Hefty litigation costs and accounting adjustments pushed Williams Cos. to a loss in the second quarter. However, with natural gas production jumping 20% from a year ago to 786 MMcf/d and a strong performance from its midstream business, the Tulsa-based gas producer and distributor raised its profit and capital expenditure guidance through 2008.

Williams posted a 2Q2006 loss of $76 million (minus 13 cents/share), compared with earnings of $41.3 million (7 cents) in 2Q2005. Three legacy litigation charges totaled $175 million, and the combined impact on a pretax basis was $267.9 million. The legal charges included a $160.7 million pretax charge associated with an agreement-in-principle to settle securities litigation filed on behalf of purchasers of Williams’ securities between 2000 and 2002, an $88 million pretax accrual, including $20 million in interest, associated with the Gulf liquids jury verdicts last week, and a $19.2 million pretax loss from discontinued operations primarily related to an environmental indemnity arbitration ruling associated with a former business.

Excluding income from continuing operations and mark-to-market accounting adjustments, earnings were $198 million (33 cents/share), compared with $99.5 million (17 cents) for the same period of 2005. Revenue fell to $2.7 billion from $2.9 billion.

“Williams’ solid performance demonstrates that we’re executing our business plan and taking action to deliver strong sustainable increases in shareholder value,” said CEO Steve Malcolm. On a conference call with financial analysts on Thursday, Malcolm said, “so far in 2006, we have invested $1 billion in our businesses, increased our dividend by 20%, completed a major transaction with our master limited partnership, eliminated virtually all of our secured debt, improved our credit ratings, and reached an agreement in principle to settle securities litigation.

“And although natural gas prices softened following a mild winter, these conditions have benefited our midstream business tremendously. The combination of lower prices for natural gas and higher prices for crude oil has pushed the sales margins for natural gas liquids to new highs — highs that could become more of the norm based on the global factors that drive demand for crude oil.

Williams, said Malcolm, is “drilling more natural gas wells than ever before, [and] we’re getting a boost from our previous deepwater investments.” He said Williams is “forecasting continued strength in [natural gas liquids] NGL margins, and we’re expecting new rates on our interstate pipeline systems to be effective early in 2007.”

Based on its performance in the first half of 2006, anticipated increases in gas production volumes and its outlook for crude oil prices — a key factor that has driven record-level sales margins for NGL — Williams raised its guidance for 2006-2008. The company now expects to earn $0.95-$1.20/share in 2006 on a recurring basis adjusted to remove the effect of mark-to-market accounting, an increase of 19% compared with the previous expectation of $0.78-$1.03.

Williams also raised its expectations for consolidated segment profit for 2006 through 2008 on a recurring basis, adjusted to remove the effect of mark-to-market accounting. Updated 2006 guidance is $1.69-$2.01 billion, up from $1.52-$1.86 billion. In 2007, guidance improved to $1.97-$2.475 billion from $2.255-$2.015 billion. And in 2008, Williams upped its guidance to $2.2-$2.875 billion from $2.015-$2.58 billion.

The company’s overall expected capital budget increased as well, with new money directed primarily toward projects that support exploration and production (E&P) gas development in the Piceance Basin. In 2006, Williams increased its capital expenditure guidance to $2.2-$2.4 billion from $1.95-$2.15 billion; in 2007, guidance was increased to $1.775-$1.975 billion from $1.6-$1.8 billion; and in 2008, spending was upped to $1.575-$1.825 billion from $1.5-$1.75 billion.

Credit Suisse energy analyst Carl Kirst said in a note to clients that Williams’ E&P unit “continues to post industry-leading results. “While Midstream may have stolen some of E&P’s thunder, we would note that when adjusting for material acquisitions/dispositions in the E&P sector, we believe at 22% growth WMB is the leader in year-over-year growth for any sizeable domestic gas producer (above 200 MMcf/d). While the company is increasing its E&P [capital expenditure] budget by 20% ($200 million), only $35 million of this is due to oilfield inflation, with the remainder aimed at either adding acreage and reserves ($60 million) or accelerating drilling plans and supporting midstream infrastructure.” Kirst said, “Bottom line, at over 20% total return potential, WMB remains one of our top ideas in the diversified gas space, and we reiterate our Outperform rating.”

In connection with the legal charges recorded in the quarter, jury verdicts were returned last week against two of Williams’ subsidiaries for breach of contract and fraud in connection with the design and construction of four Louisiana gas processing plants. After a three-month trial in the 215th District Court of Harris County, TX, the Houston jury awarded $206 million damages to two Texas construction companies in a five-year dispute against Williams subsidiaries Williams Power Co. Inc. and Gulf Liquids New River Project LLC and against Winterthur International America Insurance Co. Corpus Christi-based Bay Ltd. was awarded $32 million in actual damages and $85 million in punitive damages. Humble, TX-based Gulsby-Bay Plant Partners was awarded $4.3 million in actual damages and $85 million in punitive damages. Plaintiffs Gulsby Engineering and National American Insurance Co. also were awarded actual and punitive damages in the case.

The jury verdicts are subject to trial and appellate court review. Entry of a judgment in the trial court is expected in the third or fourth quarter. If the trial court enters a judgment consistent with the jury’s verdicts against the company’s subsidiaries, Williams said it would seek a reversal through appeal.

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