UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
COMMISSION FILE NUMBER 1-13108
VASTAR RESOURCES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-4446177
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
15375 MEMORIAL DRIVE
HOUSTON, TEXAS 77079
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
__________________
(281) 584-6155
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
__________________
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
--- ---
NUMBER OF SHARES OF COMMON STOCK, $.01 PAR VALUE, OUTSTANDING AS OF
SEPTEMBER 30, 1998: 97,368,590.
PART I. FINANCIAL INFORMATION
VASTAR RESOURCES, INC.
CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
CONSOLIDATED STATEMENT OF INCOME
For the Three For the Nine
Months Ended Months Ended
September 30, September 30,
---------------- ----------------
(Millions of dollars, 1998 1997 1998 1997
except per share amounts) ----- ----- ----- -----
REVENUES
Net sales and other operating
revenues............................. $206.6 $226.4 $643.2 $724.8
Earnings from equity affiliate........ 5.3 0.4 15.9 0.4
Other revenues........................ 5.4 5.0 30.3 20.1
------ ------ ------ ------
Net revenues....................... 217.3 231.8 689.4 745.3
------ ------ ------ ------
EXPENSES
Operating expenses.................... 39.6 41.6 113.2 110.5
Exploration expenses.................. 35.3 37.5 167.7 134.4
Selling, general and administrative
expenses............................. 12.6 15.5 38.8 46.7
Taxes other than income taxes......... 11.6 10.9 37.7 35.5
Depreciation, depletion and
amortization......................... 82.3 69.1 225.6 212.8
Interest.............................. 14.4 11.5 40.7 35.9
------ ------ ------ ------
Total expenses..................... 195.8 186.1 623.7 575.8
------ ------ ------ ------
Income before income taxes............ 21.5 45.7 65.7 169.5
Income tax benefit.................... (16.1) (6.7) (52.7) (4.1)
------ ------ ------ ------
Net income.......................... $ 37.6 $ 52.4 $118.4 $173.6
====== ====== ====== ======
Basic earnings per share.............. $ 0.39 $ 0.54 $ 1.22 $ 1.78
====== ====== ====== ======
Diluted earnings per share............ $ 0.38 $ 0.54 $ 1.21 $ 1.78
====== ====== ====== ======
Cash dividends paid per share
of common stock....................... $0.075 $0.075 $0.225 $0.225
====== ====== ====== ======
The accompanying notes are an integral part of
these consolidated financial statements.
- 1 -
VASTAR RESOURCES, INC.
CONSOLIDATED BALANCE SHEET
(Unaudited)
September 30, December 31,
1998 1997
------------- ------------
(Millions of dollars)
ASSETS
Current assets:
Cash and cash equivalents............................... $ 17.5 $ 10.2
Accounts receivable:
Trade................................................. 73.5 132.5
Related parties....................................... 141.4 111.6
Inventories............................................. 10.6 9.9
Prepaid expenses and other assets....................... 19.1 24.7
-------- --------
Total current assets.................................. 262.1 288.9
Oil and gas properties and equipment, net................ 1,799.2 1,591.4
Other long-term assets................................... 58.3 44.5
-------- --------
Total assets......................................... $2,119.6 $1,924.8
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable:
Trade................................................. $ 175.2 $ 248.6
Related parties....................................... 9.8 60.7
Accrued liabilities..................................... 50.1 50.2
-------- --------
Total current liabilities............................ 235.1 359.5
Long-term debt........................................... 867.2 672.1
Deferred liabilities and credits......................... 214.3 213.6
Deferred income taxes.................................... 199.5 174.1
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; authorized, 110,000,000
shares; issued and outstanding, 97,368,590 shares
as of September 30, 1998 and 97,304,127 shares as of
December 31, 1997....................................... 1.0 1.0
Capital in excess of par value of stock.................. 456.4 454.9
Accumulated earnings..................................... 146.1 49.6
-------- --------
Total stockholders' equity............................. 603.5 505.5
-------- --------
Total liabilities and stockholders' equity.......... $2,119.6 $1,924.8
======== ========
The accompanying notes are an integral part of
these consolidated financial statements.
- 2 -
VASTAR RESOURCES, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
For the Nine Months Ended
September 30,
-------------------------
1998 1997
(Millions of dollars) ------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................. $ 118.4 $ 173.6
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation, depletion and amortization.................. 225.6 212.8
Deferred income taxes..................................... 25.4 64.2
Dry hole expense and undeveloped leasehold amortization... 99.6 63.8
Earnings from equity affiliate............................ (15.9) (0.4)
Gain on asset sales....................................... (21.0) (13.7)
Net change in accounts receivable, inventories
and accounts payable..................................... (95.8) 77.6
Other..................................................... (23.0) (10.6)
------- -------
Net cash provided by operating activities................... 313.3 567.3
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to oil and gas properties and equipment,
including dry hole costs................................... (528.4) (407.8)
Proceeds from asset sales................................... 47.0 15.5
Other....................................................... 0.7 (19.2)
------- -------
Net cash used in investing activities....................... (480.7) (411.5)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term debt issuance....................... 196.4 109.5
Repayments of long-term debt................................ (1.3) (251.6)
Dividends paid.............................................. (21.9) (21.9)
Other....................................................... 1.5 0.7
------- -------
Net cash provided by (used in) financing activities......... 174.7 (163.3)
------- -------
Net change in cash and cash equivalents..................... 7.3 (7.5)
Cash and cash equivalents at beginning of period............ 10.2 21.9
------- -------
Cash and cash equivalents at end of period.................. $ 17.5 $ 14.4
======= =======
The accompanying notes are an integral part of
these consolidated financial statements.
- 3 -
VASTAR RESOURCES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. INTRODUCTION.
The foregoing information is unaudited and has been prepared from the
records of Vastar Resources, Inc. ("Vastar" or the "Company"). In the opinion of
management, the financial information reflects all adjustments (consisting only
of items of a normal recurring nature) necessary for a fair presentation of the
Company's financial position and results of operations in conformity with
generally accepted accounting principles. Such statements are presented in
accordance with the requirements of Regulation S-X, which does not require all
disclosures normally required by generally accepted accounting principles or
those normally required on Form 10-K. These interim financial statements should
be read in conjunction with the annual financial statements for the year ended
December 31, 1997, and the Notes thereto contained in the Company's Form 10-K
for the year ended December 31, 1997, and Form 10-Q for the quarters ended March
31 and June 30, 1998. Certain previously reported amounts have been restated to
conform with classifications adopted in 1998.
NOTE 2. NET SALES AND OTHER OPERATING REVENUES.
For the Three For the Nine
Months Ended Months Ended
September 30, September 30,
------------------- --------------------
(Millions of dollars) 1998 1997 1998 1997
-------- -------- -------- ---------
Sales and other operating revenues:
Unrelated parties................. $ 175.3 $ 693.7 $ 587.6 $2,427.9
Related parties (1)............... 199.9 110.8 607.2 244.6
------- ------- -------- --------
Total............................ 375.2 804.5 1,194.8 2,672.5
Less:
Purchases (2)..................... (165.2) (561.2) (543.9) (1,882.7)
Delivery expense.................. (3.4) (16.9) (7.7) (65.0)
------- ------- -------- --------
Net sales and
other operating revenues.......... $ 206.6 $ 226.4 $ 643.2 $ 724.8
======= ======= ======== ========
- -----------------
(1) The weighted average lifting and purchase cost per Mcfe associated with
proprietary production and third-party purchased volumes multiplied by the
related party sales volumes results in average costs of $175.8 million and
$94.5 million for the three-month periods ended September 30, 1998 and 1997,
respectively, and $513.2 million and $180.5 million for the nine-month periods
ended September 30, 1998 and 1997, respectively.
(2) Includes purchases from related parties at a cost of $31.3 million and
$6.6 million for the three-month periods ended September 30, 1998 and 1997,
respectively, and $88.6 million and $14.6 million for the nine-month periods
ended September 30, 1998 and 1997, respectively.
- 4 -
VASTAR RESOURCES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
NOTE 3. SOUTHERN COMPANY ENERGY MARKETING, L.P. ("SCEM").
SCEM is a strategic marketing alliance created by the Company and
Southern Energy, Inc., a Delaware corporation ("SEI"), formerly known as SEI
Holdings, Inc. and a subsidiary of The Southern Company. Through its
subsidiaries, Vastar currently holds a 40 percent interest in SCEM, and SEI,
through its subsidiaries, currently holds a 60 percent interest. SCEM is
primarily engaged in the business of trading and marketing natural gas,
electricity and other energy-related commodities. SCEM provides energy and
energy-related commodities, products and services to wholesale and retail
customers in North America. Transactions with SCEM are conducted on the basis of
normal commercial relationships at prevailing market prices.
For the first five years of operation, Vastar is entitled to receive,
subject to certain exceptions, minimum cash distributions from SCEM of $20
million for the year 1998, $20 million for the year 1999, $25 million for the
year 2000, $30 million for the year 2001, and $30 million for the year 2002. As
a result of the minimum earnings distribution exceeding the Company's ownership
interest in SCEM's earnings for the nine-month period ended September 30, 1998,
the Company is recognizing its accrued share of the 1998 minimum earnings level
within the current period. For additional details regarding SCEM, refer to the
Company's Report on Form 10-K for the year ended December 31, 1997.
NOTE 4. EXPLORATION EXPENSES.
For the Three For the Nine
Months Ended Months Ended
September 30, September 30,
--------------- ----------------
(Millions of dollars) 1998 1997 1998 1997
------ ------ ------- ------
Dry hole costs....................... $ 8.2 $10.5 $ 73.3 $ 41.5
Geological and geophysical........... 4.6 7.2 29.7 37.5
Undeveloped leasehold amortization... 8.8 7.8 26.3 22.3
Staff................................ 10.3 9.7 31.3 27.4
Lease rentals........................ 3.4 2.3 7.1 5.7
----- ----- ------ ------
Total............................... $35.3 $37.5 $167.7 $134.4
===== ===== ====== ======
- 5 -
VASTAR RESOURCES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Unaudited)
NOTE 5. EARNINGS PER SHARE.
For the Three
Months Ended
September 30,
----------------------
1998 1997
--------- ----------
Basic earnings per share:
Income available to common shareholders
(millions of dollars)........................... $ 37.6 $ 52.4
Average shares of common stock outstanding
(thousands)..................................... 97,359 97,276
Basic earnings per share.......................... $ 0.39 $ 0.54
Diluted earnings per share:
Income available to common shareholders
(millions of dollars)........................... $ 37.6 $ 52.4
Incremental shares assuming the exercise
of stock options (thousands)..................... 521 473
Average shares of common stock outstanding plus
effect of dilutive securities (thousands)........ 97,880 97,749
Diluted earnings per share........................ $ 0.38 $ 0.54
For the Nine
Months Ended
September 30,
---------------------
1998 1997
--------- ---------
Basic earnings per share:
Income available to common shareholders
(millions of dollars)........................... $ 118.4 $ 173.6
Average shares of common stock outstanding
(thousands)..................................... 97,336 97,266
Basic earnings per share.......................... $ 1.22 $ 1.78
Diluted earnings per share:
Income available to common shareholders
(millions of dollars)........................... $ 118.4 $ 173.6
Incremental shares assuming the exercise
of stock options (thousands)..................... 645 288
Average shares of common stock outstanding plus
effect of dilutive securities (thousands)........ 97,981 97,554
Diluted earnings per share........................ $ 1.21 $ 1.78
- 6 -
VASTAR RESOURCES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
NOTE 6. COMMITMENTS AND CONTINGENCIES.
The Company and its subsidiaries are involved in a number of lawsuits,
all of which have arisen in the ordinary course of the Company's business. The
Company believes that any ultimate liability resulting from any of these suits
will not have a material adverse effect on its financial position or results of
operations.
The operations and financial position of Vastar continue to be affected
from time to time in varying degrees by domestic and foreign political
developments as well as legislation and regulations pertaining to restrictions
on oil and gas production, imports and exports, natural gas regulation, taxes,
environmental regulations and cancellation or impairment of contract rights.
Both the likelihood of such occurrences and their overall effect on the Company
vary greatly and are not predictable. These uncertainties are part of a number
of items that Vastar has taken and will continue to take into account in
periodically establishing accounting reserves.
Vastar and Atlantic Richfield Company ("ARCO") have agreements whereby
Vastar has agreed to indemnify ARCO against certain claims or liabilities to
which ARCO could be subject relating to ARCO's historical ownership and
operation of the properties transferred by ARCO to Vastar upon the formation of
Vastar, including liabilities under laws relating to the protection of the
environment and liabilities arising out of certain litigation. ARCO has agreed
to indemnify Vastar with respect to other claims and liabilities and other
litigation matters not related to Vastar's business or properties as reflected
in its consolidated financial statements.
In September 1996, the Company entered into a contract with Diamond
Offshore Drilling Company ("Diamond") for the major upgrade and operation of a
semisubmersible drilling rig, Ocean Victory, for a three-year deepwater drilling
program in the Gulf of Mexico, which commenced in November 1997. Since November
1997, scheduled increases in the day rates and enhancements to the rig made by
Diamond at the Company's request have resulted in higher remaining contract
costs. This contract has a remaining life of 2.4 years and a remaining cost of
$147.0 million before any reimbursement from partners or potential partners.
In September 1998, the Company signed a letter of intent with R&B Falcon
Drilling Co. for the operation of a semisubmersible, ultra-deepwater drilling
rig, for a three-year deepwater drilling program in the Gulf of Mexico, which is
scheduled to commence in 2001. This contract has an anticipated cost of
approximately $220.0 million, before any reimbursement from partners or
potential partners and operating cost escalations. Vastar has the option to
extend the primary term of the contract through five one-year options.
In connection with SCEM's marketing and risk activities, Vastar and SEI
have agreed to guarantee certain obligations of SCEM. The total amount of the
obligations to be guaranteed is set by the Board of Governors of SCEM. Vastar
and SEI have agreed, subject to certain limitations, to indemnify each other for
their respective pro rata share of any amount paid in connection with these
guarantees. Each company's pro rata share is equal to their respective
percentage ownership in SCEM at the time the guaranteed obligation is incurred.
In addition, Vastar's obligation to indemnify SEI, in years ending prior to
January 1, 2003, is limited, subject to certain limitations, to the amount
Vastar receives from SCEM in excess of the minimum distributions for that year.
Similarly, if Vastar does not receive its minimum distribution from SCEM in any
year, SEI has agreed to indemnify Vastar, subject to certain limitations, for
all amounts paid by Vastar under these guarantees for that year.
- 7 -
VASTAR RESOURCES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
NOTE 6. COMMITMENTS AND CONTINGENCIES (continued).
The Company has significant credit risk exposure to SCEM and SEI.
Neither SCEM nor SEI has yet obtained a credit rating from any nationally
recognized statistical rating organization. The credit risk exposure consists of
three principal items. First, SCEM has promised to make certain minimum
distributions to Vastar during the first five years of SCEM's operations. SEI
has guaranteed this obligation as well as the amounts that would become due to
Vastar on the exercise of Vastar's option to sell its remaining interest on
January 1, 2003. Second, SCEM is obligated to pay (and SEI has guaranteed
payment for) gas purchased under the Gas Purchase and Sale Agreement between the
Company and SCEM, pursuant to which Vastar has agreed to sell substantially all
of its natural gas production to SCEM. Third, Vastar has been indemnified by
SEI, with certain limitations, with respect to amounts which Vastar may be
required to pay under guarantees which Vastar has provided to secure certain
obligations of SCEM. If at December 31, 1998, SEI has not obtained and does not
thereafter maintain in effect an investment grade rating, SEI has agreed to
provide certain credit enhancements to secure the payment of SCEM's obligations
under the Gas Purchase and Sale Agreement and the minimum distributions. For
additional details regarding SCEM, refer to the Company's Report on Form 10-K
for the year ended December 31, 1997.
The Company has performed and continues to perform ongoing credit
evaluations of its other customers and generally does not require collateral on
its credit sales. Any amounts anticipated as uncollectible are charged to income
and credited to a valuation account. The amounts included in the allowance for
uncollectible accounts receivable at September 30, 1998 and 1997, were
insignificant.
NOTE 7. TAXES.
The provision for taxes on income is comprised of the following:
For the Three For the Nine
Months Ended Months Ended
September 30, September 30,
----------------- -----------------
(Millions of dollars) 1998 1997 1998 1997
------- ------- ------- -------
Federal:
Current................... $(34.1) $ 0.6 $(78.6) $(70.9)
Deferred.................. 17.5 (8.3) 24.5 63.2
------ ----- ------ ------
Total federal............ (16.6) (7.7) (54.1) (7.7)
------ ----- ------ ------
State:
Current................... (0.2) 1.1 0.5 2.6
Deferred.................. 0.7 (0.1) 0.9 1.0
------ ----- ------ ------
Total state................ 0.5 1.0 1.4 3.6
------ ----- ------ ------
Total income tax benefit $(16.1) $(6.7) $(52.7) $ (4.1)
====== ===== ====== ======
- 8 -
VASTAR RESOURCES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
NOTE 7. TAXES - (continued).
A reconciliation of the income tax benefit with tax at the federal
statutory rate for the specified period is as follows:
For the Three For the Nine
Months Ended Months Ended
September 30, September 30,
----------------- ------------------
(Millions of dollars) 1998 1997 1998 1997
------- ------- ------- --------
Income before taxes............. $ 21.5 $ 45.7 $ 65.7 $169.5
====== ====== ====== ======
Tax at the statutory rate....... $ 7.5 $ 16.0 $ 23.0 $ 59.3
Increase (reduction) in taxes
resulting from:
State income taxes (net
of federal effect)........... 0.3 0.6 0.9 2.3
Tax credits and other......... (23.9) (23.3) (76.6) (65.7)
------ ------ ------ ------
Income tax benefit ............ $(16.1) $ (6.7) $(52.7) $ (4.1)
====== ====== ====== ======
During the first quarter of 1997, ARCO and Vastar agreed to a second
amendment to the Tax Sharing Agreement, effective January 1, 1997 (the "Second
Amendment"). The Second Amendment removes certain limitations under the original
agreement and generally allows Vastar to receive payment for all Internal
Revenue Section 29 tax credits in the year generated provided ARCO is also able
to utilize the credits in that year. In return, the Company agreed to a 3.25
percent reduction in the value of the Section 29 tax credits generated on or
after January 1, 1997 from properties acquired by the Company before June 1,
1995. ARCO and Vastar also agreed to apply the same 3.25 percent reduction to
the $61.4 million of Section 29 tax credits carried forward as of December 31,
1996, in exchange for immediate payment upon execution of the Second Amendment.
Accordingly, Vastar received a payment from ARCO of $59.4 million on March 20,
1997. The federal tax provision for the nine months ended September 30, 1997,
included a $59.4 million current tax benefit and a $61.4 million deferred tax
expense related to the payment received by Vastar in the first quarter of 1997
with respect to the tax credit carry forward as of December 31, 1996.
For further information on the Tax Sharing Agreement, refer to the
Company's Report on Form 10-K for the year ended December 31, 1997.
- 9 -
VASTAR RESOURCES, INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
(Unaudited)
NOTE 8. LONG-TERM DEBT.
Long-term debt is comprised of the following:
September 30, December 31,
(Millions of dollars) 1998 1997
------ ------
8.75% Notes, due 2005.................... $149.6 $149.4
6.95% Notes, due 2006.................... 75.0 75.0
6.96% Notes, due 2007.................... 75.0 75.0
6.39% Notes, due 2008.................... 50.0 ---
6.00% Putable/Callable Notes, due 2010... 100.0 ---
Commercial Paper......................... 417.6 372.7
------ ------
Total.................................... $867.2 $672.1
====== ======
In April 1998, Vastar issued $100 million of 6.00% Putable/Callable
Notes due April 20, 2010 Putable/Callable April 20, 2000. The Notes were issued
under the Indenture, dated as of January 1, 1995, as supplemented by the
Supplemental Indenture, dated May 18, 1995, and as further supplemented by the
Second Supplemental Indenture dated April 16, 1998. The net proceeds of $99.9
million were used to pay down debt incurred under the Company's Commercial Paper
Program. In addition, the Company sold its call option under the notes to Union
Bank of Switzerland, London branch, and received $2.5 million, which was also
used to pay down debt incurred under the Company's Commercial Paper Program.
At September 30, 1998, Vastar had an outstanding interest swap covering
$100 million related to the Putable/Callable Notes. The swap effectively changed
the fixed rate debt of 6.00 percent to a floating quarterly rate of 5.69 percent
for the three months ended September 30, 1998.
NOTE 9. SUBSEQUENT EVENTS.
On October 21, 1998, the Company declared a quarterly dividend of $0.075
per share of common stock, payable on December 1, 1998, to stockholders of
record on November 6, 1998.
On October 31, 1998, Vastar Resources, Inc. ("Vastar" or the "Company")
purchased from Atlantic Richfield Company ("ARCO") 100 percent of the capital
stock of Vastar Offshore, Inc. ("VOI"), formerly known as Western Midway Company
and a wholly owned subsidiary of ARCO, for $470 million in cash and debt. The
$470 million purchase price has been reduced by approximately $35 million as a
result of post-closing adjustment items to date. These items include the
operating cash flows attributable to VOI's properties from the July 1, 1998
effective date to the October 31, 1998 closing date. VOI's existing indebtedness
of $300 million will remain outstanding. The $300 million indebtedness is due
March 9, 2003, and is owed to ARCO. The remaining net purchase price of $135
million was financed through the issuance of the Company's commercial paper.
The transaction was consummated pursuant to a Stock Purchase Agreement, dated
August 4, 1998, between Vastar and ARCO, as amended on August 12, 1998 and
October 30, 1998.
The assets of VOI include 23 producing fields comprised of 45 lease
blocks and 93 platforms with 295 active wells, as well as interests in more than
40 undeveloped lease blocks, all in the central and western Gulf of Mexico. VOI
also holds interests in pipelines, gathering lines and a shorebase in Cameron,
Louisiana.
The transaction was part of a three-company transaction involving
Vastar, ARCO and Mobil Exploration & Producing U.S. Inc., as agent for Mobil Oil
Exploration & Producing Southeast Inc. and Mobil Producing Texas & New Mexico
Inc. ("Mobil"). Pursuant to this transaction, VOI, then a wholly owned
subsidiary of ARCO, first exchanged certain California properties held by VOI
for the assets described above which were held by Mobil. Then ARCO sold all of
the capital stock of VOI to Vastar. For additional information regarding this
transaction, refer to the Company's Report on Form 8-K dated October 31, 1998,
filed with the SEC on November 9, 1998.
- 10 -
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
IMPACT OF THE MARKETING ALLIANCE.
In August 1997, the Company entered into a Formation Agreement with
Southern Energy, Inc., a Delaware corporation ("SEI"), formerly known as SEI
Holdings, Inc., a subsidiary of The Southern Company, to combine certain natural
gas and power trading and marketing operations of the two companies and create a
new energy services company. The new company is named Southern Company Energy
Marketing L.P. ("SCEM" or the "Venture"). Through its subsidiaries, Vastar
currently holds a 40 percent interest in the Venture, and SEI, through its
subsidiaries, currently holds a 60 percent interest. Pursuant to a two-phase
closing, SCEM began gas marketing effective September 1, 1997, and power
marketing effective January 1, 1998. The Company did not contribute its crude
oil or natural gas liquids marketing businesses to the Venture.
The Company is accounting for its interest in the Venture using the
equity method of accounting. Therefore, the Company's consolidated results after
September 1, 1997, no longer reflect its gas marketing activities in the
individual line items of the financial statements. For more details on the
Company's investment in SCEM and related matters, refer to the Company's Report
on Form 10-K for the year ended December 31, 1997.
Due to this change in accounting method for the gas marketing business,
the pro forma statistical and financial results for the three and nine months
ended September 30, 1997, are provided below to reflect the Company's results
as if the equity method of accounting had been used during that time period.
These pro forma financial and statistical results are provided for information
only. They are based on historical information and do not reflect the actual
results that would have occurred had the Venture been in existence during this
time period.
RESULTS OF OPERATIONS.
Sales and production volumes and average price statistics for the
specified periods are as follows:
For the Three For the Nine
Months Ended Months Ended
September 30, September 30,
------------------------- -------------------------
Pro As Pro As
forma Reported forma Reported
1998 1997 1997 1998 1997 1997
------ ------ -------- ------ ------ --------
Natural gas
Sales (MMcfd)*.............................. 1,380 1,280 2,649 1,358 1,209 3,026
Production (MMcfd).......................... 977 888 888 940 881 881
Average sales price (per Mcf)*.............. $ 1.85 $ 1.93 $ 2.13 $ 1.91 $ 2.04 $ 2.32
Average wellhead price (per Mcf)............ $ 1.79 $ 1.86 $ 1.86 $ 1.88 $ 1.96 $ 1.96
Crude oil
Sales (MBbld)*.............................. 109.7 103.5 103.5 115.5 101.4 101.4
Production (MBbld).......................... 32.8 33.6 33.6 34.6 34.4 34.4
Average realized price (per Bbl)*........... $13.11 $19.59 $19.59 $14.90 $21.24 $21.24
Natural gas liquids ("NGLs")
Production (MBbld).......................... 12.0 16.0 16.0 14.0 16.8 16.8
Average realized price (per Bbl)............ $ 8.38 $11.34 $11.34 $ 9.67 $12.95 $12.95
Total production (MMcfed)*................... 1,246 1,186 1,186 1,232 1,188 1,188
- ---------------------
* As used in this Form 10-Q the terms "Bcf," "MMcf" and "Mcf" mean billion,
million and thousand cubic feet, respectively; the terms "Bcfd," "MMcfd" and
"Mcfd" mean billion, million and thousand cubic feet per day, respectively;
the terms "MMBbl" and "MBbl" mean million and thousand barrels, respectively;
the term "Bbl" means barrel; the terms "MMBbld" and "MBbld" mean million and
thousand barrels per day, respectively; the term "MMcfed" means million cubic
feet equivalent per day. In calculating Mcf and Bbl equivalents, one Bbl is
deemed to equal six Mcf.
- 11 -
RESULTS OF OPERATIONS - (continued).
The following table sets forth the statement of income for the specified periods:
For the Three For the Nine
Months Ended Months Ended
September 30, September 30,
------------------------------ ------------------------------
Pro As Pro As
forma Reported forma Reported
(Millions of dollars) 1998 1997 1997 1998 1997 1997
-------- -------- -------- ------- -------- --------
REVENUES
Natural gas
Sales.................................. $ 234.7 $ 227.9 $ 519.2 $ 710.1 $ 673.5 $1,918.3
Purchases.............................. (74.8) (82.8) (354.8) (241.6) (225.3) (1,397.4)
Delivery expense....................... (2.2) (0.5) (14.7) (2.8) (0.8) (53.2)
------- ------- ------- ------ ------ --------
Net sales - natural gas 157.7 144.6 149.7 465.7 447.4 467.7
------- ------- ------- ------ ------ --------
Crude oil
Sales.................................. 130.0 178.4 178.4 438.9 556.9 556.9
Purchases.............................. (89.2) (116.7) (116.7) (294.4) (353.4) (353.4)
Delivery expense....................... (1.3) (1.2) (1.2) (3.8) (4.2) (4.2)
------- ------- ------- ------ ------ --------
Net sales - crude oil................ 39.5 60.5 60.5 140.7 199.3 199.3
------- ------- ------- ------ ------ --------
NGLs and other
Sales.................................. 10.5 18.4 106.9 45.8 70.9 197.3
Purchases and other costs.............. (1.1) (1.7) (90.7) (9.0) (11.9) (139.5)
------- ------- ------- ------ ------ --------
Net sales -
NGLs and other..................... 9.4 16.7 16.2 36.8 59.0 57.8
------- ------- ------- ------ ------ --------
Net sales and other
operating revenues.................. 206.6 221.8 226.4 643.2 705.7 724.8
Earnings from equity affiliate.......... 5.3 2.8 0.4 15.9 10.1 0.4
Other revenues.......................... 5.4 5.0 5.0 30.3 20.1 20.1
------- ------- ------- ------ ------ --------
Net revenues......................... 217.3 229.6 231.8 689.4 735.9 745.3
------- ------- ------- ------ ------ --------
EXPENSES
Operating expenses...................... 39.6 41.6 41.6 113.2 110.5 110.5
Exploration expenses.................... 35.3 37.5 37.5 167.7 134.4 134.4
Selling, general and
administrative expenses................ 12.6 13.4 15.5 38.8 37.6 46.7
Taxes other than income taxes........... 11.6 10.8 10.9 37.7 35.2 35.5
Depreciation, depletion and
amortization........................... 82.3 69.1 69.1 225.6 212.8 212.8
Interest................................ 14.4 11.5 11.5 40.7 35.9 35.9
------- ------- ------- ------ ------ --------
Total expenses......................... 195.8 183.9 186.1 623.7 566.4 575.8
------- ------- ------- ------ ------ --------
Income before income taxes.............. 21.5 45.7 45.7 65.7 169.5 169.5
Income tax benefit...................... (16.1) (6.7) (6.7) (52.7) (4.1) (4.1)
------- ------- ------- ------ ------ --------
Net income.............................. $ 37.6 $ 52.4 $ 52.4 $118.4 $173.6 $ 173.6
======= ======= ======= ====== ====== ========
- 12 -
THIRD QUARTER 1998 vs. PRO FORMA THIRD QUARTER 1997.
For the purpose of this analysis, the third quarter 1998 results are
being compared to the pro forma third quarter 1997 results.
Net income for the third quarter of 1998 was $37.6 million, compared to
$52.4 million for the third quarter of 1997. The 28 percent decrease in earnings
was primarily the result of lower commodity prices for all products and
increased depreciation, depletion and amortization expense, partially offset by
increased natural gas production.
Natural gas sales increased slightly to $234.7 million in the third
quarter of 1998 as compared to the same period last year. The higher revenues
were primarily the result of a ten percent increase in production available for
sale, which was offset by slightly lower commodity prices. Natural gas purchases
during the third quarter of 1998 decreased by ten percent from the same period
last year primarily from a decrease in the average purchase price.
Average natural gas wellhead prices for the third quarter of 1998
decreased seven cents per Mcf from the third quarter of 1997 to $1.79 per Mcf.
The lower price realization was due to lower market prices, as reflected in the
third quarter 1998 average price for Henry Hub of $2.00 per Mcf compared to
$2.33 per Mcf in the third quarter of last year. The Company's decline in
wellhead price was less than the market because (i) the Company experienced
reduced basis differentials (effectively higher prices) in the third quarter of
1998 as compared to the same period last year for gas production from the San
Juan Basin and (ii) smaller hedging losses in the third quarter of 1998 as
compared to the same period last year. Hedging activity for the third quarter
1998 and the third quarter 1997 resulted in a $4.0 million gain and a $9.9
million loss, respectively.
Third quarter 1998 average natural gas production increased by 89 MMcfd
from the same period last year which resulted from increased gas production in
more than a dozen offshore fields, including Mississippi Canyon 148, High Island
117 and Ship Shoal 126; and from several onshore fields, including the Ignacio
Blanco-Fruitland fields in Colorado, the Deep Anadarko trend in Oklahoma and the
Arkoma Basin in Arkansas. The increase in production was achieved despite the
curtailments in the Gulf of Mexico during the third quarter due to hurricanes
and tropical storms requiring the shut-down of production at selected fields at
various times during the third quarter.
Crude oil sales in the third quarter of 1998 decreased $48.4 million
from the same period last year, primarily as a result of a significant decrease
in crude oil sales prices. The lower price realization was due to a general
market price decline as reflected in the third quarter of 1998 average price for
NYMEX-WTI-at-Cushing of $13.84 per Bbl compared to $19.70 per Bbl in the third
quarter of last year.
Third quarter 1998 average crude oil production decreased slightly to
32.8 MBbld from third quarter 1997 levels. Volumes were impacted negatively by
the storm-related shut-ins of production in the South Pass area, which produces
a large percentage of the Company's crude and condensate.
Net sales for natural gas liquids ("NGLs") and other products were down
for the third quarter of 1998 as compared to the same period last year. The
decrease was a result of a significant decrease in average NGLs realized prices
and a decrease in NGLs production available for sale. Realized prices for NGLs
were lower in the third quarter of 1998 as a result of depressed crude oil
prices. Lower production primarily resulted from the selective decisions by the
Company and other operators to bypass processing in favor of selling the wet gas
stream due to the favorable natural gas price market.
Depreciation, depletion and amortization expense for the third quarter
of 1998 increased $13.2 million to $82.3 million. The increase was a result of
(i) higher depletion rates associated with the start-up of higher cost wells and
(ii) increased production rates.
- 13 -
THIRD QUARTER 1998 vs. PRO FORMA THIRD QUARTER 1997 - continued.
Interest expense for the third quarter of 1998 increased $2.9 million as
compared to the same period last year. The increase is the result of higher
average outstanding debt levels during the third quarter of 1998 as compared to
the third quarter of 1997.
The income tax benefit of $16.1 million in the third quarter of 1998 was
greater than in the same period last year because of lower pre-tax earnings and
slightly higher tax credits. The income tax benefit for the third quarter of
1998 and the third quarter of 1997 included the net benefit of $23.9 million and
$23.6 million, respectively, of Internal Revenue Code Section 29 tax credits for
non-conventional fuels.
NINE MONTHS ENDED SEPTEMBER 30, 1998 vs.
NINE MONTHS PRO FORMA ENDED SEPTEMBER 30, 1997.
For the purpose of this analysis, the first nine months of 1998 results
are being compared to the pro forma first nine months of 1997 results.
Net income for the first nine months of 1998 was $118.4 million,
compared to $173.6 million for the same period last year. The 32 percent
decrease in earnings was primarily the result of lower commodity prices and
higher exploration expenses.
Natural gas sales increased slightly to $710.1 million in the first nine
months of 1998 as compared to the same period last year. The higher revenues
were the result of a seven percent increase in production available for sale
partially offset by a six percent decrease in average sales prices. Natural gas
purchases during the first nine months of 1998 increased from the same period
last year primarily as a result of higher purchased volumes, partially offset by
lower purchased natural gas prices.
Average natural gas wellhead prices for the first nine months of 1998
decreased eight cents per Mcf from the first nine months of 1997 to $1.88 per
Mcf. The lower price realization was due to a general market price decline as
reflected in the first nine months of 1998 average price for Henry Hub of $2.15
per Mcf compared to $2.47 per Mcf in the first nine months of last year.
Partially offsetting this impact were: (i) smaller realized hedging losses and;
(ii) reduced basis differentials (effectively higher prices) for gas production
from the San Juan Basin. Hedging losses included in the first nine months of
1998 and 1997 were $0.9 million and $28.1 million, respectively.
The first nine months of 1998 average natural gas production increased
by 59 MMcfd from the same period last year. This increase was primarily a result
of exploitation efforts in the San Juan Basin, the High Island 117 and Ship
Shoal 126 field start-ups and production increases at Mississippi Canyon 148.
These increases more than offset natural field declines and storm related shut-
ins.
Crude oil sales in the first nine months of 1998 decreased $118.0
million from the same period last year, primarily as a result of significant
decreases in crude oil sales prices. The lower price realization was due to a
general market price decline as reflected in the first nine months of 1998
average price for NYMEX-WTI-at-Cushing of $15.40 per Bbl compared to $21.57 per
Bbl in the first nine months of last year.
The first nine months of 1998 average crude oil production increased
slightly to 34.6 MBbld from the first nine months of 1997 levels primarily as a
result of exploitation efforts at Eugene Island 175 and production increases at
Ship Shoal 126 and West Cameron 66. These increases were partially offset by the
shut-in of production at selected fields related to the hurricanes and tropical
storms experienced during the third quarter of 1998.
Net NGLs and other products were down for the first nine months of 1998
as compared to the same period last year. The decrease was a result of a 25
percent decrease in average NGLs realized prices and a decrease in NGLs
production available for sale. Lower production primarily resulted from the
selective decisions by the Company and other operators to bypass processing in
favor of selling the wet gas stream due to the favorable natural gas price
market.
- 14 -
NINE MONTHS ENDED SEPTEMBER 30, 1998 vs.
NINE MONTHS PRO FORMA ENDED SEPTEMBER 30, 1997 - continued.
Other revenues increased during the first nine months of 1998 as
compared to the same period last year primarily as a result of the $17.7 million
pre-tax gain associated with the $40.0 million payment received in the formation
of SCEM.
Exploration expenses for the first nine months of 1998 increased $33.3
million as compared to the same period last year. The increase in costs was
primarily a result of higher dry hole costs. Dry hole expenses were $73.3
million in the first nine months of 1998 as compared to $41.5 million in the
same period last year. The increase in dry hole costs is primarily a result of
higher drilling costs and increased drilling activity which resulted in more
wells being decisioned in the first nine months of 1998 as compared to the first
nine months of 1997.
Interest expense for the first nine months of 1998 increased
$4.8 million as compared to the same period last year. The increase is the
result of higher average outstanding debt levels during the first nine months of
1998 as compared to the first nine months of 1997.
The income tax benefit of $52.7 million in the first nine months of 1998
was greater than the same period last year because of lower pre-tax earnings and
higher tax credits. The income tax benefit for the first nine months of 1998 and
the first nine months of 1997 included the net benefit of $76.7 million and
$66.1 million, respectively, of Internal Revenue Code Section 29 tax credits for
non-conventional fuels. The increase in tax credits in the first nine months of
1998 was primarily a result of higher tax credit-eligible production in the San
Juan Basin.
LIQUIDITY AND CAPITAL RESOURCES.
In the first nine months of 1998, cash flow from operations was $313.3
million, compared to $567.3 million for the same period in 1997. This decrease
was due, in part, to lower commodity product prices and higher working capital
requirements during the first nine months of 1998 as compared to the same period
last year. In the first quarter of 1997, the Company also received a one-time
payment from ARCO of $59.4 million related to the monetization of certain tax
credit carry forwards pursuant to an amendment of the Tax Sharing Agreement
between the Company and ARCO.
Net cash used in investing activities in 1998 was $480.7 million, an
increase of $69.2 million over the first nine months of 1997, primarily as a
result of an increased drilling program partially offset by the proceeds
received in connection with the transaction that resulted in the formation of
SCEM.
The following table summarizes the Company's capital investments for the
comparative periods.
CAPITAL SPENDING SUMMARY
For the Nine
Months Ended
September 30,
-----------------
(Millions of dollars) 1998 1997
------ ------
Exploratory drilling................... $138.8 $ 88.3
Development drilling................... 247.1 166.2
Property acquisitions.................. 70.1 99.9
Other additions........................ 72.4 53.4
------ ------
Total additions to property,
plant and equipment.................. 528.4 407.8
Geological and geophysical............. 29.7 37.5
------ ------
Total capital program............... $558.1 $445.3
====== ======
- 15 -
LIQUIDITY AND CAPITAL RESOURCES - continued.
Exploratory and development drilling costs increased in the first nine
months of 1998 as compared to the first nine months of 1997 primarily as the
result of (i) increased drilling activity both in deepwater and on the Gulf of
Mexico shelf and (ii) higher rig rates paid to rig operators. To date, in the
fourth quarter the Company has experienced lower rig rates as compared to the
first nine months of 1998.
Cash flow provided by financing activities was $174.7 million in the
first nine months of 1998, which included a $195.1 million increase of long-term
debt (net of payments) necessary to fund the current capital program.
The Company's ratio of earnings to fixed charges for the nine months
ended September 30, 1998 and 1997 was 2.5 and 5.7, respectively. This ratio is
computed by dividing earnings by fixed charges. For this purpose, earnings
include income before income taxes and fixed charges. Fixed charges include
interest and amortization of debt expenses and the estimated interest component
of rental expense.
RISK MANAGEMENT AND MARKET-SENSITIVE INSTRUMENTS.
The Company uses various financial instruments for non-trading purposes
in the normal course of business to manage and reduce risks associated with
price volatility, contractual commitments and other market variables associated
with its natural gas and petroleum liquids production. These financial
instruments have the effect of locking in the prices during specified periods
which the Company will receive for the volumes to which the financial
instruments relate. As a result, while these arrangements are structured to
reduce the Company's exposure to decreases in price associated with the hedged
commodity, they can also limit the benefit the Company might otherwise have
received from any price increases associated with the hedged commodity. Such
risk management activities are generally accomplished pursuant to exchange-
traded futures and over-the-counter options.
The Company realized approximately a $4.0 million pre-tax gain and $9.9
million pre-tax loss in the third quarter of 1998 and 1997, respectively, and a
$0.1 million and $28.1 million of pre-tax losses in the first nine months of
1998 and 1997, respectively, as a result of hedging transactions for natural gas
and crude oil.
- 16 -
RISK MANAGEMENT AND MARKET-SENSITIVE INSTRUMENTS - continued.
The following table summarizes the Company's open positions as of September 30,
1998, which the Company uses to manage its exposure to fluctuations in natural
gas prices.
Remaining Contract Average Weighted
Financial Instrument Time Period Volume Average Prices
- -------------------- ------------------ --------- --------------
Fixed Prices Oct - Dec 1998 150 MMcfd $ 2.07
Collar* Oct 1998 30 MMcfd $1.95 - $2.21
Collars Oct - Dec 1998 136 MMcfd $2.28 - $2.82
Puts Sold** Oct - Dec 1998 136 MMcfd $ 1.92
Call Sold*** Oct - Dec 1998 50 MMcfd $ 2.65
Collars Jan - Sept 1999 183 MMcfd $2.30 - $2.91
Puts Sold Jan - Sept 1999 183 MMcfd $ 1.97
Calls Sold Jan - June 1999 100 MMCfd $ 2.78
- ------------
* A "collar" is a financial instrument or a combination of financial
instruments which establishes (i) a floor that allows the Company to receive no
less than an average stated price per Mcf and (ii) a ceiling that will limit the
Company to receive no more than an average stated price per Mcf.
** A "put" is an option contract that gives the holder the right but not the
obligation to sell the underlying security, such as a futures contract, at a
specified price for a certain fixed period of time.
*** A "call" is an option contract that gives the holder the right but not the
obligation to buy the underlying security, such as a futures contract, at a
specified price for a certain fixed period of time.
As of September 30, 1998, the fair value (unrealized pre-tax loss or
gain to the Company) for the hedged natural gas transactions for the remainder
of 1998 and all of 1999 would be a $2.4 million loss. This loss calculation is
based on forward price quotes from brokers and NYMEX forward prices as of
September 30, 1998, which averaged $2.38 per Mcf for the balance of 1998 and
$2.31 per Mcf for 1999. The Company had no outstanding oil hedge positions as of
September 30, 1998. The actual gains or losses realized by the Company from such
hedge transactions may vary significantly from the foregoing amounts due to the
fluctuation of prices in the commodity markets. For example, a hypothetical ten
percent increase in the forward price quotes would increase the unrealized loss
for 1998 and 1999 by approximately $6.8 million for natural gas. In order to
calculate the hypothetical loss, the relevant parameters of the futures
contracts are the type of commodity, the delivery price and the delivery
location; due to the short period before expiration, time value of money is
ignored in the calculation. This analysis only includes the commodity derivative
instrument and not the exposure related to the underlying commodity itself.
Natural gas prices fluctuated between $1.60 per Mcf and $2.47 per Mcf (Henry
Hub) and crude oil prices fluctuated between $12.73 per Bbl and $16.13 per Bbl
(NYMEX-WTI-at-Cushing) during the third quarter of 1998.
The Company has long-term contracts with certain cogeneration facilities
which have an average remaining life of 12 years. These contracts cover an
average of 77 MMcfd of the Company's natural gas production for the remainder of
the year at an average price of $2.51 per Mcf.
During the first nine months of 1998, the Company's long-term sales
commitments did not exceed the total of proprietary production and other natural
gas production controlled through call rights with third-party producers and
marketing agreements with the Company's royalty owners.
The Company's Commercial Paper Program is subject to interest rate risk.
An increase in interest rates would increase interest expense at current
borrowing levels. For example, a ten percent increase in the London Interbank
Offered Rate (a benchmark pursuant to which the Company's interest rates may be
set) would have increased interest expense by $0.6 million and $1.7 million for
the third quarter and the first nine months of 1998, respectively.
- 17 -
RISK MANAGEMENT AND MARKET-SENSITIVE INSTRUMENTS - continued.
At September 30, 1998, Vastar had an outstanding interest rate swap
covering $100 million related to the Putable/Callable Notes. The swap
effectively changed the fixed rate debt of 6.00 percent to a floating quarterly
rate.
IMPACT OF THE YEAR 2000 ISSUE.
The Year 2000 issue is the result of computer programs written and
computer chips programmed using two digits rather than four to define the
applicable year. Any of the Company's computer programs that have date-sensitive
software as well as anything with a computer chip may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing operational disruptions.
The Company is utilizing both internal and external resources to
research, reprogram, replace and test for Year 2000 readiness. The Company plans
to complete the Year 2000 readiness program for most critical systems no later
than December 31, 1999. The total cost of the Year 2000 project (i) is currently
estimated at between $3 million and $4 million, (ii) is being funded through
operating cash flows and (iii) will be expensed as incurred over the next two
years. To date, the Company has incurred and expensed approximately $1.5 million
related to the assessment of its Year 2000 project and the development and
implementation of its remediation plan.
The Company's State of Readiness
The Company's program for addressing the Year 2000 issue is divided into
six steps: Inventory, Investigation, Assessment of Potential Year 2000 Impact,
Testing and Validation, Repair and Replacement and Process Completion.
Inventory
The Company has a program to identify all items that might be affected
by the Year 2000 issue. The inventory included items from both information
technology ("IT") and non-IT systems such as computer hardware and software,
data, telecommunications, building and office equipment, automation and
measurement devices, files and forms. The inventory identified items developed
by (i) the Company and its affiliates, through their respective employees and
contractors and (ii) third parties. The inventory covered all areas of the
Company's operations including accounting, drilling, engineering, exploration,
facilities, land, legal, payroll, production, and safety health and
environmental.
- 18 -
IMPACT OF THE YEAR 2000 ISSUE (continued).
The Company prioritized the inventoried items into four areas based on
an assessment of the anticipated risks to the Company in the event of a delay or
failure of the item caused by a Year 2000 problem:
(i) High Priority - Items which if they were to become inoperable or
uncontrollable would present an unreasonable risk of (a) loss of life, (b)
loss of revenue or (c) impact to the environment;
(ii) Medium Priority - Items which are important or convenient to the
operation of the Company's business but as to which the Company has available
alternatives or has determined that a material adverse effect on the financial
condition or results of operation of the Company would not result if such
items become inoperable or uncontrollable.
(iii) Low Priority - Items which are used in the Company's business but not
necessary for the successful operation of the Company; and
(iv) De-install - Items expected to be discontinued or replaced prior to
January 1, 2000.
Within each category the Company then determined which of the items were
developed in-house by the Company, by Company affiliates such as Atlantic
Richfield Company or by third parties. The inventory has been substantially
completed. However, efforts will continue with respect to newly acquired items
and user-developed items.
Investigation
The Company investigates each item for possible Year 2000 readiness
claims. Code reviews, peer reviews, vendor contact, internet research, industry
forums, self audits, and other activities all provide evidence as to the Year
2000 readiness claim of the item. The investigation has also been substantially
completed. However, the Company will continue to monitor existing claims as well
as address Year 2000 readiness with respect to the newly acquired items.
Assessment of Potential Year 2000 Impact
An assessment of the item, its usage, risk, priority, evidence gathered,
and other factors help determine future actions by the Company. Some items may
be accepted as Year 2000 ready, others may warrant additional testing or
validation, while others may need repair, upgrades, or replacement.
Testing and Validation
For items with high priority, less convincing evidence to support a
Year 2000 readiness claim or otherwise raising concerns regarding Year 2000
readiness, the Company performs additional testing to validate previous claims
of readiness.
Repair and Replacement
For those items with known issues, the Company ensures Year 2000
readiness with respect to each item to the extent possible. Activities include,
but are not limited to, rewriting internally developed software, implementing
hardware and software upgrades from third parties, replacing or upgrading
embedded chip devices, and monitoring the progress of Company affiliates'
remediation of shared systems.
Process Completion
The above-described process is well under way and the Company has made
significant progress. Using an average phase completion method of estimation,
the Company estimates 70 percent of the high priority items to be complete with
an expected completion date of July 1, 1999. With respect to medium and low
priority items, the Company estimates these items to be 80 percent and 70
percent complete, respectively. These activities may not be completed by January
1, 2000, but the Company believes that the failure of such items to be Year 2000
ready will not have a material adverse effect on the financial condition or
results of operations of the Company.
Supply Chain Analysis
In addition to assessing its own systems which may be affected by the
Year 2000 issue, the Company has also sought to determine if it will be affected
by Year 2000 issues affecting third parties with which the Company has a
material relationship. These parties include, but are not limited to, customers,
natural gas pipelines, vendors, co-owners, partners, joint ventures and
operators of oil and gas properties in which the Company owns an interest, as
well as general suppliers, telecommunications providers, transportation
providers, emergency response providers and utilities. The Company has requested
by letter a detailed explanation of the Year 2000 issues affecting such third
parties and will be doing further due diligence as may be warranted to determine
whether the issues are being handled in a timely and expedient manner. This
analysis is estimated to be 40 percent complete with an expected final
completion date of March 1, 1999.
- 19 -
Contingency
As part of the Year 2000 readiness program, individual contingency plans
have been set in place for high priority items. These contingency plans include
identifying and ensuring the Year 2000 readiness of alternative technologies and
in some cases a plan for reversion to manual operation. However, the Company
realizes the need to address contingency plans at the enterprise level. The
Company is in the process of developing contingency plans to handle the most
reasonably likely worst case scenarios caused by an interrelated failure of key
components or widespread outages of key services. The Company has not completed
its enterprise wide contingency plan but expects to complete it by August 1,
1999.
Conclusion
The difficulty with predicting the impact to the Company of Year 2000
failures stems from the interdependence between the Company and the various
third parties on which the Company relies. As a result of the general
uncertainty inherent in the Year 2000 problem, the Company is unable to
determine at this time whether the consequences of Year 2000 failures would have
a material impact on the Company's results of operations or financial condition.
Completion of the Company's Year 2000 readiness program as scheduled is expected
to reduce the possibility of significant interruptions of normal operations.
Safe Harbor Cautionary Statement
Vastar desires to take advantage of the "safe harbor" provisions
contained in Section 27A of the Securities Act of 1933, as amended (the "1933
Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the
"1934 Act"), and is including this statement herein in order to do so.
The discussion above contains forward looking statements. Readers are
cautioned that these statements are based upon certain assumptions, including,
but not limited to, assumptions as to the availability of trained personnel and
the ability to timely locate all relevant Year 2000 issues which might affect
the Company and the assumption that representations by third parties are
correct. The Company also assumes that the Company's repair and replacement
programs will be timely completed and that certain vendors and contractors will
timely perform as promised. Actual results could differ materially if the
Company's assumptions are incorrect. Due to the general uncertainty as to the
Year 2000 readiness of third parties and the interconnection of business, the
Company cannot ensure its ability to resolve its Year 2000 problems in a timely
and cost effective manner. The failure to properly address all of the Company's
Year 2000 readiness issues could have a material adverse affect on the Company's
operations and business or expose it to third-party liability.
- 20 -
NEW ACCOUNTING STANDARDS.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 requires all
derivatives to be recognized in the statement of financial position as either
assets or liabilities and measured at fair value. In addition, all hedging
relationships must be designated, reassessed and documented pursuant to the
provisions of SFAS No. 133. This statement is effective for financial statements
for fiscal years beginning after June 15, 1999. The Company has not yet
completed its evaluation of the impact of the provisions of SFAS No. 133.
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position 98-1 ("SOP 98-1"), "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use." SOP 98-1 is
effective for financial statements for fiscal years beginning after December 15,
1998. SOP 98-1 establishes criteria for determining which costs of developing
or obtaining internal-use computer software should be charged to expense and
which should be capitalized. The Company has not yet completed evaluating the
impact of the provisions of SOP 98-1.
------------------------
Management cautions against projecting any future results based on
present earnings levels because of economic uncertainties, the extent and form
of existing or future governmental regulations and other possible actions by
governments.
The foregoing financial information is unaudited and has been prepared
from the books and records of the Company. In the opinion of Management, the
financial information reflects all adjustments, consisting only of normal
recurring adjustments, necessary for the fair presentation of the financial
position, results of operations and cash flows in conformity with generally
accepted accounting principles.
- 21 -
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
There have been no material developments with respect to the Company's
legal proceedings as previously reported in the Company's Report on Form 10-K
for the period ending December 31, 1997 and the Company's Reports on Form 10-Q
for the quarterly periods ended June 30 and March 31, 1998.
Item 6. Exhibits and Reports on Form 8-K.
(a)
12 Computation of Earnings to Fixed Charges
27 Financial Data Schedule as of nine months ending
September 30, 1998
(b) Reports on Form 8-K.
The following current report on Form 8-K was filed during the
quarter ended September 30, 1998 and through the date hereof.
Date of Report Item Nos. Financial Statements
-------------- --------- --------------------
October 31, 1998 2 and 7 (i) Statements of Combined
Revenues and Direct
Operating Revenues,
relating to certain
oil and gas assets
from certain subsidiaries
of Mobil Oil Corporation
(ii) Pro Forma Combined
Financial Statements
- 22 -
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VASTAR RESOURCES, INC.
(Registrant)
Dated: November 10, 1998 /s/ Joseph P. McCoy
------------------------------
Joseph P. McCoy
Vice President and Controller
(Duly Authorized Officer and
Principal Accounting Officer)
- 23 -
Exhibit Index
Exhibit No. Description
- ----------- ---------------------------------------------------------
12 Computation of Ratio of Earnings to Fixed Charges
27 Financial Data Schedule for the nine months ending
September 30, 1998