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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
For the fiscal year ended December 31, 1998
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or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from ______________ to ______________
Commission file number 1-8246
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SOUTHWESTERN ENERGY COMPANY
(Exact name of Registrant as specified in its charter)
ARKANSAS 71-0205415
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1083 Sain Street, P.O.Box 1408, Fayetteville, Arkansas 72702-1408
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(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code (501) 521-1141
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Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
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Common Stock - Par Value $.10 New York Stock Exchange
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
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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. X
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The aggregate market value of the voting stock held by non-affiliates of
the Registrant was $174,889,210 based on the New York Stock Exchange - Composite
Transactions closing price on March 29, 1999 of $7 1/8.
The number of shares outstanding as of March 29, 1999, of the
Registrant's Common Stock, par value $.10, was 24,933,280.
DOCUMENTS INCORPORATED BY REFERENCE
Documents incorporated by reference and the Part of the Form 10-K into
which the document is incorporated: (1) Annual Report to holders of the
Registrant's Common Stock for the year ended December 31, 1998 - PARTS I, II,
and IV; and (2) definitive Proxy Statement to holders of the Registrant's Common
Stock in connection with the solicitation of proxies to be used in voting at the
Annual Meeting of Shareholders on May 18, 1999 - PART III.
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SOUTHWESTERN ENERGY COMPANY
FORM 10-K
ANNUAL REPORT
For the Year Ended December 31, 1998
TABLE OF CONTENTS
PART I
Page
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Item 1. Business....................................................................................... 1
Business Strategy.............................................................................. 1
Exploration and Production..................................................................... 1
Natural Gas Distribution ...................................................................... 7
Marketing and Transportation................................................................... 11
Other Items.................................................................................... 14
Item 2. Properties..................................................................................... 14
Item 3. Legal Proceedings.............................................................................. 16
Item 4. Submission of Matters to a Vote of Security Holders............................................ 18
Executive Officers of the Registrant........................................................... 18
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.......................... 19
Item 6. Selected Financial Data........................................................................ 20
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 20
Item 7.A. Quantitative and Qualitative Disclosure About Market Risks..................................... 20
Item 8. Financial Statements and Supplementary Data.................................................... 22
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........... 22
PART III
Item 10. Directors and Executive Officers of the Registrant............................................. 22
Item 11. Executive Compensation......................................................................... 23
Item 12. Security Ownership of Certain Beneficial Owners and Management................................. 23
Item 13. Certain Relationships and Related Transactions................................................. 23
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................... 23
PART I
Item 1. Business
Southwestern Energy Company (the "Company" or "Southwestern") is an
integrated energy company primarily focused on natural gas. The Company was
organized in 1929 as a local gas distribution company in northwest Arkansas. The
Company is incorporated under the laws of the state of Arkansas and is an exempt
holding company under the Public Utility Holding Company Act of 1935. Today,
Southwestern is involved in the following business segments:
1. Exploration and Production -- Engaged in natural gas and oil
exploration, development and production, with operations principally
located in Arkansas, Oklahoma, Texas, New Mexico, south Louisiana, and
the Gulf Coast.
2. Natural Gas Distribution -- Engaged in the gathering, distribution and
transmission of natural gas to approximately 179,000 customers in
northern Arkansas and parts of Missouri.
3. Marketing and Transportation -- Provides marketing and transportation
services in the Company's core areas of operation and owns a 25%
interest in the NOARK Pipeline System, Limited Partnership (NOARK).
This Report on Form 10-K includes certain statements that may be deemed to
be "forward-looking statements" within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Part II, Item 7 of this Report for a discussion of factors that
could cause actual results to differ materially from any such forward-looking
statements.
Business Strategy
The Company's business strategy is to provide long-term growth through
focused exploration and production of oil and natural gas, while creating
additional value through the Company's natural gas distribution, marketing and
transportation activities. The Company seeks to maximize cash flow and earnings
and provide consistent growth in oil and gas production and reserves through the
discovery, production and marketing of high margin reserves from a balanced
portfolio of drilling opportunities. This balanced portfolio includes low risk
development drilling in the Arkoma Basin, moderate risk exploration and
exploitation in the Permian Basin in New Mexico, and high potential exploration
opportunities in south Louisiana and the Gulf Coast. Additionally, the Company
strives to operate its utility systems safely and efficiently and to position
them to earn their full, authorized return. The Company is also committed to
enhancing shareholder value by creating and capturing additional value beyond
the wellhead through its marketing and transportation activities.
Exploration and Production
In 1943, the Company commenced a program of exploration for and development
of natural gas reserves in Arkansas for supply to its utility customers. In
1971, the Company initiated an exploration and development program outside
Arkansas, unrelated to the utility requirements. Since that time, the Company's
exploration and development activities outside Arkansas have expanded
substantially.
1
During 1998, Southwestern brought in new senior operating management and
replaced over 50% of its professional technical staff to refocus its exploration
and production segment. Additionally in 1998, the Company closed its Oklahoma
City office and moved these operations to its Houston office in an effort to
increase future profitability. Another major part of this segment's
restructuring was the reorganization into asset management teams. Two
exploitation teams were formed (an Arkoma team and a Permian
Basin/Mid-Continent/Gulf Coast team) to manage Southwestern's producing
properties, and three exploration teams (Permian Basin, Texas Gulf Coast and
south Louisiana) were formed to provide an area specific focus in exploration
projects. A new incentive compensation system was also put in place in 1998 for
the professional staff which aligns our employees' efforts with the interests of
our shareholders, while fostering a culture that is innovative and focused on
growth as well as profitability.
At December 31, 1998, the Company had proved oil and gas reserves of 344.8
billion cubic feet (Bcf) equivalent, including proved natural gas reserves of
303.7 Bcf and proved oil reserves of 6,850 thousand barrels (MBbls). All of the
Company's reserves are located entirely within the United States. Revenues of
the exploration and production subsidiaries are predominately generated from
production of natural gas. Sales of gas production accounted for 89% of total
operating revenues for this segment in 1998, 86% in 1997, and 90% in 1996.
Areas of Operation
Southwestern engages in gas and oil exploration and production through its
subsidiaries, SEECO, Inc. (SEECO), Southwestern Energy Production Company
(SEPCO), and Diamond "M" Production Company (Diamond M). SEECO operates
exclusively in the state of Arkansas and holds a large base of both developed
and undeveloped gas reserves and conducts an ongoing drilling program in the
historically productive Arkansas part of the Arkoma Basin. SEPCO conducts
development drilling and exploration programs in areas outside Arkansas,
including the Permian Basin of Texas and New Mexico, the Gulf Coast areas of
Louisiana and Texas, and the Anadarko Basin of Oklahoma. Diamond M operates
properties in the Permian Basin of Texas.
The following table provides December 31, 1998 information as to proved
reserves, well count, and gross and net acreage, and 1998 annual information as
to production and reserve additions for each of the Company's core operating
areas.
Arkoma Mid-Continent Permian Gulf Coast Total
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Proved Reserves:
Gas (Bcf) 214.9 33.7 27.8 27.3 303.7
Oil (MBbls) - 2,242 3,532 1,076 6,850
Total Reserves (Bcfe) 214.9 47.1 49.0 33.8 344.8
Production (Bcfe) 20.7 6.7 4.7 4.8 36.9
Reserve Additions (Bcfe) 22.9 2.7 19.2 2.7 47.5
Total Gross Wells 818 1,414 362 68 2,662
Percent Operated 48% 37% 59% 41% 45%
Gross Acreage 336,664 137,107 63,610 141,640 679,021
Net Acreage 269,715 50,786 29,281 62,797 412,579
2
Arkoma. Southwestern has been active in the Arkansas portion of the Arkoma
Basin since 1943. As a result, it has developed a substantial acreage position
and reserve base in the basin. At December 31, 1998, the Company had
approximately 214.9 Bcf of natural gas reserves in the Arkoma Basin. This
represents 71% of the Company's natural gas reserves and 62% of total reserves
on a Bcf equivalent basis. Southwestern's average net daily production in 1998
in the Arkoma Basin was 56.9 million cubic feet equivalent (MMcfe).
Historically, Southwestern has conducted its Arkansas development drilling
program primarily within the boundaries of its utility gathering system. In
1997, the Company accelerated the extension of its Arkoma drilling program
outside of its traditional operating areas to new fields. During 1998,
Southwestern enjoyed successful stepout drilling in the lightly-explored
southern edges of the Arkoma Basin in Arkansas and in the western part of the
basin in Oklahoma. Overall, the Company participated in 52 gross wells (23.6
net) in the Arkoma Basin during 1998 with a success ratio of 83%. These wells
contributed 22.9 Bcf to total 1998 reserve additions. During 1999, Southwestern
plans to continue to capitalize on its geological experience in the Arkoma Basin
and increase its emphasis on development drilling outside of the traditional
Arkansas fairway.
Mid-Continent. The Company's activities in this region are primarily
focused on the Anadarko Basin of Oklahoma. At December 31, 1998, the Company had
approximately 33.7 Bcf of natural gas reserves and 2,242 MBbls of oil reserves
in the region, representing 11% and 33%, respectively, of the Company's total
gas and oil reserves. Average net daily production in 1998 for this region was
18.2 MMcfe. During 1998, the Company closed its Oklahoma City office and moved
these operations to Houston. Southwestern does not expect its Mid-Continent
operations to be a primary area of future growth.
Permian. In recent years, Southwestern has experienced excellent success in
the lower and middle Morrow formations in the Permian Basin in southeast New
Mexico. At December 31, 1998, the Company had approximately 27.8 Bcf of natural
gas reserves and 3,532 MBbls of oil reserves in the region, representing 9% and
51%, respectively, of the Company's total gas and oil reserves. Average net
daily production in 1998 for this region was 12.9 MMcfe.
Since its first exploratory discovery in 1995, the Company's drilling
program in this area has resulted in 21 successful wells of 26 drilled.
Continued development of our Gaucho unit, in which the Company has approximately
a 50% working interest, resulted in reserve additions of 13.2 Bcf equivalent in
1998. The Rio Blanco #4-1, located two miles from existing Gaucho production,
was recently completed and could extend the Gaucho field and lead to further
development. Five wells have been drilled within the Gaucho prospect and,
including the Rio Blanco #4-1, four are producing at a combined daily gross rate
of 21.1 MMcf of natural gas and 137 barrels of condensate. The Company believes
that its drilling activities in this area will provide additional opportunities
for growth in production and reserves.
Gulf Coast/South Louisiana. The Company became active in the Gulf Coast and
south Louisiana areas in 1990. At December 31, 1998, the Company had
approximately 27.3 Bcf of natural gas reserves and 1,076 MBbls of oil reserves
in the region, representing 9% and 16%, respectively, of the Company's total gas
and oil reserves. Average net daily production in 1998 for this region was 13.1
MMcfe. Southwestern considers this region to be a primary area for growth in the
Company's production and reserves.
3
South Louisiana continues to be the major focus area of high impact
exploration activities. In 1998, the Company used its growing inventory of 3-D
seismic data and leasehold acreage to create the largest inventory of
exploration prospects in the Company's history. Drilling began in the fourth
quarter of 1998 with four wells spud to date. Two of these wells are currently
drilling and two test wells were dry, demonstrating the higher risk nature of
south Louisiana exploration. The Company anticipates additional drilling in
this area in 1999.
Over the past several years, the Company has built an extensive inventory
of 3-D seismic data covering almost 550 square miles in south Louisiana. In
1998, the Company continued to analyze the seismic data from the East
Atchafalaya and Boure 3-D shoots with promising results. Southwestern became
involved in the East Atchafalaya project in mid-1995 through a joint venture
with Union Pacific Resources. The joint venture has acquired 113 square miles of
3-D seismic data covering portions of St. Martin and Iberia Parishes, Louisiana.
The Company has participated in four wells to date in the project. While two
wells did not find commercially productive reserves, the other two wells were
completed as producing wells. Additional wildcat drilling is planned in 1999.
Southwestern has a 50% working interest in the Boure project, a 185 square
mile 3-D survey in Assumption Parish adjacent to the East Atchafalaya project
area. The acquisition phase is complete and the data is currently being
interpreted. The Company expects to drill up to two wells in the project in
1999.
In late 1998, the Company formed a strategic alliance with industry
partners to jointly evaluate and explore a new proprietary 3-D seismic survey in
the Nodosaria Embayment area of Lafayette, St. Landry and Acadia Parishes. The
survey covers a 140-square mile area that contains several identified
exploration leads, and provides 3-D data over the Bosco producing field which
the Company purchased in 1995. The 3-D data is expected to be delivered in
October 1999 with drilling to commence in the year 2000.
The Texas transition zone represents a new focus area for Southwestern, and
covers the onshore Texas coast and the Texas state waters. Southwestern is
currently developing the regional geologic mapping necessary to tie these
distinct geological areas together. In 1999, the Company plans to drill up to
four prospects and has developed several more leads as it continues to add to
its existing acreage. The Company believes that this area has been relatively
under-explored, as compared to the federal waters of the Gulf of Mexico, and
expects it to be a meaningful source of new drilling opportunities.
The higher risk, higher return exploratory prospects in south Louisiana and
the Gulf Coast are part of the Company's overall strategy of balanced oil and
gas exploration and production. These high impact exploration plays provide an
opportunity for significant reserve growth, while the low-risk Arkoma and
medium-risk Permian drilling activities provide a stable base of continuing
reserve additions and production.
Acquisitions
Prior to 1997, the Company had increased its emphasis on acquisitions of
producing properties. However, in 1997, the market for producing property
acquisitions became demand-driven causing existing properties to sell at higher
prices as compared to historical levels. As a result, the Company did not make
any producing property acquisitions in 1998 or 1997, compared to $45.8 million
spent in 1996, $6.0 million spent in 1995,
4
and $13.9 million in 1994. The Company acquired approximately 32.7 Bcf of gas
and 6,350 MBbls of oil during 1996, 4.5 Bcf of gas and 851 MBbls of oil during
1995, and 20.6 Bcf of gas and 1,038 MBbls of oil during 1994. The 1996
acquisitions were primarily in Texas and Oklahoma, the 1995 acquisitions were
primarily in the Gulf Coast areas of Louisiana and Texas, and the 1994
acquisitions were primarily in the Anadarko Basin of Oklahoma. The Company's
current strategy in this area is to pursue selective acquisitions that would
complement its existing operations.
Capital Spending
Southwestern began 1999 with planned capital expenditures for gas and oil
exploration and development of $56.6 million, up from $52.4 million in 1998. The
Company plans to maintain its capital investments within the limits of
internally generated cash flow, and will adjust its capital program accordingly
if commodity prices remain at their current low levels.
Sales and Major Customers
Natural gas equivalent production averaged 101 million cubic feet per day
(MMcfd) in 1998, compared to 104 MMcfd in 1997, and 101 MMcfd in 1996. The
Company's gas production was 32.7 Bcf in 1998, down from 33.4 Bcf in 1997, and
34.8 Bcf in 1996. The Company also produced 703,000 barrels of oil in 1998,
compared to 749,000 barrels in 1997, and 391,000 barrels in 1996. The decreases
in gas production were the result of lower sales from the Company's Arkansas
properties, which are largely affected by the demands of the Company's utility
distribution systems.
The Company's natural gas production received an average wellhead price of
$2.34 per thousand cubic feet (Mcf) in 1998, compared to $2.57 per Mcf in 1997
and $2.26 per Mcf in 1996. Oil prices declined significantly, with an average
price in 1998 of $13.60 per barrel, compared to $19.02 per barrel in 1997 and
$21.21 per barrel in 1996.
Southwestern's largest single customer for sales of its gas production is
the Company's utility subsidiary, Arkansas Western Gas Company (Arkansas
Western). These sales are made by SEECO. Sales to Arkansas Western accounted for
approximately 36% of total exploration and production revenues in 1997, 43% in
1997, and 46% in 1996. All of the Company's remaining sales are to unaffiliated
purchasers.
SEECO's production was 19.5 Bcf in 1998, down from 21.7 Bcf in 1997 and
23.1 Bcf in 1996. SEECO's sales to Arkansas Western were 11.3 Bcf in 1998, down
from 14.3 Bcf in 1997 and 16.3 Bcf in 1996. The decreases in gas sales were
primarily the result of warmer weather in the utility's service territory.
Gas volumes sold by SEECO to Arkansas Western for its northwest Arkansas
division (AWG) were 7.7 Bcf in 1998, 8.6 Bcf in 1997, and 10.1 Bcf in 1996.
Through these sales, SEECO furnished 59% of the northwest Arkansas system's
requirements in 1998, 64% in 1997, and 62% in 1996. SEECO also delivered
approximately 2.0 Bcf in 1998, 1.0 Bcf in 1997, and 1.1 Bcf in 1996 directly to
certain large business customers of AWG through a transportation service of the
utility subsidiary. Most of the sales to AWG were pursuant to a twenty-year
contract between SEECO and AWG, entered into in July 1978, under which the
price was frozen
5
between 1984 and 1994. This contract was amended in 1994 as a result of a
settlement reached to resolve certain gas cost issues before the Arkansas Public
Service Commission hereafter referred to as the "Gas Cost Settlement." The sales
price under this contract averaged $2.99 per thousand cubic feet (Mcf) through
November of 1998, $3.46 per Mcf in 1997, and $3.13 per Mcf in 1996. This
contract expired July 24, 1998 but continued on a month-to-month basis through
November 1998.
In March 1997, AWG filed a gas supply plan with the Arkansas Public Service
Commission (APSC) which projected system load growth patterns and long range gas
supply needs for the utility's northwest Arkansas system. The gas supply plan
also addressed replacement supplies for AWG's long-term contract with SEECO.
After discussions with the APSC it was determined that the majority of the
utility's future gas supply needs should be provided through a competitive
bidding process. On October 1, 1998, AWG sent requests for proposals to various
suppliers requesting bids on seven different packages of gas supply to be
effective December 1, 1998. These bid requests included replacement of the gas
supply and no-notice service previously provided by the long-term gas supply
contract between AWG and SEECO. Eleven potential suppliers returned bids in late
October.
SEECO along with the Company's marketing subsidiary successfully bid on
five of the seven packages with prices based on the NorAm East Index plus a
demand charge. The volumes of gas projected to be sold under these contracts in
their first year are approximately equal to the historical annual volumes sold
under the expired long-term contracts. However, the volumes to be sold under
these contracts are not fixed as they were under the expired contract. The total
premium over the NorAm East Index under these contracts is estimated to be
approximately $1.0 million lower (after tax) than the annual premium earned
under the expired long-term contract. Other sales to AWG are made under
long-term contracts with flexible pricing provisions.
SEECO's sales to Associated Natural Gas Company (Associated), a division of
Arkansas Western which operates natural gas distribution systems in northeast
Arkansas and parts of Missouri, were 3.6 Bcf in 1998, 5.7 Bcf in 1997, and 6.2
Bcf in 1996. These deliveries accounted for approximately 50% of Associated's
total requirements in 1998, 61% in 1997, and 62% in 1996. In 1998, certain
industrial customers of Associated began buying their gas supply directly from
producers or marketers. This caused a decline in the percentage of Associated's
gas supply provided by SEECO as these volumes were previously purchased by
Associated from SEECO and then delivered to their industrial customers.
Effective October 1990, SEECO entered into a ten-year contract with Associated
to supply a portion of its system requirements at a price to be redetermined
annually. The sales price under this contract was $2.20 per Mcf for the contract
period ended September 30, 1995, $1.785 per Mcf for the contract period ended
September 30, 1996, and $2.225 per Mcf for the contract period ended September
30, 1997. For the contract period beginning October 1, 1997, the contract was
revised to redetermine the sales price monthly based on an index posting plus a
reservation fee. The sales price under the contract averaged $2.37 for 1998
compared to $2.51 for 1997.
At present, SEECO's contracts for sales of gas to unaffiliated customers
consist of short-term sales made to customers of the utility subsidiary's
transportation program and spot sales into markets away from the utility's
distribution system. These sales are subject to seasonal price swings. SEECO's
sales to unaffiliated customers is also affected by the demand of the utility
for production on its gathering system. SEECO's sales to
6
unaffiliated purchasers accounted for approximately 19% of total exploration and
production revenues in 1998, 15% in 1997, and 14% in 1996.
The combined gas production of SEPCO and Diamond M was 13.2 Bcf in 1998, up
from 11.7 Bcf in 1997 and 1996. Oil production was 703 MBbls in 1998, compared
to 749 MBbls in 1997, and 391 MBbls in 1996. SEPCO's and Diamond M's gas and oil
production is sold under contracts with unaffiliated purchasers which reflect
current short-term prices and which are subject to seasonal price swings.
SEPCO's and Diamond M's combined gas and oil sales accounted for 43% of total
exploration and production revenues in 1998 and 1997, and 40% in 1996.
Competition
All phases of the gas and oil industry are highly competitive. Southwestern
competes in the acquisition of properties, the search for and development of
reserves, the production and sale of gas and oil and the securing of the labor
and equipment required to conduct operations. Southwestern's competitors include
major gas and oil companies, other independent gas and oil concerns and
individual producers and operators. Many of these competitors have financial and
other resources that substantially exceed those available to Southwestern. Gas
and oil producers also compete with other industries that supply energy and
fuel.
Competition in the state of Arkansas has increased in recent years, due
largely to the development of improved access to interstate pipelines. Due to
the Company's significant leasehold acreage position in Arkansas and its
long-time presence and reputation in this area, the Company believes it will
continue to be successful in acquiring new leases in Arkansas. While improved
intrastate and interstate pipeline transportation in Arkansas should increase
the Company's access to markets for its gas production, these markets will
generally be served by a number of other suppliers. Thus, the Company will
encounter competition that may affect both the price it receives and contract
terms it must offer. Outside Arkansas, the Company is less established and faces
competition from a larger number of other producers. The Company has in recent
years been successful in building its inventory of undeveloped leases and
obtaining participating interests in drilling prospects outside Arkansas.
Natural Gas Distribution
The Company's subsidiary Arkansas Western Gas Company operates integrated
natural gas distribution systems concentrated primarily in northern Arkansas and
southeast Missouri. The APSC and the Missouri Public Service Commission (MPSC)
regulate the Company's utility rates and operations. The Company serves
approximately 179,000 customers and obtains a substantial portion of the gas
they consume through its Arkoma Basin gathering facilities.
Arkansas Western consists of two operating divisions. The AWG division
gathers natural gas in the Arkansas River Valley of western Arkansas and
transports the gas through its own transmission and distribution systems,
ultimately delivering it at retail to approximately 110,000 customers in
northwest Arkansas. The Associated division receives its gas from transportation
pipelines and delivers the gas through its own transmission and distribution
systems, ultimately delivering it at retail to approximately 69,000 customers
7
primarily in northeast Arkansas and southeast Missouri. Associated, formerly a
wholly-owned subsidiary of Arkansas Power and Light Company, was acquired and
merged into Arkansas Western effective June 1, 1988.
Gas Purchases and Supply
AWG purchases its system gas supply through a competitive bidding process
implemented in late 1998 and directly at the wellhead under long-term contracts.
As previously indicated, SEECO furnished approximately 59% of AWG's system
requirements in 1998, 64% in 1997, and 62% in 1996.
As discussed above in "Exploration and Production," AWG's twenty-year gas
supply contract with SEECO expired in July 1998. Supplies previously provided by
this contract are now obtained through a competitive bidding process. The
Company's subsidiaries successfully bid on five of the seven gas supply packages
available and will provide approximately the same volume to AWG that has
historically been provided, but at a reduced premium.
AWG also purchases gas from unaffiliated producers under take-or-pay
contracts. Currently, the Company believes that it does not have a significant
exposure to take-or-pay liabilities resulting from these contracts. The Company
expects to be able to continue to satisfactorily manage its exposure to
take-or-pay liabilities.
Associated purchases gas for its system supply from unaffiliated suppliers
accessed by interstate pipelines and from affiliates. Purchases from SEECO are
under a ten-year contract with annual price redeterminations. Purchases from
unaffiliated suppliers are under firm contracts with terms between one and three
years. The rates charged by most suppliers include demand components to ensure
availability of gas supply, administrative fees, and a commodity component which
is based on monthly indexed market prices. Associated's gas purchases are
transported through eight pipelines. The pipeline transportation rates include
demand charges to reserve pipeline capacity and commodity charges based on
volumes transported. Associated has also contracted with five interstate
pipelines for storage capacity to meet its peak seasonal demands. These
contracts involve demand charges based on the maximum deliverability, capacity
charges based on the maximum storage quantity, and charges for the quantities
injected and withdrawn.
AWG has no restriction on adding new residential or commercial customers
and will supply new industrial customers that are compatible with the scale of
its facilities. AWG has never denied service to new customers within its service
area or experienced curtailments because of supply constraints. In addition,
Associated has never denied service to new customers within its service area or
experienced curtailments because of supply constraints since the acquisition
date. Curtailment of large industrial customers of AWG and Associated occurs
only infrequently when extremely cold weather requires that systems be dedicated
exclusively to human needs customers.
8
Markets and Customers
The utility continues to capitalize on the healthy economies and sustained
customer growth found in its service territory. AWG and Associated provide
natural gas to approximately 157,000 residential, 22,000 commercial, and 300
industrial customers, while also providing gas transportation services to
approximately 50 end-use and off-system customers. The utility's service
territory includes northwest Arkansas, which in 1998 was the 8th fastest growing
region in the United States. The population in Washington and Benton counties in
northwest Arkansas has grown at an annual rate of 3.5 percent since 1990, and
the total population of the two-county area is projected to be nearly 300,000 by
the year 2000. Total gas throughput in 1998 was 32.8 Bcf, down from 37.0 Bcf in
1997, and 39.0 in 1996. The decreases were the result of comparatively warmer
weather during the heating season in 1998 and 1997. Off-system transportation
volumes were 1.1 Bcf in 1998, compared to 2.8 Bcf transported in 1997, and 3.6
Bcf transported in 1996.
Residential and Commercial. Approximately 80% of the utility's revenues are
from residential and commercial markets. Residential and commercial customers
combined accounted for 57% of total gas throughput for the gas distribution
segment in 1998, 1997, and 1996. Gas volumes sold to residential customers were
11.1 Bcf, down from 12.6 Bcf sold in 1997, and 13.4 Bcf sold in 1996. Gas sold
to commercial customers totaled 7.6 Bcf in 1998, down from 8.4 Bcf in 1997, and
8.8 Bcf in 1996. The decrease in gas volumes sold in 1998 was due to weather in
Arkansas Western's service territory that was 16% warmer than in 1997.
The gas heating load is one of the most significant uses of natural gas and
is sensitive to outside temperatures. Sales, therefore, vary throughout the
year. Profits, however, have become less sensitive to fluctuations in
temperature recently as tariffs implemented in Arkansas as a result of the
recently approved rate filings contain a weather normalization clause to lessen
the impact of revenue increases and decreases which might result from weather
variations during the winter heating season.
Industrial and End-use Transportation. Deliveries to industrial customers,
which are generally smaller concerns using gas for plant heating or product
processing, accounted for 13.0 Bcf in gas deliveries in 1998, 13.2 Bcf in 1997,
and 13.0 Bcf in 1996. No industrial customer accounts for more than 4% of
Arkansas Western's total throughput.
In an effort to more fully meet the service needs of larger business
customers, both AWG and Associated instituted a transportation service in 1991
that allows such customers in Arkansas to obtain their own gas supplies directly
from other suppliers. A total of 40 customers are currently using the Arkansas
transportation service. AWG's seventeen largest customers in northwest Arkansas
are using the transportation service. Associated's four largest customers in
northeast Arkansas and eight of Associated's eleven largest Missouri customers
are currently using transportation service.
Competition
AWG and Associated have experienced a general trend in recent years toward
lower rates of usage among their customers, largely as a result of conservation
efforts that the Company encourages. Competition is increasingly being
experienced from alternative fuels, primarily electricity, fuel oil, and
propane. A significant
9
amount of fuel switching has not been experienced, though, as natural gas is
generally the least expensive, most readily available fuel in the service
territories of AWG and Associated.
The competition from alternative fuels and, in a limited number of cases,
alternative sources of natural gas have intensified in recent years. Industrial
customers are most likely to consider utilization of these alternatives, as they
are less readily available to commercial and residential customers. In an effort
to provide some pricing alternatives to its large industrial customers with
relatively stable loads, AWG offers an optional tariff to its larger business
customers and to any other large business customer which shows that it has an
alternate source of fuel at a lower price or that one of its direct competitors
has access to cheaper sources of energy. This optional tariff enables those
customers willing to accept the risk of price and supply volatility to direct
AWG to obtain a certain percentage of their gas requirements in the spot market.
Participating customers continue to pay the non-gas cost of service included in
AWG's present tariff for large business customers and agree to reimburse AWG for
any take-or-pay liability caused by spot market purchases on the customer's
behalf.
Regulation
The Company's utility rates and operations are regulated by the APSC and
MPSC. In Arkansas, the Company operates through municipal franchises that are
perpetual by state law. These franchises, however, are not exclusive within a
geographic area. In Missouri, the Company operates through municipal franchises
with various terms of existence.
In the recent past, changes at the federal level have brought significant
changes to the regulatory structure governing interstate sales and
transportation of natural gas. The Federal Energy Regulatory Commission's (FERC)
Order No. 636 series changed a major portion of the gas acquisition merchant
function provided to gas distributors by interstate pipelines. AWG obtains its
supply through competitive bids from suppliers and at the wellhead directly from
producers and has not been directly impacted by Order No. 636. Associated has
acquired the bulk of its gas supply at the wellhead since its acquisition by
Arkansas Western, but continued until Order No. 636 to purchase a portion of
both its peak and base requirements from interstate suppliers. The changes
mandated by Order No. 636 placed the responsibility for arranging firm supplies
of natural gas directly on local distribution companies.
As the regulatory focus of the natural gas industry shifts from the federal
level to the state level, utilities across the nation are being required to
unbundle their sales services from transportation services in an effort to
promote greater competition. Although no such legislation or regulatory
directives related to natural gas are presently pending in Arkansas or Missouri,
the Company is aggressively controlling costs and constantly evaluating issues
such as system capacity and reliability, obligation to serve, and rate design,
with an eye toward minimizing any stranded or transition costs.
In Arkansas, the state legislature is now considering legislation that
would deregulate the retail sale of electricity in Arkansas as soon as 2002. At
this time, it is unknown whether or not such legislation will be adopted or if
it is adopted, what its final form will be. The Company is also unable to
predict the precise impact of any such legislation on its utility operations.
The Company's utility subsidiary has historically maintained
10
a substantial price advantage over electricity for most applications. However,
if retail electric competition is implemented in Arkansas, it is possible that
some portion of this price advantage may be lost in some markets. As described
in the paragraph above, the Company is taking steps to preserve its competitive
advantage over alternative energy sources, including electricity. If electric
deregulation occurs in Arkansas, legislative or regulatory precedents may be set
that would also affect natural gas utilities in the future. These issues may
include further unbundling of services and the regulatory treatment of stranded
costs.
Gas distribution revenues in future years will be impacted by both customer
growth and rate increases allowed by regulatory commissions. In recent years,
AWG has experienced customer growth of approximately 3% annually, while
Associated has experienced customer growth of approximately 1% annually. Based
on current economic conditions in the Company's service territories, the Company
expects this trend in customer growth to continue. AWG and Associated pass along
to customers through an automatic cost of gas adjustment clause any increase or
decrease experienced in purchased gas costs. In December 1996, AWG received
approval from the APSC for a rate increase of $5.1 million annually. The Company
received approvals in December 1997 from the APSC and the MPSC for rate
increases and tariff changes for Associated which will allow the utility to
collect an additional $3.0 million annually. Of the $3.0 million increase,
approximately $2.0 million is in the form of base rate increases and $1.0
million is related to the increased cost of service of the Company's gathering
plant which is recovered through either the purchased gas adjustment clause or
through direct charges to transportation customers. Rate increase requests that
may be filed in the future will depend on customer growth, increases in
operating expenses, and additional investments in property, plant and equipment.
AWG's rates for gas delivered to its retail customers are not regulated by the
FERC, but its transmission and gathering pipeline systems are subject to the
FERC's regulations concerning open access transportation since AWG accepted a
blanket transportation certificate in connection with its merger with
Associated.
Marketing and Transportation
Gas Marketing
The marketing group was formed in mid-1996 to better enable the Company to
capture downstream opportunities which arise through marketing and
transportation activity. Through utilization of Southwestern's existing asset
base, the group's focus is to create and capture value beyond the wellhead. The
Company presently plans to continue to expand its natural gas marketing
activities, with particular emphasis on third-party marketing in the
Mid-Continent region of the United States. The merger of the NOARK Pipeline with
the Ozark Gas Transmission System discussed below is expected to afford greater
supply and market opportunities, allowing the group to expand its marketing
operations in Oklahoma.
The Company's marketing operations include the marketing of Southwestern's
own gas production and third-party natural gas. Operating income for this
segment was $1.8 million in 1998 and $1.3 million in 1997. This segment had an
operating loss of $.5 million in 1996. The segment marketed 49.6 Bcf of natural
gas in 1998, compared to 36.2 Bcf in 1997, and 13.0 Bcf in 1996. Of the total
volumes marketed, purchases from the Company's exploration and production
subsidiaries accounted for 25% in 1998, 23% in 1997, and 56% in 1996.
11
NOARK Pipeline
At December 31, 1998, the Company held a 25% general partnership interest
in NOARK. NOARK Pipeline was a 258-mile long intrastate natural gas transmission
system that originated in western Arkansas and terminated in northeast Arkansas,
crossing three major interstate pipelines and interconnecting with the Company's
distribution systems. NOARK Pipeline was completed and placed in service in 1992
and has been operating below capacity and generating losses since it was placed
in service. The Company's share of the pretax loss from operations related to
its NOARK investment was $3.1 million in 1998, $4.5 million in 1997, and $3.8
million in 1996.
In January 1998, the Company entered into an agreement with Enogex Inc.
(Enogex), a subsidiary of OGE Energy Corp., to expand NOARK Pipeline and provide
access to Oklahoma gas supplies through an integration of NOARK Pipeline with
the Ozark Gas Transmission System (Ozark). Ozark was a 437-mile interstate
pipeline system that began in eastern Oklahoma and terminated in eastern
Arkansas. On July 1, 1998, the Federal Energy Regulatory Commission (FERC)
authorized the operation and integration of Ozark and NOARK Pipeline as a
single, integrated pipeline. The FERC order also authorized the purchase of
Ozark by a subsidiary of Enogex and the construction of integration facilities.
Enogex acquired Ozark and contributed the pipeline system to the NOARK
partnership and also acquired the NOARK partnership interests not held by
Southwestern. Enogex funded the acquisition of Ozark and the expansion and
integration with NOARK Pipeline which resulted in the Company's interest in the
partnership decreasing to 25% with Enogex owning a 75% interest. There are also
provisions in the agreement with Enogex which allow for future revenue
allocations to the Company above its 25% partnership interest if certain minimum
throughput and revenue assumptions are not met.
The rationale behind the merger of the two pipelines was simple: NOARK
Pipeline standing alone did not have the access to gas supply necessary to make
the pipeline system economically viable. The merged pipeline system now has
access to major gas producing fields in Oklahoma. With access to greater
regional production, Southwestern expects the pipeline's additional throughput
to create new marketing and transportation opportunities and significantly
reduce the losses experienced on the project in the past. The merged pipeline
also provides the Company's utility systems with additional access to gas
supply.
The new integrated system, known as Ozark Pipeline, became operational
November 1, 1998, and includes 749 miles of pipeline with a total throughput
capacity of 330 MMcfd. Deliveries are currently being made by the integrated
pipeline to portions of AWG's distribution system, to Associated, and to the
interstate pipelines with which it interconnects. In 1998, NOARK Pipeline had an
average daily throughput of 27.3 million cubic feet of gas per day (MMcfd)
before the integration with Ozark, compared to average daily throughput of 39.8
MMcfd in 1997, and 57.5 MMcfd in 1996. After the integration in November 1998,
Ozark Pipeline had an average daily throughput of 184.6 MMcfd. At December 31,
1998, AWG had transportation contracts with Ozark Pipeline for 82.3 MMcfd of
firm capacity. These contracts expire in 2002 and 2003 and are renewable
annually thereafter until terminated with 180 days' notice.
12
Competition
The Company's gas marketing activities are in competition with numerous
other companies offering the same services, many of which possess larger
financial and other resources than those of Southwestern. Some of these
competitors are affiliates of companies with extensive pipeline systems that are
used for transportation from producers to end-users. Other factors affecting
competition are cost and availability of alternative fuels, level of consumer
demand, and cost of and proximity of pipelines and other transportation
facilities. The Company believes that its ability to effectively compete within
the marketing segment in the future depends upon establishing and maintaining
strong relationships with producers and end-users.
NOARK Pipeline previously competed with two interstate pipelines, one of
which was the Ozark system, to obtain gas supplies for transportation to other
markets. Because of the available transportation capacity in the Arkansas
portion of the Arkoma Basin, competition had been strong and had resulted in
NOARK Pipeline transporting gas for third parties at rates below the maximum
tariffs presently allowed. The integration with Ozark provides increased
supplies to transport to both local markets and markets served by the three
major interstate pipelines that Ozark Pipeline connects with in eastern
Arkansas. As discussed below under "Regulation," FERC's Order No. 636 has
generally increased competition in the transportation segment as end-users are
now acquiring their own supplies and independently arranging for the
transportation of those supplies. The Company believes that Ozark Pipeline will
provide the additional supplies necessary to compete more effectively for the
transportation of natural gas to end-users and markets served by the interstate
pipelines.
Regulation
Since the mid-1980's, the FERC has issued a series of orders, culminating
in Order No. 636 in April 1992, that have altered the marketing and
transportation of natural gas. Order No. 636 required interstate natural gas
pipelines to "unbundle," or segregate, the sales, transportation, storage and
other components of their existing sales services, and to separately state the
rates for each of the unbundled services. Order No. 636 and subsequent FERC
orders issued in individual pipeline proceedings have been the subject of
appeals, the results of which have generally been supportive of the FERC's open
access policy. Generally, Order No. 636 has eliminated or substantially reduced
the interstate pipelines' role as wholesalers of natural gas and has
substantially increased competition in natural gas markets. While some
regulatory uncertainty remains, Order No. 636 may ultimately enhance the ability
of the Company to market natural gas, although it may also create greater
competition for the Company.
Prior to the integration with Ozark, the operations of NOARK Pipeline were
regulated by the APSC. The APSC had established a maximum transportation rate of
approximately $.285 per dekatherm. The integration of NOARK Pipeline with Ozark
resulted in an interstate pipeline system subject to FERC regulations and FERC
approved tariffs. The APSC no longer has jurisdiction over NOARK Pipeline's
transportation rates and services. The FERC has initially set the maximum
transportation rate of Ozark Pipeline at $.2455 per dekatherm.
13
Other Items
-----------
Environmental Matters
The Company's operations are subject to extensive federal, state and local
laws and regulations, including the Comprehensive Environmental Response,
Compensation and Liability Act, the Clean Water Act, the Clean Air Act and
similar state statutes. These laws and regulations require permits for drilling
wells and the maintenance of bonding requirements in order to drill or operate
wells and also regulate the spacing and location of wells, the method of
drilling and casing wells, the surface use and restoration of properties upon
which wells are drilled, the plugging and abandoning of wells, the prevention
and cleanup of pollutants and other matters. Southwestern maintains insurance
against costs of clean-up operations, but is not fully insured against all such
risks.
Compliance with environmental laws and regulations has had no material
effect on Southwestern's capital expenditures, earnings, or competitive
position. Although future environmental obligations are not expected to have a
material impact on the results of operations or financial condition of the
Company, there can be no assurance that future developments, such as
increasingly stringent environmental laws or enforcement thereof, will not cause
the Company to incur material environmental liabilities or costs.
Real Estate Development
A. W. Realty Company (AWR) owns an interest in approximately 160 acres of
real estate, most of which is undeveloped. AWR's real estate development
activities are concentrated on a 130-acre tract of land located near the
Company's headquarters in a growing part of Fayetteville, Arkansas. The Company
has owned an interest in this land for many years. The property is zoned for
commercial, office, and multi-family residential development. AWR continues to
review with a joint venture partner various options for developing this property
that would minimize the Company's initial capital expenditures, but still enable
it to retain an interest in any appreciation in value. This activity, however,
does not represent a significant portion of the Company's business.
Employees
At December 31, 1998, the Company had 706 employees, 98 of whom are
represented under a collective bargaining agreement. The Company believes that
its relations with its employees are good.
Item 2. Properties
The portions of the Registrant's 1998 Annual Report to Shareholders (filed
as Exhibit 13 to this filing) listed below are hereby incorporated by reference
for the purpose of describing its properties.
Refer to the Appendix (filed as a part of Exhibit 13 to this filing) for
information concerning areas of operation of the Company's business segments.
Also, see pages 35-38 (Notes 5 and 6 to the financial statements) for additional
14
information about the Company's gas and oil operations. For information
concerning capital expenditures, refer to page 23 ("Capital Expenditures"
section of "Management's Discussion and Analysis of Financial Condition and
Results of Operations"). Also refer to page 47 ("Financial and Operating
Statistics") for information concerning gas and oil produced. The following
table provides information concerning miles of pipe of the Company's gas
distribution systems.
AWG Associated Total
----- ---------- -----
Gathering 390 - 390
Transmission 806 608 1,414
Distribution 3,088 1,674 4,762
----- ----- -----
4,284 2,282 6,566
===== ===== =====
The following information is provided to supplement that presented in the 1998
Annual Report to Shareholders:
Leasehold Acreage
Undeveloped Developed
Gross Net Gross Net
----------------- -----------------
Arkoma...................... 141,529 124,048 195,135 145,667
Mid-Continent............... 38,127 16,867 98,980 33,919
Permian..................... 19,190 13,500 44,420 15,781
Gulf Coast.................. 53,340 29,593 88,300 33,204
----------------- -----------------
252,186 184,008 426,835 228,571
================= =================
Producing Wells
Gas Oil Total
Gross Net Gross Net Gross Net
------------- ------------- ---------------
Arkoma...................... 818 422.5 - - 818 422.5
Mid-Continent............... 497 199.9 917 305.8 1,414 505.7
Permian..................... 17 6.1 345 218.3 362 224.4
Gulf Coast.................. 35 14.2 33 24.8 68 39.0
------------- ------------- ---------------
1,367 642.7 1,295 548.9 2,662 1,191.6
============= ============= ===============
15
Net Wells Drilled During the Year
Exploratory
Productive
Year Wells Dry Holes Total
---- ---------- --------- -----
1998................ .5 3.9 4.4
1997................ 1.3 3.0 4.3
1996................ 5.3 3.0 8.3
Development
Productive
Year Wells Dry Holes Total
---- ---------- --------- -----
1998................ 29.4 6.4 35.8
1997................ 27.5 13.5 41.0
1996................ 29.4 11.8 41.2
Wells in Progress as of December 31, 1998
Type of Well Gross Net
------------ ----- ---
Exploratory............................ 5.0 1.1
Development............................ 12.0 4.0
---- ---
Total.................................. 17.0 5.1
==== ===
No individually significant discovery or other major favorable or adverse
event has occurred since December 31, 1998.
During 1998, Southwestern was required to file Form 23, "Annual Survey of
Domestic Oil and Gas Reserves" with the Department of Energy. The basis for
reporting reserves on Form 23 is not comparable to the reserve data included in
Note 6 to the financial statements in the 1998 Annual Report to Shareholders.
The primary differences are that Form 23 reports gross reserves, including the
royalty owners' share, and includes reserves for only those properties where the
Company is the operator.
Item 3. Legal Proceedings
In May 1996, a class action suit was filed against the Company in the
Circuit Court of Sebastian County, Arkansas on behalf of royalty owners alleging
improprieties in the disbursements of royalty proceeds. A trial was held on the
class action suit beginning in late September 1998 that resulted in a verdict
against the Company and two of its wholly-owned subsidiaries, SEECO, Inc. and
Arkansas Western Gas Company, in the amount of $62.1 million. The trial judge
subsequently awarded pre-judgment interest in an amount of $31.1 million, and
16
post-judgment interest accrued from the date of the judgment at the rate of 10%
per annum simple interest. The Company has been required by the state court to
post a judgment bond in the amount of $102.5 million (verdict amount plus
pre-judgment interest and one year of post-judgment interest) in order to stay
the jury's verdict and proceed with an appeal process. The bond was placed by a
surety company and was collateralized by unsecured letters of credit.
The verdict was returned following a trial on the issues of the class
action lawsuit brought by certain royalty owners of SEECO, Inc., who contend
that since 1979 the defendants breached implied covenants in certain oil and gas
leases, misrepresented or failed to disclose material facts to royalty owners
concerning gas purchase contracts between the Company's subsidiaries, and failed
to fulfill other alleged common law duties to the members of the royalty owner
plaintiff class. The litigation was commenced in May 1996 and was disclosed by
the Company at that time.
The Company believes that the jury's verdict was wrong as a matter of law
and fact and that incorrect rulings by the trial judge (including evidentiary
rulings and prejudicial jury instructions) provide substantial grounds for a
successful appeal. The Company has obtained a temporary stay of the judgment on
the jury's verdict and has filed and will vigorously prosecute an appeal in the
Arkansas Supreme Court. If the Company is not successful in its appeal from the
jury verdict, the Company's financial condition and results of operations would
be materially and adversely affected.
In its Form 8-K filed July 2, 1996, the Company disclosed that a lawsuit
relating to overriding royalty interests in certain Arkansas oil and gas
properties had been filed against it and two of its wholly-owned subsidiaries.
The lawsuit, which was brought by a party who was originally included in (but
opted out of) the class action litigation described above, involves claims
similar to those upon which judgment was rendered against the Company and its
subsidiaries. In September 1998, another party who opted out of the class
threatened the Company with similar litigation. While the amounts of these
pending and threatened claims could be material, management believes, based on
its investigations, that the Company's ultimate liability, if any, will not be
material to its consolidated financial position or results of operations.
The United States Minerals Management Service (MMS), a federal agency
responsible for the administration of federal oil and gas leases, is
investigating the Company and its subsidiaries in respect of claims similar to
those in the class action litigation. MMS was included in the class action
litigation against its objections, but has not pursued further action to remove
itself from the class. If MMS does remove itself from the class, its claims may
be brought separately under federal statutes that provide for treble damages and
civil penalties. In such event, the Company believes it would have defenses that
were not available in the class action litigation. While the aggregate amount of
MMS's claims could be material, management believes, based on its
investigations, that the Company's ultimate liability, if any, will not be
material to its consolidated financial position or results of operations.
In 1997, the Company's subsidiary, Southwestern Energy Production Company
(SEPCO), filed suit against several parties, including an outside consultant
previously employed by SEPCO, alleging breach of contract, fraud, and other
causes of action in connection with services performed on SEPCO's south
Louisiana exploration projects. On June 23, 1998, the outside consultant filed a
counterclaim against SEPCO. The
17
consultant's primary cause of action relates to a claim that he is contractually
entitled to a 25% interest in the Boure' project, one of SEPCO's south Louisiana
exploration projects. The counterclaim alleges seven different claims for
relief, including breach of contract, fraud, and defamation and requests damages
in excess of $10,000,000 for each claim plus punitive damages in excess of
$10,000,000. The Company feels these claims are without merit and intends to
vigorously contest them. Although the total amount of these claims is
significant in the aggregate, management believes, based on its investigation,
that the Company's ultimate liability, if any, will not be material to its
consolidated financial position or results of operation.
The Company is subject to other litigation and claims that have arisen in
the ordinary course of business. The Company accrues for such items when a
liability is both probable and the amount can be reasonably estimated. In the
opinion of management, the results of such litigation and claims will not have a
material effect on the results of operations or the financial position of the
Company.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted during the fourth quarter of the fiscal year
ended December 31, 1998, to a vote of security holders, through the solicitation
of proxies or otherwise.
Executive Officers of the Registrant
Years Served as
Name Officer Position Age Officer
---- ---------------- --- -------
Harold M. Korell President and Chief Executive Officer and 54 2
Director
Greg D. Kerley Senior Vice President and Chief Financial Officer 43 9
Alan H. Stevens Senior Vice President, Southwestern Energy Production 54 1
Company and SEECO, Inc.
Debbie J. Branch Senior Vice President, Southwestern Energy Services 47 3
Company and Southwestern Energy Pipeline Company
Charles V. Stevens Senior Vice President, Arkansas Western Gas Company 49 10
Mr. Korell was appointed to his present position in October 1998 and
assumed the position of Chief Executive Officer on January 1, 1999. He joined
the Company in 1997 as Executive Vice President and Chief Operating Officer.
From 1992 to 1997, he was employed by American Exploration Company where he was
most recently Senior Vice President - Operations. From 1990 to 1992, he was
Executive Vice President of McCormick Resources and from 1973 to 1989, he held
various positions with Tenneco Oil Company, including Vice President,
Production.
18
Mr. Kerley was appointed to his present position in July 1998. Previously,
he served as Senior Vice President Treasurer and Secretary from 1997 to 1998,
Vice President - Treasurer and Secretary from 1992 to 1997, and Controller from
1990 to 1992. Mr. Kerley also served as the Chief Accounting Officer from 1990
to 1998.
Mr. Alan Stevens joined the Company in his present position in January
1998. Prior to joining the Company, he was President and Chief Operating Officer
for Petsec Energy during 1997. Previously, he was employed by Occidental
Petroleum Company from 1989 to 1997 where he was most recently Vice President of
Worldwide Exploration.
Ms. Branch joined the Company in her present position in 1996. Prior to
joining the Company, she was Executive Vice President of Stalwart Energy Company
from 1994 to 1996 and founder and President of Vesta Energy Company from 1983 to
1993.
Mr. Charles Stevens has served the Company in his present position since
December 1997. Previously, he served as Vice President of Arkansas Western Gas
Company from 1988 to 1997.
All officers are elected at the Annual Meeting of the Board of Directors
for one-year terms or until their successors are duly elected. There are no
arrangements between any officer and any other person pursuant to which he was
selected as an officer. There is no family relationship between any of the named
executive officers or between any of them and the Company's directors.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Shareholder Information on page 48 and "Common Stock Statistics" included
in the Company's Financial and Operating Statistics on page 46 of the 1998
Annual Report to Shareholders are hereby incorporated by reference for
information concerning the market for and prices of the Company's Common Stock,
the number of shareholders, and cash dividends paid.
The terms of certain of the Company's long-term debt instruments and
agreements impose restrictions on the payment of cash dividends. At December 31,
1998, $92.5 million of retained earnings was available for payment as cash
dividends. These covenants generally limit the payment of dividends in a fiscal
year to the total of net income plus $20.0 million less dividends paid and
purchases, redemptions or retirements of capital stock during the period since
January 1, 1990. Dividends totaling $6.0 million were paid during 1998.
The Company paid dividends at an annual rate of $.24 per share in 1998 and
1997. While the Board of Directors intends to continue the practice of paying
dividends quarterly, amounts and dates of such dividends as may be declared will
necessarily be dependent upon the Company's future earnings and capital
requirements.
19
Item 6. Selected Financial Data
Pages 46 and 47 ("Financial and Operating Statistics") of the 1998 Annual
Report to Shareholders are hereby incorporated by reference.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations, and
The text on pages 17 through 25 ("Management's Discussion and Analysis of
Financial Condition and Results of Operations") of the 1998 Annual Report to
Shareholders is hereby incorporated by reference.
Item 7.A. Quantitative and Qualitative Disclosure About Market Risks
Market risks relating to the Company's operations result primarily from
changes in commodity prices and interest rates, as well as credit risk
concentrations. The Company uses natural gas and crude oil swap agreements and
options to reduce the volatility of earnings and cash flow due to fluctuations
in the prices of natural gas and oil. The Board of Directors has approved risk
management policies and procedures to utilize financial products for the
reduction of defined commodity price risks. These policies prohibit speculation
with derivatives and limit swap agreements to counterparties with acceptable
credit standings.
Credit Risks
The Company's financial instruments that are exposed to concentrations of
credit risk consist primarily of trade receivables and derivative contracts
associated with commodities trading. Concentrations of credit risk with respect
to receivables are limited due to the large number of customers and their
dispersion across geographic areas. No single customer accounts for greater than
4% of accounts receivable. See the discussion of credit risk associated with
commodities trading below.
Interest Rate Risk
The following table provides information on the Company's financial
instruments that are sensitive to changes in interest rates. The table presents
the Company's debt obligations, principal cash flows and related
weighted-average interest rates by expected maturity dates. Variable average
interest rates reflect the rates in effect at December 31, 1998 for borrowings
under the Company's revolving credit facilities. The Company's policy is to
manage interest rates through use of a combination of fixed and floating rate
debt. Interest rate swaps may be used to adjust interest rate exposures when
appropriate. There were no interest rate swaps outstanding at December 31, 1998.
20
Fair
Value
Expected Maturity Date 12/31/98
----------------------------------------------------------- --------
1999 2000 2001 2002 2003 Thereafter Total
---- ---- ---- ---- ---- ---------- -----
($ in millions)
Fixed Rate $1.5 - $2.0 $2.0 $2.0 $241.0 $248.5 $257.3
Average Interest Rate 8.86% - 9.36% 9.36% 9.36% 7.19% 7.25%
Variable Rate - - $20.0 $14.9 - - $34.9 $34.9
Average Interest Rate - - 5.33% 5.55% - - 5.42%
Commodities Risk
The Company uses over-the-counter natural gas and crude oil swap agreements
and options to hedge sales of Company production and marketing activity against
the inherent price risks of adverse price fluctuations or locational pricing
differences between a published index and the NYMEX (New York Mercantile
Exchange) futures market. These swaps include (1) transactions in which one
party will pay a fixed price (or variable price) for a notional quantity in
exchange for receiving a variable price (or fixed price) based on a published
index (referred to as price swaps), and (2) transactions in which parties agree
to pay a price based on two different indices (referred to as basis swaps).
The primary market risk related to these derivative contracts is the
volatility in market prices for natural gas and crude oil. However, this market
risk is offset by the gain or loss recognized upon the related sale of the
natural gas or oil that is hedged. Credit risk relates to the risk of loss as a
result of non-performance by the Company's counterparties. The counterparties
are primarily major investment and commercial banks which management believes
present minimal credit risks. The credit quality of each counterparty and the
level of financial exposure the Company has to each counterparty are
periodically reviewed to ensure limited credit risk exposure.
The following table provides information about the Company's financial
instruments that are sensitive to changes in commodity prices. The table
presents the notional amount in Bcf (billion cubic feet), the weighted average
contract prices, and the total dollar contract amount by expected maturity
dates. The "Carrying Amount" for the contract amounts are calculated as the
contractual payments for the quantity of gas or oil to be exchanged under
futures contracts and do not represent amounts recorded in the Company's
financial statements. The "Fair Value" represents values for the same contracts
using comparable market prices at December 31, 1998. The net difference between
the contract amounts and fair value amounts of the contracts was $8.2 million at
December 31, 1998.
21
Expected Maturity Date
------------------------------------------------------
1999 2000 2001
---- ---- ----
Carrying Fair Carrying Fair Carrying Fair
Amount Value Amount Value Amount Value
-------- ----- -------- ----- -------- -----
Natural Gas:
Swaps with a fixed price receipt
Contract volume (Bcf) 10.1 - -
Weighted average price per Mcf $2.40 - -
Contract amount (in millions) $24.3 $29.4 - - - -
Swaps with a fixed price payment
Contract volume (Bcf) 1.4 - -
Weighted average price per Mcf $2.25 - -
Contract amount (in millions) $3.1 $2.6 - - - -
Basis swaps
Contract volume (Bcf) 6.4 - -
Weighted average basis difference
per Mcf $.095 - -
Contract amount (in millions) $.6 $.4 - - - -
Oil:
Price floor
Contract volume (MBbls) 375 350 325
Weighted average price per Bbl $18.00 $18.00 $18.00
Contract amount (in millions) $6.8 $8.6 $6.3 $7.5 $5.9 $6.7
Item 8. Financial Statements and Supplementary Data
Pages 27 through 47 of the 1998 Annual Report to Shareholders are hereby
incorporated by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
There have been no changes in or disagreements with accountants on
accounting and financial disclosure.
PART III
Item 10. Directors and Executive Officers of the Registrant
The definitive Proxy Statement to holders of the Company's Common Stock in
connection with the solicitation of proxies to be used in voting at the Annual
Meeting of Shareholders on May 18, 1999 (the 1999 Proxy Statement), is hereby
incorporated by reference for the purpose of providing information about the
identification of directors. Refer to the sections "Election of Directors" and
"Security Ownership of Directors, Nominees, and Executive Officers" for
information concerning the directors.
22
Information concerning executive officers is presented in Part I, Item 4 of
this Form 10-K.
Item 11. Executive Compensation
The 1999 Proxy Statement is hereby incorporated by reference for the
purpose of providing information about executive compensation. Refer to the
section "Executive Compensation."
Item 12. Security Ownership of Certain Beneficial Owners and Management
The 1999 Proxy Statement is hereby incorporated by reference for the
purpose of providing information about security ownership of certain beneficial
owners and management. Refer to the sections "Security Ownership of Certain
Beneficial Owners" and "Security Ownership of Directors, Nominees, and Executive
Officers" for information about security ownership of certain beneficial owners
and management.
Item 13. Certain Relationships and Related Transactions
The 1999 Proxy Statement is hereby incorporated by reference for the
purpose of providing information about related transactions. Refer to the
section "Security Ownership of Directors, Nominees, and Executive Officers" for
information about transactions with members of the Company's Board of Directors.
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) The following consolidated financial statements of the Company and its
subsidiaries, included on pages 27 through 45 of its 1998 Annual Report to
Shareholders and the report of independent public accountants on page 26 of such
report are hereby incorporated by reference:
Report of Independent Public Accountants.
Consolidated Balance Sheets as of December 31, 1998 and 1997.
Consolidated Statements of Income for the years ended December 31,
1998, 1997, and 1996.
Consolidated Statements of Cash Flows for the years ended December
31, 1998, 1997, and 1996.
Consolidated Statements of Retained Earnings for the years ended
December 31, 1998, 1997, and 1996.
Notes to Consolidated Financial Statements, December 31, 1998, 1997,
and 1996.
(2) The consolidated financial statement schedules have been omitted
because they are not required under the related instructions, or are not
applicable.
23
(3) The exhibits listed on the accompanying Exhibit Index (pages 26 - 28)
are filed as part of, or incorporated by reference into, this Report.
(b) Reports on Form 8-K:
A Current Report on Form 8-K was filed on October 16, 1998,
referencing a press release issued that day announcing the verdict of
a state court jury in a class action royalty lawsuit against the
Company and two of its subsidiaries.
A Current Report on Form 8-K was filed on October 30, 1998,
referencing a press release issued October 29, 1998, announcing the
appointment by the Company's Board of Directors of Harold Korell to
replace Charles E. Scharlau as Chief Executive Officer of the Company
effective January 1, 1999. Mr. Korell was also elected to the
Company's Board of Directors effective immediately.
24
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused the report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SOUTHWESTERN ENERGY COMPANY
---------------------------
(Registrant)
Dated: March 26, 1999 BY: /s/ GREG D. KERLEY
-------------------------------
Greg D. Kerley
Senior Vice President
and Chief Financial Officer
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 indicated on March 26, 1999.
/s/ HAROLD M. KORELL President and Chief Executive Officer
- ---------------------------------- and Director
Harold M. Korell
/s/ GREG D. KERLEY Senior Vice President
- ---------------------------------- and Chief Financial Officer
Greg D. Kerley
/s/ STANLEY T. WILSON Controller and Chief Accounting Officer
- ----------------------------------
Stanley T. Wilson
/s/ CHARLES E. SCHARLAU Director and Chairman
- ----------------------------------
Charles E. Scharlau
/s/ LEWIS E. EPLEY, JR. Director
- ----------------------------------
Lewis E. Epley, Jr.
/s/ JOHN PAUL HAMMERSCHMIDT Director
- ----------------------------------
John Paul Hammerschmidt
/s/ ROBERT L. HOWARD Director
- ----------------------------------
Robert L. Howard
/s/ KENNETH R. MOURTON Director
- ----------------------------------
Kenneth R. Mourton
Supplemental Information to be Furnished With Reports Filed Pursuant to
Section 15(d) of the Act by Registrants Which Have Not Registered Securities
Pursuant of Section 12 of the Act.
Not Applicable
25
EXHIBIT INDEX
Exhibit
No. Description
- ------- -----------
3. Articles of Incorporation and Bylaws of the Company (amended and
restated Articles of Incorporation incorporated by reference to Exhibit
3 to Annual Report on Form 10-K for the year ended December 31, 1993);
Bylaws of the Company (amended Bylaws of the Company incorporated by
reference to Exhibit 3 to Annual Report on Form 10-K for the year ended
December 31, 1994).
4.1 Shareholder Rights Agreement, dated May 5, 1989 (incorporated by
reference to Exhibit 1 filed with the Company's Form 8-K on May 10,
1989).
4.2 Prospectus, Registration Statement, and Indenture on 6.70% Senior Notes
due December 1, 2005 and issued December 5, 1995 (incorporated by
reference to the Company's Forms S-3 and S-3/A filed on November 1,
1995, and November 17, 1995, respectively, and also to the Company's
filings of a Prospectus and Prospectus Supplement on November 22, 1995,
and December 4, 1995, respectively).
4.3 Prospectus Supplement and Form of Distribution Agreement on $125,000,000
of Medium-Term Notes dated February 21, 1997 (Prospectus Supplement
incorporated by reference to the Company's filing of a Prospectus
Supplement on February 21, 1997, Form of Distribution Agreement
incorporated by reference to Exhibit 10 filed with the Company's Form
8-K dated February 21, 1997).
Material Contracts:
10.1 Gas Purchase Contract between SEECO, Inc. and Associated Natural Gas
Company, dated October 1, 1990, and as amended September 30, 1997
(original contract incorporated by reference to Exhibit 10 to Annual
Report on Form 10-K for the year ended December 31, 1990; amendment
incorporated by reference to Exhibit 10.2 to Annual Report on Form 10-K
for the year ended December 31, 1997).
10.2 Compensation Plans:
(a) Summary of Southwestern Energy Company Annual and Long-Term
Incentive Compensation Plan, effective January 1, 1985, as
amended July 10, 1989 (replaced by Southwestern Energy Company
Incentive Compensation Plan, effective January 1, 1993) (original
plan incorporated by reference to Exhibit 10 to Annual Report on
Form 10-K for the year ended December 31, 1984; first amendment
thereto incorporated by reference to Exhibit 10 to Annual Report
on Form 10-K for the year ended December 31, 1989).
(b) Southwestern Energy Company Incentive Compensation Plan,
effective January 1, 1993, and Amended and Restated as of January
1, 1999 (amended and restated plan filed herewith).
(c) Nonqualified Stock Option Plan, effective February 22, 1985, as
amended July 10, 1989 (replaced by Southwestern Energy Company
1993 Stock Incentive Plan, dated April 7, 1993) (original plan
incorporated by reference to Exhibit 10 to Annual Report on Form
10-K for the year ended December 31, 1985; amended plan
incorporated by reference to Exhibit 10 to Annual Report on Form
10-K for the year ended December 31, 1989).
26
Exhibit
No. Description
- ------- -----------
(d) Southwestern Energy Company 1993 Stock Incentive Plan, dated
April 7, 1993 and Amended and Restated as of February 18, 1998
(amended and restated plan filed herewith).
(e) Southwestern Energy Company 1993 Stock Incentive Plan for Outside
Directors, dated April 7, 1993 (incorporated by reference to the
appendix filed with the Company's definitive Proxy Statement to
holders of the Registrant's Common Stock in connection with the
solicitation of proxies to be used in voting at the Annual
Meeting of Shareholders on May 26, 1993).
10.3 Southwestern Energy Company Supplemental Retirement Plan, adopted May
31, 1989, and Amended and Restated as of December 15, 1993, and as
further amended February 1, 1996 (amended and restated plan incorporated
by reference to Exhibit 10.5 to Annual Report on Form 10-K for the year
ended December 31, 1993; amendment dated February 1, 1996, incorporated
by reference to Exhibit 10.5 to Annual Report on Form 10-K for the year
ended December 31, 1995).
10.4 Southwestern Energy Company Supplemental Retirement Plan Trust, dated
December 30, 1993 (incorporated by reference to Exhibit 10.6 to Annual
Report on Form 10-K for the year ended December 31, 1993).
10.5 Southwestern Energy Company Nonqualified Retirement Plan, effective
October 4, 1995 (incorporated by reference to Exhibit 10.7 to Annual
Report of Form 10-K for the year ended December 31, 1995).
10.6 Split-Dollar Life Insurance Agreement for Stanley D. Green, effective
February 1, 1996 (incorporated by reference to Exhibit 10.8 to Annual
Report on Form 10-K for the year ended December 31, 1995).
10.7 Executive Severance Agreement for Charles E. Scharlau, effective August
4, 1989 (incorporated by reference to Exhibit 10 to Annual Report on
Form 10-K for the year ended December 31, 1989).
10.8 Executive Severance Agreement for Stanley D. Green, effective August 4,
1989 (incorporated by reference to Exhibit 10 to Annual Report on Form
10-K for the year ended December 31, 1989).
10.9 Employment and Consulting Agreement for Charles E. Scharlau, dated May
21, 1998 (filed herewith).
10.10 Employment Agreement for Harold M. Korell, effective April 28, 1997
(incorporated by reference to Exhibit 10.15 to Annual Report on Form
10-K for the year ended December 31, 1997).
10.11 Form of Indemnity Agreement, between the Company and each officer and
director of the Company (incorporated by reference to Exhibit 10.20 to
Annual Report on Form 10-K for the year ended December 31, 1991).
10.12 Form of Executive Severance Agreement for the Executive Officers of the
Company, effective February 17, 1999 (filed herewith).
10.13 Omnibus Project Agreement of NOARK Pipeline System, Limited Partnership
by and among Southwestern Energy Pipeline Company, Southwestern Energy
Company, Enogex Arkansas Pipeline Corporation, and Enogex Inc., dated
January 12, 1998 (incorporated by reference to Exhibit 10.17 to Annual
Report on Form 10-K for the year ended December 31, 1997).
27
Exhibit
No. Description
- ------- -----------
10.14 Amended and Restated Limited Partnership Agreement of NOARK Pipeline
System, Limited Partnership dated January 12, 1998 and amended June 18,
1998 (amended and restated agreement incorporated by reference to
Exhibit 10.18 to Annual Report on Form 10-K for the year ended December
31, 1997; first amendment thereto filed herewith).
13. 1998 Annual Report to Shareholders, except for those portions not
expressly incorporated by reference into this Report. Those portions not
expressly incorporated by reference are not deemed to be filed with the
Securities and Exchange Commission as part of this Report (filed
herewith).
21. Subsidiaries of the Registrant (incorporated by reference to Exhibit 21
to Annual Report on Form 10-K for the year ended December 31, 1996).
27. Financial Data Schedule for the year ended December 31, 1998 (filed
herewith).
28