WILLIAMS COMPANIES, INC. quarterly report, Q2 FY2012

Business Context and Reporting Period

The Williams Companies, Inc. filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2012. Williams is an energy infrastructure company focused on natural gas pipelines, gathering and processing, natural gas liquids, and olefins. Its reporting segments are Williams Partners and Midstream Canada & Olefins; the former exploration and production business was spun off as WPX Energy on December 31, 2011 and is presented as discontinued operations.

Williams owned approximately 68% of Williams Partners L.P. at June 30, 2012, including its general partner interest and incentive distribution rights.

Key Financial Metrics

Metric	Three Months Ended June 30, 2012	Three Months Ended June 30, 2011	Six Months Ended June 30, 2012	Six Months Ended June 30, 2011
Revenue	$1.846 billion	$1.984 billion	$3.865 billion	$3.855 billion
Operating income	$332 million	$460 million	$859 million	$899 million
Income from continuing operations	$166 million	$239 million	$525 million	$599 million
Net income attributable to Williams	$132 million	$227 million	$555 million	$548 million
Diluted EPS	$0.21	$0.38 total EPS; $0.29 continuing operations	$0.90 total EPS; $0.68 continuing operations	$0.92 total EPS; $0.79 continuing operations
Operating margin	18.0%	23.2%	22.2%	23.4%

Six-month net income included $135 million from discontinued operations, principally a $144 million gain on reconsolidation related to former Venezuelan operations. Second-quarter discontinued operations produced a $1 million loss.

Six-month operating cash flow was $858 million, down from $1.684 billion, largely because 2011 included cash flow from the former exploration and production business and because of unfavorable working-capital changes and lower operating income.
Six-month capital expenditures were $922 million, compared with $1.094 billion in the prior-year period. Investing cash flow was negative $2.890 billion, including $2.049 billion for business acquisitions.
Cash and cash equivalents were $679 million at June 30, 2012, compared with $889 million at December 31, 2011.
Total debt was approximately $9.037 billion, consisting of $4 million of current maturities and $9.033 billion of long-term debt. The fair value of long-term debt was $10.426 billion.
Available liquidity was reported at $3.234 billion, including cash and unused revolving-credit capacity. WPZ had $345 million drawn on its $2 billion credit facility; Williams had no loans outstanding on its $900 million facility.
Total assets increased to $20.267 billion from $16.502 billion at year-end 2011, primarily from the Laser and Caiman acquisitions. Total equity increased to $5.627 billion from $2.586 billion, including a substantial increase in noncontrolling interests.

Material Changes Versus the Prior Comparable Period

Second-quarter revenue declined 7%, while six-month revenue was essentially flat. The quarterly decline reflected lower NGL, olefin, and marketing prices.
Williams Partners’ second-quarter segment profit fell to $339 million from $471 million. The principal drivers were lower NGL production and marketing margins, higher operating expenses, and acquisition-related costs.
Williams Partners’ six-month segment profit declined to $827 million from $908 million despite higher fee revenues. Higher gathering, processing, and transportation fees were more than offset by weaker NGL margins, higher operating costs, and acquisition and transition expenses.
Midstream Canada & Olefins’ six-month segment profit increased to $171 million from $146 million, primarily due to higher Geismar ethylene margins and favorable foreign-exchange effects. Second-quarter segment profit declined to $68 million from $72 million as Canadian NGL and propylene margins weakened.
Interest expense improved because of corporate debt retirements in December 2011 and higher capitalized interest.
The six-month tax provision increased to $204 million from $87 million. The 2011 period benefited from approximately $124 million of federal and international tax settlements and assessments.
In April 2012, Williams issued 30 million common shares and received $887 million of net proceeds, used principally to fund its additional investment in WPZ for the Caiman acquisition. WPZ also raised equity in January and April.
WPZ acquired the Laser assets for approximately $766 million of total consideration and Caiman Eastern Midstream for approximately $2.327 billion of total consideration, including cash and WPZ units.

Guidance, Outlook, Risks, Contingencies, and Unusual Items

Management expected 2012 dividends of approximately $1.20 per common share, nearly 55% above 2011, and announced a July quarterly dividend of $0.3125 per share. Management also described planned 20% dividend increases in 2013 and 2014.
Management estimated 2012 cash flow from operations of $1.75 billion to $2.0 billion and planned to maintain at least $1 billion of consolidated liquidity.
Reported 2012 capital-investment expectations varied by scope: approximately $5.275 billion to $5.675 billion excluding WPZ units issued for acquisitions, and approximately $6.66 billion including WPZ equity issued in connection with acquisitions. Investors should reconcile these presentations.
NGL margins declined sharply because of a warm winter, high propane inventories, abundant supplies, and slowing economic conditions. Management expected depressed near-term margins, some recovery by year-end, and lower full-year 2012 NGL margins than in 2011.
Management expects the business mix to become increasingly fee-based, reducing long-term sensitivity to commodity prices. However, lower commodity prices could reduce operating cash flow, producer drilling, and WPZ distributions.
Major growth projects include the Constitution Pipeline, expected to cost approximately $748 million and enter service in March 2015; Utica infrastructure development of approximately $800 million, with WPZ expected to fund approximately $380 million; and continued Marcellus, Gulf Coast, Canadian, and olefins expansions.
Transco issued $400 million of 4.45% senior unsecured notes in July 2012 and used part of the proceeds to repay $325 million of 8.875% notes that matured July 15, 2012.
Williams disclosed guarantees related to former subsidiaries, including approximately $245 million of maximum potential obligations related to WPX contracts and approximately $37 million related to WilTel lease obligations.
Environmental liabilities accrued at June 30, 2012 totaled $45 million. The Alaska refinery contamination matter had an estimated reasonably possible exposure ranging from insignificant to $32 million; the Liberty Gas Storage counterclaim exceeded $200 million but could not be evaluated reliably.
Williams had a material weakness in accounting for deferred taxes related to its investment in WPZ. Management stated that it corrected the accounting, enhanced controls, refiled the affected 2011 financial statements, and considered the weakness remediated as of June 30, 2012.
Key risks include commodity-price volatility, counterparty and customer credit risk, access to capital, debt covenants and credit ratings, regulatory and FERC proceedings, environmental liabilities, weather and operational hazards, offshore construction risks, and cybersecurity or terrorism-related disruptions.

Important Facts for Investors to Verify

Verify the sustainability of the planned dividend increases against parent-company cash flows, WPZ distributions, acquisition-related financing, and capital requirements.
Assess the effect of continued weak NGL margins on Williams Partners’ earnings, cash flow, hedging results, and 2012 guidance.
Reconcile the different 2012 capital-investment estimates and determine the portion funded by parent debt, WPZ debt, WPZ equity, and operating cash flow.
Review the preliminary purchase-price allocations for the Laser and Caiman acquisitions, including $724 million of goodwill and $1.662 billion of other intangibles recorded at June 30, 2012.
Monitor the remediation of the deferred-tax material weakness and the effect of the related restatement or refiled financial statements.
Evaluate contingent liabilities, environmental accruals, indemnifications, and unresolved litigation, particularly the WPX-related matters and the Liberty Gas Storage counterclaim.
Confirm post-quarter debt activity, credit-facility availability, credit ratings, and potential collateral requirements if Williams or WPZ were downgraded below investment grade.