattan Bank, as Administrative Agent, Bank of America National Trust and Savings Association, as Syndication Agent and SunTrust Bank, Atlanta, as Documentation Agent Dear Sirs: We have acted as special counsel for Sonat Inc., a Delaware corporation (the "Company"), in connection with the execution and delivery of the Credit Agreement (the "Agreement") dated as of January 20, 1999, among the Company, the Banks named therein and The Chase Manhattan Bank, as Administrative Agent, Bank of America National Trust and Savings Association, as Syndication Agent and SunTrust Bank, Atlanta, as Documentation Agent. This opinion is delivered to you pursuant to ss.4.01(v) of the Agreement. All capitalized terms not otherwise defined herein shall have the meanings attributed to them in the Agreement. In this connection, and as a basis for the opinions expressed below, we have examined or relied upon originals or copies, certified or otherwise identified to our satisfaction, of such records, instruments, certificates and other documents, have made such inquiries as to questions of fact of officers and representatives of the Company and have made such examinations of law as we have deemed necessary or appropriate for purposes of giving the opinions hereinafter expressed. As to certain matters in respect of the opinions expressed in paragraphs 1 and 2 below, we have relied, with your permission, solely on the opinion, a copy of which is attached hereto, of William A. Smith, Executive Vice President and General Counsel. In rendering the opinions expressed below, we have assumed that the Agreement has been duly authorized, executed and delivered by each party thereto other than the Company, that each party thereto other than the Company has the requisite power and authority to execute, deliver and perform the Agreement, and that such execution, delivery and performance by such other parties does not and will not breach, conflict with or constitute a violation of the laws or governmental rules or regulations of any jurisdiction. Each of the opinions expressed below is restricted to matters controlled or affected by Federal laws, the General Corporation Law of the State of Delaware and the laws of the State of New York. 72 2 On the basis of the foregoing, it is our opinion that: 1. The Company is a corporation duly incorporated, validly existing and in good standing under the laws of the State of Delaware and is duly licensed or qualified to do business and is in good standing in the States of Alabama, Texas and New York, constituting those states which we have been advised are the states in which the Company believes the conduct of its business or the ownership of its assets requires such qualification, and the Company has the corporate power to make the Agreement and the Notes and to borrow under the Agreement. 2. The making and performance by the Company of the Agreement and the Notes and borrowings under the Agreement have been duly authorized by all necessary corporate action and do not and will not contravene any provision of law applicable to the Company or of the certificate of incorporation or by-laws of the Company or result in the material breach of, or constitute a material default or require any consent under, or result in the creation of any material lien, charge or other security interest or encumbrance (except as may be required by the Agreement) upon any property or assets of the Company pursuant to, any indenture or other agreement or instrument to which the Company is a party or by which the Company or any of its property may be bound or affected. 3. No approval, license or consent of any governmental regulatory body is requisite to the making and performance by the Company of the Agreement or the execution, delivery and payment of the Notes. 4. The Agreement and the Notes have been duly executed and delivered by the Company and each constitutes a valid and binding agreement of the Company enforceable in accordance with its terms (subject to applicable bankruptcy, fraudulent conveyance, fraudulent transfer, preferential transfer, insolvency, moratorium and other like laws of general application affecting creditors' rights and to the application of general principles of equity, including without limitation concepts of materiality, reasonableness, good faith and fair dealing and whether considered in a proceeding in equity or at law), except that we express no opinion as to ss.2.06(c) of the Agreement. In connection with the above, we wish to point out that provisions of the Agreement which permit any Agent or any Bank to take action or make determinations or allocations, or to benefit from indemnities and similar undertakings of the Company, may be subject to a requirement that such action be taken or such determinations or allocations be made, and that any action or inaction by an Agent or a Bank which may give rise to a request for payment under such an indemnity or similar undertaking be taken or not taken, on a reasonable basis and in good faith. 73 3 We express no opinion with respect to: (A) the effect of any provision of the Agreement which is intended to permit modification thereof only by means of an agreement in writing by the parties thereto; (B) the effect of any provision of the Agreement imposing penalties or forfeitures; (C) the enforceability of any provision of the Agreement to the extent that such provision constitutes a waiver of illegality as a defense to performance of contract obligations; and (D) the effect of any provision of the Agreement relating to indemnification or exculpation in connection with violations of any securities laws or relating to indemnification, contribution or exculpation in connection with willful, reckless or criminal acts or gross negligence of the indemnified or exculpated Person or the Person receiving contribution. Very truly yours, 74 (ATTACHMENT TO EXHIBIT B) [Form of Opinion of General Counsel] January , 1999 --- Hughes Hubbard & Reed LLP One Battery Park Plaza New York, New York 10004 Dear Sirs: As Executive Vice President and General Counsel of Sonat Inc., a Delaware corporation (the "Company"), I am familiar with the Credit Agreement (the "Agreement") dated as of January 20, 1999, among the Company, the Banks named therein and The Chase Manhattan Bank, as Administrative Agent, Bank of America National Trust and Savings Association, as Syndication Agent and SunTrust Bank, Atlanta, as Documentation Agent. This opinion is delivered to you in connection with the opinion which you are rendering pursuant to ss.4.01(v) of the Agreement. You may rely on this opinion in rendering your opinion, you may attach a copy hereof to your opinion and the Banks may rely on this opinion as if it were addressed to them. All capitalized terms not otherwise defined herein shall have the meaning attributed to them in the Agreement. In this connection, and as a basis for the opinions expressed below, I have examined or relied upon originals or copies certified or otherwise identified to my satisfaction, of such records, instruments, certificates and other documents, have made inquiries as to questions of fact of officers and representatives of the Company and have made such examinations of law as I have deemed necessary or appropriate for purposes of giving the opinions hereinafter expressed. On the basis of the foregoing, it is my opinion that: 1. The Company is duly licensed or qualified to do business and is in good standing in the States of Alabama, Texas and New York, constituting those states in which the Company believes the conduct of its business or the ownership of its assets requires such qualification. 2. The making and performance by the Company of the Agreement and the Notes and borrowings under the Agreement do not and will not contravene any provision of law of the State of Alabama or the United States applicable to the Company by virtue of the nature of its or any of its Subsidiaries' businesses or of the properties owned or leased by any of them or result in the material breach of, or constitute a material default or require any consent under, or result in the creation of any material lien, charge or other security interest or encumbrance upon any property or assets of the Company pursuant to, any indenture or other agreement or instrument to which the Company is a party or by which the Company or any of its property may be bound or affected. 75 2 3. The Company is not an "investment company" or a company "controlled" by an "investment company", within the meaning of the Investment Company Act of 1940, as amended. 4. Neither the Company nor any of its Subsidiaries is subject to regulation under the Public Utility Holding Company Act of 1935, as amended. Very truly yours, 76 EXHIBIT C [Form of Opinion of Special Counsel to the Banks and the Agents] January , 1999 --- To the Banks currently party to the Credit Agreement referred to below and listed on Schedule 1 attached hereto; The Chase Manhattan Bank, as Administrative Agent, Bank of America National Trust and Savings Association, as Syndication Agent and SunTrust Bank, Atlanta, as Documentation Agent Gentlemen: We have acted as your special counsel in connection with the Credit Agreement (the "Credit Agreement") dated as of January 20, 1999, among Sonat Inc. (the "Company"), the Banks named therein and The Chase Manhattan Bank, as Administrative Agent, Bank of America National Trust and Savings Association, as Syndication Agent and SunTrust Bank, Atlanta, as Documentation Agent. Terms defined in the Credit Agreement are used herein as defined therein. We have assumed for purposes of our opinion hereinafter set forth that (1) the Credit Agreement is a valid and legally binding obligation of each of the Banks and that the Credit Agreement has been duly authorized, executed and delivered by the Company, each Bank and each Agent, (2) the Company is duly incorporated and validly existing under the laws of the State of Delaware and has full power, authority and legal right to make and perform the Credit Agreement and the Notes and that such execution, delivery and performance by the Company does not contravene its certificate of incorporation or by-laws or violate, or require any consent not obtained under, any applicable law or regulation or any order, writ, injunction or decree of any court or other governmental authority and does not violate, or require any consent not obtained under, any contractual obligation applicable to or binding upon the Company and (3) the Company is not an "investment company" within the meaning of and subject to regulation under the Investment Company Act of 1940. We have examined (i) a copy of the Credit Agreement signed by the Company, each Bank and each Agent, (ii) a copy of the Notes delivered on the date hereof and (iii) a copy of the opinion letter of Hughes Hubbard & Reed LLP, counsel for the Company, addressed to you and dated the date hereof in respect of the Credit Agreement together with the opinion of the Executive Vice President and General Counsel of the Company, attached thereto. We have assumed the genuineness of all signatures, the authenticity of documents submitted to us as originals, the conformity with the originals of all documents submitted to us as certified or photostatic copies, and the authenticity of the originals of such latter documents. 77 2 Based upon the foregoing and subject to the comments and qualifications set forth below, we are of the opinion that the Credit Agreement constitutes, and the Notes when executed and delivered for value (assuming due execution and delivery by the Company) will constitute, valid and binding obligations of the Company enforceable in accordance with their respective terms, except as the foregoing may be limited by bankruptcy, insolvency, fraudulent conveyance, reorganization, moratorium or other similar laws relating to or affecting creditors' rights generally, general equitable principles (whether considered in a proceeding in equity or at law) and an implied covenant of good faith and fair dealing, and except that we express no opinion as to ss.2.06(c) of the Credit Agreement. We express no opinion in respect to: (A) the effect of any provision of the Credit Agreement which is intended to permit modification thereof only by means of an agreement in writing by the parties thereto; (B) the effect of any provisions of the Credit Agreement imposing penalties or forfeitures; (C) the enforceability of any provision of the Credit Agreement to the extent that such provision constitutes a waiver of illegality as a defense to performance of contract obligations; and (D) the effect of any provision of the Credit Agreement relating to indemnification or exculpation in connection with violations of any securities laws or relating to indemnification, contribution or exculpation in connection with willful, reckless or criminal acts or gross negligence of the indemnified or exculpated Person or the Person receiving contribution. We are members of the Bar of the State of New York and do not herein intend to express any opinion as to any matters governed by any laws other than the law of the State of New York and the Federal law of the United States of America. This opinion is rendered to you in connection with the above described transactions. This opinion may not be relied upon by you for any other purpose, or relied upon by, or furnished to, any other person, firm or corporation without our prior written consent. Very truly yours, 78 EXHIBIT D [Form of Money Market Quote Request] [Date] To: [Bank] From: Sonat Inc. Re: Money Market Quote Request Pursuant to ss.1.02 of the Credit Agreement (the "Credit Agreement") dated as of January 20, 1999, among Sonat Inc., the banks named therein and The Chase Manhattan Bank, as Administrative Agent, Bank of America National Trust and Savings Association, as Syndication Agent and SunTrust Bank, Atlanta, as Documentation Agent, we hereby give notice that we request Money Market Quotes for the following proposed Money Market Borrowing(s):
Borrowing Quotation Interest Date Date [1] Amount [2] Period [3] ---- -------- ---------- ----------
Money Market Quotes responding to this Money Market Quote Request must be submitted to us not later than [time and date] [4]. Terms used herein have the meanings assigned to them in the Credit Agreement. SONAT INC. By ------------------------ Title: - -------------------- [1] For use if a Money Market Rate in a Set Rate Auction is requested to be submitted before the Borrowing Date. [2] Each amount must be $25,000,000 or a larger multiple of $5,000,000. [3] A period of up to 180 days after the making of such Set Rate Loan and ending on a Business Day. [4] Insert time and date determined pursuant to ss.1.02(c)(i). 79 THIS PAGE IS A SIGNATURE PAGE TO THE CREDIT AGREEMENT DATED AS OF JANUARY 20, 1999 AMONG SONAT INC., THE BANKS NAMED HEREIN, THE CHASE MANHATTAN BANK, AS ADMINISTRATIVE AGENT, BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, AS SYNDICATION AGENT AND SUNTRUST BANK, ATLANTA, AS DOCUMENTATION AGENT. [Form of Money Market Quote] To: Sonat Inc. Attention: Re: Money Market Quote to Sonat Inc. (the "Borrower") This Money Market Quote is given in accordance with ss.1.02(c) of the Credit Agreement (the "Credit Agreement") dated as of January 20, 1999, among the Borrower, the banks named therein and The Chase Manhattan Bank, as Administrative Agent, Bank of America National Trust and Savings Association, as Syndication Agent and SunTrust Bank, Atlanta, as Documentation Agent. Terms defined in the Credit Agreement are used herein as defined therein. In response to the Borrower's invitation dated ____________, 19__, we hereby make the following Money Market Quote(s) on the following terms: 1. Quoting Bank: 2. Person to contact at Quoting Bank: 3. We hereby offer to make Money Market Loan(s) in the following principal amount[s], for the following Interest Period(s) and at the following rate(s):
Borrowing Quotation Interest Date Date [1] Amount [2] Period [3] Rate [4] ---- -------- ---------- ---------- --------
We understand and agree that the offer(s) set forth above, subject to the satisfaction of the applicable conditions set forth in the Credit Agreement, irrevocably obligate[s] us to make the Money Market Loan(s) for which any offer(s) (is/are) accepted, in whole or in part (subject to the third sentence of ss.1.02(d) of the Credit Agreement). Very truly yours, [Name of Bank] By ------------------------------ Authorized Officer 2 80 3 THIS PAGE IS A SIGNATURE PAGE TO THE CREDIT AGREEMENT DATED AS OF JANUARY 20, 1999 AMONG SONAT INC., THE BANKS NAMED HEREIN, THE CHASE MANHATTAN BANK, AS ADMINISTRATIVE AGENT, BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, AS SYNDICATION AGENT AND SUNTRUST BANK, ATLANTA, AS DOCUMENTATION AGENT. Dated: , --------------- - -------------------------- [1] As specified in the related Money Market Quote Request. [2] The principal amount bid for each Interest Period may not exceed the principal amount requested. Bids must be made for at least $5,000,000 or a larger multiple of $1,000,000. [3] A period of up to 180 days after the making of such Set Rate Loan and ending on a Business Day, as specified in the related Money Market Quote Request. [4] Specify rate of interest per annum (rounded to the nearest 1/10,000 of 1%). 3 EX-10.1 3 SUPPLEMENTAL BENEFIT PLAN OF SONAT INC. 1 EXHIBIT 10.1 SONAT INC. SUPPLEMENTAL BENEFIT PLAN (AS AMENDED AND RESTATED EFFECTIVE JANUARY 1, 1997) ARTICLE I - PURPOSE AND HISTORY 1.1 PURPOSE This Supplemental Benefit Plan, as amended and restated herein (the "Plan"), is adopted by Sonat Inc. (the "Company") on its own behalf and on behalf of its subsidiaries and affiliates (the "Employers") which are participating companies in the Sonat Inc. Retirement Plan (the "Retirement Plan") and/or the Sonat Savings Plan (formerly the Sonat Inc. Stock Purchase Plan) (the "Savings Plan"). The purposes of this Plan are: (i) To provide benefits ("Excess Retirement Plan Benefits") in excess of the limitations imposed by Sections 401(a)(9), 401(a)(17), 415, and/or the incidental benefit requirements of the Internal Revenue Code of 1986, as amended (the "Code"), on the Retirement Plan. (ii) To provide benefits ("Vesting Benefits") to certain employees whose rights to Vested Benefits have not vested under Article 5 of the Retirement Plan in the event that their employment is terminated after a Change of Control (as defined in Section 4.3 below). (iii) To provide benefits ("Excess Savings Plan Benefits") to employees whose ability to make employee contributions or to receive employer contributions to the Savings Plan is limited by Sections 401(a)(17), 401(m), and/or 415 of the Code. 2 1.2 HISTORY OF THE PLAN The Plan was adopted on July 28, 1983, as an amendment and restatement of the Company's Supplemental Pension Plan, which was adopted effective January 1, 1976. The Plan was amended and restated as of January 1, 1985 in order to (1) provide certain "Excess Disability Benefits", (2) conform the references in the Plan to the provisions of the Retirement Plan and the Sonat Inc. Stock Purchase Plan as in effect on the date thereof, and (3) clarify the meaning and intent of the Plan. The Plan was amended and restated as of January 1, 1987 in order to (1) provide that Excess Retirement Plan Benefits and Excess Savings Plan Benefits include benefits in excess of the limitations imposed by Section 401(a)(17) of the Code (as well as Section 415 of the Code) on the Retirement Plan and Savings Plan, (2) provide as Excess Savings Plan Benefits matching contributions on amounts an employee is unable to contribute to the Savings Plan by reason of the limitations imposed by Sections 401(a)(17), 401(m), and/or 415 of the Code, (3) modify the time of commencement and form in which Excess Retirement Plan Benefits, Excess Savings Plan Benefits and Vesting Benefits are paid, (4) provide for the accelerated distribution of Excess Savings Plan Benefits in the event of a Participant's Termination of Employment following a Change of Control (as defined herein) and (5) transfer the provisions and obligations relating to Excess Disability Benefits from this Plan to the Sonat Inc. Supplemental Disability Plan (the "Supplemental Disability Plan"). The Plan was amended effective as of September 6, 1989 to reflect an amendment to the Retirement Plan permitting participants to elect that benefits payable to a child be instead payable to a trust for the benefit of such child. The Plan was amended and restated as of December 1, 1991 in order to further modify the time of commencement and form in which Excess Retirement Plan Benefits, Excess Savings Plan Benefits and Vesting Benefits are paid. -2- 3 The Plan was amended and restated effective as of February 25, 1993 in order to provide flexibility to participants as to the time of commencement and form in which Excess Retirement Plan Benefits and Excess Savings Plan Benefits are paid. The Plan was amended effective as of July 1, 1993 to clarify the provisions applicable to employees of Sonat Offshore Drilling Inc. ("SODI") and its subsidiaries whose benefits under the Retirement Plan and the Savings Plan were transferred to plans established by SODI following the initial public offering of SODI common stock ("SODI Employees"). The Plan was amended effective as of April 28, 1994 to change the interest rate used for purposes of the definition of Actuarial Equivalent. The Plan was amended effective January 1, 1995 in order to (1) provide that amounts credited as Excess Savings Plan Benefits will be deemed invested in phantom shares of common stock of the Company and/or phantom shares of certain mutual funds, and (2) permit the payment of Excess Retirement Plan Benefits to a trust for the benefit of one or more children of the participant. The Plan was amended effective as of December 1, 1995 to change the definition of a "Change of Control." The Plan is amended and restated as of the date hereof to (1) provide that Excess Savings Plan Benefits will be credited as phantom units of the Sonat Stock Fund established under the Company's Savings Plan, as well as phantom shares of certain mutual fund investments chosen by the Company, (2) permit daily transfers among the phantom funds in which a Participant's Diversifiable Account (as defined in Article III) is deemed invested, and (3) permit transfers out of the Phantom Stock Subaccount (as defined in Article III) of a Participant's Diversifiable Account. -3- 4 ARTICLE II - EXCESS RETIREMENT PLAN BENEFITS 2.1 ELIGIBILITY Each employee whose Retirement Benefit or Vested Benefit from the Retirement Plan is limited by Code Sections 401(a)(17) and/or 415 and the incorporation of those limitations in the Retirement Plan or whose Survivors Benefits under the Retirement Plan are limited by Code Section 401(a)(9) or the incidental benefit requirements of the Code and the incorporation of such limitations in the Retirement Plan (a "Participant") shall be entitled to Excess Retirement Plan Benefits under this Plan, regardless of whether such Participant has received notice that he or she is so entitled. All capitalized terms used in this Article II and not defined in this Plan shall have the meanings ascribed thereto in the Retirement Plan. 2.2 DETERMINATION OF APPLICABLE FORM OF BENEFIT If a Participant's date of Termination of Continuous Employment occurred prior to December 1, 1991, such Participant's Excess Retirement Plan Benefits shall be paid in annuity form as provided in Section 2.4 below ("Annuity Form"). If a Participant's date of Termination of Continuous Employment occurred on or after December 1, 1991, such Participant's Excess Retirement Plan Benefits shall be paid in lump sum form as provided in Section 2.3 below ("Lump Sum Form") unless, at least twelve months before the date of the Participant's Termination of Continuous Employment, the Participant filed with the Company an irrevocable written election to have such benefits paid in Annuity Form, in which case such benefits shall be paid in Annuity Form. Notwithstanding any other provision of the Plan, a Participant's election with respect to the portion of his or her Excess Retirement Plan Benefit attributable to his or her retirement benefit shall determine the Form in which the portion of such benefit attributable to any related survivor benefit is paid. -4- 5 2.3 LUMP SUM FORM The following provisions of this Section 2.3 apply to Excess Retirement Plan Benefits which are paid in Lump Sum Form. (A) BENEFIT UPON TERMINATION OF CONTINUOUS EMPLOYMENT. Upon the Termination of Continuous Employment (other than death) of a Participant who is entitled to a Retirement Benefit or a Vested Benefit and whose Excess Retirement Plan Benefits are payable in Lump Sum Form, such Participant shall be entitled to an Excess Retirement Plan Benefit, payable in the form of a cash lump sum, that is equal to the sum of: (1) the "Actuarial Equivalent" (as defined in Section 2.3(d) below) of the excess, if any, of (i) the amount that hypothetically would have been payable to the Participant as a Retirement Benefit or a Vested Benefit, as the case may be, under the Retirement Plan if Sections 401(a)(17) and 415 of the Code were nonexistent and the provisions of the Retirement Plan incorporating the limitations contained in Sections 401(a)(17) and 415 of the Code were inoperative, over (ii) the amount which hypothetically would have been payable to the Participant as a Retirement Benefit or Vested Benefit, as the case may be, under the Retirement Plan upon application of the actual terms of the Retirement Plan, assuming that for purposes of clauses (i) and (ii) the Participant elected to receive such Benefit in the form of a single life annuity commencing on the earliest date on which the Participant may commence receipt of his Retirement Benefit or Vested Benefit, as the case may be, under the terms of the Retirement Plan; plus (2) if the Participant is entitled to a Retirement Benefit and has an Eligible Spouse (as defined in Section 2.3(e) below) on the date of such Termination of Continuous Employment, the Actuarial Equivalent of the excess, if any, of (i) the amount that hypothetically would have been payable to the Eligible Spouse as a Survivors Benefit under the Retirement Plan upon the death of the -5- 6 Participant if Sections 401(a)(17) and 415 of the Code were nonexistent and Section 7.10 and the provisions of the Retirement Plan incorporating the limitations contained in Sections 401(a)(17) and 415 of the Code were inoperative, over (ii) the amount which hypothetically would have been payable to the Eligible Spouse as a Survivors Benefit under the Retirement Plan upon application of the actual terms of the Retirement Plan, with such excess to be valued as a reversionary annuity, payable immediately upon the death of the Participant, using the interest rate and mortality table set forth in Section 2.3(d). Such cash lump-sum payment shall be paid as soon as practicable (and within 30 days) after the Participant's Termination of Continuous Employment. (B) CERTAIN SURVIVOR BENEFITS. Upon the death of a Participant whose Excess Retirement Plan Benefits are payable in Lump Sum Form, either (1) after the Participant's Termination of Continuous Employment (if such Participant was entitled to a Retirement Benefit and did not have an Eligible Spouse at the date of such Termination of Continuous Employment), or (2) prior to the Participant's Termination of Continuous Employment, his or her Eligible Spouse (or, if the Participant has no Eligible Spouse at the date of death, each of the Participant's Eligible Children) shall be entitled to an Excess Retirement Plan Benefit, payable in the form of a cash lump sum, that is equal to the Actuarial Equivalent of the excess, if any, of (i) the amount that hypothetically would have been payable to the Eligible Spouse or such Eligible Child (as the case may be) as a Survivors Benefit under the Retirement Plan upon the death of the Participant if Sections 401(a)(17) and 415 of the Code were nonexistent and Section 7.10 and the provisions of the Retirement Plan incorporating the limitations contained in Section 401(a)(17) and 415 of the Code were inoperative, over (ii) the amount actually payable to the Eligible Spouse or such Eligible Child (as the case may be) as a Survivors Benefit under the Retirement Plan upon application of the actual terms of the -6- 7 Retirement Plan. Such lump-sum payment shall be paid as soon as practicable (and within 30 days) after the Participant's death. (C) ADDITIONAL SURVIVORS BENEFITS TO ELIGIBLE CHILDREN. If the Participant's Eligible Spouse dies after the date of death of the Participant, the Participant's Eligible Children shall each be entitled to an Excess Retirement Plan Benefit, payable in the form of a cash lump sum, that is equal to the Actuarial Equivalent of the excess, if any, of (i) the amount that hypothetically would have been payable to such Eligible Child as a Survivors Benefit under the Retirement Plan if Sections 401(a)(17) and 415 of the Code were nonexistent and Section 7.10 and the provisions of the Retirement Plan incorporating the limitations contained in Section 401(a)(17) and 415 of the Code were inoperative, over (ii) the amount actually payable to such Eligible Child as a Survivors Benefit under the Retirement Plan. Such cash lump-sum payment shall be paid as soon as practicable (and within 30 days) after the Eligible Spouse's death. (D) DEFINITION OF ACTUARIAL EQUIVALENT. For purposes of Section 2.3 and Section 4.2, "Actuarial Equivalent" shall mean a benefit actuarially equal in value to the value of a given benefit in a given form or schedule, based upon (1) the 1983 Group Annuity Mortality Table (or, if different, the mortality table or tables used to calculate Actuarial Equivalents under the Retirement Plan as of the date on which an Actuarial Equivalent is being determined under this Plan) and (2) an interest rate equal to the yield on new 7-12 year AA-rated general obligation tax-exempt bonds as determined by Merrill Lynch & Co. (or its affiliates) and published in The Wall Street Journal (or other financial publication) on the business day immediately preceding the date of the Participant's Termination of Continuous Employment (for calculation of Actuarial Equivalents under Sections 2.3(a) and 4.2 of this Plan), the date of the Participant's death (for calculation of Actuarial Equivalents under Section 2.3(b) of this Plan), or the date of the Participant's Eligible Spouse's death (for calculation of Actuarial Equivalents under Section 2.3(c) of this Plan) (or, if such yield is not so determined and published on such business day, on the most immediately preceding day on which such yield was so determined and published); provided, however, that if such yield has not been so -7- 8 determined and published within 90 days prior to the date of the Participant's Termination of Continuous Employment or death or the date of the Participant's Eligible Spouse's death (as the case may be), the interest rate shall be the yield on substantially similar securities on the business day preceding the applicable date as determined by AmSouth Bank N.A. upon the request of either the Company or the Participant, Eligible Spouse or Eligible Child (as the case may be). Notwithstanding the preceding provisions of this Section 2.3(d), if the only Survivors Benefit to which an Eligible Spouse is entitled under the Retirement Plan is an ERISA Preretirement Survivor Annuity, determination of Actuarial Equivalent under Section 2.3(b) shall be based upon the assumption that payment of the amounts described in clauses (i) and (ii) of Section 2.3(b) commence on the first day of the month immediately following the later of the date on which the Participant would have attained age 55 or the Participant's date of death. (E) DEFINITION OF ELIGIBLE SPOUSE. For purposes of Section 2.3, "Eligible Spouse" shall mean the person who was married to the Participant under the laws of the State where the marriage was contracted throughout the one year period ending on the earlier of the date on which the Participant has a Termination of Continuous Employment or the date of the Participant's death. If the Participant does not have an Eligible Spouse on the date of Termination of Continuous Employment, the person who was married to the Participant under the laws of the State where the marriage was contracted throughout the one year period ending on the date of the Participant's death shall be the Participant's Eligible Spouse. In no event may a Participant have more than one Eligible Spouse under this Plan. 2.4 ANNUITY FORM The following provisions of this Section 2.4 apply to Excess Retirement Plan Benefits which are paid in Annuity Form. (A) RETIREMENT ANNUITY. Each Participant who is entitled to a Retirement Benefit or a Vested Benefit and whose Excess Retirement Plan Benefits are payable in -8- 9 Annuity Form shall be entitled to Excess Retirement Plan Benefits equal to the excess, if any, of (i) the amount that hypothetically would have been payable to the Participant as a Retirement Benefit or a Vested Benefit, as the case may be, under the Retirement Plan (after any increases in Retirement Benefits or Vested Benefits payable generally under the Company's retirement program which take effect after the Participant's Termination of Continuous Employment) if Sections 401(a)(17) and 415 of the Code were nonexistent and the provisions of the Retirement Plan incorporating the limitations contained in Sections 401(a)(17) and 415 of the Code were inoperative, over (ii) the amount which hypothetically would have been payable to the Participant as a Retirement Benefit or Vested Benefit, as the case may be, under the Retirement Plan upon application of the actual terms of the Retirement Plan, assuming that for purposes of clauses (i) and (ii) the Participant elected to receive such Benefit in the form of a single life annuity commencing on the date on which the Participant actually commences receipt of his Retirement Benefit or Vested Benefit, as the case may be, under the Retirement Plan. Excess Retirement Plan Benefits shall be paid commencing at the time and in the form provided below: (i) If the Participant is entitled to a Retirement Benefit under the Retirement Plan, the Participant's Excess Retirement Plan Benefit shall be payable to the Participant in the form of a single life annuity, in monthly installments commencing (A) on the Participant's early or normal retirement date, as the case may be, under the Retirement Plan; or (B) in the case of a Participant entitled to a Projected Retirement Benefit, upon his or her Termination of Continuous Employment. (ii) If the Participant is entitled to a Vested Benefit under the Retirement Plan, the amount of the Participant's Excess Retirement Plan Benefit shall be calculated using the Retirement Plan's early benefit commencement factors (which are incorporated in the Retirement Plan's definition of Actuarial Equivalent) and the Section 415 limits which apply for the benefit -9- 10 commencement date elected by the Participant under the Retirement Plan. However, payment of such Excess Retirement Plan Benefit shall not commence until the first day of the month following the Participant's attainment of normal retirement age. Such Benefit shall be payable (1) to the Participant in the form of a single life annuity if the Participant does not have a Spouse at the time the Excess Retirement Plan Benefit commences, and (2) to the Participant and his or her Spouse in the form of a 50% joint and survivor annuity if the Participant has a Spouse at the time the Excess Retirement Plan Benefit commences. (iii) If payment of the Participant's Vested Benefit under the Retirement Plan commences prior to the first day of the month following the Participant's attainment of normal retirement age, the Company shall create and maintain on its books an account for such Participant (the "Vested Benefits Account") to which the Company shall credit the following amounts. At the beginning of each month beginning with the first month for which the Participant receives a Vested Benefit under the Retirement Plan and ending with the month in which the Participant attains normal retirement age, the Company shall credit the Vested Benefits Account with an amount equal to the amount of the Excess Retirement Plan Benefit calculated under Section 2.4(a)(ii) above. At the end of each calendar quarter beginning with the first calendar quarter in which an amount is credited pursuant to the preceding sentence and ending with the calendar quarter referred to in the following sentence, the Company shall also credit to such Vested Benefits Account a sum which is equal to the product of (i) the average balance in such Account for the calendar quarter (without regard to any debits made at the end of the calendar quarter) times (ii) one-fourth of the annual prime rate for corporate borrowers quoted by The Chase Manhattan Bank, N.A. at the beginning of the calendar quarter. At the end of the calendar quarter in which -10- 11 occurs the earlier of the Participant's attainment of normal retirement age or the Participant's death, the Company shall debit the Participant's Vested Benefits Account and pay to such Participant (or in the event of the Participant's death, to his or her Beneficiary) the entire balance in such Account. (B) SURVIVOR ANNUITY. Each Eligible Family Member of a Participant under the Retirement Plan shall be entitled to Excess Retirement Plan Benefits equal to the excess, if any, of (i) the amount that hypothetically would have been payable to the Eligible Family Member as a Survivors Benefit under the Retirement Plan (after any increases in Survivors Benefits payable generally under the Company's retirement program which take effect after the Participant's death) if Sections 401(a)(17) and 415 of the Code were nonexistent and Section 7.10 and the provisions of the Retirement Plan incorporating the limitations contained in Section 401(a)(17) and 415 of the Code were inoperative, over (ii) the amount actually payable to the Eligible Family Member as a Survivors Benefit under the Retirement Plan. Excess Retirement Plan Benefits shall be paid to the Eligible Family Members, commencing on the first day of the month following the death of the Participant, as follows: (i) If the Participant's Eligible Family Members include an Eligible Spouse (which term, for purposes of this Section 2.4, shall have the meaning set forth in the Retirement Plan), the Excess Retirement Plan Benefits for such Eligible Family Members shall be payable to such Eligible Spouse until such person dies or is no longer an Eligible Spouse. (ii) If Excess Retirement Plan Benefits cease to be payable to an Eligible Spouse, or in the event there is no Eligible Spouse at the date of the Participant's death, the Excess Retirement Plan Benefits otherwise payable to such Eligible Spouse shall be payable to an Eligible Child, until the earlier of the death of such Eligible Child or the date on which he or she ceases to be an Eligible Child, with such Benefits to be divided -11- 12 equally among the Eligible Children in the event that there is more than one Eligible Child. In the event there is more than one Eligible Child and Excess Retirement Plan Benefits cease with respect to one Eligible Child, each subsequent payment of Excess Retirement Plan Benefits will be divided equally among the remaining Eligible Children. Notwithstanding the preceding provisions of this Section 2.4(b), if the only Survivor's Benefit to which the Eligible Family Member is entitled under the Retirement Plan is an ERISA Preretirement Survivor Annuity, (i) payment of the Excess Retirement Plan Benefits shall commence on the first day of the month immediately following the later of the date on which the Participant would have attained age 55 or the Participant's date of death, and (ii) the Excess Retirement Plan Benefits shall cease to be payable upon the death of the Eligible Spouse. 2.5 DEFINITION OF ELIGIBLE CHILD For purposes of Section 2.3 and 2.4, the term "Eligible Child" shall mean the deceased Participant's Eligible Child (as defined in the Retirement Plan). However, if the Participant has so elected under the Retirement Plan, payments which otherwise would be made to an Eligible Child shall be made to an Eligible Trust (as defined in the Retirement Plan). Notwithstanding the Participant's election to have payments made to a trust, if the Administrative Committee of the Retirement Plan determines that the trust is not an Eligible Trust at the time payment to such trust is to be made, such payment shall not be made to the trust and shall instead be made directly to the Participant's Eligible Child. 2.6 PROVISIONS REGARDING SODI EMPLOYEES (a) For purposes of Article II, all references to the Retirement Plan as it relates to SODI Employees (as defined in Section 1.2) shall be deemed to refer to such plan as in effect on June 30, 1993. In no event shall SODI Employees accrue benefits under Article II of this Plan after June 30, 1993 (unless rehired by the Company). -12- 13 (b) For purposes of determining the timing of benefit payments under this Plan, SODI Employees shall not be deemed to have incurred a Termination of Continuous Employment by virtue of the initial public offering of SODI common stock, but shall instead be deemed to have incurred a Termination of Continuous Employment upon the termination of their employment with SODI and its subsidiaries (as defined for purposes of the SODI retirement plan). (c) Retirement, Vested and Survivor Benefits of SODI Employees under this Plan shall be determined based on the SODI Employee's accrued retirement or vested benefit, as the case may be (under the Retirement Plan and this Plan), as of June 30, 1993 and the maximum dollar limit under Code Section 415(b) and the defined benefit fraction under Code Section 415(e) applicable as of June 30, 1993. In addition, where the SODI Employee's Termination of Continuous Employment occurs before the SODI Employee has attained age 65, the benefits payable under this Plan shall be determined as follows. (1) In the case of a SODI Employee who is eligible for early retirement under the Retirement Plan on the date of his or her Termination of Continuous Employment, the Participant's benefit accrued as of June 30, 1993 (under both the Retirement Plan and this Plan) payable at age 65 shall first be reduced to the date of the Participant's Termination of Continuous Employment using the early retirement factors in the Retirement Plan as in effect on June 30, 1993, and from this amount there shall be subtracted the amount of the Participant's June 30, 1993 accrued benefit payable under the Retirement Plan, calculated using the Code Section 415 limits in effect on June 30, 1993 as adjusted to reflect early commencement of the benefit on the date of the Participant's Termination of Continuous Employment. (2) In the case of a SODI Employee who is not eligible for early retirement under the Retirement Plan on the date of his or her Termination of Continuous Employment, the Participant's benefit accrued as of June 30, 1993 -13- 14 (under both the Retirement Plan and this Plan) payable at age 65 shall first be reduced to the earliest date when the Participant may commence receipt of his benefit under the Retirement Plan, using the factors in the Retirement Plan as in effect on June 30, 1993 for determining the actuarial equivalent of the Participant's vested benefit (as set forth in such plan's definition of Actuarial Equivalent), and from this amount there shall be subtracted the amount of the Participant's June 30, 1993 accrued benefit payable under the Retirement Plan, calculated using the Code Section 415 limits in effect on June 30, 1993 as adjusted to reflect early commencement of the benefit on the earliest date when the Participant may commence receipt of his benefit under the Retirement Plan. Notwithstanding any other provision of this Plan, Survivors Benefits of SODI Employees who die after June 30, 1993 shall be determined by reference to the Survivors Benefits payable under the Sonat Offshore Retirement Plan rather than the Retirement Plan. (d) For purposes of Section 2.2, a SODI Employee's election to have Excess Retirement Plan Benefits paid in Annuity Form which is filed with SODI at least twelve full calendar months before such Participant's Termination of Continuous Employment shall be deemed an election filed with the Company to have benefits under this Plan paid in Annuity Form. ARTICLE III - EXCESS SAVINGS PLAN BENEFITS 3.1 ELIGIBILITY Each employee on whose behalf Company Matching Contributions to the Savings Plan are limited by Sections 401(a)(17), 401(m), and/or 415 of the Code and the incorporation of those limitations in the Savings Plan (a "Participant") shall be entitled to Excess Savings Plan Benefits under this Plan, regardless of whether such Participant has received notice that he or she is so entitled. In addition, each Participant whose ability to make aggregate Before-Tax and After-Tax Contributions to -14- 15 the Savings Plan is limited by Sections 401(a)(17), 401(m), and/or 415 of the Code and the incorporation of those limitations in the Savings Plan shall be entitled to Excess Savings Plan Benefits under this Plan, regardless of whether such Participant has received notice that he or she is so entitled. All capitalized terms used in this Article III and not defined in this Plan shall have the meanings ascribed thereto in the Savings Plan. 3.2 CREDITS TO ACCOUNT (A) AMOUNT CREDITED. The Company shall create and maintain on its books two accounts for each Participant (the "Diversifiable Account" and the "Non-Diversifiable Account", respectively, which are collectively referred to as the "Accounts") to which it shall credit (i) the amount of any Company Matching Contributions which are not paid to the Savings Plan by virtue of the limitations of Sections 401(a)(17), 401(m), and/or 415 of the Code and the incorporation of those limitations in the Savings Plan, plus (ii) the amount of any Company Matching Contributions that would have been made under the Plan (but for the limitations of Sections 401(a)(17), 401(m), and/or 415 of the Code and the incorporation of those limitations in the Savings Plan) had the Participant contributed the Before-Tax and After-Tax Contributions which he or she elected to contribute but was precluded from contributing by virtue of the limitations of Sections 401(a)(17), 401(m), and/or 415 of the Code and the incorporation of those limitations in the Savings Plan. Such amounts, if any, shall be credited at such time after the end of each pay period as Company Matching Contributions for such pay period are paid to the Savings Plan. The Accounts shall be debited upon payment to the Participant as provided in Section 3.4. The amount of a Participant's Excess Savings Plan Benefits shall be equal to the fair market value of his or her Accounts, as determined pursuant to Section 3.2 (c). (B) CREDITING OF CONTRIBUTIONS. 50% of each amount credited on behalf of a Participant pursuant to Section 3.2 (a) shall be credited to the Non-Diversifiable Account. All amounts in the Non-Diversifiable Account shall be credited to a -15- 16 subaccount (the "Phantom Stock Subaccount") that is deemed invested in units ("Units") of the Sonat Stock Fund established under the Company's Savings Plan (the "Sonat Stock Fund"). The remaining 50% of each amount credited on behalf of the Participant pursuant to Section 3.2 (a) shall be credited to the Diversifiable Account. All amounts in the Diversifiable Account shall be credited, at the direction of the Participant (pursuant to Section 3.3), to one or more of (i) the Phantom Stock Subaccount, or (ii) a subaccount which is deemed invested in shares of one of the mutual fund investments designated by the Company (each of such subaccounts referred to as a "Phantom Mutual Fund Subaccount"). In each case, the Participant's Phantom Stock Subaccount and each Phantom Mutual Fund Subaccount (collectively, the "Subaccounts") shall be credited with the number of phantom Units or phantom shares (including fractional Units or shares) equal to the number of Units or shares which could have been purchased with the dollar amount to be credited, valued at the closing price of such Unit or share on the business day such amounts are credited. At the time that any dividends are paid on the Sonat Stock Fund or the applicable mutual fund, as the case may be, the Participant's Phantom Stock Subaccount or Phantom Mutual Fund Subaccount, as the case may be, shall be adjusted to reflect such dividend payment in a manner consistent with the treatment of accounts that are actually invested in the Sonat Stock Fund or the applicable mutual fund, as the case may be. (C) DETERMINATION OF FAIR MARKET VALUE. Except as provided in Section 3.4, the fair market value of a Phantom Stock Subaccount or a Phantom Mutual Fund Subaccount, as the case may be, on any given date shall be determined by multiplying (i) the number of phantom Units or shares credited to such Subaccount on such date, by (ii) the closing price of a Unit or share (of the Sonat Stock Fund or of such mutual fund, as the case may be) as of such date (or, if such date is not a business day, on the preceding business day). -16- 17 3.3 INVESTMENT ELECTIONS AND TRANSFERS (A) NEW CONTRIBUTIONS TO DIVERSIFIABLE ACCOUNT. A Participant may on any business day elect (in the manner and subject to any limitations specified by the Company) to designate the Subaccounts to which new contributions to the Participant's Diversifiable Account shall be credited. All amounts credited to the Participant's Diversifiable Account on or after the date of such an election shall be credited in accordance with such election. The Participant may make a new election on any business day (in the manner and subject to any limitations specified by the Company), which shall take effect on the close of business on the day the Company receives such election. If a Participant fails to make an election, all amounts credited to the Participant's Account prior to the effective date of a properly-made election shall be credited as phantom shares of the Benchmark Government Portfolio (or such other short-term money market investment as the Company may designate). (B) TRANSFERS WITHIN DIVERSIFIABLE ACCOUNT. A Participant may on any business day elect (in the manner and subject to any limitations specified by the Company) to transfer a portion of his or her Diversifiable Account from one Subaccount to another. Transfers shall be made as of the close of business on the day the Company receives the election, based on the respective closing prices of the respective phantom Units or shares on such business day. Notwithstanding the foregoing provisions, a Participant may not transfer among his or her Subaccounts on or after a Lump Sum Valuation Date, or during the period beginning on an Installment Valuation Date and ending upon the close of business on the next Installment Payment Date (as such terms are defined in Section 3.4). (C) NON-DIVERSIFIABLE ACCOUNT. All amounts credited to a Participant's Non-Diversifiable Account shall be credited to the Phantom Stock Subaccount. Transfers out of such Subaccount shall not be permitted. -17- 18 3.4 PAYMENT OF ACCOUNTS Upon a Participant's Termination of Employment, on each Lump Sum Payment Date or Installment Payment Date (as such terms are defined below) the Company shall debit his or her Accounts and pay to such Participant (or in the event of the Participant's death, to his or her Beneficiary) amounts at the times determined pursuant to this Section 3.4. (A) CASH LUMP SUM. Except as provided in Section 3.4(b) or 3.4(c) below, upon a Participant's Termination of Employment, there shall be paid to the Participant in a cash lump sum on the fifteenth day of the calendar quarter following his or her Termination of Employment (or, if such day is not a business day, on the next business day thereafter) (the "Lump Sum Payment Date") (or as soon as practicable thereafter) an amount equal to the sum of: (i) the value of the Participant's Accounts, as determined below, plus (ii) the amount of any Company Matching Contributions that would have been credited to the Accounts under Section 3.2 for pay periods beginning before the Participant's Termination of Employment if such Company Matching Contributions have not yet been credited on the last business day of the calendar quarter in which the Participant's Termination of Employment occurs ("Lump Sum Valuation Date"). For purposes of determining the value of a Participant's Accounts pursuant to this Section 3.4 (a), (i) each of the Participant's Phantom Mutual Fund Subaccounts shall have a value equal to the product of (1) the closing price of a share of such mutual fund on the Lump Sum Valuation Date and (2) the number of phantom shares credited to such Subaccount on the Lump Sum Valuation Date, and (ii) the Participant's Phantom Stock Subaccounts shall have a value equal to the product of (1) the average of the closing prices of a Unit on the ten business days ending on the Lump Sum Valuation Date and (2) the number of phantom Units credited to such Subaccounts on the Lump Sum Valuation Date. (B) INSTALLMENTS. A Participant may elect to have all or (subject to any limitations imposed by the Company) any designated portion of his or her Accounts -18- 19 paid in a number of annual installments (up to a maximum of 15 installment payments) designated by the Participant. To be effective, such election must be written, irrevocable, and filed with the Company at least twelve months before the Participant's Termination of Employment. Payment shall be made in the designated number of installments as set forth below (the date of each payment being an "Installment Payment Date"). The first installment shall be paid on the fifteenth day of the calendar quarter following the Participant's Termination of Employment (or if such day is not a business day, on the next business day thereafter) or as soon as practicable thereafter. Each subsequent installment shall be paid on an Installment Payment Date that is the anniversary of the fifteenth day of such calendar quarter (or, if such day is not a business day, on the next business day thereafter). Each installment shall be in an amount equal to (i) the value of the Participant's Accounts at the time of payment of such installment, as determined below, divided by (ii) the number of installments remaining to be paid (including the installment about to be paid), and shall be made on a pro rata basis from the Participant's Accounts and Subaccounts. For purposes of determining the value of an installment of a Participant's Accounts pursuant to this Section 3.4 (b), (i) each of the Participant's Phantom Mutual Fund Subaccounts shall have a value equal to the product of (1) the closing price of a share of such mutual fund on the last business day of the calendar quarter immediately preceding the Installment Payment Date (the "Installment Valuation Date") and (2) the number of phantom shares credited to such Subaccount on the Installment Valuation Date, and (ii) the Participant's Phantom Stock Subaccounts shall have a value equal to the product of (1) the average of the closing prices of a Unit on the ten business days ending on the Installment Valuation Date and (2) the number of phantom Units credited to such Subaccounts on the Installment Valuation Date. (C) PRIOR ELECTIONS. Notwithstanding the provisions of Sections 3.4 (a) and (b), any election made by a Participant prior to February 25, 1993 to have payment of all or a portion of his or her Accounts made in installments shall be irrevocable. In the event that no election is in effect for a given year after 1983 and prior to 1988, the -19- 20 Participant shall be deemed to have elected installment payments for such year for purposes of the preceding sentence. The provisions of Sections 3.4 (a) and (b) shall apply with respect to any portion of the Participant's Accounts which was distributable in the form of a lump sum pursuant to a Participant's election or Plan provision which became effective prior to February 25, 1993. 3.5 CHANGE OF CONTROL PROVISIONS (A) BEFORE TERMINATION OF EMPLOYMENT. Notwithstanding a Participant's election or the provisions of Section 3.4, in the event of a Participant's Termination of Employment within three years following a Change of Control (as defined in Section 4.3), then there shall be paid to the Participant in a cash lump sum, as soon as practicable (and within 30 days) after his or her Termination of Employment an amount equal to the sum of (i) the value of the Participant's Accounts, as determined below, plus (ii) the amount of any Company Matching Contributions that would have been credited to the Accounts under Section 3.2 for pay periods beginning before the Participant's Termination of Employment if such Company Matching Contributions have not yet been credited at the time of valuation of the Participant's Accounts. For purposes of determining the value of a Participant's Accounts pursuant to this Section 3.5(a), (i) the Participant's Phantom Mutual Fund Subaccounts shall have a value equal to the product of (1) the closing price of a share of such mutual fund on the date of the Participant's Termination of Employment (or, if the Participant's Termination of Employment does not occur on a business day, on the next succeeding business day) and (2) the number of phantom shares credited to such Subaccount on the date of the Participant's Termination of Employment (or the following business day, if applicable), and (ii) the Participant's Phantom Stock Subaccounts shall have a value equal to the product of (1) the average of the closing prices of a Unit on the ten business days ending on the date of the Participant's Termination of Employment (or, if the Participant's Termination of Employment does not occur on a business day, on the next succeeding business day), and (2) the number of phantom Units credited to such -20- 21 Subaccounts on the date of the Participant's Termination of Employment (or the following business day, if applicable). (B) AFTER TERMINATION OF EMPLOYMENT. Notwithstanding any other election made by a Participant or the provisions of Section 3.4, in the event a "Change of Control" (as defined in Section 4.3) occurs after a Participant's Termination of Employment, payment of the Participant's Accounts shall be made in a cash lump sum as soon as practicable (and within 30 days) after such Change of Control. The amount of such lump-sum payment shall equal the value of the Participant's Accounts, as determined below. For purposes of determining the value of a Participant's Accounts pursuant to this Section 3.5(b), (i) the Participant's Phantom Mutual Fund Subaccounts shall have a value equal to the product of (1) the closing price of a share of such mutual fund on the date of the Change of Control (or, if the Change of Control does not occur on a business day, on the next succeeding business day) and (2) the number of phantom shares credited to such Subaccount on the date of the Change of Control (or the following business day, if applicable), and (ii) the Participant's Phantom Stock Subaccounts shall have a value equal to the product of (1) the average of the closing prices of a Unit on the ten business days ending on the date of the Change of Control (or, if the Change of Control does not occur on a business day, on the next succeeding business day), and (2) the number of phantom Units credited to such Subaccounts on the date of the Change of Control (or the following business day, if applicable). 3.6 BENEFICIARY For purposes of this Article III, "Beneficiary" shall mean (i) the person, persons or entity designated by a Participant to receive Excess Savings Plan Benefits in the event of the Participant's death, or (ii) if the Participant has made no such designation, his or her Beneficiary under the Savings Plan. -21- 22 3.7 ANTIDILUTION ADJUSTMENTS In the event of a reorganization, recapitalization, stock split, stock dividend, combination of shares, rights offer, liquidation, dissolution, merger, consolidation, spin-off, sale of assets, or other change in or affecting the corporate structure or capitalization of the Company, the Board of Directors of the Company shall make appropriate adjustment to the Phantom Stock Subaccounts of Participants so that the phantom Units in such Subaccounts shall be treated as if they were actual Units. In the event the Common Stock is converted into cash or other securities or property, the value of the Units on the date of such conversion shall be determined by AmSouth Bank NA, and the phantom Units shall be converted into cash based on such value and credited as phantom shares of the Benchmark Government Portfolio (or such other Phantom Mutual Fund Subaccount as may be designated by the Board of Directors). 3.8 PROVISIONS REGARDING SODI EMPLOYEES SODI Employees (as defined in Section 1.2) shall not be deemed to have incurred a Termination of Employment by virtue of the initial public offering of SODI common stock, but shall instead be deemed to have incurred a Termination of Employment upon the termination of their employment with SODI and its subsidiaries (as defined for purposes of the SODI savings plan). In no event shall SODI Employees accrue benefits under Article III of this Plan after June 30, 1993 (unless rehired by the Company), but Accounts established pursuant to Article III hereof shall continue to be credited with interest as provided in Section 3.2(b). ARTICLE IV - VESTING BENEFITS 4.1 ELIGIBILITY Each employee who has had a Termination of Continuous Employment and who is a member of the Vesting Group (as defined in Section 4.4 below) (a "Participant") -22- 23 shall be entitled to Vesting Benefits hereunder, regardless of whether such Participant has received notice that he or she is so entitled, but only if a Change of Control (as defined in Section 4.3 below) has occurred while he or she is employed by one of the Employers and is a member of the Vesting Group. All capitalized terms used in this Article IV and not defined in this Plan shall have the meanings ascribed thereto in the Retirement Plan. 4.2 AMOUNT AND FORM OF VESTING BENEFIT Each Participant shall be entitled to a Vesting Benefit, payable in the form of a cash lump sum, that is equal in amount to the Actuarial Equivalent (as defined in Section 2.3(d) above) of the excess, if any, of (i) the amount hypothetically payable to the Participant as a Vested Benefit under the Retirement Plan if (x) Section 5.01 of the Retirement Plan were hypothetically amended to provide a Vesting Date based on a period of Vesting Service equivalent to the actual Vesting Service of the Participant, and (y) Sections 401(a)(17) and 415 of the Code were nonexistent and the provisions of the Retirement Plan incorporating the limitations contained in Sections 401(a)(17) and 415 of the Code were inoperative, over (ii) the amount payable as a Vested Benefit under the Retirement Plan, assuming for purposes of clauses (i) and (ii) that the Participant commenced receiving benefits under such clause in the form of a single life annuity on the earliest date on which the Participant could have commenced receipt of a Vested Benefit under the Retirement Plan (had he or she been entitled to such Benefit). The grant of Vesting Benefits shall not increase the Participant's Credited Service under the Retirement Plan. Such cash lump-sum payment shall be paid as soon as practicable (and within 30 days) after the Participant's Termination of Continuous Employment. 4.3 DEFINITION OF CHANGE OF CONTROL A "Change of Control" shall mean: -23- 24 (i) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934 (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (1) the then outstanding shares of common stock of the Company (the "Outstanding Common Stock") or (2) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Voting Securities"); provided, however, that for purposes of this subsection (i), the following acquisitions shall not constitute a Change of Control: (A) any acquisition directly from the Company, (B) any acquisition by the Company, (C) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company or (D) any acquisition by any corporation pursuant to a transaction which complies with clauses (A), (B) and (C) of subsection (iii); or (ii) Individuals who, as of December 1, 1995, constitute the Board of Directors (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board of Directors; provided, however, that any individual becoming a Director subsequent to such date whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the Directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of Directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board of Directors; or -24- 25 (iii) Consummation of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company (a "Business Combination"), in each case, unless, following such Business Combination, (A) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Common Stock and Outstanding Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 50% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of Directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination, of the Outstanding Common Stock and Outstanding Voting Securities, as the case may be, (B) no Person (excluding any corporation resulting from such Business Combination or any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (C) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board of Directors, providing for such Business Combination. -25- 26 4.4 DEFINITION OF VESTING GROUP An employee shall be deemed to be a member of the Vesting Group if, immediately prior to the occurrence of a Change of Control, he or she (1) is a participant in the Retirement Plan, (2) is employed as an officer by an Employing Company (as defined in the Retirement Plan) and (3) is not fully vested under the Retirement Plan. ARTICLE V - FUNDING 5.1. UNFUNDED PLAN The Plan shall be unfunded, and the entire cost of the benefits and administration of the Plan shall be borne by the Company. ARTICLE VI - MISCELLANEOUS 6.1 EFFECT OF IRS DETERMINATION If any amounts whose distribution is deferred pursuant to the Plan are found in a "determination" (within the meaning of Section 1313(a) of the Code) to have been includible in gross income by a Participant prior to payment of such amounts under the Plan, such amounts shall be immediately paid to such Participant notwithstanding the Participant's election or any other provision of the Plan. 6.2 AMENDMENT The Company intends to maintain the Plan in force indefinitely, but necessarily reserves the right by action of its Board of Directors to amend or discontinue the Plan at any time, provided that (i) no amendment or discontinuance of the Plan shall diminish in any way payments under this Plan due thereafter under rights created or grants made before such amendment or discontinuance and (ii) rights created or grants made before -26- 27 such amendment or discontinuation shall continue in force and effect and shall continue to accrue as though no amendment or discontinuation of this Plan had occurred. 6.3 EXCESS DISABILITY BENEFITS The Excess Disability Benefits formerly provided under this Plan are instead payable under the Supplemental Disability Plan to the full extent that they formerly would have been payable under this Plan. To the extent that a benefit is payable pursuant to the Supplemental Disability Plan it shall not be payable under this Plan, and to the extent that a benefit is payable pursuant to this Plan it shall not be payable under the Supplemental Disability Plan. 6.4 NON-ALIENATION; TAX WITHHOLDING No benefit payable under this Plan shall be subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, garnishment, encumbrance, or charge; provided, however, that taxes may be withheld from benefit payments to the extent required by any federal, state or local law or regulation. 6.5 NO RIGHT TO CONTINUED EMPLOYMENT Participation in the Plan shall not give any employee the right to be retained in the employ of the Employers. 6.6 DEFINITION OF PARTICIPANT Any employee who is a "Participant" under any Section of this Plan shall not be deemed to be a "Participant" under any other Section unless he or she also satisfies the definition of "Participant" under such other Section. Any Plan provision to the contrary notwithstanding, an employee shall not be a "Participant" under any Section of this Plan unless either (i) the employee is a member of a select group of management or highly compensated employees (as provided in Section 201(b) of the Employee Retirement Income Security Act of 1974, as amended), or (ii) the benefits under this -27- 28 Plan are provided solely by virtue of the limitations of Section 415 of the Code and the incorporation of those limitations in the Retirement Plan or the Savings Plan, as the case may be. 6.7 PLAN ADMINISTRATION AND INTERPRETATION The administration of the Plan and the exclusive power to interpret it is vested in the Employee Benefits Committee of the Board of Directors of the Company. The Employee Benefits Committee may delegate any or all of its duties and responsibilities hereunder to the Administrative Committee of the Retirement Plan. 6.8 SUBSIDIARIES AND AFFILIATES Each subsidiary or affiliate of the Company which the Company has designated as a participating company in the Retirement Plan and/or the Savings Plan with respect to its employees shall automatically be deemed to have adopted this Plan; provided however, that if the terms of the Retirement Plan or the Savings Plan with respect to such subsidiary or affiliate are different from those applicable to the Company, such difference or differences shall be given effect in applying this Plan. References herein to the Retirement Plan or the Savings Plan shall be in regard to such plan as amended from time to time. 6.9 MINORS AND INCOMPETENTS If a person entitled to benefits under this Plan is a minor or is physically unable or mentally incompetent to receive such benefits and to execute a valid release therefor, the Plan may pay such benefits to the guardian or representative of such person or the individual or institution maintaining custody of such person (provided that such payment shall be made for and applied to the benefit of the person entitled thereto), and the release of such guardian, representative, individual or institution shall be a valid and complete discharge for payment of such benefit. -28- 29 6.10 CHOICE OF LAW THIS PLAN SHALL BE INTERPRETED PURSUANT TO THE LAWS OF THE STATE OF ALABAMA, WITHOUT GIVING EFFECT TO ITS CONFLICTS OF LAWS PRINCIPLES. I IN WITNESS WHEREOF, Sonat Inc. has caused this Plan as amended and restated hereby to be executed as of January 1, 1997. SONAT INC. By: ---------------------------- Ronald L. Kuehn, Jr. Chairman of the Board, President and Chief Executive Officer -29- EX-10.15 4 SONAT INC. DEFERRED COMPENSATION PLAN 1 EXHIBIT 10.15 SONAT INC. DEFERRED COMPENSATION PLAN PLAN SUMMARY - NOVEMBER 1, 1998 TABLE OF CONTENTS
PAGE HOW THE PLAN WORKS 1. What is Sonat Inc. Deferred Compensation Plan? An Overview...........................................................1 2. What are the advantages of the Deferred Compensation Plan?.................................................................2 3. What are the trade-offs if I participate?.............................3 4. How does the Deferred Compensation Plan compare with the Sonat Savings Plan?..........................................4 5. Does my participation affect my other Sonat benefits?.................4 ELIGIBILITY 6. Who is eligible to participate in the Deferred Compensation Plan?....................................................5 DEFERRAL ELECTIONS 7. What deferral elections can I make?...................................5 8. When do I make my election to defer?..................................5 9. How much can I defer?.................................................6 10. What are my investment options?.......................................6 11. Can I change how future allocations will be invested, and move funds among the investment options?..............................7 12. When will I receive my deferral account balance?......................7 13. How will my account be paid out of the Plan?..........................9 14. How do I name my beneficiary?........................................11
(i) 2 ACCESS TO YOUR MONEY BEFORE THE PAYMENT EVENT 15. Can I get money from my account before the date I elect for deferral payments to begin?..............................16 TAX CONSIDERATIONS 16. What are some of the more common tax-related questions that should concern me?..............................................17 ENROLLMENT 17. How do I sign up for the Deferred Compensation Plan?.................18 18. Who can I talk to if I have questions about the Deferred Compensation Plan or the enrollment package?.........................18 OTHER INFORMATION 19. What information will I receive about my Plan balance?...............19 20. What are the Section 16 consequences of participating in the Plan?.........................................................19 21. Can the Plan be amended or discontinued?.............................22 EXHIBIT A Comparison of Non-qualified Deferred Compensation Plan and Before-Tax (401K) Contributions to Qualified Sonat Savings Plan.........................................................23
(ii) 3 SONAT INC. DEFERRED COMPENSATION PLAN PLAN SUMMARY The Sonat Inc. Deferred Compensation Plan ("the Plan") provides you with a tax-advantaged opportunity to save for retirement and other future income needs. You are encouraged to review the Plan with your family and your tax and financial advisors to determine how the Plan can help you meet your personal financial goals. The following is a summary of the Plan, in a Question-and-Answer format. The official provisions of the Plan are in the Plan document, which you may obtain from the Human Resources Department in Birmingham. If there is any conflict or inconsistency between this summary or any other written or oral communication and the Plan document, the official Plan document will always govern. The Plan is subject to continued compliance with Internal Revenue Service regulations. HOW THE PLAN WORKS 1. WHAT IS THE SONAT INC. DEFERRED COMPENSATION PLAN? - AN OVERVIEW The Plan is a non-qualified deferred compensation program that allows you to make pre-tax deferrals of base pay and bonuses, allocate the deferrals to various investment options, and have your account balance paid to you in the future. You will be able to elect, for each year, the amount of base pay and bonus that you wish to defer. You may defer up to 25% of your base pay and up to 90% of your annual bonus. Your deferrals will accrue earnings as if held in "phantom" investments in the investment options available under the Sonat Savings Plan. -1- 4 Generally speaking, distribution will be made upon termination of your employment. You may instead select a specified date on which to receive payments, which may be before or after your anticipated retirement or termination date. Payment will be made as a lump sum or in annual installments, at your election. 2. WHAT ARE THE ADVANTAGES OF THE DEFERRED COMPENSATION PLAN? A. REDUCED CURRENT INCOME TAXES. Your current federal taxable income is reduced by the amount you elect to defer. However, you will be taxed at the ordinary income rates in effect at the time of distribution of your account. All state income tax laws (except in Pennsylvania and New Jersey) follow the federal law and exclude the amount you defer from current taxable income. Please consult with your personal tax advisor regarding the laws for your particular state. B. MORE DOLLARS AVAILABLE FOR INVESTMENT. The initial deferral (investment) into this Plan can be a more efficient investment than most other outside investments, because you are investing pre-tax income rather than after-tax income. For example:
========================== OUTSIDE INVESTMENT THIS PLAN ========================================================== Compensation $1.00 $1.00 ---------------------------------------------------------- Current Income Tax @ 36% -.36 -.00 ---------------------------------------------------------- Net Funds Invested $ .64 $1.00 ==========================================================
-2- 5 C. TAX-DEFERRED ACCUMULATION. Earnings in your Plan account are not subject to federal income tax until paid to you. As a result, investments in the Plan can generate higher results than similar investments whose earnings are taxed each year. D. POSSIBLE FUTURE TAX SAVINGS. You may achieve additional income tax savings when you receive your deferral account, if you are in a lower tax bracket at that time. 3. WHAT ARE THE TRADE-OFFS IF I PARTICIPATE? A. REDUCED CURRENT CASH FLOW. By deferring your compensation, you reduce your current cash flow. Therefore, if you require a greater amount of current income, deferral may not be appropriate for you. However, the cash flow reduction may be significantly less than the amount deferred, since your deferral is in pre-tax dollars. For example, if your tax rate is 36%, $10,000 of compensation produces approximately $6,400 of after-tax income. Therefore, deferring $10,000 reduces your disposable after-tax income by $6,400, and you also have the equivalent of $10,000 working for you in your deferral account. B. THE PROGRAM IS UNFUNDED. Under current IRS regulations, your deferral account must be an unsecured general obligation of Sonat Inc. and may not be funded in any way. Therefore, your right to receive payments under the Plan will be subject to Sonat Inc.'s ability to pay, and in the event of Sonat's bankruptcy or insolvency will be the same as any other unsecured general creditor. The Plan does not create a trust relationship between you, or any other person, and the Company. -3- 6 C. RESTRICTED ACCESS TO YOUR MONEY. You do not have access to your deferrals and earnings until the date you specify on your election form, except in the limited circumstances discussed at Question 15. D. EMPLOYMENT AND LOCAL TAXES. Amounts you defer under the Plan are subject to Social Security taxes (up to the statutory limit), Medicare taxes and local (county and city) taxes (if applicable). Withholding of these taxes on base pay deferral amounts will be made from your remaining undeferred base pay. If you defer any of your bonus, the taxes on your deferral will be withheld from the portion of the bonus that is not deferred. (This is the reason the Plan does not allow complete deferral of a bonus payout.) However, under current law, the payments from your accounts will not be subject to Social Security, Medicare or local taxes at the time of distribution. E. POSSIBLE HIGHER TAX RATE. The benefits of your deferral may be smaller than you would otherwise expect if, at the time of distribution, you are in a higher tax bracket than when you deferred. 4. HOW DOES THE DEFERRED COMPENSATION PLAN COMPARE WITH THE SONAT SAVINGS PLAN? Please refer to Exhibit A of this Summary. 5. DOES MY PARTICIPATION AFFECT MY OTHER SONAT BENEFITS? Your participation in the Plan will have no effect on your other Sonat benefits. -4- 7 ELIGIBILITY 6. WHO IS ELIGIBLE TO PARTICIPATE IN THE DEFERRED COMPENSATION PLAN? To be eligible to participate in the Plan, you must be an officer of the Company or one of its principal subsidiaries, and must be selected for participation by the Company's Chief Executive Officer. DEFERRAL ELECTIONS 7. WHAT DEFERRAL ELECTIONS CAN I MAKE? Each year you will be able to elect to defer both base pay and bonus. Each item of compensation (base pay and bonus) for each year will be treated as a discrete election. With each deferral election, you will select how much you wish to defer, how you wish it to be paid (lump sum or installments), and when you wish to receive it in the future. You will also select how the deferred amounts will be allocated among the investment choices under the Plan. All of these elections are discussed in more detail below. 8. WHEN DO I MAKE MY ELECTION TO DEFER? An election to defer base pay must be made before the calendar year in which the base pay is earned. The election to defer a bonus earned for a given calendar year must be made by March 31 of that year. Special rules will apply for an officer who first becomes eligible to participate in the Plan after January 1, 1997. Such an officer must make deferral elections for the remainder of the year's base pay, and the bonus earned for that year, during that year and within 31 days after becoming eligible. -5- 8 9. HOW MUCH CAN I DEFER? You may defer up to 25% of your annual base pay. Your deferral can be for 1, 2, 3, 4 or 5% of base pay, or in 5% increments up to 25%. You may also defer up to 90% of your annual bonus in 10% increments. An election to defer a bonus will apply only to your annual bonus opportunity, and not to any special bonus that you may receive. In certain circumstances, if you elect to defer 90% of an annual bonus, the remaining 10% may not be enough to satisfy the applicable federal and state income, Social Security, Medicare and local tax withholding obligations. If this situation applies to you, the Company will automatically reduce the amount of bonus deferred (generally to about 85%), and use the remainder to satisfy the tax withholding obligations. Your election to defer is irrevocable, so you should carefully assess the impact of your deferral elections on your personal financial situation. 10. WHAT ARE MY INVESTMENT OPTIONS? Your deferral accounts will accrue earnings, according to your election, as if held in the investment options available under the Sonat Savings Plan. These investment options are listed in the Summary of Investment Options for the Plan. Your allocations to these investment choices must be in 1% increments. For more information, see the most recent Summary of Investment Options. Please note that your deferrals will not actually be invested in these funds, but will be valued as if they were. (This bookkeeping treatment is often called a "phantom" investment.) Your account's value will change as the values of the relevant funds change, including reinvestments of dividends and earnings. -6- 9 11. CAN I CHANGE HOW FUTURE ALLOCATIONS WILL BE INVESTED, AND MOVE FUNDS AMONG THE INVESTMENT OPTIONS? You may change the way future allocations are invested by selecting a new allocation (in 1% increments, with a total of 100% among the investment choices). You may also transfer your current balance among the investment options by selecting (in 1% increments, with a total allocation of 100%) the options in which you want your funds to be invested. Each procedure can be done by phone on any business day, and will be effective on the day you make the phone call. To process these transactions, you should call the individuals in the Company's Human Resources Department who are listed in the most recent Summary of Investment Options. 12. WHEN WILL I RECEIVE MY DEFERRAL ACCOUNT BALANCE? Each time you make a deferral election, you will elect a payment event upon which to receive the amount deferred (and earnings on that amount) - termination of employment, or a specified future date. Each year and each element of compensation (base pay or bonus) will be treated as a separate election. Special Plan provisions apply in the event of your death, or in the event of a change of control of the Company. A. TERMINATION OF EMPLOYMENT You may select termination of employment as the payment event. This selection would cover termination due to early or normal retirement, disability, discharge, or resignation. AN ELECTION TO RECEIVE A DEFERRED AMOUNT (AND EARNINGS) UPON TERMINATION OF EMPLOYMENT WILL BE IRREVOCABLE. -7- 10 B. SPECIFIED DATE You may instead select a specified date on which to receive the amount deferred (and earnings). Such a date must be a July 1, must be at least two years after the deferral election is made, and must be no later than your 70th birthday. If you select a payment event of a specified date you may, by making a subsequent election at least 12 months before the specified date, elect to postpone the date of payment. The new date must be a July 1, must be at least two years after the date you first selected, and must be no later than your 70th birthday. (You may not select termination of employment as your new payment event.) YOU MAY POSTPONE THE SPECIFIED PAYMENT DATE OF A GIVEN DEFERRAL (AND EARNINGS) ONLY ONCE. For example, if you elect to have a portion of your 1999 base pay (and earnings) paid on July 1, 2002, you could elect a later payment date (on or after July 1, 2004) by filing an election before July 1, 2001. C. DEATH Upon your death, your entire balance in the Plan will be paid to your beneficiary in a cash lump sum on the fifteenth day of the calendar quarter following your death (or the first business day thereafter). For information about beneficiary designations, see Question 14. D. CHANGE OF CONTROL If your employment terminates within three years after a Change of Control of the Company (as defined in the Plan), your entire balance in the Plan will be paid to you in a cash lump sum as soon as practicable (and within 30 days) after your termination of employment. Also, if a Change of Control occurs after termination of your employment, your entire balance in the Plan will be paid to you in a cash lump sum as soon as practicable (and within 30 days) after the Change of Control. -8- 11 E. COMMITTEE DISCRETION TO DEFER PAYMENT Under current tax law, if you are an executive whose pay is disclosed in the Company's proxy statement, and if the "non-performance based" pay you receive in a year exceeds $1,000,000, the Company will not receive a tax deduction for the excess non-performance based pay. In general, under the Company's current compensation programs, the following elements of pay are "non-performance based" when received: base pay; a portion of annual bonus; base pay deferred from previous years (and earnings thereon); and a portion of annual bonuses deferred from previous years (and earnings thereon). IF THE EXECUTIVE COMPENSATION COMMITTEE DETERMINES THAT YOUR RECEIPT OF A PAYMENT FROM THE PLAN COULD CAUSE THE COMPANY TO LOSE A TAX DEDUCTION UNDER THIS LAW, THE COMMITTEE CAN DEFER ALL OR PART OF THE PAYMENT TO ELIMINATE OR REDUCE LOSS OF THE TAX DEDUCTION. UNDER CURRENT LAW, THIS ISSUE CAN GENERALLY ARISE ONLY IF YOU RECEIVE A PAYMENT BEFORE TERMINATION OF EMPLOYMENT. 13. HOW WILL MY ACCOUNT BE PAID OUT OF THE PLAN? When you make a deferral election, you will elect how you wish to receive the amount deferred (and earnings on that amount). As with the payment event, each year and each element of compensation (base pay and bonus) will be treated as a separate election. You may choose, in each case, a lump sum payment or annual installments. -9- 12 A. ANNUAL INSTALLMENTS You may elect to have payment made to you in 2-15 annual installments. IF YOU MAKE AN INSTALLMENT ELECTION, THAT ELECTION IS IRREVOCABLE. If you elect installment payments to begin on a specified future date, the first payment will be made on the July 1 that you selected (or, if that day is not a business day, on the next business day). If you elect installment payments to begin upon termination of employment, the first payment will be made on the fifteenth day of the following calendar quarter (or if that day is not a business day, on the next business day). Each subsequent payment will be made on the anniversary of the preceding payment. Each installment will equal (1) the balance of the amount deferred (and earnings) being paid out under the installment election at the time of payment, divided by (2) the number of payments remaining to be paid (including the current installment). For example, if you elect for a deferral (and earnings) to be paid in three annual installments beginning July 1, 2005, the first payment will equal 1/3 of the balance on July 1, 2005; the second installment will equal 1/2 of the balance on July 1, 2006; and the last installment will equal the remaining balance on July 1, 2007. B. LUMP SUM If you make a lump sum election, payments will be made to you in that form. If you elect a lump sum, you may later decide, by making an irrevocable election at least 12 months before the payment event (that is, termination of employment or a specified date, according to your election), to instead receive the payment in 2-15 annual installments, as discussed above. Therefore, if you are not sure whether you want installment payments at the time you make a deferral election, you may wish to elect a lump sum, and consider making an installment election later. -10- 13 If a lump sum payment is to be made on a specified future date, payment will be made on the July 1 that you selected (or, if that day is not a business day, on the next business day). If a lump sum payment is to be made after your termination of employment, payment will be made on the fifteenth day of the following calendar quarter (or, if that day is not a business day, on the next business day). C. ACCOUNT VALUATION All investment options (except the Sonat Stock Fund investment) will be valued at the close of the June 15 (or, if that day is not a business day, the next business day) before the payment date (if payment is being made on a specified future date), or on the last business day of the calendar quarter before the payment date (if payment is being made upon termination of employment). The Sonat Stock Fund investment will be valued based on the average of the closing price of the Fund on the 10 business days ending on June 15 (or next business day) or the last business day of the calendar quarter (as the case may be). All installment payments will be made on a pro rata basis from your investments at the time of payment. 14. HOW DO I NAME MY BENEFICIARY? Upon your death, your beneficiary(ies) will be paid your entire Plan balance. You may make or change a beneficiary designation at any time, by filling out a Beneficiary Designation Form and filing it with the Company's Human Resources Department. You may name one or more primary beneficiaries, as well as one or more contingent beneficiaries (to receive your Plan balance if all primary beneficiaries predecease you). If you make no beneficiary designation, or if all designated beneficiaries predecease you, your Plan balance will be paid to your estate. -11- 14 ACCESS TO YOUR MONEY BEFORE THE PAYMENT EVENT 15. CAN I GET MONEY FROM MY ACCOUNT BEFORE THE DATE I ELECT FOR DEFERRAL PAYMENTS TO BEGIN? Access to your Plan balance before the payment event that you select is very limited. You may withdraw funds from your deferral account only in the event of an extreme and unforeseen financial hardship. A. FINANCIAL HARDSHIP DISTRIBUTIONS In the event of unusual, extraordinary expenses or unforeseen financial hardship, you may request a distribution of the amount reasonably necessary to meet your financial need. This definition of hardship is more stringent than the hardship provision in the Sonat Savings Plan, and does not, for instance, include college expenses, or costs in connection with a home purchase. It generally encompasses hardship generated by unforeseen circumstances, such as unreimbursed medical expenses, family loss of income by layoff and the like. The Executive Compensation Committee of the Board of Directors may approve or deny the request in its sole discretion, and distribution is limited to the amount necessary to relieve the hardship plus your income tax liability on the distribution. If approved, this distribution is not subject to any penalty taxes, and is ordinary income for federal and state income tax purposes. B. LOANS Loans are not available from your account balance, since the Plan would lose its favorable tax treatment if loans were permitted. -16- 15 TAX CONSIDERATIONS 16. WHAT ARE SOME OF THE MORE COMMON TAX-RELATED QUESTIONS THAT SHOULD CONCERN ME? AM I TAXED ON MY DEFERRALS OR EARNINGS CREDITED TO THEM? Under current tax law, neither your deferrals nor the earnings thereon are subject to federal income tax before withdrawal from the Plan. All state income laws (except in Pennsylvania and New Jersey) follow the federal law and exclude the amount you defer from current taxable income. Under current law, there will be no income tax liability until you actually receive a payment. Check with your legal or tax counsel concerning your specific state or local (city, county) tax laws. WHAT ABOUT SOCIAL SECURITY, MEDICARE AND LOCAL TAXES? Deferred amounts are subject to these taxes AT THE TIME OF DEFERRAL. The eventual payment of your deferral accounts, including earnings, will not be subject to these taxes under current law. Distributions from the Plan will not reduce your Social Security benefits after retirement, as they do not represent wages for services performed in the calendar year of receipt. HOW WILL PAYMENTS BE REPORTED? Payments made to you will be reported on Form W-2, whether you are employed or retired at time of distribution. Payments to beneficiaries made in the event of your death will be reported on Form 1099. CAN I ROLL OVER MY DISTRIBUTION TO AN IRA? No, because this is not a tax-qualified program under the Internal Revenue Code. When electing a Plan distribution, you should seek professional tax advice to determine the best course of action in light of your financial circumstances. -17- 16 WILL THE PLAN BENEFITS PAID TO MY BENEFICIARIES BE INCLUDED IN MY GROSS ESTATE FOR FEDERAL ESTATE TAX PURPOSES? Yes, the cumulative amounts in your account at the time of death will be included in your estate. If, however, your spouse is your beneficiary and the benefit qualifies for the estate tax marital deduction, the amount in your account may not increase your taxable estate. You should consult with your legal and financial advisors about beneficiary designations and the payment of benefits in the event of your death. HOW WILL MY DISTRIBUTIONS BE TAXED? Under current law, distributions from your account are taxed as ordinary income when received, and no special tax advantages or penalties apply. Federal and state income taxes will be withheld from your payments when they are made. ENROLLMENT 17. HOW DO I SIGN UP FOR THE DEFERRED COMPENSATION PLAN? You will be given enrollment materials a few weeks before a deferral election is required under the Plan. You should review these materials carefully with your family and financial advisors, and return all the necessary forms by the dates described in the materials. 18. WHO CAN I TALK TO IF I HAVE QUESTIONS ABOUT THE DEFERRED COMPENSATION PLAN OR THE ENROLLMENT PACKAGE? See the most recent Summary of Investment Options for the names and phone numbers to call if you have questions about the Plan. -18- 17 OTHER INFORMATION 19. WHAT INFORMATION WILL I RECEIVE ABOUT MY PLAN BALANCE? You will receive a quarterly statement that will provide you with the balance in your account, deferrals and investment earnings for the quarter, and other information. 20. WHAT ARE THE SECTION 16 CONSEQUENCES OF PARTICIPATING IN THE PLAN? You need to review this Question and Answer only if you are an executive officer of Sonat Inc. who is subject to the provisions of Section 16 of the Securities Exchange Act. Section 16(b) requires executive officers to pay over to the Company any profit realized from the purchase and sale, or sale and purchase, of Company equity securities within any period of less than six months. Section 16(a) requires reports of changes in beneficial ownership of Sonat equity securities to the Securities and Exchange Commission. YOU WILL BE NOTIFIED IF YOU ARE SUBJECT TO SECTION 16. The following will describe how transactions in the Plan are treated for purposes of Sections 16(b) (short swing profit liability) and 16(a) (reporting). When a transaction is said to be "exempt", it means the transaction is not a "purchase" or a "sale" under Section 16(b). (As noted below, however, many exempt transactions still trigger reporting requirements under Section 16(a).) -19- 18 A. CONTRIBUTIONS; INVESTMENT OF EARNINGS Acquisitions of units of the phantom Sonat Stock Fund through deferrals and reinvestment of earnings under the Plan are exempt under Section 16(b). B. TRANSFERS AMONG INVESTMENT OPTIONS; IN-SERVICE CASH WITHDRAWALS AND PAYMENTS; SAVINGS PLAN LOANS Transfers among investment options under the Plan are called "discretionary" transactions under the Section 16 rules. The Section 16 consequence of a discretionary transaction in the Plan is affected by the discretionary transactions in ANY Sonat plan that involves stock or phantom stock funds - the Sonat Savings Plan, the Savings Plan feature of the Supplemental Benefit Plan (the "Supplemental Savings Plan"), and the Deferred Compensation Plan. A discretionary disposition of units of the Sonat Stock Fund or phantom Sonat Stock Fund in ANY of these plans (such as a transfer into a mutual fund investment, or the liquidation of stock to acquire loan proceeds or to fund a cash in-service withdrawal from the Savings Plan) will be exempt UNLESS you elected to make a discretionary acquisition (such as transfer from a mutual fund (or phantom mutual fund) into units of the Sonat Stock Fund (or phantom Sonat Stock Fund)) within the previous 6 months under ANY plan. Similarly, a discretionary acquisition of units of the Sonat Stock Fund (or phantom Sonat Stock Fund) under ANY plan (as described above) is exempt, UNLESS you elected to make a discretionary disposition of units of the Sonat Stock Fund (or phantom Sonat Stock Fund) under ANY plan within the previous 6 months. For example, assume the following sequence of transactions, with no prior discretionary transactions under any plan: December 1, 1998 -- you transfer 1,000 units out of the Sonat Stock Fund in the Savings Plan into a mutual fund. -20- 19 January 1, 1999 -- you transfer 1,000 units out of the phantom Sonat Stock Fund in the Supplemental Savings Plan into a phantom mutual fund. March 1, 1999 -- you acquire 1,000 units of the phantom Sonat Stock Fund in the Deferred Compensation Plan by transfer from a phantom mutual fund. July 1, 1999 -- you take an in-service cash withdrawal from the Savings Plan which results in the liquidation of 500 units of the Sonat Stock Fund. The first two transactions are exempt under Section 16(b), because they are both dispositions of Sonat stock or phantom stock and there was no discretionary acquisition under any plan within the preceding six months. The March 1 transaction is a non-exempt "purchase" under Section 16(b), because it is a discretionary acquisition that occurs only two months after a discretionary disposition (the January 1 transfer). The fact that the January and March transactions occurred in different plans does not change the result. The March 1 purchase can be matched against any sale that occurs inside or outside the plans within six months before or after March 1 (including a sale resulting from a cashless option exercise). The July transaction is a discretionary disposition that occurred within three months of the March 1 discretionary acquisition, so it is a non-exempt "sale" under Section 16(b). The March purchase and the July sale will be matched against each other for Section 16(b) short-swing profit liability purposes. -21- 20 C. DISTRIBUTIONS FROM THE PLAN In general, the liquidation of phantom Sonat Stock Funds units in connection with a distribution from the Plan is a Section 16(b) "sale", unless the Executive Compensation Committee of the Company's Board of Directors specifically approves the related deferral election. (However, such a liquidation is exempt under Section 16(b) if the distribution results from termination of employment, if you did not initially elect a lump-sum payment and subsequently change to annual installments.) D. REPORTING REQUIREMENTS Transactions in the Plan that result in a Section 16 "purchase" or "sale" must be reported on Form 4. All other (exempt) transactions must be reported on Form 5 (or, if you so elect, on an earlier Form 4). Each Form 4 or Form 5 report that shows a transaction in phantom Sonat Stock Fund units must show the total number of shares of phantom Sonat stock represented by the units credited to your account in the Plan. 21. CAN THE PLAN BE AMENDED OR DISCONTINUED? The Company's Board of Directors retains the right to amend or terminate the Plan at any time. However, your accrued benefits at the time of any amendment, suspension or termination of the Plan cannot be reduced. -22- 21 SONAT INC. DEFERRED COMPENSATION PLAN PLAN SUMMARY EXHIBIT A COMPARISON OF NON-QUALIFIED DEFERRED COMPENSATION PLAN AND BEFORE-TAX (401K) CONTRIBUTIONS TO QUALIFIED SONAT SAVINGS PLAN
================================================================================================================ NON-QUALIFIED DEFERRED QUALIFIED COMPENSATION PRINCIPAL CHARACTERISTICS SONAT SAVINGS PLAN PLAN ================================================================================================================ Yes Deferral on Pre-Tax Basis Yes(1) ---------------------------------------------------------------------------------------------------------------- Yes FICA/Medicare Withheld on Deferrals Yes ---------------------------------------------------------------------------------------------------------------- Yes Earnings Accumulate Tax Deferred Yes ---------------------------------------------------------------------------------------------------------------- No Actual Funds or Assets Held in Participant Accounts Yes ---------------------------------------------------------------------------------------------------------------- Yes Distributions Subject to Income Taxes Yes ---------------------------------------------------------------------------------------------------------------- Federal Income Tax Statutory Withholding Rate on 28% Lump-Sum Payments 20%(2) ---------------------------------------------------------------------------------------------------------------- No Rollover into an IRA Allowed Yes ---------------------------------------------------------------------------------------------------------------- No 5 or 10 Year Income Tax Averaging Available Yes(3) ---------------------------------------------------------------------------------------------------------------- Yes(4) Hardship Withdrawals Available Yes ---------------------------------------------------------------------------------------------------------------- No Loans Against Accounts Available Yes ---------------------------------------------------------------------------------------------------------------- No 10% Penalty Tax for pre-age 59 1/2 distributions Yes(2) ================================================================================================================
- -------------- (1) Amount limited by IRS rules. (2) If not rolled over. (3) 5 year averaging not available on distributions after 1999; 10 year averaging grandfathered for those born on or before January 1, 1936. (4) "Hardship" definition is much more stringent than in the Savings Plan. -23- EX-12 5 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES 1 EXHIBIT 12 SONAT INC. AND SUBSIDIARIES COMPUTATION OF RATIOS OF EARNINGS FROM CONTINUING OPERATIONS TO FIXED CHARGES TOTAL ENTERPRISE (a)
Years Ended December 31, ------------------------------------------------------------------------- 1998 1997 1996 1995 1994 ---- ---- ---- ---- ---- (In Thousands) Earnings from Continuing Operations: Income before income taxes $(838,232) $ 322,472 $ 379,004 $ 399,280 $ 176,901 Fixed charges (see computation below) 195,215 168,981 162,291 174,634 133,902 Less allowance for interest capitalized (5,123) (7,448) (7,642) (8,072) (7,736) --------- --------- --------- --------- --------- Total Earnings Available for Fixed Charges $(648,140) $ 484,005 $ 533,653 $ 565,842 $ 303,067 ========= ========= ========= ========= ========= Fixed Charges: Interest expense before deducting interest capitalized $ 187,102 $ 160,829 $ 154,769 $ 167,068 $ 126,193 Rentals(b) 8,113 8,152 7,522 7,566 7,709 --------- --------- --------- --------- --------- $ 195,215 $ 168,981 $ 162,291 $ 174,634 $ 133,902 ========= ========= ========= ========= ========= Ratio of Earnings to Fixed Charges (3.3)(c) 2.9 3.3 3.2 2.3 ========= ========= ========= ========= =========
- ----------- (a) Amounts include the Company's portion of the captions as they relate to persons accounted for by the equity method. (b) These amounts represent 1/3 of rentals which approximate the interest factor applicable to such rentals of the Company and its subsidiaries and unconsolidated affiliates. (c) Earnings from continuing operations for the year ended December 31, 1998 reflect ceiling test charges for the impairment of certain oil and gas properties and restructuring expenses primarily associated with a reduction in work force. Earnings before income taxes were reduced $1,050.2 million as a result of the ceiling test charges and restructuring charge. Because of these charges, earnings were inadequate to cover fixed charges of $195.2 million for the year ended December 31, 1998. The coverage deficiency was $843.4 million for the year. EX-21 6 SUBSIDIARIES OF SONAT INC. 1 EXHIBIT 21 SUBSIDIARIES OF SONAT INC. AS OF MARCH 1, 1999
Percent of Country of Voting Organization Securities or, if United Owned by States, State Immediate Name of Company of Organization Parent - --------------- --------------- --------- SONAT INC.: (a) SNT REALTY INC. (b) Alabama 100% SONAT ENERGY SERVICES COMPANY Delaware 100% Sonat West Georgia L.L.C.(c) Delaware 100% Sonat Intrastate-Alabama Inc. Alabama 100% Sonat Generating L.L.C.(c) Delaware 100% Sonat Marketing Company(d) Delaware 100% Sonat Marketing Company L. P.(e)(f)(g) Delaware 65% JV Trading Inc. (h) Delaware 100% Keystone Trading Company Delaware 100% Vail Trading Company Delaware 100% Sonat Power Inc. (i) Delaware 100% Sonat Mid-Georgia L.L.C.(j) Delaware 100% Pacific Gas Power Inc. Delaware 100% Sonat Power Marketing Inc.(k) Delaware 100% Sonat Power Marketing L. P. Delaware 65% Utilities Service Group L.P. (l) Delaware 100%
- ---------------------------- Indentations indicate subsidiaries of subsidiaries 2
Percent of Country of Voting Organization Securities or, if United Owned by States, State Immediate Name of Company of Organization Parent - --------------- --------------- --------- SONAT EXPLORATION COMPANY (m) Delaware 100% Field Gas Gathering Inc. Delaware 100% Sonat Minerals Inc. Delaware 100% Sonat Minerals Leasing Inc. Delaware 100% Sonat Texas Gathering Company Delaware 100% Sonat Oil Transmission Inc. Delaware 100% Stateline Gas Gathering Company Delaware 100% SONAT EXPLORATION GOM INC. Delaware 100% Sonat Energy Development I Company Delaware 100% SONAT POWER SYSTEMS INC. Delaware 100% SONAT SERVICES INC. Alabama l00% Sonat Services (D. C.) Inc. Delaware 100% SOUTHERN NATURAL GAS COMPANY(n)(o) Delaware 100% Sea Robin Pipeline Company(p) Louisiana 100% Sonat Gathering Company Delaware 100% Sonat Ventures Inc. (q)(r) Delaware 100% Sonat NGV Technology Inc. (s) Delaware 100% South Georgia Natural Gas Company Delaware l00% Southern Deepwater Pipeline Company L.L.C. Delaware l00% Southern LNG Inc. Delaware l00%
3
Percent of Country of Voting Organization Securities or, if United Owned by States, State Immediate Name of Company of Organization Parent - --------------- --------------- --------- Southern Gas Storage Company (t) Delaware l00% Southern Offshore Pipeline Company L.L.C. Delaware 100%
Notes - ----- (a) Sonat Inc. owns 50 percent of Citrus Corp., which owns 100 percent of the stock of Florida Gas Transmission Company, Florida Intrastate Pipeline Company, Citrus Trading Corp., Citrus Industrial Sales Company, Citrus Energy Services, Inc. and Citrus Interstate Pipeline Company. Houston Natural Gas Company, a wholly owned subsidiary of Enron Corp., owns the remaining 50 percent of Citrus Corp. (b) SNT Realty Inc. has a 50-percent interest in Fifth Avenue Realty Company, an unincorporated joint venture, the remaining 50 percent of which is owned by AmSouth Bank N.A. (c) Sonat West Georgia L.L.C. and Sonat Generating L.L.C. each hold general partnership interest in West Georgia Generating Company L.P., a Delaware limited partnership. (d) Sonat Marketing Company is a 65-percent participant and General Partner in Sonat Marketing Company L. P., a limited partnership; AGL Energy Services, Inc., a wholly owned subsidiary of AGL Resources, Inc., holds a 35-percent limited partnership interest. (e) Sonat Marketing Company L.P. has a 50-percent interest in Sonat Public Service Company L.L.C., a limited liability company, the remaining 50 percent of which is owned by PSNC Production Corporation, a wholly owned subsidiary of Public Service Company of North Carolina, Inc. (f) Sonat Marketing Company L.P. has a 50-percent interest in Stone & Webster Sonat Energy Resources L.L.C., a Delaware limited liability company; the remaining 50-percent interest is held by Stone & Webster Engineers & Construction, Inc, a wholly owned subsidiary of Stone & Webster, Inc. (g) Sonat Marketing Company L.P has a 50-percent interest in Unicom Gas Services LLC, a limited liability company, the remaining 50 percent of which is held by Unicom Energy Services, Inc., a wholly owned subsidiary of Unicom Corporation. (h) JV Trading Inc. has a 50-percent partnership interest in Seminole Gas Marketing; the remaining 50-percent partnership interest of which is held by Suwannee Gas Marketing, Inc., a subsidiary of Lykes Energy, Inc.
-3- 4 (i) Sonat Power Inc. is a 50-percent participant in AES/Sonat Power L.L.C., a limited liability company, the remaining 50-percent interest of which is held by AES Gas Power, Inc., a wholly owned subsidiary of The AES Corporation. (j) Sonat Mid-Georgia L.L.C. is a 50-percent participant in Mid-Georgia Cogen L.P., the remaining 50 percent is held jointly by NCP Inc. and NCP Houston Power Inc., wholly owned subsidiaries of GPU, Inc. (k) Sonat Power Marketing Inc. is a 65-percent participant and General Partner in Sonat Power Marketing L.P., a limited partnership; AGL Power Services, Inc., a wholly owned subsidiary of AGL Resources, Inc., holds a 35-percent limited partnership interest. (l) Sonat Energy Services Company has a 64-percent limited partnership interest and a 1-percent general partnership interest and Sonat Power Marketing Inc. has a 35-percent limited partnership interest in Utilities Service Group L.P., a Delaware limited partnership. (m) Sonat Exploration Company has a 50-percent interest in Black Warrior Methane Corp. and Black Warrior Transmission Corp., the remaining 50 percent of each is held by Jim Walter Resources, Inc. (n) Southern Natural Gas Company has a 33.33-percent interest in Destin Pipeline Company, L.L.C., a limited liability company, the remaining 66.66-percent interest is held equally by BP Amoco Destin Pipeline Company, a wholly owned subsidiary of BP Amoco Corporation, and Tejas Destin, LLC, a wholly owned subsidiary of Shell Oil Company. (o) Southern Natural Gas Company is a 50-percent participant in Etowah LNG Company, L.L.C., a limited liability company, the remaining 50 percent is held by AGL Peaking Services, Inc., a wholly owned subsidiary of AGL Resources, Inc. (p) Sea Robin Pipeline Company, an unincorporated joint venture organized under the laws of the State of Louisiana, is a wholly owned subsidiary of Southern Natural Gas Company through two wholly owned limited liability companies, Southern Offshore Pipeline Company, L.L.C. and Southern Deepwater Pipeline Company, L.L.C. (q) Sonat Ventures Inc. is a 50-percent participant in Monarch CNG, an Alabama general partnership, the remaining 50-percent interest of which is held by Midtown NGV, Inc., a wholly owned subsidiary of Energen Corporation. (r) Sonat Ventures Inc. is a 50-percent participant in Florida Natural Fuels, Ltd., a Florida limited partnership, the remaining 50-percent interest of which is held by Suwannee Gas Marketing, Inc., a wholly owned subsidiary of Lykes Energy, Inc. (s) Sonat NGV Technology Inc. is a one-half participant in NGV Southeast Technology Center, L.L.C., a Georgia limited liability company, the remaining 50 percent of which is held by Georgia Energy Company, a subsidiary of AGL Resources, Inc. (t) Southern Gas Storage Company has a 50-percent interest in Bear Creek Storage Company, an unincorporated joint venture, the remaining 50 percent of which is owned by Tennessee Storage Company, a wholly owned subsidiary of Tennessee Gas Pipeline Company, a subsidiary of El Paso Energy Corporation. Bear Creek Storage Company has a l00-percent interest in Bear Creek Capital Corporation.
-4- EX-22 7 PROXY STATEMENT OF SONAT INC 1 EXHIBIT 22 SONAT INC. P.O. BOX 2563, BIRMINGHAM, ALABAMA 35202 TELEPHONE: (205) 325-3800 - -------------------------------------------------------------------------------- NOTICE OF ANNUAL MEETING OF STOCKHOLDERS TO BE HELD APRIL 22, 1999 To Our Stockholders: The Annual Meeting of Stockholders of Sonat Inc., a Delaware corporation, will be held at the Luxury Collection Hotel, 1919 Briar Oaks Lane, Houston, Texas, at 9:00 a.m., local time, on Thursday, April 22, 1999, for the following purposes: 1. To elect four Directors as members of the Board of Directors of the Company, to serve until the 2002 Annual Meeting of Stockholders and until their respective successors have been duly elected and qualified. 2. To elect an Auditor of the Company for the ensuing year. The Board of Directors of the Company has recommended Ernst & Young LLP, the present Auditor, for election as Auditor (Proposal No. l). 3. To transact such other business as may properly be brought before the meeting. Only holders of Common Stock of record at the close of business on March 5, 1999, will be entitled to vote at the meeting. The meeting may be adjourned from time to time without other notice than by announcement at the meeting or at any adjournment thereof. Any and all business for which the meeting is hereby noticed may be transacted at any such adjournment. By order of the Board of Directors, /s/ Beverley T. Krannich BEVERLEY T. KRANNICH Secretary Birmingham, Alabama March 22, 1999 - -------------------------------------------------------------------------------- YOUR VOTE IS IMPORTANT PLEASE COMPLETE, SIGN AND RETURN YOUR PROXY IN THE ENCLOSED RETURN ENVELOPE. - -------------------------------------------------------------------------------- 2 PROXY STATEMENT FOR ANNUAL MEETING OF STOCKHOLDERS APRIL 22, 1999 This Proxy Statement is furnished in connection with the solicitation of proxies by Sonat Inc. (the "Company") on behalf of the Board of Directors of the Company, to be voted at the Annual Meeting of Stockholders, called to be held on Thursday, April 22, 1999 at 9:00 a.m. at the Luxury Collection Hotel, 1919 Briar Oaks Lane, Houston, Texas. Mailing of the Proxy Statement and the accompanying proxy card to the stockholders is expected to commence on or about March 23, 1999. VOTING SECURITIES As of March 11, 1999, the Company had outstanding 110,047,818 shares of Common Stock, par value $1.00 per share, which are its only voting securities. Holders of Common Stock are entitled to one vote for each share held. The Board of Directors has fixed March 5, 1999, as the record date for the determination of stockholders entitled to notice of, and to vote at, the Annual Meeting. THE PROXY If a proxy is executed properly by a stockholder and is not revoked, it will be voted at the Annual Meeting in the manner specified on the proxy. If no manner is specified, it will be voted "FOR" the election of the four nominees for Director and "FOR" Proposal No. 1. The submission of an executed proxy will not affect a stockholder's right to attend, and to vote in person at, the Annual Meeting. A stockholder who executes a proxy may revoke it at any time before it is voted by filing a written revocation with the Secretary of the Company, executing a proxy bearing a later date or attending and voting in person at the Annual Meeting. THE BOARD OF DIRECTORS URGES YOU TO SIGN, DATE AND RETURN THE ENCLOSED PROXY IN THE ENCLOSED RETURN ENVELOPE. ELECTION OF DIRECTORS The Company's Restated Certificate of Incorporation provides for the classification of the Board of Directors into three classes (Class I, Class II and Class III). Four Class I Directors are to be elected at the Annual Meeting of Stockholders to serve for a three-year term and until the election and qualification of their respective successors in office. On January 30, 1998, pursuant to the terms of an Agreement and Plan of Merger dated as of November 22, 1997 (the "Zilkha Merger Agreement") between the Company and Zilkha Energy Company, an oil and gas exploration, development and production company ("Zilkha Energy"), a wholly-owned subsidiary of the Company merged with Zilkha Energy. Pursuant to the terms of the Zilkha Merger Agreement, on December 5, 1997, the Board of Directors appointed Selim K. Zilkha as a Class III Director and Michael S. Zilkha as a Class I Director. Such appointments were effective immediately following the effective time of the merger on January 30, 1998. The Zilkha Merger Agreement provides that as long as Michael S. Zilkha, Selim K. Zilkha and their respective affiliates own at least 8% of the Company's Common Stock, the Board of Directors will nominate and support the reelection of the Zilkhas to the Board following the expiration of their respective terms. If such stock ownership drops below 8% of the Company's Common Stock, the Zilkha Merger Agreement provides that the Zilkhas will promptly tender their resignations as Directors. On March 13, 1999, the Company and El Paso Energy Corporation ("El Paso") entered into an agreement and plan of merger (the "El Paso Merger Agreement") pursuant to which, among other things, the Company and El Paso will be merged (the "El Paso Merger"). Pursuant to the terms of the El Paso Merger Agreement (and assuming that the Company stockholders and the El Paso stockholders approve the El Paso Merger Agreement and the El Paso Merger and that certain other conditions are met), the Company shall be merged with and into El Paso, with El Paso continuing as the surviving corporation. If the El Paso Merger is consummated, the Board of Directors of the combined company shall consist of fifteen members, nine of whom shall be designated by El Paso and six of whom shall be designated by the Company. 3 The four nominees for election as Class I Directors are Ronald L. Kuehn, Jr., Robert J. Lanigan, Charles Marshall and Michael S. Zilkha. Each of the nominees has been previously elected as a Director by the stockholders, except for Mr. Zilkha (who was appointed to the Board of Directors in connection with the Zilkha Energy merger, as discussed above). In the event that any of the nominees becomes unavailable for any reason, which is not anticipated, the Board of Directors in its discretion may, unless it has taken appropriate action to provide for a lesser number of Directors, designate a substitute nominee, in which event, pursuant to the accompanying proxy, votes will be cast for such substitute nominee. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" RONALD L. KUEHN, JR., ROBERT J. LANIGAN, CHARLES MARSHALL AND MICHAEL S. ZILKHA AS CLASS I DIRECTORS. NOMINEES FOR DIRECTOR -- CLASS I -- TERMS TO EXPIRE 2002 [Ronald L. Kuehn Jr. RONALD L. KUEHN, JR., age 63, is Chairman of the Board, Picture] President and Chief Executive Officer of the Company. He has served as a Director of the Company since 1981. Mr. Kuehn is also a Director of AmSouth Bancorporation, Praxair, Inc., Protective Life Corporation, The Dun & Bradstreet Corporation, Transocean Offshore Inc. and Union Carbide Corporation, and a member of the Board of Trustees of Tuskegee University and Southern Research Institute. During the past five years, Mr. Kuehn has served as an executive officer of the Company. - -------------------------------------------------------------------------------------------- ROBERT J. LANIGAN, age 70, is Chairman Emeritus of the Board [Robert J. Lanigan Picture] of Directors of Owens-Illinois, Inc., the principal business of which is the manufacture and sale of packaging products. He has served as a Director of the Company since 1983. Mr. Lanigan is also a Director of Cognizant Corporation, Daimler-Chrysler Corporation, The Dun & Bradstreet Corporation and Transocean Offshore Inc. During the past five years prior to his appointment to his current position, Mr. Lanigan served as an executive officer of Owens-Illinois, Inc. - -------------------------------------------------------------------------------------------- CHARLES MARSHALL, age 69, is the former Vice Chairman of the [Charles Marshall Picture] Board of American Telephone and Telegraph Company. He has served as a Director of the Company since 1982. Mr. Marshall is also a Director of Ceridian Corporation, GATX Corporation, Hartmarx Corporation and Sundstrand Corporation. Prior to his retirement, Mr. Marshall served as an executive officer of American Telephone and Telegraph Company. - --------------------------------------------------------------------------------------------
2 4 MICHAEL S. ZILKHA, age 44, is the former Executive Vice [Michael S. Zilkha Picture] President of Zilkha Energy. He served as an executive officer of Zilkha Energy from July 1986 to January 1998. Mr. Zilkha was an editor at Atlantic Monthly Press from 1985 to 1986, and from 1978 to 1985, he was President of ZE Records, an independent record production company in New York. - --------------------------------------------------------------------------------------------
CONTINUING DIRECTORS -- CLASS II -- TERMS TO EXPIRE 2000 JEROME J. RICHARDSON, age 62, is Owner/Founder of the NFL [Jerome J. Richardson Carolina Panthers. He has served as a Director of the Picture] Company since 1991. Mr. Richardson is also Chairman of the NFL Stadium Committee, a Director of The NCAA Foundation and a Trustee of Wofford College. During the past five years prior to his retirement in May 1995, Mr. Richardson served as an executive officer of Flagstar Companies, Inc. and Flagstar Corporation. - -------------------------------------------------------------------------------------------- ADRIAN M. TOCKLIN, age 47, is President and Chief Executive [Adrian M. Tocklin Picture] Officer of Tocklin & Associates, Inc., an insurance management and consulting firm. She has served as a Director of the Company since 1994. Ms. Tocklin is also a Director of CNA Surety Corp. and First Insurance Company of Hawaii, and a Trustee of George Washington University. During the past five years prior to her retirement in April 1998, Ms. Tocklin served as an executive officer of CNA Insurance Companies and The Continental Corporation. - --------------------------------------------------------------------------------------------
3 5 JAMES B. WILLIAMS, age 66, is Chairman of the Executive [James B. Williams Picture] Committee of the Board of Directors of SunTrust Banks, Inc. He has served as a Director of the Company since 1987. Mr. Williams is also a Director of The Coca-Cola Company, Genuine Parts Company, Georgia-Pacific Corporation, Rollins, Inc. and RPC, Inc. During the past five years prior to his retirement in March 1998, Mr. Williams served as Chairman of the Board and Chief Executive Officer of SunTrust Banks, Inc. - -------------------------------------------------------------------------------------------- JOE B. WYATT, age 63, is Chancellor, Chief Executive Officer [Joe B. Wyatt Picture] and Trustee of Vanderbilt University, a position he has held during the past five years. He has served as a Director of the Company since 1984. Chancellor Wyatt is also a Director of Advanced Network & Services, Inc., Ingram Micro, Inc., Reynolds Metals Company, The Aerostructures Corporation and University Research Association. - --------------------------------------------------------------------------------------------
CONTINUING DIRECTORS -- CLASS III -- TERMS TO EXPIRE 2001 MAX L. LUKENS, age 50, is Chairman, President and Chief [Max L. Lukens Picture] Executive Officer of Baker Hughes Incorporated, the principal business of which is the provision of products and services to the petroleum and continuous process industries. He has served as a Director of the Company since 1995. Mr. Lukens is also a Director of Baker Hughes Incorporated and Transocean Offshore Inc. During the past five years, Mr. Lukens has served as an executive officer of Baker Hughes Incorporated. - --------------------------------------------------------------------------------------------
4 6 BENJAMIN F. PAYTON, age 66, is President of Tuskegee [Benjamin F. Payton Picture] University, a position he has held during the past five years. He has served as a Director of the Company since 1992. Dr. Payton is also a Director of AmSouth Bancorporation, Liberty Corporation, Morrison's Health Care, Inc., Praxair, Inc. and Ruby Tuesday, Inc. - -------------------------------------------------------------------------------------------- JOHN J. PHELAN, JR., age 67, is the former Chairman of the [John J. Phelan, Jr. Board and Chief Executive Officer of the New York Stock Picture] Exchange. From 1991 to 1993, he was President of the International Federation of Stock Exchanges. Mr. Phelan has served as a Director of the Company since 1990. He is also a Director of Eastman Kodak Company, Merrill Lynch & Co., Inc. and Metropolitan Life Insurance Company and a Senior Advisor to The Boston Consulting Group. - -------------------------------------------------------------------------------------------- SELIM K. ZILKHA, age 71, is the former Chief Executive [Slim K. Zilkha Picture] Officer of Zilkha Energy. He served as the sole Director and Chief Executive Officer of Zilkha Energy from March 1984 until January 1998. Prior to such time, Mr. Zilkha was a banker with Zilkha & Sons in the United States and Europe from 1947 to 1955 and in London from 1955 to 1960. In 1960, he founded Mothercare, PLC, a retail chain catering to mothers-to-be, babies and small children in Great Britain, Europe and the United States. Mr. Zilkha sold his interest in Mothercare, PLC in January 1982.
Selim K. Zilkha is the father of Michael S. Zilkha. There are no other family relationships between Directors and executive officers of the Company. William O. Bourke, who is currently a Class I Director, will retire from the Board of Directors on April 22, 1999, in accordance with the Board's retirement policy. BOARD MEETINGS AND COMMITTEES During 1998 the Board of Directors held eight regular and special meetings. The Board has established Committees that assist the Board in the discharge of its responsibilities. Each Director attended at least 75% of the meetings of the Board and the Committees on which the Director served. Audit Committee. The Audit Committee reviews and reports to the Board the scope and results of audits by the Auditor and the Company's internal auditing staff, and reviews with the Auditor the 5 7 adequacy of the Company's system of internal controls. It reviews transactions between the Company and its Directors and officers and Company policies with respect thereto, and compliance with the Company's business ethics and conflict of interest policies. The Committee also recommends a firm of certified public accountants to serve as Auditor of the Company (subject to nomination by the Board and election by the stockholders), authorizes all audit and other professional services rendered by the Auditor and periodically reviews the independence of the Auditor. Membership on the Audit Committee is restricted to those Directors who are not active or retired officers or employees of the Company. The Company's policy on Audit Committee membership complies with the Audit Committee Policy Statement adopted by the New York Stock Exchange. The current members of the Committee are John J. Phelan, Jr., Chairman, Charles Marshall, Jerome J. Richardson, Adrian M. Tocklin and Joe B. Wyatt. The Committee met three times during 1998. Committee on Directors. The Committee on Directors makes recommendations to the Board with respect to the size and composition of the Board, Board retirement and tenure policies, and Director compensation. It also reviews the qualifications of potential candidates for the Board of Directors, evaluates the performance of incumbent Directors and recommends to the Board nominees to be elected at the Annual Meeting of Stockholders. The current members of the Committee are Charles Marshall, Chairman, William O. Bourke, Benjamin F. Payton, John J. Phelan, Jr., Jerome J. Richardson, James B. Williams and Selim K. Zilkha. The Committee met once during 1998. The Committee on Directors will consider nominees for Director recommended by stockholders. Recommendations should be submitted in writing, accompanied by a resume of the nominee's qualifications and business experience and a signed statement of the proposed candidate consenting to be named as a candidate and, if nominated and elected, to serve as a Director, and addressed to the offices of the Company to the attention of Beverley T. Krannich, Secretary. Employee Benefits Committee. The Employee Benefits Committee periodically reviews the status of the Company's employee benefit programs and the performance of the managers of the funded programs. To assist in its review, the Committee meets periodically with the chairman of the administrative committee of the funded plans. The current members of the Committee are Joe B. Wyatt, Chairman, Robert J. Lanigan, Benjamin F. Payton, Adrian M. Tocklin, James B. Williams and Michael S. Zilkha. The Committee met twice during 1998. Executive Compensation Committee. The Executive Compensation Committee reviews and makes recommendations to the Board with respect to the Company's overall executive compensation policy. The Committee also reviews and approves the compensation of the officers of the Company and makes awards under the Executive Award Plan, Performance Award Plan and Cash Bonus Plan. Membership on the Executive Compensation Committee is restricted to Directors who are not active or retired officers or employees of the Company. The current members of the Committee are Robert J. Lanigan, Chairman, William O. Bourke, Max L. Lukens, James B. Williams and Joe B. Wyatt. The Committee met seven times during 1998. Finance Committee. The Finance Committee approves long-term financial policies and annual financial plans, significant capital expenditures, insurance programs and investment policies of the Company. It also makes recommendations to the Board concerning dividend policy, the issuance and terms of debt and equity securities and the establishment of bank lines of credit. The current members of the Committee are James B. Williams, Chairman, Robert J. Lanigan, Max L. Lukens, John J. Phelan, Jr., Jerome J. Richardson and Selim K. Zilkha. The Committee met three times during 1998. Public Affairs Committee. The Public Affairs Committee reviews the Company's policies and practices which address issues of social and public concern, such as government affairs, the environment, energy conservation and charitable contributions. It also reviews stockholder relations and considers stockholder proposals and matters of corporate governance. The current members 6 8 of the Committee are William O. Bourke, Chairman, Charles Marshall, Benjamin F. Payton, John J. Phelan, Jr., Adrian M. Tocklin and Michael S. Zilkha. The Committee met twice during 1998. Strategic Planning Committee. The Strategic Planning Committee assists in the formulation of the business strategies of the Company and its subsidiaries and reviews the Company's management succession plan. The current members of the Committee are Max L. Lukens, Chairman, William O. Bourke, Robert J. Lanigan, Charles Marshall, Benjamin F. Payton, John J. Phelan, Jr., Jerome J. Richardson, Adrian M. Tocklin, James B. Williams, Joe B. Wyatt, Michael S. Zilkha and Selim K. Zilkha. The Committee met six times during 1998. COMPENSATION OF OUTSIDE DIRECTORS FEES AND RETAINERS. Each non-employee Director of the Company receives a quarterly retainer of $9,000 ($10,250 for Committee Chairmen) and a fee of $1,250 for each Board meeting and each Board Committee meeting attended, plus incurred expenses where appropriate. Pursuant to the Director's Fees Deferral Plan, a Director may elect to defer receipt of some or all of the Director's fees and retainer. All amounts deferred are credited to the Director's account under the Plan. The Director may invest the Plan balance in "phantom" investments in the Company's common stock and twelve mutual funds. The Director may choose to have the account balance distributed in a lump sum or in annual installments, commencing upon termination of service as a Director. RETIREMENT PLAN FOR DIRECTORS. Directors of the Company who during some portion of their service as Directors were not officers of the Company or its subsidiaries are participants in the Retirement Plan for Directors. An eligible Director who ceases being a Director after reaching age 70, completing five years of service as a non-employee Director or as a result of death or permanent disability, will receive a retirement benefit from the Plan. The Director may choose to have such benefit paid as either (1) a cash lump sum in an amount equal to the value of a series of quarterly payments equal to the retainer (as of the date of the Director's retirement) for the period the Director served as a non-employee Director of the Company or (2) in a series of quarterly payments with a value equal to such lump-sum payment. RESTRICTED STOCK PLAN FOR DIRECTORS. Each non-employee Director of the Company is a participant in the Restricted Stock Plan for Directors. Each such Director who was a member of the Board of Directors on April 1, 1998 (the effective date of the Plan, as amended and restated on February 26, 1998) was granted 2,000 shares of restricted stock on such date. The Plan provides that 400 shares granted to each Director will vest on April 1 of each of the years 1999 through 2003. Each person who first becomes a non-employee Director after April 1, 1998 and before April 1, 2003 will be granted 33.33 shares of restricted stock for each calendar month or fraction thereof from the Director's election as a non-employee Director to the following March 31 (rounded to the nearest whole share), plus 400 shares for each subsequent Plan Year (April 1 -- March 31) until April 1, 2003. The product of 33.33 shares times the number of full and partial calendar months from the Director's election as a non-employee Director to the following March 31 (rounded to the nearest whole share) will vest on the April 1 following such election, and 400 shares will vest on each April 1 thereafter through April 1, 2003. All shares of restricted stock will vest immediately upon the Director's death or disability. At the time the restricted stock vests, the Director will receive a cash tax-offset "supplemental payment" in an amount equal to the amount necessary to pay the federal income tax payable with respect to both the vesting of restricted stock and receipt of the supplemental payment, assuming the Director is taxed at the maximum effective federal income tax rate. If a Director leaves the Board of Directors before all of the Director's shares of restricted stock have vested, the unvested shares will be forfeited. 7 9 OWNERSHIP OF COMMON STOCK BY DIRECTORS AND EXECUTIVE OFFICERS The following table shows the amount and nature of beneficial ownership of shares of the Common Stock of the Company beneficially owned by the Directors and certain executive officers of the Company, and by all present Directors and executive officers of the Company as a group, as of January 31, 1999. For information regarding certain entities known by the Company to be the beneficial owner of more than 5% of the Company's Common Stock as of December 31, 1998, see "Institutional Ownership of Common Stock" at page 22.
AMOUNT AND NATURE PERCENT OF NAME OF BENEFICIAL OWNER OF BENEFICIAL OWNERSHIP (1) CLASS ------------------------ --------------------------- ---------- William O. Bourke......................... 7,000 * John B. Holmes, Jr........................ 10,450(2) * Ronald L. Kuehn, Jr....................... 846,922(2 and 3) * Robert J. Lanigan......................... 8,040(4) * Max L. Lukens............................. 4,107 * Charles Marshall.......................... 16,958 * James E. Moylan, Jr....................... 131,236(2 and 5) * Benjamin F. Payton........................ 4,805 * John J. Phelan, Jr........................ 4,660 * Jerome J. Richardson...................... 7,464 * James A. Rubright......................... 113,289(2) * William A. Smith.......................... 235,659(2) * Adrian M. Tocklin......................... 5,390(6) * James B. Williams......................... 25,361 * Joe B. Wyatt.............................. 5,200 * Michael S. Zilkha......................... 8,994,664(7) 8.2% 909 Fannin Two Houston Center, Suite 2910 Houston, TX 77010 Selim K. Zilkha........................... 14,118,916(8) 12.8% 750 Lausanne Road Los Angeles, CA 90077 All present Directors and Executive Officers as a Group (21 persons)........ 24,831,831(9) 22.6%
- --------------- * Less than 1%. NOTE 1: Each Director and executive officer has sole voting power and sole investment power with respect to all shares beneficially owned by such individual, unless otherwise indicated. In connection with the execution of the El Paso Merger Agreement, on March 13, 1999, El Paso entered into separate voting agreements with (1) Michael S. Zilkha, Selim K. Zilkha and an affiliated entity, and (2) Ronald L. Kuehn, Jr., pursuant to which, among other things, such stockholders of the Company agreed to vote their shares of the Company's Common Stock in favor of the El Paso Merger Agreement and the transactions contemplated thereby. The number of shares shown includes 2,000 shares of restricted stock for each of William O. Bourke, Robert J. Lanigan, Max L. Lukens, Charles Marshall, Benjamin F. Payton, John J. Phelan, Jr., Jerome J. Richardson, Adrian M. Tocklin, James B. Williams, Joe B. Wyatt, Michael S. Zilkha and Selim K. Zilkha, granted under the Company's Restricted Stock Plan for Directors, which shares had not vested as of January 31, 1999. Such persons have the power to vote and receive dividends on such shares, but do not have the power to dispose of, or to direct the disposition of, such shares until such shares are vested pursuant to the terms of such plan. The number of shares shown includes "phantom" shares of the Company's Common Stock held by the following individuals: (a) Charles Marshall, 7,358 phantom shares; Adrian M. Tocklin, 757 phantom shares; and James B. Williams, 8,161 phantom shares (all held under the Company's Director's Fees Deferral Plan); and (b) John B. Holmes, Jr., 186 phantom shares; Ronald L. 8 10 Kuehn, Jr., 43,021 phantom shares; James E. Moylan, Jr., 462 phantom shares; James A. Rubright, 842 phantom shares; and William A. Smith, 965 phantom shares (all held under the Company's Supplemental Benefit Plan and Deferred Compensation Plan). NOTE 2: The number of shares shown for Messrs. Kuehn, Moylan, Rubright and Smith includes 118,400 shares, 7,900 shares, 7,900 shares and 7,700 shares, respectively, of restricted stock granted under the Company's Executive Award Plan, which shares had not vested as of January 31, 1999. Such persons have the right to vote and receive dividends on such shares, but do not have the power to dispose of, or to direct the disposition of, such shares until such shares are vested pursuant to the terms of such plan. The number of shares shown for Messrs. Holmes, Kuehn, Moylan, Rubright and Smith also includes (a) 264 shares, 52,127 shares, 11,858 shares, 556 shares and 17,664 shares, respectively, held by the Trustee under the Company's Savings Plan as of January 31, 1999; and (b) 10,000 shares, 616,200 shares, 105,000 shares, 98,500 shares and 192,400 shares, respectively, covered by options under the Company's Executive Award Plan which were exercisable within sixty days after January 31, 1999. NOTE 3: The number of shares shown for Mr. Kuehn includes 10,500 shares owned by his wife, 20 shares owned by his children, and 2,000 shares held in trust for his children, of which shares he disclaims any beneficial ownership. NOTE 4: The number of shares shown for Mr. Lanigan includes 4,240 shares held in a family limited partnership. Mr. Lanigan is the sole shareholder of the corporate general partner of the partnership, and he and his wife own all of the limited partnership interests of the partnership. NOTE 5: The number of shares shown for Mr. Moylan includes 1,237 shares owned by his wife, of which shares he disclaims any beneficial ownership. NOTE 6: The number of shares shown for Ms. Tocklin includes 100 shares owned by her husband, of which shares she disclaims any beneficial ownership. NOTE 7: The number of shares shown for Michael S. Zilkha includes 180,000 shares held in a family limited partnership. Mr. Zilkha and his wife each own a 50% interest in the limited liability company that is the general partner of the partnership, and Mr. Zilkha owns all of the limited partnership interest of the partnership. NOTE 8: The number of shares shown for Selim K. Zilkha includes 14,116,816 shares held in the Selim K. Zilkha Trust (of which Mr. Zilkha is settlor, trustee and beneficiary). NOTE 9: The number of shares shown includes 168,100 shares of restricted stock granted under the Company's Executive Award Plan, which shares had not vested as of January 31, 1999; 118,687 shares held by the Trustee under the Company's Savings Plan as of January 31, 1999; 1,226,460 shares covered by options under the Company's Executive Award Plan which were exercisable within sixty days after January 31, 1999; 24,000 shares of restricted stock granted under the Company's Restricted Stock Plan for Directors, which shares had not vested as of January 31, 1999; and 64,185 phantom shares of the Company's Common Stock held under the Company's Director's Fees Deferral Plan, Supplemental Benefit Plan and Deferred Compensation Plan as of January 31, 1999. COMPENSATION OF EXECUTIVE OFFICERS REPORT OF THE EXECUTIVE COMPENSATION COMMITTEE The Executive Compensation Committee of the Board of Directors of the Company, which is composed solely of non-employee Directors, administers the Company's executive compensation program. The Committee's primary responsibility is to ensure that the executive compensation program furthers the interests of the Company and its stockholders. The Company's executive compensation program has three principal objectives: (1) to attract and retain a highly qualified and motivated management team; (2) to appropriately reward individual 9 11 executives for their contributions to the attainment of the Company's key strategic goals; and (3) to link the interests of executives and stockholders through stock-based plans and performance measures. The Committee meets with outside consultants at least annually to evaluate the Company's performance against the performance of a peer group of companies and to review and compare the level of compensation paid or awarded to key executives to the compensation practices of the peer group. The peer group used for determining 1998 compensation for corporate executives consisted of 12 publicly held companies in the energy business (the "Corporate Peer Group"). In comparing the level of the Company's compensation to that of the companies in the Corporate Peer Group, the Committee reviews an analysis which "size-adjusts" the compensation paid by a company to take into account the relative size of the company as measured by its revenues. The recommended size-adjustment is computed by an independent compensation consulting firm. The Committee also reviews and may give greater weight to compensation survey data specific to a particular business segment when considering the compensation of executive officers whose job is related primarily to a single business segment. The key components of the Company's executive compensation program are base salary, annual cash bonus incentives, and long-term stock incentives. The Committee's policies with respect to each component of the program, including the bases for the compensation of Mr. Kuehn, Chairman of the Board, President and Chief Executive Officer of the Company, are described below. The Committee consults with Mr. Kuehn in reviewing the individual performance and compensation of key executives of the Company (other than Mr. Kuehn). The Committee reviews Mr. Kuehn's performance and compensation in executive session at least annually. BASE SALARIES. Base salaries are initially established by an evaluation of the executive's position, responsibilities and experience and a review of salary surveys. Each year the Committee reviews the base salaries of key executive officers of the Company and its subsidiaries and determines whether salaries should be adjusted, based primarily on the executive's individual performance and experience and salary survey information. In general, the Committee's objective is to maintain overall executive salaries at the median of the salaries for comparable executives in the Corporate Peer Group or other relevant peer group. Executive salaries for 1998 were slightly below the median level overall, although some executives were below and some above the median. Mr. Kuehn has been in his current position for approximately 14 1/2 years, and has significantly longer tenure than the average tenure of the chief executive officers in the Corporate Peer Group. His current salary (which was increased 9.0% effective October 1) is 2.0% above the median of the Corporate Peer Group. ANNUAL CASH BONUS INCENTIVES. Annual cash bonus incentive opportunities are awarded each year. The amount of an executive's bonus opportunity (which is expressed as a percentage of base salary) is dependent primarily upon such individual's position and responsibilities and the bonus opportunities provided to comparable positions within the Corporate Peer Group or other relevant peer group. At the beginning of each year, the Committee reviews and approves annual performance goals. Shortly after the end of the year, the Committee determines the appropriate bonus payout levels based on the degree to which these goals have been achieved. The design of the annual incentive program takes into account the fact that the Company's financial results can be significantly affected by factors that are beyond the control of the Company and its management, such as oil and natural gas prices. Therefore, when compared to the programs of many other employers, the Company's annual incentive program generally provides a lower level of payout when the Company significantly exceeds the established financial goals, and a higher level of payout when the Company's financial goals are only partially achieved. The payout of an executive's 1998 bonus opportunity was based on the level of achievement of certain corporate and subsidiary financial goals, corporate and subsidiary business goals, and individual goals, as described below. The goals for each executive's bonus opportunity were weighted as follows: financial goals -- 50%; business goals -- 35%; and individual goals -- 15%. The 10 12 Committee also has the discretion to make additional cash bonus awards to recognize exceptional individual performance. The corporate financial goals included in the 1998 bonus opportunities were the Company's 1998 earnings per share ("EPS") as compared to EPS targets established by the Committee, the Company's annual cash flow return on assets as compared to the mean of the cash flow return of a group of energy companies whose aggregate asset mix approximates that of the Company (the "Financial Peer Group"), and the Company's annual total stockholder return ("TSR") as compared to the mean of the TSR of the Financial Peer Group. For subsidiary officers, subsidiary financial goals included subsidiary earnings before corporate charges ("EBC") as compared to EBC targets established by the Committee, and subsidiary annual cash flow return on assets as compared to the mean of the cash flow return of a subsidiary peer group. Each goal had a minimum level of achievement that was required for any payout to be made. The corporate and subsidiary business goals included in the 1998 bonus opportunities included operating, marketing and strategic goals relating to each major business segment, and goals relating to safety and the environment, human resources, and corporate citizenship. When appropriate, an executive's goals focused on the company for which he was primarily employed. Achievement of many of the goals was determined by quantitative or objective measures, while other goals were subjective in nature. Each executive's 1998 bonus opportunity included individual performance. Mr. Kuehn's individual performance was based primarily on the Committee's assessment of his leadership for the year. In January 1999, the Committee reviewed in detail the extent to which the 1998 performance goals had been achieved. The Company's EPS and TSR were below the minimum payout levels, while cash flow return on assets was above the mean for the Financial Peer Group and resulted in a payout percentage of 123% of the bonus opportunity for that goal. The level of achievement of subsidiary financial goals varied among the business segments. The Sonat Pipeline Group had payout percentages of 45% of the bonus opportunity for its EBC goal and 100% of the bonus opportunity for its cash flow return on assets goal. Sonat Exploration Company had earnings below the minimum payout level for its EBC goal, and a payout percentage of 135% of the bonus opportunity for its cash flow return on assets goal. The level of achievement of corporate and subsidiary business goals varied considerably among the Company's business segments. The payout percentage for these goals ranged from 47% to 69%. Including individual performance, the total bonus payout percentages under the 1998 annual incentive program for Company and subsidiary officers ranged from 48% to 87%. Mr. Kuehn's total bonus payout percentage for 1998 was 48% of his bonus opportunity, compared to 70% of his bonus opportunity for 1997 and 108% of his bonus opportunity for 1996. LONG-TERM STOCK INCENTIVES. The long-term stock incentives component of the Company's executive compensation program is designed to align executive and stockholder interests by rewarding executives for the attainment of stock price appreciation and total stockholder returns. As a general rule, the Committee administers the long-term stock incentive program through annual grants of stock options and restricted stock to certain executive officers of the Company and its major operating subsidiaries. For purposes of determining the value of long-term incentive compensation, an independent compensation consulting firm values stock options using a modified Black-Scholes option pricing model. Similarly, the consulting firm values restricted share grants based on the present value of the shares on the date of grant (taking into account the vesting schedules of the grants and projected executive turnover). The Committee may adjust the grants to take into account individual performance and the number of options and restricted shares previously granted to the executive. In addition, the Committee may make special awards to individual executives during the year on a discretionary basis. 11 13 The number of stock options and restricted shares granted to each executive officer as part of the annual grant program is generally determined primarily by individual position and responsibilities, compensation survey data of the Company's Corporate Peer Group, and the Company's three-year total stockholder return (considering stock price appreciation and dividends paid, and weighted for most recent performance) as compared to the total stockholder return of the Financial Peer Group. The amount of an executive's annual long-term incentive grant (expressed as a percentage of base salary)is tied to the Company's total stockholder return as compared to that of the Financial Peer Group. A minimum level of total stockholder return must be attained in order for grants to be made under the program. In 1998, the Company's weighted annualized three-year total stockholder return was below the minimum level established by the Committee. In December 1998, the Committee reviewed compensation survey data which indicated that over the past few years the value of the long-term incentive grants made to senior executives was substantially below the level required to appropriately compensate the Company's key officers. The Committee also considered executive retention and the Committee's continued desire to align the interests of executives and stockholders and to motivate the Company's senior management to increase total stockholder return. Based on these considerations, the Committee granted long-term incentive awards in December 1998 at a level designed to be at or below the 25th percentile of the Corporate Peer Group. All grants were made in the form of stock options; no restricted shares were awarded. Mr. Kuehn was awarded stock options in December 1998. As discussed above, the amount of this award was intended to result in long-term compensation at or below the 25th percentile of the Corporate Peer Group. Mr. Kuehn's total long-term incentive grants in 1998 had a value of 97% of his salary, as compared to 185% of his salary in 1997 and 235% of his salary in 1996. The Committee will continue to consider individual position and responsibilities, compensation survey data, total stockholder return, and stockholder interests in its administration of the long-term stock incentive program. STOCK OWNERSHIP GUIDELINES. The Committee has established guidelines designed to encourage key executives of the Company and its subsidiaries to attain specified levels of stock ownership over a five-year period. Stock ownership goals are based on the value of the Company's stock, and are expressed as a multiple of the executive's base salary. The Committee periodically reviews the guidelines and the executives' progress toward attaining the stock ownership goals. POLICY WITH RESPECT TO SECTION 162(m). Section 162(m) of the Internal Revenue Code limits the tax deduction that the Company or its subsidiaries can take with respect to the compensation of certain executive officers, unless the compensation is "performance-based." The Committee expects that all income recognized by executive officers with respect to restricted stock and stock options granted under the Executive Award Plan will qualify as performance-based compensation. The Committee feels that it should not use only arithmetic formulas in carrying out its responsibilities for compensating the Company's management. Therefore, the Committee currently intends to continue to make cash bonus payments that are based on the achievement of subjective, non-quantifiable goals, and that may therefore not qualify as performance-based compensation. The Committee believes that these Company, subsidiary and individual goals, while not properly measurable by the kind of quantifiable targets that are required to qualify compensation as performance-based, are important to the long-term financial success of the Company and to its stockholders. CONCLUSION. The Committee believes that the executive compensation philosophy that it has adopted effectively serves the interests of the stockholders and the Company. It is the Committee's intention that the pay delivered to executives be commensurate with Company performance. 12 14 Robert J. Lanigan William O. Bourke Max L. Lukens James B. Williams Joe B. Wyatt
SUMMARY COMPENSATION TABLE The following table shows, for the fiscal years ending December 31, 1996, 1997 and 1998 the cash compensation paid by the Company, and a summary of certain other compensation paid or accrued for such years, to certain of the Company's executive officers (as determined pursuant to the rules of the Securities and Exchange Commission) (the "named executive officers") for service in all capacities with the Company and its subsidiaries. SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION ANNUAL COMPENSATION AWARDS ---------------------------------- ---------------------------- SECURITIES RESTRICTED UNDERLYING ALL OTHER NAME AND OTHER ANNUAL STOCK OPTIONS/ COMPENSATION PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION AWARDS(1) SARS (2) - ------------------ ---- -------- -------- ------------ ---------- ---------- ------------ Ronald L. Kuehn, Jr., 1998 $797,500 $440,000 $1,283,945(3) $ 0 112,600 $ 47,850 Director, Chairman of 1997 $770,500 $550,000 $ 0 $385,528(4) 92,000 $105,522 the Board, President and 1996 $736,500 $800,000 $2,154,978(3) $748,800(5) 82,500 $111,058 Chief Executive Officer John B. Holmes, Jr., 1998 $341,667 $182,940 $ 0 $ 0 185,000 $ 20,067 Senior Vice President(6) James E. Moylan, Jr., 1998 $294,250 $116,625 $ 0 $ 0 35,000 $ 33,016 Senior Vice President 1997 $259,000 $132,100 $ 0 $ 70,096(4) 25,000 $ 30,098 and Chief Financial 1996 $245,000 $190,000 $ 0 $208,000(5) 20,000 $ 29,131 Officer James A. Rubright, 1998 $372,667 $187,990 $ 0 $ 0 85,000 $ 43,522 Executive Vice 1997 $314,250 $163,600 $ 0 $ 70,096(4) 25,000 $ 41,810 President 1996 $300,250 $193,700 $ 0 $208,000(5) 20,000 $ 41,246 William A. Smith, 1998 $365,000 $160,000 $ 0 $ 0 35,000 $ 40,380 Executive Vice 1997 $365,000 $131,300 $ 669,098(3) $ 70,096(4) 23,000 $ 43,547 President and General 1996 $365,000 $218,300 $ 919,299(3) $197,600(5) 17,000 $ 44,260 Counsel
NOTE 1: The amount shown represents the dollar value of restricted stock awards made during the year, calculated by multiplying the closing price of unrestricted shares of the Company's Common Stock on the date of grant by the number of shares awarded. Dividends are paid on all shares of restricted stock. All shares of restricted stock granted to Messrs. Moylan, Rubright and Smith generally vest at the earlier of age 65 or 10 years from the date of grant, unless the average closing price of the Company's Common Stock achieves certain specified levels, in which case vesting of such shares is accelerated. All shares of restricted stock granted to Mr. Kuehn generally vest on April 1, 2001. All shares of restricted stock that have not previously vested are generally forfeited upon termination of employment, unless such termination occurs either by reason of death or disability or for the convenience of the Company (as determined by the Executive Compensation Committee). All shares of restricted stock that have not previously vested will immediately vest upon a "Change of Control" of the Company, as described under "Compensation Upon Change of Control" below. The El Paso Merger, if consummated, will constitute a Change of Control for this purpose. The number of shares of restricted stock held by the named executive officers as of December 31, 1998, and the value of such shares (calculated by multiplying the closing price of unrestricted shares of the Company's Common Stock on December 31, 1998 ($27.0625) by the number of shares held on such date) is as follows: Mr. Kuehn, 118,400 shares, $3,204,200; 13 15 Mr. Holmes, 0 shares, $0; Mr. Moylan, 7,900 shares, $213,794; Mr. Rubright, 7,900 shares, $213,794; and Mr. Smith, 7,700 shares, $208,381. NOTE 2: With respect to 1998, represents the following amounts for each of Messrs. Kuehn, Holmes, Moylan, Rubright and Smith, respectively: (1) Company matching contributions to the trust established under the Company's Savings Plan -- $9,600, $9,167, $9,600, $9,600 and $9,600; (2) Company contributions to the Savings Plan accounts under the Company's Supplemental Benefit Plan -- $38,250, $10,900, $8,055, $12,760 and $12,300; and (3) with respect to premiums paid by the Company under the Company's "split-dollar" Executive Life Insurance Program, the sum of (a) the value of the premium payment used to purchase term life insurance plus (b) the value of the benefit to the executive officer of the remainder of the premium payment -- $0, $0, $15,361, $21,162 and $18,480. NOTE 3: Represents the amount of tax-offset "supplemental payments" paid upon the exercise of stock options (or tandem stock appreciation rights) granted under the Company's Executive Award Plan. NOTE 4: Represents the value of 8,800 shares, 1,600 shares, 1,600 shares and 1,600 shares of restricted stock granted on December 5, 1997 to Messrs. Kuehn, Moylan, Rubright and Smith, respectively. NOTE 5: Represents the value of 14,400 shares, 4,000 shares, 4,000 shares and 3,800 shares of restricted stock granted on December 5, 1996 to Messrs. Kuehn, Moylan, Rubright and Smith, respectively. NOTE 6: Mr. Holmes was employed by the Company on January 30, 1998 and was named Senior Vice President of the Company effective as of May 1, 1998. OPTION GRANT TABLE The following table contains certain information with respect to stock options (and tandem stock appreciation rights that become exercisable only upon certain change of control events ("Limited SARs")) granted in 1998 under the Company's Executive Award Plan to the named executive officers. OPTION/SAR GRANTS IN LAST FISCAL YEAR
POTENTIAL REALIZABLE VALUE AT ASSUMED ANNUAL RATES OF STOCK PRICE APPRECIATION FOR OPTION INDIVIDUAL GRANTS TERM (10 YEARS) ------------------------------------------------------- -------------------------------- NUMBER OF % OF TOTAL SECURITIES OPTIONS/SARS UNDERLYING GRANTED TO EXERCISE OPTIONS/SARS EMPLOYEES PRICE EXPIRATION NAME GRANTED (1) IN 1998 ($/SHARE)(2) DATE(3) 5%(4) 10%(4) ---- ------------ ------------ ------------ ---------- --------------- -------------- All Stockholders......... 110,059,886 -- -- -- $ 1,898,808,183 $4,813,193,964 Ronald L. Kuehn, Jr.(5)................. 112,600 8.5% $27.4375 12/3/08 $ 1,942,632 $ 4,924,280 John B. Holmes, Jr.(6)... 50,000 3.8% $ 44.69 1/20/08 $ 1,405,500 $ 3,561,000 John B. Holmes, Jr.(7)... 75,000 5.7% $ 43.875 4/22/08 $ 2,069,625 $ 5,244,375 John B. Holmes, Jr.(5)... 60,000 4.5% $27.4375 12/3/08 $ 1,035,150 $ 2,623,950 James E. Moylan, Jr.(5)................. 35,000 2.6% $27.4375 12/3/08 $ 603,838 $ 1,530,638 James A. Rubright(7)..... 25,000 1.9% $ 43.875 4/22/08 $ 689,875 $ 1,748,125 James A. Rubright(5)..... 60,000 4.5% $27.4375 12/3/08 $ 1,035,150 $ 2,623,950 William A. Smith(5)...... 35,000 2.6% $27.4375 12/3/08 $ 603,838 $ 1,530,638 Named Executive Officers' Potential Realizable Value as a % of All Stockholders' Potential Realizable Value -- December 4, 1998 Grant 0.27% 0.27%
14 16 NOTE 1: Each stock option shown in the table was granted with a tandem Limited SAR that may be exercised only within 60 days after a Change of Control (as defined under "Compensation Upon Change of Control" below). For more information on Limited SARs, see "Compensation Upon Change of Control" below. Any stock options (and tandem Limited SARs) that have not previously become exercisable are generally forfeited upon termination of employment, unless such termination occurs by reason of normal retirement, death, disability or for the convenience of the Company (as determined by the Executive Compensation Committee). Any options (and tandem Limited SARs) held by then-current employees will become immediately exercisable in the event of a "Change of Control" of the Company, as described under "Compensation Upon Change of Control" below. The El Paso Merger, if consummated, will constitute a Change of Control for the foregoing purposes. NOTE 2: The exercise price equals the closing price of the Company's Common Stock on the date of grant. NOTE 3: The stock options (and tandem Limited SARs) are subject to termination prior to their expiration date in the event of termination of employment. NOTE 4: For each named executive officer, the potential realizable values shown represent the difference between the Resulting Company Stock Price for the option (as described below) and the exercise price of the option, multiplied by the number of options granted to such executive officer. For all stockholders, the potential realizable values shown represent the difference between the Resulting Company Stock Price for the options granted on December 4, 1998 and the exercise price of such options, multiplied by the number of outstanding shares of the Company's Common Stock as of December 31, 1998. The Resulting Company Stock Price for an option equals the price the Company's Common Stock would attain at the end of the option's 10-year term if the price of the Company's Common Stock appreciated from the date of stock option grant at a rate of 5% or 10% per year (as the case may be). The Resulting Company Stock Prices are as follows: (1) for the options granted on January 21, 1998, $72.80 (5% annual stock price appreciation) and $115.91 (10% annual stock price appreciation), (2) for the options granted on April 23, 1998, $71.47 (5% annual stock price appreciation) and $113.80 (10% annual stock price appreciation) and (3) for the options granted on December 4, 1998, $44.69 (5% annual stock price appreciation) and $71.17 (10% annual stock price appreciation). NOTE 5: Represents stock options (and tandem Limited SARs) granted on December 4, 1998. The stock options (and tandem Limited SARs) become exercisable in equal installments on each of the first five anniversaries of the date of grant, provided that the entire grant will become immediately exercisable if, during any 10 business day period ending prior to December 4, 2003, the average of the closing prices of the Company's Common Stock during such period is at least $41.1563. NOTE 6: Represents stock options (and tandem Limited SARs) granted to Mr. Holmes on January 21, 1998 (contingent upon his commencement of employment with the Company on January 30, 1998). The stock options (and tandem Limited SARs) become exercisable in five equal installments on each of the first five anniversaries of the date of grant, provided that the entire grant will become immediately exercisable if, during any 10 business day period ending prior to January 21, 2003, the average of the closing prices of the Company's Common Stock during such period is at least $67.04. NOTE 7: Represents stock options (and tandem Limited SARs) granted on April 23, 1998. The stock options (and tandem Limited SARs) become exercisable in five equal installments on each of the first five anniversaries of the date of grant, provided that the entire grant will become 15 17 immediately exercisable if, during any 10 business day period ending prior to April 23, 2003, the average of the closing prices of the Company's Common Stock during such period is at least $65.8125. AGGREGATED OPTION/SAR EXERCISES AND FISCAL YEAR-END OPTION/SAR VALUE TABLE The following table shows certain information with respect to the named executive officers concerning the exercise of stock options (or stock appreciation rights ("SARs") granted in tandem therewith) during 1998 and unexercised stock options (and tandem SARs) held as of December 31, 1998.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION/SAR VALUES ------------------------------------------------------------------------------------ NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED, UNEXERCISED OPTIONS/SARS IN-THE-MONEY OPTIONS/SARS SHARES AT FISCAL YEAR END(1) AT FISCAL YEAR END(2) ACQUIRED ON VALUE --------------------------- --------------------------- NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ---- ----------- ---------- ----------- ------------- ----------- ------------- Ronald L. Kuehn, Jr...... 70,000 $1,863,750 616,200 235,700 $1,826,625 $0 John B. Holmes, Jr....... 0 $ 0 10,000 175,000 $ 0 $0 James E. Moylan, Jr...... 0 $ 0 105,000 67,000 $ 195,563 $0 James A. Rubright........ 0 $ 0 98,500 117,000 $ 0 $0 William A. Smith......... 0 $ 0 192,400 63,600 $ 630,750 $0
NOTE 1: Certain stock options granted before December 6, 1991, were granted with tandem SARs. Each stock option granted before December 6, 1991 was granted with a tax-offset "supplemental payment" payable upon the exercise of the stock option (or tandem SAR). The amount of the supplemental payment is the amount necessary to pay the federal income tax payable with respect to both (1) exercise of the stock option (or tandem SAR) and (2) receipt of the supplemental payment, based on the assumption that the participant is taxed at the maximum effective federal income tax rate. NOTE 2: The value of each unexercised in-the-money stock option (or tandem SAR) is equal to the difference between $27.0625 (the closing price of the Company's Common Stock on December 31, 1998) and the exercise price of the stock option. Such value does not include the value of any tax-offset supplemental payments. DEFINED BENEFIT PLANS Employees and officers of the Company and participating subsidiaries are participants in the Company's Retirement Plan. The Retirement Plan provides two types of benefits -- pension benefits and cash balance benefits. The pension benefits portion of the Retirement Plan (the "Pension Program") provides annual retirement benefits that are based on average covered compensation for the highest five consecutive years of the final ten years of employment. Covered compensation under the Pension Program currently includes salaries and amounts paid under the Performance Award Plan and the Cash Bonus Plan (reported in the Summary Compensation Table); covered compensation does not include amounts relating to the grant or vesting of restricted stock, the exercise of stock options and SARs, and receipt of supplemental payments under the Executive Award Plan, or to employer contributions under the Savings Plan or the Supplemental Benefit Plan. The maximum annual retirement benefit under the Pension Program is 65% of the participant's average covered compensation minus 50% of his primary social security benefit. Participants accrue benefits under the following formula: (a) 2.4% of average covered compensation minus 2.0% of primary social security benefits for each year of service before January 1, 1992; plus (b) 2.0% of average covered compensation minus 1.667% of primary social security benefits for each year of 16 18 service after January 1, 1992; plus (c) when the total of (a) plus (b) above equals 60% of average covered compensation minus 50% of primary social security benefits, 1% of average covered compensation for each year of service after January 1, 1992, not included in the calculation in (b) above, up to five such additional years of service. The eligible survivors of a deceased Pension Program participant are entitled to a survivors benefit, which equals 75% or 50% of the participant's retirement benefit (depending upon the participant's date of hire, age and years of service). Pension Program benefits are generally paid as life annuities. Under the cash balance benefits portion of the Retirement Plan (the "Cash Balance Program"), Company contributions and interest are credited to a hypothetical account for the participant under the Retirement Plan. Company contributions equal 1 1/2% or 2 1/2% of the participant's salary (as shown in the Summary Compensation Table), depending on the participant's date of hire, age and years of service. Interest credits are based on the 30-year Treasury Constant Maturities rate. Cash Balance Program benefits are based on the value of the participant's hypothetical account at termination of employment, and are paid as a lump sum, life annuity or 50% joint and survivor annuity. The Supplemental Benefit Plan provides its eligible participants and their eligible survivors with Pension Program and Cash Balance Program benefits that would have been payable under the Retirement Plan but for the fact that benefits payable under funded pension plans are limited by federal tax laws. As a general rule, during 1998 the federal tax laws limited annual benefits under the Retirement Plan to $130,000 (subject to reduction in certain circumstances), and required the Retirement Plan to disregard any portion of the participant's 1998 compensation in excess of $160,000. A participant may choose to have benefits under the Supplemental Benefit Plan paid either as a life annuity or in a cash lump sum upon termination of employment. The following table sets forth information with respect to the named executive officers concerning the benefits payable under the Retirement Plan and Supplemental Benefit Plan. DEFINED BENEFIT PLAN TABLE
YEARS OF YEARS OF CASH 1998 1998 ESTIMATED PENSION BALANCE PENSION PROGRAM CASH BALANCE ANNUAL PROGRAM PROGRAM COVERED PROGRAM COVERED RETIREMENT NAME SERVICE(1) SERVICE(2) COMPENSATION(3) COMPENSATION(4) BENEFIT(5) ---- ---------- ---------- --------------- --------------- ------------- Ronald L. Kuehn, Jr. ..... 28.4 1.0 $1,237,500 $797,500 $811,483 John B. Holmes, Jr. ...... 0.9 0.9 $ 524,607 $341,667 $168,754 James E. Moylan, Jr. ..... 22.5 1.0 $ 410,875 $294,250 $290,642 James A. Rubright......... 4.8 1.0 $ 560,657 $372,667 $226,552 William A. Smith.......... 28.7 1.0 $ 525,000 $365,000 $356,295
NOTE 1: The number of years of credited service under the Pension Program as of December 31, 1998. NOTE 2: The number of years of service under the Cash Balance Program as of December 31, 1998. NOTE 3: The aggregate of the named executive officer's salary and bonus for 1998 (as shown in the Summary Compensation Table). NOTE 4: The named executive officer's salary for 1998 (as shown in the Summary Compensation Table). NOTE 5: The aggregate estimated annual benefit payable as a single life annuity to the named executive officer under the Retirement Plan and Supplemental Benefit Plan, based on the assumptions that (1) such officer's average covered compensation under the Pension Program at his retirement date equals his 1998 Pension Program covered compensation; (2) such officer's salary under the Cash Balance Program between December 31, 1998 and his retirement date equals his 1998 Cash Balance Program covered compensation; and (3) such officer's hypothetical account 17 19 under the Cash Balance Program is credited with interest after December 31, 1998 at the annual interest rate in effect for the Program as of such date (6.33%), and determined without regard to the offset for primary social security benefits under the Pension Program. The assumed retirement dates are April 30, 2001 for Mr. Kuehn, and age 65 for the other named executive officers. PERFORMANCE GRAPH The following graph compares the cumulative total stockholder return on the Company's Common Stock for the five-year period ending December 31, 1998, with the cumulative total return of three indices during such period. COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL STOCKHOLDER RETURN SONAT INC.; STANDARD & POOR'S 500 STOCK INDEX; STANDARD & POOR'S NATURAL GAS DISTRIBUTION/PIPELINE GROUP (1); STANDARD & POOR'S OIL & GAS (EXPLORATION & PRODUCTION) GROUP (2) [CUMULATIVE PERFORMANCE GRAPH]
SONAT INC. S&P 500 S&P NATURAL GAS S&P OIL AND GAS ---------- ------- --------------- --------------- 12/31/93 100.00 100.00 100.00 100.00 12/31/94 100.58 101.31 92.21 79.59 12/31/95 132.36 139.37 126.31 93.36 12/31/96 196.15 171.36 164.49 128.73 12/31/97 178.01 228.52 193.54 113.71 12/31/98 110.45 293.81 211.77 78.44
The total returns set forth above assume that $100 was invested in the Company's Common Stock and each of the indices set forth above on December 31, 1993, and that all dividends were reinvested. NOTE 1: The Standard & Poor's Natural Gas Distribution/Pipeline Group consists of the following companies: The Coastal Corporation, Columbia Energy Group, Consolidated Natural Gas Company, Eastern Enterprises, Enron Corp., NICOR Inc., ONEOK Inc., Peoples Energy Corporation, Sempra Energy, Sonat Inc. and The Williams Companies, Inc. NOTE 2: The Standard & Poor's Oil & Gas (Exploration & Production) Group consists of the following companies: Anadarko Petroleum Corporation, Apache Corporation, Burlington Resources, Inc., Kerr-McGee Corporation, Oryx Energy Company and Union Pacific Resources Group, Inc. 18 20 COMPENSATION UPON CHANGE OF CONTROL Certain of the Company's benefit plans provide for the acceleration of certain benefits in the event of a "Change of Control" of the Company. Under such plans, a Change of Control will be deemed to have occurred if (1) any person or group becomes the owner of (or obtains the right to acquire) 20% or more of the Company's common stock or outstanding voting securities (with certain exceptions, as set forth in the plans); (2) the individuals who, as of December 1, 1995, constituted the Board of Directors (the "Incumbent Board"), cease to be at least a majority of the Board of Directors (but including as Incumbent Board members, except as otherwise provided, any director whose election or nomination was approved by the Incumbent Board); or (3) there is consummation of a reorganization, consolidation or merger involving the Company, or sale of all or substantially all of the Company's assets, unless the stockholders and Board of Directors of the Company before the transaction control the resulting company after the transaction. Any outside Director who is eligible for a retirement benefit under the Retirement Plan for Directors will receive such benefit (regardless of whether the Director has met the other eligibility requirements of the Plan) in the event the Director ceases to be a Director following a Change of Control. The balance in a Director's account in the Director's Fees Deferral Plan will be distributed in a lump sum if the Director's service as a Director is terminated within three years following a Change of Control, regardless of any other elections the Director may have made with respect to the timing and manner of payment of amounts in the account. Also, all shares of restricted stock granted under the Restricted Stock Plan for Directors will vest immediately upon a Change of Control. Upon the occurrence of a Change of Control, all outstanding shares of restricted stock under the Executive Award Plan will immediately vest, and all outstanding options (and tandem SARs) under the Executive Award Plan held by then-current employees will become immediately exercisable. Also, upon the occurrence of a Change of Control, the participant will receive 100% of his bonus opportunities under the Performance Award Plan and the Cash Bonus Plan. Any officer of the Company or certain of its subsidiaries who at the time of a Change of Control is not vested under the Retirement Plan will be provided with a vested benefit under the Supplemental Benefit Plan equal to the benefit that would have been payable under the Retirement Plan if the officer's actual years of service had been sufficient for vesting. Following a Change of Control, a participant's Savings Plan account under the Supplemental Benefit Plan will be distributed within 30 days of termination of employment. The named executive officers have Limited SARs in tandem with all outstanding options under the Executive Award Plan. Upon exercise of a Limited SAR or an SAR in connection with a Change of Control, the executive officer would receive the difference between (1) the "change of control price" and (2) the exercise price of the Limited SAR or SAR. The El Paso Merger, if consummated, will constitute a Change of Control for the foregoing purposes and for purposes of the Executive Severance Agreements described below. EXECUTIVE SEVERANCE AGREEMENTS The Company has Executive Severance Agreements with Messrs. Kuehn, Holmes, Moylan, Rubright and Smith. These agreements provide that if the executive officer's employment is terminated either (1) within three years after a Change of Control (as defined above), either (a) by the Company for reasons other than dishonesty, conviction of a felony or willful unauthorized disclosure of confidential information or other than as a consequence of death, disability or retirement at normal retirement age (April 30, 2001 for Mr. Kuehn and age 65 for the other officers) or (b) by the executive officer for reasons relating to a diminution of responsibilities or compensation or relocation requiring a change in residence or a significant increase in travel, or (2) by the executive officer for any reason during the 30-day period immediately following the first anniversary of the Change of Control, he will receive: (1) a lump sum severance payment equal to three times his "earnings" (defined to include the sum of (a) the executive's annual base pay, (b) the largest 19 21 cash bonus payable to the executive either upon the Change of Control or in the previous two years, and (c) the average value of the executive's stock option and restricted stock grants over the last three years) (such lump sum payment to be reduced pro rata to the extent there are less than 36 months until the officer reaches normal retirement age); (2) life, medical, and accident and disability insurance as provided in the Company's insurance programs or, in certain circumstances, substantially equivalent insurance to be provided by the Company for a period of 36 months after termination of employment (or until normal retirement age, whichever is sooner); and (3) for an executive officer who is not otherwise entitled to an early retirement benefit under the Retirement Plan, a lump-sum payment in an amount equal in value to the annual benefit such officer would have received had he been entitled to an early retirement benefit (reduced by any benefits payable to him under the Retirement Plan and the Supplemental Benefit Plan), and the survivors benefit with respect to such early retirement benefit. The Executive Severance Agreements also provide that if the executive officer receives payments that would be subject to the tax imposed by Section 4999 of the Internal Revenue Code, the executive shall be entitled to receive an additional payment in an amount necessary to put the executive officer in the same after-tax position as if such tax had not been imposed. Assuming that the executive officers terminated employment on April 1, 1999, in a manner entitling them to benefits under the Executive Severance Agreements, the respective executive officers would receive the following lump sum cash payments pursuant to items (1) and (3) above: Mr. Kuehn, $6,854,989 in severance pay and $0 in retirement benefits; Mr. Holmes, $4,229,280 in severance pay and $39,141 in retirement benefits; Mr. Moylan, $2,968,032 in severance pay and $554,553 in retirement benefits; Mr. Rubright, $4,229,280 in severance pay and $159,945 in retirement benefits; and Mr. Smith, $3,022,254 in severance pay and $1,245,418 in retirement benefits. The Executive Severance Agreements provide that the executive officer may not voluntarily leave the employ of the Company if a third party attempts to effect a Change of Control until such third party abandons such attempt or a Change of Control has occurred. The Agreements renew automatically for one-year terms unless terminated at the end of any term by the Board of Directors. The Agreements shall also terminate if the Executive Compensation Committee determines that the executive officer is no longer a key employee. In no event shall the Agreements terminate within three years after a Change of Control, or during any period in which a Change of Control is threatened. ELECTION OF AUDITOR (PROPOSAL NO. 1) Ernst & Young LLP has been nominated for election as Auditor of the Company. The Restated Certificate of Incorporation provides that no other person shall be eligible for election as Auditor unless notice of intention to nominate such person has been given to the Company not less than ten days before the Annual Meeting. A representative of Ernst & Young LLP will be present at the Annual Meeting with the opportunity to make a statement if such representative desires to do so and will be available to respond to appropriate questions. THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE ELECTION OF ERNST & YOUNG LLP AS AUDITOR (PROPOSAL NO. 1). 20 22 OTHER MATTERS PROPOSALS OF STOCKHOLDERS STOCKHOLDER PROPOSALS IN THE COMPANY'S PROXY STATEMENT. In order for proposals by stockholders to be considered for inclusion in the proxy statement and form of proxy relating to the 2000 Annual Meeting of Stockholders, such proposals must be received at the principal executive offices of the Company, AmSouth-Sonat Tower, Birmingham, Alabama 35203, by no later than November 24, 1999. STOCKHOLDER PROPOSALS TO BE PRESENTED AT MEETINGS. A stockholder who desires to propose any business at an annual meeting of stockholders must give the Secretary of the Company written notice which is received not later than the close of business on the 60th day nor earlier than the close of business on the 90th day before the first anniversary of the preceding year's annual meeting (the "Notice Deadline"). (Special notice provisions apply if the date of the annual meeting is more than 30 days before or more than 60 days after such anniversary date.) Adjournment of an annual meeting shall not commence a new Notice Deadline. The stockholder's notice must set forth (a) a brief description of the business desired to be brought before the meeting, the reasons for conducting such business at the meeting and the beneficial owner, if any, on whose behalf the proposal is made; (b) a representation that the stockholder is a holder of record of stock of the Company entitled to vote at such meeting (or if the record date for such meeting is subsequent to the date required for such stockholder notice, a representation that the stockholder is a holder of record at the time of such notice and intends to be a holder of record on the record date for such meeting) and intends to appear in person or by proxy at such meeting to propose such business; (c) any material interest of the stockholder in such business; and (d) for both the stockholder giving notice and the beneficial owner, if any, on whose behalf the proposal is made (1) the name and address of such stockholder and beneficial owner and (2) the class and number of shares owned beneficially and of record by such stockholder and beneficial owner. STOCKHOLDER NOMINATIONS FOR DIRECTORS. A stockholder who desires to nominate Directors at a meeting of stockholders must give the Secretary of the Company written notice within the Notice Deadline (for an annual meeting) or, for a special meeting at which directors are to be elected pursuant to the Company's notice of meeting, not earlier than the close of business on the 90th day before such special meeting and not later than the close of business on the later of the 60th day before such special meeting or the 10th day after the date public announcement is made of the date of the special meeting and the nominees proposed by the Board of Directors to be elected at such meeting. The stockholder's notice must set forth (a) the name and address of the stockholder giving the notice and of the beneficial owner, if any, on whose behalf the nominations are made; (b) the class and number of shares owned beneficially and of record by such stockholder and such beneficial owner; (c) a representation that the stockholder is a holder of record of stock of the Company entitled to vote at such meeting (or if the record date for such meeting is subsequent to the date required for such stockholder notice, a representation that the stockholder is a holder of record at the time of such notice and intends to be a holder of record on the record date for such meeting) and intends to appear in person or by proxy at the meeting to nominate the person or persons specified in the notice; (d) a description of all arrangements or understandings between the stockholder or beneficial owner and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination or nominations are to be made; (e) such other information regarding each nominee proposed by such stockholder as would have been required to be disclosed in solicitations of proxies for election of directors pursuant to the rules of the Securities and Exchange Commission; and (f) the consent of each nominee to be named in the proxy statement as a nominee and to serve as a Director of the Company if so elected. The Chairman of the meeting may refuse to transact any business or to acknowledge the nomination of any person if a stockholder has failed to comply with the foregoing procedures. 21 23 A copy of the Company's By-Laws may be obtained from the Company upon written request to the Company at its Birmingham, Alabama office. INSTITUTIONAL OWNERSHIP OF COMMON STOCK The table below sets forth, as of December 31, 1998, certain information with respect to each entity known by the Company to be the beneficial owner of more than 5% of the Company's Common Stock. For information regarding certain individuals known by the Company to be the beneficial owner of more than 5% of the Company's Common Stock as of January 31, 1999, see "Ownership of Common Stock by Directors and Executive Officers" at page 8.
NAME AND ADDRESS OF NUMBER OF SHARES PERCENT BENEFICIAL OWNER TITLE OF CLASS BENEFICIALLY OWNED OF CLASS - ------------------- -------------- ------------------ -------- Putnam Investments, Inc....................... Common Stock 9,702,120 8.8 and certain of its subsidiaries. One Post Office Square Boston, MA 02109
In a report on Schedule 13G filed with the Securities and Exchange Commission with respect to the ownership of the Company's Common Stock as of December 31, 1998, Putnam Investments, Inc. and its subsidiaries each stated that such stock was acquired in the ordinary course of business and was not acquired for the purpose of changing or influencing the control of the Company and was not acquired in connection with or as a participant in any transaction having such a purpose or effect. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE John M. Musgrave, Vice President -- Planning and Treasurer of the Company, filed one late report under Section 16(a) of the Securities Exchange Act of 1934 ("Section 16(a)") with respect to his initial ownership of the Company's Common Stock. Selim K. Zilkha, a Director of the Company, filed one late report under Section 16(a) with respect to a charitable gift of the Company's Common Stock. VOTING AT THE ANNUAL MEETING The presence, in person or by proxy, of the holders of a majority of the Company's Common Stock is necessary to constitute a quorum at the Annual Meeting or any adjournment thereof. The vote required for the election of Directors and the approval of the other matters scheduled for a vote at the Annual Meeting is controlled by the provisions of the Company's Charter and By-Laws and the Delaware General Corporation Law. Directors are elected by a plurality vote. Approval of Proposal No. 1 would require a plurality vote. Abstentions and broker "non-votes" (shares not voted on a matter because a nominee holding shares for a beneficial owner neither receives voting instructions from such beneficial owner nor has discretionary voting power with respect thereto) shall not have an effect on the vote for the election of Directors and on Proposal No. 1. The vote will be tabulated by an independent tabulator and the results of such vote will be certified by independent inspectors of election. SOLICITATION OF PROXIES The Company will bear the costs of solicitation of proxies. Officers and regular employees of the Company may solicit proxies by mail, telephone, telegraph and personal interview. In addition, the Company has retained D. F. King & Co., Inc. to assist in the solicitation of proxies, and anticipates that the fees that it will incur for this service, excluding out-of-pocket expenses, will not exceed $11,000. Arrangements will be made with brokerage houses and with other custodians, nominees and fiduciaries to forward proxy soliciting material to beneficial owners. The Company will 22 24 reimburse persons holding stock for others in their names or in those of their nominees for their reasonable out-of-pocket expenses in sending proxy material to their principals and obtaining their proxies. ------------------------ The information provided under the headings "Report of the Executive Compensation Committee" and "Performance Graph" above shall not be deemed to be "soliciting material" or to be "filed" with the Securities and Exchange Commission or subject to Regulations 14A or 14C, other than as provided in Item 402 of Regulation S-K, or to the liabilities of Section 18 of the Securities Exchange Act of 1934 and, unless specific reference is made therein to such headings, shall not be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934. The Company is not aware that any matters other than those mentioned above will be presented for action at the 1999 Annual Meeting, but if any other matters do properly come before the meeting, the persons named as proxies will vote upon such matters in accordance with their best judgment. Please complete, sign, date and return the enclosed proxy card promptly. SONAT INC. /s/ Beverley T. Krannich Beverley T. Krannich SECRETARY Birmingham, Alabama March 22, 1999 23 25 PROXY SONAT SAVINGS PLAN SONAT INC. ANNUAL MEETING -- APRIL 22, 1999 I hereby direct The Northern Trust Company, as Trustee of the Sonat Savings Plan, to sign and forward a proxy in the form being solicited by the Board of Directors and to vote as directed on the reverse side all shares of Sonat Inc. Common Stock held with respect to my account under the Plan at the Annual Meeting of Stockholders of Sonat Inc. to be held on April 22, 1999 and at any adjournment thereof. TO BE COMPLETED, SIGNED AND DATED ON THE REVERSE SIDE. 26 SONAT SAVINGS PLAN SONAT INC. ANNUAL MEETING -- APRIL 22, 1999 THE BOARD RECOMMENDS A VOTE "FOR ALL NOMINEES" AND "FOR" PROPOSAL NO. 1. 1. ELECTION OF DIRECTORS FOR ALL NOMINEES [ ] WITHHOLD AUTHORITY [ ] Ronald L. Kuehn, Jr., Robert J. Lanigan, (except those whose names are inserted on the line below) to vote for all nominees Charles Marshall and Michael S. Zilkha
2. ELECTION of Ernst & Young LLP as Auditor (Proposal No. 1). FOR [ ] AGAINST [ ] ABSTAIN [ ] THE UNDERSIGNED'S VOTE IS TO BE CAST AS SPECIFIED ABOVE. IF NO VOTE IS SPECIFIED, IT WILL BE VOTED "FOR ALL NOMINEES" IN ITEM 1 AND "FOR" PROPOSAL NO. 1.
Dated ___________, 1999 Signature _________________________________ Sign here as name appears hereon. 27 PROXY SONAT INC. AMSOUTH -- SONAT TOWER BIRMINGHAM, ALABAMA 35203 THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS. The undersigned hereby appoints Ronald L. Kuehn, Jr., James A. Rubright and William A. Smith, and each of them, proxies, with full powers of substitution, and hereby authorizes each of them to represent the undersigned at the Annual Meeting of Stockholders of Sonat Inc. to be held on April 22, 1999 and at any adjournment thereof, and to vote all shares of stock which the undersigned would be entitled to vote if personally present as directed on the reverse side hereof with respect to the items set forth in the Proxy Statement and upon any other matter which may properly come before the meeting or any adjournment thereof. THIS PROXY IS CONTINUED ON THE REVERSE SIDE. PLEASE SIGN ON THE REVERSE SIDE AND RETURN PROMPTLY. - FOLD AND DETACH HERE - 28 Please mark your votes [X] like this. THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR ITEMS 1 AND 2. WITHHELD FOR FOR ALL Item 1 -- ELECTION of Directors Nominees for the Board of Directors: [ ] [ ] Ronald L. Kuehn, Jr., Robert J. Lanigan, Charles Marshall and Michael S. Zilkha WITHHELD FOR: (Write that nominee's name in the space provided below). FOR AGAINST ABSTAIN Item 2 -- ELECTION of Ernst & Young LLP as Auditor (Proposal No. 1). [ ] [ ] [ ] Signature(s)_____________________________________________Date___________________ NOTE: Please sign as name appears hereon. Joint owners should each sign. When signing as attorney, executor, administrator, trustee or guardian, please give full title as such. - FOLD AND DETACH HERE - EX-23.1 8 CONSENT OF ERNST & YOUNG LLP 1 EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in (i) the Registration Statement (Form S-8, No. 33-64367) pertaining to the Sonat Inc. Executive Award Plan and the related Prospectus, (ii) the Registration Statement (Form S-8, No. 33-50142) pertaining to the Sonat Savings Plan and the related Prospectus and (iii) the Registration Statement (Form S-3, No. 333-62383) of Sonat Inc. and the related Prospectus and Prospectus Supplement of our report dated January 19, 1999, with respect to the consolidated financial statements of Sonat Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 1998. Our report refers to a change in accounting for oil and gas properties from the successful efforts method to the full cost method. Our audits also included the financial statement schedules of Sonat Inc. listed in Item 14(a). These schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. Birmingham, Alabama Ernst & Young LLP March 19, 1999 EX-23.2 9 CONSENT OF WILLIAM M COBB & ASSOCIATES INC 1 EXHIBIT 23.2 CONSENT OF INDEPENDENT PETROLEUM ENGINEERS We hereby consent to the references to us and to the use of the information derived from our reserve report on the interests of Sonat Exploration GOM Inc. (formerly Zilkha Energy Company) ("Sonat GOM"), dated January 14, 1999, relating to the estimated quantities of certain of Sonat GOM's proved reserves, in the Sonat Inc. Annual Report on Form 10-K for 1998 under the caption "Sonat Exploration Company" and to the incorporation by reference of such references and information in the Sonat Inc. Registration Statements on Form S-8 (No. 33-64367 and No. 33-50142) and Registration Statement on Form S-3 (No. 333-62383). We also consent to our being named as experts for purposes of such Registration Statements. WILLIAM M. COBB & ASSOCIATES, INC. By: F. J. Marek, P.E. Vice President Dallas, Texas March 4, 1999 EX-23.3 10 CONSENT OF RYDER SCOTT COMPANY 1 EXHIBIT 23.3 CONSENT OF INDEPENDENT PETROLEUM ENGINEERS We hereby consent to the references to us relating to the estimated quantities of certain of Sonat Exploration Company's proved reserves in the Sonat Inc. Annual Report on Form 10-K for 1998 under the caption "Sonat Exploration Company." and to the incorporation by reference of such references and information in the Sonat Inc. Registration Statement on Form S-8 (No. 33-64367 and No. 33-50142) and Registration Statement on Form S-3 (No. 333-62383). We also consent to our being named as experts for purposes of such Registration Statements. RYDER SCOTT COMPANY PETROLEUM ENGINEERS Houston, Texas March 8, 1999 EX-23.4 11 CONSENT OF KPMG LLP 1 EXHIBIT 23.4 The Board of Directors Sonat Exploration GOM Inc. (formerly Zilkha Energy Company) We consent to the incorporation by reference in (i) the registration statements (No 33-34367 and No. 33-50142) on Form S-8, and (ii) the registration statement (No. 333-62383) on Form S-3 and related prospectus of Sonat Inc. of our report dated December 8, 1997, with respect to the Statements of Operations and Cash Flows of Zilkha Energy Company as of December 31, 1996 which report is incorporated by reference in the Form 10-K of Sonat Inc. for the year ended December 31, 1998. Our report, dated December 8, 1997, refers to a change in accounting for oil and gas properties from the full cost method to the successful efforts method. KPMG LLP Houston, Texas March 19, 1999 EX-23.5 12 CONSENT OF KPMG LLP 1 EXHIBIT 23.5 The Board of Directors Sonat Exploration GOM Inc. (formerly Zilkha Energy Company) We consent to the incorporation by reference in the Form 10-K of Sonat Inc. for the year ended December 31, 1998, of our report dated December 8, 1997, with respect to the Statements of Operations and Cash Flows of Zilkha Energy Company for the year ended December 31, 1996, which report is incorporated by reference in the Form 8-K of Sonat Inc. dated April 23, 1998. Our report, dated December 8, 1997, refers to a change in accounting for oil and gas properties from the full cost method to the successful efforts method. KPMG LLP Houston, Texas March 19, 1999 EX-24 13 POWERS OF ATTORNEY 1 EXHIBIT 24 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director of Sonat Inc., does hereby constitute and appoint Ronald L. Kuehn, Jr.; Thomas W. Barker, Jr.; James E. Moylan, Jr.; William A. Smith; and John C. Griffin, and each of them, his true and lawful attorneys to execute in his name (whether on behalf of Sonat Inc. or as a director of Sonat Inc.) the Sonat Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1998, and any and all amendments thereto to be filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and to file the same, with all exhibits thereto, and any other documents in connection therewith, with the Securities and Exchange Commission. The undersigned does hereby ratify and confirm all that said attorneys and agents, and each of them, shall do or cause to be done by virtue hereof. Each of such attorneys shall have and may exercise all powers to act hereunder with or without the others. IN WITNESS WHEREOF, the undersigned has signed his name hereto as of the 25th day of February, 1999. /s/ William O. Bourke -------------------------------- William O. Bourke 2 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned, an officer and director of Sonat Inc., does hereby constitute and appoint Ronald L. Kuehn, Jr.; Thomas W. Barker, Jr.; James E. Moylan, Jr.; William A. Smith; and John C. Griffin, and each of them, his true and lawful attorneys to execute in his name (whether on behalf of Sonat Inc. or as an Officer or director of Sonat Inc.) the Sonat Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1998, and any and all amendments thereto to be filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and to file the same, with all exhibits thereto, and any other documents in connection therewith, with the Securities and Exchange Commission. The undersigned does hereby ratify and confirm all that said attorneys and agents, and each of them, shall do or cause to be done by virtue hereof. Each of such attorneys shall have and may exercise all powers to act hereunder with or without the others. IN WITNESS WHEREOF, the undersigned has signed his name hereto as of the 25th day of February, 1998. /s/ Ronald L. Kuehn, Jr. ---------------------------------- Ronald L. Kuehn, Jr. 3 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director of Sonat Inc., does hereby constitute and appoint Ronald L. Kuehn, Jr.; Thomas W. Barker, Jr.; James E. Moylan, Jr.; William A. Smith; and John C. Griffin, and each of them, his true and lawful attorneys to execute in his name (whether on behalf of Sonat Inc. or as a director of Sonat Inc.) the Sonat Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1998, and any and all amendments thereto to be filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and to file the same, with all exhibits thereto, and any other documents in connection therewith, with the Securities and Exchange Commission. The undersigned does hereby ratify and confirm all that said attorneys and agents, and each of them, shall do or cause to be done by virtue hereof. Each of such attorneys shall have and may exercise all powers to act hereunder with or without the others. IN WITNESS WHEREOF, the undersigned has signed his name hereto as of the 1st day of March, 1999. /s/ Robert J. Lanigan ---------------------------------- Robert J. Lanigan 4 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director of Sonat Inc., does hereby constitute and appoint Ronald L. Kuehn, Jr.; Thomas W. Barker, Jr.; James E. Moylan, Jr.; William A. Smith; and John C. Griffin, and each of them, his true and lawful attorneys to execute in his name (whether on behalf of Sonat Inc. or as a director of Sonat Inc.) the Sonat Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1998, and any and all amendments thereto to be filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and to file the same, with all exhibits thereto, and any other documents in connection therewith, with the Securities and Exchange Commission. The undersigned does hereby ratify and confirm all that said attorneys and agents, and each of them, shall do or cause to be done by virtue hereof. Each of such attorneys shall have and may exercise all powers to act hereunder with or without the others. IN WITNESS WHEREOF, the undersigned has signed his name hereto as of the 25th day of February, 1999. /s/ Max L. Lukens ---------------------------- Max L. Lukens 5 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director of Sonat Inc., does hereby constitute and appoint Ronald L. Kuehn, Jr.; Thomas W. Barker, Jr.; James E. Moylan, Jr.; William A. Smith; and John C. Griffin, and each of them, his true and lawful attorneys to execute in his name (whether on behalf of Sonat Inc. or as a director of Sonat Inc.) the Sonat Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1997, and any and all amendments thereto to be filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and to file the same, with all exhibits thereto, and any other documents in connection therewith, with the Securities and Exchange Commission. The undersigned does hereby ratify and confirm all that said attorneys and agents, and each of them, shall do or cause to be done by virtue hereof. Each of such attorneys shall have and may exercise all powers to act hereunder with or without the others. IN WITNESS WHEREOF, the undersigned has signed his name hereto as of the 1st day of March, 1999. /s/ Charles Marshall ------------------------------ Charles Marshall 6 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director of Sonat Inc., does hereby constitute and appoint Ronald L. Kuehn, Jr.; Thomas W. Barker, Jr.; James E. Moylan, Jr.; William A. Smith; and John C. Griffin, and each of them, his true and lawful attorneys to execute in his name (whether on behalf of Sonat Inc. or as a director of Sonat Inc.) the Sonat Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1998, and any and all amendments thereto to be filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and to file the same, with all exhibits thereto, and any other documents in connection therewith, with the Securities and Exchange Commission. The undersigned does hereby ratify and confirm all that said attorneys and agents, and each of them, shall do or cause to be done by virtue hereof. Each of such attorneys shall have and may exercise all powers to act hereunder with or without the others. IN WITNESS WHEREOF, the undersigned has signed his name hereto as of the 25th day of February, 1999. /s/ Benjamin F. Payton ----------------------------------- Benjamin F. Payton 7 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director of Sonat Inc., does hereby constitute and appoint Ronald L. Kuehn, Jr.; Thomas W. Barker, Jr.; James E. Moylan, Jr.; William A. Smith; and John C. Griffin, and each of them, his true and lawful attorneys to execute in his name (whether on behalf of Sonat Inc. or as a director of Sonat Inc.) the Sonat Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1998, and any and all amendments thereto to be filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and to file the same, with all exhibits thereto, and any other documents in connection therewith, with the Securities and Exchange Commission. The undersigned does hereby ratify and confirm all that said attorneys and agents, and each of them, shall do or cause to be done by virtue hereof. Each of such attorneys shall have and may exercise all powers to act hereunder with or without the others. IN WITNESS WHEREOF, the undersigned has signed his name hereto as of the 25th day of February, 1999. /s/ John J. Phelan, Jr. ----------------------------------- John J. Phelan, Jr. 8 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director of Sonat Inc., does hereby constitute and appoint Ronald L. Kuehn, Jr.; Thomas W. Barker, Jr.; James E. Moylan, Jr.; William A. Smith; and John C. Griffin, and each of them, his true and lawful attorneys to execute in his name (whether on behalf of Sonat Inc. or as a director of Sonat Inc.) the Sonat Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1998, and any and all amendments thereto to be filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and to file the same, with all exhibits thereto, and any other documents in connection therewith, with the Securities and Exchange Commission. The undersigned does hereby ratify and confirm all that said attorneys and agents, and each of them, shall do or cause to be done by virtue hereof. Each of such attorneys shall have and may exercise all powers to act hereunder with or without the others. IN WITNESS WHEREOF, the undersigned has signed his name hereto as of the 25th day of February, 1999. /s/ Jerome J. Richardson ---------------------------------- Jerome J. Richardson 9 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director of Sonat Inc., does hereby constitute and appoint Ronald L. Kuehn, Jr.; Thomas W. Barker, Jr.; James E. Moylan, Jr.; William A. Smith; and John C. Griffin, and each of them, his true and lawful attorneys to execute in his name (whether on behalf of Sonat Inc. or as a director of Sonat Inc.) the Sonat Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1998, and any and all amendments thereto to be filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and to file the same, with all exhibits thereto, and any other documents in connection therewith, with the Securities and Exchange Commission. The undersigned does hereby ratify and confirm all that said attorneys and agents, and each of them, shall do or cause to be done by virtue hereof. Each of such attorneys shall have and may exercise all powers to act hereunder with or without the others. IN WITNESS WHEREOF, the undersigned has signed her name hereto as of the 25th day of February, 1999. /s/ Adrian M. Tocklin ---------------------------------- Adrian M. Tocklin 10 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director of Sonat Inc., does hereby constitute and appoint Ronald L. Kuehn, Jr.; Thomas W. Barker, Jr.; James E. Moylan, Jr.; William A. Smith; and John C. Griffin, and each of them, his true and lawful attorneys to execute in his name (whether on behalf of Sonat Inc. or as a director of Sonat Inc.) the Sonat Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1998, and any and all amendments thereto to be filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and to file the same, with all exhibits thereto, and any other documents in connection therewith, with the Securities and Exchange Commission. The undersigned does hereby ratify and confirm all that said attorneys and agents, and each of them, shall do or cause to be done by virtue hereof. Each of such attorneys shall have and may exercise all powers to act hereunder with or without the others. IN WITNESS WHEREOF, the undersigned has signed his name hereto as of the 25th day of February, 1999. /s/ James B. Williams ------------------------------ James B. Williams 11 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director of Sonat Inc., does hereby constitute and appoint Ronald L. Kuehn, Jr.; Thomas W. Barker, Jr.; James E. Moylan, Jr.; William A. Smith; and John C. Griffin, and each of them, his true and lawful attorneys to execute in his name (whether on behalf of Sonat Inc. or as a director of Sonat Inc.) the Sonat Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1998, and any and all amendments thereto to be filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and to file the same, with all exhibits thereto, and any other documents in connection therewith, with the Securities and Exchange Commission. The undersigned does hereby ratify and confirm all that said attorneys and agents, and each of them, shall do or cause to be done by virtue hereof. Each of such attorneys shall have and may exercise all powers to act hereunder with or without the others. IN WITNESS WHEREOF, the undersigned has signed his name hereto as of the 25th day of February, 1999. /s/ Joe B. Wyatt ---------------------- Joe B. Wyatt 12 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director of Sonat Inc., does hereby constitute and appoint Ronald L. Kuehn, Jr.; Thomas W. Barker, Jr.; James E. Moylan, Jr.; William A. Smith; and John C. Griffin, and each of them, his true and lawful attorneys to execute in his name (whether on behalf of Sonat Inc. or as a director of Sonat Inc.) the Sonat Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1998, and any and all amendments thereto to be filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and to file the same, with all exhibits thereto, and any other documents in connection therewith, with the Securities and Exchange Commission. The undersigned does hereby ratify and confirm all that said attorneys and agents, and each of them, shall do or cause to be done by virtue hereof. Each of such attorneys shall have and may exercise all powers to act hereunder with or without the others. IN WITNESS WHEREOF, the undersigned has signed his name hereto as of the 25th day of February, 1999. /s/ Selim K. Zilkha ------------------------------ Selim K. Zilkha 13 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that the undersigned, a director of Sonat Inc., does hereby constitute and appoint Ronald L. Kuehn, Jr.; Thomas W. Barker, Jr.; James E. Moylan, Jr.; William A. Smith; and John C. Griffin, and each of them, his true and lawful attorneys to execute in his name (whether on behalf of Sonat Inc. or as a director of Sonat Inc.) the Sonat Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1998, and any and all amendments thereto to be filed with the Securities and Exchange Commission pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 and to file the same, with all exhibits thereto, and any other documents in connection therewith, with the Securities and Exchange Commission. The undersigned does hereby ratify and confirm all that said attorneys and agents, and each of them, shall do or cause to be done by virtue hereof. Each of such attorneys shall have and may exercise all powers to act hereunder with or without the others. IN WITNESS WHEREOF, the undersigned has signed his name hereto as of the 25th day of February, 1999. /s/ Michael S. Zilkha --------------------------------- Michael S. Zilkha EX-27 14 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS OF SONAT INC. FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1998 DEC-31-1998 7,104 0 438,434 0 69,093 800,509 8,399,934 5,703,767 4,361,094 1,576,599 1,099,484 0 0 111,388 1,217,863 4,361,094 3,207,707 3,709,818 2,744,969 2,908,355 1,384,643 0 131,714 (828,265) (297,748) (530,517) 0 0 0 (530,517) (4.82) (4.82)
EX-99.1 15 REPORT OF RYDER SCOTT COMPANY 1 EXHIBIT 99.1 [RYDER SCOTT COMPANY PETROLEUM ENGINEER LETTERHEAD] March 10, 1999 Sonat Exploration Company Post Office Box 1513 Houston, Texas 77251-1513 Gentlemen: At your request, we have reviewed the estimates of the remaining proved reserves attributable to certain properties of Sonat Exploration Company (Sonat), as of January 1, 1999, as prepared by its engineering and geological staff and based on Securities and Exchange Commission (SEC) guidelines. The properties that we reviewed are comprised of 1410 reserve determinations and are located in the states of Alabama, Arkansas, Louisiana, Oklahoma, and Texas. The net reserves attributable to the properties that we reviewed account for 64.3 percent of Sonat's total net remaining gas reserves and 41.8 percent of Sonat's total net remaining liquid hydrocarbon reserves. The properties represent 56.8 percent of the total proved discounted future net income based on the unescalated pricing policy of the SEC as taken from reserve and income projections prepared by Sonat Exploration Company as of January 1, 1999. The estimated reserves presented in this report are related to hydrocarbon prices. Sonat has informed us that in the preparation of their reserve and income projections, as of January 1, 1999, they used December 1998 hydrocarbon prices as required by SEC guidelines; however, actual future prices may vary significantly from December 1998. Therefore, volumes of reserves actually recovered and the amounts of income actually received may differ significantly from the estimated quantities presented in this report. The estimated net reserves attributable to Sonat's interest in properties that we reviewed, as calculated by Sonat, are summarized as follows: SEC CASE Estimated Net Remaining Proved Reserves Attributable to Certain Properties of Sonat Exploration Company As of January 1, 1999 ------------------------------------------------------------
Natural Gas Gas Oil/Condensate Plant Liquids Equivalents (MMCF) (Barrels) (Barrels) (MMCFE) ---------- -------------- ------------- ----------- Net Reserves of Properties Reviewed by Ryder Scott - --------------------------- Proved Producing 609,458 3,637,338 3,943,780 655,291 Proved Behind Pipe 96,582 1,884,051 978,000 113,351 Proved Undeveloped 206,968 1,434,228 646,000 219,828 ------- --------- --------- ------- Total Proved 913,008 6,955,617 5,567,780 988,470
2 March 10, 1999 Page 2 REVIEW PROCEDURE AND OPINION In performing our review, we have relied upon data furnished by Sonat with respect to property interests owned, production and well tests from examined wells, geological structural and isopach maps, well logs, core analyses, and pressure measurements. These data were accepted as authentic and sufficient for determining the reserves unless, during the course of our examination, a matter of question came to our attention in which case the data were not accepted until all questions were satisfactorily resolved. Our review included such tests and procedures as we considered necessary under the circumstances to render the conclusions set forth herein. In our opinion, Sonat's estimates of future reserves for the reviewed properties were prepared in accordance with generally accepted procedures for the estimation of future reserves, and we found on bias in the utilization and analysis of data in estimates for these properties. In general, we were in reasonable agreement with Sonat's estimates of remaining proved reserves for the properties which we reviewed. It is our opinion that the data presented herein for the properties that we reviewed fairly reflect the estimated net reserves owned by Sonat. Certain technical personnel of Sonat are responsible for the preparation of reserve estimates on new properties and for the preparation of revised estimates, when necessary, on old properties. These personnel assembled the necessary data and maintained the data and workpapers in an orderly manner. We consulted with these technical personnel and had access to their workpapers and supporting data in the course of our review. RESERVE ESTIMATES The reserves for the properties that we reviewed were estimated by performance methods or the volumetric method. The reserve estimates by the performance method utilized extrapolations of various historical data in those cases where such data were definitive. Reserves were estimated by the volumetric method in those cases where there were inadequate historical data to establish a definitive trend or where the use of production performance data as a basis for the reserve estimates was considered to be inappropriate and the volumetric data were adequate for a reasonable estimate. The reserves presented herein, as estimated by Sonat and reviewed by us, are estimates only and should not be construed as being exact quantities. Moreover, estimates of reserves may increase or decrease as a result of future operations. APPLICABLE DEFINITIONS Liquid hydrocarbons are expressed in standard 42 gallon barrels and are converted into gas equivalents at the ratio of 1 barrel of hydrocarbon liquids to 6 MCF of gas. All gas volumes are expressed in millions of cubic feet (MMCF) at the official temperature and pressure bases of the areas in which the gas reserves are located. The proved developed non-producing reserves attributable to the total properties are comprised of behind pipe reserves. 3 March 10, 1999 Page 3 The proved reserves, which are attributable to the properties that we reviewed, conform to the definition as set forth in the Securities and Exchange Commission's Regulation S-X Part 210.4-10 (a) as clarified by subsequent Commission Staff Accounting Bulletins. The proved reserves are defined as follows: Proved reserves of crude oil, condensate, natural gas, and natural gas liquids are estimated quantities that geological and engineering data demonstrate with reasonable certainty to be recoverable in the future from known reservoirs under existing operating conditions, i.e., prices and costs as of the date the estimate is made. Prices include consideration of changes in existing prices provided only by contractual arrangements, but not on escalation based on future conditions. Reservoirs are considered proved if economic producibility is supported by either actual production or conclusive formation test. In certain instances, proved reserves are assigned on the basis of a combination of core analysis and electrical and other type logs which indicate the reservoirs are analogous to reservoirs in the same field which are producing or have demonstrated the ability to produce on a formation test. The area of a reservoir considered proved includes (1) that portion delineated by drilling and defined by fluid contacts, if any, and (2) the adjoining portions not yet drilled that can be reasonably judged as economically productive on the basis of available geological and engineering data. In the absence of data on fluid contacts, the lowest known structural occurrence of hydrocarbons controls the lower proved limit of the reservoir. Reserves that can be produced economically through the application of improved recovery techniques are included in the proved classification when these qualifications are met: (1) successful testing by a pilot project or the operation of an installed program in the reservoir provides support for the engineering analysis on which the project or program was based, and (2) it is reasonably certain the project will proceed. Improved recovery includes all methods for supplementing natural reservoir forces and energy, or otherwise increasing ultimate recovery from a reservoir, including (1) pressure maintenance, (2) cycling, and (3) secondary recovery in its original sense. Improved recovery also includes the enhanced recovery methods of thermal, chemical flooding, and the use of miscible and immiscible displacement fluids. Proved natural gas reserves are comprised of non-associated, associated and dissolved gas. An appropriate reduction in gas reserves has been made for the expected removal of natural gas liquids, for lease and plant fuel, and for the exclusion of non-hydrocarbon gases if they occur in significant quantities and are removed prior to sale. Estimates of proved reserves do not include crude oil, natural gas, or natural gas liquids being held in underground or surface storage. Proved reserves are estimates of hydrocarbons to be recovered from a given date forward. They may be revised as hydrocarbons are produced and additional data become available. Proved developed oil and gas reserves are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. Additional oil and gas expected to be obtained through the application of fluid injection or other improved recovery techniques for supplementing the natural forces and mechanisms of primary recovery should be included as "proved developed reserves" only after testing by a pilot project or after the operation of an installed program has confirmed through production response that increased recovery will be achieved. Proved developed reserves may be subcategorized as producing or non-producing using the SPE/WPC Definitions: Producing Reserves sub-categorized as producing are expected to be recovered from completion intervals which are open and producing at the time of the estimate. Improved recovery reserves are considered producing only after the improved recovery project is in operation. 4 March 10, 1999 Page 4 NON-PRODUCING Reserves sub-categorized as non-producing include behind pipe reserves. Behind pipe reserves are expected to be recovered from zones in existing wells, which will require additional completion work or future recompletion prior to the start of production. Proved undeveloped oil and gas reserves are reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Reserves on undrilled acreage shall be limited to those drilling units offsetting productive units that are reasonably certain of production when drilled. Proved reserves for other undrilled units can be claimed only where it can be demonstrated with reasonable certainty that there is continuity of production from the existing productive formation. Estimates for proved undeveloped reserves are attributable to any acreage for which an application of fluid injection or other improved technique is contemplated, only when such techniques have been proved effective by actual tests in the area and in the same reservoir. GENERAL In general, the reserve estimates for the properties that we reviewed are based on data available through December 1998. Gas imbalances, if any, were not taken into account in the gas reserve estimates reviewed. Neither we nor any of our employees have any interest in the subject properties and neither the employment to do this work nor the compensation is contingent on our estimates of reserves for the properties which were reviewed. This report was prepared for the exclusive use of Sonat. The data and work papers used in the preparation of this report are available for examination by authorized parties in our offices. Please contact us if we can be of further service. Very truly yours, RYDER SCOTT COMPANY PETROLEUM ENGINEERS /s/ John R. Warner ------------------------------ John R. Warner, P.E. Senior Vice President EX-99.2 16 REPORT OF WILLIAM M COBB & ASSOCIATES INC 1 EXHIBIT 99.2 [WILLIAM M. COBB & ASSOCIATES, INC. LETTERHEAD] January 14, 1999 Mr. Larry Brewer Sonat Exploration Company Four Greenway Plaza, 4th Floor Houston, TX 77046-0402 Dear Mr. Brewer: In accordance with your request, we have estimated the proved reserves and future income, as of January 1, 1999, attributable to the interest of Sonat Exploration GOM Inc. (Sonat GOM) in certain oil and gas properties located in State and Federal Offshore Waters in the Gulf of Mexico. Table 1 summarizes our estimates of the proved oil and gas reserves and their pre-Federal Income Tax value undiscounted and discounted at ten percent. Values shown are determined utilizing constant oil and gas prices as specified by Sonat GOM. The discounted present worth of future income values, shown in Table 1 or in other portions of this report, are not intended to necessarily represent an estimate of fair market value. TABLE 1 ------- SONAT GOM NET RESERVES AND VALUE AS OF JANUARY 1, 1999 FLAT PRICING
FUTURE NET PRE-TAX NET RESERVES INCOME - M$ ------------------- ------------------------------ OIL GAS PRESENT WORTH RESERVE CATEGORY (MBBL) (MMCF) TOTAL DISCOUNTED AT 10% - ---------------- ------ ------- ------- ----------------- PROVED Producing.......... 4,900 113,769 209,268 181,675 Non-Producing...... 3,110 40,818 88,802 70,435 Undeveloped........ 570 37,008 62,496 46,147 ----- ------- ------- ------- TOTAL PROVED........ 8,580 191,595 360,566 298,257
Oil (Condensate) volumes are expressed in thousands of stock tank barrels (MBBL). A stock tank barrel is equivalent to 42 United States gallons. Gas volumes are expressed in millions 2 Page 2 of standard cubic feet (MMCF) as determined at 60 degrees Fahrenheit and the legal pressure base prevailing in the state in which the reserves are located. Table 2 summarizes the economic parameters specific to each property. These include abandonment costs, fixed operating expenses, transportation and processing fees ($/Mcf and $/Bbl), Btu factors, ownership reversion payout balances (estimated as of January 1, 1999) and evaluated ownership (both before payout and after payout, if applicable). Figures 1 through 3 are included to highlight various conclusions regarding the Sonat GOM reserves. Figure 1 is a pie chart which shows the distribution of value (present worth discounted at ten percent) by reserve category for the total proved reserves. Figure 2 is a pie chart showing the future net revenue for the proved reserves attributable to both oil and gas. Finally, Figure 3 presents a projection of future net cash flow versus time for each proved reserve category and for the total proved reserves. A value ranking of the Sonat GOM properties may be found under the tab "Property Ranking." The properties are listed by field in order of decreasing present worth, discounted at ten percent, of the total proved reserves. DISCUSSION Two new properties have been added to the Sonat GOM property base through successful exploration efforts since July 1, 1998. Following is a brief description of each of the new properties. SOUTH TIMBALIER 46 -- Sonat GOM owns a 100 percent working interest in the Sonat #1 well which was drilled offshore Louisiana in November, 1998. Drilled to a total depth of 15,400 feet, the well encountered 102 feet of gas pay in the Big -A- sand at a depth of 14,370 feet. Proved reserves of 9,150 MMCF were assigned to lowest known gas. Production is scheduled to commence in March 1999 with an estimated initial rate of 20 MMCF per day. There is no behind-pipe potential attributed to this wellbore. SOUTH TIMABLIER 86 -- Sonat GOM owns a 100 percent working interest in the Sonat #1 well which was drilled offshore Louisiana in October, 1998. Drilled to a total depth of 13,626 feet, the well encountered hydrocarbon-bearing sands at depths ranging from 13,100 to 13,500 feet. The well is scheduled to be completed initially in the "BP" sand at a depth of 13,500 feet with proved reserves to lowest known gas of 1,402 MMCF. With net pay of 26 feet, the well is projected to commence production in February 1999 at a rate of five MMCF per day. Behind-pipe reserves of 1,115 MMCF are attributable to the "P-95" sand at 13,100 feet. OIL AND GAS PRICING The flat pricing case for future oil and gas prices utilizes constant prices of $10.10/BBL and $1.98/MMBtu, respectively, for all wells. Gas prices are adjusted by property for Btu factor. 3 Page 3 For 1999, average oil and gas prices for the total Sonat GOM proved reserves are projected to be $10.10/BBL of oil and $2.13/MCF of gas, respectively. OPERATING COSTS Operating costs for the Sonat GOM properties are based on historical values furnished by Sonat GOM. Future operating costs and capital expenditures are projected at current values with no future escalation. RESERVE METHODOLOGY Reserve calculations for the Sonat GOM properties are based on actual production and pressure performance when sufficient historical data is available and applicable. For properties with limited production performance data and those producing under a natural water-drive mechanism, reserves are determined utilizing the volumetric technique. To perform the volumetric calculations, we have analyzed well logs provided by Sonat GOM to determine reservoir properties such as porosity, water saturation, and net pay thickness. Areal extent and reservoir bulk volume are determined from structure and net pay isopach maps provided by Sonat GOM. We have studied the Sonat GOM maps, and in certain instances, we modified the maps based on our interpretation of available well logs. It is noted that reserve volumes calculated using the volumetric technique are generally less reliable than those supported by actual performance trends and, as such, should be considered to contain a higher element of risk. ECONOMIC PROJECTIONS Summary economic projections for the Sonat GOM properties may be found under the tab "Summary Tables." These summaries show future net operating revenue before deducting state severance tax and ad valorem tax for the proved reserves. Cash flow is after deducting these taxes, operating costs, and capital costs. Abandonment costs for the offshore properties were provided by Sonat GOM. All economic evaluations are made without consideration of Federal Income Taxes. Detailed projections for each reserve category are presented along with a one line summary by field. Detailed economic projections are also presented for each individual property. These detailed projections are found behind a tab identifying each property. Our definition of reserves may be found under the tab "Reserve Definitions." It is similar to and consistent with reserve definitions used throughout the industry. We have not made any field examination of the Sonat GOM properties. Therefore, operating ability and condition of the production equipment have not been considered. No consideration was given in this report to potential environmental liabilities which may exist, nor were any costs included for potential liability to restore and clean up damages, if any, 4 Page 4 caused by past operating practices. Sonat GOM advised us that they have furnished all of the geological, engineering, economic, and other data required for this analysis. In evaluating the information at our disposal concerning this appraisal, we have excluded from our consideration all matters as to which legal or accounting interpretation, rather than engineering, may be controlling. As in all aspects of oil and gas evaluation, there are uncertainties inherent in the interpretation of engineering and geological data. Therefore, conclusions necessarily represent only informed professional judgments. The reserves included in this report are estimates only and should not be construed as being exact quantities. The revenues from such reserves and the actual costs related thereto could be more or less then the estimated amounts. Because of governmental policies and uncertainties of supply and demand, the prices actually received for the reserves included in this report, and the costs incurred in recovering such reserves, may vary from the price and cost assumptions in this report. In any case, estimates of reserves may increase or decrease as a result of future operations. Titles to the appraised properties have not been examined by William M. Cobb & Associates, Inc., nor has the actual degree of interest owned been independently confirmed. The data used in our evaluation were obtained from Sonat Exploration GOM Inc. and the nonconfidential files of William M. Cobb & Associates, Inc. and were considered accurate. Basic field performance data, together with our engineering work sheets, are maintained on file in our office. Very truly yours, WILLIAM M. COBB & ASSOCIATES, INC. /s/ LARRY E. TARRANT, P.E. -------------------------------- Larry E. Tarrant, P.E. Sr. Reservoir Engineer /s/ FRANK J. MAREK, P.E. -------------------------------- Frank J. Marek, P.E. Vice President /s/ WILLIAM M. COBB, P.E. -------------------------------- William M. Cobb, P.E. President -----END PRIVACY-ENHANCED MESSAGE-----