It was a rocky week for Williams, which delayed its final earnings estimate Tuesday in order to evaluate contingent liabilities with its spin-off Williams Communications Group (WCG), an action that sparked a rash of investor lawsuits and split the two main ratings agencies down the middle. Late Friday Moody’s Investor Service confirmed Williams ratings, and classified them as stable, while even later Friday Standard and Poor’s (S&P) placed Williams and subsidiaries on CreditWatch with negative implications.

Moody’s confirmed the ratings of the parent company (WMB, Baa2 senior unsecured) and its subsidiaries. Moody’s also confirmed the Baa3 debt rating of Williams Communications Group (WCG) Note Trust, a third-party special purpose vehicle to which Williams has a contingent obligation.

S&P took the opposite tack, saying it saw “a higher probability” that all or some of the $1.4 billion of senior notes issued by the WCG Note Trust, “will be refinanced with debt rather than equity by Williams, due to a significantly greater than expected deterioration of the asset value of Williams Communications.”

On Tuesday the company had issued “pre-release” earnings estimates, saying it would not have a complete and final earnings report until it assessed contingent liabilities related to WCG, which was spun off last year.

The company said the delay and its assessment “was initiated in light of Williams’ previously announced intention to eliminate credit-rating and equity-price triggers as part of contingent financial commitments associated with the 2001 spin-off of WCG, and because of recent developments within the telecommunications industry. Company officials in a webcast cited the recent downgrade of WCG by Standard & Poor’s and the Chapter 11 bankruptcy filing of Global Crossing, a major communications carrier, on Monday, which sparked another downturn in telecommunications stocks.

Williams said that within the next few weeks it expected to be able to estimate the financial effect, if any, regarding its ultimate obligation related to WCG’s $1.4 billion debt and a network lease agreement covering assets that cost $750 million. Any financial impact would likely be classified as discontinued operations in Williams’ final 2001 consolidated income statement.

The announcement ignited a frenzy among class action litigators and by Friday at least five lawsuits had been filed alleging the companies made “material misrepresentations to the markets” between July 24, 2000 and Jan. 29, 2002. The lawsuits claimed the actions served to inflate the price of the two companies’ common stock.

Moody’s had no problem with the situation.”We believe that Williams has the financial resources and liquidity to perform on its obligations to WCG without impairing its own credit quality.” The ratings agency said its affirmation came after discussions Thursday with Williams management about its contingent obligations related to the “financially stressed Williams Communications Group (WCG, Caa3 senior unsecured, negative outlook).” Williams has $2.5 billion of various contingent obligations to support WCG, the largest of which is the $1.4 billion of notes issued by the Note Trust. “The possibility of Williams assuming the Note Trust debt in some fashion or repaying it was fully factored into our rating confirmation of WMB debt in December 2001,” Moody’s said.

Further, the agency “is monitoring the progress of WMB’s debt reduction plan that it announced in December. The plan includes placing mandatorily convertible securities (a $1.1 billion offering was concluded in January), selling assets, curtailing capital spending by about $1 billion, and eliminating rating triggers (the most significant of which is included in the Note Trust covenants). Moody’s expects that cash raised from these initiatives will be used to maintain debt at levels reasonable for its rating and its business risk (fully adjusted debt-to-capital in the mid-50% range, retained cash flow-to-debt approaching 20%) as well as for capital expenditures. We expect WMB to adjust spending levels in line with its internal cash flows and proceeds received from asset sales.”

Moody’s said Williams has “ample liquidity” and ” maintains lines that can well accommodate the substantial and volatile working capital needs of its energy trading business. It also draws financial flexibility in its ability to reduce spending when necessary, since its mandatory capital expenditures are relatively low.”

But S&P said that if Williams adds new debt to pay off the WCG obligation the company “may be challenged further to achieve leverage targets that are more appropriate for the current rating.”

S&P also found “uncertainty surrounding the timing and pricing of the sale of substantial assets to shore up the balance sheet,” and noted that “the recent drop in the stock price at least modestly constrains financial flexibility and may trigger “material adverse change” clauses, or similar clauses in bank revolvers and/or commercial paper back-up facilities.”

S&P plans to conduct a thorough bottom-up analysis, by business unit, “to determine whether the current rating is appropriate, given the potentially weakened capital structure, quality of cash flow, and diminished financial flexibility.”

Among the ratings put on watch with negative implications by S&P are Williams corporate rating of BBB+/A-2 and its senior unsecured debt rating of BBB. The individual pipeline ratings of BBB+ also are on watch.

Williams stock had rebounded by 7.47% Friday to close at $19. It had started out the week at just under $25, but dropped precipitously Tuesday when Williams announced it was deferring its final earnings release.

Several of the lawsuits initiated following Williams action also named Williams Chairman Keith E. Bailey, WCG’s Chairman Howard E. Janzen and CFO Scott E. Schubert. The suits, originating in New York, Pennsylvania, California, Connecticut, and Arkansas, were filed in the United States District Court for the Northern District of Oklahoma.

The initial complaint filed by the law firm of Milberg Weiss Bershad Hynes & Lerach LLP alleges that Williams and its communications offshoot failed to disclose:

(1) that the spin-off of WCG from Williams was not in stockholders best interests, but was aimed at “allowing Williams to shore up its balance sheet so it could issue more stock and/or debt to acquire companies using its common stock as currency and protect its debt rating;

(2) “that WCG was operating at levels well below expectations, such that revenue projections were overstated, and costs and expenses were understated, and also such that, in an effort to control costs, defendants would soon have to take actions which would have a further adverse impact on WCG’s profitability;

(3) “that approximately $2 billion of WCG debt that was guaranteed for payment by Williams around the time of the spin-off was improperly footnoted as a mere contingent obligation of Williams, which was materially false and misleading because the declining financial condition of WCG made it increasingly certain that Williams would be forced to pay on such guaranties, for which it did not adequately reserve;

(4) “that WCG’s assets were permanently impaired and had to be written-off and that WCG avoided taking such write-offs on its own books through the series of financial machinations described in the complaint;

(5) “that Williams was carrying on its financial statements, receivables from WCG that were impaired, uncollectible and should have been written-off in whole or in substantial part. Rather than writing off these impaired assets, which amounted to tens of millions of dollars, WMB agreed to extend up to $100 million of WCG’s receivables with an outstanding balance due on March 31, 2001, to March 15, 2002; and

(6) “that the sale and leaseback of WCG’s office properties in or about September of 2001 was a non-arm’s-length transaction at an inflated value for the properties whose motive and intent was to funnel monies to WCG and avoid forcing Williams to perform its guaranties and thereby adversely affect its results and debt ratings.”

The complaint can be viewed at https://www.milberg.com/williamscompanies/.

Williams promptly came back with a reassurance to investors on Wednesday that it “remains fully committed to maintaining its current investment-grade credit rating,” and called the market’s response to its announcement on Tuesday an “overreaction not supported by facts.”

“All relevant facts surrounding Williams’ 2001 spin-off of Williams’ former communications unit, including all items related to contingent financial obligations, have been properly accounted for and disclosed in SEC filings,” said CEO Steve Malcolm. “These issues also have been discussed since their inception with investors, banks, rating agencies and any individual who asked any question about any publicly filed document. Other than our internal assessment of whether we will ever have to perform on our Williams Communications contingent obligations, there are no issues, accounting or otherwise, that prompted the delay of releasing final 2001 earnings on Tuesday.

“As we have said, we are committed to earnings growth, asset sales, capital spending reductions, expense reductions or utilizing any other element within our extensive financial capabilities to maintain or further strengthen our already strong balance sheet. These measures give us the capability, if required, to satisfy our contingent obligations of up to $2.2 billion related to Williams Communications.

“We are constructively addressing the issues related to our former communications business in a manner that we expect will not impact current earnings growth or our ability to achieve all of the recurring earnings growth targets we have established.”

Malcolm noted that on Tuesday in its pre-release of earnings, the company estimated that it would have a record $2.7 billion in recurring segment profit. “It is disappointing that the market largely ignored the terrific year we posted in 2001 and the reaffirmation of our 2002 earnings target.” He said in addition to the record earnings that are expected for 2001, Williams currently has $38 billion in assets and significant liquidity, including $1.2 billion cash on hand, $1.1 billion of commercial paper availability, fully backed by banks and $700 million of available multi-year revolving credit facilities.

Williams said it expects to show recurring 2001 earnings of $2.35/share, which includes a 12 cents/share fourth quarter charge for credit exposure related to Enron’s bankruptcy. This compares with recurring earnings of $2.33/share in the previous year. The company said 2001 earnings were bolstered by “substantially improved performance of its energy marketing & trading and exploration & production units.”

Income from the trading unit is expected to increase. Malcolm, Williams’ new president and CEO, told analysts in a webcast Williams Energy Marketing & Trading (WEMT) has 140 deals in the works, and expects to close on several large ones in the first quarter. In addition, new pipeline projects will come on-line in 2002 and the company’s E&P division will be continuing development of its newly acquired Barrett Resources. Malcolm reaffirmed the previous 2002 recurring earnings guidance of from $2.65 to $2.75 per share, saying the company expects to show 12-15% growth a year going forward.

Malcolm described the lineup of potential deals for WEMT as “spectacular,” ranging from small 50 MW deals to several thousand MW, with terms varying from a year up to 15 to 20 years. “We haven’t seen margins deteriorate,” he said, in the type of long-term firm deal that Williams specializes in. “There is an interest in our risk management skills,” since counterparties are concerned about uncertainties in the market, and “we are a risk management company.”

Nevertheless, Malcolm said most fourth quarter gains were in proprietary trading. He blamed the lack of large structured deals in the third and fourth quarters on hesitation brought on by the Enron meltdown. “Certain counterparties were wondering if we would all melt down.” Malcolm noted the difference between Williams and Enron. “We have been viewed as anti-Enron,” he said pointing to the company’s significant assets behind its marketing and trading operations and the fact that it operates on a different business plan.

Williams’ new CEO withstood a tough grilling from securities analysts who questioned over and over the company’s mark-to-market accounting and the ramifications of the financial connections with WCG. Malcolm confirmed that 60% of the trading company’s $1.3 billion net income is in unrealized gains. Treasurer Jim Ivey said the company’s debt-to-capital ratio in 2002 is about 55%, which is the level the ratings agencies were looking for.

Ivey said he expects to see less volatility in prices in 2002, and “if the economy recovers, we expect gas to firm up at the earliest in April or May.”

In its earnings pre-release Williams’ estimated unaudited income from continuing operations is $2.01 per share on a diluted basis for 2001 versus $2.15 per share in 2000.

The company showed a substantial drop in fourth quarter recurring earnings, which are expected to be 34 cents per share versus 89 cents for the same quarter of 2000. Williams estimated fourth quarter 2001 income from continuing operations to be 13 cents on a diluted basis versus 80 cents per share for the previous year.

WEMT showed $1.3 billion in recurring segment profit in 2001 versus $1.1 billion for the previous year. The improvement was primarily due to increased origination of price risk management services and structured risk management solutions, which also served to reduce natural gas and power portfolio risk. Recurring results include fourth quarter charges totaling $91 million for credit exposure related to Enron’s bankruptcy.

At year-end, approximately 70% of the value recognized in WEMT’s power structured risk management portfolio is expected to be realized over the next five years. In addition, approximately 80% of the power structured risk management portfolio volumes are fully hedged for the first 10 years, Williams said.

Estimated 2001 WEMT segment profit of $1.3 billion includes the previously disclosed $23 million loss from the writedown of certain marketable equities, while segment profit of $1 billion in 2000 included $65.5 million in impairments and loss accruals.

WEMT’s recurring profit for the fourth quarter of 2001 is estimated to be $169.9 million versus $547 million for the same period of 2000. The decline primarily was due to lower spark spreads recognized in the fourth quarter of 2001.

Williams’ gas pipeline business showed $710.9 million in recurring profit in 2001 versus $750.7 million for the previous year. The benefit in 2000 of rate refund liability reversals and rate surcharges totaling $74 million are partially offset in 2001 by a $15.1 million favorable regulatory adjustment, higher earnings from investments in joint venture projects of $19 million and increased natural gas transportation revenues on the Transco system.

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