SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999 OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 000-27473
SPINNAKER EXPLORATION COMPANY
(Exact name of registrant as specified in its charter)
DELAWARE 76-0560101
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1200 SMITH STREET, SUITE 800
HOUSTON, TEXAS 77002
(Address of principal executive offices) (Zip Code)
(713) 759-1770
(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 [_] No [X]
As of November 10, 1999, there were 20,403,664 shares of the Registrant's Common
Stock, par value $0.01 per share, outstanding.
SPINNAKER EXPLORATION COMPANY
FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1999
Page
----
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets
September 30, 1999 and December 31, 1998................ 3
Consolidated Statements of Operations
Three and Nine Months Ended September 30,
1999 and 1998........................................... 4
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 1999 and 1998........... 5
Notes to Interim Consolidated Financial
Statements.............................................. 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS.... 12
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK................................ 17
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS......... 18
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.................. 18
SIGNATURES.................................................. 19
EXHIBIT INDEX............................................... 20
2
SPINNAKER EXPLORATION COMPANY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31, SEPTEMBER 30,
1998 1999
-----------------------------------
ASSETS (UNAUDITED)
CURRENT ASSETS:
Cash and cash equivalents............................................................. $ 2,141 $ 3,363
Accounts receivable................................................................... 3,821 8,794
Other................................................................................. 775 3,130
-------- --------
Total current assets................................................................ 6,737 15,287
PROPERTY AND EQUIPMENT:
Oil and gas, on the basis of full-cost accounting -
Proved properties.................................................................... 71,091 112,620
Unproved properties and properties under development, not being amortized............ 28,383 46,630
Furniture and fixtures................................................................ 2,798 3,599
-------- --------
102,272 162,849
Less - Accumulated depreciation, depletion and amortization........................... (6,665) (20,454)
-------- --------
Total property and equipment........................................................ 95,607 142,395
OTHER ASSETS:
Organization costs and other, net..................................................... 425 30
-------- --------
Total assets........................................................................ $102,769 $157,712
======== ========
LIABILITIES AND EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued liabilities.............................................. $ 18,378 $ 19,591
Short-term debt....................................................................... 19,000 72,000
-------- --------
Total current liabilities........................................................... 37,378 91,591
ACCRUED PREFERRED DIVIDENDS PAYABLE.................................................... 8,478 16,268
COMMITMENTS AND CONTINGENCIES
EQUITY:
Preferred stock, $0.01 par value; 10,000,000 shares authorized;
3,030,920 shares issued and outstanding at December 31, 1998
and September 30, 1999............................................................... 30 30
Common stock, $0.01 par value; 50,000,000 shares authorized;
4,082,200 shares and 5,157,200 shares issued and outstanding
at December 31, 1998 and September 30, 1999, respectively............................ 20 52
Additional paid-in capital............................................................ 74,649 79,993
Accumulated deficit................................................................... (17,786) (30,222)
-------- --------
Total equity........................................................................ 56,913 49,853
-------- --------
Total liabilities and equity........................................................ $102,769 $157,712
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
3
SPINNAKER EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
----------------------- --------------------
1998 1999 1998 1999
------ ------ ------ ------
REVENUES................................................... $ 603 $10,300 $ 1,564 $ 19,883
EXPENSES:
Lease operating expenses.................................. (69) 2,332 262 3,515
Depletion, depletion and amortization-
natural gas and oil properties........................... 409 5,439 1,057 13,058
Depreciation and amortization-other....................... 63 54 199 152
General and administrative................................ 937 1,154 2,896 3,398
Stock appreciation rights expense (benefit)............... (267) -- 637 1,651
------- ------- ------- --------
Total expenses.......................................... 1,073 8,979 5,051 21,774
------- ------- ------- --------
INCOME (LOSS) FROM OPERATIONS.............................. (470) 1,321 (3,487) (1,891)
OTHER INCOME (EXPENSE):
Interest income........................................... 44 49 177 134
Interest expense.......................................... -- (1,453) -- (3,460)
Capitalized interest...................................... -- 332 -- 966
------- ------- ------- --------
Total other income (expense)............................ 44 (1,072) 177 (2,360)
------- ------- ------- --------
INCOME (LOSS) BEFORE INCOME TAXES.......................... (426) 249 (3,310) (4,251)
Income tax provision...................................... -- -- -- --
------- ------- ------- --------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE...................................... (426) 249 (3,310) (4,251)
Cumulative effect of change in accounting principle....... -- -- -- (395)
------- ------- ------- --------
NET INCOME (LOSS).......................................... (426) 249 (3,310) (4,646)
ACCRUAL OF DIVIDENDS ON PREFERRED STOCK.................... (2,123) (2,702) (4,621) (7,790)
------- ------- ------- --------
NET LOSS AVAILABLE TO COMMON STOCKHOLDERS.................. $(2,549) $(2,453) $(7,931) $(12,436)
======= ======= ======= ========
BASIC LOSS PER COMMON SHARE:
Loss before cumulative effect of change in accounting
principle................................................ $ (0.63) $ (0.48) $ (1.96) $ (2.70)
Cumulative effect of change in accounting principle....... -- -- -- (0.09)
------- ------- ------- --------
NET LOSS PER COMMON SHARE.................................. $ (0.63) $ (0.48) $ (1.96) $ (2.79)
======= ======= ======= ========
DILUTED LOSS PER COMMON SHARE:
Loss before cumulative effect of change in accounting
principle................................................ $ (0.63) $ (0.48) $ (1.96) $ (2.70)
Cumulative effect of change in accounting principle....... -- -- -- (0.09)
------- ------- ------- --------
NET LOSS PER COMMON SHARE.................................. $ (0.63) $ (0.48) $ (1.96) $ (2.79)
======= ======= ======= ========
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
Basic..................................................... 4,057 5,145 4,055 4,461
======= ======= ======= ========
Diluted................................................... 4,057 5,145 4,055 4,461
======= ======= ======= ========
The accompanying notes are an integral part of the consolidated financial
statements.
4
SPINNAKER EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
--------------------
1998 1999
------ ------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................................................ $ (3,310) $ (4,646)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating
activities:
Depreciation, depletion and amortization................................................ 1,256 13,210
Stock appreciation rights expense (benefit)............................................. 637 1,651
Cumulative effect of change in accounting principle..................................... -- 395
Change in components of working capital:
Accounts receivable..................................................................... 3,380 (3,383)
Accounts payable and accrued liabilities................................................ 1,825 9,145
Other current assets and other.......................................................... (2,008) (923)
-------- --------
Net cash provided by operating activities.............................................. 1,780 15,449
CASH FLOWS FROM INVESTING ACTIVITIES:
Oil and gas properties................................................................... (63,409) (56,297)
Change in property related payables...................................................... 8,451 (10,129)
Purchases of furniture and fixtures...................................................... (689) (801)
-------- --------
Net cash used in investing activities.................................................. (55,647) (67,227)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings................................................................. -- 53,000
Proceeds from issuance of preferred stock................................................ 51,738 --
-------- --------
Net cash provided by financing activities.............................................. 51,738 53,000
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS...................................... (2,129) 1,222
CASH AND CASH EQUIVALENTS, beginning of period............................................ 2,682 2,141
-------- --------
CASH AND CASH EQUIVALENTS, end of period.................................................. $ 553 $ 3,363
======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURES:
Cash paid for interest, net of amounts capitalized....................................... $ -- $ 2,072
Cash paid for income taxes............................................................... -- --
The accompanying notes are an integral part of the consolidated financial
statements.
5
SPINNAKER EXPLORATION COMPANY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 1999
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Spinnaker
Exploration Company (the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information and
the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the opinion
of management, all adjustments (consisting only of normal and recurring
adjustments) necessary to present a fair statement of the results for the
periods included herein have been made and the disclosures contained herein are
adequate to make the information presented not misleading. Operating results for
the three and nine months ended September 30, 1999 are not necessarily
indicative of the results that may be expected for the year ended December 31,
1999. For further information, refer to the consolidated financial statements
and footnotes thereto included in the Company's registration statement on Form
S-1, as amended (Registration No. 333-83093), initially filed with the
Securities and Exchange Commission on July 16, 1999.
2. INITIAL PUBLIC OFFERING
On September 28, 1999, the Company priced its initial public offering of 8.0
million shares of common stock and commenced trading the following day. After
payment of underwriting discounts and commissions, the Company received net
proceeds of $108.7 million on October 4, 1999. With a portion of the proceeds,
the Company retired all outstanding debt of $72.0 million. The Company will use
the remaining net proceeds after offering costs to fund exploration and
development activities. In connection with the initial public offering, the
Company converted all outstanding preferred shares into shares of common stock,
and certain shareholders reinvested preferred dividends payable of $16.3 million
into shares of common stock.
3. PRO FORMA FINANCIAL INFORMATION
The initial public offering closed on October 4, 1999 and is not reflected in
the accompanying consolidated financial statements at and for the three and nine
months ended September 30, 1999. The pro forma condensed consolidated statements
of operations for the year ended December 31, 1998 and for the nine months ended
September 30, 1999 assume the completion of the initial public offering, the
conversion of each share of preferred stock into two shares of common stock, the
reinvestment of preferred stock dividends into shares of common stock and the
retirement of all outstanding debt occurred on January 1, 1998 and 1999,
respectively, and are as follows (in thousands, except per share data):
6
SPINNAKER EXPLORATION COMPANY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
SEPTEMBER 30, 1999
FOR THE YEAR ENDED FOR THE NINE
DECEMBER 31, MONTHS ENDED
1998 SEPTEMBER 30, 1999
------------------ ------------------
(PRO FORMA)
REVENUES.......................................................... $ 3,298 $19,883
EXPENSES.......................................................... 10,100 21,774
------- -------
LOSS FROM OPERATIONS.............................................. (6,802) (1,891)
OTHER INCOME (EXPENSE)............................................ 221 (406)
------- -------
LOSS BEFORE INCOME TAXES.......................................... (6,581) (2,297)
Income tax provision............................................ -- --
------- -------
LOSS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE... (6,581) (2,297)
Cumulative effect of change in accounting principle............. -- (395)
------- -------
PRO FORMA NET LOSS................................................ $(6,581) $(2,692)
======= =======
PRO FORMA BASIC AND DILUTED LOSS PER COMMON SHARE................. $ (0.47) $ (0.14)
======= =======
PRO FORMA WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING--
Basic and diluted.............................................. 14,078 19,110
======= =======
The pro forma condensed consolidated statement of operations for the year
ended December 31, 1998 reflects adjustments of approximately $0.5 million and
$0.2 million to eliminate interest expense and capitalized interest as a
result of the retirement of all outstanding debt and $7.1 million to eliminate
dividends as a result of the conversion of each share of preferred stock into
two shares of common stock.
The pro forma condensed consolidated statement of operations for the nine
months ended September 30, 1999 reflects adjustments of approximately $2.9
million and $1.0 million to eliminate interest expense and capitalized
interest as a result of the retirement of all outstanding debt and $7.8
million to eliminate dividends as a result of the conversion of each share of
preferred stock into two shares of common stock.
The pro forma weighted average number of common shares outstanding includes
adjustments for the issuance of common shares in connection with the initial
public offering, the conversion of each share of preferred stock into two
shares of common stock, the reinvestment of preferred stock dividends into
shares of common stock and an adjustment to shares issued to Petroleum Geo-
Services ASA ("PGS") and Warburg, Pincus Ventures, L.P. ("Warburg") as
consideration for providing guarantees under the Credit Agreement.
The pro forma condensed consolidated balance sheet at September 30, 1999
assumes the completion of the initial public offering, the conversion of each
share of preferred stock into two shares of common stock, the reinvestment of
preferred stock dividends into shares of common stock and the retirement of all
outstanding debt occurred on September 30, 1999 and is as follows (in thousands,
except share data):
7
SPINNAKER EXPLORATION COMPANY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
SEPTEMBER 30, 1999
SEPTEMBER 30,
1999
-------------
(PRO FORMA)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents....................................... $ 40,006
Accounts receivable and other................................... 10,924
--------
Total current assets.......................................... 50,930
PROPERTY AND EQUIPMENT........................................... 162,849
Less - Accumulated depreciation, depletion and amortization..... (20,454)
--------
Total property and equipment.................................. 142,395
OTHER ASSETS..................................................... 30
--------
Total assets.................................................. $193,355
========
LIABILITIES AND EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued liabilities........................ $ 19,591
--------
Total current liabilities..................................... 19,591
COMMITMENTS AND CONTINGENCIES
EQUITY:
Common stock, $0.01 par value; 50,000,000 shares
authorized; 20,410,423 shares issued and
outstanding at September 30, 1999.............................. 204
Additional paid-in capital...................................... 203,782
Accumulated deficit............................................. (30,222)
--------
Total equity.................................................. 173,764
--------
Total liabilities and equity.................................. $193,355
========
The pro forma condensed consolidated balance sheet reflects adjustments of
approximately $108.7 million for the receipt of offering proceeds and issuance
of 8.0 million shares of common stock, $72.0 million for the retirement of all
outstanding debt, $16.2 million for the reinvestment of preferred stock
dividends into approximately 1.2 million shares of common stock, $1.0 million
for the reclassification of offering costs from other current assets to
equity, $0.1 million for the payment of preferred stock dividends and $0.1
million for the conversion of each share of preferred stock into two shares of
common stock.
The pro forma common shares issued and outstanding includes adjustments for
the issuance of common shares in connection with the initial public offering,
the conversion of each share of preferred stock into two shares of common
stock and the reinvestment of preferred stock dividends into shares of common
stock.
4. SEISMIC DATA AGREEMENT
PGS entered into a seismic data agreement with the Company dated December 20,
1996, whereby it agreed to transfer to the Company certain rights to 3-D seismic
data in consideration of equity. The seismic data agreement was amended
effective June 30, 1999. The amended agreement modified the amount, type and
geographic coverage of the data and related information made available to the
Company. In exchange for the amended rights under this seismic data agreement,
the Company issued to PGS an additional 1.0 million shares of common stock. This
transaction has been accounted for at PGS's cost of $2.9 million, pursuant to
Staff Accounting Bulletin No. 48.
8
SPINNAKER EXPLORATION COMPANY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
SEPTEMBER 30, 1999
5. ORGANIZATION COSTS
As of December 31, 1998, other assets included capitalized organization costs
incurred by the Company in its initial formation. The Company was amortizing the
start-up costs over a period of five years. On April 3, 1998, the AICPA issued
Statement of Position 98-5 ("SOP 98-5"), "Reporting on the Costs of Start-Up
Activities," which requires that costs for start-up activities and organization
costs be expensed as incurred and not capitalized as had previously been
allowed. SOP 98-5 was effective for financial statements for fiscal years
beginning after 1998. The Company adopted this policy in the first quarter of
1999 and recorded a charge related to this accounting change of $0.4 million in
conjunction with the write-off of previously capitalized organization costs.
6. SHORT-TERM DEBT
In September 1998, the Company entered into an $85.0 million credit agreement
("Credit Agreement") with certain financial institutions. Proceeds from
borrowings under the Credit Agreement were used to fund exploration and
development activities. The Credit Agreement was secured by the Company's
interests in natural gas and oil properties and by certain guarantees of PGS and
Warburg. The stockholder guarantees for the Credit Agreement were $75.0 million,
split evenly between PGS and Warburg. On a semi-annual basis, the Company's
proved reserves were required to be evaluated to re-determine the borrowing
base. If the borrowing base increased, the guarantees were permanently decreased
dollar for dollar. No borrowing base increases were made by the financial
institutions. If payments were made under a guarantee, the balance due to the
guarantors was immediately and automatically converted into equity of the
Company at a rate of $15 per share. In consideration for providing guarantees
under the Credit Agreement, PGS and Warburg were entitled to receive, from time
to time, common stock, with related issuances being accounted for at the fair
value of the guarantees provided. Such amounts were $0 for the three and nine
months ended September 30, 1998 and $0.3 million and $0.8 million for the three
and nine months ended September 30, 1999, respectively, and have been included
in interest expense in the accompanying Consolidated Statements of Operations.
The Credit Agreement contained certain covenants and restrictive provisions,
including limitations on the incurrence of additional debt or liens, the sales
of property, the declaration or payment of dividends and the repurchase or
redemption of capital stock and including the maintenance of certain financial
ratios. At September 30, 1999, the Company had outstanding borrowings under the
Credit Agreement of $72.0 million. Simultaneously with the completion of the
initial public offering, the Company retired all outstanding borrowings under
the Credit Agreement.
On October 29, 1999, the Company amended and restated the original Credit
Agreement. The $25.0 million Amended and Restated 364-Day Credit Agreement
("Amended and Restated Credit Agreement") among the Company, Bank of Montreal
and Credit Suisse First Boston matures on October 28, 2000. The terms and
provisions of the Amended and Restated Credit Agreement are similar to the
original Credit Agreement, except that the Amended and Restated Credit Agreement
is not guaranteed by PGS and Warburg.
7. STOCK APPRECIATION RIGHTS EXPENSE (BENEFIT)
The Company adopted the 1998 Stock Option Plan (the "Stock Option Plan") in
January 1998, which included stock appreciation rights provisions. Based on
management's estimate of the share values of the Company, stock appreciation
rights expense was $0.6 million and $1.7 million during the nine months ended
September 30, 1998 and 1999, respectively. The Stock Option Plan was amended and
restated in September 1999, eliminating the stock appreciation rights provisions
of the stock option agreements.
9
SPINNAKER EXPLORATION COMPANY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
SEPTEMBER 30, 1999
8. EARNINGS PER SHARE
Basic and diluted net loss per share is computed based on the following
information (in thousands, except per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1998 1999 1998 1999
------- -------- -------- --------
Numerator:
Net loss available to common stockholders........ $(2,549) $(2,453) $(7,931) $(12,436)
======= ======= ======= =======
Denominator:
Denominator for basic earnings per share -
Weighted average shares......................... 4,057 5,145 4,055 4,461
======= ======= ======= =======
Dilutive securities:
Stock options................................... -- -- -- --
Preferred stock................................. -- -- -- --
------- ------- ------- -------
Dilutive potential common shares................. -- -- -- --
------- ------- ------- -------
Denominator for diluted earnings per share -
Adjusted weighted average shares and assumed
conversions................................... 4,057 5,145 4,055 4,461
======= ======= ======= =======
Net loss per common share:
Basic:
Loss before cumulative effect of change in
accounting principle........................... $ (0.63) $ (0.48) $ (1.96) $ (2.70)
Cumulative effect of change in accounting
principle...................................... -- -- -- (0.09)
------- ------- ------- -------
Net loss per common share........................ $ (0.63) $ (0.48) $ (1.96) $ (2.79)
======= ======= ======= =======
Diluted:
Loss before cumulative effect of change in
accounting principle........................... $ (0.63) $ (0.48) $ (1.96) $ (2.70)
Cumulative effect of change in accounting
principle...................................... -- -- -- (0.09)
------- ------- ------- -------
Net loss per common share........................ $ (0.63) $ (0.48) $ (1.96) $ (2.79)
======= ======= ======= =======
9. HEDGING TRANSACTIONS
The Company currently sells most of its natural gas and oil production under
price sensitive or market price contracts. To reduce exposure to fluctuations in
natural gas and oil prices, the Company recently began to enter into hedging
arrangements. However, these contracts also limit the benefits the Company would
realize if prices increase. The Company has entered into the following collar
arrangements covering the period beginning October 1, 1999. One MMBtu
approximates one Mcf of gas.
10
SPINNAKER EXPLORATION COMPANY
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - CONTINUED
SEPTEMBER 30, 1999
Gas Collars Oil Collars
-------------------------------------------------- -------------------------------------------
Average Average Average Average Average Average
Daily NYMEX NYMEX Daily NYMEX NYMEX
Volume Floor Ceiling Volume Floor Ceiling
Time Period (MMBtu) Price/MMBtu Price/MMBtu (Bbl) Price/Bbl Price/Bbl
- ----------------------- ----------- --------------- -------------- ----------- ----------- ------------
Fourth Quarter 1999 25,000 $2.93 $3.14 500 $20.23 $22.26
First Quarter 2000 25,000 2.86 3.06 500 19.28 21.35
Second Quarter 2000 25,000 2.40 2.60 500 18.48 20.58
Third Quarter 2000 25,000 2.36 2.57 500 17.90 20.01
10. NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 established accounting and
reporting standards requiring that all derivative instruments be recorded in the
balance sheet as either an asset or liability measured at its fair value. The
SFAS requires that changes in a derivative's fair value be recognized currently
in earnings unless specific hedge accounting criteria are met. Accounting for
qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the income statement and requires a company to
formally document, designate and assess the effectiveness of transactions that
qualify for hedge accounting. SFAS No. 133 was originally effective for fiscal
years beginning after June 15, 1999; however, SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities-Deferral of the Effective Date of
FASB Statement No. 133-An Amendment of FASB Statement No. 133" extended
implementation to fiscal years beginning after June 15, 2000. Early adoption is
permitted. The Company does not expect the adoption of SFAS No. 133 to have a
material impact on the results of operations.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements and Assumptions
This Form 10-Q includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. All statements other than
statements of historical facts included in this Form 10-Q regarding the
Company's financial position, business strategy, natural gas and oil reserves,
budgets and plans and objectives of management for future operations are
forward-looking statements. Although the Company believes that the expectations
reflected in such forward-looking statements are reasonable, it can give no
assurance that such expectations will prove to have been correct. Important
factors that could cause actual results to differ materially from the Company's
expectations are that the Company's future operating results are difficult to
forecast because of its limited operating history, the 3-D seismic data and
other technologies cannot eliminate exploration risk, the ability to find
additional reserves could be materially impaired if PGS terminates the data
agreement or chooses not to acquire any further data, the Company's relatively
small number of offshore properties increases its exposure to production
problems, reserve estimate inaccuracies, the Company's Gulf of Mexico focus
subjects it to higher reserve replacement needs, the natural gas and oil
business involves many operating and financial risks, especially in the deep
waters of the Gulf of Mexico, and other factors discussed under the caption
"RISK FACTORS" in the Company's registration statement on Form S-1, as amended
(Registration No. 333-83093), initially filed with the Securities and Exchange
Commission on July 16, 1999. One or more of these matters could negatively
impact the Company's ability to implement successfully its business strategy.
GENERAL
Spinnaker Exploration Company is an independent energy company engaged in the
exploration, development and production of natural gas and oil in the U.S. Gulf
of Mexico. The Company's operating results depend substantially on the success
of its exploratory drilling program and the price of natural gas and oil.
Revenues, profitability and future growth rates also substantially depend on
factors beyond the Company's control, such as economic, political and regulatory
developments and competition from other sources of energy. The energy markets
historically have been very volatile, and natural gas and oil prices may
fluctuate widely in the future. Sustained periods of low prices for natural gas
and oil could materially and adversely affect the Company's financial position,
its results of operations, the quantities of natural gas and oil reserves that
it can economically produce and its access to capital.
RESULTS OF OPERATIONS
The following table sets forth certain operating information with respect to
the natural gas and oil operations of the Company:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------- -----------------------------------
1998 1999 1998 1999
--------------- --------------- -------------- ---------------
Production:
Natural gas (MMcf).................................. 336 3,190 817 7,447
Oil and condensate (MBbls).......................... .6 75 2 124
Total (MMcfe)...................................... 339 3,637 827 8,189
Revenues (in thousands):
Natural gas......................................... $ 596 $ 8,767 $ 1,543 $17,629
Oil and condensate.................................. 7 1,533 21 2,254
Total.............................................. $ 603 $10,300 $ 1,564 $19,883
Average sales price per unit:
Natural gas (per Mcf).............................. $ 1.78 $ 2.75 $ 1.89 $ 2.37
Oil and condensate (per Bbl)........................ 11.64 20.57 12.65 18.24
Total (per Mcfe)................................... $ 1.78 $ 2.83 $ 1.89 $ 2.43
Expenses (per Mcfe):
Lease operating expenses............................ $(0.20) $ 0.64 $ 0.32 $ 0.43
Depreciation, depletion and amortization - natural
gas and oil properties............................. 1.21 1.50 1.28 1.59
Income (loss) from operations (in thousands)......... $ (470) $ 1,321 $(3,487) $(1,891)
12
Three Months Ended September 30, 1999 Compared to the Three Months Ended
September 30, 1998
Production increased approximately 3.3 Bcfe during the third quarter of 1999
compared to the third quarter of 1998. The average daily production rate at the
end of September 1999 was approximately 55,000 Mcfe as compared to rates of
7,000 Mcfe at the end of September, 1998 and 34,000 Mcfe at the end of June,
1999.
Natural gas and oil revenues increased $9.7 million and income from operations
increased $1.8 million during the third quarter of 1999 compared to the third
quarter of 1998. Natural gas revenues increased $8.2 million and oil and
condensate revenues increased $1.5 million in the third quarter of 1999 compared
to the third quarter of 1998. Natural gas production volumes increased primarily
due to 7 wells which commenced production subsequent to September 30, 1998,
contributing to $7.4 million of the increase in natural gas revenues. Average
natural gas prices increased, contributing to $0.8 million of the increase in
natural gas revenues. Oil and condensate production volumes increased primarily
due to 8 wells which commenced production subsequent to September 30, 1998,
contributing to $1.5 million of the increase in oil and condensate revenues.
Lease operating expenses increased $2.4 million in the third quarter of 1999
compared to the third quarter of 1998. Of the total increase in lease operating
expenses, $2.0 million was attributable to 7 wells which commenced production
subsequent to September 30, 1998, including $1.1 million of workover expense,
primarily related to the Garden Banks #367 field (Dulcimer).
General and administrative expenses increased $0.2 million in the third
quarter of 1999 compared to the third quarter of 1998. The increase in general
and administrative expenses was primarily due to employment-related costs
associated with an increase in personnel subsequent to September 30, 1998. Stock
appreciation rights expense for the third quarter of 1999 was $0 compared to
income of $0.3 million for the third quarter of 1998. Stock appreciation rights
expense decreased due to a reduction in management's estimate of the share value
of the Company at September 30, 1998. During the third quarter of 1999, all
officers and employees agreed to eliminate the stock appreciation rights
provision of the stock option agreements, which resulted in no impact to the
consolidated financial statements.
DD&A increased $5.0 million in the third quarter of 1999 compared to the third
quarter of 1998. Of the total increase, $4.0 million was attributable to a
substantial increase in production and $1.0 million was due to an increase in
the unit depletion rate.
Interest expense, net of capitalized interest, increased $1.1 million in the
third quarter of 1999 compared to the third quarter of 1998 as a result of
borrowings under the Credit Agreement subsequent to September 30, 1998.
The Company recognized net income of $0.2 million for the third quarter ended
September 30, 1999 compared to a net loss of $0.4 million for the third quarter
ended September 30, 1998. After preferred dividends of $2.7 million, the Company
recognized a net loss available to common stockholders of $2.5 million, or $0.48
per share, for the quarter ended September 30, 1999. After preferred dividends
of $2.1 million, the Company recognized a net loss available to common
stockholders of $2.5 million, or $0.63 per share, for the third quarter in 1998.
Nine Months Ended September 30, 1999 Compared to the Nine Months Ended September
30, 1998
Production increased approximately 7.4 Bcfe during the first nine months of
1999 compared to the same period in 1998. Natural gas and oil revenues increased
$18.3 million and the loss from operations decreased $1.6 million during the
first nine months of 1999 compared to the same period in 1998. Natural gas
revenues increased $16.1 million and oil and condensate revenues increased $2.2
million during the first nine months of 1999 compared to the same period in
1998. Natural gas production volumes increased primarily due to 7 wells which
commenced production subsequent to September 30, 1998, contributing to $14.9
million of the increase in natural gas revenues. Average natural gas prices
increased, contributing to $1.2 million of the increase in natural gas revenues.
Oil and condensate production volumes increased primarily due to 8 wells which
commenced production subsequent to September 30, 1998, contributing to $2.2
million of the increase in oil and condensate revenues.
Lease operating expenses increased $3.3 million during the first nine months
of 1999 compared to the same period in 1998. Of the total increase in lease
operating expenses, $2.9 million was attributable to 7 wells which commenced
13
production subsequent to September 30, 1998, including $1.1 million of workover
expense, primarily related to the Garden Banks #367 field (Dulcimer).
General and administrative expenses increased $0.5 million during the first
nine months of 1999 compared to the same period in 1998. The increase in general
and administrative expenses was primarily due to employment-related costs
associated with an increase in personnel subsequent to September 30, 1998. Stock
appreciation rights expense for the first nine months of 1999 was $1.7 million
compared to $0.6 million for the same period in 1998. Stock appreciation rights
expense increased due to an increase in management's estimate of the share value
of the Company at June 30, 1999. During the third quarter of 1999, all officers
and employees agreed to eliminate the stock appreciation rights provision of the
stock option agreements.
DD&A increased $12.0 million during the first nine months of 1999 compared to
the same period in 1998. Of the total increase, $9.4 million was attributable to
a substantial increase in production and $2.6 million was due to an increase in
the unit depletion rate. Depreciation and amortization--other decreased during
the first nine months of 1999 compared to the same period in 1998 primarily due
to no amortization being recorded during 1999 as a result of the adoption of
Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities,"
which required the Company to expense and not capitalize the costs for start-up
activities and organization costs as incurred. Upon adoption of Statement of
Position 98-5 during the first quarter of 1999, the Company wrote-off
approximately $395,000 of the remaining unamortized organization costs, which is
reflected as a cumulative effect of change in accounting principle in the
Consolidated Statements of Operations.
Interest expense, net of capitalized interest, increased $2.5 million during
the first nine months of 1999 compared to the same period in 1998 as a result of
borrowings under the Credit Agreement subsequent to September 30, 1998.
The Company recognized a net loss of $4.6 million for the nine months ended
September 30, 1999 compared to a net loss of $3.3 million for the nine months
ended September 30, 1998. After preferred dividends of $7.8 million, the Company
recognized a net loss available to common stockholders of $12.4 million, or
$2.79 per share, for the nine months ended September 30, 1999. After preferred
dividends of $4.6 million, the Company recognized a net loss available to common
stockholders of $7.9 million, or $1.96 per share, for the nine months ended
September 30, 1998.
LIQUIDITY AND CAPITAL RESOURCES
Through September 30, 1999, the Company has funded its activities primarily
with the proceeds from private placements of its equity securities and
borrowings under the Credit Agreement. The Company has experienced and expects
to continue to experience substantial working capital requirements, primarily
due to its active exploration and development programs. While the Company
believes that the net proceeds from the initial public offering, cash flow from
operations and borrowings under the Amended and Restated Credit Agreement should
allow the Company to implement its present business strategy during 1999 and
2000, additional financing may be required in the future to fund its growth and
exploration and development programs. In the event these capital resources are
not available to the Company, the Company may have to curtail exploration and
other activities or sell some of its assets on an untimely or unfavorable basis.
Cash and cash equivalents increased $1.2 million from $2.2 million at December
31, 1998 to $3.4 million at September 30, 1999. The increase resulted from $15.4
million provided by operating activities and $53.0 million provided by financing
activities, offset in part by $67.2 million used in investing activities.
OPERATING ACTIVITIES
The Company intends to use cash flows from operations to fund a portion of its
future acquisition, exploration and development activities. Net cash of $15.4
million provided by operating activities included $10.6 million provided by
operations and $4.8 provided by working capital and other activities.
Cash flow from operations will depend on the prices of natural gas and oil and
on the Company's ability to increase production through its exploration and
development drilling program. The Company currently sells most of its natural
gas and oil production under price sensitive or market price contracts. To
reduce exposure to fluctuations in natural gas and oil prices, the Company
recently began to enter into hedging arrangements. However, these contracts
14
also limit the benefits the Company would realize if prices increase. The
Company has entered into the following collar arrangements covering the period
beginning October 1, 1999. One MMBtu approximates one Mcf of gas.
Gas Collars Oil Collars
--------------------------------------------------- -------------------------------------------
Average Average Average Average Average Average
Daily NYMEX NYMEX Daily NYMEX NYMEX
Volume Floor Ceiling Volume Floor Ceiling
Time Period (MMBtu) Price/MMBtu Price/MMBtu (Bbl) Price/Bbl Price/Bbl
- --------------------- ------------ --------------- --------------- ---------- ------------ ------------
Fourth Quarter 1999 25,000 $2.93 $3.14 500 $20.23 $22.26
First Quarter 2000 25,000 2.86 3.06 500 19.28 21.35
Second Quarter 2000 25,000 2.40 2.60 500 18.48 20.58
Third Quarter 2000 25,000 2.36 2.57 500 17.90 20.01
The average daily production rate at the end of September 1999 was
approximately 55,000 Mcfe as compared to rates of 7,000 Mcfe at the end of
September, 1998 and 34,000 Mcfe at the end of June, 1999.
The increase in Accounts Receivable was primarily due to a $3.2 million
increase in accrued oil and gas revenues. The increase in Other was primarily
due to increased drilling advances of $0.9 million and increased deposits for
offshore lease sales of $0.9 million as compared to balances at December 31,
1998.
INVESTING ACTIVITIES
Net cash of $67.2 million used in investing activities during the first nine
months of 1999 included net oil and gas property capital expenditures of $66.4
million and purchases of furniture and fixtures of $0.8 million.
The 1999 - 2000 budget includes development costs that are contingent on the
success of future exploratory drilling. The Company does not anticipate that
budgeted leasehold acquisition activities will include the acquisition of
producing properties. The Company does not anticipate any significant
abandonment or dismantlement costs through 2000. The Company has capital
expenditure plans totaling approximately $28 million during the remainder of
1999, primarily for exploratory drilling costs. Actual levels of capital
expenditures may vary significantly due to many factors, including drilling
results, natural gas and oil prices, industry conditions, decisions of operators
and other industry owners and the prices of oilfield goods and services. The
Company plans to fund the 1999 capital expenditures and a portion of 2000
capital expenditures through net proceeds from the offering and cash flows from
operations. The Company expects to use cash generated from operations to fund
the remaining portion of 2000 exploration and development activities not funded
from the proceeds of the initial public offering.
FINANCING ACTIVITIES
Net cash of $53.0 million was provided from borrowings under the Credit
Agreement during the first nine months of 1999. In September 1998, the Company
entered into the $85.0 million Credit Agreement with Credit Suisse First Boston,
New York Branch, Bank of Montreal and Bank of America, N.A. (formerly
NationsBank, N.A.). Simultaneously with the completion of the initial public
offering, the Company retired all outstanding borrowings under the Credit
Agreement, which were $72.0 million as of October 4, 1999.
On October 29, 1999, the Company amended and restated the original Credit
Agreement. The $25.0 million Amended and Restated 364-Day Credit Agreement among
the Company, Bank of Montreal and Credit Suisse First Boston matures on October
28, 2000. The Company may borrow only up to the borrowing base, which is $16.0
million as of October 29, 1999. On a semi-annual basis, the Company's proved
reserves are required to be evaluated to re-determine the borrowing base. The
Amended and Restated Credit Agreement contains covenants and restrictive
provisions, including the following limitations, subject to some exceptions,
where the Company:
. may not incur any other indebtedness from borrowings, except for indebtedness
of up to $1 million and indebtedness owed to guarantors of the Amended and
Restated Credit Agreement;
. may not incur any liens upon properties or assets other than permitted liens
securing indebtedness of up to $1 million, pledges or deposits to secure
hedging agreements up to $5 million and other liens in the ordinary course of
business;
. may not enter into any amalgamation or merger unless it is the survivor and
no default exists;
15
. may not dispose of all or substantially all property, business or assets;
. may not dispose of any properties valued in the borrowing base except
obsolete equipment, inventory sold in the ordinary course of business, some
interests in natural gas and oil properties included in the borrowing base in
an aggregate amount not to exceed $500,000 between the borrowing base
determination and non-proved reserves;
. may not make or pay any dividend, distribution or payment in respect of
capital stock nor purchase, redeem, retire, or permit any reduction or
retirement of capital stock, except for certain exceptions on the Series A
Convertible Preferred Stock;
. must maintain the ratio of consolidated current assets as of the end of each
fiscal quarter to consolidated current liabilities other than debt under the
Amended and Restated Credit Agreement as of the end of such fiscal quarter so
that it is not less than 1.00 to 1.00;
. may not enter into any hedging agreement unless the Company meets specified
requirements including limits on the aggregate amounts maturing in any month
under any floor hedging contracts and under any forward sales transactions.
YEAR 2000 COMPLIANCE
The "Year 2000" issue is a general term used to refer to the business
implications of the arrival of the new millennium. In simple terms, on January
1, 2000, all computer hardware and software systems that use the two-digit year
convention could fail completely or create erroneous data as a result of the
system failing to recognize the two digit internal date "00" as representing
the Year 2000.
State of Readiness
The Company was formed recently and is engaged solely in the exploration,
development and production of natural gas and oil. The Company's computer
hardware and software systems were recently acquired. Based upon the Company's
analysis, evaluations and written communications from vendors and licensors of
financial and seismic interpretation software, it does not believe that any
equipment or programming modifications are necessary and that these systems are
or are expected to be Year 2000 compliant. Additionally, the Company has
assessed other less critical information technology systems and believes they
are compliant. The Company does not believe that the risks of system malfunction
resulting from the interrelationship of its systems with those of customers,
suppliers and contractors are significant. The Year 2000 issue affects
customers, the suppliers of 3-D seismic data and other third parties with whom
the Company does business. The Company has investigated how the Year 2000 issue
will affect computer systems controlling pipelines and distribution facilities
with which it directly or indirectly connect and the availability of 3-D seismic
data. The Company either has received or is in the process of receiving written
documentation from these third parties regarding their Year 2000 readiness and
issues. The Company has also reviewed publicly available information, if any, as
to whether their systems are Year 2000 compliant. The Company completed its Year
2000 assessments prior to September 30, 1999; however, it plans to continue
reviewing the Year 2000 issue on an on-going basis throughout 1999.
Costs to Address Year 2000 Issues
Costs directly related to assessing Year 2000 issues through September 30,
1999 are less than $100,000 and have been expensed. The Company does not expect
to incur significant additional costs related to Year 2000 compliance during the
remainder of 1999. These estimated costs are based on management's best
estimates; however, there is no guarantee that these estimates will be achieved,
and actual results could differ materially from those anticipated.
Year 2000 Risk Factors
The Company cannot provide assurance that its internal operations do not have
any material issues with respect to Year 2000 compliance. In addition, the
Company may not properly identify all potential problems or all potentially
affected systems or remedy all problems in its systems. The Company has no means
of ensuring that third parties will be Year 2000 ready. The inability of third
parties to complete their Year 2000 resolution process in a timely fashion could
materially impact the Company's results of operations and cash flows. The effect
of non-compliance by third parties is not determinable. The most reasonably
likely "worst case" impacts would be: impairment of the Company's ability to
deliver production to, or receive payment from, third parties gathering and/or
purchasing its production from affected facilities; impairment of the ability of
third-party suppliers or service companies to provide needed materials
16
or services to the Company's planned or ongoing operations, necessitating
deferral or shut-in of exploration, development or production operations;
impairment of the Company's ability to receive and process 3-D seismic data,
which would hinder its ability to generate and drill exploratory prospects; and
the Company's inability to execute financial transactions with banks or other
third parties whose systems fail or malfunction.
Contingency Plans
The Company has investigated alternatives to computer hardware and software
and has determined that no commercially reasonable alternatives exist.
Therefore, the Company has been unable to develop a contingency plan other than
working with computer hardware and software vendors to remedy any Year 2000-
related problems as quickly as possible.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
The Company is exposed to changes in interest rates. Changes in interest rates
affect the interest earned on the Company's cash and cash equivalents and the
interest rate paid on borrowings under the Credit Agreement. Under its current
policies, the Company does not use interest rate derivative instruments to
manage exposure to interest rate changes.
Commodity Price Risk
The Company's revenues, profitability and future growth depend substantially
on prevailing prices for natural gas and oil. Prices also affect the amount of
cash flow available for capital expenditures and the Company's ability to borrow
and raise additional capital. The amount the Company can borrow under its credit
facility is subject to periodic re-determination based in part on changing
expectations of future prices. Lower prices may also reduce the amount of
natural gas and oil that the Company can economically produce. The Company
currently sells most of its natural gas and oil production under price sensitive
or market price contracts. To reduce exposure to fluctuations in natural gas and
oil prices, the Company recently began to enter into hedging arrangements.
17
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
During the three months ended September 30, 1999, the Company issued 12,500
shares of common stock to PGS and 12,500 shares of common stock to Warburg in
consideration for providing guarantees under the original Credit Agreement for
the third quarter of 1999. These transactions were accounted for at the fair
value of the guarantees provided, or $0.3 million, and were made in reliance on
an exemption from registration under Section 4(2) of the Securities Act of 1933,
as amended, as transactions by the issuer not involving a public offering.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.4.1 Amended and Restated 364-Day Credit Agreement dated as of October
29, 1999 among Spinnaker Exploration Company, L.L.C., as borrower
and certain financial institutions, as lenders, Bank of Montreal,
as administrative agent and Credit Suisse First Boston, as
documentation agent.
27 Financial Data Schedule.
(b) Reports on Form 8-K
None.
18
SIGNATURES
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.
SPINNAKER EXPLORATION COMPANY
Date: November 12, 1999 By: /s/ JAMES M. ALEXANDER
---------------------- -----------------------------------
James M. Alexander
Vice President, Chief Financial
Officer and Secretary
Date: November 12, 1999 By: /s/ JEFFREY C. ZARUBA
---------------------- -----------------------------------
Jeffrey C. Zaruba
Treasurer
19
EXHIBIT INDEX
EXHIBIT
NUMBER Description
------ -----------
10.4.1 Amended and Restated 364-Day Credit Agreement dated as of October
29, 1999 among Spinnaker Exploration Company, L.L.C., as borrower
and certain financial institutions, as lenders, Bank of Montreal,
as administrative agent and Credit Suisse First Boston, as
documentation agent.
27 Financial Data Schedule.
20