1
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NO. 1-13726
CHESAPEAKE ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
OKLAHOMA 73-1395733
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6100 NORTH WESTERN AVENUE
OKLAHOMA CITY, OKLAHOMA 73118
(Address of principal executive offices) (Zip Code)
(405) 848-8000
(Registrant's telephone number, including area code)
---------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
At April 30, 1998, there were 105,105,580 shares of the registrant's $.01
par value Common Stock outstanding.
- --------------------------------------------------------------------------------
2
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
INDEX TO FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 1998
PART I. FINANCIAL INFORMATION
PAGE
----
Item 1. Consolidated Financial Statements (Unaudited):
Consolidated Balance Sheets at March 31, 1998 and
December 31, 1997 3
Consolidated Statements of Operations for the Three Months Ended
March 31, 1998 and 1997 4
Consolidated Statements of Cash Flows for the Three Months Ended
March 31, 1998 and 1997 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 15
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 21
Item 2. Changes in Securities 21
Item 3. Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 23
2
3
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
ASSETS
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
($ IN THOUSANDS)
CURRENT ASSETS:
Cash and cash equivalents ............................ $ 31,945 $ 123,860
Restricted cash ...................................... 2,001 --
Short-term investments ............................... 5,876 12,570
Accounts receivable:
Oil and gas sales ................................... 11,553 10,654
Oil and gas marketing sales ......................... 16,592 20,493
Joint interest and other, net of allowance
for doubtful accounts of $961,000 and $691,000 .... 26,773 38,781
Related parties ..................................... 5,502 4,246
Inventory ............................................ 5,217 5,493
Other ................................................ 5,053 1,624
----------- -----------
Total Current Assets .............................. 110,512 217,721
----------- -----------
PROPERTY AND EQUIPMENT:
Oil and gas properties, at cost based on full
cost accounting:
Evaluated oil and gas properties .................... 1,564,941 1,095,363
Unevaluated properties .............................. 144,403 125,155
Less: accumulated depreciation, depletion and
amortization ...................................... (883,734) (602,391)
----------- -----------
825,610 618,127
Other property and equipment ......................... 78,068 67,633
Less: accumulated depreciation and amortization ...... (7,528) (6,573)
----------- -----------
Total Property and Equipment ...................... 896,150 679,187
----------- -----------
OTHER ASSETS ........................................... 58,673 55,876
----------- -----------
TOTAL ASSETS ...................................... $ 1,065,335 $ 952,784
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ..................................... $ 100,135 $ 81,775
Accrued liabilities and other ........................ 53,519 42,733
Revenues and royalties due others .................... 26,020 28,972
----------- -----------
Total Current Liabilities ......................... 179,674 153,480
----------- -----------
LONG-TERM DEBT, NET .................................... 654,013 508,992
----------- -----------
REVENUES AND ROYALTIES DUE OTHERS ...................... 10,551 10,106
----------- -----------
DEFERRED INCOME TAXES .................................. -- --
----------- -----------
STOCKHOLDERS' EQUITY:
Preferred Stock, $.01 par value, 10,000,000 shares
authorized; none issued ............................ -- --
Common Stock, 250,000,000 shares authorized;
$.01 par value; 100,102,270 and 74,298,061
shares issued and outstanding at March 31,
1998, and December 31, 1997, respectively .......... 1,001 743
Paid-in capital ...................................... 659,868 460,733
Accumulated deficit .................................. (439,772) (181,270)
----------- -----------
Total Stockholders' Equity ........................ 221,097 280,206
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............. $ 1,065,335 $ 952,784
=========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
3
4
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
MARCH 31,
-----------------------
1998 1997
--------- --------
REVENUES:
Oil and gas sales ........................................ $ 50,241 $ 57,399
Oil and gas marketing sales .............................. 26,524 22,410
Interest and other ....................................... 224 3,277
--------- --------
Total revenues ....................................... 76,989 83,086
--------- --------
COSTS AND EXPENSES:
Production expenses ...................................... 7,894 3,158
Production taxes ......................................... 1,544 1,150
Oil and gas marketing expenses ........................... 26,261 21,747
Impairment of oil and gas properties ..................... 250,000 --
Oil and gas depreciation, depletion and amortization ..... 31,342 24,663
Depreciation and amortization of other assets ............ 1,380 873
General and administrative ............................... 4,380 2,481
Interest ................................................. 10,688 3,654
--------- --------
Total costs and expenses ............................. 333,489 57,726
--------- --------
INCOME (LOSS) BEFORE INCOME TAX AND EXTRAORDINARY ITEM .... (256,500) 25,360
--------- --------
INCOME TAX EXPENSE:
Current .................................................. -- --
Deferred ................................................. -- 9,255
--------- --------
Total income tax expense ............................. -- 9,255
--------- --------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM ................... (256,500) 16,105
EXTRAORDINARY ITEM:
Loss on early extinguishment of debt, net of applicable
income tax of $101 ................................... -- (177)
--------- --------
NET INCOME (LOSS) .................................... $(256,500) $ 15,928
========= ========
EARNINGS PER COMMON SHARE (BASIC)
Income (loss) before extraordinary item .................. $ (3.19) $ .23
Extraordinary item ....................................... -- --
--------- --------
Net income (loss) ........................................ $ (3.19) $ .23
========= ========
EARNINGS PER COMMON SHARE (ASSUMING DILUTION)
Income (loss) before extraordinary item .................. $ (3.19) $ .22
Extraordinary item ....................................... -- --
--------- --------
Net income (loss) ........................................ $ (3.19) $ .22
========= ========
WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT
SHARES OUTSTANDING
Basic .................................................... 80,330 69,534
========= ========
Assuming dilution ........................................ 80,330 73,493
========= ========
The accompanying notes are an integral part of these
consolidated financial statements.
4
5
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
------------------------
1998 1997
--------- ---------
($ IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ...................................... $(256,500) $ 15,928
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation, depletion and amortization .............. 32,326 25,236
Impairment of oil and gas assets ...................... 250,000 --
Deferred taxes ........................................ -- 9,154
Investments in securities, net ........................ -- 34,777
Amortization of loan costs ............................ 396 300
Amortization of bond discount ......................... 21 5
Loss on sale of fixed assets and other ................ 368 18
Extraordinary loss before income tax benefit .......... -- 278
Equity in (earnings) losses of equity investees ....... 22 (91)
Bad debt expense ...................................... 604 88
Changes in current assets and liabilities ............. 21,948 (46,007)
--------- ---------
Cash provided by operating activities ............... 49,185 39,686
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Exploration, development and acquisition of oil
and gas properties .................................. (149,002) (158,245)
Proceeds from sale of assets ........................... 220 2,850
Repayment of long-term loan ............................ 2,000 --
Additions to other property and equipment .............. (19,684) (4,712)
--------- ---------
Cash used in investing activities ................... (166,466) (160,107)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term borrowings ..................... 145,000 292,626
Payments on long-term borrowings ....................... (120,000) (12,664)
Cash received from exercise of stock options ........... 61 625
Other financing ........................................ 305 (95)
--------- ---------
Cash provided by financing activities ............... 25,366 280,492
--------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ..... (91,915) 160,071
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ........... 123,860 140,739
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD ................. $ 31,945 $ 300,810
========= =========
THREE MONTHS ENDED
MARCH 31,
---------------------
1998 1997
--------- ------
($ IN THOUSANDS)
DETAILS OF ACQUISITION OF HUGOTON ENERGY CORPORATION:
Fair value of assets acquired .......................... $ 336,517 $ --
Liabilities acquired ................................... $(128,146) $ --
Stock issued ........................................... $(206,321) $ --
Fair value of Hugoton stock options converted
into Chesapeake stock options ........................ $ (2,050) $ --
The accompanying notes are an integral part of these
consolidated financial statements.
5
6
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(UNAUDITED)
1. ACCOUNTING PRINCIPLES
The accompanying unaudited consolidated financial statements of Chesapeake
Energy Corporation and Subsidiaries (the "Company") have been prepared in
accordance with the instructions to Form 10-Q as prescribed by the Securities
and Exchange Commission. All material adjustments (consisting solely of normal
recurring adjustments) which, in the opinion of management, are necessary for a
fair presentation of the results for the interim periods have been reflected.
The results for the three months ended March 31, 1998 are not necessarily
indicative of the results to be expected for the full fiscal year.
The Company has changed its fiscal year end from June 30 to December 31. This
Form 10-Q relates to the three months ended March 31, 1998 (the "Current
Quarter") and March 31, 1997 (the "Prior Quarter").
2. RECENT ACQUISITIONS
On December 16, 1997, the Company acquired AnSon Production Corporation
("AnSon"), a privately owned oil and gas producer based in Oklahoma City.
Consideration for the acquisition was approximately $43 million, which included
the issuance of 3,792,724 shares of Chesapeake's common stock and the payment
of $24.8 million on May 7, 1998, pursuant to a make-whole provision.
On January 30, 1998, the Company entered into a 40/60 alliance with Ranger Oil
Limited to jointly develop a 3.2 million acre area of mutual interest in the
Helmet area of northeastern British Columbia. As part of the transaction, the
Company paid approximately $48 million for proved oil and gas reserves,
undeveloped leasehold and a 40% interest in Ranger's infrastructure in the area.
On February 6, 1998, the Company purchased the Mid-Continent properties of
EnerVest Management Company, L.L.C. for $38 million.
On March 10, 1998, the Company acquired Hugoton Energy Corporation ("Hugoton")
pursuant to a merger by issuing approximately 25.8 million shares of the
Company's common stock in exchange for 100% of Hugoton's common stock.
See Consolidated Statements of Cash Flows.
On April 22, 1998, the Company issued $230 million (4.6 million shares) of its
7% Cumulative Convertible Preferred Stock, $50 per share liquidation preference,
and $500 million of its 9.625% Series A Senior Notes due 2005. Net proceeds from
these offerings were approximately $712 million.
On April 27, 1998, the Company acquired from Gothic Energy Corporation certain
proved oil and gas reserves for $20 million, purchased $50 million of Gothic 12%
preferred stock, acquired ten-year warrants to purchase 15% of Gothic's
currently outstanding common stock for $0.01 per share, acquired a 50% interest
in Gothic's undeveloped leasehold acreage and entered into a five-year drilling
and acquisitions participation agreement.
On April 27, 1998, Chesapeake acquired the British Columbia properties of
Sunoma Energy Corporation for $33 million.
On April 28, 1998 the Company acquired by merger the Mid-Continent operations of
DLB Oil & Gas, Inc. for $17.5 million in cash, 5,000,000 shares of the Company's
common stock, and the assumption of $90 million in outstanding debt and working
capital obligations.
On April 30, 1998, the Company acquired 100% of the stock of MC Panhandle Corp.,
a wholly-owned subsidiary of Occidental Petroleum Corporation, by paying
approximately $95 million, net of working capital adjustments.
Effective April 30, 1998, the Company purchased all of its outstanding 10.5%
Senior Notes due 2002. Of the $90,000,000 aggregate principal amount,
$89,830,000 was acquired pursuant to the Company's offer to purchase, which
commenced April 1, 1998, and the remaining $170,000 was acquired on the same
terms after the tender period. The cost to acquire the 10.5% Senior Notes was
approximately $99,000,000. The early retirement of these notes will result in
an extraordinary charge of approximately $12 million during the quarter ended
June 30, 1998.
6
7
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(UNAUDITED)
3. LEGAL PROCEEDINGS
The Company and certain of its officers and directors are defendants in a
consolidated class action suit alleging violations of the Securities Exchange
Act of 1934. The plaintiffs assert that the defendants made material
misrepresentations and failed to disclose material facts about the success of
the Company's exploration efforts in the Louisiana Trend. As a result, the
complaint alleges the price of the Company's common stock was artificially
inflated from January 25, 1996 until June 27, 1997, when the Company issued a
press release announcing disappointing drilling results in the Louisiana Trend
and a full-cost ceiling writedown to be reflected in its June 30, 1997 financial
statements. The plaintiffs further allege that certain of the named individual
defendants sold common stock during the class period when they knew or should
have known adverse nonpublic information. The plaintiffs seek a determination
that the suit is a proper class action and damages in an unspecified amount,
together with interest and costs of litigation, including attorneys' fees. The
Company and the individual defendants believe that these claims are without
merit, and intend to defend against them vigorously. No estimate of loss or
range of estimate of loss, if any, can be made at this time.
Various purported class actions alleging violations of the Securities Act of
1933 and the Oklahoma Securities Act have been filed against the Company and
others on behalf of investors who purchased common stock of Bayard Drilling
Technologies, Inc. ("Bayard") in its initial public offering in November 1997.
In May 1998, the plaintiffs in the two cases pursuing state claims dismissed
their state court suits and became co-lead plaintiffs in the remaining federal
case. Total proceeds of the offering were $254 million, of which the Company
received net proceeds of $90.2 million. Plaintiffs allege that the Company, a
major customer of Bayard's drilling services and the owner of 30.1% of Bayard's
common stock outstanding prior to the offering, was a controlling person of
Bayard. Plaintiffs assert that the Bayard prospectus contained material
omissions and misstatements relating to (i) the Company's financial "hardships"
and their significance on Bayard's business, (ii) increased costs associated
with Bayard's growth strategy, and (iii) undisclosed pending related-party
transactions between Bayard and third parties other than the Company. The
alleged defective disclosures are claimed to have resulted in a decline in
Bayard's share price following the public offering. The plaintiffs seek a
determination that the suit is a proper class action and damages in an
unspecified amount or rescission, together with interest and costs of
litigation, including attorney's fees. The Company believes that the claims are
without merit and intends to defend against them vigorously. No estimate of loss
or range of estimate of loss, if any, can be made at this time.
In October 1996, Union Pacific Resources Company ("UPRC") sued the Company
alleging infringement of a patent for a drilling method, tortious interference
with confidentiality contracts between UPRC and certain of its former employees
and misappropriation of proprietary information of UPRC. UPRC's claims against
the Company are based on services provided to the Company by a third party
vendor controlled by former UPRC employees. UPRC is seeking injunctive relief,
damages of an unspecified amount, including actual, enhanced, consequential and
punitive damages, interest, costs and attorneys' fees. The Company believes that
it has meritorious defenses to UPRC's allegations and has requested the court to
declare the UPRC patent invalid. The Company has also filed a motion to construe
UPRC's patent claims and various motions for summary judgment. No estimate of
loss or range of estimate of loss, if any, can be made at this time; however, in
reports filed in the proceeding, experts for UPRC
7
8
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(UNAUDITED)
claim that damages could be as much as $18 million while Company experts state
that the amount should not exceed $25,000, in each case based on a reasonable
royalty.
The Company is currently involved in various other routine disputes incidental
to its business operations. While it is not possible to determine the ultimate
disposition of these matters, management, after consultation with legal counsel,
is of the opinion that the final resolution of all such currently pending or
threatened litigation is not likely to have a material adverse effect on the
consolidated financial position or results of operations of the Company.
4. IMPAIRMENT OF OIL AND GAS PROPERTIES
The Company incurred an impairment of oil and gas properties charge of $250
million in the Current Quarter. This writedown was caused by several factors,
including the effects of accounting for the Hugoton acquisition using the
purchase accounting method, oil prices declining from $17.62 at December 31,
1997 to $13.92 at March 31, 1998, gas prices declining from $2.29 at December
31, 1997 to $2.01 at March 31, 1998 and higher drilling and completion costs
compared to previous estimates. Additionally, lower oil and gas prices at March
31, 1998 and higher drilling costs caused downward revisions in the Company's
proved reserves as certain proved undeveloped reserves previously estimated by
the Company were rendered uneconomic and therefore excluded by the Company from
its proved reserves.
The primary reason for the impairment charge was the completion of the
acquisition in March 1998 of Hugoton, which was accounted for using the purchase
method. The purchase price, which was established in November 1997 when the
acquisition was announced (based on a Chesapeake common stock price of $8.00 per
share), was allocated almost entirely to Hugoton's evaluated oil and gas
properties. Based upon reserve estimates as of March 31, 1998, the portion of
the purchase price which was allocated to evaluated oil and gas properties
exceeded the associated discounted future net revenues from Hugoton's estimated
proved reserves by approximately $150 million.
5. NET INCOME (LOSS) PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128"). SFAS
128 requires presentation of "basic" and "diluted" earnings per share, as
defined, on the face of the statement of operations for all entities with
complex capital structures. SFAS 128 is effective for financial statements
issued for periods ending after December 15, 1997 and requires restatement of
all prior period earnings per share amounts. The Company has adopted SFAS 128
and has restated all prior periods presented.
SFAS 128 requires a reconciliation of the numerators and denominators of the
basic and diluted EPS computations. For the Current Quarter there was no
difference between actual weighted average shares outstanding, which are used in
computing basic EPS and diluted weighted average shares, which are used in
computing diluted EPS. Options to purchase 10.2 million shares of common stock
at a weighted average exercise price of $5.69 were outstanding during the
Current Quarter but were not included in the computation of diluted EPS because
the effect of these outstanding options would be antidilutive. A reconciliation
for the Prior Quarter is as follows:
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------
For the Quarter Ended March 31, 1997:
Basic EPS
Income available to common stockholders ... $15,928 69,534 $0.23
=====
Effect of Dilutive Securities
Employee stock options .................... -- 3,959
------- ------
Diluted EPS
Income available to common stockholders and
assumed conversions ..................... $15,928 73,493 $0.22
======= ====== =====
8
9
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(UNAUDITED)
6. SENIOR NOTES
10.5% Notes
The Company had outstanding at March 31, 1998, $90 million in aggregate
principal amount of 10.5% Senior Notes due 2002. The 10.5% Notes were senior,
unsecured obligations of the Company and were fully and unconditionally
guaranteed, jointly and severally, by Guarantor Subsidiaries (as defined below).
All outstanding 10.5% Notes were acquired by the Company effective April 30,
1998. See Note 2.
9.125% Notes
The Company has outstanding $120 million in aggregate principal amount of 9.125%
Senior Notes which mature April 15, 2006. The 9.125% Notes bear interest at an
annual rate of 9.125%, payable semiannually on each April 15 and October 15. The
9.125% Notes are senior, unsecured obligations of the Company and are fully and
unconditionally guaranteed, jointly and severally, by the Guarantor
Subsidiaries.
7.875% Notes
The Company has outstanding $150 million in aggregate principal amount of 7.875%
Senior Notes which mature March 15, 2004. The 7.875% Notes bear interest at the
rate of 7.875%, payable semiannually on each March 15 and September 15. The
7.875% Notes are senior, unsecured obligations of the Company and are fully and
unconditionally guaranteed, jointly and severally, by the Guarantor
Subsidiaries.
8.5% Notes
The Company has outstanding $150 million in aggregate principal amount of 8.5%
Senior Notes which mature March 15, 2012. The 8.5% Notes bear interest at the
rate of 8.5%, payable semiannually on each March 15 and September 15. The 8.5%
Notes are senior, unsecured obligations of the Company and are fully and
unconditionally guaranteed, jointly and severally, by the Guarantor
Subsidiaries.
The Company is a holding company and owns no operating assets and has no
significant operations independent of its subsidiaries. The Company's
obligations under its Senior Notes have been fully and unconditionally
guaranteed, on a joint and several basis, by each of the Company's "Restricted
Subsidiaries" (as defined in the respective indentures governing the Senior
Notes) (collectively, the "Guarantor Subsidiaries"). Each of the Guarantor
Subsidiaries is a direct or indirect wholly-owned subsidiary of the Company.
The Senior Note Indentures contain certain covenants, including covenants
limiting the Company and the Guarantor Subsidiaries with respect to asset sales,
restricted payments, the incurrence of additional indebtedness and the issuance
of preferred stock, liens, sale and leaseback transactions, lines of business,
dividend and other payment restrictions affecting Guarantor Subsidiaries,
mergers or consolidations, and transactions with affiliates. The Company is
obligated to repurchase the 9.125% Senior Notes in the event of a change of
control or certain asset sales.
9
10
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1998
(UNAUDITED)
Set forth below are condensed consolidating financial statements of the
Guarantor Subsidiaries, the Company's subsidiaries which are not guarantors of
the Senior Notes (the "Non-Guarantor Subsidiaries") and the Company. Separate
financial statements of each Guarantor Subsidiary have not been provided because
management has determined that they are not material to investors.
As of and for the three months ended March 31, 1998, the Non-Guarantor
Subsidiaries were Chesapeake Energy Marketing, Inc., Chesapeake Acquisition
Corporation and subsidiaries of those companies. As of and for the three months
ended March 31, 1997, the Non-Guarantor Subsidiaries were Chesapeake Energy
Marketing, Inc. and Chesapeake Canada Corporation. For both periods, the
remaining subsidiaries of the Company were Guarantor Subsidiaries.
10
11
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF MARCH 31, 1998
($ IN THOUSANDS)
ASSETS
GUARANTOR NON-GUARANTOR COMPANY
SUBSIDIARIES SUBSIDIARIES (PARENT) ELIMINATIONS CONSOLIDATED
----------- --------- ----------- ----------- ------------
CURRENT ASSETS:
Cash and cash equivalents ................ $ (15,466) $ 9,148 $ 40,264 $ -- $ 33,946
Short-term investments ................... -- -- 5,876 -- 5,876
Accounts receivable, net ................. 40,931 26,224 2 (6,737) 60,420
Inventory ................................ 5,143 74 -- -- 5,217
Other .................................... 4,771 277 5 -- 5,053
----------- --------- ----------- ----------- -----------
Total Current Assets .................. 35,379 35,723 46,147 (6,737) 110,512
----------- --------- ----------- ----------- -----------
PROPERTY AND EQUIPMENT:
Oil and gas properties ................... 1,165,645 399,296 -- -- 1,564,941
Unevaluated leasehold .................... 130,106 14,297 -- -- 144,403
Other property and equipment ............. 58,251 3,402 16,415 -- 78,068
Less: accumulated depreciation,
Depletion and amortization ............. (703,750) (186,454) (1,058) -- (891,262)
----------- --------- ----------- ----------- -----------
Total Property & Equipment ............ 650,252 230,541 15,357 -- 896,150
----------- --------- ----------- ----------- -----------
INVESTMENTS IN SUBSIDIARIES AND
INTERCOMPANY ADVANCES .................... 81,755 274,529 1,214,222 (1,570,506) --
----------- --------- ----------- ----------- -----------
OTHER ASSETS ............................... 4,418 9,283 44,972 -- 58,673
----------- --------- ----------- ----------- -----------
TOTAL ASSETS .......................... $ 771,804 $ 550,076 $ 1,320,698 $(1,577,243) $ 1,065,335
=========== ========= =========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable and current maturities
of long-term debt ...................... $ -- $ -- $ -- $ -- $ --
Accounts payable and other ............... 119,679 30,677 36,250 (6,932) 179,674
----------- --------- ----------- ----------- -----------
Total Current Liabilities ............. 119,679 30,677 36,250 (6,932) 179,674
----------- --------- ----------- ----------- -----------
LONG-TERM DEBT ............................. -- 120,000 534,013 -- 654,013
REVENUES PAYABLE ........................... 10,106 445 -- -- 10,551
DEFERRED INCOME TAXES ...................... -- -- -- -- --
INTERCOMPANY PAYABLES ...................... 911,684 47,175 -- (958,859) --
STOCKHOLDERS' EQUITY:
Common Stock ............................. 10 4 991 (4) 1,001
Other .................................... (269,675) 351,775 749,444 (611,448) 220,096
----------- --------- ----------- ----------- -----------
Total Stockholders' Equity ............ (269,665) 351,779 750,435 (611,452) 221,097
----------- --------- ----------- ----------- -----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY ................ $ 771,804 $ 550,076 $ 1,320,698 $(1,577,243) $ 1,065,335
=========== ========= =========== =========== ===========
11
12
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 1997
($ IN THOUSANDS)
ASSETS
GUARANTOR NON-GUARANTOR COMPANY
SUBSIDIARIES SUBSIDIARIES (PARENT) ELIMINATIONS CONSOLIDATED
----------- --------- ----------- ----------- ------------
CURRENT ASSETS:
Cash and cash equivalents ................ $ (589) $ 13,999 $ 110,450 $ -- $ 123,860
Short-term investments ................... -- -- 12,570 -- 12,570
Accounts receivable, net ................. 57,476 22,882 1,524 (7,708) 74,174
Inventory ................................ 4,918 575 -- -- 5,493
Other .................................... 1,613 1 10 -- 1,624
----------- --------- ----------- ----------- -----------
Total Current Assets .................. 63,418 37,457 124,554 (7,708) 217,721
----------- --------- ----------- ----------- -----------
PROPERTY AND EQUIPMENT:
Oil and gas properties ................... 1,056,118 39,245 -- -- 1,095,363
Unevaluated leasehold .................... 125,155 -- -- -- 125,155
Other property and equipment ............. 51,868 343 15,422 -- 67,633
Less: accumulated depreciation,
Depletion and amortization ............. (593,359) (14,650) (955) -- (608,964)
----------- --------- ----------- ----------- -----------
Total Property & Equipment ............ 639,782 24,938 14,467 -- 679,187
----------- --------- ----------- ----------- -----------
INVESTMENTS IN SUBSIDIARIES AND
INTERCOMPANY ADVANCES .................... 81,755 49,958 903,713 (1,035,426) --
----------- --------- ----------- ----------- -----------
OTHER ASSETS ............................... 10,189 6,918 38,769 -- 55,876
----------- --------- ----------- ----------- -----------
TOTAL ASSETS .......................... $ 795,144 $ 119,271 $ 1,081,503 $(1,043,134) $ 952,784
=========== ========= =========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable and current maturities
of long-term debt ...................... $ -- $ -- $ -- $ -- $ --
Accounts payable and other ............... 104,259 29,649 27,280 (7,708) 153,480
----------- --------- ----------- ----------- -----------
Total Current Liabilities ............. 104,259 29,649 27,280 (7,708) 153,480
----------- --------- ----------- ----------- -----------
LONG-TERM DEBT ............................. -- -- 508,992 -- 508,992
REVENUES PAYABLE ........................... 10,106 -- -- -- 10,106
DEFERRED INCOME TAXES ...................... -- -- -- -- --
INTERCOMPANY PAYABLES ...................... 853,958 2,959 -- (856,917) --
STOCKHOLDERS' EQUITY:
Common Stock ............................. 10 3 733 (3) 743
Other .................................... (173,189) 86,660 544,498 (178,506) 279,463
----------- --------- ----------- ----------- -----------
Total Stockholders' Equity ............ (173,179) 86,663 545,231 (178,509) 280,206
----------- --------- ----------- ----------- -----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY ................ $ 795,144 $ 119,271 $ 1,081,503 $(1,043,134) $ 952,784
=========== ========= =========== =========== ===========
12
13
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
($ IN THOUSANDS)
GUARANTOR NON-GUARANTOR COMPANY
SUBSIDIARIES SUBSIDIARIES (PARENT) ELIMINATIONS CONSOLIDATED
------------ ------------ -------- ------------ ------------
FOR THE THREE MONTHS ENDED MARCH 31, 1998
REVENUES:
Oil and gas sales .......................... $ 41,803 $ 7,812 $ -- $ 626 $ 50,241
Oil and gas marketing sales ................ -- 47,725 -- (21,201) 26,524
Interest and other ......................... (28) 142 20,035 (19,925) 224
--------- --------- -------- -------- ---------
Total Revenues .......................... 41,775 55,679 20,035 (40,500) 76,989
--------- --------- -------- -------- ---------
COSTS AND EXPENSES:
Production expenses and taxes .............. 6,901 2,537 -- -- 9,438
Oil and gas marketing expenses ............. -- 46,836 -- (20,575) 26,261
Impairment of oil and gas properties ....... 83,500 166,500 -- -- 250,000
Oil and gas depreciation, depletion
and amortization ......................... 26,121 5,221 -- -- 31,342
Other depreciation and amortization ........ 806 77 497 -- 1,380
General and administrative ................. 3,755 593 32 -- 4,380
Interest ................................... 17,482 1,741 11,390 (19,925) 10,688
--------- --------- -------- -------- ---------
Total Costs & Expenses .................. 138,565 223,505 11,919 (40,500) 333,489
--------- --------- -------- -------- ---------
INCOME (LOSS) BEFORE INCOME TAXES
AND EXTRAORDINARY ITEM ..................... (96,790) (167,826) 8,116 -- (256,500)
INCOME TAX EXPENSE (BENEFIT) ................. -- -- -- -- --
--------- --------- -------- -------- ---------
NET INCOME (LOSS) BEFORE
EXTRAORDINARY ITEM ......................... (96,790) (167,826) 8,116 -- (256,500)
--------- --------- -------- -------- ---------
EXTRAORDINARY ITEM:
Loss on early extinguishment of debt,
net of applicable income tax ............. -- -- -- -- --
--------- --------- -------- -------- ---------
NET INCOME (LOSS) ....................... $ (96,790) $(167,826) $ 8,116 $ -- $(256,500)
========= ========= ======== ======== =========
FOR THE THREE MONTHS ENDED MARCH 31, 1997
REVENUES:
Oil and gas sales .......................... $ 56,795 $ -- $ -- $ 604 $ 57,399
Gas marketing sales ........................ -- 45,568 -- (23,158) 22,410
Interest and other ......................... 177 197 2,903 -- 3,277
--------- --------- -------- -------- ---------
Total revenues .......................... 56,972 45,765 2,903 (22,554) 83,086
--------- --------- -------- -------- ---------
COSTS AND EXPENSES:
Production expenses and taxes .............. 4,308 -- -- -- 4,308
Gas marketing expenses ..................... -- 44,301 -- (22,554) 21,747
Oil and gas depreciation ................... 24,663 -- -- -- 24,663
Other depreciation and amortization ........ 508 20 345 -- 873
General and administrative ................. 1,757 235 489 -- 2,481
Interest ................................... 172 -- 3,482 -- 3,654
--------- --------- -------- -------- ---------
Total Costs & Expenses .................. 31,408 44,556 4,316 (22,554) 57,726
--------- --------- -------- -------- ---------
INCOME (LOSS) BEFORE INCOME TAX .............. 25,564 1,209 (1,413) -- 25,360
INCOME TAX EXPENSE ........................... 9,330 441 (516) -- 9,255
--------- --------- -------- -------- ---------
NET INCOME (LOSS) BEFORE
EXTRAORDINARY ITEM .................... 16,234 768 (897) -- 16,105
--------- --------- -------- -------- ---------
EXTRAORDINARY ITEM:
Loss on early extinguishment of debt, net
of applicable income tax ................. (179) -- 2 -- (177)
--------- --------- -------- -------- ---------
NET INCOME (LOSS) ....................... $ 16,055 $ 768 $ (895) $ -- $ 15,928
========= ========= ======== ======== =========
13
14
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
($ IN THOUSANDS)
GUARANTOR NON-GUARANTOR COMPANY
SUBSIDIARIES SUBSIDIARIES (PARENT) ELIMINATIONS CONSOLIDATED
------------ ------------ -------- ------------ ------------
FOR THE THREE MONTHS ENDED MARCH 31, 1998
CASH FLOWS FROM OPERATING
ACTIVITIES: .................................. $(128,409) $ 161,162 $ 16,432 $ -- $ 49,185
CASH FLOWS FROM INVESTING ACTIVITIES:
Oil and gas properties ....................... (114,698) 4,938 -- -- (109,760)
Proceeds from sale of assets ................. 220 -- -- -- 220
Investment in service operations ............. -- (39,242) -- -- (39,242)
Other additions .............................. (19,538) 2,313 (459) -- (17,684)
--------- --------- --------- --------- ---------
(134,016) (31,991) (459) -- (166,466)
--------- --------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings ..................... -- -- 145,000 -- 145,000
Payments on borrowings ....................... -- -- (120,000) -- (120,000)
Cash received from exercise of stock
options .................................... -- -- -- -- --
Cash received from issuance of common
stock ...................................... -- -- 61 -- 61
Other financing .............................. -- 305 -- -- 305
Intercompany advances, net ................... 245,547 (134,327) (111,220) -- --
--------- --------- --------- --------- ---------
245,547 (134,022) (86,159) -- 25,366
--------- --------- --------- --------- ---------
Net increase (decrease) in cash .............. (16,878) (4,851) (70,186) -- (91,915)
Cash, beginning of period .................... (589) 13,999 110,450 -- 123,860
--------- --------- --------- --------- ---------
Cash, end of period .......................... $ (17,467) $ 9,148 $ 40,264 $ -- $ 31,945
========= ========= ========= ========= =========
FOR THE THREE MONTHS ENDED MARCH 31, 1997
CASH FLOWS FROM OPERATING
ACTIVITIES: .................................. $ 70,762 $ 2,085 $ (33,161) $ -- $ 39,686
CASH FLOWS FROM INVESTING ACTIVITIES:
Oil and gas properties ....................... (158,280) 35 -- -- (158,245)
Proceeds from sales .......................... 2,850 -- -- -- 2,850
Investment in gas marketing company .......... -- -- -- -- --
Other additions .............................. (859) -- (3,853) -- (4,712)
--------- --------- --------- --------- ---------
(156,289) 35 (3,853) -- (160,107)
--------- --------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term borrowings ........... -- -- 292,626 -- 292,626
Payments on borrowings ....................... (67,569) 1,710 53,195 -- (12,664)
Cash received from exercise of stock
options .................................... -- -- 625 -- 625
Other financing .............................. -- -- (95) -- (95)
Intercompany advances, net ................... 134,385 (3,350) (131,035) -- --
--------- --------- --------- --------- ---------
66,816 (1,640) 215,316 -- 280,492
--------- --------- --------- --------- ---------
Net increase (decrease) in cash and cash
equivalents ................................ (18,711) 480 178,302 -- 160,071
Cash, beginning of period .................... 4,782 6,182 129,775 -- 140,739
--------- --------- --------- --------- ---------
Cash, end of period .......................... $ (13,929) $ 6,662 $ 308,077 $ -- $ 300,810
========= ========= ========= ========= =========
14
15
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RECENT EVENTS
On December 16, 1997, the Company acquired AnSon Production Corporation
("AnSon"), a privately owned oil and gas producer based in Oklahoma City.
Consideration for the acquisition was approximately $43 million, which included
the issuance of 3,792,724 shares of Chesapeake's common stock and the payment of
$24.8 million on May 7, 1998, pursuant to a make-whole provision.
On January 30, 1998, the Company entered into a 40/60 alliance with Ranger Oil
Limited to jointly develop a 3.2 million acre area of mutual interest in the
Helmet area of northeastern British Columbia. As part of the transaction, the
Company paid approximately $48 million for proved oil and gas reserves,
undeveloped leasehold and a 40% interest in Ranger's infrastructure in the area.
On February 6, 1998, the Company purchased the Mid-Continent properties of
EnerVest Management Company, L.L.C. for $38 million.
On March 10, 1998, the Company acquired Hugoton Energy Corporation ("Hugoton")
pursuant to a merger by issuing approximately 25.8 million shares of the
Company's common stock in exchange for 100% of Hugoton's common stock.
See Consolidated Statements of Cash Flows.
On April 22, 1998, the Company issued $230 million (4.6 million shares) of its
7% Cumulative Convertible Preferred Stock, $50 per share liquidation preference,
and $500 million of its 9.625% Series A Senior Notes due 2005. Net proceeds from
these offerings were approximately $712 million.
On April 27, 1998, the Company acquired from Gothic Energy Corporation certain
proved oil and gas reserves for $20 million, purchased $50 million of Gothic 12%
preferred stock, acquired ten-year warrants to purchase 15% of Gothic's
currently outstanding common stock for $0.01 per share, acquired a 50% interest
in Gothic's undeveloped leasehold acreage and entered into a five-year drilling
and acquisitions participation agreement.
On April 27, 1998, Chesapeake acquired the British Columbia properties of
Sunoma Energy Corporation for $33 million.
On April 28, 1998, the Company acquired by merger the Mid-Continent operations
of DLB Oil & Gas, Inc. for $17.5 million in cash, 5,000,000 shares of the
Company's common stock, and the assumption of $90 million in outstanding debt
and working capital obligations.
On April 30, 1998, the Company acquired 100% of the stock of MC Panhandle Corp.,
a wholly-owned subsidiary of Occidental Petroleum Corporation, by paying
approximately $95 million, net of working capital adjustments.
Effective April 30, 1998, the Company purchased all of its outstanding 10.5%
Senior Notes due 2002. Of the $90,000,000 aggregate principal amount,
$89,830,000 was acquired pursuant to the Company's offer to purchase, which
commenced April 1, 1998, and the remaining $170,000 was acquired on the same
terms after the tender period. The cost to acquire the 10.5% Senior Notes was
approximately $99,000,000. The early retirement of these notes will result in an
extraordinary charge of approximately $12 million during the quarter ended June
30, 1998.
15
16
RESULTS OF OPERATIONS - Three months ended March 31, 1998 vs. March 31, 1997
General. For the three months ended March 31, 1998 (the "Current Quarter"), the
Company realized a net loss of $256.5 million, or $3.19 per common share. This
compares to net income of $15.9 million, or $0.22 per common share, in the three
months ended March 31, 1997 (the "Prior Quarter"). The loss in the Current
Quarter was primarily caused by a $250.0 million asset writedown recorded under
the full-cost method of accounting and, to a much lesser extent, a $6.5 million
loss from recurring operations. The asset writedown was primarily caused by the
Hugoton acquisition in March 1998 for consideration in excess of the present
value (10% discount) of the future net revenues of the proved reserves acquired
as of March 31, 1998 (approximately $150 million of the writedown) and by
decreases in oil and gas prices from December 31, 1997 to March 31, 1998. See
Impairment of Oil and Gas Properties. No such writedown occurred in the Prior
Quarter.
Oil and Gas Sales. During the Current Quarter, oil and gas sales decreased 13%
to $50.2 million from $57.4 million in the Prior Quarter. The decrease resulted
from significantly lower oil and gas prices, partially offset by a 12% increase
in production volumes. For the Current Quarter, the Company produced 23.0
billion cubic feet equivalent ("bcfe"), consisting of 1.2 million barrels of oil
("mmbo") and 16 billion cubic feet of natural gas ("bcf"), compared to 0.8 mmbo
and 15.7 bcf, or 20.5 bcfe, in the Prior Quarter. Average oil prices realized
were $14.84 per barrel of oil ("bo") in the Current Quarter compared to $21.55
in the Prior Quarter, a decrease of 31%. Average gas prices realized were $2.06
per thousand cubic feet ("mcf") in the Current Quarter compared to $2.55 per mcf
in the Prior Quarter, a decrease of 19%.
For the Current Quarter, the Company realized an average price of $2.19 per
thousand cubic feet equivalent ("mcfe"), compared to $2.79 per mcfe in the Prior
Quarter. The Company's hedging activities resulted in increased oil and gas
revenues of $1.8 million, or $0.08 per mcfe, in the Current Quarter, compared to
decreases in oil and gas revenues of $0.2 million, or $0.01 per mcfe, in the
Prior Quarter.
The following table shows the Company's production by region for the Current
Quarter and the Prior Quarter:
FOR THE THREE MONTHS ENDED MARCH 31,
----------------------------------------
1998 1997
------------------ ------------------
OPERATING AREAS (MMCFE) PERCENT (MMCFE) PERCENT
------ ------- ------ -------
Mid-Continent ........... 7,646 33% 4,241 21%
Austin Chalk Trend ...... 12,054 53 15,017 73
Canada .................. 730 3 -- --
Other Areas ............. 2,533 11 1,290 6
------ --- ------ ---
Total .............. 22,963 100% 20,548 100%
====== === ====== ===
Natural gas production represented approximately 69% of the Company's total
production volume on an equivalent basis in the Current Quarter, compared to 77%
in the Prior Quarter. This decrease in natural gas production as a percentage of
total production was primarily the result of new production in the Louisiana
portion of the Austin Chalk Trend, which tends to produce more oil than gas. The
Company anticipates that as a result of its recent acquisitions, increased
drilling in the Mid-Continent and Canada and decreased drilling in Louisiana,
natural gas will represent 70-75% of anticipated 1998 production.
Oil and Gas Marketing Sales. The Company realized $26.5 million in oil and gas
marketing sales for third parties in the Current Quarter, with corresponding oil
and gas marketing expenses of $26.3 million, for a margin of $0.2 million. This
compares to sales of $22.4 million, expenses of $21.7 million, and a margin of
$0.7 million in the Prior Quarter. The Company anticipates gross margins will
increase during 1998 as a result of the acquisition of certain gas gathering,
transportation and marketing assets completed in 1998.
Interest and Other. Interest and other revenues for the Current Quarter were
$0.2 million compared to $3.3 million in the Prior Quarter. The decrease was
primarily caused by the Company maintaining lower invested cash balances
resulting in reduced interest income.
16
17
Production Expenses and Taxes. Production expenses increased to $7.9 million in
the Current Quarter, a $4.7 million increase from the $3.2 million incurred in
the Prior Quarter. On a production unit basis, production expenses were $0.34
and $0.16 per mcfe in the Current and Prior Quarters, respectively. The primary
reason for the increase in production expenses was the increased lifting costs
associated with the Louisiana production, which represented a higher proportion
of production in the Current Quarter than the Prior Quarter. Also contributing
to the increase was the addition of production obtained in the Hugoton and AnSon
acquisitions, which typically has higher production expense per Mcfe of
production than the Company's historical production base. The Company
anticipates production expenses will continue to rise during 1998 as the result
of additional acquisitions closed in April 1998, and expects production expenses
to average $0.35 to $0.40 per mcfe for 1998.
Production taxes, which consist primarily of wellhead severance taxes, were
$1.5 million and $1.2 million in the Current and Prior Quarters, respectively.
This increase, from $0.06 per mcfe to $0.07 per mcfe, was the result of the
higher tax rates associated with production obtained in the acquisitions as
compared to the Company's historical production base.
Impairment of Oil and Gas Properties. The Company utilizes the full-cost method
to account for its investments in oil and gas properties. Under this method, all
costs of acquisition, exploration and development of oil and gas reserves
(including such costs as leasehold acquisition costs, geological and geophysical
expenditures, certain capitalized internal costs, dry hole costs and tangible
and intangible development costs) are capitalized as incurred. These oil and gas
property costs, including the estimated future capital expenditures to develop
the proved undeveloped reserves, are depleted and charged to operations using
the unit-of-production method based on the ratio of current production to proved
oil and gas reserves as estimated by the Company's independent engineering
consultants and Company engineers. Costs directly associated with the
acquisition and evaluation of unproved properties are excluded from the
amortization computation until it is determined whether or not proved reserves
can be assigned to the property or whether impairment has occurred. To the
extent that capitalized costs of oil and gas properties, net of accumulated
depreciation, depletion and amortization and related deferred income taxes,
exceed the discounted future net revenues of proved oil and gas properties, such
excess costs are charged to operations.
The Company incurred an impairment of oil and gas properties charge of $250
million in the Current Quarter, compared to no impairment in the Prior Quarter.
This writedown was caused by several factors, including the Hugoton acquisition,
oil prices declining from $17.62 at December 31, 1997 to $13.92 at March 31,
1998, gas prices declining from $2.29 at December 31, 1997 to $2.01 at March 31,
1998 and higher drilling and completion costs compared to previous estimates.
Additionally, lower oil and gas prices at March 31, 1998 and higher drilling
costs caused downward revisions in the Company's proved reserves as certain
proved undeveloped reserves previously estimated by the Company were rendered
uneconomic and therefore not included in the Company's evaluation of its proved
reserves.
The primary reason for the impairment charge was the completion of the
acquisition in March 1998 of Hugoton, which was accounted for using the purchase
method. The purchase price, which was established in November 1997 when the
acquisition was announced (based on a Chesapeake common stock price of $8.00 per
share), was allocated almost entirely to Hugoton's evaluated oil and gas
properties. Based upon reserve estimates as of March 31, 1998, the portion of
the purchase price which was allocated to evaluated oil and gas properties
exceeded the associated discounted future net revenues from Hugoton's estimated
proved reserves by approximately $150 million.
Since March 31, 1998, oil and gas prices have declined further. If prices do not
increase from current levels by June 30, 1998, the Company could incur
additional impairment charges, reducing earnings and shareholders' equity.
Oil and Gas Depreciation, Depletion and Amortization. Depreciation, depletion
and amortization of oil and gas properties ("DD&A") for the Current Quarter was
$31.3 million, compared to $24.7 million in the Prior Quarter. This increase was
caused by increased production and an increase in the DD&A rate per mcfe from
$1.20 to $1.36 in the Prior and Current Quarters, respectively. The Company's
DD&A rate is expected to decrease to
17
18
approximately $1.10-$1.15 per mcfe for the remainder of 1998 as the result of
the impairment charge, the acquisitions completed in April, and reduced
drilling in Louisiana.
Depreciation and Amortization of Other Assets. Depreciation and amortization of
other assets ("D&A") increased to $1.4 million in the Current Quarter compared
to $0.9 million in the Prior Quarter. This increase in D&A was caused by
increased investments in depreciable buildings and equipment and increased
amortization of debt issuance costs as a result of the issuance of Senior Notes
in March 1997. The Company anticipates an increase in D&A throughout 1998 as a
result of higher building depreciation expense on the Company's corporate
offices, additional equipment and depreciable assets added from the
acquisitions, and higher amortization caused by the increased offering costs
incurred in the Senior Notes issued in April 1998.
General and Administrative. General and administrative expenses ("G&A"), which
are net of capitalized internal payroll and non-payroll expenses, were $4.4
million in the Current Quarter compared to $2.5 million in the Prior Quarter.
This increase was primarily caused by increased employment levels associated
with the Company's continuing growth. The increase was also caused by increased
accounting, legal, reservoir engineering and other expenses incurred in the
Current Quarter as a result of the Company's change to a December 31 fiscal year
end reporting period for which there were no comparable expenses in the Prior
Quarter. The Company capitalized $2.1 million of internal costs in the Current
Quarter directly related to the Company's oil and gas exploration and
development efforts, compared to $1.4 million in the Prior Quarter. The Company
anticipates that G&A costs for 1998 will continue to increase as the result of
industry wage inflation, legal fees associated with litigation, and increases in
employment due to the acquisition program.
Interest and Other. Interest and other expense increased to $10.7 million in the
Current Quarter from $3.7 million in the Prior Quarter. This increase was a
result of a full quarter of interest expense in the Current Quarter on the $300
million principal amount of Senior Notes issued at the end of the Prior Quarter.
In addition to the interest expense reported, the Company capitalized $2.3
million of interest during the Current Quarter compared to $2.7 million
capitalized in the Prior Quarter. Interest expense will increase during the
remainder of 1998 as a result of the issuance of $500 million of Senior Notes in
April 1998.
Provision for Income Taxes. The Company recorded no income tax expense for the
Current Quarter, compared to income tax expense of $9.3 million in the Prior
Quarter. At March 31, 1998, the Company had a net operating loss carryforward of
approximately $383 million for regular federal income taxes which will expire in
future years beginning in 2007. Management believes that it cannot be
demonstrated at this time that it is more likely than not that the deferred
income tax assets, comprised primarily of the net operating loss carryforward,
will be realizable in future years, and therefore a valuation allowance of $174
million has been recorded. The Company does not expect to record any book income
tax expense for the remainder of 1998 based on information available at this
time.
RISK MANAGEMENT ACTIVITIES
Periodically the Company utilizes hedging strategies to hedge the price of a
portion of its future oil and gas production. These strategies include (1) swap
arrangements that establish an index-related price above which the Company pays
the counterparty and below which the Company is paid by the counterparty, (2)
the purchase of index-related puts that provide for a "floor" price below which
the counterparty pays the Company the amount by which the price of the commodity
is below the contracted floor, (3) the sale of index-related calls that provide
for a "ceiling" price above which the Company pays the counterparty the amount
by which the price of the commodity is above the contracted ceiling, and (4)
basis protection swaps, which are arrangements that guarantee the price
differential of oil or gas from a specified delivery point or points. Results
from hedging transactions are reflected in oil and gas sales to the extent
related to the Company's oil and gas production. The Company only enters into
hedging transactions related to the Company's oil and gas production volumes or
physical purchase or sale commitments of its oil and gas marketing subsidiaries.
18
19
As of March 31, 1998, the Company had the following natural gas swap
arrangements for periods after March 1998:
MONTHLY NYMEX-INDEX
VOLUME STRIKE PRICE
MONTHS (MMBTU) (PER MMBTU)
------ ------- ------------
May 1998................... 5,270,000 $ 2.310
June 1998.................. 6,300,000 $ 2.356
July 1998.................. 6,510,000 $ 2.356
August 1998................ 6,510,000 $ 2.356
September 1998............. 6,300,000 $ 2.356
October 1998............... 4,030,000 $ 2.317
The Company has closed a transaction for natural gas previously hedged for the
period April through November 1999 and received proceeds of $0.9 million, which
will be recognized as income during the corresponding months of production.
The Company does not currently have any oil hedge transactions in place.
Gains or losses on the crude oil and natural gas hedging transactions are
recognized as price adjustments in the months of related production.
LIQUIDITY AND CAPITAL RESOURCES
In April 1998, the Company completed an offering of $230 million of 7%
Cumulative Convertible Preferred Stock and $500 million principal amount of
9.625% Senior Notes due 2005. The net proceeds of these offerings were
approximately $712 million, of which $170 million was used to retire all of the
Company's commercial bank debt, approximately $100 million was used to retire
all $90 million principal amount of the Company's 10.5% Senior Notes due 2002,
$345 million was used to fund certain of the Company's acquisitions, with the
balance of the net proceeds increasing the Company's working capital.
As of March 31, 1998, the Company had a working capital deficit of approximately
$69 million which has been eliminated with the proceeds from the April 1998
Preferred Stock and Senior Note offerings. The Company estimates that its
capital expenditures (excluding acquisitions) for 1998 will be between $225
million and $250 million, including $200-$220 million for drilling and
completion expenditures, and the balance for acreage acquisition and
maintenance, seismic programs and capitalized general and administrative costs.
The capital expenditure budget is largely discretionary, and can be adjusted by
the Company based on operating results or other factors. The Company believes it
has sufficient capital resources from anticipated cash flow from operations and
working capital to fund its drilling program for 1998.
The Company is currently negotiating with its commercial bank group to obtain a
secured revolving bank loan. It is anticipated that this facility will be
completed by the end of May 1998 and will contain terms and conditions similar
to the bank facilities the Company has had in the past. It is anticipated that
the facility will be documented at $500 million, but will have collateral-based
borrowing limitations. The debt incurrence covenants of the Senior Note
indentures will also be a limiting factor. The primary purpose of the facility
will be to fund potential acquisitions of oil and gas reserves.
During April 1998, the Company received a senior debt credit rating decrease
from both Moody's Investors Service and Standard & Poor's Rating Services to B1
and B+, respectively. The rating agencies cited, among other factors, the
Company's long-term debt to total book capitalization, which, after the recent
Senior Notes and Preferred Stock offerings, is approximately 67%.
The Company's cash provided by operating activities increased 24% to $49.2
million during the Current Quarter compared to $39.7 million during the Prior
Quarter. The increase was due primarily to cash provided from changes in current
assets and current liabilities between periods.
19
20
Cash used in investing activities increased to $166.5 million during the Current
Quarter from $160.1 million in the Prior Quarter. The Company completed several
acquisitions requiring cash in the Current Quarter which totaled $82 million,
compared to none in the Prior Quarter, offset by a significant decrease in
drilling activity and leasehold acquisitions in the Current Quarter compared to
the Prior Quarter. During the Current Quarter the Company expended approximately
$62 million to initiate drilling on 52 gross (32.9 net) wells and invested
approximately $5 million in leasehold acquisitions. This compares to $129
million to initiate drilling on 35 gross (17.1 net) wells and $30 million to
purchase leasehold in the Prior Quarter.
Cash provided by financing activities was $25.4 million in the Current Quarter,
compared to $280.5 million in the Prior Quarter. During the Current Quarter, the
Company retired $120 million in bank debt which it assumed at the completion of
the Hugoton acquisition. The Company refinanced the Hugoton debt and obtained
additional working capital of $25 million with proceeds from the Company's
commercial bank credit facility. During the Prior Quarter, the Company issued
$300 million in Senior Notes.
The Company is subject to certain routine legal proceedings, none of which are
expected to have a material adverse effect upon the Company's financial
condition or operations. The Company is also a defendant in other non-routine
lawsuits, which are described in Note 3 of the notes to the accompanying
financial statements. Also see Part II, Item 1 of this report. An adverse
outcome in one or more of such suits could have a material effect on the
Company, although management is unable to quantify the Company's exposure to
liability. No provision for litigation liability has been recorded in the
Company's financial statements.
FORWARD LOOKING STATEMENTS
This Form 10-Q includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act and Section 21E of the Exchange Act. All
statements other than statements of historical facts included in this Form 10-Q,
including without limitation statements under "Management's Discussion and
Analysis of Financial Condition and Results of Operations" regarding planned
capital expenditures, expected oil and gas production, the Company's financial
position, business strategy and other plans and objectives for future
operations, capital expenditures plans, and expected future expenses are forward
looking statements. Although the Company believes that the expectations
reflected in such forward-looking statement are reasonable, it can give no
assurance that such expectations will prove to have been correct. Factors that
could cause actual results to differ materially from those expected by the
Company, including, without limitation, factors discussed under Risk Factors in
the Company's Form 10-K for the period ended December 31, 1997 are concentration
of unevaluated leasehold in Louisiana, impairment of asset value, need to
replace reserves, substantial capital requirements, substantial indebtedness,
fluctuations in the prices of oil and gas, uncertainties inherent in estimating
quantities of oil and gas reserves and projecting future rates of production and
timing of development expenditures, competition, operating risks, acquisition
and integration of operation risks, restrictions imposed by lenders, liquidity
and capital requirements, the effects of governmental and environmental
regulation, patent and securities litigation and adverse changes in the market
for the Company's oil and gas production. Readers are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of the
date hereof. The Company undertakes no obligation to release publicly the result
of any revisions to these forward-looking statements that may be made to reflect
events or circumstances after the date hereof, including, without limitation,
changes in the Company's business strategy or planned capital expenditures, or
to reflect the occurrence of unanticipated events.
20
21
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is subject to ordinary routine litigation incidental to its
business. In addition, the Company and its officers and directors are defendants
in certain purported class actions based on federal securities fraud claims.
Also the Company is defending claims of patent infringement, tortious
interference with confidentiality contracts and misappropriation of proprietary
information in another pending action. These matters are described in Item 3 of
the Company's Transition Report on Form 10-K for the six-month period ended
December 31, 1997. Subsequent developments are as follows:
On March 16, 1998, the Company and named officers and directors filed a motion
to dismiss in In re Chesapeake Energy Corporation Securities Litigation pending
in the U.S. District Court for the Western District of Oklahoma.
In May 1998, two purported class actions filed on behalf of investors who
purchased common stock of Bayard Drilling Technologies, Inc. in its initial
public offering on November 4, 1997 were dismissed without prejudice pursuant to
stipulation of all parties. These actions had been filed in the District Court
for Oklahoma County, Oklahoma alleging violations by the Company and others of
Sections 11 and 12 of the Securities Act of 1933 and Section 408 of the
Oklahoma Securities Act. The Company was a selling stockholder in the offering.
On May 12, 1998, the plaintiffs in the dismissed cases became co-lead plaintiffs
in the remaining federal case: Tom Yuan v. Bayard, et al. filed in the U.S.
District Court for the Western District of Oklahoma.
ITEM 2. CHANGES IN SECURITIES
On April 22, 1998, the Company sold 4,600,000 shares (the "Shares") of 7%
Cumulative Convertible Preferred Stock having a liquidation preference of $50
per share in a private placement to Donaldson, Lufkin & Jenrette Securities
Corporation, Morgan Stanley & Co. Incorporated, Bear, Stearns & Co. Inc., Lehman
Brothers Inc. and J.P. Morgan Securities Inc. (the "Initial Purchasers")
pursuant to the exemption from registration provided by Section 4 (2) of the
Securities Act of 1933 (the "Securities Act"). The Initial Purchasers resold the
shares to qualified institutional buyers, as defined in, and in reliance on the
exemption from registration provided by, Rule 144A under the Securities Act. The
aggregate offering price for the Shares was $230 million, and aggregate
discounts and commissions were $6.9 million.
Each of the Shares is convertible at the holders' option, exercisable at any
time unless previously redeemed, into shares of Company common stock at a
conversion price of $6.95 per Share (equivalent to a conversion rate of
approximately 7.1942 shares of common stock for each Share), subject to
adjustment pursuant to antidilution provisions.
The Shares are redeemable, in whole or in part, at the Company's option at any
time on or after May 1, 2001, initially at a price of $52.45 per share and
thereafter at prices declining to $50 per share on or after May 1, 2008, plus in
each case all accrued and unpaid dividends to the redemption date, which
redemption price may be paid in cash, by delivery of shares of Company common
stock or through a combination thereof. Upon any Change of Control (as defined
in the Certificate of Designation for the Shares), each holder of Shares will,
in the event that the Market Value (as defined) at such time is less than the
Conversion Price, have a one-time option to convert such holder's Shares into
common stock at an adjusted Conversion Price equal to the greater of (x) the
Market Value for the period ending on the Change of Control date and (y)
66 2/3% of the Market Value for the period ended April 16, 1998. In lieu of
issuing shares of common stock for Shares surrendered for conversion upon a
Change of Control, the Company may, at its option, make a cash payment equal to
the Market Value of the common stock otherwise issuable determined for the
period ending on the Change of Control date.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
- - Not applicable
21
22
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held a special meeting of shareholders on March 10, 1998 to approve
the merger of Hugoton Energy Corporation into a subsidiary of the Company.
The proposal to approve and adopt the Agreement and Plan of Merger between the
Company and Hugoton Energy Corporation and the issuance of the Company's Common
Stock pursuant to the merger was approved by a vote of 54,018,852 shares for,
representing 73% of the outstanding shares of Common Stock; 542,797 shares voted
against the proposal; 132,847 shares abstained from voting; and 19,610,315
shares were broker non-votes.
ITEM 5. OTHER INFORMATION
- - Not applicable
22
23
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as a part of this report:
Exhibit No.
-----------
3.1 Registrant's Certificate of Incorporation, as amended
4.3 Indenture dated as of April 1, 1998 among Chesapeake Energy
Corporation, its subsidiaries signatory thereto as Subsidiary
Guarantors and United States Trust Company of New York, as
Trustee, with respect to 9.625% Senior Notes due 2005.
4.11 Registration Rights Agreement dated as of April 22, 1998 by and
among Chesapeake Energy Corporation and Donaldson, Lufkin &
Jenrette Securities Corporation, Morgan Stanley & Co.
Incorporated, Bear, Stearns & Co. Inc., Lehman Brothers Inc. and
J.P. Morgan Securities, Inc., with respect to 7% Cumulative
Convertible Preferred Stock.
4.12 Registration Rights Agreement dated as of April 22, 1998 by and
among Chesapeake Energy Corporation, The Named Guarantors and
Donaldson, Lufkin & Jenrette Securities Corporation, Morgan
Stanley & Co. Incorporated, Bear, Stearns & Co. Inc., Lehman
Brothers Inc., J.P. Morgan Securities, Inc. and Morgan Stanley &
Co., Incorporated, with respect to 9.625% Senior Notes due 2005.
27 Financial Data Schedules
(b) Reports on Form 8-K
During the quarter ended March 31, 1998, the Company filed the
following Current Reports on Form 8-K dated:
January 15, 1998 announcing property acquisition in Western
Canada and in the Mid-Continent,
January 26, 1998 announcing successful negotiation of $500
million credit facility,
February 5, 1998 reporting on drilling activities and pending
transactions,
February 13, 1997 reporting renegotiated terms of the DLB merger
agreement,
March 5, 1998 announcing the Company and Hugoton Energy
Corporation set shareholder meetings seeking approval of merger,
March 5, 1998 announcing the Company enhances its position in the
Texas Panhandle, and agrees to purchase properties from
Occidental Petroleum Corporation,
March 5, 1998 announcing preliminary transition period results,
March 5, 1998 reporting on activity in Northeast British
Columbia,
March 20, 1998 announcing that shareholders of the Company and
Hugoton Energy Corporation has approved the merger,
23
24
March 23, 1998 announcing cash dividend for shareholders,
March 25, 1998 announcing 1997 transition period results,
March 31, 1998 announcing senior notes and preferred stock
offerings,
March 31, 1998 announcing increased reserves in the Helmet Area
of Northeast British Columbia, and
March 31, 1998 announcing continuation of Mid-Continent
Consolidation, and announcing transaction with Gothic Energy
Corporation.
24
25
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CHESAPEAKE ENERGY CORPORATION
-----------------------------
(Registrant)
May 15, 1998 /s/ Aubrey K. McClendon
- --------------------- -----------------------------
Date Aubrey K. McClendon
Chairman and
Chief Executive Officer
May 15, 1998 /s/ Marcus C. Rowland
- --------------------- -----------------------------
Date Marcus C. Rowland
Vice President and
Chief Financial Officer
25
26
Index to Exhibits
Exhibit No. Description Page
- ----------- ----------- ----
3.1 Registrant's Certificate of Incorporation as amended
4.3 Indenture dated as of April 1, 1998 among Chesapeake Energy
Corporation, its subsidiaries signatory thereto as Subsidiary
Guarantors and United States Trust Company of New York, as
Trustee, with respect to 9.625% Senior Notes due 2005.
4.11 Registration Rights Agreement dated as of April 22, 1998 by and
among Chesapeake Energy Corporation and Donaldson, Lufkin &
Jenrette Securities Corporation, Morgan Stanley & Co.
Incorporated, Bear, Stearns & Co. Inc., Lehman Brothers Inc. and
J.P. Morgan Securities, Inc., with respect to 7% Cumulative
Convertible Preferred Stock.
4.12 Registration Rights Agreement dated as of April 22, 1998 by and
among Chesapeake Energy Corporation, The Named Guarantors and
Donaldson, Lufkin & Jenrette Securities Corporation, Morgan
Stanley & Co. Incorporated, Bear, Stearns & Co. Inc., Lehman
Brothers Inc., J.P. Morgan Securities, Inc. and Morgan Stanley &
Co., Incorporated, with respect to 9.625% Senior Notes due 2005.
27.1 Financial Data Schedules
27.2 Financial Data Schedules Restated
27.3 Financial Data Schedules Restated
27.4 Financial Data Schedules Restated
27.5 Financial Data Schedules Restated
27.6 Financial Data Schedules Restated
27.7 Financial Data Schedules Restated
27.8 Financial Data Schedules Restated