REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors
Spectrum Field Services, Inc.
We have audited the accompanying balance sheets of Spectrum Field Services, Inc.
(a Delaware corporation) as of December 31, 2003 and 2002, and the related
statements of operations, comprehensive income (loss), changes in shareholders'
equity and cash flows for each of the three years in the period ended December
31, 2003. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Spectrum Field Services, Inc.
as of December 31, 2003 and 2002, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2003, in
conformity with accounting principles generally accepted in the United States of
America.
/s/ Grant Thornton LLP
Tulsa, Oklahoma
May 17, 2004
(except with respect to the matters
discussed in Note J, as to which the
date is June 30, 2004)
SPECTRUM FIELD SERVICES, INC.
Balance sheets
December 31, 2003 and 2002
(in thousands, except share data)
2003 2002
--------- ---------
ASSETS
CURRENT ASSETS:
Cash $ 173 $ 478
Accounts receivable 8,473 7,554
Inventories 179 553
Prepaid expenses and other 108 200
Income tax receivable - 207
Security deposits 257 -
Deferred income taxes 10 -
--------- ---------
Total current assets 9,200 8,992
PROPERTY, PLANT AND EQUIPMENT, net 47,050 47,774
DEFERRED INCOME TAXES 1,644 -
SECURITY DEPOSITS 1,481 225
OTHER ASSETS, net 250 1,159
--------- ---------
Total assets $ 59,625 $ 58,150
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 4,800 $ 1,428
Accrued producer payables 6,470 6,109
Accrued liabilities 129 234
Hedge liabilities 338 719
Current maturities of long-term debt 4,995 3,076
--------- ---------
Total current liabilities 16,732 11,566
LONG-TERM DEBT, less current maturities 39,117 35,200
PREFERRED DIVIDENDS PAYABLE 2,129 1,075
DEFERRED INCOME TAXES - 2,063
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred stock, $0.01 par value; 8.0% cumulative; 20,000,000 shares
authorized; 13,856,047 shares of Series A preferred stock issued;
11,052,304 shares outstanding at December 31, 2003 and 2002 13,856 13,856
Common stock, $0.01 par value; 5,000,000 shares authorized; 2,722,195 and
2,712,195 shares issued; 2,084,891 and 2,074,891 shares outstanding at
December 31, 2003 and 2002, respectively 27 27
Additional paid-in capital 3,149 3,043
Retained earnings (accumulated deficit) (5,279) 1,729
Treasury stock - preferred, at cost (3,758) (3,758)
Treasury stock - common, at cost (6,252) (6,252)
Deferred compensation (43) (70)
Accumulated other comprehensive loss, net of tax of $32 and $201 in
2003 and 2002, respectively (53) (329)
--------- ---------
Total shareholders' equity 1,647 8,246
--------- ---------
Total liabilities and shareholders' equity $ 59,625 $ 58,150
========= =========
The accompanying notes are an integral part of these balance sheets.
SPECTRUM FIELD SERVICES, INC.
Statements of operations
For the years ended December 31, 2003, 2002 and 2001
(In thousands)
2003 2002 2001
--------- --------- ---------
SALES OF NATURAL GAS AND LIQUIDS $ 98,772 $ 65,760 $ 86,316
COST OF NATURAL GAS AND LIQUIDS 78,827 49,659 64,160
--------- --------- ---------
Gross profit 19,945 16,101 22,156
OPERATING EXPENSE 6,262 6,954 8,891
GENERAL AND ADMINISTRATIVE EXPENSE 4,322 2,374 2,947
IMPAIRMENT OF PROPERTY, PLANT AND EQUIPMENT - 1,889 -
DEPRECIATION 16,050 4,407 2,779
--------- --------- ---------
(LOSS) INCOME FROM OPERATIONS (6,689) 477 7,539
INTEREST EXPENSE 2,725 2,659 3,423
OTHER EXPENSE (INCOME), net 843 (10) (299)
--------- --------- ---------
(LOSS) INCOME BEFORE INCOME TAXES (10,257) (2,172) 4,415
INCOME TAX (BENEFIT) PROVISION (4,303) (500) 1,677
--------- --------- ---------
NET (LOSS) INCOME (5,954) (1,672) 2,738
PREFERRED STOCK DIVIDENDS 1,054 752 643
--------- --------- ---------
NET (LOSS) INCOME ATTRIBUTABLE TO COMMON SHAREHOLDERS $ (7,008) $ (2,424) $ 2,095
========= ========= =========
The accompanying notes are an integral part of these financial statements.
SPECTRUM FIELD SERVICES, INC.
Statements of comprehensive income (loss)
For the years ended December 31, 2003, 2002 and 2001
(In thousands)
2003 2002 2001
--------- --------- ---------
NET (LOSS) INCOME $ (5,954) $ (1,672) $ 2,738
OTHER COMPREHENSIVE INCOME (LOSS):
Change in value of derivative instruments, net of tax of
$169, $(201) and $0 in 2003, 2002 and 2001,
respectively 276 (329) -
--------- --------- ---------
COMPREHENSIVE (LOSS) INCOME $ (5,678) $ (2,001) $ 2,738
========= ========= =========
RECONCILIATION OF ACCUMULATED OTHER COMPREHENSIVE LOSS:
Balance, beginning of period $ (329) $ - $ -
Current period reclassification to earnings, net of tax of
$793, $5 and $0 in 2003, 2002 and 2001, respectively
1,293 7 -
Current period change, net of tax of $623, $206 and
$0 in 2003, 2002 and 2001, respectively
(1,017) (336) -
--------- --------- ---------
Balance, end of period $ (53) $ (329) $ -
========= ========= =========
The accompanying notes are an integral part of these financial statements.
SPECTRUM FIELD SERVICES, INC.
Statements of changes in shareholders' equity
For the years ended December 31, 2003, 2002 and 2001
(in thousands, except share data)
Retained
Preferred Stock Common Stock Additional Earnings
------------------------ --------------------- Paid-in (Accumulated
Shares Amount Shares Amount Capital Deficit)
---------- -------- --------- ------ ------- ----------
Balance, December 31, 2000 10,886,576 $ 10,887 2,211,109 $ 22 $2,643 $ 2,058
Repurchase of shares - - - - - -
Net income available to
common shareholders - - - - - 2,095
Vesting of restricted common
stock - - - - - -
Vesting of phantom units - - - - 112 -
---------- -------- --------- ------ ------ -------
Balance, December 31, 2001 10,886,576 10,887 2,211,109 22 2,755 4,153
Repurchase of restricted
common stock - - - - - -
Repurchase of preferred
shares - - - - - -
Issuance of stock 2,969,471 2,969 545,529 5 540 -
Net loss attributable to
common shareholders - - - - - (2,424)
Vesting of restricted common
stock - - - - - -
Cancellation of unvested
restricted common stock - - (44,444) - (140) -
Net change in accumulated
other comprehensive loss - - - - - -
Termination of phantom unit
plan - - - - (112) -
---------- -------- --------- ------ ------ -------
Balance, December 31, 2002 13,856,047 13,856 2,712,194 27 3,043 1,729
Issuance of restricted stock - - 10,000 - 32 -
Net loss attributable to
common shareholders - - - - - (7,008)
Vesting of restricted common
stock - - - - - -
Compensation expense for
stock options - - - - 74 -
Net change in accumulated
other comprehensive loss - - - - - -
---------- -------- --------- ------ ------ -------
Balance, December 31, 2003 13,856,047 $ 13,856 2,722,194 $ 27 $3,149 $(5,279)
========== ======== ========= ====== ====== =======
Accumulated
Treasury Stock Other
--------------------- Deferred Comprehensive
Preferred Common Compensation Loss Total
--------- ------ ------------ --------------- -------
Balance, December 31, 2000 $ - $ - $ (665) $ - $14,945
Repurchase of shares (3,754) (5,932) - - (9,686)
Net income available to
common shareholders - - - - 2,095
Vesting of restricted common
stock - - 166 - 166
Vesting of phantom units - - - - 112
--------- ------- ------ ----- -------
Balance, December 31, 2001 (3,754) (5,932) (499) - 7,632
Repurchase of restricted
common stock - (320) - - (320)
Repurchase of preferred
shares (4) - - - (4)
Issuance of stock - - - - 3,514
Net loss attributable to
common shareholders - - - - (2,424)
Vesting of restricted common
stock - - 289 - 289
Cancellation of unvested
restricted common stock - - 140 - -
Net change in accumulated
other comprehensive loss - - - (329) (329)
Termination of phantom unit
plan - - - - (112)
--------- ------- ------ ----- -------
Balance, December 31, 2002 (3,758) (6,252) (70) (329) 8,246
Issuance of restricted stock - - (32) - -
Net loss attributable to
common shareholders - - - - (7,008)
Vesting of restricted common
stock - - 59 - 59
Compensation expense for
stock options - - - - 74
Net change in accumulated
other comprehensive loss - - - 276 276
--------- ------- ------ ----- -------
Balance, December 31, 2003 $ (3,758) $(6,252) $ (43) $ (53) $ 1,647
========= ======= ====== ====== =======
The accompanying notes are an integral part of these financial statements.
SPECTRUM FIELD SERVICES, INC.
Statements of cash flows
For the years ended December 31, 2003, 2002 and 2001
(In thousands)
2003 2002 2001
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss (income) $ (5,954) $ (1,672) $ 2,738
Adjustments to reconcile net loss to net cash
provided by operating activities-
Depreciation and amortization of loan origination fees 16,364 4,718 3,127
Deferred income taxes (3,717) (196) 1,870
Noncash compensation expense 133 177 278
Unrealized (gain) loss on ineffective hedges (105) 189 -
Loss (gain) on sale of assets 456 (10) -
Impairment of property, plant and equipment - 1,889 -
Noncash interest expense 1,188 946 386
Changes in assets and liabilities-
Accounts receivable (919) (2,505) 1,474
Inventories 374 201 (287)
Prepaid expenses and other 92 (45) -
Income tax receivable 207 816 (973)
Other assets (749) (989) (160)
Accounts payable 3,372 (29) (1,204)
Accrued producer payables 361 2,426 (4,829)
Accrued liabilities (105) 40 (917)
--------- --------- ---------
Net cash provided by operating activities 10,998 5,956 1,503
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (17,410) (2,844) (5,949)
Proceeds from sale of assets 1,628 169 -
--------- --------- ---------
Net cash used in investing activities (15,782) (2,675) (5,949)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings from long-term debt 6,600 284 3,850
Payments on long-term debt (4,510) (5,848) (3,000)
Borrowings under line of credit 8,208 1,700 13,350
Payments on line of credit (5,650) (6,050) (9,050)
Proceeds from issuance of stock - 3,514 -
Repurchase of stock - (324) -
Borrowings from subordinated notes - 3,515 -
Other - (5) -
Dividends paid - - (322)
Loan origination fees (169) (98) (50)
--------- --------- ---------
Net cash provided by (used in) financing activities 4,479 (3,312) 4,778
--------- --------- -----------
NET CHANGE IN CASH (305) (31) 332
CASH, beginning of period 478 509 177
--------- --------- ---------
CASH, end of period $ 173 $ 478 $ 509
========= ========= =========
SUPPLEMENTAL INFORMATION:
Cash paid for interest $ 1,076 $ 1,384 $ 3,226
========= ========= =========
Cash paid for income taxes $ - $ - $ 774
========= ========= =========
Noncash financing activity - paid in kind interest $ 1,188 $ 946 $ 386
========= ========= =========
Noncash financing activity - issuance of restricted common stock $ 32 $ - $ -
========= ========= =========
Noncash financing activity - capital lease $ - $ - $ 125
========= ========= =========
Noncash financing activity - repurchase of preferred and common stock
and extinguishments of subordinated notes (Note A) $ - $ - $ 13,000
========= ========= =========
The accompanying notes are an integral part of these financial statements.
SPECTRUM FIELD SERVICES, INC.
Notes to financial statements
December 31, 2003, 2002 and 2001
(in thousands, except share data)
A - OPERATIONS AND ORGANIZATION
Spectrum Field Services, Inc. (the Company), was incorporated in Delaware
on May 8, 2000. The Company was formed to acquire and operate natural gas
processing plants and gathering systems in Velma, Oklahoma and Kingman,
Kansas.
On February 28, 2001, the Company entered into an agreement to repurchase
the interest of one of the Company's equity investors, which was also a
major customer of the Company. The agreement resulted in the Company
forgiving $13,000 in accounts receivable owed by the shareholder at
February 28, 2001, in exchange for the retirement of the outstanding
subordinated debt owed to the shareholder, the repurchase of all of the
shareholder's common and Series A preferred stock, and the retirement of
the shareholder's outstanding stock warrant. This transaction was treated
as a noncash transaction for presentation in the statement of cash flows.
The Company refinanced the subordinated debt with additional borrowings of
long-term debt.
On August 1, 2003, the Company sold all of the assets of the Company's
natural gas processing plant located in Kingman, Kansas for $1,200. The
value of the plant was written down by $1,889 as of December 31, 2002, in
contemplation of the transaction in accordance with Statement of Financial
Accounting Standards No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (SFAS 144). In 2003, an additional loss of $215 was
recorded which related to the sale of the plant. The additional loss was
recorded as other expense in the Company's statement of operations.
On December 30, 2003, the Company engaged Lehman Brothers to explore
strategic alternatives for the Company including a merger, sale or other
transactions involving the stock or assets of the Company.
B - SIGNIFICANT ACCOUNTING POLICIES AND BALANCE SHEET DETAIL
1. Accounts Receivable
The Company grants credit to its customers for the purchase of natural gas
and natural gas liquids. Accounts receivable consist of amounts billed to
customers and an accrual for sales not yet billed. The Company writes off
accounts receivable when management believes the receivables to be
uncollectible. A summary of accounts receivable at December 31 is as
follows:
2003 2002
------- -------
Customer receivables $ 119 $ 44
Accrued sales 8,354 7,510
------- -------
$ 8,473 $ 7,554
======= =======
SPECTRUM FIELD SERVICES, INC.
Notes to financial statements - continued
December 31, 2003, 2002 and 2001
(in thousands, except share data)
2. Inventories
The Company's inventories are primarily comprised of replacement pipe,
natural gas and natural gas liquids and are stated at the lower of cost or
market.
A summary of inventories at December 31 is as follows:
2003 2002
---- ----
Replacement pipe $ 76 $ 110
Natural gas 65 179
Natural gas liquids - 232
Other 38 32
----- -----
$ 179 $ 553
===== =====
3. Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation is provided
using the straight-line method over the estimated useful lives of the
assets as follows:
Buildings and improvements 7 to 39 years
Plant, machinery and equipment 10 to 20 years
Rights of way 20 years
Office furniture and equipment 5 to 7 years
Autos 5 years
Maintenance, repairs and betterments, including replacement of minor items
of physical properties, are charged to expense. Major additions to physical
properties are capitalized. The cost of the assets retired or sold is
credited to the asset accounts and the related accumulated depreciation is
charged to the accumulated depreciation accounts. The gain or loss from
sale or retirement of property, if any, is included in the statement of
operations.
A summary of property, plant and equipment at December 31 is as follows:
2003 2002
--------- ---------
Land $ 181 $ 181
Buildings and improvements 486 287
Plant, machinery and equipment 48,415 48,797
Rights of way 6,313 5,079
Office furniture and equipment 1,329 1,515
Autos 275 242
Construction in process 445 -
--------- ---------
57,444 56,101
Less- accumulated depreciation (10,394) (8,327)
--------- ---------
$ 47,050 $ 47,774
========= =========
2
SPECTRUM FIELD SERVICES, INC.
Notes to financial statements - continued
December 31, 2003, 2002 and 2001
(in thousands, except share data)
4. Security Deposits
Security deposits primarily represent amounts paid by the Company to the
Velma Gas Plant's electricity provider to finance the upgrade of the
electricity provider's facilities to accommodate the Company's additional
electricity requirements resulting from the addition of several new
electric compressors at the Velma Gas Plant. The electricity provider is
required to repay the amount paid by the Company over time based on the
Company's electric power consumption. Management projects such payments to
occur over a six-year period. The Company has classified the amount
expected to be received from the electricity provider within one year as a
current asset. No interest is charged on the outstanding balance.
5. Other Long-Term Assets
Other long-term assets consist primarily of loan origination fees and
deposits made for the purchase of equipment. Loan origination fees are
capitalized at cost and amortized over the term of the associated notes
using the straight-line method. The following is a summary of the Company's
other assets at December 31:
December 31, 2003 December 31, 2002
--------------------------------- ----------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
-------------- ------------ -------------- ------------
Loan origination fees (3-5 years) $ 1,122 $ (872) $ 953 $ (558)
Deposits for equipment purchases - - 750 -
Other - - 14 -
-------- -------- -------- --------
Total $ 1,122 $ (872) $ 1,717 $ (558)
======== ======== ======== ========
6. Long-Lived Assets
The Company periodically evaluates whether events and circumstances have
occurred that indicate the remaining estimated useful life of long-lived
assets may warrant revision or that the remaining balance of long-lived
assets may not be recoverable. When factors indicate that long-lived assets
should be evaluated for possible impairment, the Company uses an estimate
of the related operation's undiscounted cash flows over the remaining life
of the assets in measuring whether the assets are recoverable. When
undiscounted cash flows are less than book value of the assets, the
required impairment is calculated as the excess of the book value of the
assets over the discounted cash flows. Impairment charges of $0, $1,889 and
$0 were recorded for the years ended December 31, 2003, 2002 and 2001,
respectively.
3
SPECTRUM FIELD SERVICES, INC.
Notes to financial statements - continued
December 31, 2003, 2002 and 2001
(in thousands, except share data)
7. Revenue and Cost Recognition
Revenues and costs are recognized at the time the natural gas is processed
and the natural gas and natural gas liquids are delivered at the tailgate
of the plant to market. For 2003 and 2002, approximately 20% of the
Company's natural gas supply comes from one supplier.
8. Income Taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS
109), which requires an asset and liability approach to financial
accounting and reporting for income taxes. Deferred income tax assets and
liabilities are computed for those differences that have future tax
consequences using currently enacted tax laws and future rates that will
apply to the periods in which they are expected to affect taxable income.
At December 31, 2003 and 2002, the Company had net noncurrent deferred tax
assets and net noncurrent deferred tax liabilities of approximately $1,644
and $2,063, respectively. The deferred tax liabilities are primarily
generated due to the difference between depreciation calculated for
financial reporting and income tax purposes. The deferred tax assets relate
primarily to net operating loss carryforwards and recognition of an
impairment loss for financial reporting purposes in 2002. At December 31,
2003, the Company has net operating loss carryforwards of approximately
$14,700, which will begin to expire in 2022. No valuation allowance has
been recorded against the Company's deferred tax asset as management
expects future taxable income will be sufficient to utilize the Company's
net operating loss carryforwards.
The Company's 2003 income tax benefit consists of a current income tax
benefit of $614 and a deferred income tax benefit of $3,689. The Company's
2002 income tax benefit consists of a current income tax benefit of $696
and a deferred income tax expense of $196. The Company's 2001 income tax
provision consists of a current income tax benefit of $193 and a deferred
income tax expense of $1,870. The effective tax rate differs from the
enacted federal income tax rate primarily due to state income taxes and tax
credits.
9. Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Significant
estimates include, but are not limited to, estimating accrued revenue and
producer payments, evaluating the realizability of long-lived assets, and
estimating the fair value of derivatives. Actual results could differ from
those estimates.
4
SPECTRUM FIELD SERVICES, INC.
Notes to financial statements - continued
December 31, 2003, 2002 and 2001
(in thousands, except share data)
10. Reclassifications
Certain reclassifications of previously reported amounts for 2002 and 2001
have been made to conform with the 2003 presentation format. These
reclassifications had no impact on net loss.
11. Concentration of Credit Risk
The Company extends trade credit to various companies in the natural gas
and natural gas liquids market in the normal course of business. In 2003
and 2002, respectively, the Company had two primary customers that
accounted for approximately 87% and 96% of the Company's sales and 80% and
83% of the Company's accounts receivable at December 31, 2003 and 2002.
During 2001, the Company had three primary customers (one of which was a
shareholder of the Company through February 28, 2001). In 2001, sales to
three customers accounted for approximately 97% of the Company's sales.
Management believes the credit worthiness of its customers mitigates the
concentration risk.
12. Derivative Instruments
The Company applies the provisions of Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities (SFAS 133). SFAS 133 requires each derivative instrument to be
recorded in the balance sheet as either an asset or liability measured at
fair value. Changes in a derivative's fair value are recognized currently
in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the statement of operations.
Companies must formally document, designate, and assess the effectiveness
of transactions that receive hedge accounting.
13. Restricted Common Stock
The Company has granted restricted common stock to certain key employees.
The Company applies fixed plan accounting in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees.
Accordingly, the Company records the issuance of restricted stock as an
increase to equity with a corresponding offset to deferred compensation
(presented as a reduction in equity on the balance sheet). The deferred
compensation is reduced by recording compensation expense over the vesting
period.
14. Recently Issued Accounting Pronouncements
The Company accounts for expected future costs associated with its
obligation to perform site reclamation and dismantle facilities of
abandoned plants and pipelines under Statement of Financial Accounting
Standards (SFAS) No. 143, Accounting for Asset Retirement Obligations. If a
reasonable estimate of the fair value of an abandonment obligation can be
made, SFAS 143 requires the Company to record a liability (an asset
5
SPECTRUM FIELD SERVICES, INC.
Notes to financial statements - continued
December 31, 2003, 2002 and 2001
(in thousands, except share data)
retirement obligation or ARO) on the balance sheets in other noncurrent
liabilities and to capitalize the asset retirement cost in the period in
which the retirement obligation is incurred. In general, the amount of an
ARO and the associated costs capitalized will be equal to the estimated
future cost to satisfy the abandonment obligation using current prices
after discounting the future cost back to the date that the abandonment
obligation was incurred using the credit-adjusted risk-free rate for the
Company. After recording these amounts, the ARO will be accreted to its
future estimated value using the credit-adjusted risk-free rate and the
additional capitalized costs will be depreciated on a straight-line basis
over the productive life of the related assets. The Company has not
recorded an asset retirement obligation as of December 31, 2003, as
management believes the amount to be immaterial to the Company's financial
statements.
In April 2002, the FASB issued SFAS No. 145, Recission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. Under the provisions of SFAS No. 145, gains and losses from
the extinguishment of debt generally will no longer be classified as
extraordinary items in the statement of operations. The provisions of SFAS
No. 145 related to the extinguishment of debt become effective for the
Company beginning in 2003. The adoption did not have a material impact on
the Company's financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities, which requires companies to recognize
costs associated with exit or disposal activities when they are incurred
rather than at the date of a commitment to an exit or disposal plan.
Examples of costs covered by the standard include lease termination costs
and certain employee severance costs that are associated with a
restructuring, discontinued operation, plant closing, or other exit or
disposal activity. SFAS 146 is effective for fiscal years beginning after
December 31, 2002, with early application encouraged. The Company adopted
this standard January 1, 2003. The adoption did not have a material impact
on the Company's financial position or results of operations.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure - an amendment of FAS 123. The
standard provides additional transition guidance for companies that elect
to voluntarily adopt the accounting provisions of SFAS No. 123, Accounting
For Stock-Based Compensation. SFAS No. 148 does not change the provisions
of SFAS No. 123 that permit entities to continue to apply the intrinsic
value method of APB 25, Accounting for Stock Issued to Employees. The
adoption of SFAS No. 148 did not have a material impact on the Company's
financial position or results of operations.
In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45
requires that upon the issuance of guarantees, the guarantor must recognize
a liability for the fair value of the obligations it assumes under the
guarantee. Liability recognition is required on a prospective basis for
6
SPECTRUM FIELD SERVICES, INC.
Notes to financial statements - continued
December 31, 2003, 2002 and 2001
(in thousands, except share data)
that are made or modified after December 31, 2002. The adoption of FIN 45
had no impact on the Company's financial position or results of operations.
In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities, an interpretation of ARB 51.
The primary objectives of FIN 46 are to provide guidance on the
identification of entities for which control is achieved through means
other than through voting rights (variable interest entities or VIEs) and
how to determine when and which business enterprise should consolidate the
VIE. This new model for consolidation applies to an entity which either (1)
the equity investors, if any, do not have a controlling financial interest
or (2) the equity investment at risk is insufficient to finance that
entity's activities without receiving additional subordinated financial
support from other parties. The adoption of this standard did not have any
impact on the Company's financial position or results of operations.
In April 2003, the FASB issued Statement No. 149, Amendment of Statement
133 on Derivative Instruments and Hedging Activities. SFAS 149 amends and
clarifies financial accounting and reporting for derivative instruments
embedded in other contracts (collectively referred to as derivatives) and
for hedging activities under SFAS 133. SFAS 149 is effective for contracts
entered into or modified after June 30, 2003, and for hedging relationships
designated after June 30, 2003. The Company adopted SFAS 149 as of July 1,
2003. The adoption of SFAS 149 did not have a material impact on the
Company's financial position or results of operations.
C - DERIVATIVE INSTRUMENTS
The Company entered into certain financial swap instruments, some of which
settled during the years ended December 31, 2003 and 2002, that are
designated as cash flow hedging instruments in accordance with SFAS 133.
The maturities of the instruments outstanding at December 31, 2003, are
less than one year. The swap instruments are contractual agreements to
exchange obligations of money between the buyer and seller of the
instruments as natural gas volumes during the pricing period are sold. The
swaps are tied to a set fixed price for the seller and floating price
determinants for the buyer priced on certain indices at the end of the
relevant trading period. The Company entered into these instruments to
hedge the forecasted gas plant residue sales to variability in expected
future cash flows attributable to changes in natural gas prices. For the
swaps that were settled during the year ended December 31, 2003, the
Company reclassified into earnings a before-tax loss of $2,086, that was
previously reported in accumulated other comprehensive loss. For the swaps
that were settled during the year ended December 31, 2002, the Company
reclassified into earnings a before-tax gain of $12, that was previously
reported in accumulated other comprehensive income (loss).
The Company entered into several swaps that were designed to hedge natural
gas liquids prices during 2003 and 2002 that did not meet specific hedge
accounting criteria. The Company recognized a before-tax loss of $254 and
$189 related to these swaps during the years ending December 31, 2003 and
2002, respectively.
7
SPECTRUM FIELD SERVICES, INC.
Notes to financial statements - continued
December 31, 2003, 2002 and 2001
(in thousands, except share data)
D - LONG-TERM DEBT
A summary of long-term debt at December 31 is as follows:
2003 2002
---------- ----------
Senior Term Note payable to a bank, interest payable quarterly at LIBOR
or the bank's reference rate plus an applicable margin based on the
Company's leverage ratio (interest rate of 4.46% at December 31,
2003), quarterly principal payments of approximately $1,000 through
June 30, 2005, with the remaining balance due July 2005.
$ 18,850 $ 21,850
Advancing Term Loan payable to a bank entered into July 1, 2003,
interest payable quarterly at LIBOR plus 3.25% (interest rate of
4.71% at December 31, 2003), quarterly principal payments of $230
through June 30, 2005, with balance due July 2005. 5,170 -
Subordinated notes payable to shareholders, interest payable quarterly at
8.00%, outstanding principal due in July 2007. 15,603 14,415
$12,000 revolving line of credit, interest payable monthly at PRIME
plus .75% or the bank's reference rate plus an applicable margin
based on the Company's leverage ratio (interest rate of 4.75% at
December 31, 2003), outstanding principal due in July 2005. 4,208 1,650
Other 281 361
---------- ----------
44,112 38,276
Less- current maturities 4,995 3,076
---------- ----------
$ 39,117 $ 35,200
========== ==========
Substantially all of the Company's assets are pledged under these loan
agreements. The terms of these agreements place certain financial and
operating covenants on the Company, the most restrictive being a
debt-to-capitalization ratio and a fixed charge ratio. The Company was in
compliance with all covenants at December 31, 2003.
At December 31, 2003, the Company entered into an agreement to modify the
terms of the revolving line of credit. Per this agreement, the amount
available to the Company under the line of credit is increased to $12,000.
However, if the Company does not consummate a sale of all or substantially
all of the Company's assets by June 30, 2004, the total amount available
under the line of credit is reduced to $6,000 and any amount owed by the
Company at June 30, 2004, over $6,000 must be repaid to the bank in an
amount not to exceed $1,800. The remaining balance will be due in July
2005.
8
SPECTRUM FIELD SERVICES, INC.
Notes to financial statements - continued
December 31, 2003, 2002 and 2001
(in thousands, except share data)
On July 23, 2002, the Company borrowed an additional $3,515 and issued
subordinated notes to shareholders. In 2003 and 2002, the Company issued
additional subordinated notes to its shareholders in lieu of making cash
interest payments. Such notes totaled $1,188 and $946 during 2003 and 2002,
respectively. The transactions are reflected as noncash financing
activities on the Company's statement of cash flows.
The future maturities of long-term debt at December 31, 2003, are as
follows:
2004 $ 4,995
2005 23,394
2006 81
2007 15,642
---------
$ 44,112
=========
E - COMMITMENTS AND CONTINGENCIES
1. Leases
The Company's corporate activities are conducted from leased office
facilities located in Tulsa, Oklahoma. The Company also leases certain
machinery, equipment and automobiles used in its operations.
Future minimum rental payments required under noncancelable operating
leases for each of the years ended December 31 are as follows:
2004 $ 80
2005 3
2006 1
---------
$ 84
=========
Rental expense was approximately $399, $444 and $496 for the years ended
December 31, 2003, 2002 and 2001, respectively.
2. Letters of Credit
At December 31, 2003, the Company has four outstanding letters of credit in
favor of various parties totaling $1,792. The letters of credit expire at
various times in 2004 and 2005.
3. Legal Proceedings
At December 31, 2003, the Company is party to various legal proceedings
incidental to its business. Certain claims have been filed or are pending
against the Company. In one matter, the Company has been named as a
9
SPECTRUM FIELD SERVICES, INC.
Notes to financial statements - continued
December 31, 2003, 2002 and 2001
(in thousands, except share data)
co-defendant in a lawsuit in which certain royalty owners of the Company's
co-defendant allege that the Company has been purchasing gas at below
market prices. The gas involved in this legal proceeding represents a very
small portion of the gas purchased by the Company. The Company plans on
defending itself vigorously. If the plaintiffs are ultimately successful,
the Company believes it has the ability to seek indemnification from its
co-defendant. As the lawsuit is in preliminary stages, management is unable
to assess the likelihood of an unfavorable outcome or estimate the amounts,
if any, that will ultimately be payable. Accordingly, no accrual has been
made in the Company's balance sheet as of December 31, 2003. In the opinion
of management, the resolution of various legal proceedings will not have a
material effect on the financial position or results of operations of the
Company.
On November 10, 2003, the Company settled a lawsuit filed against the
Company by a former shareholder. The settlement agreement requires the
Company to pay the former shareholder $1,820. At December 31, 2003, the
Company has recorded an accrual of $1,820, which is included in accounts
payable in the balance sheet and other expense in the statement of
operations. The amount was paid in January 2004.
On March 9, 2004, the Oklahoma Tax Commission (OTC) filed a petition
against the Company alleging that the Company underpaid gross production
taxes beginning in June 2000. The OTC is seeking a settlement of $5,000
plus interest and penalties. The Company plans on defending itself
vigorously. As the lawsuit is in preliminary stages, management is unable
to assess the likelihood of an unfavorable outcome or estimate the amounts,
if any, that will ultimately be payable. Accordingly, no accrual has been
made in the Company's balance sheet as of December 31, 2003.
4. Employment Agreements
The Company had outstanding agreements with two key employees to provide
severance payments to those employees upon the occurrence of certain
triggering events, including the sale of the Company's assets, a merger, or
liquidation of the Company. Termination of both employees will result in a
liability of between $142 and $229.
F - COMMON AND PREFERRED STOCK
Each share of Series A preferred stock is due quarterly dividends payable
in arrears at a rate of 8% per Series A share beginning September 30, 2000.
During 2001, the Company paid $322 of dividends to preferred stockholders
representing dividends for the first two quarters of the year. Dividends
for the last two quarters of 2001 and all of 2002 and 2003 have been
declared but not paid and are recorded as dividends payable in the balance
sheet. Additionally, each share is redeemable for cash at the option of the
shareholder upon a change of control at a price equal to the original price
paid for the shares plus any accrued and unpaid dividends. The shares of
Series A preferred stock shall, with respect to dividend rights and rights
upon liquidation, receive preference over any common stock.
10
SPECTRUM FIELD SERVICES, INC.
Notes to financial statements - continued
December 31, 2003, 2002 and 2001
(in thousands, except share data)
1. Incentive Stock Plan and Stock Option Plan
The Company adopted the Spectrum Field Services, Inc. 2000 Incentive Stock
Plan (the Plan) in order to attract, motivate and retain quality employees
and to encourage valued employees to have a proprietary interest in the
Company. Under the Plan, the Company may issue to selected employees
Non-Qualified Stock Options, Incentive Stock Options, Stock Appreciation
Rights, Restricted Stock, Performance Units or Performance Shares, or
Phantom Stock Rights. The Company has reserved 222,222 shares of common
stock for issuance under the Plan.
During 2000, the Company granted key employees 211,110 shares of restricted
common stock valued at $665 when issued ($3.15 per share), as determined by
management. The employees vest in the restricted stock ratably over a
four-year period beginning in 2001. As vesting occurs, the Company will
reverse the deferred compensation and charge compensation expense equal to
the estimated fair value of the vested shares at the time of the grant.
During 2002, the Company entered into agreements with three officers
holding unvested restricted common shares. According to the agreements, the
Company accelerated the vesting of some shares and repurchased all of the
officers' vested shares for $320. In addition, all remaining unvested
shares were cancelled for those officers. The Company reversed $140 of
deferred compensation related to the cancellation of the unvested shares in
2002 as a result.
During January 2003, the Company granted 10,000 shares of restricted common
stock to an employee. The stock at the time of grant was valued at $3.15,
which represented management's estimate of the fair value of the restricted
stock on the grant date. This grant vests 75% in 2003 and the remaining 25%
in 2004.
The Company recorded $59, $289 and $166 of expense in 2003, 2002 and 2001,
respectively, related to the vesting of restricted common stock. As of
December 31, 2003, 54,444 shares of restricted common stock are
outstanding.
In 2002, the Company granted certain stock options to two key employees of
the Company. The options will vest if a qualified triggering event occurs.
A triggering event is determined to be the earlier occurrence of (i) the
date of an initial public offering of the Company's common stock, (ii) the
sale of all or substantially all of the assets of the Company or (iii)
immediately before (a) the sale of all the outstanding common stock of the
Company by the holders thereof or (b) the merger of the Company or similar
business combination with another entity in which the Company is not the
survivor.
The number of options granted under the two agreements was 111,110. At
December 31, 2003 and 2002, no options were vested as a triggering event
had not occurred. The exercise price of the options is $1.00 per share. The
options granted are accounted for using fixed plan accounting in accordance
11
SPECTRUM FIELD SERVICES, INC.
Notes to financial statements - continued
December 31, 2003, 2002 and 2001
(in thousands, except share data)
with APB No. 25 as management determined that both the exercise price and
the number of shares under option that will eventually vest were known at
the grant date. The intrinsic value of the options was determined to be
$239 at the grant date based on management's best estimate of the fair
value of the Company's shares at the grant date. The Company records
compensation expense over the expected service period. As of December 31,
2003, the Company has recorded cumulative compensation expense of $74. The
remaining $165 of compensation expense will be recorded over the remaining
service period or when a triggering event occurs which causes the options
to immediately vest.
The effect of Statement of Financial Standards No. 123, Accounting for
Stock Based Compensation (SFAS 123) is not material. Therefore, the Company
has made no disclosure of the pro forma net income as if SFAS 123 had been
adopted. All options granted under the agreements expire after ten years.
Transactions in stock options are summarized as follows:
Shares
Under Option Exercise Price
------------ --------------
Outstanding at December 31, 2001 - -
Granted 111,110 $ 1.00
Exercised - -
Cancelled - -
-------
Outstanding at December 31, 2002 111,110 $ 1.00
Granted - -
Exercised - -
Cancelled - -
-------
Outstanding at December 31, 2003 111,110 $ 1.00
=======
The following is a summary of stock options outstanding as of December 31,
2003:
Options Outstanding Options Exercisable
--------------------------- ----------------------
Number Remaining Number
Exercise of Contractual of Exercise
Price Shares Life Shares Price
-------- ------ ------------ ------ --------
$ 1.00 111,110 9.0 - $ 1.00
-------
111,110
=======
2. Phantom Unit Plan
In August 2001, the Company adopted the Employee Participation Unit Plan
(the EPU Plan). Under the EPU Plan, the Company was authorized to issue
167,190 phantom units to employees from time to time at the discretion
12
SPECTRUM FIELD SERVICES, INC.
Notes to financial statements - continued
December 31, 2003, 2002 and 2001
(in thousands, except share data)
of the Board of Directors. Phantom units are designed to allow holders of
the phantom units to share in the value of the Company with the common
shareholders. Holders of phantom units had no voting or other privileges
typically available to common shareholders.
During 2002 and 2001, the Company granted 151,800 phantom units to
employees. All units granted vested ratably over a five-year period. The
participants of the EPU Plan receive benefits equal to the estimated fair
value of their vested units only upon normal retirement, disability or a
change of control. The form of the benefits to be paid under the EPU Plan
was at the discretion of the Board of Directors.
The EPU Plan met the criteria for variable plan accounting under the
provisions of APB 25. Accordingly, at each reporting period, compensation
cost was measured based on the estimated fair value of the vested phantom
units. Compensation expense (benefit) was recorded to the extent that the
fair value of vested units increased (decreased) from the previous
reporting period. The Company recorded $112 of compensation expense related
to the outstanding phantom units during 2001. During 2002, the Company
cancelled the EPU Plan and paid $54 to the participants of the EPU Plan,
which was recorded as expense. Additionally, the Company reversed the
previously recognized compensation expense of $112.
3. Shareholders' Commitment
On March 23, 2001, two shareholders of the Company signed an agreement
committing to purchase up to $6,500 of additional debt or equity securities
if requested to do so by the holders of the senior debt. The agreements
were amended in 2003 and 2002 to $5,500 and $3,000, respectively. Such
request can only occur if an event of default (as defined in the credit
agreement) has occurred and is continuing. As of December 31, 2003, this
commitment was $4,500 and expires on June 30, 2004.
On July 23, 2002, the Company received additional capitalization from the
equity owners. The Company issued 545,529 shares of common stock ($.01 par
value) and 2,969,471 shares of Series A preferred stock ($.01 par value) in
exchange for $3,514 of cash. The Company also issued additional
subordinated notes to certain shareholders of $3,515. The Company pays a
commitment fee to the shareholders related to the agreements. Fees paid to
the shareholders totaled approximately $110, $60 and $130 in 2003, 2002 and
2001.
G - BENEFIT PLANS
The Company sponsors a defined contribution retirement plan. The Company
makes discretionary matching contributions to the plan. The Company
expensed contributions of approximately $84, $151 and $181 for the years
ended December 31, 2003, 2002 and 2001, respectively.
13
SPECTRUM FIELD SERVICES, INC.
Notes to financial statements - continued
December 31, 2003, 2002 and 2001
(in thousands, except share data)
H - CHANGE IN ACCOUNTING ESTIMATE
In December 2002, the Company began a project to replace certain
gas-powered compressors with electric-powered compressors at its natural
gas processing plant in Velma, Oklahoma. The project was completed in
October 2003. In 2002, management revised the estimated useful lives of the
previous gas-powered compressors to reflect usage of those assets through
July 2003. The Company treated the change in useful life as a change in
accounting estimate. Accordingly, the Company revised its depreciation
calculation on a prospective basis from the date the project was probable,
which was November 30, 2002. As a result, the Company recorded additional
depreciation expense of $1,342 during 2002 and depreciated the remaining
net book value of $9,868 in 2003. Additionally, the Company accelerated
depreciation in 2003 on certain other compressors that were not originally
part of this project. This resulted in additional depreciation of $497.
In April 2003, the Company began a project to replace the Sulphur Recovery
Unit (SRU) at its natural gas processing plant in Velma, Oklahoma.
Management revised the estimated useful life of the SRU to reflect usage of
the asset through October 2003. The Company treated the change in useful
life as a change in accounting estimate. As a result, the Company
depreciated the remaining net book value of $3,287 in 2003. The project was
completed in March 2004.
I - RELATED PARTY TRANSACTIONS
During 2003, the Company had sales to an affiliate of approximately $687,
which is recorded as accrued sales at December 31, 2003. During 2002, there
were no sales to affiliates.
During part of 2001, one of the Company's primary customers was a
shareholder. All transactions between the Company and the shareholder were
at prevailing market rates. During 2001, the Company had sales to the
shareholder of approximately $15,000. At December 31, 2001, no amounts were
due from the shareholder.
During 2003, 2002 and 2001, the Company had sales of condensate to an
affiliate of approximately $453, $1,663 and $2,100, respectively.
J - SUBSEQUENT EVENTS
On June 10, 2004, the Company, along with Energy Spectrum Partners II LP,
Energy Spectrum Partners III LP and other various sellers, entered into a
Securities Purchase Agreement with Atlas Pipeline Operating Partnership,
L.P. to sell the outstanding capital stock of the Company for a total
purchase price of $140,000 adjusted for changes in net working capital,
less amounts owed for long-term debt and adjusted for other transaction
costs.
At June 30, 2004, the Company entered into an agreement to modify the terms
of the revolving line of credit agreement. However, if the Company does not
consummate a sale of all or substantially all of the Company's assets by
August 31, 2004, the total amount available shall be automatically and
permanently reduced to $6,000 effective September 1, 2004. The remaining
balance will be due in July 2005.
14
UNAUDITED FINANCIAL STATEMENTS
These unaudited interim financial statements as of March 31, 2004 and
for the three month periods ended March 31, 2004 and 2003 were prepared by
Spectrum Field Services, Inc. (Spectrum) and should be read in conjunction with
the audited financial statements contained in this Form 8-K, which include
Spectrum's audited balance sheets as of December 31, 2003 and 2002 and the
related statements of operations, comprehensive income (loss), changes in
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2003.
SPECTRUM FIELD SERVICES, INC.
Unaudited Interim Balance Sheet
March 31, 2004
(in thousands, except share data)
March 31, 2004
--------------
ASSETS
CURRENT ASSETS:
Cash $ 0
Accounts receivable 9,430
Inventories 334
Prepaid expenses and other 115
Security deposits 328
Deferred income taxes 10
--------
Total current assets 10,217
PROPERTY, PLANT AND EQUIPMENT, net 49,596
DEFERRED INCOME TAXES 1,645
SECURITY DEPOSITS 1,417
OTHER ASSETS, net 196
--------
Total assets $ 63,071
========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 2,457
Accrued producer payables 7,577
Accrued liabilities 25
Hedge liabilities 706
Interest Payable 29
Current maturities of long-term debt 4,992
--------
Total current liabilities 15,786
LONG-TERM DEBT, less current maturities 42,433
PREFERRED DIVIDENDS PAYABLE 2,392
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Preferred stock, $0.01 par value; 8.0% cumulative; 20,000,000 shares
authorized; 13,856,047 shares of Series A preferred stock issued; 11,052,304
shares outstanding 13,856
Common stock, $0.01 par value; 5,000,000 shares authorized; 2,722,194 shares
issued; 2,084,891 shares outstanding 27
Additional paid-in capital 3,149
Accumulated deficit (4,209)
Treasury stock - preferred, at cost (3,758)
Treasury stock - common, at cost (6,252)
Deferred compensation (43)
Accumulated other comprehensive loss, net of tax of $192 (310)
--------
Total shareholders' equity 2,460
--------
Total liabilities and shareholders' equity $ 63,071
========
The accompanying notes are an integral part of this balance sheet
SPECTRUM FIELD SERVICES, INC.
Unaudited Interim Statements of Operations and Accumulated Deficit
For the three months ended March 31, 2004 and 2003
(In thousands)
2004 2003
-------- --------
SALES OF NATURAL GAS AND LIQUIDS $ 27,785 $ 28,378
COST OF NATURAL GAS AND LIQUIDS 21,951 22,944
-------- --------
Gross profit 5,834 5,434
OPERATING EXPENSE 1,115 1,434
GENERAL AND ADMINISTRATIVE EXPENSE 673 489
DEPRECIATION 740 4,772
-------- --------
INCOME (LOSS) FROM OPERATIONS 3,306 (1,261)
INTEREST EXPENSE 778 619
OTHER EXPENSE, net 378 87
-------- --------
INCOME (LOSS) BEFORE INCOME TAXES 2,150 (1,967)
INCOME TAX PROVISION (BENEFIT) 816 (757)
-------- --------
NET INCOME (LOSS) 1,334 (1,210)
PREFERRED STOCK DIVIDENDS 264 221
-------- --------
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS 1,070 (1,431)
RETAINED EARNINGS (ACCUMULATED DEFICIT),
BEGINNING OF PERIOD (5,279) 1,729
-------- --------
RETAINED EARNINGS (ACCUMULATED DEFICIT),
END OF PERIOD $ (4,209) $ 298
======== ========
The accompanying notes are an integral part of these financial statements.
SPECTRUM FIELD SERVICES, INC.
Unaudited Interim Statements of Comprehensive Income (Loss)
For the three months ended March 31, 2004 and 2003
(In thousands)
2004 2003
------- -------
NET INCOME (LOSS) $ 1,334 $(1,210)
OTHER COMPREHENSIVE INCOME (LOSS):
Change in value of derivative instruments, net of tax of
$(159) and $(146) in 2004 and 2003, respectively (257) (237)
------- -------
COMPREHENSIVE INCOME (LOSS) $ 1,077 $(1,447)
======= =======
RECONCILIATION OF ACCUMULATED OTHER COMPREHENSIVE LOSS:
Balance, beginning of period $ (53) $ (329)
Current period reclassification to earnings, net of tax
of $5 and $374 in 2004 and 2003, respectively 8 611
Current period change, net of tax of $(164) and
$(525) in 2004 and 2003, respectively
(265) (848)
------- -------
Balance, end of period $ (310) $ (566)
======= =======
The accompanying notes are an integral part of these financial statements.
SPECTRUM FIELD SERVICES, INC.
Unaudited Interim Statements of Cash Flows
For the three months ended March 31, 2004 and 2003
(In thousands)
2004 2003
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income $ 1,334 $(1,210)
Adjustments to reconcile net loss to net cash
provided by operating activities-
Depreciation and amortization of loan origination fees 853 4,845
Noncash compensation expense -- 2
Unrealized (gain) loss on ineffective hedges 109 (110)
Noncash interest expense 312 288
Changes in assets and liabilities-
Accounts receivable (957) (5,386)
Inventories (155) (206)
Prepaid expenses and other (7) 35
Interest Payable 28 --
Income tax receivable -- 415
Other assets (8) (744)
Accounts payable (2,342) (452)
Accrued producer payables 1,110 4,976
Accrued liabilities (104) (134)
------- -------
Net cash provided by operating activities 173 2,319
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (3,295) (2,432)
Proceeds from sale of assets 10 120
------- -------
Net cash used in investing activities (3,285) (2,312)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term debt (1,251) (518)
Borrowings under line of credit 4,250 1,500
Payments on line of credit -- (500)
Loan origination fees (60) --
------- -------
Net cash provided by financing activities 2,939 482
------- -------
NET CHANGE IN CASH (173) 489
CASH, beginning of period 173 478
------- -------
CASH, end of period $ 0 $ 967
======= =======
SUPPLEMENTAL INFORMATION:
Cash paid for interest $ 340 $ 242
======= =======
Cash paid for income taxes $ -- $ --
======= =======
Noncash financing activity - paid in kind interest $ 312 $ 288
======= =======
Noncash financing activity - issuance of restricted common stock $ -- $ 2
======= =======
The accompanying notes are an integral part of these financial statements.
SPECTRUM FIELD SERVICES, INC.
NOTES TO UNAUDITED INTERIM FINANCIAL STATEMENTS
For the three months Ended March, 31, 2004 and 2003
(in thousands, except share data)
A - BASIS OF PRESENTATION
The interim financial statements of Spectrum Field Services, Inc. (the
Company) as of March 31, 2004 and for the three month periods ended March
31, 2004 and 2003 have been prepared in accordance with accounting
principles generally accepted in the United States of America and on the
same basis as the audited financial statements for the year ended December
31, 2003. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles
generally accepted in the United States of America have been condensed or
omitted pursuant to the rules and regulations of the Securities and
Exchange Commission. However, in the opinion of management, these interim
financial statements include all the necessary adjustments to fairly
present the results of the interim periods presented. The results of
operations for the three month period ended March 31, 2004 may not
necessarily be indicative of the results of operations for the full year
ending December 31, 2004.
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Significant
estimates include, but are not limited to, estimating accrued revenue and
producer payments, evaluating the realizability of long-lived assets, and
estimating the fair value of derivatives. Actual results could differ from
those estimates.
B - OPERATIONS AND ORGANIZATION
The Company was incorporated in Delaware on May 8, 2000. The Company was
formed to acquire and operate natural gas processing plants and gathering
systems in Velma, Oklahoma and Kingman, Kansas.
On August 1, 2003, the Company sold all of the assets of the Company's
natural gas processing plant located in Kingman, Kansas for $1,200. The
value of the plant was written down by $1,889 as of December 31, 2002, in
contemplation of the transaction in accordance with Statement of Financial
Accounting Standards No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (SFAS 144).
C- SIGNIFICANT ACCOUNTING POLICIES AND BALANCE SHEET DETAIL
1. ACCOUNTS RECEIVABLE
The Company grants credit to its customers for the purchase of natural gas
and natural gas liquids. Accounts receivable consist of amounts billed to
customers and an accrual for sales not yet billed. The Company writes off
accounts receivable when management believes the receivables to be
uncollectible. A summary of accounts receivable at March 31, 2004 is as
follows:
Customer receivables $ 73
Accrued sales 9,357
--------
$ 9,430
========
2. Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation is provided
using the straight-line method over the estimated useful lives of the
assets as follows:
Buildings and improvements 7 to 39 years
Plant, machinery and equipment 10 to 20 years
Rights of way 20 years
Office furniture and equipment 5 to 7 years
Autos 5 years
Maintenance, repairs and betterments, including replacement of minor items
of physical properties, are charged to expense. Major additions to physical
properties are capitalized. The cost of the assets retired or sold is
credited to the asset accounts and the related accumulated depreciation is
charged to the accumulated depreciation accounts. The gain or loss from
sale or retirement of property, if any, is included in the statement of
operations.
A summary of property, plant and equipment at March 31, 2004, is as
follows:
Land $ 181
Buildings and improvements 486
Plant, machinery and equipment 47,728
Rights of way 6,441
Office furniture and equipment 1,321
Autos 300
Construction in process 445
---------
56,902
Less- accumulated depreciation (7,306)
---------
$ 49,596
=========
3. Security Deposits
Security deposits primarily represent amounts paid by the Company to the
Velma Gas Plant's electricity provider to finance the upgrade of the
electricity provider's facilities to accommodate the Company's additional
electricity requirements resulting from the addition of several new
electric compressors at the Velma Gas Plant. The electricity provider is
required to repay the amount paid by the Company over time based on the
Company's electric power consumption. Management projects such payments to
occur over a six-year period. The Company has classified the amount
expected to be received from the electricity provider within one year as a
current asset. No interest is charged on the outstanding balance.
4. Other Long-Term Assets
Other long-term assets consist of loan origination fees. Loan origination
fees are capitalized at cost and amortized over the term of the associated
notes using the straight-line method. The following is a summary of the
Company's other assets at March 31, 2004:
Gross Carrying Accumulated
Amount Amortization
-------------- ------------
Loan origination fees (3-5 years) $ 1,122 $ (926)
======= =======
5. Long-Lived Assets
The Company periodically evaluates whether events and circumstances have
occurred that indicate the remaining estimated useful life of long-lived
assets may warrant revision or that the remaining balance of long-lived
assets may not be recoverable. When factors indicate that long-lived assets
should be evaluated for possible impairment, the Company uses an estimate
of the related operation's undiscounted cash flows over the remaining life
of the assets in measuring whether the assets are recoverable. When
undiscounted cash flows are less than book value of the assets, the
required impairment is calculated as the excess of the book value of the
assets over the discounted cash flows.
6. Concentration of Credit Risk
The Company extends trade credit to various companies in the natural gas
and natural gas liquids market in the normal course of business. For the
three month periods ended March 31, 2004 and 2003, the Company had two
primary customers that accounted for approximately 79% and 92% of the
Company's sales and 73% and 83% of the Company's accounts receivable.
Management believes the credit worthiness of its customers mitigates the
concentration risk.
7. Derivative Instruments
The Company applies the provisions of Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Instruments and Hedging
Activities (SFAS 133). SFAS 133 requires each derivative instrument to be
recorded in the balance sheet as either an asset or liability measured at
fair value. Changes in a derivative's fair value are recognized currently
in earnings unless specific hedge accounting criteria are met. Special
accounting for qualifying hedges allows a derivative's gains and losses to
offset related results on the hedged item in the statement of operations.
Companies must formally document, designate, and assess the effectiveness
of transactions that receive hedge accounting.
8. Restricted Common Stock
The Company has granted restricted common stock to certain key employees.
The Company applies fixed plan accounting in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees.
Accordingly, the Company records the issuance of restricted stock as an
increase to equity with a corresponding offset to deferred compensation
(presented as a reduction in equity on the balance sheet). The deferred
compensation is reduced by recording compensation expense over the vesting
period.
D - DERIVATIVE INSTRUMENTS
The Company entered into certain financial swap instruments, some of which
settled during the three months ended March 31, 2004 and 2003 that are
designated as cash flow hedging instruments in accordance with SFAS 133.
The maturities of the instruments outstanding at March 31, 2004, are less
than one year. The swap instruments are contractual agreements to exchange
obligations of money between the buyer and seller of the instruments as
natural gas volumes during the pricing period are sold. The swaps are tied
to a set fixed price for the seller and floating price determinants for the
buyer priced on certain indices at the end of the relevant trading period.
The Company entered into these instruments to hedge the forecasted gas
plant residue sales to variability in expected future cash flows
attributable to changes in natural gas prices. For the swaps that were
settled during the three months ended March 31, 2004, the Company
reclassified into earnings a before-tax loss of $13, that was previously
reported in accumulated other comprehensive loss. For the swaps that were
settled during the three months ended March 31, 2003, the Company
reclassified into earnings a before-tax loss of $985, that was previously
reported in accumulated other comprehensive income (loss).
The Company entered into several swaps that were designed to hedge natural
gas liquids prices during the three months ended March 31, 2004 and 2003
that did not meet specific hedge accounting criteria. The Company
recognized a before-tax loss of $378 and $87 related to these swaps during
the three months ended March 31, 2004 and 2003, respectively.
E - LONG-TERM DEBT
A summary of long-term debt at March 31, 2004 is as follows:
Senior Term Note payable to a bank, interest payable quarterly at LIBOR
or the bank's reference rate plus an applicable margin based on the
Company's leverage ratio (interest rate of 4.09% at March 31, 2004),
quarterly principal payments of approximately $1,000 through June 30,
2005, with the remaining balance due July 2005. $ 17,850
Advancing Term Loan payable to a bank entered into July 1, 2003, interest
payable quarterly at LIBOR plus 3.25% (interest rate of 4.34% at March 31,
2004), quarterly principal payments of $230 through June 30, 2005, with
balance due July 2005. 4,940
Subordinated notes payable to shareholders, interest payable quarterly at
8.00%, outstanding principal due in July 2007. 15,915
$12,000 revolving line of credit, interest payable monthly at PRIME plus .75%
or the bank's reference rate plus an applicable margin based on the
Company's leverage ratio (interest rate of 4.75% at March 31, 2004) on
balance of $958 and interest payable monthly at LIBOR plus 3% (interest
rate of 4.12% at March 31, 2004) on balance of $7,500 , outstanding
principal due in July 2005. 8,458
Other 262
----------
47,425
Less- current maturities 4,992
----------
$ 42,433
==========
Substantially all of the Company's assets are pledged under these loan
agreements. The terms of these agreements place certain financial and
operating covenants on the Company, the most restrictive being a
debt-to-capitalization ratio and a fixed charge ratio. The Company was in
compliance with all covenants at March 31, 2004.
At June 30, 2004, the Company entered into an agreement to modify the terms
of the revolving line of credit agreement. However, if the Company does not
consummate a sale of all or substantially all of the Company's assets by
August 31, 2004, the total amount available shall be automatically and
permanently reduced to $6,000 effective September 1, 2004. The remaining
balance will be due in July 2005.
The future maturities of long-term debt at March 31, 2004 are as follows:
2004 $ 4,992
2005 26,421
2006 81
2007 15,931
---------
$ 47,425
=========
F - RELATED PARTY TRANSACTIONS
During the three months ended March 31, 2004 and 2003, the Company had
residue sales to an affiliate of approximately $2,362 and $0, respectively.
During the three months ended March 31, 2004 and 2003, the Company had
sales of condensate to an affiliate of approximately $0 and $312,
respectively.
G - CONTINGENCY
On March 9, 2004, the Oklahoma Tax Commission (OTC) filed a petition
against the Company alleging that the Company underpaid gross production
taxes beginning in June 2000. The OTC is seeking a settlement of $5,000
plus interest and penalties. The Company plans on defending itself
vigorously. As the lawsuit is in preliminary stages, management is unable
to assess the likelihood of an unfavorable outcome or estimate the amounts,
if any, that will ultimately be payable. Accordingly, no accrual has been
made in the Company's balance sheet as of March 31, 2004.
H - CHANGE IN ACCOUNTING ESTIMATE
In December 2002, the Company began a project to replace certain
gas-powered compressors with electric-powered compressors at its natural
gas processing plant in Velma, Oklahoma. The project was completed in
October 2003. In 2002, management revised the estimated useful lives of the
previous gas-powered compressors to reflect usage of those assets through
July 2003. The Company treated the change in useful life as a change in
accounting estimate. Accordingly, the Company revised its depreciation
calculation on a prospective basis from the date the project was probable,
which was November 30, 2002.
J - SUBSEQUENT EVENT
On June 10, 2004, the Company, along with Energy Spectrum Partners II LP,
Energy Spectrum Partners III LP and other various sellers, entered into a
Securities Purchase Agreement with Atlas Pipeline Operating Partnership,
L.P. to sell the outstanding capital stock of the Company for a total sales
price of $140,000 adjusted for changes in net working capital and the
excess tax benefit amount, less amounts owed for long-term debt and other
long-term liabilities.