1
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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 SEPTEMBER 30, 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 October 30, 1998, there were 96,710,450 shares of the registrant's $.01
par value Common Stock outstanding.
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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
INDEX TO FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 1998
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets at September 30, 1998 (Unaudited) and
December 31, 1997 3
Consolidated Statements of Operations for the Three and Nine Months
Ended September 30, 1998 and 1997 (Unaudited) 4
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 1998 and 1997 (Unaudited) 5
Notes to Consolidated Financial Statements (Unaudited) 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 16
Item 3. Quantitative and Qualitative Disclosure About Market Risks 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Changes in Securities and Use of Proceeds 25
Item 3. Defaults Upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
2
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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
($ IN THOUSANDS)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ............................................... $ 20,749 $ 123,860
Restricted cash ......................................................... 4,200 --
Short-term investments .................................................. -- 12,570
Accounts receivable:
Oil and gas sales ...................................................... 11,524 10,654
Oil and gas marketing sales ............................................ 23,120 20,493
Joint interest and other, net of allowance for doubtful accounts
of $1,209,000 and $691,000............................................ 30,183 38,781
Related parties ........................................................ 16,568 4,246
Inventory ............................................................... 6,327 5,493
Other ................................................................... 4,618 1,624
----------- -----------
Total current assets ................................................. 117,289 217,721
----------- -----------
PROPERTY AND EQUIPMENT:
Oil and gas properties, at cost based on full-cost accounting:
Evaluated oil and gas properties ....................................... 2,054,907 1,095,363
Unevaluated properties ................................................. 92,083 125,155
Less: accumulated depreciation, depletion and amortization.............. (1,176,946) (602,391)
----------- -----------
970,044 618,127
Other property and equipment ............................................ 78,974 67,633
Less: accumulated depreciation and amortization ......................... (20,537) (6,573)
----------- -----------
Total property and equipment ......................................... 1,028,481 679,187
----------- -----------
OTHER ASSETS .............................................................. 81,504 55,876
----------- -----------
TOTAL ASSETS ......................................................... $ 1,227,274 $ 952,784
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable ........................................................ $ 43,150 $ 81,775
Accrued liabilities and other ........................................... 55,505 42,733
Revenues and royalties due others ....................................... 20,645 28,972
----------- -----------
Total current liabilities ............................................ 119,300 153,480
----------- -----------
LONG-TERM DEBT, NET ....................................................... 919,055 508,992
----------- -----------
REVENUES AND ROYALTIES DUE OTHERS ......................................... 12,524 10,106
----------- -----------
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value, 10,000,000 shares authorized;
4,600,000 and 0 shares of 7% cumulative convertible stock
issued and outstanding at September 30, 1998 and December 31,
1997, respectively, entitled in liquidation to $230 million............. 230,000 --
Common stock, $.01 par value, 250,000,000 shares authorized;
96,702,650 and 74,298,061 shares issued and outstanding at.............. 967 743
September 30, 1998 and December 31, 1997, respectively
Paid-in capital ......................................................... 677,453 460,733
Accumulated deficit ..................................................... (702,063) (181,270)
Less: treasury stock, at cost; 8,503,300 and 0 shares
at September 30, 1998 and December 31, 1997, respectively............... (29,962) --
----------- -----------
Total stockholders' equity ........................................... 176,395 280,206
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................................ $ 1,227,274 $ 952,784
=========== ===========
The accompanying notes are an integral part
of these consolidated financial statements.
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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- --------------------------
1998 1997 1998 1997
--------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
REVENUES:
Oil and gas sales ......................................... $ 70,082 $ 45,667 $ 195,962 $ 148,420
Oil and gas marketing sales ............................... 36,256 26,865 96,451 73,018
Interest and other ........................................ 778 5,878 3,573 14,585
--------- --------- --------- ---------
Total revenues ........................................ 107,116 78,410 295,986 236,023
--------- --------- --------- ---------
COSTS AND EXPENSES:
Production expenses ....................................... 14,208 3,894 36,775 11,071
Production taxes .......................................... 1,976 1,286 6,141 3,342
Oil and gas marketing expenses ............................ 34,720 26,690 94,686 72,282
Impairment of oil and gas properties ...................... -- -- 466,000 236,000
Impairment of other assets ................................ -- -- 10,000 --
Oil and gas depreciation, depletion and amortization ...... 34,069 28,550 109,311 95,571
Depreciation and amortization of other assets ............. 2,518 1,142 5,820 3,088
General and administrative ................................ 5,197 2,760 14,711 7,823
Interest .................................................. 18,577 8,575 47,930 20,909
--------- --------- --------- ---------
Total costs and expenses .............................. 111,265 72,897 791,374 450,086
--------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAX AND EXTRAORDINARY ITEM ..... (4,149) 5,513 (495,388) (214,063)
INCOME TAX BENEFIT ......................................... -- -- -- (17,898)
--------- --------- --------- ---------
INCOME (LOSS) BEFORE EXTRAORDINARY ITEM .................... (4,149) 5,513 (495,388) (196,165)
EXTRAORDINARY ITEM:
Loss on early extinguishment of debt ...................... -- -- (13,334) (177)
--------- --------- --------- ---------
NET INCOME (LOSS) .......................................... (4,149) 5,513 (508,722) (196,342)
PREFERRED STOCK DIVIDENDS .................................. (4,026) -- (8,051) --
--------- --------- --------- ---------
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS ......... $ (8,175) $ 5,513 $(516,773) $(196,342)
========= ========= ========= =========
EARNINGS PER COMMON SHARE (BASIC AND ASSUMING DILUTION)
Income (loss) before extraordinary item ................... $ (0.08) $ 0.08 $ (5.34) $ (2.79)
Extraordinary item ........................................ -- -- (0.14) --
--------- --------- --------- ---------
Net income (loss) ......................................... $ (0.08) $ 0.08 $ (5.48) $ (2.79)
========= ========= ========= =========
WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT
SHARES OUTSTANDING
Basic ..................................................... 98,046 70,376 94,355 70,376
========= ========= ========= =========
Assuming dilution ......................................... 98,046 72,699 94,355 70,376
========= ========= ========= =========
The accompanying notes are an integral part
of these consolidated financial statements.
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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
1998 1997
--------- ---------
($ IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ................................................................ $(508,722) $(196,342)
Adjustments to reconcile net loss to net cash provided by operating
activities:
Depreciation, depletion and amortization ............................... 113,449 97,571
Impairment of oil and gas assets ....................................... 466,000 236,000
Impairment of other assets ............................................. 10,000 --
Deferred taxes ......................................................... -- (17,898)
Amortization of loan costs ............................................. 1,682 1,088
Amortization of bond discount .......................................... 77 46
Gain on sale of fixed assets and other ................................. (142) (3,766)
Extraordinary loss ..................................................... 13,334 177
Equity in (earnings) losses of equity investees ........................ 487 (181)
Bad debt expense ....................................................... 516 324
--------- ---------
Cash provided by operating activities before changes
in current assets and liabilities .................................. 96,681 117,019
Changes in current assets and liabilities .............................. (43,358) (32,207)
--------- ---------
Cash provided by operating activities ................................ 53,323 84,812
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Exploration, development and acquisition of oil and gas properties ...... (478,394) (380,804)
Investment in preferred stock of Gothic Energy Corporation .............. (39,500) --
Proceeds from sale of assets ............................................ 6,714 1,190
Additions to other property and equipment ............................... (9,771) (40,605)
Long-term loans made to third parties ................................... -- (20,000)
Repayment of long-term loan ............................................. 2,000 --
Other investments ....................................................... -- (13,751)
--------- ---------
Cash used in investing activities .................................... (518,951) (453,970)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term borrowings ...................................... 658,750 292,626
Payments on long-term borrowings ........................................ (474,166) (12,750)
Proceeds from issuance of preferred stock ............................... 222,760 --
Purchase of treasury stock .............................................. (29,962) --
Dividends paid on common stock .......................................... (5,592) (1,405)
Dividends paid on preferred stock ....................................... (4,025) --
Cash received from exercise of stock options ............................ 131 1,340
Other financing ......................................................... -- (210)
--------- ---------
Cash provided by financing activities ................................ 367,896 279,601
--------- ---------
EFFECT OF EXCHANGE RATE CHANGES ON CASH ................................... (5,379) --
--------- ---------
NET DECREASE IN CASH AND CASH EQUIVALENTS ................................. (103,111) (89,557)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ............................ 123,860 140,739
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD .................................. $ 20,749 $ 51,182
========= =========
The accompanying notes are an integral part
of these consolidated financial statements.
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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 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 and nine months ended September 30, 1998 are not
necessarily indicative of the results to be expected for the full fiscal year.
The Company changed its fiscal year end from June 30 to December 31 for the
period ended December 31, 1997. This Form 10-Q relates to the three and nine
months ended September 30, 1998 (the "Current Quarter" and "Current Period",
respectively) and September 30, 1997 (the "Prior Quarter" and "Prior Period",
respectively).
2. RECENT EVENTS
On July 7, 1998 the Company's Board of Directors authorized management to
explore strategic alternatives to enhance shareholder value, including a
possible sale or merger of the Company, based upon the Board's opinion that the
market was substantially undervaluing the Company's assets and exploration
potential. Also on July 7, 1998 Chesapeake's Board of Directors unanimously
adopted a shareholder rights plan designed to deter coercive takeover tactics
and to prevent a change of control from occurring without all shareholders
receiving a fair price.
Pursuant to the decision to explore various alternatives, the Company engaged
Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ") to advise the
Company. The Company and DLJ are presently evaluating various alternatives,
including the potential sale or merger of the Company, sale of certain assets,
or alternative financial strategies. This process is underway and is expected to
be concluded within the next few months.
On November 2, 1998 the Company announced it had entered into an agreement to
tender its 19.9% stake in Pan East Petroleum Corp. ("Pan East") to Poco
Petroleums Ltd. and agreed to a property exchange with Pan East. Subject to the
successful completion by Poco of its tender offer, the Company anticipates
receiving approximately $26 million in cash and increasing its net reserves by
four bcfe. As of September 30, 1998, the Company's net investment in the common
stock of Pan East of $21.3 million has been accounted for using the equity
method and is included in Other Assets in the accompanying Consolidated Balance
Sheets.
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.
A purported class action alleging violations of the Securities Act of 1933 and
the Oklahoma Securities Act has been filed against the Company and others on
behalf of investors who purchased common stock of Bayard Drilling Technologies,
Inc. ("Bayard") in, or traceable to, its initial public offering in November
1997. Total proceeds of the
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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
offering were $254 million, of which the Company received net proceeds of $90
million as a selling shareholder. 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 "problems" and their
impact on Bayard's operating results, (ii) increased costs associated with
Bayard's growth strategy, (iii) undisclosed pending related-party transactions
between Bayard and third parties other than the Company, (iv) Bayard's planned
use of offering proceeds and (v) Bayard's capital expenditures and liquidity.
The alleged defective disclosures are claimed to have resulted in a decline in
Bayard's share price following the public offering. 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 attorneys' 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 drillbit steering method. Other claims
asserted by UPRC have been dismissed. UPRC's infringement 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 and enhanced damages, interest, costs
and attorneys' fees. The Company believes that it has meritorious defenses to
UPRC's allegations and that the UPRC patent is invalid. The Company has filed a
motion to construe UPRC's patent claims and other dispositive motions are
pending. 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
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. NET LOSS PER SHARE
In February 1997, the Financial Accounting Standards Board ("FASB") 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, the Current Period
and the Prior Period, there was no difference between actual weighted average
shares outstanding, which are used in computing basic EPS, and diluted weighted
average shares outstanding, which are used in computing diluted EPS. Options to
purchase 10.6 million and 8.5 million shares of common stock at a weighted
average exercise price of $3.88 and $5.48 were outstanding at September 30, 1998
and 1997, respectively, 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:
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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
Net Income Shares Outstanding
(Numerator) (Denominator) Per-Share
(in 000's) (in 000's) Amount
----------- ------------------ ---------
For the quarter ended September 30, 1997:
Basic EPS
Income available to common stockholders ............ $5,513 70,376 $0.08
=====
Effect of Dilutive Securities
Employee stock options ............................. -- 2,323
------ ------
Diluted EPS
Income available to common stockholders
and assumed conversions .......................... $5,513 72,699 $0.08
====== ====== =====
5. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENT
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
131 "Disclosures about Segments of an Enterprise and Related Information". This
Statement establishes standards for the way that public enterprises report
information about operating segments in annual financial statements and requires
that those enterprises report selected information about operating segments in
interim financial reports issued to shareholders. The Statement is effective for
annual financial statements for periods beginning after December 15, 1997 and
for interim financial statements issued subsequent to adoption in the annual
financial statements. The Company expects that the adoption of this standard
will not impact its results of operation or financial position, but may require
additional disclosures.
In June 1998, the FASB issued Statement of Financial Accounting Standards No.
133, Accounting for Derivative Instruments and Hedging Activities ("FAS 133").
FAS 133 is effective for all fiscal quarters of all fiscal years beginning after
June 15, 1999 (January 1, 2000 for the Company). FAS 133 requires that all
derivative instruments be recorded on the balance sheet at their fair value.
Changes in the fair value of derivatives are recorded each period in current
earnings or other comprehensive income, depending on whether a derivative is
designed as part of a hedge transaction and, if it is, the type of hedge
transaction. For fair-value hedge transactions in which the Company is hedging
changes in the fair value of an asset, liability, or firm commitment, changes in
the fair value of the derivative instrument will generally be offset in the
income statement by changes in the hedged item's fair value. For cash-flow hedge
transactions, in which the Company is hedging the variability of cash flows
related to a variable-rate asset, liability, or a forecasted transaction,
changes in the fair value of the derivative instrument will be reported in other
comprehensive income. The gains and losses on the derivative instrument that are
reported in other comprehensive income will be reclassified as earnings in the
periods in which earnings are impacted by the variability of the cash flows of
the hedged item. The ineffective portion of all hedges will be recognized in
current-period earnings.
The Company has not yet determined the impact that the adoption of FAS 133 will
have on its results of operations or its financial position.
6. ACQUISITION OF HUGOTON
In March 1998, the Company acquired Hugoton Energy Corporation ("Hugoton")
pursuant to a merger by issuing 25.8 million shares of the Company's common
stock in exchange for 100% of Hugoton's common stock. The acquisition of Hugoton
was accounted for using the purchase method as of March 1, 1998, and the results
of operations of Hugoton have been included since that date.
The following unaudited pro forma information has been prepared assuming Hugoton
had been acquired as of the beginning of the periods presented. The pro forma
information is presented for information purposes only and is not necessarily
indicative of what would have occurred if the acquisition had been made as of
those dates. In
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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
addition, the pro forma information is not intended to be a projection of future
results and does not reflect the efficiencies expected to result from the
integration of Hugoton.
Pro Forma Information (Unaudited)
Nine Months Ended September 30,
1998 1997
----------- ----------
(In thousands, except per share data)
Revenues................................................ $ 305,678 $ 294,462
Loss before extraordinary item.......................... $ (496,837) $ (192,285)
Net Loss................................................ $ (510,171) $ (192,462)
Loss before extraordinary item per common share......... $ (4.96) $ (2.00)
Net loss per common share............................... $ (5.10) $ (2.00)
The Company acquired other businesses and oil and gas properties in the Current
Period. The results of operations of these businesses and properties were not
material in relation to the Company's consolidated results of operations.
7. SENIOR NOTES
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
(as defined below).
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.
9.625% Notes
On April 22, 1998, the Company issued $500 million aggregate principal amount of
9.625% Senior Notes which mature May 1, 2005. The 9.625% Notes bear interest at
an annual rate of 9.625%, payable semiannually on each May 1 and November 1. The
9.625% 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
9
10
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
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% and 9.625% Notes in the event of a
change of control or certain asset sales.
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 and nine months ended September 30, 1998, the only
Non-Guarantor Subsidiary was Chesapeake Energy Marketing, Inc. As of and for the
three and nine months ended September 30, 1997, the Non-Guarantor Subsidiaries
were Chesapeake Energy Marketing, Inc. and Chesapeake Canada Corporation. For
the 1997 and 1998 periods, the remaining subsidiaries of the Company were
Guarantor Subsidiaries.
10
11
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF SEPTEMBER 30, 1998
($ IN THOUSANDS)
GUARANTOR NON-GUARANTOR COMPANY
SUBSIDIARIES SUBSIDIARIES (PARENT) ELIMINATIONS CONSOLIDATED
------------ ------------- -------- ------------ ------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ............ $ (4,882) $ 2,981 $ 26,850 $ -- $ 24,949
Short-term investments ............... -- -- -- -- --
Accounts receivable, net ............. 56,930 32,746 276 (8,557) 81,395
Inventory ............................ 6,189 138 -- -- 6,327
Other ................................ 4,059 43 516 -- 4,618
----------- ----------- ----------- ----------- -----------
Total Current Assets .............. 62,296 35,908 27,642 (8,557) 117,289
----------- ----------- ----------- ----------- -----------
PROPERTY AND EQUIPMENT:
Oil and gas properties ............... 2,054,907 -- -- -- 2,054,907
Unevaluated leasehold ................ 92,083 -- -- -- 92,083
Other property and equipment ......... 59,484 2,572 16,918 -- 78,974
Less: accumulated depreciation,
depletion and amortization ......... (1,196,120) (85) (1,278) -- (1,197,483)
----------- ----------- ----------- ----------- -----------
Total Property and Equipment ...... 1,010,354 2,487 15,640 -- 1,028,481
----------- ----------- ----------- ----------- -----------
INVESTMENTS IN SUBSIDIARIES AND
INTERCOMPANY ADVANCES ................ 474,616 -- 471,151 (945,767) --
OTHER ASSETS ........................... 39,500 580 41,424 -- 81,504
----------- ----------- ----------- ----------- -----------
TOTAL ASSETS ...................... $ 1,586,766 $ 38,975 $ 555,857 $ (954,324) $ 1,227,274
=========== =========== =========== =========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Notes payable and current maturities
of long-term debt .................. $ -- $ -- $ -- $ -- $ --
Accounts payable and other ........... 82,006 14,910 31,240 (8,856) 119,300
----------- ----------- ----------- ----------- -----------
Total Current Liabilities ......... 82,006 14,910 31,240 (8,856) 119,300
----------- ----------- ----------- ----------- -----------
LONG-TERM DEBT ......................... -- -- 919,055 -- 919,055
----------- ----------- ----------- ----------- -----------
REVENUES PAYABLE ....................... 12,524 -- -- -- 12,524
----------- ----------- ----------- ----------- -----------
INTERCOMPANY PAYABLES .................. 1,346,717 10,524 (1,357,540) 299 --
----------- ----------- ----------- ----------- -----------
STOCKHOLDERS' EQUITY:
Preferred Stock ...................... -- -- 230,000 -- 230,000
Common Stock ......................... 27 1 956 (17) 967
Other ................................ 145,492 13,540 732,146 (945,750) (54,572)
----------- ----------- ----------- ----------- -----------
Total Stockholders' Equity ........ 145,519 13,541 963,102 (945,767) 176,395
----------- ----------- ----------- ----------- -----------
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY ............ $ 1,586,766 $ 38,975 $ 555,857 $ (954,324) $ 1,227,274
=========== =========== =========== =========== ===========
11
12
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
CONDENSED CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 1997
($ IN THOUSANDS)
GUARANTOR NON-GUARANTOR COMPANY
SUBSIDIARIES SUBSIDIARIES (PARENT) ELIMINATIONS CONSOLIDATED
------------ ------------- -------- ------------ ------------
ASSETS
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 and 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
----------- ----------- ----------- ----------- -----------
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
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
($ IN THOUSANDS)
GUARANTOR NON-GUARANTOR COMPANY
SUBSIDIARIES SUBSIDIARIES (PARENT) ELIMINATIONS CONSOLIDATED
------------ ------------- -------- ------------ ------------
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998
REVENUES:
Oil and gas sales ........................... $ 69,780 $ (187) $ -- $ 489 $ 70,082
Oil and gas marketing sales ................. 973 64,769 -- (29,486) 36,256
Interest and other .......................... 966 405 28,024 (28,617) 778
--------- --------- --------- --------- ---------
Total Revenues ........................... 71,719 64,987 28,024 (57,614) 107,116
--------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Production expenses and taxes ............... 16,184 -- -- -- 16,184
Oil and gas marketing expenses .............. 1,040 62,677 -- (28,997) 34,720
Impairment of oil and gas properties ........ -- -- -- -- --
Impairment of other assets .................. -- -- -- -- --
Oil and gas depreciation, depletion
and amortization .......................... 34,069 -- -- -- 34,069
Other depreciation and amortization ......... 1,637 88 793 -- 2,518
General and administrative .................. 4,514 636 47 -- 5,197
Interest .................................... 26,605 4 20,585 (28,617) 18,577
--------- --------- --------- --------- ---------
Total Costs and Expenses ................. 84,049 63,405 21,425 (57,614) 111,265
--------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES
AND EXTRAORDINARY ITEM ...................... (12,330) 1,582 6,599 -- (4,149)
INCOME TAX EXPENSE (BENEFIT) .................. -- -- -- -- --
--------- --------- --------- --------- ---------
NET INCOME (LOSS) BEFORE
EXTRAORDINARY ITEM .......................... (12,330) 1,582 6,599 -- (4,149)
--------- --------- --------- --------- ---------
EXTRAORDINARY ITEM:
Loss on early extinguishment of debt,
net of applicable income tax .............. -- -- -- -- --
--------- --------- --------- --------- ---------
NET INCOME (LOSS) ........................ $ (12,330) $ 1,582 $ 6,599 $ -- $ (4,149)
========= ========= ========= ========= =========
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1997
REVENUES:
Oil and gas sales ........................... $ 45,049 $ -- $ -- $ 618 $ 45,667
Gas marketing sales ......................... -- 44,326 -- (17,461) 26,865
Interest and other .......................... 135 487 20,118 (14,862) 5,878
--------- --------- --------- --------- ---------
Total Revenues ........................... 45,184 44,813 20,118 (31,705) 78,410
--------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Production expenses and taxes ............... 5,180 -- -- -- 5,180
Gas marketing expenses ...................... -- 43,533 -- (16,843) 26,690
Impairment of oil and gas properties ........ -- -- -- -- --
Oil and gas depreciation, depletion and
Amortization .............................. 28,550 -- -- -- 28,550
Other depreciation and amortization ......... 628 21 493 -- 1,142
General and administrative .................. 2,578 265 (83) -- 2,760
Interest .................................... 12,246 33 11,158 (14,862) 8,575
--------- --------- --------- --------- ---------
Total Costs and Expenses ................. 49,182 43,852 11,568 (31,705) 72,897
--------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAX ............... (3,998) 961 8,550 -- 5,513
INCOME TAX EXPENSE (BENEFIT) .................. -- -- -- -- --
--------- --------- --------- --------- ---------
NET INCOME (LOSS) BEFORE
EXTRAORDINARY ITEM ..................... (3,998) 961 8,550 -- 5,513
EXTRAORDINARY ITEM:
Loss on early extinguishment of debt, net
of applicable income tax .................. -- -- -- -- --
--------- --------- --------- --------- ---------
NET INCOME (LOSS) ........................ $ (3,998) $ 961 $ 8,550 $ -- $ 5,513
========= ========= ========= ========= =========
13
14
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
($ IN THOUSANDS)
GUARANTOR NON-GUARANTOR COMPANY
SUBSIDIARIES SUBSIDIARIES (PARENT) ELIMINATIONS CONSOLIDATED
------------ ------------- -------- ------------ ------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
REVENUES:
Oil and gas sales ........................... $ 193,800 $ -- $ -- $ 2,162 $ 195,962
Oil and gas marketing sales ................. 973 173,405 -- (77,927) 96,451
Interest and other .......................... 1,471 685 72,007 (70,590) 3,573
--------- --------- --------- --------- ---------
Total Revenues ........................... 196,244 174,090 72,007 (146,355) 295,986
--------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Production expenses and taxes ............... 42,916 -- -- -- 42,916
Oil and gas marketing expenses .............. 1,040 169,411 -- (75,765) 94,686
Impairment of oil and gas properties ........ 466,000 -- -- -- 466,000
Impairment of other assets .................. 10,000 -- -- -- 10,000
Oil and gas depreciation, depletion
and amortization .......................... 109,311 -- -- -- 109,311
Other depreciation and amortization ......... 3,698 142 1,980 -- 5,820
General and administrative .................. 13,122 1,535 54 -- 14,711
Interest .................................... 67,704 4 50,812 (70,590) 47,930
--------- --------- --------- --------- ---------
Total Costs and Expenses ................. 713,791 171,092 52,846 (146,355) 791,374
--------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES
AND EXTRAORDINARY ITEM ...................... (517,547) 2,998 19,161 -- (495,388)
INCOME TAX EXPENSE (BENEFIT) .................. -- -- -- -- --
--------- --------- --------- --------- ---------
NET INCOME (LOSS) BEFORE
EXTRAORDINARY ITEM .......................... (517,547) 2,998 19,161 -- (495,388)
--------- --------- --------- --------- ---------
EXTRAORDINARY ITEM:
Loss on early extinguishment of debt,
net of applicable income tax .............. (2,164) -- (11,170) -- (13,334)
--------- --------- --------- --------- ---------
NET INCOME (LOSS) ........................ $(519,711) $ 2,998 $ 7,991 $ -- $(508,722)
========= ========= ========= ========= =========
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
REVENUES:
Oil and gas sales ........................... $ 150,416 $ (3,579) $ -- $ 1,583 $ 148,420
Gas marketing sales ......................... -- 131,661 -- (58,643) 73,018
Interest and other .......................... 746 665 67,564 (54,390) 14,585
--------- --------- --------- --------- ---------
Total Revenues ........................... 151,162 128,747 67,564 (111,450) 236,023
--------- --------- --------- --------- ---------
COSTS AND EXPENSES:
Production expenses and taxes ............... 14,824 (411) -- -- 14,413
Gas marketing expenses ...................... -- 129,342 -- (57,060) 72,282
Impairment of oil and gas properties ........ 236,000 -- -- -- 236,000
Oil and gas depreciation, depletion
and amortization .......................... 96,864 (1,293) -- -- 95,571
Other depreciation and amortization ......... 1,737 30 1,321 -- 3,088
General and administrative .................. 6,348 691 784 -- 7,823
Interest .................................... 49,582 (184) 25,901 (54,390) 20,909
--------- --------- --------- --------- ---------
Total Costs and Expenses ................. 405,355 128,175 28,006 (111,450) 450,086
--------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAX ............... (254,193) 572 39,558 -- (214,063)
INCOME TAX EXPENSE (BENEFIT) .................. (19,384) (967) 2,453 -- (17,898)
--------- --------- --------- --------- ---------
NET INCOME (LOSS) BEFORE
EXTRAORDINARY ITEM ..................... (234,809) 1,539 37,105 -- (196,165)
EXTRAORDINARY ITEM:
Loss on early extinguishment of debt, net
of applicable income tax .................. (179) -- 2 -- (177)
--------- --------- --------- --------- ---------
NET INCOME (LOSS) ........................ $(234,988) $ 1,539 $ 37,107 $ -- $(196,342)
========= ========= ========= ========= =========
14
15
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
($ IN THOUSANDS)
GUARANTOR NON-GUARANTOR COMPANY
SUBSIDIARIES SUBSIDIARIES (PARENT) ELIMINATIONS CONSOLIDATED
------------ ------------- ------- ------------ ------------
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
CASH FLOWS FROM OPERATING
ACTIVITIES: .......................................... $ 32,384 $ (21,068) $ 42,007 $ -- $ 53,323
--------- --------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Oil and gas properties ............................... (478,394) -- -- -- (478,394)
Proceeds from sale of assets ......................... 3,114 -- 3,600 -- 6,714
Investment in preferred stock of Gothic .............. (39,500) -- -- -- (39,500)
Repayment of long-term loan .......................... 2,000 -- -- -- 2,000
Other additions ...................................... (6,161) (1,343) (2,267) -- (9,771)
--------- --------- --------- --------- ---------
(518,941) (1,343) 1,333 -- (518,951)
--------- --------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from borrowings ............................. -- -- 658,750 -- 658,750
Payments on borrowings ............................... -- -- (474,166) -- (474,166)
Cash received from issuance of preferred stock ....... -- -- 222,760 -- 222,760
Cash paid for purchase of treasury stock ............. -- -- (29,962) -- (29,962)
Cash received from exercise of stock options ......... -- -- 131 -- 131
Cash dividends paid on common and
preferred stock .................................... -- -- (9,617) -- (9,617)
Intercompany advances, net ........................... 465,229 (2,545) (462,684) -- --
--------- --------- --------- --------- ---------
465,229 (2,545) (94,788) -- 367,896
--------- --------- --------- --------- ---------
Effect of exchange rate changes on cash .............. (5,379) -- -- -- (5,379)
--------- --------- --------- --------- ---------
Net increase (decrease) in cash ...................... (26,707) (24,956) (51,448) -- (103,111)
Cash, beginning of period ............................ (284) 13,694 110,450 -- 123,860
--------- --------- --------- --------- ---------
Cash, end of period .................................. $ (26,991) $ (11,262) $ 59,002 $ -- $ 20,749
========= ========= ========= ========= =========
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
CASH FLOWS FROM OPERATING ACTIVITIES: .................. $ 76,828 $ 742 $ 7,242 $ -- $ 84,812
--------- --------- --------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Oil and gas properties ............................... (380,868) 64 -- -- (380,804)
Proceeds from sale of assets ......................... 1,190 -- -- -- 1,190
Loans to third parties ............................... (2,000) -- (18,000) -- (20,000)
Other investments .................................... -- -- (13,751) -- (13,751)
Other additions ...................................... (34,723) (240) (5,642) -- (40,605)
--------- --------- --------- --------- ---------
(416,401) (176) (37,393) -- (453,970)
--------- --------- --------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from long-term borrowings ................... -- -- 292,626 -- 292,626
Payments on borrowings ............................... (67,655) 1,710 53,195 -- (12,750)
Cash received from exercise of stock options.......... -- -- 1,340 -- 1,340
Cash dividends paid on common stock .................. -- -- (1,405) -- (1,405)
Other financing ...................................... -- (15) (195) -- (210)
Intercompany advances, net ........................... 396,018 (1,709) (394,309) -- --
--------- --------- --------- --------- ---------
328,363 (14) (48,748) -- 279,601
--------- --------- --------- --------- ---------
Net increase (decrease) in cash and cash
Equivalents ........................................ (11,210) 552 (78,899) -- (89,557)
Cash, beginning of period ............................ 4,865 6,099 129,775 -- 140,739
--------- --------- --------- --------- ---------
Cash, end of period .................................. $ (6,345) $ 6,651 $ 50,876 $ -- $ 51,182
========= ========= ========= ========= =========
15
16
PART I. FINANCIAL INFORMATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RECENT EVENTS
On July 7, 1998 the Company's Board of Directors authorized management to
explore strategic alternatives to enhance shareholder value, including a
possible sale or merger of the Company, based upon the Board's opinion that the
market is substantially undervaluing the Company's assets and exploration
potential. Also on July 7, 1998 Chesapeake's Board of Directors unanimously
adopted a shareholder rights plan designed to deter coercive takeover tactics
and to prevent a change of control from occurring without all shareholders
receiving a fair price.
Pursuant to the decision to explore various alternatives, the Company engaged
Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ") to advise the
Company. The Company and DLJ are presently evaluating various alternatives,
including the potential sale or merger of the Company, sale of certain assets,
or alternative financial strategies. This process is underway and is expected to
be concluded within the next few months.
On November 2, 1998 the Company announced it entered into an agreement to tender
its 19.9% stake in Pan East Petroleum Corp. ("Pan East") to Poco Petroleums Ltd.
and agreed to a property exchange with Pan East. Subject to the successful
completion by Poco of its tender offer, the Company anticipates receiving
approximately $26 million in cash and increasing its net reserves by four
billion cubic feet equivalent of natural gas. As of September 30, 1998, the
Company's net investment in the common stock of Pan East of $21.3 million has
been accounted for using the equity method and is included in Other Assets in
the accompanying Consolidated Balance Sheets.
RESULTS OF OPERATIONS
Three Months Ended September 30, 1998 vs. September 30, 1997
General. For the three months ended September 30, 1998 (the "Current Quarter"),
the Company realized a net loss of $4.1 million, or a loss of $0.08 per common
share after deducting preferred dividends of $4.0 million. This compares to net
income of $5.5 million, or income of $0.08 per common share, for the three
months ended September 30, 1997 (the "Prior Quarter").
During the Current Quarter and Prior Quarter, the Company did not record any
impairment of its oil and gas properties. Any future impairment is subject to a
number of factors, some of which are beyond the control of the Company,
including oil and natural gas prices. Lower oil or gas prices could have a
material adverse effect on the Company's operations and financial condition and
may result in future write-downs of the Company's oil and gas properties due to
full-cost ceiling test limitations. As of September 30, 1998, the Company
estimates that the present value (SEC-PV10%) of its proved reserves, based on
prices at that time of $15.43 per bbl (NYMEX) and $2.32 per mcf (NYMEX),
adjusted for usual well-head quality and location (basis) variances, was $929
million. The Company estimates that, as of September 30, 1998, for every $0.10
per thousand cubic feet ("mcf") reduction in natural gas prices and $1.00 per
barrel of oil ("bbl") reduction in oil prices, the present value of the
Company's proved oil and gas reserves would be reduced by approximately $55
million and $22 million, respectively.
Oil and Gas Sales. During the Current Quarter, oil and gas sales increased
significantly to $70.1 million from $45.7 million, an increase of $24.4 million,
or 53%. This increase resulted from significantly higher oil and gas production
volumes, which increased from 19.2 bcfe in the Prior Quarter to 36.3 bcfe in the
Current Quarter, an increase of 17.1 bcfe, or 89%. The higher production volumes
were primarily the result of the Company's acquisitions completed during the
first four months of 1998. For the Current Quarter, the Company produced 1.6
million barrels of oil ("mmbo") and 26.8 billion cubic feet of natural gas
("bcf"), compared to 0.9 mmbo and 13.9 bcf in the Prior Quarter. Average oil
prices realized were $12.41 per barrel of oil in the Current Quarter compared
16
17
to $18.48 per barrel in the Prior Quarter, a decrease of 33%. Average gas prices
realized were $1.88 per mcf in the Current Quarter compared to $2.12 per mcf in
the Prior Quarter, a decrease of 11%.
For the Current Quarter, the Company realized an average price of $1.93 per
thousand cubic feet equivalent of natural gas ("mcfe"), compared to $2.38 per
mcfe in the Prior Quarter. The Company's hedging activities resulted in
increased oil and gas revenues of $6.5 million, or $0.18 per mcfe, in the
Current Quarter, compared to increases in oil and gas revenues of $0.4 million
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 SEPTEMBER 30,
----------------------------------------------------------
1998 1997
----------------------------- --------------------------
OPERATING AREAS MMCFE PERCENT MMCFE PERCENT
- --------------------- ------------- ------------- ------------- ------------
Mid-Continent ................ 17,969 50% 4,277 22%
Gulf Coast ................... 13,099 36 13,793 72
Canada ....................... 2,533 7 -- --
Other areas .................. 2,667 7 1,091 6
------ ------ ------ ------
Total ................... 36,268 100% 19,161 100%
====== ====== ====== ======
Natural gas production represented approximately 74% of the Company's total
production volume on an equivalent basis in the Current Quarter, compared to 73%
in the Prior Quarter. The Company anticipates natural gas will represent 70-80%
of anticipated 1998 and 1999 production.
Oil and Gas Marketing Sales. The Company realized $36.3 million in oil and gas
marketing sales for third parties in the Current Quarter, with corresponding oil
and gas marketing expenses of $34.7 million, for a gross profit margin of $1.6
million. This compares to sales of $26.9 million and expenses of $26.7 million,
resulting in a gross profit margin of $0.2 million in the Prior Quarter.
Interest and Other. Interest and other revenues for the Current Quarter were
$0.8 million compared to $5.9 million in the Prior Quarter. The decrease was
primarily caused by the Company maintaining lower invested cash balances
resulting in reduced interest income during the Current Quarter.
Production Expenses and Taxes. Production expenses increased to $14.2 million in
the Current Quarter, a $10.3 million increase from $3.9 million incurred in the
Prior Quarter. This significant increase was due to higher production
attributable to acquisitions and higher unit-of-production expense. On a
production unit basis, production expenses were $0.39 and $0.20 per mcfe in the
Current and Prior Quarters, respectively. Properties acquired in late 1997 and
1998 typically have higher unit-of-production expenses than the Company's
historical production base. The Company anticipates production expenses will
average $0.40 per mcfe for 1998.
Production taxes, which consist primarily of wellhead severance taxes, were $2.0
million and $1.3 million in the Current and Prior Quarters, respectively. This
increase was the result of increased production, offset by certain accounting
reclassifications. On a per unit basis, production taxes were $0.05 per mcfe in
the Current Quarter compared to $0.07 per mcfe in the Prior Quarter. The Company
anticipates incurring production taxes at the rate of $0.07 per mcfe for the
remainder of 1998 and 1999.
Oil and Gas Depreciation, Depletion and Amortization. Depreciation, depletion
and amortization of oil and gas properties ("DD&A") for the Current Quarter was
$34.1 million, compared to $28.6 million in the Prior Quarter. This increase was
caused by significantly increased production, partially offset by a decrease in
the DD&A rate per mcfe from $1.49 to $0.94 in the Prior and Current Quarters,
respectively. The Company's DD&A rate is expected to be approximately
$0.95-$1.00 per mcfe for the remainder of 1998.
Depreciation and Amortization of Other Assets. Depreciation and amortization of
other assets ("D&A") increased to $2.5 million in the Current Quarter compared
to $1.1 million in the Prior Quarter. This increase in D&A was caused by
increased investments in depreciable buildings and equipment incurred in
conjunction with the
17
18
acquisitions and increased amortization of debt issuance costs as a result of
the issuance of Senior Notes in April 1998. The Company anticipates D&A expense
throughout the remainder of 1998 to remain at approximately the same level
incurred in the Current Quarter.
General and Administrative. General and administrative expenses ("G&A"), which
are net of capitalized internal payroll and non-payroll expenses, were $5.2
million in the Current Quarter compared to $2.8 million in the Prior Quarter.
This increase was primarily caused by increased employment levels resulting from
the Company's acquisitions. The Company capitalized $0.8 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 the remainder of 1998 will
not increase significantly and expects G&A costs to trend somewhat lower in
1999.
Interest. Interest expense increased to $18.6 million in the Current Quarter
from $8.6 million in the Prior Quarter. This increase was a result of additional
interest expense in the Current Quarter on the $500 million principal amount of
Senior Notes issued on April 22, 1998. In addition to the interest expense
reported, the Company capitalized $2.0 million of interest during the Current
Quarter compared to $2.6 million capitalized in the Prior Quarter. The Company
does not anticipate interest expense will increase significantly during the
remainder of 1998.
Provision for Income Taxes. The Company recorded no income tax expense for the
Current Quarter or the Prior Quarter. At September 30, 1998, the Company had a
net operating loss carryforward of approximately $525 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 has been recorded equaling the net deferred tax
asset. The Company does not expect to record any book income tax expense or
benefit for the remainder of 1998.
Nine Months Ended September 30, 1998 vs. September 30, 1997
General. For the nine months ended September 30, 1998 (the "Current Period"),
the Company realized a net loss of $508.7 million, or a loss of $5.48 per common
share after deducting preferred dividends of $8.1 million. This compares to a
net loss of $196.3 million, or a loss of $2.79 per common share, in the nine
months ended September 30, 1997 (the "Prior Period"). The loss in the Current
Period was primarily caused by a $466 million asset writedown recorded under the
full-cost method of accounting, a $10 million impairment related to certain of
the Company's gas processing and transportation assets located in Louisiana, a
$13.3 million extraordinary loss on the early extinguishment of debt, and a
$19.4 million loss from recurring operations. The asset writedown was partially
caused by the acquisitions completed during the Current Period for consideration
in excess of the present value (10% discount) of the future net revenues of the
acquired proved reserves as of March 31, 1998 or June 30, 1998. See "-
Impairment of Oil and Gas Properties". The loss in the Prior Period was caused
by a $236 million asset write-down recorded under the full-cost method of
accounting. The asset writedown in the Prior Period was primarily caused by poor
exploration results in the Company's drilling program, particularly in the
Austin Chalk portion of the Louisiana Trend, combined with decreased oil and gas
prices, and higher drilling and equipping costs.
Oil and Gas Sales. During the Current Period, oil and gas sales increased
significantly to $196.0 million from $148.4 million, an increase of $47.6
million, or 32%. This increase resulted from significantly higher oil and gas
production volumes, which increased from 61.0 bcfe in the Prior Period to 96.5
bcfe in the Current Period, an increase of 35.5 bcfe, or 58%. The higher
production volumes were primarily the result of the Company's acquisitions
completed during the first four months of 1998. For the Current Period, the
Company produced 4.6 mmbo and 69.0 bcf, compared to 2.5 mmbo and 45.9 bcf in the
Prior Period. Average oil prices realized were $13.21 per barrel in the Current
Period compared to $19.66 per barrel in the Prior Period, a decrease of 33%.
Average gas prices realized were $1.96 per mcf in the Current Period compared to
$2.15 per mcf in the Prior Period, a decrease of 9%.
For the Current Period, the Company realized an average price of $2.03 per mcfe,
compared to $2.43 per mcfe in the Prior Period. The Company's hedging activities
resulted in increased oil and gas revenues of $10.5 million, or
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$0.11 per mcfe, in the Current Period, compared to increases in oil and gas
revenues of $0.1 million in the Prior Period.
The following table shows the Company's production by region for the Current
Period and the Prior Period:
FOR THE NINE MONTHS ENDED SEPTEMBER 30,
-----------------------------------------------------------
1998 1997
----------------------------- ---------------------------
OPERATING AREAS MMCFE PERCENT MMCFE PERCENT
- --------------------- ------------- ------------- ------------- ------------
Mid-Continent ................ 44,809 46% 12,568 21%
Gulf Coast ................... 39,519 41 45,136 74
Canada ....................... 5,677 6 -- --
Other areas .................. 6,457 7 3,291 5
------ ------ ------ ------
Total ................... 96,462 100% 60,995 100%
====== ====== ====== ======
Natural gas production represented approximately 72% of the Company's total
production volume on an equivalent basis in the Current Period, compared to 75%
in the Prior Period.
Oil and Gas Marketing Sales. The Company realized $96.4 million in oil and gas
marketing sales for third parties in the Current Period, with corresponding oil
and gas marketing expenses of $94.7 million, resulting in a gross profit margin
of $1.7 million. This compares to sales of $73.0 million and expenses of $72.3
million with a gross profit margin of $0.7 million in the Prior Period.
Interest and Other. Interest and other revenues for the Current Period were $3.6
million compared to $14.6 million in the Prior Period. The decrease was
primarily caused by the Company maintaining lower invested cash balances
resulting in reduced interest income during the Current Period.
Production Expenses and Taxes. Production expenses increased to $36.8 million in
the Current Period, a $25.7 million increase from $11.1 million incurred in the
Prior Period, due to the significantly higher production levels and higher per
unit costs. On a production unit basis, production expenses were $0.38 and $0.18
per mcfe in the Current and Prior Periods, respectively. The primary reason for
the increase per mcfe was production from properties acquired in late 1997 and
1998, which typically have higher unit-of-production expenses than the Company's
historical production base.
Production taxes, which consist primarily of wellhead severance taxes, were $6.1
million and $3.3 million in the Current and Prior Periods, respectively. This
increase was primarily the result of increased production. On a per unit basis,
production taxes were $0.06 per mcfe in the Current Period compared to $0.05 per
mcfe in the Prior Period, the result of higher tax rates associated with
production from properties acquired in late 1997 and 1998 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
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 $466
million in the Current Period ($250 million recorded during the quarter ended
March 31, 1998, and $216 million recorded during the quarter ended June
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30, 1998), compared to an impairment charge of $236 million in the Prior Period.
The writedown in the Current Period was caused by a combination of several
factors, including the acquisitions completed by the Company during the Current
Period, which were accounted for using the purchase method. The most significant
of these acquisitions were Hugoton Energy Corporation and DLB Oil & Gas, Inc.
Higher drilling and completion costs, the evaluation of certain leasehold,
seismic and other exploration-related costs that were previously unevaluated,
together with decreases in oil and gas prices from December 31, 1997 to June 30,
1998, were the remaining contributing factors which led to the writedown in the
Current Period. The $236 million writedown incurred in the Prior Period was due
primarily to significant expenditures for acreage acquisition and drilling costs
followed by unfavorable exploration and production results in Louisiana,
together with increases in drilling and equipment costs and lower oil and gas
prices as of June 30, 1997. Future impairment charges, if any, will be dependent
upon several factors, primarily oil and gas prices in effect at the date of
determination and the results of the Company's exploration activities.
Impairment of Other Assets. In the Current Period, the Company incurred an
impairment charge of $10 million as of June 30, 1998 related to certain of the
Company's gas processing and transportation assets located in Louisiana. No such
charge was recorded in the Prior Period.
Oil and Gas Depreciation, Depletion and Amortization. DD&A for the Current
Period was $109.3 million, compared to $95.6 million in the Prior Period. This
increase was caused by significantly increased production offset by a decrease
in the DD&A rate per mcfe from $1.57 to $1.13 in the Prior and Current Periods,
respectively.
Depreciation and Amortization of Other Assets. D&A increased to $5.8 million in
the Current Period compared to $3.1 million in the Prior Period. This increase
in D&A was caused by increased investments in depreciable buildings and
equipment incurred in conjunction with acquisitions and increased amortization
of debt issuance costs as a result of the issuance of Senior Notes in April
1998.
General and Administrative. G&A, which is net of capitalized internal payroll
and non-payroll expenses, was $14.7 million in the Current Period compared to
$7.8 million in the Prior Period. This increase was primarily caused by
increased employment levels associated with the Company's acquisitions. The
Company capitalized $4.0 million of internal costs in the Current Period
directly related to the Company's oil and gas exploration and development
efforts, compared to $4.2 million in the Prior Period.
Interest. Interest expense increased to $47.9 million in the Current Period from
$20.9 million in the Prior Period. This increase was a result of additional
interest expense in the Current Period on the $500 million principal amount of
Senior Notes issued on April 22, 1998. In addition to the interest expense
reported, the Company capitalized $5.8 million of interest during the Current
Period compared to $7.9 million capitalized in the Prior Period.
Provision for Income Taxes. The Company recorded no income tax expense for the
Current Period, and recorded a $17.9 million tax benefit in the Prior Period.
Loss on Early Extinguishment of Debt. During the Current Period and Prior
Period, the Company recorded a loss on early extinguishment of debt of $13.3
million and $0.2 million, respectively. The loss in the Current Period was due
primarily to the early retirement of the Company's 10.5% Senior Notes due 2002.
The cost to acquire the $90 million aggregate principal amount 10.5% Senior
Notes of $99 million, together with the write-off of associated debt issue
costs, resulted in an extraordinary charge of $13.3 million during the Current
Period. The Company did not record any such charges in the Current Quarter or
Prior Quarter.
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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. The
Company only enters into commodity 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. Results from commodity hedging transactions
are reflected in oil and gas sales to the extent related to the Company's oil
and gas production. Gains or losses on crude oil and natural gas hedging
transactions are recognized as price adjustments in the months of related
production.
As of September 30, 1998, the Company had the following natural gas swap
arrangement for periods after September 1998:
MONTHLY NYMEX-INDEX
VOLUME STRIKE PRICE
MONTHS (MMBTU) (PER MMBTU)
------ ------- ------------
October 1998............... 4,960,000 $ 2.346
The swap arrangement listed above was closed but not settled as of September 30,
1998, resulting in net proceeds to the Company of $1.1 million in October 1998.
The Company has closed transactions for natural gas previously hedged for the
period April 1999 through November 1999 and locked in net proceeds of $3.2
million. Subsequent to September 30, 1998, the Company sold December 1998
natural gas call options with a strike price of $2.60 on volume of 3.1 bcf for
$0.1325 per mmbtu, and sold January 1999 natural gas call options with a strike
price of $2.70 on volume of 3.1 bcf for $0.2225 per mmbtu.
As of October 15, 1998, the Company closed transactions for oil previously
hedged from January 1999 through December 1999, resulting in a $0.9 million
reduction of revenue. The Company has closed transactions for crude oil
previously hedged for the period from September 1998 through February 1999 and
has locked in net proceeds of $0.4 million.
The Company also utilizes hedging strategies to manage fixed-interest rate
exposure. Through the use of a swap arrangement, the Company believes that it
can benefit from stable or falling interest rates and reduce its upfront
interest expense. As of September 30, 1998, the Company's interest rate swap
resulted in a $0.2 million reduction of interest expense for the period August
1998 through October 1998, which settled on November 2, 1998.
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 $711 million, of which $170 million was used to retire all of the
Company's commercial bank debt, approximately $99 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 September 30, 1998, the Company had a working capital deficit of
approximately $2.0 million. The Company, as the result of significantly lower
oil and gas prices and a change in the Company's strategy away from higher risk
drilling and toward a more balanced acquisition and exploitation strategy, has
continued to reduce its capital expenditure plans. The Company currently
estimates that it will expend approximately $50 million for drilling, seismic
and leasehold expenditures for the three months ended December 31, 1998 and is
currently
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budgeting $195 million in expenditures for 1999. 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, planned asset sales and
unused commercial bank facilities to fund the reduced drilling program for the
remainder of 1998.
As part of its capital resources plan, the Company has undertaken to sell
various non-core assets. The Company expects to realize between $75 and $100
million of cash from these asset sales within the six months beginning October
1, 1998, inclusive of the $26 million transaction announced on November 2, 1998
between Poco Petroleums Ltd. and the Company involving Pan East common stock and
oil and gas reserves in the Helmet area of British Columbia. Other completed
asset sales combined with offers currently in hand total approximately $25
million. These asset sales are independent of the Company's strategic
alternatives evaluation process.
The Company has a $50 million secured revolving bank facility with its primary
commercial bank. As a result of its reduced capital expenditure plan, reduced
acquisition program, and the planned sale of assets, the Company believes this
size of bank facility is appropriate for the foreseeable future, although
significantly larger secured facilities could be established within the limits
of the Company's senior note indentures. The facility contains terms and
conditions similar to the bank facilities the Company has had in the past,
including collateral-based borrowing limitations. The primary purpose of the
facility is to provide standby liquidity for the Company. The Company had no
borrowings outstanding under this facility at September 30, 1998.
On May 20, 1998, the Company's Board of Directors approved the expenditure of up
to $25 million to purchase outstanding Company common stock. On July 14, 1998,
the Board increased the authorized expenditure to $30 million. As of August 25,
1998 the Company had purchased approximately 8.5 million shares of common stock
for an aggregate amount of $30.0 million pursuant to such authorization.
The Company's senior note indentures contain restrictions on the Company's
ability to make Restricted Payments (as defined), including the payment of
preferred stock dividends unless certain tests are met. The Company anticipates
that, based on expected production, pricing, and expenses for the twelve months
ending December 31, 1998, it may not be able to meet the requirements to incur
additional unsecured indebtedness, and consequently would not be able to pay
cash dividends on its 7% Cumulative Convertible Preferred Stock as of February
1, 1999. Subsequent payments will be subject to the same restrictions and are
dependent upon variables that are beyond the Company's ability to predict,
chiefly the future level of oil and gas prices. This restriction does not affect
the Company's ability to borrow under or expand its secured commercial bank
facility. If the Company fails to pay dividends for six quarterly periods, the
holders of preferred stock would be entitled to elect two additional members to
the Board.
The Company's cash provided by operating activities before changes in current
assets and liabilities decreased 17% to $96.7 million during the Current Period
compared to $117.0 million during the Prior Period. The decrease was due
primarily to reduced operating income as a result of a decrease in average oil
and gas prices between periods.
Cash used in investing activities increased to $518.9 million during the Current
Period from $453.9 million in the Prior Period. The Company completed several
acquisitions requiring cash in the Current Period which totaled $345 million,
compared to none in the Prior Period, offset by a significant decrease in
drilling activity and leasehold acquisitions in the Current Period compared to
the Prior Period. During the Current Period the Company expended approximately
$143.8 million to initiate drilling on 166 gross (91.5 net) wells and invested
approximately $11.1 million in leasehold acquisitions. This compares to $254.4
million to initiate drilling on 140 gross (78.2 net) wells and $113.1 million to
purchase leasehold in the Prior Period.
Cash provided by financing activities was $367.9 million in the Current Period,
compared to $279.6 million in the Prior Period. During the Current Period, the
Company retired $465 million of debt consisting of $85 million of debt assumed
at the completion of the DLB acquisition, $120 million of debt assumed at the
completion of the Hugoton acquisition, $90 million of senior notes, and $170
million of borrowings made under its commercial bank credit facilities. The
Company issued $500 million in senior notes and $230 million in preferred stock.
During the Prior Period, the Company issued $300 million in Senior Notes.
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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 for these
non-routine lawsuits in the Company's financial statements.
YEAR 2000
Project. The Company has placed a high priority on proactively resolving
computer or imbedded chip problems related to the "Year 2000" which may have
adverse material effects on its continuing operations or cash flow. This problem
would be caused by the inability of a component (software, hardware or equipment
with embedded microprocessors) to correctly process date data in and between the
20th and 21st centuries and therefore fail to properly perform its intended
functions, and/or to exchange correct date data with other components. This
problem would most typically be caused by erroneous date calculations, which
results from using two digits to signify a year (century implied), handling leap
years incorrectly or the use of "special" values that can be confused with
legitimate calendar dates. The scope of the Year 2000 project includes
conducting an inventory of the Company's software, hardware and "embedded
systems" equipment, assessing potential for failure and the associated risk,
prioritizing the need for remediation, repairing or replacing significant
noncompliant items, and testing. In addition, the Company will take a similar
approach to mitigating risks associated with the Year 2000 readiness of material
business partners (vendors, suppliers, customers, etc.). The project will also
identify contingency plans to cope with unexpected events resulting from Year
2000 issues.
Beginning in mid 1997, the Company began an assessment of its core financial and
operational software systems. Three critical systems were identified with date
sensitivities: oil and gas financial accounting, production accounting and
land/lease administration. A Year 2000 compliant release of the oil and gas
financial accounting package in use at the Company is available and has been
scheduled for implementation during the first calendar quarter of 1999. The
production accounting system in use at the Company is also scheduled for upgrade
to a Year 2000 compliant version early in 1999. Both of these upgrades have been
scheduled to maintain currency with the respective vendors' support and to take
advantage of additional features and performance enhancements. A project has
been underway since early 1997 to implement a completely revamped version of the
land/lease administration package in use at the Company to provide significantly
increased functionality and reliability. The terms of this development
arrangement stipulated Year 2000 compliance and is being monitored. Assessment
continues for lower priority software systems.
In addition, the Year 2000 compliant AS/400, on which the accounting package
resides, was upgraded to provide additional capacity in late 1997. Operating
system upgrades will be implemented in the near future for the Windows NT based
servers to complete their remediation.
Other activities either already underway or scheduled to start during the
balance of 1998 include testing of desktop PC's, assessment of material business
partners, and inventory of embedded systems in field locations. The following
table summarizes the current overall status of the project with anticipated
completion dates:
-------------------------------------------------------------------------------------
Phase
-------------------------------------------------------------------------------------
Component Inventory Assessment/Prioritization Remediation/Contingency
---------------------- ----------------------- ------------------------------ ----------------------------
Software November 30, 1998 December 31, 1998 June 30, 1999
Hardware December 31, 1998 January 31, 1999 March 31, 1999
Business Partners December 31, 1998 March 31, 1999 June 30, 1999
Embedded Systems March 31, 1999 April 30, 1999 June 30, 1999
(Non-IT Systems)
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In addition to the above, during the second quarter of 1999 the Company will
develop an overall contingency plan to assure continued operations which will
include precautionary measures.
Cost. To date, the Company has incurred only minor consulting costs for Year
2000 project planning and scope definition. All software packages requiring an
upgrade which have been identified will be upgraded within normal maintenance
procedures and will not require additional out of pocket expense. In all cases
these upgrades had been previously scheduled to maintain desired vendor support
and no upgrade project schedule has been accelerated to achieve Year 2000
compliance. An accurate cost cannot be determined prior to conclusion of the
Assessment/Prioritization phase, but it is expected total project expenditures
including the use of outside consultants should not exceed $1 million. This does
not include any costs which may be assessed by joint venture partners on
properties not operated by the Company.
Risks/Contingency. The failure to remediate critical systems (software, hardware
or embedded systems), or the failure of a material business partner to resolve
critical Year 2000 issues could have serious adverse impact on the ability of
the Company to continue operations and meet obligations. At the current time, it
is believed that any interruption in operation will be minor and short-lived and
will pose no safety or environmental risks. However, until all assessment phases
have been completed it is impossible to accurately identify the risks, quantify
potential impacts or establish a contingency plan. The Company has not yet
clearly identified the most likely worst case scenario if the Company and its
material business partners do not achieve Year 2000 compliance on a timely
basis. The Company currently intends to complete its contingency planning by
June 30, 1999.
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 oil and gas
reserve estimates, 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, expected
future expenses, and Year 2000 compliance efforts are forwardlooking statements.
Although the Company believes that the expectations reflected in such
forward-looking statements 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, ability to supplement capital resources with
asset sales, substantial indebtedness, fluctuations in the prices of oil and
gas, uncertainties inherent in estimating quantities of oil and gas reserves,
projecting future rates of production and the 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, adverse changes in the market for the Company's oil
and gas production and the Company's ability to successfully address Year 2000
issues. 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
- - Not applicable
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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 two purported class actions alleging violations of federal and Oklahoma state
securities laws. Also the Company is defending a patent infringement claim 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,
as updated by its Quarterly Reports on Form 10-Q for the first and second
quarters of 1998.
On September 11, 1998, the Company and the other named defendants filed a motion
to dismiss in Yuan, et al. v. Bayard Drilling Technologies, Inc., et al. pending
in the U.S. District Court for the Western District of Oklahoma.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Effective as of September 11, 1998, the Rights Agreement between the Company and
UMB Bank, N.A., as rights agent, was amended to add as an "Exempt Person" the
pledgee of shares beneficially owned by certain other Exempt Persons as of the
date of the amendment, to the extent that such pledgee exercises its rights
under the pledge other than the exercise of any voting power or the acquisition
of ownership.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
- - Not applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- - Not applicable
ITEM 5. OTHER INFORMATION
In July 1998, the Company made a $5 million secured loan to each of Aubrey K.
McClendon and Tom L. Ward, the Company's Chairman and Chief Executive Officer
and President, respectively. Each loan is payable on or before December 31, 1998
with interest accruing at an annual rate of 9 1/8%, payable quarterly.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed as a part of this report:
Exhibit No.
4.1.1 Fourth Supplemental Indenture, dated July 1, 1998, to
Indenture dated as of March 15, 1997 among the
Registrant, as issuer, its subsidiaries signatory
thereto, as Subsidiary Guarantors, and United States
Trust Company of New York, as Trustee, with respect to
7-7/8% Senior Notes due 2004.
4.2.1 Fourth Supplemental Indenture, dated July 1, 1998, to
Indenture dated as of March 15, 1997 among the
Registrant, as issuer, its subsidiaries signatory
thereto, as Subsidiary Guarantors, and United States
Trust Company of New York, as Trustee, with respect to
8-1/2% Senior Notes due 2012.
4.3.1 Fourth Supplemental Indenture, dated July 1, 1998, to
Indenture dated as of April 1, 1996 among the
Registrant, as issuer, its subsidiaries signatory
thereto, as Subsidiary Guarantors,
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and United States Trust Company of New York, as
Trustee, with respect to 9-1/8% Senior Notes due 2006.
4.4.1 First Supplemental Indenture, dated July 1, 1998, to
Indenture dated as of April 1, 1998 among the
Registrant, as issuer, its subsidiaries signatory
thereto, as Subsidiary Guarantors, and United States
Trust Company of New York, as Trustee, with respect to
9-5/8% Senior Notes due 2005.
10.2.1 Amended and Restated Employment Agreement dated July 1,
1998 between Aubrey K. McClendon and Chesapeake Energy
Corporation.
10.2.2 Amended and Restated Employment Agreement dated July 1,
1998 between Tom L. Ward and Chesapeake Energy
Corporation.
10.3 Amendment No. 1 dated September 11, 1998 to Rights
Agreement dated July 15, 1998 between the Registrant
and UMB Bank, N.A., as Rights Agent.
12 Schedule of Ratios
27 Financial Data Schedule
(b) Reports on Form 8-K
During the quarter ended September 30, 1998, the Company filed the
following Current Reports on Form 8-K:
On July 2, 1998, the Company filed a current report on Form 8-K
reporting under Item 5 that the Company issued a press release
announcing the declaration of quarterly cash dividends on the Company's
common stock and preferred stock.
On July 6, 1998, the Company filed a current report on Form 8-K
reporting under Item 5 that the Company issued a press release
announcing that Thomas L. Winton has been named Senior Vice President
Information Technology.
On July 9, 1998, the Company filed a current report on Form 8-K
reporting under Item 5 that the Company issued a press release
announcing that the Board of Directors authorized management to explore
strategic alternatives to enhance shareholder value, involving possible
sale or merger of the Company.
On July 16, 1998, the Company filed a current report on Form 8-K
reporting under Item 5 that the Company issued a press release
announcing that the Board of Directors adopted a shareholder rights
plan on July 7, 1998.
On July 31, 1998, the Company filed a current report on Form 8-K
reporting under Item 5 that the Company issued a press release
announcing it had hired Donaldson Lufkin & Jenrette to act as financial
advisor in evaluating the Company's various strategic alternatives.
On August 7, 1998, the Company filed a current report on Form 8-K
reporting under Item 5 that the Company issued a press release
reporting 1998 second quarter results.
On September 29, 1998, the Company filed a current report on Form 8-K
reporting under Item 5 that the Company issued a press release
announcing the declaration of a quarterly cash dividend on the
Company's preferred stock and the suspension of cash dividends on its
common stock.
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On October 7, 1998, the Company filed a current report on Form 8-K
reporting under Item 5 that the Company issued a press release
announcing a significant Tuscaloosa discovery.
On October 23, 1998, the Company filed a current report on Form 8-K
reporting under Item 5 that the Company issued a press release
providing a status report on drilling activity.
On November 9, 1998, the Company filed a current report on Form 8-K
announcing that it agreed to tender its 19.9% stake in Pan East
Petroleum Corp. to Poco Petroleums Ltd. and agreed to a property
exchange with Pan East.
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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)
November 16, 1998 /s/ Aubrey K. McClendon
- -------------------------- -------------------------------------
Date Aubrey K. McClendon
Chairman and
Chief Executive Officer
November 16, 1998 /s/ Marcus C. Rowland
- -------------------------- -------------------------------------
Date Marcus C. Rowland
Executive Vice President and
Chief Financial Officer
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Index to Exhibits
Exhibit No. Description Page
- ---------- ----------- ----
4.1.1 Fourth Supplemental Indenture, dated July 1, 1998, to
Indenture dated as of March 15, 1997 among the
Registrant, as issuer, its subsidiaries signatory
thereto, as Subsidiary Guarantors, and United States
Trust Company of New York, as Trustee, with respect to
7-7/8% Senior Notes due 2004.
4.2.1 Fourth Supplemental Indenture, dated July 1, 1998, to
Indenture dated as of March 15, 1997 among the
Registrant, as issuer, its subsidiaries signatory
thereto, as Subsidiary Guarantors, and United States
Trust Company of New York, as Trustee, with respect to
8-1/2% Senior Notes due 2012.
4.3.1 Fourth Supplemental Indenture, dated July 1, 1998, to
Indenture dated as of April 1, 1996 among the
Registrant, as issuer, its subsidiaries signatory
thereto, as Subsidiary Guarantors, and United States
Trust Company of New York, as Trustee, with respect to
9-1/8% Senior Notes due 2006.
4.4.1 First Supplemental Indenture, dated July 1, 1998, to
Indenture dated as of April 1, 1998 among the
Registrant, as issuer, its subsidiaries signatory
thereto, as Subsidiary Guarantors, and United States
Trust Company of New York, as Trustee, with respect to
9-5/8% Senior Notes due 2005.
10.2.1 Amended and Restated Employment Agreement dated July 1,
1998 between Aubrey K. McClendon and Chesapeake Energy
Corporation.
10.2.2 Amended and Restated Employment Agreement dated July 1,
1998 between Tom L. Ward and Chesapeake Energy
Corporation.
10.3 Amendment No. 1 dated September 11, 1998 to Rights
Agreement dated July 15, 1998 between the Registrant and
UMB Bank, N.A., as Rights Agent.
12 Schedule of Ratios
27 Financial Data Schedule