UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for Quarterly Period Ended March 31, 2002
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: 000-31819
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Canaan Energy Corporation
(Exact name of Registrant as specified in its charter)
Oklahoma 73-1300132
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
211 North Robinson, Suite 1000N, Oklahoma City, Oklahoma 73102
(Address of principal executive offices, including zip code)
(405) 604-9200
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X|No |_|
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date:
At May 15, 2002, Canaan Energy Corporation had outstanding 4,353,646 shares
of Common Stock, par value $.01
Part I. Financial Information
Item 1. Financial Statements
CANAAN ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
March 31, December 31,
2002 2001
------------ ------------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 2,370,022 $ 2,579,843
Accounts receivable 3,462,872 3,783,670
Income tax receivable 2,756,021 2,534,000
Other assets 54,716 22,157
------------ ------------
Total current assets 8,643,631 8,919,670
------------ ------------
Property and equipment, at cost, based on the full cost method
of accounting for oil and natural gas properties 117,217,937 115,809,831
Less accumulated depreciation and amortization (51,046,576) (49,357,756)
------------ ------------
66,171,361 66,452,075
Other assets 128,250 148,500
------------ ------------
Total assets $ 74,943,242 $ 75,520,245
============ ============
LIABILITIES and STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable:
Trade $ 1,768,231 $ 2,792,294
Revenue and royalties due to others 1,850,201 1,796,019
Accrued expenses 479,622 377,878
------------ ------------
Total current liabilities 4,098,054 4,966,191
------------ ------------
Long-term debt 42,764,683 42,264,683
Fair value of derivative instruments 1,073,125 -
Other long-term liabilities 436,005 -
Deferred income taxes 7,179,597 7,587,385
Stockholders' equity:
Common stock, $0.01 par value 49,318 49,318
Additional paid-in capital 57,027,781 57,027,781
Treasury stock, at cost, 578,169 shares in 2002 and 2001 (6,885,509) (6,885,509)
Retained earnings (accumulated deficit) (30,134,475) (29,489,604)
Accumulated other comprehensive loss (665,337) -
------------ ------------
Total stockholders' equity 19,391,778 20,701,986
------------ ------------
Total liabilities and stockholders' equity $ 74,943,242 $ 75,520,245
============ ============
See accompanying notes to financial statements.
1
CANAAN ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
Three months ended March 31,
2002 2001
----------- -----------
(unaudited)
Revenues:
Oil and natural gas sales $ 4,605,014 $11,421,012
Costs and expenses:
Lease operating 1,157,875 1,097,989
Production taxes 266,165 828,005
Depreciation, depletion and amortization 1,688,820 1,725,234
General and administrative expenses 2,046,652 1,079,411
Interest expense 503,932 829,969
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Total costs and expenses 5,663,444 5,560,608
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Other income, principally interest 18,316 126,428
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Earnings before income taxes (1,040,114) 5,986,832
Income tax expense (benefit) (395,243) 2,256,000
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Net earnings (loss) $ (644,871) $ 3,730,832
=========== ===========
Earnings (loss) per average common share
outstanding - basic $ (0.15) $ 0.76
=========== ===========
Earnings (loss) per average common share
outstanding - diluted $ (0.15) $ 0.76
=========== ===========
Weighted average common shares outstanding -
basic 4,353,646 4,916,315
=========== ===========
Weighted average common shares outstanding -
diluted 4,353,646 4,930,655
=========== ===========
See accompanying notes to financial statements.
2
CANAAN ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three months ended March 31,
2002 2001
----------- -----------
(unaudited)
Net earnings (loss) $ (644,871) $ 3,730,832
Other comprehensive income, net of tax:
Cumulative effect of change in accounting principle - (1,578,899)
Derivative losses reclassified into oil and natural gas sales - 761,726
Change in fair value of derivative instruments (665,337) 525,173
----------- -----------
Comprehensive income (loss) $(1,310,208) $ 3,438,832
=========== ===========
See accompanying notes to financial statements.
3
CANAAN ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended March 31,
2002 2001
----------- -----------
(unaudited)
Cash flows from operating activities:
Net earnings (loss) $ (644,871) $ 3,730,832
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Depreciation, depletion and amortization 1,688,820 1,725,234
Deferred income tax expense (benefit) (362,971) 386,000
Amortization of debt issuance costs 20,250 16,611
Decrease (Increase) in accounts receivable and
other assets 429,189 (2,250,479)
Decrease in accounts payable, accrued expenses and
other liabilities (432,132) (203,816)
----------- -----------
Net cash provided by operating activities 698,285 3,404,382
----------- -----------
Cash flows from investing activities -
Capital expenditures (1,408,106) (2,126,721)
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Net cash used in investing activities (1,408,106) (2,126,721)
------------ -----------
Cash flows from financing activities -
Borrowings on long-term debt 500,000 -
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Net cash provided by financing activities 500,000 -
----------- -----------
Net increase (decrease) in cash and cash equivalents (209,821) 1,277,661
Cash and cash equivalents at beginning of period 2,579,843 6,481,550
----------- -----------
Cash and cash equivalents at end of period $ 2,370,022 $ 7,759,211
=========== ===========
Supplemental Cash Flow Information:
Cash payments (refunds) for income taxes $ (173,222) $ 1,368,112
=========== ===========
Cash payments for interest $ 410,698 $ 813,358
=========== ===========
See accompanying notes to financial statements.
4
CANAAN ENERGY CORPORATION
Notes to Financial Statements
1. Organization and Basis of Presentation
Canaan Energy Corporation ("Canaan") is engaged primarily in the acquisition,
development and production of oil and natural gas properties.
Accounting policies employed by Canaan reflect industry practices and conform to
accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements and notes thereto have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Accordingly, certain disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been omitted. The accompanying consolidated
financial statements and notes thereto should be read in conjunction with the
consolidated financial statements and notes thereto included in Canaan's 2001
Annual Report on Form 10-K.
The consolidated financial statements include the financial statements of Canaan
and its wholly owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
In the opinion of management, the accompanying unaudited financial statements as
of March 31, 2002, and for the three months ended March 31, 2002 and March 31,
2001, reflect adjustments (which were normal and recurring) which, in the
opinion of management, are necessary for a fair statement of the financial
position and results of operations of the interim periods presented. Results of
the three months ended are not necessarily indicative of results expected for
the full year.
2. Long-Term Debt
The Company has a secured revolving credit facility with a group of banks which
provides for a borrowing base of $45,000,000, with no monthly principal payments
currently required, based on the Company's oil and natural gas reserves. The
credit facility has a maturity date of October 2003. The terms of the facility
give the Company the option of either borrowing at the LIBOR rate plus a margin
of 1.5% to 2.50% or at a base rate approximating the prime rate plus a margin
ranging from 0.0% to 0.75% depending on the amount of advances outstanding in
relation to the borrowing base. At March 31, 2002, the Company had $40,000,000
of its total debt balance under the LIBOR interest option, resulting in a rate
on that date of 4.58%. The credit facility contains various affirmative and
restrictive covenants limiting additional indebtedness, sales of assets, mergers
and consolidations, dividends and distributions and requires the maintenance of
various financial ratios. The credit facility is subject to a commitment fee for
the banks maintaining of funds available for Canaan. The commitment fee ranges
from 0.25% to 0.50%, based on the amount of the revolving commitment in effect
for the applicable period. Borrowings under the agreement are secured by
substantially all of the Company's oil and natural gas properties.
For the three months ended March 31, 2002, the Company's Debt to EBITDA Ratio
and Debt Service Coverage Ratio did not comply with that required under the
credit agreement. In February 2002, the bank lending group granted the Company a
one-time waiver of the projected default by the Company to be created by the
noncompliance with respect to the Debt to EBITDA Ratio and Debt Service Coverage
Ratio
5
for the quarter ended March 31, 2002. All other financial ratios calculated
under the credit agreement were within their required ranges. There can be no
assurance that the bank lending group will grant waivers of default arising from
any future noncompliance with prescribed financial ratios when, or if they
occur.
3. Derivative Instruments and Hedging Activities
Changes in the fair value of a derivative that is effective and that is
designated and qualifies as a cash-flow hedge are recorded in other
comprehensive income, until earnings are affected by the variability in cash
flows of the designated hedged item.
All of the Company's derivatives that qualify for hedge accounting treatment are
"cash-flow" hedges. The Company designates its cash flow hedge derivatives on
the date the derivative contract is entered into. The Company formally documents
all relationships between hedging instruments and hedged items, as well as its
risk-management objective and strategy for undertaking various hedge
transactions. This process includes linking all derivatives that are designated
as cash-flow hedges to specific forecasted transactions. The Company also
assesses, both at the hedge's inception and on an ongoing basis, whether the
derivatives that are used in hedging transactions are effective in offsetting
changes in cash flows of hedged items.
By using derivative financial instruments to hedge exposures to changes in
commodity prices, the Company exposes itself to credit risk and market risk.
Credit risk is the failure of the counterparty to perform under the terms of the
derivative contract. To mitigate this risk, the hedging instruments are usually
placed with counterparties that the Company believes are minimal credit risks.
Market risk is the adverse effect on the value of a financial instrument that
results from a change in interest rates, commodity prices, or currency exchange
rates. The market risk associated with commodity-price contracts is managed by
establishing and monitoring parameters that limit the types and degree of market
risk that may be undertaken.
The Company periodically enters into financial hedging activities with respect
to a portion of its projected oil and natural gas production through various
financial transactions to manage its exposure to oil and natural gas price
volatility. These transactions include financial price swaps whereby the Company
will receive a fixed price for its production and pay a variable market price to
the contract counterparty. These financial hedging activities are intended to
support oil and natural gas prices at targeted levels and to manage the
Company's exposure to oil and natural gas price fluctuations. The oil and
natural gas reference prices upon which these price hedging instruments are
based reflect various market indices that have a high degree of historical
correlation with actual prices received by the Company.
During February and March 2002, Canaan entered into financial natural gas price
hedging instruments which represented approximately 3,210,000 MMBTU of natural
gas production at a weighted average price of $2.86 per MMBTU. The hedged
natural gas volumes represent approximately 48% of Canaan's 2002 estimated
natural gas production on an Mcfe basis. The 2002 hedging instruments settle
monthly through December 31, 2002. As of March 31, 2002, the Company has
2,900,000 MMBTU remaining on the various contracts, which are hedged at a
weighted average price of $2.92 per MMBTU.
The Company does not hold or issue derivative instruments for trading purposes.
The Company's commodity-price swaps in place as of March 31, 2002 have been
designated as a cash flow hedge. Changes in the fair value of the derivative is
reported on the balance sheet in "Accumulated Other Comprehensive Income"
("AOCI"). These amounts are reclassified to oil and natural gas sales when the
forecasted transaction takes place.
6
The Company assesses the effectiveness of its hedges based on, at least
quarterly, relative changes in fair value between the derivative instrument and
the hedged forecasted sale of oil and natural gas. For the quarter ended March
31, 2002, the Company recorded an immaterial net charge which represented the
ineffectiveness of the cash-flow hedge. The ineffectiveness is recorded in oil
and natural gas sales in the consolidated statement of operations.
As of March 31, 2002, all of the net deferred losses on derivative instruments
accumulated in AOCI are expected to be reclassified to earnings by December 31,
2002 (the expiration of the price swap contract). The reclassifications will be
made as the hedged natural gas is produced.
4. Earnings Per Share
All outstanding options were excluded from the calculation of diluted earnings
per share for the three-month period ended March 31, 2002, as the Company
incurred a net loss. The dilutive effect of the stock options for the 2001
period was an addition of 14,340 shares.
5. Subsequent Event
On April 19, 2002, the Company, CHK Acquisition, Inc., an Oklahoma corporation
("Sub"), and Chesapeake Energy Corporation, an Oklahoma corporation
("Chesapeake"), executed an Agreement and Plan of Merger pursuant to which Sub
will, subject to the conditions and upon the terms stated therein, merge with
and into the Company. Pursuant to the Merger, $18 will be paid for each
outstanding share of common stock of the Company. All outstanding employee
options to purchase the Company's common stock will be fully vested and
converted into a right to receive the difference between $18 per share and the
exercise price. Under certain circumstances, the Company has agreed to provide
Chesapeake with a $5,000,000 break-up fee in the event the transaction is not
completed.
7
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion is intended to assist in an understanding of Canaan's
financial position as of March 31, 2002, and its results of operations for the
three-month periods ended March 31, 2002 and 2001. It is presumed that readers
have read or have access to Canaan's 2001 Form 10-K.
On April 19, 2002, the Company and Chesapeake entered into a merger agreement
pursuant to which Chesapeake will acquire the Company. Pursuant to the merger,
$18.00 will be paid for each outstanding share of common stock of the Company.
All outstanding employee options to purchase the Company's common stock will be
fully vested and converted into a right to receive the difference between $18.00
per share and the exercise price. The consummation of the merger is subject to
customary terms and conditions, including the approval of the shareholders of
the Company and is expected to occur by August 2002. As discussed herein, our
expectations of 2002 operations and capital expenditures and resources are those
of the Company exclusive of effects of the proposed merger. Upon consummation of
the merger, management of Chesapeake may have other expectations based on their
available resources.
Three Months Ended March 31, 2002 Compared with the Three Months Ended March 31,
- --------------------------------------------------------------------------------
2001
- ----
For the three months ended March 31, 2002, we recorded a net loss of $644,871 or
$.15 per share on total revenues of $4,605,014. These results compare with net
earnings for the three months ended March 31, 2001 of $3,730,832 or $.76 per
share on total revenues of $11,421,012. This 117% decrease in net earnings was
primarily due to lower oil and natural gas prices received during the first
three months of 2002 coupled with lower production, as well as the recognition
of a contract fulfillment obligation to a terminated officer of the Company, as
more fully described below in the general and administrative discussion. The
downward effects of these items on net earnings were partially mitigated by an
income tax benefit of $395,000 for the first three months of 2002 as compared to
an income tax provision of $2,256,000 for the comparable period of 2001, as well
as reductions in production taxes and interest expense.
Revenues. Revenues from oil and natural gas sales decreased by 60%, or
$6,815,998 to $4,605,014 for the three months ended March 31, 2002, as compared
to $11,421,012 for the same period of 2001. This decrease was the result of
significantly lower natural gas prices coupled with a decrease in production on
an Mcfe basis. In February 2002, Oklahoma experienced severe winter storms which
produced heavy freezing precipitation over a number of days, causing massive
power losses which lasted weeks in some areas of the state. The results were the
shutting-in of production for a number of the Company's operated properties
during a large part of February. An estimated 25,000 Mcfe was lost during this
period due to the winter storm. Natural gas production decreased 4% to 1,609,443
Mcf during the three months ended March 31, 2002 as compared to 1,684,813 Mcf
for the first three months of 2001. Oil production declined 1% from 43,247 Bbls
during the three months ended March 31, 2001 to 42,763 Bbls for the three months
ended March 31, 2002. The average price realized for natural gas decreased by
63%, or $3.80 per Mcf, to $2.27 per Mcf during the three months ended March 31,
2002, as compared to $6.07 per Mcf for the same period of 2001. Hedging
activities for 2002 increased our average price for natural gas by $.01 per Mcf
during the three months ended March 31, 2002, as opposed to decreasing our
average price by $.74 for the comparable period of 2001. The average price
realized for oil decreased by 19%, or $4.72 per Bbl to $20.65 during the three
months ended March 31, 2002, as compared to $25.37 per Bbl for the same period
of 2001. Natural gas hedging contract arrangements entered into in February and
March of 2002, covering approximately 23% of our daily natural gas production,
expire in December 2002.
Lease operating expense. Lease operating expense increased by 5%, or $59,886, to
$1,157,875 for the three months ended March 31, 2002, as compared to $1,097,989
for the same period of 2001. The
8
increase was due primarily to repairs and workovers coupled with the additional
wells added during the last nine months of 2001. On an Mcfe basis, lease
operating expense increased 10% during the three months ended March 31, 2002 to
$.62 per Mcfe from $.56 per Mcfe during the same period in 2001.
Production taxes. Production taxes decreased 68%, or $561,840 to $266,165 for
the three months ended March 31, 2002, as compared to $828,005 for the same
period of 2001. This decrease was primarily the result of significantly lower
natural gas prices received during the three months ended March 31, 2002 as
compared to the same period of 2001. Production taxes are generally calculated
based on gross oil and natural gas revenues prior to any hedging adjustments.
Depreciation and amortization expense. Depreciation and amortization expense
decreased 2%, or $36,414 to $1,688,820 for the three months ended March 31,
2002, as compared to $1,725,234 for the same period of 2001. Depreciation and
amortization expense from oil and natural gas properties decreased 2%, or
$33,789 to $1,657,893 during the three months ended March 31, 2002 compared to
$1,691,685 for the comparable period of 2001, due to decreased production during
the three months ended March 31, 2002. Amortization expense per equivalent Mcf
was $.89 for the three months ended March 31, 2002 versus $0.87 for the same
period of 2001.
General and administrative expense. General and administrative expenses
increased $967,241 or 90% to $2,046,652 during the three months ended March 31,
2002 as compared to $1,079,411 for the same period of 2001. The principal
component of the increase is due to an accrual of $561,121 for a severance
package for a former executive. Pursuant to his employment agreement with the
Company which provided for employment to continue for a period of five years
from November 1, 2000, if terminated without cause, the executive will continue
to receive on a bi-monthly basis his base salary of $170,000 per year for the
remaining term of his agreement ending October 31, 2005. Additionally, during
the three months ended March 31, 2002, we incurred $150,000 for investment
banking representation relating to the merger with Chesapeake. The Company also
incurred bank charges to obtain bank waivers for non-compliance with certain
debt covenants during the three months ended December 31, 2001, and March 31,
2002. During 2002, the Company incurred $86,000 in related bank fees.
General and administrative expenses per equivalent Mcf were $1.10 for the three
months ended March 31, 2002 as compared $.56 for the same period of 2001, a 96%
increase. Adjusted for the severance charge and the investment banking fee,
general and administrative expenses per equivalent Mcf were $.72 for the three
months ended March 31, 2002, compared to $.56 for the same period of 2001, a 29%
increase.
Interest expense. Interest expense decreased $326,037 or 39% to $503,932 during
the three months ended March 31, 2002 from $829,969 during the same period of
2001. The average interest rate on our debt has decreased substantially to a
4.55% average interest rate for the first three months of 2002 as compared to a
9.78% average interest rate for the same period of 2001.
Income taxes. Income tax decreased $2,651,243 from a provision of $2,256,000 for
the three months ended March 31, 2001 to a benefit of $395,243 for the three
months ended March 31, 2002. This decrease was due to lower pre-tax income, as
previously discussed. The effective tax rates for the two periods were
comparable.
Capital Expenditures, Capital Resources and Liquidity
- -----------------------------------------------------
As of March 31, 2002 and December 31, 2001, we had cash balances of $2,370,022
and $2,579,843, respectively. Working capital increased from $3,953,479 at
December 31, 2001 to $4,545,577 at March 31, 2002, due principally to lower
accounts payable resulting from reduced capital expenditures.
9
For the three months ended March 31, 2002, net cash provided by operating
activities was $698,285 as compared to net cash provided by operating activities
of $3,404,382 for the three months ended March 31, 2001. This decrease was
primarily the result of a substantial decrease in pre-tax earnings due to lower
natural gas prices received during the three months ended March 31, 2002. EBITDA
decreased $7,389,397 or 87% from $8,542,035 for the three months ended March 31,
2001 to $1,152,638 for the three months ended March 31, 2002.
Net cash used in investing activities for the three months ended March 31, 2002
was $1,408,106 as compared to $2,126,721 used in investing activities during the
three months ended March 31, 2001, resulting in a $718,615 decrease in cash
used. This change was primarily the result of decreased capital expenditures
related to our 2002 drilling program as compared to the same period of 2001.
Net cash provided by financing activities was $500,000 for the three months
ended March 31, 2002 compared with zero during the same period of 2001. Cash
used in financing activities consists entirely of draws on our bank credit
facility.
Capital expenditures. Our capital expenditures to date have focused primarily on
the development of oil and natural gas properties in the Mid-Continent Region,
as well as acquisitions of proved developed producing oil and natural gas
properties located in the same area.
Prior to our agreement with Chesapeake our projected capital expenditures for
2002 were estimated to be $10 million, with approximately one half of our
drilling budget dedicated to low-risk projects in the Anadarko Basin area of the
Mid-Continent Region. We expended $1,408,106 during the three months ended March
31, 2002.
Under the terms of the Merger Agreement with Chesapeake, capital expenditures in
excess of $10,000 require the prior approval of Chesapeake, with certain limited
exceptions. Accordingly, we expect our capital expenditures to be limited.
Capital Resources. Our cash requirements have been met primarily in the past
through cash generated from operations, and through available credit from our
revolving bank credit facility. Our current credit facility provides for a
borrowing base of $45,000,000, with no monthly principal payments currently
required, based on our oil and natural gas reserves. The credit facility has a
maturity date of October 2003, and contains terms that give us the option either
of borrowing at the LIBOR rate plus a margin of 1.5% to 2.5% or at a base rate
approximating the prime rate plus a margin ranging from 0% to 0.75% depending on
the amount of advances outstanding in relation to the borrowing base. The credit
facility contains various negative and affirmative covenants limiting additional
indebtedness, sale of assets, mergers and consolidations, dividends and
distributions and requires the maintenance of various financial ratios.
Borrowings under the agreement are secured by substantially all of the Company's
oil and natural gas properties. At March 31, 2002, we had $42,764,683 advanced
under the credit facility and our available credit was approximately $2,200,000.
Forward Looking Statements
- --------------------------
This document includes certain statements that may be deemed to be "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 document that address activities, events or developments that Canaan Energy
Corporation, an Oklahoma Corporation ("Canaan" or "Companies"), expects,
believes or anticipates will or may occur in the future are forward looking
statements. They include statements regarding the Company's drilling
10
plans and objectives, related exploration and development costs, number and
location of planned wells, reserve estimates and values, statements regarding
the quality of the Company's properties and potential reserve and production
levels. These statements are based on certain assumptions and analyses made by
the Company in the light of its experience and perception of historical trends,
current conditions, expected future developments and other factors it believes
appropriate in the circumstances, including the assumption that there will be no
material change in the operating environment for the Company's properties and
that there will be no material acquisitions or divestitures. Such statements are
subject to a number of risks, including but not limited to commodity price
risks, drilling and production risks, risks related to weather and unforeseen
events, governmental regulatory risks and other risks, many of which are beyond
the control of the Company. See our Annual Report on Form 10-K for the year
ended December 31, 2000 for a more complete discussion of these risks. For all
of these reasons, actual results or developments may differ materially from
those projected in the forward looking statements. The Company assumes no
obligation to update the forward looking statements to reflect events or
circumstances occurring after the date of the statement.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The following information provides quantitative and qualitative information
about Canaan's potential exposure to market risks. The term "market risk" refers
to the risk of loss arising from adverse changes in oil and gas prices and
interest rates. The disclosures are not meant to be precise indicators of
expected future losses, but rather indicators of reasonably possible losses.
Commodity Price Risk. Canaan's major market risk exposure will be in the pricing
applicable to its oil and gas production. Realized pricing will be primarily
driven by the prevailing worldwide price for crude oil and spot market prices
applicable to its U.S. natural gas production. Pricing for oil and gas
production has been volatile and unpredictable for several years.
Canaan expects to periodically enter into financial hedging activities with
respect to a portion of forecasted oil and gas production through financial
price swaps whereby the Company receives a fixed price for production and pays a
variable market price to the contract counterparty. These financial price
hedging activities are intended to reduce exposure to oil and gas price
fluctuations. Realized gains or losses from the settlement of these financial
hedging instruments are recognized in oil and gas sales when the associated
production occurs. The gains and losses realized as a result of these hedging
activities are substantially offset in the cash market when the hedged commodity
is delivered.
At March 31, 2002, Canaan had financial hedging arrangements as follows:
Weighted Average Fair Value at
Commodity Period Volumes Price March 31, 2002
- ----------------------------------------------------------------------------------------------------------------------
April 1, 2002 to
Natural Gas December 31, 2002 2,900,000 MMBtu $2.92 $(1,073,125)
Interest Rate Risk. Canaan had long-term debt outstanding of $42.8 million as of
March 31, 2002. All of the debt outstanding at March 31, 2002 bears interest at
floating rates which averaged 4.55% as of March 31, 2002. A 10% increase in
short-term interest rates on the floating-rate debt outstanding at March 31,
2002 would equal approximately 46 basis points. Such an increase in interest
rates would have increased Canaan's annual interest expense by approximately
$197,000 assuming amounts borrowed at March 31, 2002 were outstanding for a 12
month period.
11
The above sensitivity analysis for interest rate risk excludes accounts
receivable, accounts payable and accrued liabilities because of the short-term
maturity of such instruments.
12
PART II -- OTHER INFORMATION
Items 1 - 5
Not applicable.
Item 6 - Exhibits and Reports on Form 8-K
(a) Exhibits
None.
(b) Reports on Form 8-K
Current Report on Form 8-K dated March 18, 2002 reporting pursuant to
Item 5 the declaration of a dividend of one preferred share purchase
right for each share of outstanding common stock held of record on
March 25, 2002 pursuant to a share rights plan approved and adopted by
the Board of Directors of the Registrant on March 13, 2002.
Current Report on Form 8-K dated April 24, 2002 announcing pursuant to
Item 5 that the Registrant had entered into a merger agreement with
Chesapeake Energy Corporation ("Chesapeake") on April 19, 2002,
wherein Chesapeake will acquire all the outstanding capital stock of
the Registrant for $18.00 cash per share.
13
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.
CANAAN ENERGY CORPORATION
(Registrant)
/s/ Leo E. Woodard
----------------------------------------
Leo E. Woodard
Chairman and Chief Executive Officer
/s/ Michael S. Mewbourn
----------------------------------------
Michael S. Mewbourn
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
/s/ John W. Mitchell
----------------------------------------
John W. Mitchell
Controller and Chief Accounting Officer
(Principal Accounting Officer)
Date: May 15, 2002
14