Liquidity
Williams considers its liquidity to come from two sources: internal liquidity, consisting of available cash investments, and external liquidity, consisting of borrowing capacity from available bank-credit facilities and Williams Holdings’ commercial paper program, which can be utilized without limitation under existing loan covenants. At December 31, 1997, Williams had access to $155 million of liquidity including $132 million available under its $1 billion bank-credit facility. This compares with liquidity of $550 million at December 31, 1996, and $656 million at December 31, 1995. The decrease in 1997 is due primarily to additional borrowings under the bank-credit facility to finance increased capital expenditures and to provide interim financing related to the debt restructuring program.

During 1997, Williams Holdings entered into a commercial paper program backed by $650 million of new short-term bank-credit facilities. At December 31, 1997, $645 million of commercial paper was outstanding under the program. After completion of the debt restructuring, Williams expects approximately $1 billion of shelf availability to remain under outstanding registration statements. These registration statements may be used to issue a variety of debt or equity securities. In addition, short-term uncommitted bank lines are utilized in managing liquidity. Williams believes any additional financing arrangements can be obtained on reasonable terms if required.

Williams had a net working-capital deficit of $772 million at December 31, 1997, compared with $309 million at December 31, 1996. Williams manages its borrowings to keep cash and cash equivalents at a minimum and has relied on bank-credit facilities to provide flexibility for its cash needs. As a result, it historically has reported negative working capital. The increase in the working-capital deficit at December 31, 1997, as compared to prior year-end is primarily a result of short-term borrowings under the commercial paper program.

Terms of certain borrowing agreements limit transfer of funds to Williams from its subsidiaries. The restrictions have not impeded, nor are they expected to impede, Williams’ ability to meet its cash requirements in the future.

During 1998, Williams expects to finance capital expenditures, investments and working-capital requirements through cash generated from operations and the use of the available portion of its $1 billion bank-credit facility, commercial paper, short-term uncommitted bank lines and debt or equity public offerings.

Operating Activities
Cash provided by operating activities was: 1997 — $920 million; 1996 — $710 million; and 1995 — $829 million. Receivables, inventories and accounts payable increased due primarily to the combination of customer equipment sales and services operations with Nortel (see Note 2) and increased trading activities by Energy Marketing & Trading.

Financing Activities
Net cash provided (used) by financing activities was: 1997 — $317 million; 1996 — $734 million; and 1995 — ($1.4) billion. Long-term debt principal payments, net of debt proceeds, were $161 million during 1997, and notes payable proceeds, net of notes payable payments, were $615 million during 1997. The increase in notes payable at December 31, 1997, reflects borrowings under the new commercial paper program to fund capital expenditures, investments and acquisition of businesses. Long-term debt proceeds, net of principal payments, were $609 million during 1996. The increase in net new borrowings during 1996 was primarily to fund capital expenditures, investments and acquisitions of businesses. Long-term debt principal payments, net of debt proceeds, were $610 million during 1995. The net payments in 1995 were primarily a result of payments Williams made to retire and/or terminate approximately $700 million of Transco Energy’s borrowings, preferred stock, interest-rate swaps and sale of receivable facilities in connection with the acquisition of Transco Energy.

The proceeds from issuance of common stock in 1997, 1996 and 1995 include Williams’ benefit plan stock purchases and exercise of stock options under Williams’ stock plan. The 1995 proceeds from issuance of common stock also includes $46.2 million from the sale of 3.6 million shares of Williams common stock.

The 1996 purchases of Williams’ treasury stock include 1.9 million shares of common stock on the open market for $31 million. The Williams’ board of directors authorized up to $800 million of such purchases. No additional shares were purchased during 1997, and Williams’ board of directors terminated the repurchase program during the fourth quarter of 1997.

Long-term debt at December 31, 1997, was $4.6 billion, compared with $4.4 billion at December 31, 1996, and $2.9 billion at December 31, 1995. At December 31, 1997 and 1996, $560 million and $200 million, respectively, in current debt obligations have been classified as non-current obligations based on Williams’ intent and ability to refinance on a long-term basis. The 1996 increase in long-term debt is due primarily to the $643 million outstanding debt assumed with the acquisition of Kern River (see Note 2), $300 million in additional borrowings under the $1 billion bank-credit facility and $250 million of debt issued by Williams Holdings. The long-term debt to debt-plus-equity ratio was 56.1 percent for 1997 and 1996 compared to 47.4 percent at December 31, 1995. If short-term notes payable and long-term debt due within one year are included in the calculations, these ratios would be 59.7 percent, 57.9 percent and 50.1 percent, respectively.

Investing Activities
Net cash provided (used) by investing activities was: 1997 — ($1.3) billion; 1996 — ($1.4) billion; and 1995 — $585 million. Capital expenditures of gas pipeline subsidiaries, primarily to expand and modernize systems, were $419 million in 1997,
$441 million in 1996, and $445 million in 1995. Expenditures in 1997 and 1996 include Transcontinental Gas Pipe Line’s expansion; expenditures in 1995 include Transcontinental Gas Pipe Line and Northwest Pipeline’s expansions. Capital expenditures of Energy Services, primarily to expand and modernize gathering and processing facilities, were $305 million in 1997, $292 million in 1996, and $336 mil-lion in 1995. Capital expenditures of Communications were $276 million in 1997, $67 million in 1996, and $32 million 1995. The 1997 expenditures include the fiber-optic network. Budgeted capital expenditures and investments for 1998 are estimated to be approximately $2.5 billion, primarily to expand and modernize pipeline systems, gathering and processing facilities and the fiber-optic network. If the pending MAPCO acquisition is completed, budgeted capital expenditures will increase an estimated $400 million.

On April 30, 1997, Williams and Northern Telecom (Nortel) combined their customer-premise equipment sales and services operations into a limited liability company, Williams Communications Solutions, LLC (LLC). In addition, Williams paid $68 million to Nortel. Williams has accounted for its 70 percent interest in the operations that Nortel contributed to the LLC as a purchase business combination. Williams recorded the 30 percent reduction in its operations contributed to the LLC as a sale to the minority shareholders of the LLC (see Note 2). During 1997, Williams also purchased a 20 percent interest in a foreign telecommunications business for $65 million in cash. During 1996, Williams acquired the remaining interest in Kern River for $206 million cash (see Note 2). In addition, during 1996 Williams acquired various communications technology businesses totaling $165 million in cash. In 1995, Williams acquired all of Transco Energy’s outstanding common stock for cash of $430.5 million and 31.2 million shares of Williams common stock valued at $334 million (see Note 2). During 1995, Williams also acquired the Gas Company of New Mexico’s natural gas gathering and processing assets in the San Juan and Permian basins for $154 million and Pekin Energy Co., the nation’s second largest ethanol producer, for $167 million in cash.

During 1995, Williams received proceeds of $2.5 billion in cash from the sale of its network services operations (see Note 3) and proceeds of $124 million from the sale of its 15 percent interest in Texasgulf Inc. (see Note 6).

New Accounting Standards
See Note 1 for the effects of Statement of Financial Accounting Standards (SFAS) No. 130, “Reporting Comprehensive Income,” and SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information.”

MAPCO Acquisition
On November 24, 1997, Williams and MAPCO Inc. announced that they had entered into a definitive merger agreement whereby Williams would acquire MAPCO by exchanging 1.665 share of Williams common stock for each outstanding share of MAPCO common stock. In addition, outstanding MAPCO employee stock options would be converted into Williams common stock. Based on the closing market price of Williams common stock on December 31, 1997, approximately 96.8 million shares of Williams common stock valued at approximately $2.8 billion would be issued in the transaction. The transaction, subject to approval by both Williams and MAPCO stockholders and to review under federal anti-trust laws, is expected to close during the first quarter of 1998 (see Note 19).

Williams expects to utilize both internal and external resources to complete this process. Existing resources will be redeployed and previously planned system replacements will be accelerated during this time. For example, implementation of previously planned financial and human resources systems is currently in process. These systems will address the year 2000 compliance issues in certain areas. Costs incurred for new software and hardware purchases will be capitalized and other costs will be expensed as incurred. For the regulated pipelines, Williams considers costs associated with the year 2000 compliance to be prudent costs incurred in the ordinary course of business, and, therefore, recoverable through rates. While the total cost of this project is still being evaluated, Williams estimates that external costs, excluding previously planned system replacements, necessary to complete the project within the schedule described will total at least
$15 million. Williams will update this estimate as additional information becomes available. The costs of the project and the completion dates are based on management’s best estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources, third party year 2000 compliance modification plans and other factors. There can be no guarantee that these estimates will be achieved and actual results could differ materially from these estimates.

The following table provides information about Williams’ notes payable, long-term debt, interest rate swaps and interest rate forward contracts that are subject to interest rate risk. For notes payable and long-term debt, the table presents principal cash flows and weighted average interest rates by expected maturity dates. For interest rate swaps and interest rate forward contracts, the table presents notional amounts and weighted average interest rates by contractual maturity dates. Notional amounts are used to calculate the contractual cash flows to be exchanged under the interest rate swaps and the settlement amounts under the interest rate forward contracts.

Commodity Price Risk
Energy Marketing & Trading has trading operations that provide price risk management services to third-party customers. The trading operations have commodity price risk exposure associated with the crude oil, natural gas, refined products, natural gas liquids and electricity energy markets in the United States and the natural gas markets in Canada. The trading operations enter into energy-related financial instruments (forward contracts, futures contracts, option contracts and swap agreements) and have commodity inventories and purchase and sale commitments which involve the physical delivery of an energy commodity. These financial instruments and physical positions and commitments are valued at market value and unrealized gains and losses from changes in market value are recognized in income. The trading operations are subject to risk from changes in energy commodity market prices, the portfolio position of its financial instruments and physical commitments, the liquidity of the market in which the contract is transacted, changes in interest rates and credit risk. Energy Marketing & Trading manages risk by maintaining its portfolio within established trading policy guidelines. A Risk Control Group, independent of the trading operations, monitors compliance with established trading policy guidelines and measures the risk associated with the trading portfolio.

Energy Marketing & Trading uses a value at risk methodology to estimate the potential one day loss from adverse changes in the market value of its trading operations. At December 31, 1997, the value at risk for the trading operations is $4 million. This reflects a 97.5 percent probability that as a result of changes in commodity prices, the one day loss in the market value of the trading portfolio will not exceed the value at risk. The value at risk includes all the financial instruments and physical positions and commitments that expose the trading operations to market risk. The value-at-risk model estimates assume normal market conditions based upon historical market prices. Value at risk does not purport to represent actual losses in market value that could be incurred from the trading portfolio, nor does it consider that changing our trading portfolio in response to market conditions could affect market prices and could take longer to execute than the one-day holding period assumed in our value at risk model.

Foreign Currency Risk
Williams has investments in companies whose operations are located in foreign countries, of which $87 million are accounted for using the cost method. Fair value for the cost method investments is deemed to approximate their carrying amount, because estimating cash flows by year is not practicable given that the time frame for selling these investments is uncertain. Williams’ financial results could be affected if the investments incur a permanent decline in value as a result of changes in foreign currency exchange rates and the economic conditions in foreign countries. Williams attempts to mitigate these risks by investing in different countries and business segments. Approximately 80 percent of the cost method investments are in Asian countries and 20 percent in South American countries. Of the Asian investments, approximately 50 percent are in countries whose currencies have recently suffered significant devaluations and volatility. The ultimate duration and severity of the conditions in Asia remains uncertain as does the long-term impact on Williams’ investments.

Regarding Forward-Looking Statements

Certain matters discussed in this report, excluding historical information, include forward-looking statements. Although Williams believes such forward-looking statements are based on reasonable assumptions, no assurance can be given that every objective will be reached. Such statements are made in reliance on the "safe harbor" protections provided under the Private Securities Litigation Reform Act of 1995.

As required by that law, the company hereby identifies the following important factors that could cause actual results to differ materially from any results projected, forecasted, estimated or budgeted by the company in forward looking statements.

• Risks and uncertainties impacting the company as a whole relate to changes in general economic conditions in the United States; the availability and cost of capital; changes in laws and regulations to which the company is subject, including tax, environmental and employment laws and regulations; the cost and effects of legal and administrative claims and proceedings against the company or its subsidiaries or which may be brought against the company or its subsidiaries; and changes in general and economic conditions and currencies in foreign countries.

• For the company’s regulated businesses, risks and uncertainties primarily relate to the impact of future federal and state regulations of business activities, including allowed rates of return and the resolution of other matters discussed herein.

• Risks and uncertainties associated with the company’s unregulated businesses primarily relate to energy prices and the ability of such entities to develop expanded markets and product offerings as well as their ability to maintain existing markets. In addition, future utilization of pipeline capacity will depend on energy prices, competition from other pipelines and alternate fuels, the general level of natural gas and petroleum product demand, and weather conditions, among other things. Further, gas prices, which directly impact transportation and gathering and processing throughput and operating profit, may fluctuate in unpredictable ways. Factors impacting future results of the company’s communications business include successful completion of its network build, technological developments, high levels of competition, lack of customer diversification and general uncertainties of governmental regulation.