- --------------------------------------------------------------------------------
UNITED STATES
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 MARCH 31, 2001
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM __________ TO __________
COMMISSION FILE NUMBER 1-11566
MARKWEST HYDROCARBON, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 84-1352233
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
155 INVERNESS DRIVE WEST, SUITE 200, ENGLEWOOD, CO 80112-5000
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: 303-290-8700
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
------- --------
The registrant had 8,569,322 shares of common stock, $.01 per share par value,
outstanding as of March 31, 2001.
- --------------------------------------------------------------------------------
Page
------------
PART I--FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Balance Sheet at March 31, 2001 and December 31, 2000 ........................... 1
Consolidated Statement of Operations for the Three Months Ended March 31, 2001
and 2000 ................................................................................. 2
Consolidated Statement of Cash Flows for the Three Months Ended March
31, 2001 and 2000 ........................................................................ 3
Consolidated Statement of Changes in Stockholders' Equity for the Three Months Ended
March 31, 2001 and 2000 .................................................................. 4
Notes to the Consolidated Financial Statements ............................................... 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations ...................................................................... 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk ..................................... 12
PART II--OTHER INFORMATION
Item 1. Legal Proceedings .............................................................................. 12
Item 6. Exhibits and Reports on Form 8-K ............................................................... 12
SIGNATURE ............................................................................................... 13
- --------------------------------------------------------------------------------
GLOSSARY OF TERMS
Bbls barrels
Bcf billion cubic feet of natural gas
Btu British thermal units, an energy measurement
EBITDA earnings before gain on sale, interest income, interest expense, income
taxes, depreciation, depletion and amortization; a cash flow financial
measure commonly used in the oil and gas industry
MM million
Mcf thousand cubic feet of natural gas
Mcfd thousand cubic feet of natural gas per day
Mcfe thousand cubic feet of natural gas equivalent
MMBtu million British thermal units, an energy measurement
MMcf million cubic feet of natural gas
MMcfd million cubic feet of natural gas per day
NGL natural gas liquids, such as propane, butanes and natural gasoline
One barrel of oil or NGL is the energy equivalent of six Mcf of natural gas.
- --------------------------------------------------------------------------------
PART I--FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
MARKWEST HYDROCARBON, INC.
CONSOLIDATED BALANCE SHEET
(000s, EXCEPT SHARE DATA)
March 31,
ASSETS 2001 December 31,
(Unaudited) 2000
------------ ------------
Current assets:
Cash and cash equivalents .................................................. $ 2,529 $ 934
Receivables ................................................................ 26,569 36,695
Inventories ................................................................ 3,313 8,058
Prepaid feedstock .......................................................... 357 --
Other assets ............................................................... 935 913
------------ ------------
Total current assets .................................................. 33,703 46,600
Property and equipment:
Gas processing, gathering, storage and marketing equipment ................. 98,776 97,311
Oil and gas properties and equipment ....................................... 21,715 18,037
Land, buildings and other equipment ........................................ 6,518 6,463
Construction in progress ................................................... 10,559 6,241
------------ ------------
137,568 128,052
Less: accumulated depreciation, depletion and amortization ................. (29,450) (27,833)
------------ ------------
Total property and equipment, net ..................................... 108,118 100,219
Intangible assets, net of accumulated amortization of
$816 and $708, respectively ................................................ 361 468
------------ ------------
Total assets .......................................................... $ 142,182 $ 147,287
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ........................................................... $ 14,483 $ 17,713
Accrued liabilities ........................................................ 8,862 13,740
Liabilities from risk management activities ................................ 1,124 --
------------ ------------
Total current liabilities ............................................. 24,469 31,453
Deferred income taxes .......................................................... 11,134 11,240
Liabilities from risk management activities .................................... 347 --
Long-term debt ................................................................. 44,000 43,000
Commitments and contingencies (see Note 4) ..................................... -- --
Stockholders' equity:
Preferred stock, par value $0.01, 5,000,000 shares authorized, 0 shares
outstanding .............................................................. -- --
Common stock, par value $0.01, 20,000,000 shares authorized, 8,563,919 and
8,561,206 shares issued, respectively .................................... 87 86
Additional paid-in capital ................................................. 42,537 42,471
Retained earnings .......................................................... 21,128 19,679
Accumulated other comprehensive income (loss) .............................. (949) --
Treasury stock, 92,850 and 104,093 shares, respectively .................... (571) (642)
------------ ------------
Total stockholders' equity ............................................ 62,232 61,594
------------ ------------
Total liabilities and stockholders' equity ............................ $ 142,182 $ 147,287
============ ============
The accompanying notes are an integral part of these financial statements.
1
MARKWEST HYDROCARBON, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
(000s, EXCEPT PER SHARE DATA)
For the three months ended
March 31,
----------------------------
2001 2000
------------ ------------
Revenue:
Gathering, processing and marketing .......................... $ 85,517 $ 44,695
Exploration and production ................................... 2,699 749
------------ ------------
Total revenue .......................................... 88,216 45,444
------------ ------------
Operating expenses:
Cost of sales ................................................ 75,845 32,330
Operating expenses ........................................... 5,017 3,806
General and administrative expenses .......................... 2,425 1,839
Depreciation, depletion and amortization ..................... 1,725 1,435
------------ ------------
Total operating expenses ............................... 85,012 39,410
------------ ------------
Income from operations ................................. 3,204 6,034
------------ ------------
Other income and expense:
Interest income .............................................. 24 23
Interest expense ............................................. 721 747
Other income (expense) ....................................... (133) 26
------------ ------------
Income before income taxes ............................. 2,374 5,336
------------ ------------
Provision for income taxes:
Current ..................................................... 509 1,145
Deferred .................................................... 416 936
------------ ------------
Provision for income taxes ............................. 925 2,081
------------ ------------
Net income ............................................. $ 1,449 $ 3,255
============ ============
Basic earnings per share of common stock ........................ $ 0.17 $ 0.39
============ ============
Earnings per share assuming dilution ............................ $ 0.17 $ 0.38
============ ============
Weighted average number of outstanding shares of common stock:
Basic ........................................................ 8,470 8,452
============ ============
Assuming dilution ............................................ 8,512 8,467
============ ============
The accompanying notes are an integral part of these financial statements.
2
MARKWEST HYDROCARBON, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(000s)
For the three months
ended March 31,
----------------------------
2001 2000
------------ ------------
Cash flows from operating activities:
Net income ........................................................... $ 1,449 $ 3,255
Add income items that do not affect working capital:
Depreciation, depletion and amortization .......................... 1,725 1,435
Deferred income taxes ............................................. 416 936
Gain on sale of assets ............................................ 9 (128)
------------ ------------
3,599 5,498
Adjustments to working capital:
(Increase) decrease in receivables ............................... 10,126 3,303
(Increase) decrease in inventories ............................... 4,745 2,292
(Increase) decrease in prepaid expenses and other assets ......... (379) (157)
Increase (decrease) in accounts payable and accrued liabilities .. (8,108) 5,966
------------ ------------
6,384 11,404
Net cash flow provided by operating activities ................... 9,983 16,902
Cash flows from investing activities:
Capital expenditures ............................................. (9,526) (6,560)
Proceeds from sale of assets ..................................... -- 5,085
------------ ------------
Net cash used in investing activities ............................ (9,526) (1,475)
Cash flows from financing activities:
Proceeds from long-term debt ..................................... 23,000 5,500
Repayments of long-term debt ..................................... (22,000) (19,590)
Exercise of stock options ........................................ 18 --
Acquisition of treasury stock .................................... -- (176)
Reissuance of treasury stock ..................................... 120 105
------------ ------------
Net cash provided by financing activities ........................ 1,138 (14,161)
------------ ------------
Net increase in cash and cash equivalents ........................ 1,595 1,266
Cash and cash equivalents at beginning of period .......................... 934 1,356
------------ ------------
Cash and cash equivalents at end of period ................................ $ 2,529 $ 2,622
============ ============
The accompanying notes are an integral part of these financial statements.
3
MARKWEST HYDROCARBON, INC.
CONSOLIDATED STATEMENT OF CHANGES IN
STOCKHOLDERS' EQUITY
(000s)
ACCUMULATED
SHARES OF SHARES OF ADDITIONAL OTHER TOTAL
COMMON TREASURY COMMON PAID-IN RETAINED TREASURY COMPREHENSIVE STOCKHOLDERS'
STOCK STOCK STOCK CAPITAL EARNINGS STOCK INCOME EQUITY
--------- --------- ------ ---------- -------- -------- ------------- -------------
Balance, December 31, 2000 ...... 8,561 (104) $ 86 $ 42,471 $ 19,679 $ (642) $ 0 $ 61,594
Transition adjustment ........... -- -- -- -- -- -- (1,230) (1,230)
Net income ...................... -- -- -- -- 1,449 -- -- 1,449
Risk management activities ...... -- -- -- -- -- -- 281 281
-------------
Comprehensive income ............ $ 1,730
=============
Exercise of options ............. 3 -- 1 17 -- -- -- 18
Reissuance of treasury stock .... -- 11 -- 49 -- 71 -- 120
--------- --------- ------ ---------- -------- -------- ------------- -------------
Balance, March 31, 2001 ......... 8,564 (93) $ 87 $ 42,537 $ 21,128 $ (571) $ (949) $ 62,232
========= ========= ====== ========== ======== ======== ============= =============
The accompanying notes are an integral part of these financial statements.
4
NOTE 1. GENERAL
The consolidated financial statements include the accounts of MarkWest
Hydrocarbon, Inc. ("MarkWest"), and its wholly owned subsidiaries:
o MarkWest Resources, Inc.
o MarkWest Michigan, Inc.
o Basin Pipeline, LLC
o West Shore Processing Company, LLC
o Matrex, LLC
Through consolidation, we have eliminated all significant intercompany accounts
and transactions.
We have prepared the unaudited financial statements presented herein in
accordance with the instructions to Form 10-Q. The statements do not include all
the information and note disclosures required by generally accepted accounting
principles for complete financial statements. Please read the interim
consolidated financial statements in conjunction with the Consolidated Financial
Statements and attached notes for the year ended December 31, 2000, included in
the Company's Annual Report on Form 10-K, as filed with the Securities and
Exchange Commission. In the opinion of management, we have made all necessary
adjustments for a fair statement of the results for the unaudited interim
periods. These are only normal recurring adjustments.
We base the effective corporate tax rate for interim periods on the estimated
annual effective corporate tax rate, excluding certain nonrecurring or unusual
events. The effective tax rate varies from statutory rates primarily due to tax
credits.
We have reclassified certain prior-year amounts to conform to the current year's
presentation.
NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES. This statement, as amended by SFAS Nos. 137
and 138, is effective for fiscal years beginning after June 15, 2000. SFAS No.
133 requires an entity to recognize all derivatives as assets or liabilities in
the balance sheet and measure those instruments at fair value. MarkWest has
adopted SFAS No. 133, as amended, on January 1, 2001. See Note 5 Adoption of
SFAS No. 133.
NOTE 3. SEGMENT REPORTING
We classify MarkWest's operations into two reportable segments, as follows:
(1) Gathering, Processing and Marketing--provide compression, gathering,
treatment, NGL extraction and fractionation services; also purchase and
market natural gas and NGLs; and
(2) Exploration and Production--explore for and produce natural gas.
We evaluate the performance of our segments and allocate resources to them based
on operating income. There are no intersegment revenues. We conduct our business
solely in the United States.
5
The table below presents information about operating income for the reported
segments for the first quarter of 2001 and 2000. Operating income for each
segment includes total revenues less operating expenses and excludes
depreciation, depletion and amortization, general and administrative expenses,
interest expense, interest income and income taxes. We have not reported asset
information by reportable segment, since we do not produce such information
internally.
Gathering,
Processing and Exploration and
Marketing Production Total
(000s) (000s) (000s)
------------------- --------------------- -------------------
FOR THE QUARTER ENDED MARCH 31, 2001:
Revenues................................... $ 85,517 $ 2,699 $ 88,216
Segment operating income................... $ 5,365 $ 1,989 $ 7,354
FOR THE QUARTER ENDED MARCH 31, 2000:
Revenues................................... $ 44,695 $ 749 $ 45,444
Segment operating income................... $ 8,995 $ 313 $ 9,308
Following is a reconciliation of total segment operating income to total
consolidated income before taxes (000s):
For the quarter ended
March 31,
----------------------------
2001 2000
------------ ------------
Total segment operating income .............. $ 7,354 $ 9,308
General and administrative expenses ......... (2,425) (1,839)
Depreciation and amortization ............... (1,725) (1,435)
Interest income ............................. 24 23
Interest expense ............................ (721) (747)
Other income (expense) ...................... (133) 26
------------ ------------
Income before taxes ............... $ 2,374 $ 5,336
============ ============
NOTE 4. CONTINGENCY
In February 2001, three complaints were filed against MarkWest Hydrocarbon,
Inc., in the Circuit Court of Wayne County, West Virginia, by Columbia Gas
Transmission Corporation and Columbia Natural Resources, Inc.; Equitable
Production Company and Equitable Energy LLC; and Cobra Petroleum Company et al.
These complaints each allege breach of contract and seek various forms of relief
(including injunctive relief) and damages. The parties have agreed to a
temporary standstill to the litigation and are currently negotiating a
resolution to this dispute. As of April 24, 2001, any litigant, including
MarkWest, can opt out of the standstill agreement. There can be no assurance
that these negotiations will be successful or that the outcome of the litigation
or the settlement discussions will be favorable to MarkWest. Losses, if any,
with regard to these complaints are undeterminable.
NOTE 5. ADOPTION OF SFAS NO. 133
MarkWest adopted SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING
ACTIVITIES, as amended, on January 1, 2001. In accordance with the transition
provisions of SFAS 133, we recorded on that date a net-of-tax cumulative effect
adjustment of approximately $1.2 million loss to other comprehensive income to
recognize at fair value all derivatives that are designated as cash-flow hedging
instruments.
SFAS 133 establishes accounting and reporting standards requiring derivative
instruments to be recorded in the balance sheet as either an asset or liability
measured at fair value. Changes in the derivative instruments' fair value are
recognized in earnings unless specific hedge accounting criteria are met.
SFAS 133 allows hedge accounting for fair-value and cash-flow hedges. A
fair-value hedge applies to a recognized asset or liability or an unrecognized
firm commitment. A cash-flow hedge applies to a forecasted transaction or a
variable cash flow of a recognized asset or liability. SFAS 133 provides that
the gain or loss on a derivative instrument designated and qualifying as a
fair-value hedging instrument as well as the offsetting loss or gain on the
hedged item be recognized currently in earnings in the same accounting period.
SFAS 133 provides that the effective portion of the gain or loss on a derivative
instrument designated and qualifying as a cash-flow hedging instrument be
reported as a component of other comprehensive income and be reclassified into
earnings in the same period during which the hedged forecasted transaction
affects earnings. (The remaining gain or loss on the derivative instrument, if
any, must be recognized currently in earnings.) Effectiveness is evaluated by
the derivative instrument's ability to generate offsetting changes in fair value
or cash flows to the hedged item. MarkWest expects
6
our hedging activities will generally qualify as cash-flow hedges. We formally
document, designate and assess the effectiveness of transactions receiving hedge
accounting treatment.
In our gathering, processing and marketing segment, we enter into fixed-price
contracts for the sale of NGLs and fixed-price purchases for the purchase of
natural gas, the difference in value being the "processing margin." At January
1, 2001, we recorded a derivative asset of approximately $2.1 million in the
balance sheet with an offsetting amount recorded, less a deferred tax liability
of approximately $0.7 million, in other comprehensive income-- approximately
$1.3 million gain. At March 31, 2001, the derivative asset was $0.2 million,
less $0.1 million deferred tax liability, resulting in a $0.1 million gain in
other comprehensive income.
In our exploration and production segment, MarkWest enters into fixed-price
contracts for the sale of natural gas. At January 1, 2001, we recorded a
derivative liability of approximately $3.9 million in the balance sheet with an
offsetting amount recorded, less a deferred tax recovery of approximately $1.4
million, in other comprehensive income--approximately $2.5 million loss. At
March 31, 2001, the derivative liability was $1.6 million, less $0.6 million
deferred tax liability, resulting in a $1.0 million loss in other comprehensive
income.
Together, at January 1, 2001, these amounts comprise the above net-of-tax
cumulative effect adjustment of approximately $1.2 million loss to other
comprehensive income. At March 31, 2001, with all transactions considered, there
is a $0.9 million loss to accumulated comprehensive income. Other comprehensive
income for the quarter ended March 31, 2001 is a gain of $0.3 million.
Following is the financial statement impact of recording the various SFAS 133
transactions (in millions):
January 1, Quarterly March 31,
Financial Statement Account 2001 Activity 2001
- --------------------------------------------------------------- ------------- ------------- -------------
Current liabilities from risk management activities $ 1.2 $ (0.1) $ 1.1
Long term liabilities from risk management activities $ 0.7 $ (0.4) $ 0.3
Deferred taxes $ (0.7) $ 0.2 $ (0.5)
Other comprehensive income $ -- $ 0.3 --
Accumulated comprehensive income (loss) $ (1.2) -- $ (0.9)
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Management's Discussion and Analysis contains statements which, to the
extent that they are not recitations of historical fact, constitute
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933 ("Section 27A") and Section 21E of the Securities and Exchange Act
of 1934 as amended ("Section 21E"). This includes, among other things,
statements with respect to the outcome of the pending litigation matters and
contract negotiations. All forward-looking statements involve risks and
uncertainties. We intend that all forward-looking statements in this document
are subject to the safe harbor protection provided by Sections 27A and 21E.
Factors that most typically impact MarkWest's operating results and financial
condition include:
o changes in general economic conditions in regions where our products are
located
o the availability and prices of NGL and competing commodities
o the availability and prices of raw natural gas supply
o our ability to negotiate favorable marketing agreements
o the risks that third party or MarkWest's natural gas exploration and
production activities will not occur or be successful
o our dependence on certain significant customers, producers, gatherers,
treaters and transporters of natural gas
o competition from other NGL processors, including major energy companies
o our ability to identify and consummate grass-roots projects or acquisitions
complementary to our business
o winter weather conditions
o intermediate or final decisions in the pending litigation and the relative
positions of the parties in the negotiation of new processing agreements
Forward-looking statements involve many uncertainties that are beyond our
ability to control. In many cases, we cannot predict what factors would cause
actual results to differ materially from those indicated by the forward-looking
statements.
THREE MONTHS ENDED MARCH 31, 2001, COMPARED TO THE THREE MONTHS ENDED MARCH 31,
2000
(IN 000s)
OVERVIEW
For the quarter ended March 31, 2001, we report net income of nearly $1.5
million, or $0.17 per share, compared to net income of $3.3 million or $0.39 per
share, for the same quarter last year. Earnings before interest, taxes and
depreciation, depletion and amortization ("EBITDA") were $4.8 million for the
first quarter this year, compared to $7.5 million reported the first quarter
last year.
Earnings in the gathering, processing and marketing segment were negatively
impacted this quarter by lower gas processing margins and losses at our propane
terminals. The price of NGLs rapidly declined in the first quarter causing
unfavorable adjustments to the value of the inventory at the terminals. These
were partially mitigated by the 23 percent increase in sales gallons at the
Siloam fractionator. Conversely, the exploration and production segment
benefited this quarter by the higher natural gas prices and higher volumes.
OPERATING DATA
Three Months Ended March 31,
---------------------------
2001 2000 % Change
------------ ------------ ------------
GATHERING, PROCESSING AND MARKETING
Appalachia:
NGL production--Siloam plant (gallons) ..... 39,300,000 33,300,000 18%
NGL sales--Siloam plant (gallons) .......... 45,300,000 36,900,000 23%
Michigan:
Pipeline throughput (Mcfd) ................. 8,200 13,400 (39%)
NGL sales (gallons) ........................ 1,900,000 2,800,000 (32%)
EXPLORATION AND PRODUCTION:
Natural gas produced (Mcfd) ................ 6,600 3,300 100%
GATHERING, PROCESSING AND MARKETING (GPM)
We are paid for our processing in Appalachia through sales of liquids extracted
and fees for units of throughput. A large portion, about 75 percent, of our
processing services for gas producers in Appalachia involves extracting NGLs
from inlet gas streams and replacing the equivalent heat content with dry
natural gas purchased in the spot or
8
forward market. Consequently, this segment of our business depends on a positive
spread between the NGL prices and the cost of the replacement natural gas.
The current economic situation is that the current and futures prices for
natural gas have risen dramatically relative to the prices for the natural gas
liquids such as propane and butane. We are currently negotiating with our
producers to modify our existing contracts. See also Part II, Item 1 Legal
Proceedings.
This is not an isolated situation with MarkWest. Nationwide, producers and gas
processors are renegotiating their processing agreements to assure the continued
processing of producer's natural gas while also providing producers the capacity
necessary to support their increasing production demands.
The operating income for the GPM segment of MarkWest was $5.4 million this
quarter compared to almost $9.0 million last year for the same quarter.
The unfavorable spread between the price of the NGLs versus the cost of the
natural gas negatively impacted our first quarter gross margin in Appalachia.
However, NGL sales volumes were 45.3 million gallons at our Siloam fractionator
versus 36.9 million gallons for the same period last year. This additional
volume contributed favorably to our first quarter 2001 gross margin.
During this past quarter, we enjoyed a full contribution of the Maytown
processing plant while in the prior quarter we only had one month's operations.
Phase II expansion continues with the expansion of our Kenova facility. This is
expected to startup early in the third quarter, but the third-party field
compression expansion program is currently running several months behind
schedule.
As mentioned earlier, the write down of inventory values at the Appalachia
propane terminals due to the dramatic decline in the prices of NGLs during the
quarter, as well as, a lower margin on sales this quarter, negatively impacted
gross margins this year as compared to last year, same quarter.
In Western Michigan, our volumes were down 39 percent during the first quarter
this year as compared to the same period last year. The throughput volumes were
13,400 Mcfd last year as compared to 8,200 Mcfd this year. The decrease in
volume was at least, in part, offset by higher prices. Litigation surrounding
another third party well is nearly settled, which is expected to allow for
connection to MarkWest's system during the second quarter this year. Another
large producer well is anticipated to be on stream during the fourth quarter
this year.
EXPLORATION AND PRODUCTION (E & P)
The operating income for the E&P segment of MarkWest was favorably impacted by
the unprecedented high natural gas prices, an acquisition, a new project in
eastern Michigan and 2000's capital program. The operating income was $2.0
million for the first quarter this year as compared to $0.3 million for the same
quarter last year.
Natural gas sold during the first quarter this year doubled from the same
quarter last year. This year, the volume was 6,600 Mcfd as compared to 3,300
Mcfd in the first quarter of 2000.
The acquisition of the Kutz field in the San Juan Basin of New Mexico that
finalized early this year, a new recompletion well in Eastern Michigan, and the
infill well drilling and recompletion program initiated last year in the San
Juan Basin of Colorado all contributed to the additional volumes this past
quarter.
REVENUE AND EXPENSES
REVENUES
Revenues nearly doubled from first quarter last year to first quarter this year.
Both price and volume increases contributed to this growth. Additionally,
several of the expansions and acquisitions from early 2000 are effecting first
quarter 2001 for all three months as opposed to only partial or no effect on
first quarter 2000.
Gas marketing revenues increased by $24.7 million. These activities are low
margin and are done in support of our processing business.
In Western Michigan, our volumes were down 39 percent during the first quarter
this year as compared to the same period last year. The throughput volumes were
13,400 Mcfd last year as compared to 8,200 Mcfd this year. The decrease in
volume was at least, in part, offset by higher prices.
9
E & P revenues increased substantially this quarter over the same period last
year. Again, the acquisitions and capital expenditures from last year and from
early 2001 have favorably impacted revenues by increasing volumes. The
unprecedented high natural gas prices have also impacted this growth.
COST OF SALES
Cost of goods sold has increased from $32.3 million first quarter last year to
$75.8 million first quarter this year. The increased cost of sales is the result
of increased gas marketing activities, higher volumes and higher unit costs for
the replacement gas.
OPERATING EXPENSES
Operating expenses increased from $3.8 million last year first quarter to $5.0
million this quarter, a 32 percent increase. Much of this cost is related to the
full quarter effect of having the 2000 expansions and acquisitions on line.
GENERAL AND ADMINISTRATIVE EXPENSES
Expenses are $0.6 million higher in 2001 than in the first quarter of 2000. This
increase is due to legal fees, and overhead costs associated with the plant
expansions and acquisitions since early last year.
DEPRECIATION, DEPLETION AND AMORTIZATION
Depreciation, depletion and amortization was $1.4 million first quarter last
year and it increased to $1.7 million this quarter. The increase is again due to
the expansions and acquisitions brought on line since early last year.
OTHER INCOME AND EXPENSES
Interest income and expense remained relatively constant since last year.
LIQUIDITY AND CAPITAL RESOURCES
MarkWest's sources of liquidity and capital resources historically have been
internal cash flow and our revolving line of credit. In the first quarter of
2000, we supplemented these sources with proceeds from the sale of our corporate
office building. In the second quarter of 2000, we increased our line of credit
by $15 million to $65 million.
The following summary table reflects our comparative cash flows for the three
months ended March 31, 2001 and 2000 (in thousands):
For the three months ended March 31,
------------------------------------
2001 2000
---------------- ----------------
Net cash provided by operating activities before
change in working capital ............................. $ 3,599 $ 5,498
Net cash provided by (used in) operating activities
from change in working capital ........................ 6,384 11,404
Net cash provided by (used in) investing activities ...... (9,526) (1,475)
Net cash used in financing activities .................... $ 1,138 $ (14,161)
CAPITAL INVESTMENT PROGRAM
MarkWest forecasts a baseline capital budget of $23.5 million in 2001, down from
an earlier projection of $24.5 million. In our gathering, processing and
marketing segment the 2001 capital budget includes $8 million for completion of
Appalachia's Phase II expansion. The 2001 capital budget also includes $12
million for our exploration and production segment--$5 million for the
acquisition of San Juan Basin properties in January 2001; up to $4 million for
infill drilling in the San Juan Basin; and up to $3 million for further
expansion of the Au Gres, Michigan, property. These latter two expenditures are
discretionary and could be reduced depending on capital availability.
FINANCING FACILITIES
Financing activities consist primarily of net borrowings under MarkWest's credit
facility. At March 31, 2001, we had $65 million of available credit, of which we
had utilized $41.5 million in net debt (debt less cash). Depending on Appalachia
processing margins, the timing and amount of our future projects beyond the
level described above and the outcome of the Appalachia producer litigation and
negotiations described in Part II, Item 1 Legal Proceedings, we may have to seek
additional sources of capital. While we believe that we will be able to secure
additional financing on acceptable terms, if required, we have no assurance that
we will be able to do so.
10
COMMODITY PRICE RISK MANAGEMENT
MarkWest's primary risk management objective is to reduce volatility in our cash
flows. Our hedging approach uses a statistical method that analyzes momentum and
average pricing over time and various fundamental data, such as industry
inventories, industry production, demand and weather. Hedging levels increase
with capital commitments and debt levels and when above-average margins exist.
We maintain a committee, including members of senior management, which oversees
all hedging activity.
We achieve our goals utilizing a combination of fixed-price forward contracts
and fixed-for-float price swaps on the over-the-counter ("OTC") market. New York
Mercantile Exchange ("NYMEX")-traded futures are authorized for use, but only
occasionally used. Swaps and futures allow us to protect margins, because gains
or losses in the physical market are generally offset by corresponding losses or
gains in the value of financial instruments.
We enter OTC swaps with counterparties that are primarily of other energy
companies. We conduct a standard credit review and have agreements with such
parties that contain collateral requirements. We use standardized swap
agreements that allow for offset of positive and negative exposures. Net credit
exposure is marked to market daily. We are subject to margin deposit
requirements under OTC agreements (and NYMEX positions).
The use of financial instruments may expose MarkWest to the risk of financial
loss in certain circumstances, including instances when (a) sales volumes are
less than expected, requiring market purchases to meet commitments; or (b) our
OTC counterparties fail to purchase or deliver the contracted quantities of
natural gas, NGLs, or crude oil, or otherwise fail to perform. To the extent
that we engage in hedging activities, we may be prevented from realizing the
benefits of favorable price changes in the physical market. However, we are
similarly insulated against decreases in such prices.
MarkWest hedges our basis risk for natural gas, but we are generally unable to
do so for NGLs. Our basis risk stems from the geographic price differentials
between our sales locations and hedging contract delivery locations. Basis risk
is the risk that an adverse change in the hedging market will not be completely
offset by an equal and opposite change in the price of the physical commodity
being hedged.
In our gathering, processing and marketing segment, we hedge Appalachia
processing margins by using a combination of methods. We protect margins by
purchasing natural gas priced on predetermined Btu differentials to propane or
crude, by simultaneously selling propane or crude oil and purchasing natural
gas, and by using swaps. Crude oil is highly correlated with certain NGL
products. All projected margins on open positions assume the basis differentials
between crude oil, and NGLs are consistent with historical averages. As of March
31, 2001, we had hedged 1,260,000 NGL gallons at $0.18 per gallon processing
margin for the balance of 2001.
For certain Appalachia natural gas sales, as of March 31, 2001, we had hedged
488,000 and 54,000 MMBtu at $5.19 per MMBtu for 2001 and 2002, respectively.
In addition to these risk management tools, MarkWest utilizes our NGL storage
facilities and contracts for third-party storage to build product inventories
during historically lower-priced periods for resale during higher-priced
periods. We also have contracts to purchase certain quantities of our natural
gas feedstock in advance of physical needs.
In our exploration and production segment, we hedge our exposure to changes in
market prices for our natural gas production. As of March 31, 2001, we had
hedged 1,223,000; 608,000; and 273,000 MMBtu of natural gas sales at prices of
$3.81, $3.81 and $3.92 per MMBtu for 2001, 2002 and 2003, respectively.
MarkWest's hedging strategy benefited our after-tax earnings compared to the
situation of not hedging. In the gathering, processing and marketing segment,
without hedging, net income would have been lower by $1.6 million and higher by
$0.6 million for the three months ended March 31, 2001 and 2000, respectively.
This impact considers only hedges of Appalachia processing margin and does not
reflect other decisions made concerning when to buy natural gas or store NGL
production for sale in later months. In the exploration and production segment,
without hedging, net income would have been higher by $0.6 million and $0.0
million for the three months ended March 31, 2001 and 2000, respectively.
We enter into speculative transactions on an infrequent basis. Specific approval
by the Board of Directors is necessary prior to executing such transactions.
Speculative transactions are marked to market at the end of each accounting
period, and any gain or loss is recognized in income for that period. There were
no such speculative activities for the quarters ended March 31, 2001 and 2000.
11
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Reference is made to Risk Management Activities in Item 2 of this Form 10-Q.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As we reported in a current report on Form 8-K, dated February 22, 2001, three
complaints have been filed against us in the Circuit Court of Wayne County, West
Virginia, by Columbia Gas Transmission Corporation and Columbia Natural
Resources, Inc.; Equitable Production Company and Equitable Energy, LLC; and
Cobra Petroleum Production Company et al. These complaints each allege breach of
contract and seek various forms of relief (including injunctive relief) and
damages.
Current and futures prices for natural gas have risen dramatically relative to
prices for NGLs (propane, butane, etc.). A large portion--about 75 percent--of
MarkWest's processing services for gas producers in Appalachia involves
extracting NGLs from inlet gas streams and replacing the equivalent heat content
with dry natural gas purchased in the spot or forward markets. This part of our
operating margin depends on a positive spread between NGL prices and natural gas
costs. Effective February 1, 2001, we provided producers with an alternative
processing contract that provides for additional compensation to MarkWest when
processing margins are low and reduced compensation when these margins are high.
To date, about 80 producers (accounting for a minority share of the volume) have
agreed to an amended contract. If producers elect to remain with the existing
contract, we have stated that we will return the replacement natural gas at a
later date. We believe this is permitted under the existing contract such that
we can earn a reasonable fee for our services. The complaints allege this
procedure for the existing contracts constitutes a breach. The parties have
agreed to a temporary standstill to the litigation and are currently negotiating
a resolution to this dispute. As of April 24, 2001, any litigant, including
MarkWest, can opt out of the standstill agreement. There can be no assurance
that these negotiations will be successful or that the outcome of the litigation
or the settlement discussions will be favorable to MarkWest.
These high natural gas price conditions are not, of course, an isolated
situation with MarkWest--nationwide, producers and gas processors are
renegotiating their processing agreements for this reason.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
11 -- Statement regarding computation of earnings per share.
(b) Reports on Form 8-K
(i) -- February 22, 2001 Lawsuits challenge MarkWest
Hydrocarbon, Inc.'s position; allege breach of contract
and seek various forms of relief (including injunctive
relief) and damages.
12
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, MarkWest,
as registrant, had this report signed on our behalf by the undersigned, who has
been duly authorized.
MarkWest Hydrocarbon, Inc.
(Registrant)
Date: May 3, 2001 By: /s/ Gerald A. Tywoniuk
----------------------------------------
Gerald A. Tywoniuk
Chief Financial Officer and Vice President of Finance
(On Behalf of the Registrant and as Principal
Financial Officer)
13