1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934 for the Quarterly Period ended
June 30, 1998
Commission File Number: 0-22867
CONTINENTAL NATURAL GAS, INC.
(Exact name of registrant as specified in its charter)
OKLAHOMA 73-1198957
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1437 SOUTH BOULDER, SUITE 1250
TULSA, OKLAHOMA 74119
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (918) 582-4700
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
---- ----
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date. As of July 31, 1998,
6,315,000 common shares, $0.1 par value, were outstanding.
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CONTINENTAL NATURAL GAS, INC.
INDEX
PAGE
PART I. Financial Information.
Item 1 - Financial Statements (Unaudited) 1
Consolidated Condensed Balance Sheets June 30, 1998
and December 31, 1997 1
Consolidated Condensed Statements of Operations
Three and Six Months Ended June 30, 1998 and 1997 2
Consolidated Condensed Statements of Cash Flows
Six Months Ended June 30, 1998 and 1997 3
Notes to Consolidated Condensed Financial Statements 4
Report of Review by Independent Accountants 6
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 7
PART II. Other Information
Item 1 - Legal Proceedings 13
Item 2 - Changes in Securities 13
Item 3 - Defaults Upon Senior Securities 13
Item 4 - Submission of Matters to a Vote of Security Holders 13
Item 5 - Other Information 14
Item 6 - Exhibits and Reports on Form 8-K 14
Signatures
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PART I - FINANCIAL INFORMATION
CONTINENTAL NATURAL GAS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
JUNE 30, DECEMBER 31,
------------- ------------
1998 1997
------------- ------------
(UNAUDITED)
(IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 6,339 $ 1,237
Accounts receivable:
Trade.................................................. 39,921 38,184
Affiliates............................................. 5,384 7,386
Other.................................................. 3,809 5,533
Notes receivable -- affiliates............................ 18 18
Gas inventory............................................. 1,361 1,679
Prepaid expenses.......................................... 260 240
-------- --------
Total current assets...................................... 57,092 54,277
Investments................................................. 479 527
Property and equipment, net of accumulated depreciation and
amortization of $13,598 for 1998 and $10,271 for 1997..... 121,096 114,785
Deferred tax asset.......................................... 6,836 7,683
Other assets................................................ 1,663 1,662
-------- --------
Total assets................................................ $187,166 $178,934
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities.................. $ 50,414 $ 48,755
Current portion of long-term debt......................... 7,500 7,500
Current portion of capital lease obligations.............. 1,316 1,402
-------- --------
Total current liabilities................................. 59,230 57,657
Long-term debt.............................................. 79,097 73,500
Capital lease obligations................................... 5,626 6,226
Deferred gain on sale-leaseback............................. 71 132
-------- --------
Total liabilities........................................... 144,024 137,515
Commitments and contingencies
Shareholders' equity
Preferred stock, $.01 par value, 5,000,000 shares
authorized, none issued................................ -- --
Convertible preferred stock, $1 par value, $40,000
liquidation value, 200 shares authorized
none outstanding ...................................... -- --
Common stock, $.01 par value, 60,000,000 shares
authorized and 6,621,003 shares issued ................ 66 66
Additional paid-in capital................................ 34,472 34,472
Retained earnings......................................... 9,339 7,987
Treasury stock, at cost................................... (204) (204)
Receivable from stock sale................................ (100) (100)
Unearned compensation associated with stock options....... (431) (802)
-------- --------
Total shareholders' equity................................ 43,142 41,419
-------- --------
Total liabilities and shareholders' equity.................. $187,166 $178,934
======== ========
The accompanying notes are an integral part of the
consolidated financial statements.
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CONTINENTAL NATURAL GAS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
(IN THOUSANDS EXCEPT PER SHARE DATA)
Natural gas sales............................ $ 50,844 $ 51,705 $ 111,023 $ 124,661
Natural gas sales -- related party........... 4,215 4,270 8,850 10,102
Natural gas liquids sales.................... 10,089 9,097 21,602 17,978
Gathering fees............................... 1,981 1,841 3,977 3,128
Other........................................ 140 (9) 242 6
---------- ---------- ---------- ----------
Total operating revenue...................... 67,269 66,904 145,694 155,875
---------- ---------- ---------- ----------
Operating costs and expenses:
Cost of purchased gas...................... 61,813 61,751 133,853 143,612
Operating expenses......................... 2,508 1,518 5,221 3,077
General and administrative................. 2,377 1,755 4,894 3,598
Depreciation, depletion and amortization... 1,843 933 3,551 1,832
---------- ---------- ---------- ----------
Total operating costs and expenses......... 68,541 65,957 147,519 152,119
---------- ---------- ---------- ----------
Operating income (loss)...................... (1,272) 947 (1,825) 3,756
---------- ---------- ---------- ----------
Other income (expense):
Interest income............................ 35 131 82 411
Equity in loss of investee................. (7) (30) (48) (63)
Interest expense........................... (2,218) (1,315) (4,229) (2,781)
Gain on sale of gathering system........... 7,515 -- 7,515 --
Other, net................................. 225 42 720 90
---------- ---------- ---------- ----------
Total other income (expense)............... 5,550 (1,172) 4,040 (2,343)
---------- ---------- ---------- ----------
Income before income taxes................... 4,278 (225) 2,215 1,413
Income tax (expense) benefit................. (1,669) 86 (864) (566)
---------- ---------- ---------- ----------
Net income (loss)............................ 2,609 (139) $ 1,351 $ 847
========== ========== ========== ==========
Less: preferred dividends.................... -- (112) -- (223)
---------- ---------- ---------- ----------
Net income (loss) available for common
shareholders............................... 2,609 (251) 1,351 624
========== ========== ========== ==========
Net income per common share:
Basic...................................... $ .41 $ (.07) $ .21 $ .17
========== ========== ========== ==========
Diluted.................................... $ .41 $ (.07) $ .21 $ .17
========== ========== ========== ==========
Weighted average common shares outstanding:
Basic...................................... 6,315,000 3,613,153 6,315,000 3,613,153
Diluted.................................... 6,344,846 3,613,153 6,355,115 3,613,153
The accompanying notes are an integral part of the
consolidated financial statements.
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CONTINENTAL NATURAL GAS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED
JUNE 30,
--------------------
1998 1997
-------- --------
(UNAUDITED)
(IN THOUSANDS)
Cash Flows from operating activities:
Net income................................................ $ 1,351 $ 847
-------- --------
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation, depletion and amortization............... 3,551 1,832
Amortization of debt issuance costs.................... 173 76
Gain on disposition of gathering system................ (7,515) --
Gain on disposition of assets.......................... (61) (61)
Equity in loss of investee............................. 48 63
Deferred income tax expense............................ 847 536
Noncash compensation on grant of stock options......... 371 --
Changes in operating assets and liabilities
Accounts receivable.................................. 1,988 21,177
Gas inventory........................................ 319 1,892
Prepaid expenses..................................... (19) 70
Accounts payable..................................... 1,801 (21,563)
Contract advance..................................... -- (20,879)
-------- --------
Total Adjustments................................. 1,503 (16,857)
-------- --------
Net cash provided by (used in) operating activities....... 2,854 (16,010)
-------- --------
Cash flows from investing activities:
Proceeds from sale of gas system ......................... 12,000 --
Capital expenditures...................................... (14,488) (6,043)
Purchase of preferred stock investment.................... 6,000 --
Redemption of preferred stock investment.................. (6,000) --
Decrease in other investments............................. -- 34
-------- --------
Net cash used in investing activities..................... (2,488) (6,009)
-------- --------
Cash flows from financing activities:
Principal payments on long--term debt..................... (40,250) (433)
Proceeds of long--term debt............................... 45,847 7,861
Debt issuance costs....................................... (175) (83)
Principal payments under capital lease obligations........ (686) (579)
-------- --------
Net cash provided by financing activities................. 4,736 6,766
-------- --------
Net increase (decrease) in cash and cash equivalents...... 5,102 (15,476)
Cash and cash equivalents at beginning of the period...... 1,237 21,077
-------- --------
Cash and cash equivalents at end of the period............ $ 6,339 5,601
======== ========
The accompanying notes are integral part of the
consolidated financial statements.
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CONTINENTAL NATURAL GAS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- BASIS OF PREPARATIONS AND PRESENTATION
In the opinion of the Company, the accompanying unaudited consolidated
financial statements contain all adjustments necessary (all adjustments are of a
normal recurring nature) to present fairly the financial position of the Company
as of June 1998 and the results of its operations for the three and six month
periods ended June 30, 1998, and 1997 and cash flows for the six months ended
June 1998 and 1997. Results for the three and six months ended June 30, 1998 are
not necessarily indicative of the results to be realized during the full year.
The year end consolidated balance sheet data was derived from the audited
financial statements (included in the Company's Annual Report on Form 10-K) but
does not include all disclosures required by generally accepted accounting
principles. These financial statements should be read in conjunction with the
Company's audited financial statements as of and for the year ended December
31, 1997 included in the Form 10-K.
Certain reclassifications have been made to the 1997 financial statement
amounts to conform to the 1998 presentation.
NOTE 2 -- MERGER WITH CMS
On August 3, 1998, the Company announced the completion of an agreement
with CMS Energy Corporation ("CMS") in which CMS will acquire 100 percent of the
Company's common stock in exchange for shares of CMS common stock totaling
approximately $65 million. The agreement is subject to ratification by the
holders of a majority of the Company's stock. The majority shareholders have
announced their intentions to vote in favor of the transaction and expect to
close the transaction early in the fourth quarter.
NOTE 3 -- EARNINGS PER SHARE
The following data shows the amounts used in computing earnings per share.
For the 3 Months Ended June 30, 1998
------------------------------------------
Income Weighted Shares Per-Share
(Numerator) (Denominator) Amount
------------------------------------------
Basic earnings per common share $2,609,015 6,315,000 .41
========
Effect of dilutive stock options -- 29,846
------------ ----------
Diluted earnings per common share $2,609,015 6,344,846 .41
============ ========== ========
For the 3 Months Ended June 30, 1997
------------------------------------------
Loss Weighted Shares Per-Share
(Numerator) (Denominator) Amount
------------------------------------------
Net Income $ (139,510)
Less: Preferred stock dividends (111,750)
------------
Basic earnings per common share (251,260) 3,613,153 $ (0.07)
------------ ---------- --------
Diluted earnings per common share $ (251,260) 3,613,153 $ (0.07)
============ ========== ========
For the 6 Months Ended June 30, 1998
------------------------------------------
Income Weighted Shares Per-Share
(Numerator) (Denominator) Amount
------------------------------------------
Basic earnings per common share $1,351,602 6,315,000 .21
========
Effect of dilutive stock options -- 40,115
------------ ----------
Diluted earnings per common share $1,351,602 6,355,115 .21
============ ========== ========
For the 6 Months Ended June 30, 1997
------------------------------------------
Income Weighted Shares Per-Share
(Numerator) (Denominator) Amount
------------------------------------------
Net Income $ 847,018
Less: Preferred stock dividends (223,500)
------------
Basic earnings per common share 623,518 3,613,153 $ .17
------------ ---------- --------
Diluted earnings per common share $ 623,518 3,613,153 $ .17
============ ========== ========
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Options on 31,000 shares of common stock with an average exercise price of
$11.41 were not included in the computation of diluted earnings per share for
three and six months ended June 30, 1998 because their effect would have been
antidilutive. Contingently issuable options on 204,000 shares of common stock
with an exercise price of $.26 were not included in the computation of diluted
earnings per share for 1998 and 1997 in accordance with the provisions of FAS
128.
NOTE 4 -- INVESTMENTS
On January 23, 1998, the Company entered into an agreement with Gothic
Energy Corporation ("Gothic") to acquire interests in four natural gathering
systems and $6 million of Gothic Senior Redeemable Preferred Stock for a total
purchase price of $12 million. The closing of these purchase transactions was
consummated in January and March of 1998.
On April 27, 1998, the Preferred Stock was redeemed by Gothic for $6
million plus related fees and dividends.
NOTE 5 -- SALE OF GAS SYSTEM
On May 29 (effective as of June 1), 1998, the Company sold a gas system for
approximately $12 million, resulting in a gain on sale of approximately $7.5
million.
NOTE 6 -- CONTINGENCIES
On May 31, 1998, the Company was served with a summons in a lawsuit
initiated by Aurora National Gas, L.L.C. and filed in Dallas, Texas (Aurora
Natural Gas L.L.C. v. Continental Natural Gas, Inc. and Gary C. Adams, Case No.
DV-98-3831, District Court of Dallas County, Texas, 68th Judicial District). The
Company has removed the case to federal court in Dallas, Texas and has filed
pleadings to (i) dismiss Gary C. Adams as a defendant and (ii) transfer the case
to federal court in Tulsa, Oklahoma. Aurora has filed a motion in federal court
to remand the case to state court. The Company does not know whether any of
these motions will be granted.
Aurora's lawsuit is based on a gas purchase contract which the Company
entered into with Gothic on January 23, 1998. Aurora alleges that it had a prior
contract with Gothic and that the Company "tortiously interfered" with Aurora's
contract. This lawsuit is in the early stages of discovery it is not possible to
fully evaluate Aurora's claims. After consultation with the Company's trial
counsel, management believes that the Company will prevail on the claims made by
Aurora and intends to vigorously defend this lawsuit--accordingly, the outcome
of this lawsuit is not likely to have a material effect on the financial
condition, results of operations or prospects of the Company. However, the
Company cannot guarantee an outcome favorable to the Company.
At June 30, 1998, the Company had net operating loss carryforwards (NOLs)
totaling approximately $40.0 million for regular tax purposes and $40.0 million
for alternative minimum tax purposes. If not utilized, these carryforwards will
expire from 2000 to 2012. Due to the lack of existing legal precedent with
respect to the tax rules governing the Company's NOLs, both the availability of
approximately $10.0 million of the Company's NOLs and its prior utilization of
NOLs (totaling approximately $34.0 million) may be challenged. Disallowance of
the use of the NOLs would result in certain taxes associated with prior
utilization of the NOLs being currently payable. In March of 1998, the Company
received notification that the Internal Revenue plans to audit the Company's
1995 tax return.
Realization of the Company's deferred tax assets is dependent upon the
generation of sufficient taxable income prior to the expiration of the NOLs and,
for financial purposes, the resolution of the matters noted above. Although
realization is not assured, management believes it is more likely than not that
the recorded net deferred tax asset will be realized. The amount of the deferred
tax asset considered realizable could be increased or decreased by a material
amount in the near-term pending resolution of these matters.
NOTE 7 -- NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, Disclosures about Segments of an
Enterprise and Related Information ("FAS 131"). FAS 131 amends standards
regarding the disclosure of information on business segments in annual financial
statements and also requires selected financial information on segments for
interim financial statements. FAS 131 will become effective for the Company when
the annual financial statements are filed for 1998. Since this Statement
requires only additional disclosure, there will be no effect on the Company's
results of operations or financial position.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, Accounting for Derivative
Instruments and Hedging Activities ("FAS 133"). FAS 133 is effective for fiscal
years beginning after June 15, 1999, but earlier application is permitted as of
the beginning of any fiscal quarter subsequent to June 15, 1998. FAS 133
standardizes the accounting for derivative instruments by requiring that all
derivatives be recognized as assets and liabilities and measured at fair value.
Upon the Statement's initial application, all derivatives are required to be
recognized in the statement of financial position as either assets or
liabilities and measured at fair value. The Company does not believe adoption
of the new standard will have a material impact on its financial statements.
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REPORT OF INDEPENDENT ACCOUNTANTS
We have reviewed the accompanying consolidated balance sheet of Continental
Natural Gas, Inc. and Subsidiaries as of June 30, 1998, and the related
consolidated statements of operations for the three and six months ended June
30, 1998 and 1997, and cash flows for the six months ended June 30, 1998 and
1997. These financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the accompanying financial statements for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Continental Natural Gas, Inc and
subsidiaries at December 31, 1997, and the related consolidated statements of
operations, changes in shareholders' equity and cash flows for the year then
ended (not presented herein); and our report dated March 27, 1998 expressed an
unqualified opinion on those consolidated financial statements. In our opinion,
the information set forth in the accompanying consolidated balance sheet at
December 31, 1997, is fairly stated in all material respects in relation to the
consolidated balance sheet from which it has been derived.
PRICEWATERHOUSECOOPERS LLP
Tulsa, Oklahoma
August 13, 1998
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MANAGEMENT'S DISCUSSION AND ANALYSIS
RESULTS OF OPERATIONS
The Company's results of operations are determined primarily by the
volume of natural gas purchased, processed and resold in its natural gas
gathering systems and processing plants. The Company also purchases for resale
natural gas unrelated to its gathering or processing business ("off-system gas")
which contributes to its profitability.
Fluctuations in the price levels of natural gas and natural gas liquids
("NGLs") also affect results of operations since the Company generally receives
a portion of the natural gas and NGLs revenue from natural gas throughput. In
the first half of 1998, natural gas prices relative to low NGLs prices created a
significant negative impact on operating results. Most of the Company's
operating expenses do not vary materially with changes in natural gas throughput
volume on existing systems; thus, increases or decreases in volumes on existing
systems generally have a direct effect on the Company's profitability.
Conversely, operating expenses such as compression rental and compression
maintenance expenses vary with volume changes as compressor units are added or
removed accordingly.
During the second quarter of 1998, the Company sold its interest in
the Sycamore gas gathering system for $12 million. The sale resulted in a gain
of approximately $7.5 million--$9 million in proceeds from the sale were
applied to the Company's outstanding indebtedness under its Credit Agreement
(as defined below). The remainder of the proceeds were used for capital
expenditures.
Second Quarter Ended June 30, 1998 Compared to Second Quarter Ended
June 30, 1997
Revenues. Total operating revenue increased to $67.3 million for
the second quarter of 1998 as compared to $66.9 million for the same period in
1997. Total natural gas sales decreased to $55.1 million for the second
quarter of 1998 from $56.0 million for the same period in 1997 as a result of a
$6.2 million price-related increase due to average sales prices of $2.48 per Mcf
in 1998 compared to $2.20 per Mcf in 1997 and a $7.1 million volume-related
decrease due to sales of 243.7 MMcf/d in 1998 compared to 279.0 MMcf/d in 1997.
This decrease in volume resulted from decreases in both off-system and on-system
gas marketing sales.
NGL sales increased 11% to $10.1 million for the second quarter of 1998
as compared to $9.1 million for the same period last year as a result of a $3.4
million price-related decrease due to average NGL sales prices of $.26 per
gallon in 1998 compared to $.35 per gallon in 1997 and a $4.4 million
volume-related increase due to increased natural gas processing throughput.
The Company earned gathering fees of $2.0 million for the second
quarter of 1998 as compared to $1.8 million for the same period in 1997 as a
result of increased fees from the Company's gathering assets located in the
Texas panhandle (the "Texas Gathering Assets") and gathering systems acquired
from Gothic Energy Corporation ("Gothic") during the first quarter of 1998.
Costs and Expenses. Total operating costs and expenses increased to
$68.5 million for the second quarter of 1998 as compared to $66.0 million for
the same period in 1997. Total natural gas costs were unchanged at $61.8 million
in 1998 as compared to 1997 as a result of a $4.7 million price-related
increase due to average purchase prices of $2.39 per Mcf in 1998 compared to
$2.21 per Mcf in 1997 and a $4.7 million volume-related decrease due to
purchases of 284.1 MMcf/d in 1998 compared to 307.3 MMcf/d in 1997. This
decrease in volume resulted from decreases in both off-system and on-system gas
marketing purchases.
Operating expenses increased to $2.5 million for the second quarter of
1998, from $1.5 million during the same period in 1997. This increase was due
primarily to operating activities from the acquisition of Taurus Energy Corp.
("Taurus") which the Company closed during the fourth quarter of 1997.
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General and administrative expenses increased 35% to $2.4 million for
the second quarter of 1998 from $1.8 million in the same period last year. This
increase was due primarily to the addition of administrative support activities
and related expenses associated with the Taurus acquisition.
Depreciation, depletion and amortization increased 100% to $1.8 million
for the second quarter of 1998 from $0.9 million for the same period in 1997
principally due to the acquisition of Taurus.
Other Income (Expense). Interest income decreased to $35,000 for the
second quarter of 1998 from $131,000 for the same period in 1997 due to
decreased cash investments. During these same time periods, interest expense
increased 69% to $2.2 million from $1.3 million due primarily to additional debt
incurred to finance the Taurus, Laverne plant and Gothic acquisitions. In
addition, the Company recognized a $7.5 million gain from the sale of the
Sycamore gas gathering system.
Income Taxes. The Company had income tax expense of $1.7 million for
the second quarter of 1998 as compared to a $86,000 benefit for 1997.
Six Months Ended June 30, 1998 Compared to Six Months Ended June 30,
1997
Revenues. Total operating revenue decreased 7% to $145.7 million for
the six months ended June 30, 1998 as compared to $155.9 million for the same
period in 1997. Total natural gas sales decreased 11% to $119.9 million for the
six months ended June 30, 1998 from $134.8 million for the same period in 1997
as a result of a $12.4 million price-related decrease due to average sales
prices of $2.46 per Mcf in 1998 compared to $2.72 per Mcf in 1997 and a $2.5
million volume-related decrease due to sales of 269.0 MMcf/d in 1998 compared to
274.0 MMcf/d in 1997. This decrease in volume resulted from decreases in
on-system gas marketing sales offset by increases in off-system gas marketing
sales.
NGL sales increased 20% to $21.6 million for the six months ended June
30, 1998 as compared to $18.0 million for the same period last year as a result
of a $6.1 million price-related decrease due to average NGL sales prices of $.28
per gallon in 1998 compared to $.36 per gallon in 1997 and a $9.7 million
volume-related increase due to increased natural gas processing throughput.
The Company earned gathering fees of $4.0 million for the six months
ended June 30, 1998 as compared to $3.1 million for the same period in 1997 as a
result of increased fees from the Texas Gathering Assets and the gathering
systems acquired from Gothic.
Costs and Expenses. Total operating costs and expenses decreased to
$147.5 million for the six months ended June 30, 1998 as compared to $152.1
million for the same period in 1997. Total natural gas costs decreased 7% to
$133.9 million in 1998 from $143.6 million in 1997 as a result of a $14.5
million price-related decrease due to average purchase prices of $2.38 per Mcf
in 1998 compared to $2.63 per Mcf in 1997 and a $4.8 million volume-related
increase due to purchases of 311.1 MMcf/d in 1998 compared to 301.1 MMcf/d in
1997. This increase in volume
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resulted from increases in off-system gas marketing purchases offset by
decreases in on-system gas marketing purchases.
Operating expenses increased to $5.2 million for the six months ended
June 30, 1998 from $3.1 million for the same period in 1997. This was due mainly
to operating activities from the acquisition of Taurus.
General and administrative expenses increased 36% to $4.9 million for
the six months ended June 30, 1998 from $3.6 million in the same period last
year. This increase was due primarily to compensation expense of $0.4 million
related to the Company's Employee Stock Plan and the addition of administrative
support activities and other related expenses associated with the Taurus
acquisition.
Depreciation, depletion and amortization increased 94% to $3.5 million
for the six months ended June 30, 1998 from $1.8 million for the same period in
1997 principally due to the acquisition of Taurus.
Other Income (Expense). Interest income decreased to $81,000 for the
six months ended June 30, 1998 from $411,000 million for the same period in 1997
due to decreased cash investments. During these same time periods, interest
expense increased 50% to $4.2 million from $2.8 million due primarily to
additional debt incurred to finance the Taurus, Laverne plant and Gothic
acquisitions. In addition, the Company recognized $.6 million from fees and
dividends earned on the Gothic Senior Redeemable Preferred Stock investment and
a $7.5 million gain from the sale of the Sycamore gathering system acquired from
Gothic in January of 1998.
Income Taxes. The Company had income tax expense of $.9 million for the
six months ended June 30, 1998 as compared to $ .6 million for 1997.
LIQUIDITY AND CAPITAL RESOURCES
General. The Company's primary sources of liquidity and capital
resources historically have been net cash provided by operating activities and
bank borrowings. The Company completed an initial public offering of Common
Stock on August 6, 1997, selling 2,115,000 shares for $11.25 per share, yielding
net proceeds of approximately $21.3 million. The proceeds were used to pay $17.3
million on the Company's term loan facility and $2.0 million on its revolving
facility, to pay $0.6 million in accrued dividends on its Convertible Preferred
Stock and the remainder for other general corporate purposes.
The following summary table reflects comparative cash flows for the
Company for the six months ended June 30, 1998 and 1997:
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Six Months Ended
June 30,
1998 1997
(in thousands)
Net cash provided by (used in)
operating activities ......... 2,854 (16,010)
Net cash provided by (used in)
investing activities ......... (2,488) (6,009)
Net cash provided by (used in)
financing activities ......... 4,736 6,766
The increase in net cash provided by operating activities for the
period ended June 30, 1998 as compared to the same period in 1997, was mainly
attributable to changes in working capital. Excluding net changes in working
capital components, the Company's operating activities used cash of $1.2 million
for this period in 1998 and generated cash of $3.3 million in 1997.
Cash used in investing activities for the six months ended June 30,
1998 was primarily for the $12.0 million Gothic acquisition including interests
in four gas gathering systems and $6.0 million of Gothic Senior Redeemable
Preferred Stock. In addition, the Company acquired additional interests in the
Laverne gas processing plant for $3.0 million. Cash generated by investing
activities included the $6.0 million redemption of the Gothic Senior Redeemable
Preferred Stock and proceeds from the sale of the Sycamore gathering system for
$12.0 million. Cash used in investing activities for the same period in 1997 was
mainly for expansion projects on the Texas Gathering Assets.
Cash provided by financing activities for the six months ended June 30,
1998 resulted from borrowings under the Company's revolving loan facility and
the Bridge Loan (see below) used for working capital requirements and funding
the Gothic acquisition. Cash provided by financing activities for the same
period in 1997 resulted mainly from borrowings under the Company's revolving
loan facility used for working capital requirements and funding various capital
projects.
Fluctuations of natural gas prices in relation to the price of NGL's
experienced by the Company have negatively impacted the Company's operating
results and the associated operating cash flows. Continued depressed margins
(and consequent negative operating cash flows) could delay or limit the
Company's planned capital expenditures, negatively impact the Company's ability
to service its debt or limit the Company's ability to fund working capital
requirements. Consequently, the Company may be required to seek additional
sources of funding.
At June 30, 1998, the Company had net operating loss carryforwards
(NOLs) totaling approximately $40.0 million for regular tax purposes and $40.0
million for alternative minimum tax purposes. If not utilized, these
carryforwards will expire from 2000 to 2012. Due to the lack of existing legal
precedent with respect to the tax rules governing the Company's NOLs, both the
availability of approximately $10.0 million of the Company's NOLs and its prior
utilization of
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NOLs (totaling approximately $34.0 million) may be challenged. Disallowance of
the use of the NOLs would result in certain taxes associated with prior
utilization of the NOLs being currently payable. In March of 1998, the Company
received notification that the Internal Revenue plans to audit the Company's
1995 tax return.
Realization of the Company's deferred tax assets is dependent upon the
generation of sufficient taxable income prior to the expiration of the NOLs and,
for financial purposes, the resolution of the matters noted above. Although
realization is not assured, management believes it is more likely than not that
the recorded net deferred tax asset will be realized. The amount of the deferred
tax asset considered realizable could be increased or decreased by a material
amount in the near-term pending resolution of these matters.
Financing Facilities. The Company entered into an Amended and Restated
Credit Agreement (the "Credit Agreement") with ING (U.S.) Capital Corporation as
of November 25, 1997 (in turn, the Credit Agreement has been syndicated to other
lenders). The Credit Agreement contains a revolving loan facility and a term
loan facility. The revolving facility has a maximum borrowing base of $25.0
million which had outstanding borrowings of $21.3 million as of June 30, 1998.
The revolving facility contains a sub-limit permitting the Company to issue
Letters of Credit amounting, in the aggregate, to $18.0 million. As of June 30,
1998, the aggregate amount outstanding under the Letters of Credit was $3.7
million. Under the term loan facility approximately $65.2 million was
outstanding as of June 30, 1998. Interest rates under both the revolving
facility and term facility are variable, at the Company's election, at: (i) up
to 3/4% (depending upon the Company's financial performance) above the greater
of (x) the arithmetic average of the prime rates announced by Chase Manhattan
Bank, Citibank, N.A. and Morgan Guaranty Trust Company of New York or (y) the
federal funds rate as published by the Federal Reserve Bank of New York plus
1/2%; or (ii) 1.375% to 2.5% (depending upon the Company's financial
performance) above the London Interbank Offered Rate (LIBOR). Current interest
payments on the revolving and term loan facility began on December 31, 1997.
Repayments of principal under the term facility began on March 31, 1998.
The Credit Agreement includes covenants regarding various financial and
legal matters. A breach of these covenants could constitute a default under the
Credit Agreement resulting in the Company's indebtedness becoming immediately
due and payable and entitling the lenders under the Credit Agreement to
foreclose against collateral pledged by the Company. For the quarter ending June
30, 1998, the Company requested and obtained waivers of certain of the financial
covenants contained in the Credit Agreement. There can be no assurance that if
the Company violates covenants that the Company's lenders will grant such
waivers in the future and, if such waivers are not granted, all of the Company's
indebtedness under the Credit Agreement would become immediately due and
payable.
On February 11, 1998, the Company entered into a Subordinated Secured
Bridge Note (the "Bridge Loan") with ING (U.S.) Capital Corporation in the
amount of $3.0 million. The purpose of the Bridge Loan was to fund short term
capital requirements of the Company. Lender's under the Credit Agreement
consented to the Bridge Loan. Amounts outstanding under the Bridge Loan were to
bear interest at: (i) the arithmetic average of the base rates announced
publicly by the Chase Manhattan Bank (National Association), Citibank, N.A. and
Morgan
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Guaranty Trust Company, plus (ii) four percent (4%). Interest on the Bridge Loan
was payable on the first day of each month with a final maturity of April 30,
1998. Although the Company had the option to extend the maturity of the Bridge
Loan until January 31, 2008, the Bridge Loan was paid in full April 30, 1998.
SEASONALITY
The Company's results of operations fluctuate from quarter to quarter,
due to variations in the prices and sales volumes of NGLs and natural gas. The
Company's primary NGL product is propane, which is used for agricultural and
home heating during the winter season and decrease during the summer season. The
Company's principal commodity, natural gas, is used primarily for heating fuel
for homes and industry, and for electric power generation. Demand and prices for
natural gas usually increase during the winter season. While the Company's gross
revenues typically increase or decrease seasonally, profitability from natural
gas processing operations is affected by the margins between the cost of natural
gas purchased and the sales prices of the NGLs extracted, which may not follow
seasonal patterns.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
On May 31, 1998, the Company was served with a summons in a lawsuit
initiated by Aurora National Gas, L.L.C. and filed in Dallas, Texas (Aurora
Natural Gas L.L.C. v. Continental Natural Gas, Inc. and Gary C. Adams, Case No.
DV-98-3831, District Court of Dallas County, Texas, 68th Judicial District). The
Company has removed the case to federal court in Dallas, Texas and has filed
pleadings in federal court to (i) dismiss Gary C. Adams as a defendant and (ii)
transfer the case to federal court in Tulsa, Oklahoma. Aurora has filed a motion
in federal court to remand the case to state court. The Company does not know
whether any of these motions will be granted.
Aurora's lawsuit is based on a gas purchase contract which the Company
entered into with Gothic on January 23, 1998. Aurora alleges that it had a prior
contract with Gothic and that the Company "tortiously interfered" with Aurora's
contract. This lawsuit is in the early stages of discovery it is not possible to
fully evaluate Aurora's claims. After consultation with the Company's trial
counsel, management believes that the Company will prevail on the claims made by
Aurora and intends to vigorously defend this lawsuit--accordingly, the outcome
of this lawsuit is not likely to have a material effect on the financial
condition, results of operations or prospects of the Company. However, the
Company cannot guarantee an outcome favorable to the Company.
Item 2. Changes in Securities.
None.
Item 3. Defaults upon Senior Securities.
The Company's Credit Agreement includes various financial covenants. A
breach of these covenants constitutes a default under the Credit Agreement
resulting in the Company's indebtedness becoming immediately due and payable.
The Company was in violation of some of these financial covenants for the
quarters ending March 31, 1998 and June 30, 1998. The Company requested and
obtained waivers of such financial covenants from its lenders. There can be no
assurance that the Company's lenders will grant such waivers in the future and,
if such waivers are not granted, all of the Company's indebtedness under the
Credit Agreement would become immediately due and payable.
Item 4. Submission of Matters to a Vote of Security Holders.
At the Annual Meeting of Shareholders held on June 8, 1998, the
following proposals were adopted by the margins indicated:
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1. To elect two Class I directors to hold office for a three-year term
expiring at the Annual Meeting of Shareholders occurring in the year 2001 or
until the election and qualification of their respective successors.
Number of Shares
For Withheld
--- --------
Scott C. Longmore 5,673,644 102,550
Terry K. Spencer 5,676,144 100,050
The Company's Class II Directors, Garry D. Smith and William H. Bauch,
continued to hold their offices for a term which expires as of the Company's
1999 Annual Meeting of Shareholders. The Company's Class III, Directors, Gary C.
Adams and William W. Pritchard, continued to hold their offices for a term which
expires as of the Company's 2000 Annual Meeting of Shareholders.
2. To ratify the selection of Coopers & Lybrand, L.L.P. as the
Company's independent accountants for the fiscal year ending December 31, 1998.
Number of Shares
For Against Abstain
--- ------- -------
5,766,884 5,900 3,410
Item 5. Other Information.
From time to time forward-looking statements have been and will be made
in written documents and oral presentations of the Company. Such statements are
based on management's beliefs as well as assumptions made by and information
currently available to management. When used in the Company's documents or oral
presentations, the words "anticipate," "believe," "estimate," "expect,"
"objective" and similar expressions are intended to identify forward-looking
statements. The Company hereby incorporates by reference the Cautionary Factors
contained in Exhibit 99.1 to the Company's Current Report on Form 8-K filed
December 9, 1997.
Item 6. Exhibits and Reports on Form 8-K.
(a) Attached hereto are the following Exhibits:
Exhibit No. Description
----------- -----------
10.1 Purchase and Sale Agreement for Sycamore Gas
System (A General Partnership) by and between
Oneok Producer Services, Inc. and
Continental/Oklahoma Natural Gas Gathering,
L.L.C. dated May 29, 1998.
15 Letter Regarding Unaudited Interim Financial
Information
27 Financial Data Schedule
99.1 Continental Natural Gas, Inc. Cautionary
Factors (incorporated by reference to Exhibit
99.1 to Current Report in Form 8-K filed
December 9, 1997, (Commission File No. 022867).
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(b) No reports on Form 8-K were filed during the quarter ended June 30,
1998.
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.
CONTINENTAL NATURAL GAS, INC.
Date: August 13, 1998 By: /s/ GARRY D. SMITH
-----------------------------------------
Garry D. Smith
Vice President-Controller and Chief
Financial and Accounting Officer
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INDEX TO EXHIBITS
Exhibit No. Description
- ----------- -----------
10.1 Purchase and Sale Agreement for Sycamore Gas System (A
General Partnership) by and between Oneok Producer Services,
Inc. and Continental/Oklahoma Natural Gas, L.L.C. dated May
29, 1998.
15 Letter Regarding Unaudited Interim Financial Information
27 Financial Data Schedule
99.1 Continental Natural Gas, Inc. Cautionary Factors (incorporated by
reference to Exhibit 99.1 to Current Report in Form 8-K filed December 9, 1997,
(Commission File No. 022867).