UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period ended September 30, 2001
Commission file No. 001-11769
KEY PRODUCTION COMPANY, INC.
707 Seventeenth Street, Suite 3300
Denver, Colorado 80202-3404
(303) 295-3995
Incorporated in the Employer Identification
State of Delaware No. 84-1089744
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ____
---
The number of shares outstanding of the Company's common stock as of September
30, 2001 is shown below:
Title of Class Number of Shares Outstanding
Common Stock, par value $0.25 per share 13,978,487
KEY PRODUCTION COMPANY, INC.
Table of Contents
Page
PART I
Item 1 - Financial Statements
Consolidated Statements of Income (Unaudited)
For the Three Months Ended September 30, 2001 and September 30, 2000 and
for the Nine Months Ended September 30, 2001 and September 30, 2000 3
Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 2001 and September 30, 2000 4
Consolidated Balance Sheets (Unaudited)
As of September 30, 2001 and December 31, 2000 5
Consolidated Statement of Stockholders' Equity (Unaudited)
For the Nine Months Ended September 30, 2001 6
Notes to Consolidated Financial Statements 7
Item 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations 11
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 17
PART II
Item 6 - Exhibits and Reports on Form 8-K 18
2
KEY PRODUCTION COMPANY, INC.
Consolidated Statements of Income
(Unaudited)
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
----------------------------- --------------------------
2001 2000 2001 2000
-------- ---------- -------- ---------
(In thousands, except per share data)
Revenues:
Gas sales $ 11,913 $ 15,005 $ 60,384 $ 34,749
Oil sales 9,055 11,925 29,547 32,211
Plant product sales 335 356 972 1,194
Other 28 68 85 277
--------- --------- -------- ---------
21,331 27,354 90,988 68,431
--------- --------- -------- ---------
Operating expenses:
Depreciation, depletion and
amortization 6,012 8,917 25,442 25,181
Lease operating 4,613 2,480 12,806 8,035
Production taxes 1,394 1,102 5,725 2,505
General and administrative 1,124 758 2,822 2,179
Financing costs:
Interest expense 438 1,099 1,631 3,338
Capitalized interest (282) (459) (939) (1,194)
Interest income (34) (53) (154) (134)
--------- --------- -------- ---------
13,265 13,844 47,333 39,910
--------- --------- -------- ---------
Income before income taxes 8,066 13,510 43,655 28,521
Provision for income taxes 3,106 4,999 16,458 10,553
--------- --------- -------- ---------
Net income $ 4,960 $ 8,511 $ 27,197 $ 17,968
========= ========= ======== =========
Basic earnings per share $ 0.35 $ 0.69 $ 1.95 $ 1.51
========= ========= ======== =========
Diluted earnings per share $ 0.35 $ 0.67 $ 1.90 $ 1.45
========= ========= ======== =========
Weighted average basic shares 13,978 12,302 13,972 11,934
========= ========= ======== =========
Weighted average diluted shares 14,159 12,725 14,320 12,384
========= ========= ======== =========
See accompanying notes to consolidated financial statements.
3
KEY PRODUCTION COMPANY, INC.
Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2001 and 2000
(Unaudited)
2001 2000
---------------- -------------
(In thousands)
Cash flows from operating activities:
Net income $ 27,197 $ 17,968
Adjustment to reconcile net income to net cash provided
by operating activities:
Depreciation, depletion and amortization 25,442 25,181
Deferred income taxes 13,058 5,526
Common stock issued as compensation 137 142
Amortization of unearned compensation 120 --
Income tax benefit related to stock options exercised 235 3,886
Changes in operating assets and liabilities:
(Increase) decrease in receivables 7,607 (5,807)
(Increase) decrease in prepaid expenses and other (1,044) 332
Increase (decrease) in accounts payable and
accrued expenses (7,233) 1,256
Increase in other liabilities 51 28
--------------- -------------
Net cash provided by operating activities 65,570 48,512
--------------- -------------
Cash flows from investing activities:
Oil and gas exploration and development expenditures (62,430) (38,964)
Acquisition of proved oil and gas reserves (473) (121)
Proceeds from sale of oil and gas properties 69 265
Other capital expenditures (440) (330)
--------------- -------------
Net cash used by investing activities (63,274) (39,150)
--------------- -------------
Cash flows from financing activities:
Payments on long-term debt, net (9,000) (11,000)
Payments to acquire treasury stock (11) (8)
Proceeds from issuance of common stock 380 3,972
--------------- -------------
Net cash used by financing activities (8,631) (7,036)
--------------- -------------
Net increase (decrease) in cash and cash equivalents (6,335) 2,326
Cash and cash equivalents at beginning of year 6,746 6,087
--------------- -------------
Cash and cash equivalents at end of period $ 411 $ 8,413
=============== =============
See accompanying notes to consolidated financial statements.
4
KEY PRODUCTION COMPANY, INC.
Consolidated Balance Sheets
(Unaudited)
September 30, December 31,
Assets 2001 2000
---------------- ---------------
(In thousands, except share data)
Current assets:
Cash and cash equivalents $ 411 $ 6,746
Receivables 17,421 25,028
Prepaid expenses and other 2,616 1,572
--------------- ---------------
20,448 33,346
--------------- ---------------
Oil and gas properties, on the basis of full cost accounting:
Proved properties 365,514 307,882
Unproved properties and properties under development,
not being amortized 24,578 21,284
--------------- ---------------
390,092 329,166
Less - accumulated depreciation, depletion and amortization (145,079) (120,337)
--------------- ---------------
245,013 208,829
--------------- ---------------
Other assets, net 1,665 1,979
--------------- ---------------
$ 267,126 $ 244,154
=============== ===============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 9,795 $ 16,963
Accrued exploration and development 2,764 4,726
Accrued lease operating expense and other 4,340 4,282
Current portion of long-term debt 2,500 --
--------------- ---------------
19,399 25,971
--------------- ---------------
Long-term debt 32,500 44,000
--------------- ---------------
Deferred income taxes 48,605 35,548
--------------- ---------------
Other liabilities 599 548
--------------- ---------------
Stockholders' equity:
Common stock, $.25 par value, 50,000,000 shares authorized,
14,259,621 and 14,223,775 shares issued, respectively 3,565 3,556
Paid-in capital 71,954 71,122
Unearned compensation (318) --
Retained earnings 93,710 66,513
Treasury stock at cost, 281,134 and 303,138 shares, respectively (2,888) (3,104)
--------------- ---------------
166,023 138,087
--------------- ---------------
$ 267,126 $ 244,154
=============== ===============
See accompanying notes to consolidated financial statements.
5
KEY PRODUCTION COMPANY, INC.
Consolidated Statement of Stockholders' Equity
For the Nine Months Ended September 30, 2001
(Unaudited)
Total
Common Paid-in Unearned Retained Treasury Stockholders'
Stock Capital Compensation Earnings Stock Equity
---------- ---------- --------------- ----------- ------------ -------------
(In thousands)
Balance, December 31, 2000 $ 3,556 $ 71,122 $ -- $ 66,513 $ (3,104) $ 138,087
Net income -- -- -- 27,197 -- 27,197
Common stock issued for
options exercised 10 481 -- -- -- 491
Income tax benefit related to
stock options exercised -- 235 -- -- -- 235
Common stock issued as
compensation -- 16 -- -- 62 78
Common stock reacquired (1) (174) -- -- (10) (185)
Unearned compensation
related to restricted stock awards -- 274 (438) -- 164 --
Amortization of unearned compensation -- -- 120 -- -- 120
--------- ---------- -------- ----------- ----------- -----------
Balance, September 30, 2001 $ 3,565 $ 71,954 $ (318) $ 93,710 $ (2,888) $ 166,023
========= ========== ======== =========== =========== ===========
See accompanying notes to consolidated financial statements
6
KEY PRODUCTION COMPANY, INC.
Notes to Consolidated Financial Statements
September 30, 2001
(Unaudited)
(1) Basis of Presentation
The accompanying financial statements are unaudited and were prepared from
the Company's records. Management believes these financial statements
include all adjustments necessary for a fair presentation of the Company's
financial position and results of operations. All adjustments are of a
normal and recurring nature. The Company prepared these statements on a
basis consistent with the annual audited statements and Regulation S-X.
Regulation S-X allows the Company to omit some of the footnote and policy
disclosures required by accounting principles generally accepted in the
United States of America and normally included in annual reports on Form
10-K. These interim financial statements should be read in conjunction with
the financial statements, summary of significant accounting policies and
notes in the Company's most recent annual report on Form 10-K.
The accounts of Key and its subsidiaries are presented in the accompanying
consolidated financial statements. All intercompany accounts and
transactions were eliminated in consolidation.
Management relies on estimates and assumptions to prepare financial
statements in conformity with accounting principles generally accepted in
the United States of America. Those estimates and assumptions 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.
Actual results could differ from those estimates.
Certain amounts in the accompanying consolidated financial statements for
prior periods have been reclassified to conform to the current year
presentation.
(2) Income Taxes
Income tax expense consisted of the following:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ---------------------
2001 2000 2001 2000
---------- --------- --------- ---------
Current taxes:
Federal $ (3,026) $ 3,886 $ 2,969 $ 3,886
State (168) 541 431 1,141
Deferred taxes 6,300 572 13,058 5,526
---------- --------- --------- ---------
$ 3,106 $ 4,999 $ 16,458 $ 10,553
========== ========= ========= =========
7
KEY PRODUCTION COMPANY, INC.
Notes to Consolidated Financial Statements
September 30, 2001
(Unaudited)
(3) Earnings Per Share
The calculations of basic and diluted earnings per common share for the
periods ended September 30, 2001 and 2000 are presented in the table below:
For the Three Months For the Nine Months
Ended Ended
-------------------- --------------------
2001 2000 2001 2000
--------- --------- --------- ---------
(In thousands, except per share data)
Basic earnings per share:
Income available to common
stockholders $ 4,960 $ 8,511 $ 27,197 $ 17,968
Weighted average basic shares
outstanding 13,978 12,302 13,972 11,934
Basic earnings per share $ 0.35 $ 0.69 $ 1.95 $ 1.51
Diluted earnings per share:
Income available to common
stockholders $ 4,960 $ 8,511 $ 27,197 $ 17,968
Incremental shares assuming the
exercise of stock options 181 423 348 450
Weighted average diluted shares
outstanding 14,159 12,725 14,320 12,384
Diluted earnings per share $ 0.35 $ 0.67 $ 1.90 $ 1.45
(4) Supplemental Disclosure of Cash Flow Information
For the Nine Months
Ended September 30,
------------------------
2001 2000
----------- -----------
(In thousands)
Cash paid during the period for:
Interest (net of interest capitalized of $939
and $1,194, respectively) $ 681 $ 2,145
Income taxes (net of refunds received) $ 4,417 $ 32
(5) Long-Term Debt
Key has a long-term credit agreement with a group of banks led by Banc of
America Securities LLC. The agreement specifies a maximum loan amount of
$150 million and provides that the lenders may periodically re-determine
the borrowing base depending upon the value of the Company's oil and gas
properties. Key may voluntarily select a borrowing base that is less than
the maximum value its properties would allow to reduce fees for unused
borrowing base capacity. If the borrowing base falls below the outstanding
loan amount, the banks may request repayment of the excess amount.
8
KEY PRODUCTION COMPANY, INC.
Notes to Consolidated Financial Statements
September 30, 2001
(Unaudited)
At September 30, 2001, the Company had elected to accept a borrowing base
of $90 million, of which $35 million was outstanding and $55 million was
unused and available.
The Company secured this debt with oil and gas assets owned by Key and its
subsidiaries. Key is also subject to customary covenants and restrictions
including limitations on additional borrowings and minimum working capital
and net worth maintenance requirements. Key is currently, and has been
since inception, in compliance with the covenants of the agreement.
The credit agreement has a maturity date of January 1, 2006, including a
revolving period that ends on July 1, 2002. If not amended before then, the
outstanding loan amount converts to a term loan and the Company must
commence quarterly principal payments. As such, the Company has classified
a portion of the loan as current.
(6) Write-Downs Under the Full Cost Ceiling Test Rules
Under the full cost accounting rules of the Securities and Exchange
Commission (SEC), the Company is required to review the carrying value of
its oil and gas properties on a quarterly basis. Under these rules,
capitalized costs of proved oil and gas properties, net of accumulated
depreciation, depletion and amortization, and deferred income taxes, may
not exceed the present value of estimated future net cash flows from proved
oil and gas reserves, discounted at 10 percent, plus the lower of cost or
fair value of unproved properties, as adjusted for related tax effects and
deferred tax revenues. These rules generally require pricing future oil and
gas production at the unescalated oil and gas prices in effect at the end
of each fiscal quarter and require a write-down if the "ceiling" is
exceeded. For interim financial reporting purposes, the SEC rules allow the
Company to reduce the amount of the write-down to the extent that prices
have recovered subsequent to the end of the fiscal quarter but prior to
filing the Company's Form 10-Q. A ceiling test write-down is a non-cash
charge to earnings.
Based on oil and gas prices in effect on September 30, 2001, the
unamortized cost of Key's oil and gas properties exceeded the ceiling from
its proved oil and gas reserves by approximately $57 million. However, the
Company was not required to recognize a charge against its oil and gas
properties because gas prices increased sufficiently after September 30,
2001 so that Key's unamortized costs did not exceed the ceiling.
(7) Pro Forma Financial Information - Acquisition of Columbus Energy Corp.
On December 29, 2000, the Company consummated a merger with Columbus Energy
Corp. (Columbus). In this transaction, the Company acquired all the
outstanding common stock of Columbus in a tax-free reorganization pursuant
to which Columbus became a wholly-owned subsidiary of Key.
The following unaudited pro forma financial information presents the
combined results of Key and Columbus, and was prepared as if the
acquisition had occurred at the beginning of 2000. The pro forma data
presented is based on numerous assumptions and is not necessarily
indicative of future results of operations.
9
KEY PRODUCTION COMPANY, INC.
Notes to Consolidated Financial Statements
September 30, 2001
(Unaudited)
For the Three Months For the Nine Months
Ended September 30, 2000 Ended September 30, 2000
------------------------ ------------------------
As reported Pro forma As reported Pro forma
----------- ---------- ----------- ----------
(In thousands, except per share amounts)
Revenues $ 27,354 $ 32,025 $ 68,431 $ 79,173
Net income $ 8,511 $ 9,084 $ 17,968 $ 18,892
Basic earnings per share $ 0.69 $ 0.66 $ 1.51 $ 1.42
Diluted earnings per share $ 0.67 $ 0.64 $ 1.45 $ 1.38
10
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This report contains "forward-looking statements" within the meaning of the
federal securities laws. These forward-looking statements include, among others,
statements concerning Key's outlook for the remainder of 2001 with regard to
production levels, price realizations, expenditures for exploration and
development, plans for funding operations and capital expenditures, and other
statements of expectations, beliefs, future plans and strategies, anticipated
events or trends and similar expressions concerning matters that are not
historical facts. The forward-looking statements in this report are subject to
risks and uncertainties that could cause actual results to differ materially
from those expressed or implied by the statements.
These risks and uncertainties include, but are not limited to, fluctuations in
the price we receive for oil and gas production, reductions in the quantity of
oil and gas sold due to decreased industry-wide demand and/or curtailments in
production from specific properties due to mechanical, marketing or other
problems, operating and capital expenditures that are either significantly
higher or lower than anticipated because the actual cost of identified projects
varied from original estimates and/or from the number of exploration and
development opportunities being greater or fewer than currently anticipated and
increased financing costs due to a significant increase in interest rates. These
and other risks and uncertainties affecting Key are discussed in greater detail
in this report and the Company's Annual Report on Form 10-K for the year ended
December 31, 2000.
Financial Results
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
------------------------ -----------------------
Selected financial data 2001 2000 2001 2000
--------- ---------- --------- ---------
(In thousands, except per share amounts)
Revenues $ 21,331 $ 27,354 $ 90,988 $ 68,431
Net income 4,960 8,511 27,197 17,968
Per share - basic 0.35 0.69 1.95 1.51
Per share - diluted 0.35 0.67 1.90 1.45
Net Income
Key generated net income of $4,960, or $.35 per diluted share, for the third
quarter of 2001 compared with $8,511, or $.67 per diluted share, for the third
quarter of 2000. This represents a decrease of 42 percent in net income. This
decrease is based on revenues of $21,331 and $27,354 for the third quarters of
2001 and 2000, respectively. Lower oil and gas prices contributed to the
decline.
For the first nine months of 2001, net income was $27,197, or $1.90 per diluted
share, a 51 percent increase compared to the same period in 2000 when we had net
income of $17,968, or $1.45 per diluted share. Revenue was $90,988 and $68,431
for the first nine months of 2001 and 2000, respectively. Higher gas prices in
the first half of the year contributed to the increase in net income and
revenues in 2001 compared to 2000.
11
Results of Operations
Information about oil and gas sales, production volumes and prices are presented
in the following table:
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
------------------------ -----------------------
2001 2000 2001 2000
--------- --------- --------- ---------
(In thousands)
Gas sales $ 11,913 $ 15,005 $ 60,384 $ 34,749
Oil sales 9,055 11,925 29,547 32,211
Plant product sales 335 356 972 1,194
--------- --------- --------- ---------
Total oil and gas sales $ 21,303 $ 27,286 $ 90,903 $ 68,154
========= ========= ========= =========
Gas volume - Mcf per day 46,172 39,394 44,320 38,009
Gas price - per Mcf $ 2.80 $ 4.14 $ 4.99 $ 3.34
Oil volume - barrels per day 4,040 4,242 4,204 4,148
Oil price - per barrel $ 24.37 $ 30.55 $ 25.74 $ 28.34
Oil and gas sales revenues declined 22 percent, or $6.0 million between the
third quarters of 2001 and 2000 to $21.3 million. Compared to a year earlier,
gas sales decreased $3.1 million, oil sales decreased $2.9 million and plant
product sales were essentially unchanged. The decline was due primarily to lower
oil and gas prices during the third quarter of 2001. We produced combined oil
and gas volumes of 70.4 MMcfe per day in the third quarter of 2001, a 9 percent
increase over the 64.8 MMcfe per day produced in the third quarter of 2000.
On a year-to-date basis, oil and gas sales grew by $22.7 million, or 33 percent.
Strong natural gas prices in the first half of 2001 and higher production
volumes boosted sales for the first nine months of 2001. For the first nine
months of 2001, combined oil and gas production averaged 69.5 MMcfe per day
versus 62.9 MMcfe per day in the first nine months of 2000.
In the third quarter of 2001, gas sales decreased $3.1 million, or 21 percent,
to $11.9 million. Lower gas prices caused a $5.7 million decrease, partially
offset by higher production volume. The average realized gas price for the third
quarter of 2001 was $2.80 per Mcf, compared to $4.14 per Mcf during the same
three months of 2000. Daily gas production rose 17% to 46.2 MMcfe versus 39.4
MMcfe in the third quarter of 2000.
Gas sales for the first nine months of 2001 of $60.4 million were 74 percent
greater than that of the first nine months of 2000. Gas prices increased to
$4.99 per Mcf in 2001 from $3.34 per Mcf in 2000. Higher prices in the first
half of 2001 added approximately $20 million to sales. Daily production
increased 17 percent to 44.3 MMcf per day in 2001 from 38.0 MMcf per day in
2000. Gas volumes are higher in 2001 as a result of new production from recent
drilling projects and the Columbus acquisition in the fourth quarter of 2000.
Our third quarter 2001 gas production includes nearly 6 MMcf per day from wells
drilled in 2001.
Oil sales decreased $2.9 million, or 24 percent, to $9.1 million in the third
quarter of 2001 compared to the comparable period in 2000. Approximately $2.3
million of the decrease is related to lower oil prices. We produced an average
of 4,040 barrels per day in 2001 compared to 4,242 barrels per day in 2000. The
slight decrease in oil production for the third quarter of 2001 is due primarily
to the Busby #6-12 well's decrease of 322 barrels per day. We realized an
average price of $24.37 per barrel in 2001, compared to $30.55 per barrel in
2000.
12
Oil sales for the first nine months of 2001 decreased $2.7 million, or eight
percent, to $29.5 million. Daily oil production in 2001 reached 4,204 barrels
per day from 4,148 barrels per day in 2000, for an additional $.3 million of
sales. At the same time production was climbing, prices dipped to an average of
$25.74 per barrel from $28.34 per barrel in 2000. Decreased prices had a
negative impact of $3.0 million on nine-month oil sales. Our results for 2001
include oil production from the Columbus acquisition as well as new production
from our drilling program.
Product sales from gas processing plants decreased six percent between the third
quarters of 2001 and 2000, and decreased 19 percent between the first nine
months of 2001 and 2000. Lower prices are the primary reason for the reduction
in plant product sales.
We have not entered into any derivative contracts or hedges with respect to our
production. As a result, the prices we receive reflect market conditions. We
remain unhedged.
As the prices for oil and gas rise and fall, the components of our oil and gas
sales fluctuate. In the first nine months of 2001, our revenues came from the
following product mix: 33 percent oil, 66 percent gas and one percent plant
products. This compares to the following mix for the first nine months of 2000:
47 percent oil, 51 percent gas and two percent plant products. On a volumetric
basis, we produced 36 percent oil and 64 percent gas in 2001. Production for the
same period of 2000 was 40 percent oil and 60 percent gas.
Our most significant source of other revenues has been income from our two gas
gathering systems in California. The decrease in gathering income between 2001
and 2000 reflects the continued decline in production from our northwest Blosser
and northwest Malton wells.
Costs and Expenses
Depreciation, depletion and amortization (DD&A) expense decreased 33 percent
between the third quarters of 2001 and 2000. The decrease in DD&A is the direct
result of the 22 percent decline in oil and gas sales revenues. Our depletion
rate as a percentage of oil and gas sales decreased to 27.3 percent from 31.9
percent between the third quarters of 2001 and 2000. DD&A for the nine-month
periods increased 1 percent between 2001 and 2000. The depletion rate as a
percentage of oil and gas sales averaged 27.2 percent and 36.0 percent for 2001
and 2000, respectively. We use the future gross revenue method and rolling
average prices to compute DD&A expense. Higher product prices over the last year
have brought the depletion rate down. We also include a small amount of fixed
asset depreciation and amortization of financing costs associated with our
credit facility in this income statement line.
Under the full cost accounting rules of the Securities and Exchange Commission
(SEC), we are required to review the carrying value of our oil and gas
properties. Under these rules, capitalized costs of proved oil and gas
properties, net of accumulated depreciation, depletion and amortization, and
deferred income taxes, may not exceed the present value of estimated future net
cash flows from proved oil and gas reserves, discounted at 10 percent, plus the
lower of cost or fair value of unproved properties, as adjusted for related tax
effects and deferred tax revenues. These rules generally require pricing future
oil and gas production at the unescalated oil and gas prices in effect at the
end of each fiscal quarter and require a write-down if the "ceiling" is
exceeded. For interim financial reporting purposes, the SEC rules allow us to
reduce the amount of the write-down to the extent prices have recovered
subsequent to the end of the fiscal quarter but prior to the filing of the
Company's Form 10-Q. A ceiling test write-down is a non-cash charge to earnings.
The risk that we will be required to write-down the carrying value of our oil
and gas properties increases when oil and gas prices are depressed or if we have
substantial downward revisions in our estimated proved reserves. Application of
these rules during periods of relatively low oil or gas prices, even if
temporary, increases the probability of a ceiling test write-down. Based on oil
and gas prices in effect on September 30, 2001, the unamortized cost of our oil
and gas properties exceeded the ceiling from our
13
proved oil and gas reserves by approximately $57 million. However, we were not
required to recognize a charge against our oil and gas properties because gas
prices increased sufficiently after September 30, 2001 so that Key's unamortized
costs did not exceed the ceiling. Because of the volatility of oil and gas
prices and, in particular, the relatively low recent prices for oil and gas, no
assurance can be given that we will not experience a ceiling test write-down in
future quarterly periods.
Between the third quarters of 2001 and 2000, our lease operating expense (LOE)
increased by 86 percent. On a unit of production basis, third quarter LOE
increased to $.71 per Mcfe in 2001 from $.42 per Mcfe in 2000. Third quarter
2001 LOE included $.5 million of workover expense and $.4 million of estimated
ad valorem taxes. Excluding workover expenses, our routine operating expenses
on a unit of production basis would be $.63 per Mcfe for the third quarter. For
the nine months, LOE increased 59 percent between 2001 and 2000. Compared on a
unit of production basis, year to date expenses increased 43 percent to $.67 per
Mcfe. In summary, LOE increased because: 1) we paid expenses on more wells as a
result of the Columbus acquisition and our drilling program, 2) we did more
workovers, repairs and maintenance to boost production, 3) high prices at the
end of 2000 increased property values and, as a result, we will be paying more
ad valorem taxes, and 4) we experienced upward cost pressures resulting from
heightened competition for oilfield services.
Production taxes for the third quarter of 2001 increased 26 percent to $1.4
million from $1.1 million last year. The tax for 2001 equates to 6.5 percent of
oil and gas sales, or $.22 per Mcfe. This compares to 4.0 percent of oil and gas
sales, or $.18 per Mcfe in 2000. For the nine-month periods, production taxes
increased to $.30 per Mcfe in 2001 from $.15 per Mcfe in 2000. The rise in
production taxes for the quarter and nine months was a result of: 1) the 74
percent increase in nine-month gas revenues, 2) as an outgrowth of the Columbus
merger, a greater proportion of our gas sales are from properties in Texas,
where the production/severance tax rate is higher than our previous blended
average, and 3) non-recurring adjustments in 2000 reduced the nine-month expense
by $.8 million.
General and administrative (G&A) expense increased 48 percent between the third
quarters and 30 percent between the first nine months of 2001 and 2000. On a
unit basis, third quarter G&A increased to $.17 per Mcfe compared to $.13 Mcfe
for the comparable period in 2000 primarily due to an increase in consulting
fees of approximately $.5 million. G&A for the first nine months increased
slightly to $.15 per Mcfe in 2001 from $.13 per Mcfe in 2000. Most of the G&A
variance was the result of higher employee compensation and benefit expense. We
had 70 employees prior to the Columbus acquisition in the fourth quarter of
2000. We finished the third quarter of 2001 with 98 employees. As prescribed by
the full cost accounting rules, we capitalize direct overhead related to
exploration and development activities.
Interest expense before capitalization was $1.6 million and $3.3 million for the
first nine months of 2001 and 2000, respectively. We capitalized interest of $.9
million and $1.2 million in 2001 and 2000, respectively. The capitalized amounts
were for borrowings associated with undeveloped leases. We paid less interest in
the first nine months of 2001 because of average lower interest rates and
because we have paid down $9 million of long-term debt since the end of the year
($14 million since September of 2000).
Income tax expense totaled $16.5 million for the first nine months of 2001
versus $10.6 million a year earlier. Tax expense was calculated using combined
federal and state effective income tax rates of 38.5 percent and 37.0 percent in
2001 and 2000, respectively.
Liquidity and Capital Resources
Liquidity
The oil and gas business is a capital-intensive industry. As such, we
continually need cash to fund exploration, development, and acquisition
activities and to pay trade commitments related to operations. Our primary
sources of liquidity are cash flows from operating activities and proceeds from
financing activities.
14
We generated cash from operating activities of $65.6 million in the first nine
months of 2001, an increase of 35 percent compared to the same period of 2000.
Most of the increase was the result of higher gas volumes and prices in 2001.
Cash expenditures for exploration and development (E&D) in the first nine months
of 2001 totaled $62.4 million, or 95 percent of cash from operating activities.
We participated in drilling 86 gross wells, with an overall success rate of 72
percent. Fifty-one of the wells drilled so far in 2001 were in the Mid-Continent
region, primarily in the Anadarko basin. We also drilled 20 wells in the Gulf
Coast region and 15 wells in the Western region, which includes California,
Wyoming and North Dakota. We funded these drilling projects with cash from
operating activities. In the first nine months of 2000, we made cash
expenditures for E&D of $39.0 million, or 80 percent of cash from operating
activities.
We borrowed $1 million in the third quarter of 2001 to make an advance on the
estimated costs of a non-operated well. Using cash flow from operating
activities and cash on hand at year-end 2000, we paid down $9 million, net of
additional borrowings of $5 million, of long-term debt during the first nine
months of 2001. At September 30, 2001, we had outstanding debt of $35 million
and $55 million of unused borrowing capacity under our existing bank credit
facility.
We believe that net cash generated from operations and amounts available under
our existing line of credit will be adequate to meet future liquidity needs,
including satisfying our financial obligations and funding our operations and
exploration and development activities. At September 30, 2001, we had material
commitments of approximately $6.5 million. All of the commitments were routine
and were made in the normal course of our business.
Recent Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard (SFAS) No. 141, Business Combinations, which is
effective immediately. SFAS No. 141 requires that the purchase method of
accounting be used for all business combinations initiated after June 30, 2001
and eliminates the pooling-of-interests method. The adoption of this standard
will not impact our current consolidated financial statements.
In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets, which is effective January 1, 2002. SFAS No. 142 requires that goodwill
and other intangible assets with indefinite useful lives no longer be amortized,
but instead tested for impairment at least annually. The adoption of this
standard will not have a material impact on our consolidated financial position,
results of operations or cash flows.
In August 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations, which is effective for fiscal years beginning after June 15, 2002.
SFAS No. 143 requires that the fair value of a liability for an asset retirement
obligation be recognized in the period in which it is incurred if a reasonable
estimate of fair value can be made. Management is currently assessing the
impact of this statement on our consolidated financial position, results of
operations and cash flows.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which is effective for fiscal years beginning
after December 15, 2001. SFAS No. 144 establishes one accounting model to be
used for long-lived assets to be disposed of by sale and broadens the
presentation of discontinued operations to include more disposal transactions.
We are currently evaluating the requirements and impact of this statement on our
consolidated financial position and results of operations.
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Future Trends
We began the fourth quarter with a slightly different perspective on our
business. While prices have rebounded since the third quarter, they are still
low compared to where they were a year ago. These conditions remind us that we
are in a volatile business where there may be price peaks and valleys.
We cannot predict whether the prices will increase or decrease in the next few
months. Our strategy is to be flexible enough to adapt to any price environment.
If prices were to go down, we might experience a decrease in cash flow, there
could be less cash available for exploration and debt repayment, and projects
that we have previously planned may be uneconomic in a lower price environment.
If price declines were significant, we could be faced with a full cost ceiling
write-down of our oil and gas properties.
If prices were to rise, we would have additional cash flow to invest in
exploration and development activities and for debt repayment, marginal projects
may become economic, and we could potentially have to use cash resources to make
estimated federal tax payments.
If faced with a material price increase or decrease, we will revise our plans
accordingly. As always, the amount and allocation of our future capital
expenditures will depend on a number of factors, including the impact of oil and
gas prices on investment opportunities and available cash flow, the availability
of drilling rigs and other oilfield services, the rate at which we can evaluate
potential drilling projects, and the number and size of attractive acquisition
opportunities.
Throughout 2001, we estimated that our exploration and development expenditures
would be $70-75 million. Despite the drop in both oil and gas prices, we are on
track to make expenditures in this range for the year. Through the first nine
months of 2001, our expenditures for exploration and development were
approximately $62 million. We anticipate a reduced rate of activity until rig
rates and gas prices come back into equilibrium with each other.
On an ongoing basis, we may actively look for acquisition opportunities and
merger candidates that would complement our existing exploration and production
positions and that have economic and strategic attributes that will facilitate
our profitable growth.
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ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Price Fluctuations
Our results of operations are highly dependent upon the prices we receive for
natural gas and crude oil production, and those prices are constantly changing
in response to market forces. Nearly all of our revenue is from the sale of gas
and oil, so these fluctuations, positive and negative, can have a significant
impact.
If we wanted to attempt to smooth out the effect of commodity price
fluctuations, we could enter into non-speculative hedge arrangements, commodity
swap agreements, forward sale contracts, commodity futures, options and other
similar agreements relating to natural gas and crude oil. To date, we have not
used any of these financial instruments to mitigate commodity price changes.
Interest Rate Risk
Our reported earnings are impacted by changes in interest rates. Any
fluctuation in the rate will directly affect the amount of interest expense we
report. At September 30, 2001, we had $35 million of debt outstanding at an
average interest rate of 4.2 percent. At our election, our interest charges are
based on either the prime rate or the LIBOR rate plus a margin predetermined by
our debt agreement. Assuming there is no change in the balance outstanding for
the remainder of 2001, a ten percent change in the average interest rate would
impact annual interest expense by approximately $37,000. As the interest rate
is variable and is reflective of current market conditions, the carrying value
of our debt approximates its fair value.
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PART II - OTHER INFORMATION
ITEM 6. - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
None.
(b) Reports on Form 8-K:
On July 31, the Company filed a report on Form 8-K. The Form 8-K
announced earnings for the quarter ended June 30, 2001.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
November 9, 2001
KEY PRODUCTION COMPANY, INC.
/s/ Paul Korus
-----------------------------------------------
Paul Korus
Vice President and Chief Financial Officer
(Principal Financial Officer)
/s/ Sherri M. Nitta
-----------------------------------------------
Sherri M. Nitta
Director, Financial Reporting
(Principal Accounting Officer)
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