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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------
Form 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission File No. 1-16383
CHENIERE ENERGY, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-4352386
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
333 Clay Street, Suite 3400
Houston, Texas 77002-4102
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (713) 659-1361
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $ 0.003 PAR VALUE AMERICAN STOCK EXCHANGE
(Title of Class) (Name of each exchange
on which registered)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b - 2 of the Act). Yes [ ] No [X]
The aggregate market value of the registrant's Common Stock held by
non-affiliates of the registrant was approximately $15,044,368 as of June 30,
2002 (based upon the June 28, 2002 closing market price of such common stock as
reported on The American Stock Exchange).
13,297,393 shares of the registrant's Common Stock were outstanding as of
March 26, 2003.
Documents incorporated by reference: The definitive proxy statement for the
registrant's Annual Meeting of Stockholders (to be filed within 120 days of the
close of the registrant's fiscal year) is incorporated by reference into Part
III.
CHENIERE ENERGY, INC.
Index to Form 10-K
PART I............................................................................................................3
Items 1. and 2. Business and Properties...........................................................................3
Item 3. Legal Proceedings........................................................................................23
Item 4. Submission of Matters to a Vote of Security Holders......................................................24
PART II..........................................................................................................25
Item 5. Market Price of and Dividends on the Registrant's Common Equity and Related Stockholder Matters..........25
Item 6. Selected Financial Data..................................................................................26
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....................27
Item 7A. Quantitative and Qualitative Disclosures About Market Risk..............................................37
Item 8. Financial Statements and Supplementary Data..............................................................38
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.....................70
PART III.........................................................................................................70
Item 10. Directors and Executive Officers of the Registrant......................................................70
Item 11. Executive Compensation..................................................................................70
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.........70
Item 13. Certain Relationships and Related Transactions..........................................................70
Item 14. Controls and Procedures.................................................................................71
PART IV..........................................................................................................71
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.........................................71
SIGNATURES.......................................................................................................74
Gryphon Exploration Company Audited Financial Statements.........................................................77
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PART I
ITEMS 1. AND 2. BUSINESS AND PROPERTIES
GENERAL
Cheniere Energy, Inc., a Delaware corporation, is a Houston-based company
engaged in oil and gas exploration, development and exploitation and in the
development of a liquefied natural gas (LNG) receiving terminal business. The
LNG receiving terminal business consists of receiving deliveries of LNG from LNG
ships, processing such LNG to return it to a gaseous state and delivering it to
pipelines for transportation to purchasers. The terms Cheniere and the Company
refer to Cheniere Energy, Inc. and its subsidiaries. The Company has
historically focused on evaluating and generating drilling prospects using a
regional and integrated approach with a large seismic database as a platform.
Cheniere's management expects that the Company's active interpretation of 3D
seismic data and generation of prospects will continue, though its participation
in the drilling of wells within the coming year or two will be leveraged through
the sale of these prospects on a promoted basis to industry participants,
whereby the capital costs are borne by industry partners. The Company is also
focusing, and expects to continue to focus, its attention on the development of
its LNG receiving terminal business.
Cheniere has been publicly traded since July 3, 1996 under the name
Cheniere Energy, Inc. The Company's principal executive offices are located at
333 Clay Street, Suite 3400, Houston, Texas 77002, and its telephone number is
(713) 659-1361.
On October 16, 2000 the Company's stockholders approved a one-for-four
reverse stock split. The reverse stock split became effective on October 18,
2000 and reduced Cheniere's issued and outstanding shares from 43,989,572 shares
to 10,997,393 shares. All historical share and per share data appearing in this
document have been restated to reflect the reverse stock split.
As used in this Report, Mcf means thousand cubic feet, Mmcf means million
cubic feet, Bcf means billion cubic feet, Bbl means barrel or 42 U.S. gallons
liquid volume, Mbbl means thousand barrels, Mcfe means thousand cubic feet of
natural gas equivalent using the ratio of six Mcf of natural gas to one Bbl of
crude oil, condensate and natural gas liquids, Mmcfe means million cubic feet of
natural gas equivalent, Bcfe means billion cubic feet of natural gas equivalent,
and Mmbtu means million British thermal units. This Report includes various
other capitalized terms that are defined when first used.
ACCESS TO PUBLIC FILINGS
Cheniere provides public access to its annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to
these reports filed with the Securities and Exchange Commission (the "SEC")
under the Securities Exchange Act of 1934 (the "Exchange Act"). These reports
may be accessed free of charge through Cheniere's internet website (located at
www.cheniere.com), where the Company provides a link to the SEC's website (at
www.sec.gov).
GENERAL DEVELOPMENT OF BUSINESS
Cheniere Energy Operating Co., Inc. (Cheniere Operating) was incorporated
in Delaware in February 1996 for the purpose of engaging in the oil and gas
exploration business, initially on the Louisiana Gulf Coast. On July 3, 1996,
Cheniere Operating underwent a reorganization whereby Bexy Communications, Inc.,
a publicly held Delaware corporation (Bexy), received 100% of the outstanding
shares of Cheniere Operating, and the former stockholders of Cheniere Operating
received approximately 93% of the issued and outstanding Bexy shares. As a
result of the share exchange, a change in the control of the Company occurred.
The transaction was accounted for as a recapitalization of Cheniere Operating.
Bexy spun off its existing assets and liabilities to its original stockholders
and changed its name to Cheniere Energy, Inc. Cheniere Operating became a wholly
owned subsidiary of the Company.
Cameron Project. In 1996, Cheniere entered into an exploration agreement
with Zydeco Exploration, Inc. to acquire and process proprietary seismic data
along the transition zone (the area approximately 3-5 miles on either side of
the Gulf of Mexico shore line) in Cameron Parish, Louisiana, covering a
228-square-mile area (the Cameron Project). The 228-square-mile survey was
acquired jointly by Cheniere and its industry partner, and initial
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processing was completed in 1997. Interpretation of the data yielded drilling
prospects located onshore and in the state and federal waters of offshore
Louisiana. Leasing activity occurred over identified prospects throughout these
areas, and five prospects were drilled during 1999. In January 2000, Cheniere
reprocessed the Cameron data. Leasing over additional prospects began later in
2000 and continues to date. In September 2001, Cheniere acquired for $500,000
all rights to the Cameron Project from the industry partner with whom it had
jointly acquired the data in 1996 and 1997. Concurrent with this acquisition,
Cheniere sold the seismic data to a seismic marketing company for $2,500,000 and
a 50% share in licensing proceeds generated by the marketing company. In
September 2002, Cheniere sold its remaining interest in future licensing
proceeds to the marketing company for $825,000. Cheniere retains a license to
all of the seismic data for use in its exploration program. See Exploration
Programs.
Offshore Louisiana Area. In an effort to provide continued access to high
quality drilling prospects, the Company expanded beyond the Cameron Project and
into the shallow waters of the Gulf of Mexico. In 1999, Cheniere licensed 8,800
square miles of seismic data from Fairfield Industries (the Offshore Louisiana
Area). The Company also made a commitment (estimated to be approximately
$5,500,000 at the time) to fund the reprocessing of the entire 8,800-square-mile
seismic database.
On September 15, 2000 Cheniere entered into an agreement (the Gryphon
Transaction) with Warburg, Pincus Equity Partners, L.P. (Warburg), a global
private equity fund based in New York, to fund exploration and development in
the Offshore Louisiana Area through a newly formed private corporation, Gryphon
Exploration Company (Gryphon). The Company contributed to Gryphon: (i) the
Company's license from Fairfield Industries to seismic data covering the
Offshore Louisiana Area; (ii) the Company's interest in its Joint Exploration
Agreement with Samson Offshore Company (Samson), (iii) certain offshore leases,
including its Shark prospect on West Cameron Block 49, (iv) a well eventually
being drilled, (v) certain prepaid expenses and (vi) furniture and fixtures, all
in exchange for (i) the assumption by Gryphon of certain accounts payable and
(ii) 100% of the common stock of the subsidiary and cash. Warburg invested
$25,000,000 and received preferred stock, with an 8% accruing dividend,
convertible into 63.2% of Gryphon's common stock. In the event Gryphon's board
of directors approves a capital call and Gryphon delivers written notice of such
capital call to the terms of the agreement, Cheniere and Warburg have an option,
subject to certain customary conditions, to contribute to Gryphon their
respective shares of an additional $75,000,000 investment. The Gryphon
Transaction was consummated on October 11, 2000. See Investment in Gryphon
Exploration Company.
Offshore Texas Project Area. Between June 2000 and October 2000, Cheniere
acquired two licenses to approximately 6,800 square miles of seismic data
primarily in the shallow waters offshore Texas and also in the West Cameron area
in the Gulf of Mexico (the Offshore Texas Project Area) in separate transactions
with Seitel Data Ltd., a division of Seitel Inc., and JEBCO Seismic, L.P.
Cheniere had committed to reprocess all of the data from the Offshore Texas
Project Area at a cost of approximately $8,500,000, payable by Cheniere in
installments beginning in October 2000 and continuing through the final delivery
of reprocessed data, which is expected to occur in 2003.
In June 2001, Cheniere sold to Gryphon for $3,500,000 one of its two
licenses to the Seitel 3D seismic data. Gryphon paid $853,197 in cash to
Cheniere and agreed to pay $2,646,803 of Cheniere's obligations related to the
reprocessing of the data. Cheniere remained responsible for payment of the final
$1,061,692 in reprocessing charges upon final delivery of all reprocessed data,
which is anticipated to be received in 2003. This payment obligation was assumed
by Gryphon in connection with Cheniere's March 2002 sale of 51,400 shares of
Gryphon common stock to Gryphon. (See Note 12 in Notes to Consolidated Financial
Statements.) Cheniere retains one license to the seismic data.
In July 2001, Cheniere sold to Gryphon one of its two licenses to the Jebco
3D seismic data covering an additional 3,000 square miles. Gryphon agreed to pay
Cheniere's accounts payable of $1.3 million and the remaining commitment of $2.9
million related to the reprocessing of the data. In connection with the
transaction, Cheniere also transferred to Gryphon 6,740 shares of Gryphon common
stock, valued by the parties at approximately $418,000 or $62 per share, based
on the estimated fair market value of the Gryphon common stock, which considered
the fair value of such stock at the formation of Gryphon and any significant
changes in Gryphon's operations or market conditions since that date. The
proceeds at closing of $1.3 million were allocated as a reduction to the
carrying amount of Cheniere's investment in Gryphon ($418,000) and unproved oil
and gas properties ($882,000). Cheniere retains one license to the seismic data.
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Cheniere's existing data set covering the Cameron Project and the
reprocessed data set covering the Offshore Texas Project Area, as it is
delivered, provide to the Company the framework with which to identify potential
drilling prospects which may then be acquired through leasing at the area-wide
federal and state lease sales and from private mineral rights owners onshore,
through farm-ins (agreements whereby a third party owner of lease interests
grants to the Company the right to earn an assignment of an interest in the
lease, typically by drilling one or more wells), and through participation in
industry prospects. Cheniere plans to continue to identify potential drilling
prospects and may participate in any drilling activities by selling interests on
a promoted basis to industry participants.
As a part of its plans to quickly expand its exploration activities, in
December 2000, Cheniere entered into a consulting agreement with Aurora
Exploration, LLC (Aurora) to assist Cheniere in the interpretation of the
Company's seismic data sets. The initial term of the agreement was through March
2001, but it was extended through September 2001. Aurora, based in Lafayette,
LA, focused its efforts on the Texas and Louisiana offshore areas of the Gulf of
Mexico shelf, using a portion of Cheniere's licensed seismic data from the
Offshore Texas Project Area. Aurora also generated prospects in the shallow
water Main Pass area of offshore Louisiana, using other seismic data provided by
Cheniere.
LNG Receiving Terminal Development. In 2000, Cheniere undertook a
feasibility study to assess the long-term natural gas markets in the U.S. and,
in particular, the potential role of LNG in meeting a portion of the gas supply
deficit expected to develop later in this decade. Based on that analysis,
Cheniere's management concluded that LNG would become an economically viable
source of natural gas supply in the U.S.
In 2001, Cheniere assembled an experienced LNG project development team and
began a study to determine viable locations for LNG receiving terminals in the
U.S. The Company then acquired options to enter into long-term leases for two
terminal sites and an option to purchase one terminal site, all along the Texas
Gulf Coast. The options may be renewed through the payment of annual or
semiannual rentals.
In 2002, Cheniere engaged outside engineering, environmental and regulatory
consultants and substantially completed the project design and planning phase of
the Freeport project, including the preparation of materials to be filed with
the Federal Energy Regulatory Commission (FERC). The design work, the federal
and state regulatory coordination, and the 13 resource reports which comprise
the environmental filing to the FERC were substantially completed during the
year. It is anticipated that the FERC filing will be submitted in March 2003.
During the first half of 2002, the Company worked, with the assistance of
Petrie Parkman & Co. as its financial advisor, to identify and secure funding
for the development/pre-construction phase of the Freeport project. In August
2002, Cheniere entered into a Contribution Agreement with entities controlled by
Michael S. Smith providing for the formation of a limited partnership, Freeport
LNG Development, L.P. (Development) to develop the Freeport receiving terminal.
Under the terms of the Contribution Agreement, Cheniere contributed its
site lease option at Freeport, its technical expertise and know-how, and all of
the work in progress related to the Freeport project in exchange for a 40%
interest in Development. Michael S. Smith, through a controlled entity, Freeport
LNG Investments, LLC (Investments), will pay Cheniere $5,000,000 in installments
and contribute up to $9,000,000 to fund Freeport project expenses before
additional contributions may be required of Cheniere. Investments holds a 60%
interest in Development and Michael S. Smith will manage the project as chief
executive officer of Development. The transaction was consummated on February
27, 2003. On March 1, 2003, pursuant to an existing option agreement, Cheniere
sold a 10% interest in Development to a third party for $2,333,333, payable over
time. In connection with the closing of the transactions in 2003, Cheniere
issued warrants for the purchase of 1,000,000 shares of its common stock at a
price of $2.50 per share, exercisable for a period of 10 years. Cheniere
retained a 30% interest in Development.
BUSINESS STRATEGY
It is the Company's belief that the long-term outlook for natural gas
prices in the U.S. is one that will sustain prices at or above $3.00 per Mcf.
The Company believes that such an environment will favor not only domestic
exploration and production, but also LNG imports into the U.S. The Company's
objective is to develop its LNG receiving terminal business and to expand the
net value of its assets by building an oil and gas reserve base in a
cost-efficient manner, through its investment in Gryphon and through
exploitation of its seismic database to
5
facilitate identifying drilling prospects. Cheniere's exploration program
combines the use of regional seismic data in shallow water areas of the Gulf of
Mexico, advanced analytical technologies, a methodology that integrates
geoscience and engineering disciplines, and a core of experienced staff.
LNG Receiving Terminals
Cheniere has assembled a team of professionals with extensive experience in
the LNG industry. The Company has researched the LNG opportunity, developed a
plan to exploit the opportunity and initiated the process of identifying and
securing sites for LNG receiving terminals as well as undertaking the necessary
regulatory and permitting work to advance the project. A substantial portion of
the time and attention of Cheniere's employees is currently focused on
developing LNG terminals.
Seismic Data
Cheniere has acquired two significant seismic database assets: (i) a
license to a 228-square-mile seismic program covering the transition zone in
Cameron Parish (the Cameron Project described above), and (ii) a
6,800-square-mile seismic database comprising several seismic surveys in the
shallow waters offshore Texas (the Offshore Texas Project Area described above).
The offshore Texas database has been available previously to the industry and
was processed using a technique called dip move out (DMO). Cheniere has acquired
the DMO data and is underwriting the reprocessing of the data utilizing another
technology known as prestack time migration (PSTM). Both DMO and PSTM are
processing techniques which improve seismic data quality to more accurately
image subsurface features and delineate hydrocarbon accumulations. Of the two
techniques, PSTM is more advanced and technically accurate. The regional PSTM
data is the technology tool which management believes gives Cheniere a
competitive advantage.
Analysis and Methodology
Cheniere has developed a prospect generation infrastructure capable of
detailed analyses of large volumes of seismic, geological, and engineering data.
Cheniere employs a rigorous methodology which includes: 1) the detailed analyses
of existing fields to identify geological and geophysical attributes for use as
analogs, 2) regional trend mapping to extend prolific plays into under-explored
areas, 3) the use of workstation interpretation techniques to rapidly identify
prospects with attributes similar to those identified in the analog fields, 4)
the integration of seismic interpretation, well control, structure,
stratigraphy, timing, sourcing factors, and production data to quantify prospect
potential, and 5) the integration of the above sciences with experience and
conservative economic evaluation to focus the exploration program on highly
commercial projects. By conducting a thorough analysis of the data and strict
adherence to the methodology, Cheniere believes it can reduce the risk of dry
holes and achieve significant growth, while maintaining a competitive cost of
finding and development.
Experience
Cheniere has built a technical and management team that is experienced in
the Gulf of Mexico and in various technical specialties required for its
exploration program. The technical staff averages over 30 years of experience
exploring for oil and gas in the Gulf Coast. The Company believes this
experienced team allows it to be very productive in the generation and
acquisition of prospects.
LNG RECEIVING TERMINAL BUSINESS
LNG is natural gas that has been reduced to a fraction of its volume
through a sophisticated refrigeration process. The liquefication of natural gas
(into LNG) allows it to be transported long distances comparatively safely and
economically. Outside the U.S., utilization of LNG has grown dramatically, with
15 sites in 12 countries capable of producing 6 Tcf (gas equivalent) of LNG per
year and 42 terminals in 11 countries capable of importing LNG. In the U.S., due
mainly to an historically abundant supply of natural gas, LNG has not been a
major energy source. However, the recent experience of U.S. natural gas
producers' limited ability to increase supply and the increasing cost of
domestic exploration and production, the Company believes LNG will become a
competitive supply alternative to domestic natural gas and other import
alternatives. Assuming current construction costs of LNG-related facilities and
tankers, LNG can be economically produced and delivered as natural gas into U.S.
pipelines at a cost of $2.50 - $3.50/MMBtu.
6
Cheniere has been developing its LNG business since late 2000 and has made
substantial progress. After completing a U.S. gas market study and preliminary
terminal location study in 2000, Cheniere decided to focus on developing
terminals on the Texas and Louisiana Gulf Coast. Texas offers several important
advantages, including (i) it is the largest natural gas-consuming state in the
U.S., (ii) the government and general population are familiar with and
supportive of the energy industry, (iii) with the expected decline in
production, Texas will have under-utilized intrastate and interstate pipelines
with access to premium Midwest, Northeast, Mid-Atlantic and Southeast U.S.
markets, and (iv) Texas has an extended coast providing a number of ports with
adequate facilities for such a terminal. Louisiana, the third largest gas
consuming state in the U.S., offers otherwise identical advantages.
Cheniere secured lease options on sites in Freeport, Corpus Christi and
Brownsville, Texas and Sabine Pass, Louisiana. In connection with Cheniere's
acquisition of its option to lease the Freeport, Texas LNG receiving terminal
site, Cheniere issued 500,000 shares of common stock valued at $1,150,000 or
$2.30 per share, the closing price of the Company's common stock on the date of
the transaction. Additionally, Cheniere has committed to issue 750,000 shares of
its common stock to the seller of the lease option in April 2003, and Cheniere
will receive no additional consideration. Cheniere is also obligated to pay to
the seller of the lease option an overriding royalty interest equal to $0.03 per
Mcf on up to 1 Bcf per day of throughput from the LNG receiving terminals which
Cheniere develops. Under the terms of the option to lease the Freeport site, the
Company may exercise the option during the six-month period commencing on March
23, 2001, and such option is renewable for five additional six-month periods by
paying additional consideration of $125,000 every six months commencing on
September 23, 2001. In 2002, the Freeport site option was converted into a
long-term lease in the name of Development, and at the closing of the
partnership in February 2003, Development assumed the royalty obligation as it
relates to throughput at the Freeport facility.
In connection with Cheniere's acquisition of its option to lease the
Brownsville, Texas LNG terminal site, Cheniere paid $33,600 for a one-year
option commencing in June 2001. Such option was renewable for two additional
one-year periods for additional consideration of $33,600 per year, and the
Company renewed the option in June 2002.
Cheniere obtained a one-year purchase option to acquire the LNG terminal
site in Sabine Pass, Texas, commencing in November 2001, in exchange for initial
consideration of $200,000, of which $75,000 was paid in cash at closing and
$125,000 was due six months from closing, provided that such option was not
terminated at an earlier date. The purchase option expired during 2002, and no
additional consideration beyond the $75,000 was paid. Cheniere entered into
negotiations for an option to lease a different tract in Sabine Pass and
acquired such option in February 2003.
In December 2002, Cheniere entered into a non-binding Memorandum of
Understanding with Sherwin Alumina L.P. (Sherwin) providing for the negotiation
of a partnership agreement which would grant Sherwin a 33% interest in
Cheniere's Corpus Christi receiving terminal project in exchange for Sherwin's
agreement to fund the first $4,500,000 in project development costs. Completion
of the partnership agreement is scheduled to occur by April 15, 2003. In the
event that such an agreement is not consummated by that date, Sherwin will grant
to Cheniere a lease option on the terminal site lands in Corpus Christi. The
option rentals will be $100,000 per year for up to 5 years. Upon exercise of the
option, lease rentals would be $400,000 per year for an initial term of 33
years, renewable for two additional terms of 33 years each.
Initially, through its participation in Development, Cheniere plans to
permit the Freeport site with average annual capacity of 365 Bcf of gas per
year. Cheniere has commenced development of its Freeport, Texas site, including
(i) completing a feasibility study, (ii) initiating the preparation of forms and
collection of information for the permitting and Federal Energy Regulatory
Commission related filings, (iii) meeting with local agencies and planners and
(iv) conducting preliminary discussions concerning the financing of the project.
In order to exploit the opportunity to develop an LNG receiving terminal,
Cheniere will need to obtain additional equity or debt financing. Cheniere has
executed non-binding Memoranda of Understanding (MOUs) for the sale of 500 MMbtu
per day of natural gas from the proposed terminal and is pursuing discussions
with other consumers of natural gas to arrange for additional gas sales through
the terminal. Cheniere and Development have also held discussions with several
LNG suppliers. Assuming prompt regulatory approvals and adequate financing, and
subject to all of the risks inherent in a new venture of this type, as described
under the "Forward Looking Statements and Risk Factors" herein, construction of
the first terminal could commence as early as 2004 with LNG being imported in
2007. However, there can be no assurance whether or when such regulatory
approvals and financing may be obtained. See Forward Looking Statements and Risk
Factors.
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EXPLORATION PROGRAMS
The Company's current oil and gas exploration and development activities
are focused on two areas: (i) the Cameron Project, which covers an area
extending roughly three to five miles on either side of the westernmost 28 miles
of Louisiana coastline; and (ii) the Offshore Texas Project Area, which covers
approximately 6,800 square miles in the shallow waters offshore Texas and the
West Cameron Area of offshore Louisiana. Substantial infrastructure along the
Gulf Coast and in the shallow Gulf of Mexico should permit Cheniere to lower its
development costs compared to those in other geographic regions and facilitate
timely development of oil and gas discoveries. The Company's officers and
technical staff have extensive experience both onshore and offshore in the Gulf
Coast and believe the Company is well-positioned to evaluate, explore and
develop properties in these areas.
Cameron Project Seismic Exploration Program
Under the terms of an exploration agreement with an industry partner
covering the Cameron Project, Cheniere paid for certain seismic costs in the
amount of approximately $16,500,000 and acquired ownership of seismic data
covering the Cameron Project, among other interests that have subsequently
expired or terminated. After the termination of the exploration agreement,
Cheniere sold the seismic data to a seismic marketing company for $2,500,000 and
a 50% share in licensing proceeds generated by the marketing company. Cheniere
subsequently sold its remaining interest in future licensing proceeds to the
marketing company for $825,000. Cheniere retains a license to all of the seismic
data for use in its exploration program. Cheniere is also entitled to receive at
no additional cost any subsequent reprocessing of the data which may be
performed by the seismic marketing company.
Seismic Exploration Program in Offshore Texas Project Area
In June 2000, Cheniere acquired a license to approximately 1,900 square
miles of seismic data from Seitel Data Ltd., a division of Seitel Inc. In
October 2000, Cheniere exercised its option to expand the agreement with Seitel
Data Ltd. to cover an additional 1,900 square miles of seismic data. Together,
the licenses acquired from Seitel represent coverage of over 433 Outer
Continental Shelf blocks in the shallow waters offshore Texas and Louisiana in
the Gulf of Mexico.
In October 2000, Cheniere negotiated a Master Data Users Agreement with the
Houston-based firm, JEBCO Seismic L.P., to acquire 3,000 square miles (333
blocks) of seismic data in both state and federal waters offshore Texas,
bringing Cheniere's total data set in the shallow waters offshore Texas and
Louisiana to approximately 6,800 square miles of seismic coverage. Cheniere had
committed to reprocess all of the data from the Offshore Texas Project Area at a
cost of approximately $8,500,000, payable in installments beginning in October
2000 and continuing through the final delivery of reprocessed data, which is
expected to occur in 2003. As of December 31, 2002, Cheniere had received
reprocessed data for the 3,000 square miles of seismic data in the Jebco data
set and 2,200 of the approximately 3,800 square miles of seismic data in the
Seitel data set, representing 76% of the total reprocessing to be done in the
Offshore Texas Project Area.
Cheniere's exploration team generated and captured 16 prospects during 2001
and 2002 and sold interests in 14 of the prospects to industry partners,
retaining various overriding royalty interests and working interests ranging
from an overriding royalty interest (a share of the hydrocarbons produced from
an oil and gas property, free of the expense of production) of less than 1% to a
carried working interest (an agreement whereby Cheniere retains an interest in a
well but bears none, or only a portion of the cost of drilling the initial well)
of approximately 24%. Seven of the prospects sold during 2001 and 2002 have been
drilled by its industry partners, and Cheniere expects that the remaining
prospects sold during those years will be drilled by its industry partners
during 2003, but Cheniere does not serve as operator of the wells and does not
control the timing of such drilling activities.
Drilling Activities
In 1999, the Company drilled and completed two discovery wells located in
adjacent fault blocks on West Cameron Block 49 in Louisiana state waters: the
Redfish well and the Stingray well. The wells were tied into a common platform
and began production during September 1999. Both wells are located in shallow
waters of approximately 25 feet and were drilled into the Lower Miocene
formation, from 9,000 to 11,000 feet. Cheniere owned a 30% working interest in
the Redfish well and a 45% working interest in the Stingray well. In April 2002,
Cheniere sold its interest in these two wells and the common platform to the
operator of the wells.
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During 2000, the Company commenced drilling an additional exploration well
on West Cameron Block 49, known as the Shark well. In connection with the
Gryphon Transaction, Cheniere assigned its interest in the Shark well, which was
then being drilled, to Gryphon. Gryphon subsequently completed the well in
February 2001. Production of natural gas from the Shark well is handled through
a common platform which, since September 1999, has also handled production from
the Company's previously-owned Stingray and Redfish wells.
During 2001, Cheniere did not participate in the drilling of any wells.
In 2002, Cheniere did not participate directly in the drilling of any
wells. Eight wells, however, were drilled during the year by Cheniere's industry
partners on prospects generated by the Company. Six of the eight wells were
productive. Cheniere does not have a cost-bearing interest in the wells; it
holds overriding royalty interests (0.7% to 3.7%), some of which are convertible
into working interests of 8.4% at payout.
INVESTMENT IN GRYPHON EXPLORATION COMPANY
Cheniere owns 100% of the outstanding common stock of Gryphon and exercises
significant influence over Gryphon's financial and operating policies through
its participation on Gryphon's board of directors; however, Cheniere does not
participate in the day-to-day management of Gryphon, does not exercise control
over Gryphon and cannot effect a change in the management of Gryphon. Cheniere's
equity share of Gryphon's losses for 2002 was $2,184,847, calculated by applying
Cheniere's 100% common stock ownership interest to Gryphon's net loss of
$519,000, reducing such result for Gryphon's preferred dividend arrearages of
$5,844,746 for the year and limiting the cumulative amount of net loss
recognized to the balance of Cheniere's investment in Gryphon. During 2002,
Cheniere's basis of its investment in Gryphon was reduced to zero, but not below
zero, because Cheniere does not guarantee any obligations of Gryphon and is not
committed to provide additional financial support to Gryphon. The amount of
Gryphon's net loss that has not yet been recorded by Cheniere was $4,179,000 at
December 31, 2002. As of December 31, 2002, after giving effect to the
conversion of all shares of Gryphon's convertible preferred stock to shares of
Gryphon common stock, Cheniere had a 9.3% interest in Gryphon.
In the Gryphon Transaction, the Company contributed the license to 8,800
square miles of seismic data that it had originally licensed from Fairfield
Industries. The data covered more than 1,100 outer continental shelf blocks in
the shallow waters of the Gulf of Mexico (the Offshore Louisiana Area). Cheniere
also assigned its rights in its Joint Exploration Agreement with Samson, which
ran from March 2000 through August 2001.
During 2001, Gryphon drilled nine exploratory wells, yielding four
discoveries and five dry holes. During 2002, Gryphon drilled seven exploratory
wells, yielding three discoveries and four dry holes, and two development wells,
both of which were discoveries. As of March 13, 2003, Gryphon had ten wells on
production and one well being drilled. Depending on rig availability, Gryphon
anticipates drilling up to fourteen exploratory wells and four development wells
during 2003. Gryphon is also engaged in acquiring drilling prospects through
leasing at area-wide federal and state lease sales and through farm-ins of
leased acreage.
9
PRODUCTION AND SALES
The following table presents certain information with respect to oil and
natural gas production attributable to the Company, average sales prices
received and average production costs during 2002, 2001 and 2000. In April 2002,
Cheniere sold its interests in its West Cameron Block 49 wells.
Year Ended December 31,
-----------------------------------
2002 2001 2000
--------- ---------- ------------
Production:
Oil (bbls) 495 2,608 3,703
Gas (mcf) 91,470 542,774 1,459,897
Gas equivalents (mcfe) 94,441 558,422 1,482,117
Average sales prices:
Oil (per barrel) $ 20.03 $ 27.43 $ 29.78
Gas (per mcf) $ 2.58 $ 4.48 $ 3.79
Selected data per mcfe:
Average sales price $ 2.53 $ 4.25 $ 3.59
Production costs $ 0.95 $ 0.75 $ 0.26
Oil and gas depreciation,
depletion and amortization
excluding impairments $ 0.79 $ 1.84 $ 2.04
For the years ended December 31, 2002 and 2001, Gryphon had production of
3,550,000 Mcfe and 824,458 Mcfe, respectively. Gryphon had no production in
2000; it was formed in October 2000.
ACREAGE AND WELLS
The following table sets forth certain information with respect to the
Company's developed and undeveloped leased acreage as of December 31, 2002.
Developed Acres Undeveloped Acres (1)
------------------- -----------------------
Gross Net Gross Net
----- ------ ------- -------
Louisiana - - 10,000 9,500
Texas - - 720 171
----- ------ ------- -------
Total - - 10,720 9,671
===== ====== ======= =======
(1) The Company has no leases which expire in 2003.
At December 31, 2002, the Company had no working interest in any producing
wells; it has overriding royalty interests in six wells.
At December 31, 2002, Gryphon held interests in leases covering 29,428
gross (11,087 net) developed acres and 167,846 gross (129,111 net) undeveloped
acres. Gryphon has interests in 9 gross (3.2 net) producing wells at December
31, 2002.
DRILLING ACTIVITIES
All of Cheniere's drilling activities have been conducted through
arrangements with independent contractors. Cheniere owns no drilling equipment.
In 2000, the Company commenced drilling a well on its Shark Prospect, but prior
to completion the Company assigned its interest in the Shark well to Gryphon,
its unconsolidated affiliate in connection with the Gryphon Transaction in
October 2000. In 2001 and 2002, the Company did not participate in the drilling
of any wells. Although Cheniere did not participate directly in the drilling of
any wells in 2002, eight wells were drilled during the year by Cheniere's
industry partners on prospects generated by the Company. Six of the eight wells
were productive. Cheniere does not have a cost-bearing interest in the wells; it
10
holds overriding royalty interests (0.7% to 3.7%), some of which are convertible
into working interests of 8.4% at prospect payout.
During 2001, Gryphon drilled 9 gross (3.1 net) wells of which 4 gross (1.6
net) wells were successful. During 2002, Gryphon drilled 9 gross (3.1 net) wells
of which 5 gross (1.6 net) wells were successful.
OIL AND GAS RESERVES
Substantially all of the information herein regarding estimates of
Cheniere's proved reserves, related future net revenues and PV-10 is taken from
reports generated by Ryder Scott Company, the Company's independent petroleum
engineers, in accordance with the rules and regulations of the SEC. The
independent engineers' estimates were based upon a review of production
histories and other geologic, economic, ownership and engineering data provided
by the Company.
December 31, 2002
Proved Reserves
---------------------------------------------------------
Oil Gas
(Bbls) (Mcf) Mcfe PV-10 (1)
---------- ---------- ---------- -------------
Cheniere Reserves
Offshore Texas 3,917 1,175,000 1,198,502 $ 4,495,345
Offshore Louisiana 63 158,000 158,378 $ 636,118
---------- ---------- ---------- -------------
Proved Reserves 3,980 1,333,000 1,356,880 $ 5,131,463
========== ========== ========== =============
Proved Developed Reserves 1,605 502,000 511,630 $ 1,938,335
========== ========== ========== =============
Equity Interest in Reserves of
Unconsolidated Affiliate (2)
Proved Reserves 371,808 27,508,000 29,738,848 $ 106,939,136
========== ========== ========== =============
Proved Developed Reserves 165,421 16,332,000 17,324,526 $ 62,854,965
========== ========== ========== =============
(1) The PV-10 amount (present value of estimated pre-tax future net revenues
discounted at 10%) is calculated using year-end prices of $29.23 per barrel
of oil and $4.64 per Mcf of gas.
(2) Includes Cheniere's proportional share, based on its 100% common stock
ownership, of the proved reserves, proved developed reserves and PV-10 value
of Gryphon. Such proportional share of Gryphon reserves and PV-10 value is
based upon Cheniere's ownership of 100% of Gryphon's common stock and will
be reduced to 9.3% upon the conversion of Gryphon's preferred shares
outstanding at December 31, 2002. Upon such conversion, Cheniere's equity
interest in Gryphon's proved reserves and PV-10 value would be reduced to
2,765,713 Mcfe and $9,945,340, respectively. See General Development of
Business.
There are numerous uncertainties inherent in estimating quantities of
proved reserves and in projecting future rates of production and future amounts
and timing of development expenditures, including many factors beyond the
control of the Company. Reserve engineering is a subjective process of
estimating underground accumulations of crude oil and natural gas that cannot be
measured in an exact manner, and the accuracy of any reserve estimate is a
function of the quality of available data and of engineering and geological
interpretation and judgment. Estimates of proved undeveloped reserves are
inherently less certain than estimates of proved developed reserves. The
quantities of oil and gas that are ultimately recovered, production and
operating costs, the amount and timing of future development expenditures,
geologic success and future oil and gas sales prices may all differ from those
assumed in these estimates. In addition, the Company's reserves may be subject
to downward or upward revision based upon production history, purchases or sales
of properties, results of future development, prevailing oil and gas prices and
other factors. Therefore, the present value shown above should not be construed
as the current market value of the estimated oil and gas reserves attributable
to the Company's properties.
In accordance with SEC guidelines, the estimates of future net revenues
from the Company's proved reserves and the present value thereof are made using
oil and gas sales prices in effect as of the dates of such estimates and are
held constant throughout the life of the properties except where such guidelines
permit alternate treatment, including, in the case of gas contracts, the use of
fixed and determinable contractual price escalations. The Company may receive
amounts different than the estimates for a number of reasons, including changes
in prices.
11
See Supplemental Information to Consolidated Financial Statements.
Estimates of the Company's proved oil and gas reserves were not filed with or
included in reports to any other federal authority or agency other than the SEC
during the fiscal year ended December 31, 2002.
COMPETITION AND MARKETS
Competition in the industry is intense, particularly with respect to the
acquisition of producing properties and proved undeveloped acreage. The Company
competes with the major oil companies and other independent producers of varying
sizes, all of which are engaged in the exploration, development and acquisition
of producing and non-producing properties. Many of the Company's competitors
have financial resources and exploration and development budgets that are
substantially greater than those of the Company, which may adversely affect the
Company's ability to compete.
Although the LNG receiving business is in its developmental stages, several
companies are exploring the possibility of engaging or developing an LNG
business. Many of these companies have financial resources and exploration and
development budgets that are substantially greater than those of the Company,
which may adversely affect the Company's ability to compete.
The Company anticipates selling a portion of its interest in certain
prospects as a means of funding its participation in the development of these
properties. The Company anticipates that competition will arise from other
companies seeking drilling funds from potential working interest partners. There
can be no assurance that the Company will be successful in securing funds in
this manner.
The availability of a ready market for and the price of any hydrocarbons
produced by the Company will depend on many factors beyond the control of the
Company, including the extent of domestic production and imports of foreign oil,
the marketing of competitive fuels, the proximity and capacity of natural gas
pipelines, the availability of transportation and other market facilities, the
demand for hydrocarbons, the political conditions in international oil-producing
regions, the effect of federal and state regulation of allowable rates of
production, taxation, the conduct of drilling operations and federal regulation
of natural gas. In the past, as a result of excess deliverability of natural
gas, many pipeline companies curtailed the amount of natural gas taken from
producing wells, shut in some producing wells, significantly reduced gas taken
under existing contracts, refused to make payments under applicable take-or-pay
provisions and have not contracted for gas available from some newly completed
wells. The Company can give no assurance that such conditions will not arise
again.
In addition, the restructuring of the natural gas pipeline industry has
eliminated the gas purchasing activity of traditional interstate gas
transmission pipeline buyers. Producers of natural gas, therefore, have been
required to develop new markets among gas marketing companies, end-users of
natural gas and local distribution companies. All of these factors, together
with economic factors in the marketing area, generally may affect the supply
and/or demand for oil and gas and thus the prices available for sales of oil and
gas.
In addition, in the event the Company completes LNG receiving facilities,
the profitability of its operations and the price of its gas will be dependent
on the availability of liquefied natural gas, the volume and price of domestic
production of natural gas, the marketing of competitive fuels, the proximity and
capacity of natural gas pipelines, the availability of transportation and other
market facilities, the demand for hydrocarbons, the political conditions in
international oil-producing regions, taxation and the domestic demand for
natural gas.
GOVERNMENT REGULATION
The Company's oil and gas exploration, production and related operations
are, and its LNG receiving facility will be, subject to federal and state
statutes and extensive rules and regulations promulgated by federal and state
agencies. Failure to comply with such laws can result in substantial penalties.
The regulatory burden on the oil and gas industry increases the Company's cost
of doing business and affects its profitability. Because such laws are
frequently amended or reinterpreted, the Company is unable to predict the future
cost or impact of complying with them.
Cheniere's construction and operation of the proposed LNG receiving
terminals will be subject to extensive federal, state and local laws and
regulations, including laws and regulations relating to safety, as well as laws
and regulations governing environmental protection and pollution control. These
laws and regulations will require the
12
acquisition of certain permits or other authorizations before construction and
operation of the terminal may occur. For example, in order to site, construct
and operate the proposed receiving terminal, Cheniere will be required to apply
for and receive authorization from the FERC under Section 3 of the Natural Gas
Act of 1938 (NGA). While Cheniere believes that the likelihood is great that it
will be able to obtain all permits and approvals necessary for the construction
and operation of the proposed facilities, including NGA Section 3 authorization
from FERC, Cheniere cannot guarantee that it will be able to do so. Nor can
Cheniere guarantee that the authorizations and permits will not include
unfavorable terms or conditions. The permits and authorizations required for
various operations and activities are, in many instances, subject to revocation,
modification and renewal by the issuing authorities.
While these compliance activities increase the cost of planning, installing
and operating facilities, Cheniere does not expect environmental and other
regulatory compliance matters to have a material adverse effect on its financial
position or results of operations. However, because such laws and regulations
are frequently changed and may impose increasingly stricter requirements,
Cheniere is unable to predict the ultimate cost of complying with such laws and
regulations.
Production
In most, if not all, areas in which the Company conducts activities,
statutes concerning the production of oil and natural gas authorize
administrative agencies to adopt rules which, among other matters, (i) regulate
the operation of, and production from, both oil and gas wells, (ii) determine
the reasonable market demand for oil and gas, and (iii) establish allowable
rates of production. Such regulation may restrict the rate at which the
Company's wells may produce oil or gas, with the result that the amount or
timing of the Company's revenues could be adversely affected.
MMS Regulation
The Company may conduct certain activities on federal oil and gas leases
which the Minerals Management Service (MMS) administers. The MMS grants leases
through competitive bidding. These leases contain relatively standardized terms
and require compliance with detailed MMS regulations and orders pursuant to The
Outer Continental Shelf Lands Act (OCSLA) (which regulations and orders are
subject to change by the MMS). For offshore operations, lessees must obtain MMS
approval for exploration plans and development and production plans prior to the
commencement of such operations. In addition to permits which may be required
from other agencies (such as the Coast Guard, the Army Corps of Engineers and
the Environmental Protection Agency), lessees must obtain a permit from the MMS
prior to the commencement of drilling. The MMS has adopted regulations requiring
offshore production facilities located on the Outer Continental Shelf (OCS) to
meet stringent engineering and construction specifications. The MMS also has
regulations restricting the flaring or venting of natural gas, and has amended
such regulations to prohibit the flaring of liquid hydrocarbons and oil without
prior authorization except under certain limited circumstances. Also, the MMS
has promulgated other regulations governing the plugging and abandonment of
wells located offshore and the removal of all production facilities. To cover
the various obligations of lessees on the OCS, the MMS generally requires that
lessees post substantial bonds or other acceptable assurances that such
obligations will be met. The cost of such bonds or other surety can be
substantial and there is no assurance that the Company will be able to obtain
such bonds or other surety in all cases.
In March 2000, the MMS amended its regulations governing the calculation of
royalties and the valuation of crude oil produced from federal leases. This rule
modifies the valuation procedures for both arm's length and non-arm's length
crude oil transactions to decrease reliance on oil posted prices and assign a
value to crude oil that better reflects its market value. The Company cannot
predict how it will be affected by this regulation.
In April 1997, after two years of study, the MMS withdrew proposed changes
to the way it values natural gas for royalty payments and requested comment on
two alternative options for natural gas valuation. The changes as originally
proposed would have established an alternative market-based method to calculate
royalties on certain natural gas sold to affiliates or pursuant to non-arm's
length sales contracts. Informal discussions among the MMS and industry
officials are continuing, although it is uncertain whether, and what, changes
may be proposed regarding gas royalty valuation.
Bonding and Financial Responsibility Requirements
The Company is required to obtain bonding, or otherwise demonstrate
financial responsibility at varying
13
levels, by governmental agencies in connection with obtaining state or federal
leases or acting as an owner or operator on such leases or of exploration and
production related facilities. These bonds may cover such obligations as
plugging and abandonment of unproductive wells, removal and closure of related
exploration, production facilities and pollution liabilities. The costs of such
bonding and financial responsibility requirements can be substantial, and there
can be no assurance that the Company will be able to obtain such bonds and/or
otherwise demonstrate financial responsibility in all cases.
Natural Gas Marketing and Transportation
The FERC regulates the transportation and sale for resale of natural gas in
interstate commerce pursuant to the NGA and the Natural Gas Policy Act of 1978
(the NGPA). In the past, the federal government has regulated the prices at
which natural gas could be sold. Deregulation of wellhead sales of natural gas
began with the enactment of the NGPA in 1978. In 1989, Congress enacted the
Natural Gas Wellhead Decontrol Act (the Decontrol Act) which removed all NGA and
NGPA price and non-price controls affecting wellhead sales of natural gas
effective January 1, 1993. While sales by producers of natural gas can currently
be made at uncontrolled market prices, Congress could reenact price controls in
the future.
Commencing in April 1992, the FERC issued its Order No. 636 and related
clarifying orders (Order No. 636), which, among other things, restructured the
interstate natural gas industry and required interstate pipelines to provide
transportation services separate, or unbundled, from the pipelines' sales of
natural gas. Order No. 636 and certain related proceedings have been the subject
of a number of judicial appeals and orders on remand by the FERC. Order No. 636
has largely been upheld on appeal. The Company cannot predict when these
remaining appeals will be completed or their impact on the Company. The FERC
continues to address Order 636-related issues (including capacity brokering,
alternative and negotiated ratemaking and transportation policy matters) in a
number of pending proceedings. It is unclear what impact, if any, increased
competition within the natural gas industry under Order Nos. 636, et al., will
have on the Company's activities. Although Order No. 636 could provide the
Company with additional market access and more fairly applied transportation
service rates, Order No. 636 could also subject the Company to more restrictive
pipeline imbalance tolerances and greater penalties for violations of these
tolerances.
The FERC has announced its intention to re-examine certain of its
transportation-related policies, including the appropriate manner in which
interstate pipelines release transportation capacity under Order No. 636, and
the use of market-based rates for interstate gas transmission. While any
resulting FERC action would affect the Company only indirectly, the FERC's
current rules and policy statements may have the effect of enhancing competition
in natural gas markets by, among other things, encouraging non-producer natural
gas marketers to engage in certain purchase and sale transactions. The Company
cannot predict what action the FERC will take on these matters, nor can it
accurately predict whether the FERC's actions will achieve the goal of
increasing competition in markets in which the Company's natural gas is sold.
However, the Company does not believe that it will be treated materially
differently than other natural gas producers and marketers with which it
competes.
OCSLA requires that all pipelines operating on or across the OCS provide
open-access, non-discriminatory service. Although the FERC has opted not to
impose the regulations of Order No. 509, in which the FERC implemented OCSLA, on
gatherers and other non-jurisdictional entities, the FERC has retained the
authority to exercise jurisdiction over those entities, if necessary, to permit
non-discriminatory access to service on OCS. In this regard, the FERC issued a
Statement of Policy (Policy Statement) regarding the application of its
jurisdiction under the NGA and OCSLA over natural gas facilities and service on
OCS. In the Policy Statement, the FERC concluded that facilities located in
water depths of 200 meters or more shall be presumed to have a primary purpose
of gathering up to the point of interconnection with the interstate pipeline
grid. The FERC has determined that gathering facilities are outside of its
jurisdiction, and thus it will no longer regulate the rates and services of such
OCS facilities under the NGA. While it is not possible to determine what the
actual impact of this new policy will be, it is possible that the Company could
experience an increase in transportation costs associated with its OCS natural
gas production and possibly reduced access to OCS transmission capacity.
The FERC has also issued numerous orders approving the sale and abandonment
of natural gas gathering facilities previously owned by interstate pipelines and
has acknowledged that if the FERC does not have jurisdiction over services
provided thereon, then such facilities and services may be subject to regulation
by state authorities in accordance with state law. A number of states have
either enacted new laws or are considering the inadequacy of existing laws
affecting gathering rates and/or services. In addition, the FERC's approval of
transfers of previously
14
regulated gathering systems to independent or pipeline-affiliated gathering
companies that are not subject to FERC regulation may affect both the costs and
the nature of gathering services that will be available to interested producers
or shippers in the future. The effects, if any, of state and federal gathering
policies on the Company's operations are uncertain.
Oil Sales and Transportation Rates
Sales of crude oil, condensate, and gas liquids by the Company are not
currently regulated under federal or state law and are made at market prices.
The FERC regulates the transportation of oil in interstate commerce pursuant to
the Interstate Commerce Act. However, the price a Company receives from the sale
of these products is affected by the cost of transporting the products to
market. Effective as of January 1, 1995, the FERC implemented regulations
establishing an indexing system for transportation rates for oil pipelines,
which would generally index such rates to inflation, subject to certain
conditions and limitations. Over time, these regulations could increase the cost
of transporting crude oil, liquids, and condensate by pipeline. The Company is
not able to predict with certainty what effect, if any, these regulations will
have on it; but other factors being equal, these regulations may tend to
increase transportation costs or reduce wellhead prices for such commodities.
Operating Hazards and Environmental Matters
The oil and gas business involves a variety of operating risks, including
the risk of fire, explosions, blow-outs, pipe failure, casing collapse,
abnormally pressured formations and environmental hazards such as oil spills,
natural gas leaks, ruptures and discharge of toxic gases, the occurrence of any
of which could result in substantial losses to the Company due to injury or loss
of life, severe damage to or destruction of property, natural resources and
equipment, pollution or other environmental damage, clean-up responsibilities,
regulatory investigation and penalties and suspension of operations. Such
hazards may hinder or delay drilling, development and on-line production
operations.
Extensive federal, state and local laws and regulations applicable to oil
and gas operations regulate the discharge of substances into the environment or
otherwise relate to the protection of the environment. These laws and
regulations may require the acquisition of a permit before drilling commences,
restrict or prohibit the types, quantities and concentration of substances that
can be released into the environment or wastes that can be disposed of in
connection with drilling and production activities, prohibit drilling activities
on certain lands lying within wetlands or other protected areas and impose
substantial liabilities for pollution or releases of hazardous substances
resulting from drilling and production operations. Failure to comply with these
laws and regulations may also result in civil and criminal fines and penalties.
Moreover, state and federal environmental laws and regulations may become more
stringent.
The Comprehensive Environmental Response, Compensation and Liability Act
(CERCLA), also known as the Superfund law, imposes liability, without regard to
fault or the original conduct, on certain classes of persons who are considered
to be responsible for the release of a hazardous substance into the environment.
These persons include the owner or operator of the disposal site or sites where
the release occurred and companies that disposed or arranged for the disposal of
the hazardous substances. Under CERCLA, such persons may be subject to joint and
several liability for the costs of cleaning up the hazardous substances that
have been released into the environment, for damages to natural resources and
for the costs of certain health studies, and it is not uncommon for neighboring
landowners and other third parties to file claims for personal injury and
property damage allegedly caused by the release of hazardous substances.
The Company's operations may be subject to the Clean Air Act (CAA) and
comparable state and local requirements. Amendments to the CAA were adopted in
1990 and contain provisions that may result in the gradual imposition of certain
pollution control requirements with respect to air emissions from the operations
of the Company. The EPA and states have been developing regulations to implement
these requirements. The Company may be required to incur certain capital
expenditures in the next several years for air pollution control equipment in
connection with maintaining or obtaining permits and approvals addressing other
air emission-related issues. The Company does not believe, however, that its
operations will be materially adversely affected by any such requirements.
In addition, the U.S. Oil Pollution Act (OPA) requires owners and operators
of facilities that could be the source of an oil spill into waters of the United
States (a term defined to include rivers, creeks, wetlands and coastal
15
waters) to adopt and implement plans and procedures to prevent any spill of oil
into any waters of the United States. OPA also requires affected facility owners
and operators to demonstrate that they have at least $35 million in financial
resources to pay for the costs of cleaning up an oil spill and compensating any
parties damaged by an oil spill. Such financial assurances may be increased to
as much as $150 million if a formal assessment indicates such an increase is
warranted.
Operations of the Company are also subject to the federal Clean Water Act
(CWA) and analogous state laws. In accordance with the CWA, the state of
Louisiana has issued regulations prohibiting discharges of produced water in
state coastal waters, effective July 1, 1997. Producers may be required to incur
certain capital expenditures in the next several years in order to comply with
the prohibition against the discharge of produced waters into Louisiana coastal
waters or increase operating expenses in connection with offshore operations in
Louisiana coastal waters. Pursuant to other requirements of the CWA, the EPA has
adopted regulations concerning discharges of storm water runoff. This program
requires covered facilities to obtain individual permits, participate in a group
permit or seek coverage under an EPA general permit.
In addition, the disposal of wastes containing naturally occurring
radioactive material, which are commonly generated during oil and gas
production, is regulated under state law. Typically, wastes containing naturally
occurring radioactive material can be managed on site or disposed of at
facilities licensed to receive such waste at costs that are not expected to be
material.
OPERATIONAL RISKS AND INSURANCE
The Company anticipates that any wells established by it will be drilled by
proven industry contractors. Based on financial considerations, the Company may
choose to utilize turnkey drilling contracts that limit its financial and legal
exposure. Under a turnkey drilling contract, a negotiated price is agreed upon
and the money is placed in escrow. The drilling contractor then assumes all of
the risk and expense, including any cost overruns, of drilling a well to
contract depth and completing any agreed upon evaluation of the wellbore. Upon
performance of all these items, the escrowed money is released to the
contractor. Circumstances may arise where the Company is unable to secure a
turnkey contract on satisfactory terms. In this case, the Company may decide to
drill, or cause to be drilled, the applicable test well(s) on either a footage
or day-rate basis. Under a footage drilling contract, the operator pays to the
drilling contractor an agreed sum per foot drilled. Under a day-rate drilling
contract, the operator pays an agreed sum for each day of drilling required to
reach contract depth. All risk and expense, including cost overruns, of drilling
a well to total depth lies with the operator in both footage and day-rate
contracts. The drilling of such test wells will be subject to the usual drilling
hazards such as cratering, explosions, uncontrollable flows of oil, gas or well
fluids, fires, pollution and other environmental risks. The Company's activities
are also subject to perils specific to marine operations, such as capsizing,
collision and damage or loss from severe weather. These hazards can cause
personal injury and loss of life, severe damage to and destruction of property
and equipment, pollution or environmental damage and suspension of operations.
In accordance with customary industry practices, the Company intends to maintain
insurance against some, but not all, of such risks and some, but not all, of
such losses. The occurrence of a significant event not fully insured or
indemnified against could materially and adversely affect the Company's
financial condition and operations. Moreover, no assurance can be given that the
Company will be able to maintain adequate insurance in the future at rates
considered reasonable by the Company.
EMPLOYEES
The Company had 14 full-time employees as of March 26, 2003.
FORWARD-LOOKING STATEMENTS AND RISK FACTORS
This annual report contains certain statements that may be deemed
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933, as amended (Securities Act), and Section 21E of the United Stated
Securities Exchange Act of 1934, as amended (Exchange Act). Readers of this
annual report are cautioned that such forward-looking statements are not
guarantees of future performance and that actual results, developments and
business decisions may differ from those envisaged by such forward-looking
statements.
All statements, other than statements of historical facts, so included in
this annual report that address activities, events or developments that the
Company intends, expects, projects, believes or anticipates will or may
16
occur in the future, including, without limitation: statements regarding the
Company's business strategy, plans and objectives and statements expressing
beliefs and expectations regarding the ability of the Company to successfully
raise the additional capital necessary to meet its obligations, the ability of
the Company to secure the leases necessary to facilitate anticipated drilling
activities and the ability of the Company to attract additional working interest
owners to participate in the exploration and development of oil and gas
reserves, are forward-looking statements within the meaning of the Act. These
forward-looking statements are and will be based on management's then-current
views and assumptions regarding future events.
The following are some of the important factors that could affect the
Company's financial performance or could cause actual results to differ
materially from estimates contained in the Company's forward-looking statements.
The important factors are not exclusive.
The Company is subject to the expenses, difficulties and uncertainties generally
associated with early stage companies.
Cheniere has a limited operating history with respect to its oil and gas
exploration activities, and the Company has not yet started operating any LNG
receiving facilities. Cheniere faces all of the risks inherent in the
establishment and growth of any new business. From the Company's inception,
Cheniere has incurred losses and may continue to incur losses, depending on
whether it generates sufficient revenue either from producing reserves acquired
through acquisitions or drilling activities or from the eventual commencement of
LNG receiving operations. Cheniere may be unable to implement and complete its
business plan, and the Company's business may be ultimately unsuccessful. These
factors make evaluating Cheniere's business and forecasting its future operating
results difficult. Furthermore, any continued losses and any delays in the
implementation or completion of the Company's business plan may have a material
adverse effect on Cheniere's business, its results of operations, its financial
condition and the market price of its common stock.
The Company's future growth and profitability are highly dependent on the
success of its exploration program and the development of its LNG receiving
terminal business.
The primary focus of Cheniere's operations has been identifying drilling
prospects, but Cheniere is also currently focusing on developing its LNG
receiving facilities. Almost all of the Company's assets are represented by
investments to date in its exploration program, including the seismic data
related thereto. Through its drilling in 1999 and 2000, Cheniere has established
only limited proved reserves (oil and gas reserves that geological and
engineering data demonstrate with reasonable certainty to be recoverable in
future years from known reservoirs under existing economic and operating
conditions). Furthermore, the Company has achieved only limited oil and gas
production as of the date of this report. Cheniere's future growth and
profitability therefore depend heavily on the success of its exploration program
in locating additional proved reserves and achieving additional oil and gas
production or the development of its LNG receiving facilities. Failure to locate
such additional reserves and to achieve additional production may have a
material adverse effect on Cheniere's business, results of operations and
financial condition.
Failure to obtain approvals and permits from governmental and regulatory
agencies with respect to the Company's LNG project could have a detrimental
effect on the project and on the Company.
Cheniere is currently focusing on developing its LNG receiving facilities.
The transportation of LNG is highly regulated, and Cheniere has yet to obtain
several governmental and regulatory approvals and permits required in order to
complete and maintain its LNG project. Company management estimates that it may
take two to three years of work to obtain the approvals and permits necessary to
proceed with the construction and operation of an LNG receiving terminal. The
Company has no control over the outcome of the review and approval process. If
Cheniere is unable to obtain the approvals and permits, the Company may not be
able to recover its investment in the project. In addition, failure to obtain
these approvals and permits may have a material adverse effect on the Company's
business, results of operations and financial condition.
Failure of LNG to become a competitive factor in the U.S. oil and gas industry
could have a detrimental effect on the Company's ability to implement and
complete its business plan.
In the U.S., due mainly to an abundant supply of natural gas, LNG has not
historically been a major energy source. Furthermore, LNG may not become a
competitive factor in the U.S. oil and gas industry. The failure of LNG
17
to become a competitive supply alternative to domestic natural gas and other
import alternatives may have a material adverse effect on Cheniere's ability to
implement and complete its business plan as well as the Company's business,
results of operations and financial condition.
The Company may not be able to obtain additional financing on terms that are
acceptable to the Company, which could harm its ability to conduct business.
As of December 31, 2002, Cheniere had $1,848,820 of current assets and a
working capital deficit of $1,413,235. Because of its low level of current
assets, the Company may need additional capital for a number of purposes. If the
Company is unable to obtain additional financing, it could significantly harm
Cheniere's ability to conduct its business, including its ability to take
advantage of opportunities that come from its exploration program and its
ability to construct LNG terminals. Cheniere's needs for additional financing
include the following:
. Additional capital may be required to pay for Cheniere's share of costs
relating to the drilling of prospects and development of those that are
successful, to exercise lease options and to acquire additional oil and gas
leases. The total amount of the Company's capital needs will be determined
in part by the number of prospects generated within its exploration
program, by the working interest that the Company retains in those
prospects and by the Company's ability to identify partners willing to bear
a portion of drilling costs which would otherwise be attributable to the
Company.
. The Company may need capital to fund its pro-rata share of the capital
calls by Gryphon that are approved by Gryphon's board of directors. If the
Company subscribes to its pro-rata portion of such capital calls but fails
to fund, it would lose its ability to subscribe to any future capital calls
and would suffer further dilution of its holdings in Gryphon. In 2002,
Gryphon made cash calls in the aggregate amount of $30,000,000, which were
funded entirely by Warburg, in March, June, September and November 2002.
Cheniere declined to participate in these cash calls and its interest in
Gryphon has been reduced from 20.2% to 9.3% on an as-converted basis, as of
December 31, 2002. It is anticipated that Gryphon will make cash calls for
additional funds. The Company's share of such future capital calls could
total up to approximately $1,400,000. If the Company elects not to fund its
pro-rata portion of such capital calls, and Warburg funds its portion, as
they would be entitled to do, and as they have since the formation of
Gryphon, the Company's ownership percentage of Gryphon's common stock on an
as-converted basis will be further reduced (to as low as 8%). See Liquidity
and Capital Resources - Exploration Funding under Item 7 of this report.
. The Company will need substantial additional funds to execute its plan for
developing and expanding its LNG receiving terminal business, including
engineering, environmental, marine, regulatory, construction and legal
work, including any such work involved in permitting and FERC filings
related to Cheniere's second and third sites. Such costs are estimated to
be approximately $3,000,000 per year for each terminal to be developed.
Additional capital could be obtained from a combination of funding sources,
many of which may have a material adverse effect on the Company's business,
results of operations and financial condition. These potential funding sources
include:
. cash flow from operating activities, which is sensitive to prices the
Company receives for its oil and natural gas,
. borrowings from financial institutions, which may subject the Company to
certain restrictive covenants, including covenants restricting the
Company's ability to raise additional capital or pay dividends,
. debt offerings, which would increase the Company's leverage and add to its
need for cash to service such debt,
. additional offerings of the Company's equity securities, which would cause
dilution of its common stock,
. sales of portions of its working interest in the prospects within its
exploration program, which would reduce future revenues from its
exploration program,
18
. sale to an industry partner of a participation in the Company's exploration
program, which would reduce future revenues from its exploration program,
. sale of all or a portion of the Company's producing oil and gas properties,
which would reduce future revenues,
. additional sales of interests in the Company's LNG projects and
. arrangement of a business development loan from, or prepayment of terminal
use fees by, prospective sellers or purchasers of LNG.
Cheniere's ability to raise additional capital will depend on the results
of its operations and the status of various capital and industry markets at the
time such additional capital is sought. Accordingly, capital may not become
available to the Company from any particular source or at all. Even if
additional capital becomes available, it may not be on terms acceptable to the
Company. Failure to obtain additional financing on acceptable terms may have a
material adverse effect on the Company's business, results of operations and
financial condition.
Because of the Company's lack of diversification, factors harming the oil and
gas industry in general, including downturns in prices for oil and gas, would be
especially harmful to it.
The Company is an independent energy company and is not actively engaged in
any other industry. Cheniere's revenues and profits are substantially dependent
on the oil and gas industry in general and the prevailing prices for oil and gas
in particular. Circumstances that harm the oil and gas industry in general will
have an especially harmful effect on Cheniere. Oil and gas prices have been and
are likely to continue to be volatile and subject to wide fluctuations in
response to any of the following factors:
. relatively minor changes in the supply of and demand for oil and gas,
. political conditions in international oil producing regions,
. the extent of domestic production and importation of oil in relevant
markets,
. the level of consumer demand,
. weather conditions,
. the competitive position of oil or gas as a source of energy as compared
with other energy sources,
. the refining capacity of oil purchasers and
. the effect of federal and state regulation on the production,
transportation and sale of oil and gas.
It is likely that adverse changes in the oil market or the regulatory
environment would have an adverse effect on the Company's business, results of
operations and financial condition, including its ability to develop and
implement its LNG project and to obtain capital from lending institutions,
industry participants, private or public investors or other sources.
The Company experiences intense competition in the oil and gas industry, which
may make it difficult for the Company to succeed.
The oil and gas industry is highly competitive. If Cheniere is unable to
compete effectively, it will not succeed. A number of factors may give the
Company's competitors advantages over Cheniere. For example, most of the
Company's current and potential competitors have significantly greater financial
resources and a significantly greater number of experienced and trained
managerial and technical personnel than the Company does. In addition, the
businesses of such competitors are in many cases more diversified than that of
Cheniere. Cheniere may not be able to compete effectively with such companies.
Moreover, the oil and gas industry competes with other industries in supplying
the energy and fuel needs of industrial, commercial and other consumers.
Increased competition
19
causing over-supply and depressed prices could have a substantially negative
impact on Cheniere's operating revenues.
Fluctuation in energy prices or supply of liquefied natural gas could adversely
affect our LNG receiving terminals business.
If LNG prices are higher than prices of domestically produced natural gas
or natural gas derived from other sources, our ability to compete with such
suppliers may be negatively impacted. In addition, in the event the supply of
LNG is limited or restricted for any reason, our ability to profitably operate
an LNG receiving facility could be materially impacted. Revenues generated by an
LNG receiving terminal depend on the volume of LNG processed and the price of
the natural gas produced, both of which can be affected by the price of natural
gas and natural gas liquids.
The Company is subject to significant operating hazards and uninsured risks, one
or more of which may create significant liabilities for it.
The Company's oil and gas operations are subject to all of the risks and
hazards typically associated with the exploration for and the development and
production of oil and gas. In accordance with customary industry practices, the
Company intends to maintain insurance against some, but not all, of these risks
and losses. Moreover, the Company may not be able to maintain adequate insurance
in the future at rates it considers reasonable. The occurrence of a significant
event not fully insured or indemnified against could seriously harm the
Company's business, results of operations and financial condition.
Risks in drilling operations include cratering, explosions, uncontrollable
flows of oil, gas or well fluids, fires, pollution and other environmental
risks. The Company's activities are also subject to perils specific to marine
operations, such as capsizing, collision and damage or loss from severe weather.
These hazards can cause personal injury and loss of life, severe damage to and
destruction of property and equipment, pollution or environmental damage and
suspension of operations.
In the event the Company completes the LNG receiving terminal, the
operations of such facility will be subject to the inherent risks normally
associated with those operations, including explosions, pollution, release of
toxic substances, fires, hurricanes and adverse weather conditions and other
hazards, each of which could result in damage to or destruction of the Company's
facilities or damages to persons and property. In addition, the Company's
operations face possible risks associated with acts of aggression on our assets.
If any of these events were to occur, the Company could suffer substantial
losses. The Company will maintain insurance against these types of risks to the
extent and in the amounts that it believes are reasonable. Its financial
condition and operations could be adversely affected if a significant event
occurs that is not fully covered by insurance.
The Company is subject to significant exploration risks, including the risk that
it may not be able to find or produce enough oil and gas to generate any
profits.
The Company's exploration activities involve significant risks, including
the risk that it may not be able to find or produce enough oil and gas to
generate any profits. The wells drilled by the Company may not discover any oil
or gas. Further, there is no way to know in advance of drilling and testing
whether any prospect will yield oil or gas in sufficient quantities to make
money for the Company. In addition, the Company is highly dependent on seismic
activity and the related application of new technology as a primary exploration
methodology. This methodology, however, requires greater pre-drilling
expenditures than traditional drilling strategies. Even when fully used and
properly interpreted, 3D seismic data can only assist the Company in identifying
subsurface reservoirs and hydrocarbon indicators, and will not allow the Company
to determine conclusively if hydrocarbons will in fact be present and
recoverable. If the Company's exploration efforts are unsuccessful, its business
and financial condition will be substantially harmed.
The Company may not be able to acquire the oil and gas leases it needs to
sustain profitable operations.
In order to engage in oil and gas exploration in the areas covered by its
3D seismic data, the Company must first acquire rights to conduct exploration
and recovery activities on such properties. Cheniere may not be successful in
acquiring farm-outs (agreements whereby the Company, as owner of lease
interests, grants to a third party the right to earn an assignment of an
interest in the lease, typically by drilling one or more wells), seismic
permits, lease
20
options, leases or other rights to explore for or recover oil and gas. Both the
United States Department of the Interior and the States of Texas and Louisiana
award oil and gas leases on a competitive bidding basis. Non-governmental owners
of the onshore mineral interests within the area covered by the Company's
exploration program are not obligated to lease their mineral rights to the
Company except where the Company has already obtained lease options. In
addition, other major and independent oil and gas companies with financial
resources significantly greater than Cheniere's may bid against Cheniere for the
purchase of oil and gas leases. If the Company is unsuccessful in acquiring
these leases, permits, options and other interests, the area covered by the
Company's 3D seismic data that could be explored through drilling will be
significantly reduced, and Cheniere's business, results of operations and
financial condition will be substantially harmed.
If the Company is unable to obtain satisfactory turnkey contracts, it may have
to assume additional risks and expenses when drilling wells.
Cheniere anticipates that any wells drilled in which it has an interest
will be drilled by established industry contractors under turnkey contracts that
limit its financial and legal exposure. Under a turnkey drilling contract, a
negotiated price is agreed upon and the money placed in escrow. The contractor
then assumes all of the risk and expense, including any cost overruns, of
drilling a well to contract depth and completing any agreed upon evaluation of
the wellbore. Upon performance of all these items, the escrowed money is
released to the contractor.
Circumstances may arise, however, where a turnkey contract is not
economically beneficial to the Company or is otherwise unobtainable from proven
industry contractors. In such instances, the Company may decide to drill wells
on a day-rate basis. Under a day-rate drilling contract, the operator pays an
agreed sum for each day of drilling required to reach contract depth. All risk
and expense of drilling a well to total depths lies with the operator in
day-rate contracts. The drilling of such test wells would subject the Company to
the usual drilling hazards such as cratering, explosions, uncontrollable flows
of oil, gas or well fluids, fires, pollution and other environmental risks. The
Company would also be liable for any cost overruns attributable to drilling
problems that otherwise would have been covered by a turnkey contract. These
liabilities, if incurred, may have a materially adverse impact on Cheniere's
business and financial condition.
Existing and future United States governmental regulation, taxation and price
controls could seriously harm the Company.
Oil and gas production and exploration are subject to comprehensive
federal, state and local laws and regulations controlling the exploration for
and production and sale of oil and gas and the possible effects of such
activities on the environment. Failure to comply with such rules and regulations
can result in substantial penalties and may harm the Company. Present, as well
as future, legislation and regulations could cause additional expenditures,
restrictions and delays in the Company's business, the extent of which cannot be
predicted and which may require the Company to limit substantially, delay or
cease operations in some circumstances. In most areas where the Company plans to
conduct activities, there are statutory provisions regulating the production of
oil and natural gas which may restrict the rate of production and adversely
affect revenues. The Company plans to acquire oil and gas leases in the Gulf of
Mexico, which, if acquired, would be granted by the federal government and
administered by the U.S. Department of Interior Minerals Management Service. The
Department strictly regulates the exploration, development and production of oil
and gas reserves in the Gulf of Mexico. Such regulations could seriously harm
the Company's operations in the Gulf of Mexico. The federal government regulates
the interstate transportation of oil and natural gas, through the Federal Energy
Regulatory Commission (FERC). The FERC has in the past regulated the prices at
which oil and gas could be sold. Federal reenactment of price controls or
increased regulation of the transport of oil and natural gas could seriously
harm the Company.
The Company's operations are also subject to extensive federal, state and
local laws and regulations governing the discharge of oil and hazardous
materials into the environment or otherwise relating to environmental
protection. These laws and regulations may require the acquisition of a permit
before drilling commences, restrict or prohibit the types, quantities and
concentration of substances that can be released into the environment or wastes
that can be disposed of in connection with drilling and production activities,
prohibit drilling activities on certain lands lying within wetlands or other
protected areas and impose substantial liabilities for pollution or releases of
hazardous substances resulting from drilling and production operations. Failure
to comply with these laws and regulations may also result in civil and criminal
fines and penalties. Moreover, state and federal environmental laws and
regulations may become more stringent.
21
Federal laws and regulations such as the Comprehensive Environmental
Response, Compensation and Liability Act (CERCLA), the Clean Air Act (CAA), the
Oil Pollution Act of 1990 (OPA) and the Clean Water Act (CWA) and analogous
state laws have continually imposed increasingly strict requirements for water
and air pollution control, solid waste management and strict financial
responsibility and remedial response obligations relating to oil spill
protection. The cost of complying with such environmental legislation could have
a general harmful effect on the Company's operations.
There is only limited trading in the Company's common stock, which makes its
stock more difficult to sell than the stock of companies with more active
markets.
There is only limited trading in Cheniere's common stock, which makes its
stock more difficult for an investor to sell than the stock of companies with
more active markets. For the year 2002, the average daily trading volume of
Cheniere's common stock on The American Stock Exchange was approximately 17,000
shares.
The Company has not paid dividends and does not expect to do so in the
foreseeable future, so its stockholders will not be able to receive a return on
their investment without selling their shares.
The Company has not paid dividends since its inception and does not expect
to in the foreseeable future, so Cheniere's stockholders will not be able to
receive a return on their investments without selling their shares. The Company
presently anticipates that all earnings, if any, will be retained for
development of its business. Any future dividends will be subject to the
discretion of the Company's board of directors and will depend on, among other
things, future earnings, the Company's operating and financial condition, its
capital requirements and general business conditions.
The Company's stockholders could experience dilution in the value of their
shares because of additional issuances of shares.
Any issuance of common stock by the Company may result in a reduction in
the book value per share or market price per share of its outstanding shares of
common stock and will reduce the proportionate ownership and voting power of
such shares. The Company has 45,000,000 authorized shares of stock, consisting
of 40,000,000 shares of common stock and 5,000,000 shares of preferred stock. As
of December 31, 2002, approximately 67% of the shares of the common stock
remained unissued. The board of directors has the power to issue any and all of
such shares without shareholder approval. It is likely that the Company will
issue shares of common stock, among other reasons, in order to raise capital to
sustain operations and/or to finance future oil and gas exploration projects. In
addition, the Company has reserved 2,593,521 shares of the common stock for
issuance upon the exercise of outstanding warrants and 2,000,000 shares of the
common stock for issuance upon the exercise of stock options. As of December 31,
2002, there were 1,983,611 issued and outstanding options to purchase common
stock. To the extent that outstanding warrants and options are exercised, the
percentage ownership of common stock of the Company's stockholders will be
diluted. Moreover, the terms upon which the Company will be able to obtain
additional equity capital may be adversely affected because the holders of
outstanding warrants and options can be expected to exercise them at a time when
the Company would, in all likelihood, be able to obtain any needed capital on
terms more favorable than the exercise terms provided by such outstanding
securities. In the event of the exercise of a substantial number of warrants and
options, within a reasonably short period of time after the right to exercise
commences, the resulting increase in the amount of the Company's common stock in
the trading market could substantially adversely affect the market price of the
common stock or the Company's ability to raise money through the sale of equity
securities.
The Company depends on key personnel and could be seriously harmed if it lost
their services.
Cheniere depends on its executive officers for various activities. The
Company does not maintain key person life insurance policies on any of its
personnel. The loss of the services of any of these individuals could seriously
harm the Company. Although Cheniere has agreements relating to compensation and
benefits with certain of its executive officers, Cheniere does not have any
employment contracts or other agreements with key personnel binding them to
provide services for any particular term. In addition, the Company's future
success will depend in part on its ability to attract and retain additional
qualified personnel. Cheniere currently has 14 full-time employees.
22
The Company depends on industry partners and could be seriously harmed if they
do not perform satisfactorily, which is usually not within the Company's
control.
Because the Company has few employees and limited operating revenues, it is
and will continue to be largely dependent on industry partners for the success
of the Company's oil and gas exploration projects. Cheniere could be seriously
harmed if its industry partners do not perform satisfactorily on projects that
affect it. The Company often has and will continue to have no control over
factors that would influence the performance of its partners.
The Company is controlled by a small number of principal stockholders who may
exercise a proportionately larger influence on Cheniere than its stockholders
with smaller holdings.
Cheniere is controlled by a small number of principal stockholders who may
cause events to occur that are not in the interests of the Company's
stockholders with smaller holdings. BSR Investments, Ltd. (BSR) is an entity
controlled by the mother of Charif Souki, Cheniere's chairman. BSR owns
approximately 10% of the outstanding common stock. Accordingly, it is likely
that BSR will have significant influence on the election of Cheniere's directors
and on its management, operations and affairs, including the ability to prevent
or cause a change in control of the Company.
Anti-takeover provisions of the certificate of incorporation, bylaws and
Delaware law could adversely impact a potential acquisition by third parties
that may ultimately be in the financial interests of the Company's stockholders.
Cheniere's certificate of incorporation, bylaws and the Delaware General
Corporation Law contain provisions that may discourage unsolicited takeover
proposals. These provisions could have the effect of inhibiting fluctuations in
the market price of the Company's shares that could result from actual or
rumored takeover attempts, preventing changes in its management or limiting the
price that investors may be willing to pay for shares of common stock. These
provisions, among other things, authorize the board of directors to designate
the terms of and to issue new series of preferred stock, to limit the personal
liability of directors, to require the Company to indemnify directors and
officers to the fullest extent permitted by applicable law and to impose
restrictions on business combinations with some interested parties.
A significant portion of the value of the Company is derived from its ownership
interest in Gryphon, over which the Company exercises no day-to-day control.
Cheniere owns 100% of the outstanding common stock of Gryphon (9.3%
effective ownership after giving effect to the conversion of Gryphon's preferred
stock outstanding at December 31, 2002) and a significant portion of the
Company's value is derived from this investment. Cheniere exercises significant
influence, primarily through board participation. Cheniere does not exercise
control over Gryphon and therefore does not have the ability to effect a change
of control of Gryphon. Accordingly, Gryphon's management team could make
business decisions without Cheniere's consent that could impair the value of
Cheniere's investment in Gryphon.
ITEM 3. LEGAL PROCEEDINGS
The Company has been and may in the future be involved as a party to
various legal proceedings, which are incidental to the ordinary course of
business. Management regularly analyzes current information and as necessary,
provides accruals for probable liabilities on the eventual disposition of these
matters. In the opinion of management and legal counsel, as of December 31,
2002, there were no threatened or pending legal matters that would have a
material impact on the Company's consolidated results of operations, financial
position or cash flows.
In February 2002, the Company received a copy of a lawsuit styled Fairfield
Industries Incorporated (Fairfield) vs. Cheniere Energy, Inc. and Gryphon
Exploration Company, which was filed in district court in Harris County, Texas.
The lawsuit related to a seismic license agreement between Fairfield and
Cheniere, which was later assigned to Gryphon. In the lawsuit, Fairfield alleged
that Cheniere and Gryphon conspired to defraud the plaintiff of certain transfer
payments, which may be owed by Cheniere in connection with the transfer to
Gryphon of the initial seismic contributed at the time of its formation. In
March 2002, Fairfield, Gryphon, and the Company settled this lawsuit. Existing
and contingent obligations to Fairfield by Cheniere totaling $2,500,000 have
been fully
23
discharged through agreement by Gryphon to make current and contingent payments
in exchange for the transfer of 30,000 Gryphon common shares from Cheniere to
Gryphon.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
24
PART II
ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
Beginning on March 5, 2001, the common stock of the Company has traded on
The American Stock Exchange under the symbol CXY. Effective March 24, 2003, the
Company changed its symbol from CXY to LNG. Between December 14, 2000 and March
2, 2001, Cheniere's common stock traded on the OTC Bulletin Board under the
symbol CHEX. Between April 11, 1997 and December 13, 2000, the common stock of
the Company traded on The Nasdaq SmallCap Market under the symbol CHEX. From the
time the Company first traded publicly until April 11, 1997, the Company's
common stock traded on the OTC Bulletin Board. The table below presents the high
and low daily closing sales prices of the common stock, as reported by the OTC
Bulletin Board and The American Stock Exchange, for each quarter during 2001 and
2002.
High Low
----------- ------------
Three Months Ended
March 31, 2001 $ 3.38 $ 2.09
June 30, 2001 $ 2.88 $ 1.85
September 30, 2001 $ 2.19 $ 0.90
December 31, 2001 $ 1.25 $ 0.75
Three Months Ended
March 31, 2002 $ 1.50 $ 0.93
June 30, 2002 $ 1.50 $ 0.82
September 30, 2002 $ 1.30 $ 0.90
December 31, 2002 $ 1.35 $ 0.80
As of March 26, 2003, there were 13,297,393 shares of the Company's common
stock outstanding held by approximately 2,800 beneficial owners.
The Company has never paid a cash dividend on its common stock. The Company
currently intends to retain earnings to finance the growth and development of
its business and does not anticipate paying any cash dividends on the common
stock in the foreseeable future. Any future change in the Company's dividend
policy will be made at the discretion of the Company's board of directors in
light of the financial condition, capital requirements, earnings and prospects
of the Company, and any restrictions under any credit agreements, as well as
other factors the board of directors deems relevant.
Equity Compensation Plan Disclosure Table - The following table summarizes
the Company's use of equity securities as a form of compensation for services
rendered to the Company.
Number of securities to be Weighted-average Number of securities
issued upon exercise of exercise price of remaining available for
outstanding options, outstanding options, future issuance under equity
warrants and rights warrants and rights compensation plans
-------------------------- -------------------- ----------------------------
Equity compensation plans
approved by security holders 1,983,611 $ 2.07 16,389
Equity compensation plans not
approved by security holders 450,000 $ 2.92 -
-------------------------- ----------------------------
Total 2,433,611 $ 2.22 16,389
========================== ============================
The Company has issued warrants for the purchase of 450,000 shares of its
common stock at exercise prices ranging from $1.20 to $11.50 per share as
additional compensation for various services rendered to the Company, including
assistance in private placements of equity securities, investor relations and
marketing of LNG terminal capacity, as well as pursuant to the terms of an
employment agreement.
25
ITEM 6. SELECTED FINANCIAL DATA
Selected financial data set forth below are derived from the Company's
audited Consolidated Financial Statements for the periods indicated. The
financial data should be read in conjunction with the Management's Discussion
and Analysis of Financial Condition and Results of Operations and the Company's
Consolidated Financial Statements and Notes thereto included elsewhere in this
report.
Year Ended
December 31,
-------------------------------------------------------------------------
2002 2001 2000 1999 1998
-------------- ------------- ------------- ------------- -----------
Revenues $ 239,055 $ 2,372,632 $ 5,320,432 $ 1,614,055 $ -
Production costs 90,038 420,242 388,637 128,859 -
Depreciation, depletion and amortization 368,562 1,243,828 3,371,383 1,361,644 39,171
Ceiling test write-down - 5,126,248 - - -
General and administrative expenses 3,475,362 4,291,963 1,938,659 1,908,805 1,619,307
Loss from operations (3,694,907) (8,709,649) (378,247) (1,785,253) (1,658,478)
Interest income (expense) 7,733 18,578 23,916 31,530 20,634
Equity in net loss of affiliate (1) (2,184,847) (2,974,191) (426,649) - -
Gain on sale of properties 340,257 - - - -
Loss on extinguishment of debt (100,544) - - - -
Net loss (5,632,308) (11,665,262) (780,980) (1,753,723) (1,637,844)
Net loss per share (basic and diluted) (2) (0.42) (0.89) (0.07) (0.27) (0.41)
Cash dividends per share $ - $ - $ - $ - $ -
Weighted average shares outstanding
(basic and diluted) (2) 13,297,393 13,035,256 10,732,678 6,449,104 4,003,864
December 31,
-------------------------------------------------------------------------
2002 2001 2000 1999 1998
------------ ------------ ------------- ------------- --------------
Cash $ 590,039 $ 610,718 $ 1,888,562 $ 1,175,950 $ 143,868
Oil and gas properties, proved, net 842,882 1,929,124 6,727,613 9,459,041 -
Oil and gas properties, unproved 16,751,347 16,236,962 18,253,731 20,648,923 20,000,425
Total assets 21,059,390 25,023,676 34,665,618 34,481,275 20,840,474
Long-term notes payable - - - - 2,025,020
Total liabilities 3,262,055 1,874,401 1,604,410 6,735,537 4,523,144
Total stockholders' equity 17,797,335 23,149,275 33,061,208 27,745,738 16,317,330
(1) Represents the Company's equity in the net loss of Gryphon. See Note 7 to
the Company's Consolidated Financial Statements.
(2) Net loss per share and weighted average shares outstanding have been
restated to give effect to the one-for-four reverse stock split which was
effective in October 2000. See Note 2 to Consolidated Financial Statements.
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Cheniere is engaged in oil and gas exploration, development and
exploitation and in the development of an LNG receiving terminal business. The
Company has historically focused on evaluating and generating drilling prospects
using a regional and integrated approach with a large seismic database as a
platform. The Company is currently focusing, and expects to continue to focus,
its attention and resources on the development of its LNG receiving terminal
business. Cheniere's management expects that the Company's active interpretation
of 3D seismic data and generation of prospects will continue, through its
participation in the drilling of wells will be accomplished through farmout
arrangements and back-in interests, whereby the capital costs are borne by
industry partners.
PRODUCTION AND PRODUCT PRICES
Information concerning the Company's production and average prices received
for the years ended December 31, 2002, 2001 and 2000 is presented in the
following table.
Year Ended December 31,
-------------------------------------
2002 2001 2000
--------- --------- -----------
Production:
Oil (Bbls) 495 2,608 3,703
Gas (Mcf) 91,470 542,774 1,459,897
Gas equivalents (Mcfe) 94,441 558,422 1,482,117
Average sales prices:
Oil (per Bbl) $ 20.03 $ 27.43 $ 29.78
Gas (per Mcf) $ 2.58 $ 4.48 $ 3.79
RESULTS OF OPERATIONS - COMPARISON OF THE FISCAL YEARS ENDED DECEMBER 31, 2002
AND 2001
The Company's financial results for the year ended December 31, 2002
reflect a loss of $5,632,308, or $0.42 per share (basic and diluted), compared
to a loss of $11,665,262 or $0.89 per share (basic and diluted) in 2001. The
major factors contributing to the Company's loss in 2002 were: general and
administrative expenses of $3,475,362 and equity in loss of unconsolidated
affiliate of $2,184,847 (including accrued dividend obligations totaling
$5,844,746 for the year, payable by Gryphon, related to its preferred stock).
Oil and gas revenues decreased to $239,055 in 2002 from $2,372,632 in 2001
as a result of decreased production volumes (94,441 Mcfe in 2002 compared with
558,422 Mcfe in 2001). The decline in production volumes primarily results from
the sale of the Company's two producing wells at West Cameron Block 49 in April
2002. Adding to the effect of declining production was a decrease in average gas
prices to $2.58 per Mcf in 2002 compared to $4.48 per Mcf in the prior year.
Production costs decreased 79% to $90,038 in 2002 from $420,242 in 2001.
Depreciation, depletion and amortization (DD&A) decreased to $368,562 in
2002 from $1,243,828 in 2001 as a result of both the decline in the Company's
production volumes, described above, and a lower DD&A rate per unit ($0.79 per
Mcfe versus $1.84 per Mcfe). The Company's DD&A rate has declined due to its
change in emphasis toward selling prospects for front-end fees plus carried
interests, as opposed to direct participation in drilling costs, and due to the
effect of ceiling test write-downs recorded in 2001.
Gross general and administrative (G&A) expenses totaled $5,915,444 in 2002,
compared to $5,073,963 in 2001. The most significant component of the increase
between years was in consulting fees, which increased by $1,207,248 to
$2,391,011 in 2002, compared to $1,183,763 in 2001. The increased consulting
expense in 2002 principally related to permitting, environmental and regulatory
work related to the LNG receiving terminals project. Offsetting total G&A
expenses were amounts capitalized to the Company's oil and gas properties and
recoveries of
27
LNG related expenses in connection with the sale of Cheniere's Freeport LNG
terminal project. Cheniere capitalizes as oil and gas property costs that
portion of G&A expenses directly related to its exploration and development
activities. Cheniere capitalized $829,000 in 2002 compared to $782,000 in 2001.
In connection with Cheniere's sale of its Freeport LNG project to Development,
Cheniere was reimbursed $1,611,082 related to G&A expenses incurred on the
project subsequent to June 30, 2002. G&A expenses, net of amounts capitalized
and recoveries, were $3,475,362 and $4,291,963 in 2002 and 2001, respectively.
Equity in net loss of unconsolidated affiliate for 2002 includes Cheniere's
equity share of Gryphon's losses of $2,184,847, calculated by applying
Cheniere's 100% common stock ownership interest to Gryphon's net loss of
$519,000, reducing such result for Gryphon's preferred dividend arrearages of
$5,844,746 for the year and limiting the cumulative amount of net loss
recognized to the balance of Cheniere's investment in Gryphon. During 2002,
Cheniere's basis of its investment in Gryphon was reduced to zero, but not below
zero, because Cheniere does not guarantee any obligations of Gryphon and is not
committed to provide additional financial support to Gryphon. The amount of
Gryphon's net loss that has not yet been recorded by Cheniere was $4,179,000 at
December 31, 2002. Cheniere's equity share of Gryphon's losses for 2001 was
$2,974,191, calculated by applying Cheniere's 100% common stock ownership
interest to Gryphon's net income of $84,000 and reducing such result for
Gryphon's preferred dividend arrearages of $3,058,191. At such time as Warburg
converts its preferred shares to common shares, Cheniere's equity share of
Gryphon's earnings will be calculated at 9.3% based on ownership interests
outstanding at December 31, 2002.
Results of Operations - Comparison of the Fiscal Years Ended December 31, 2001
and 2000
The Company's financial results for the year ended December 31, 2001
reflect a loss of $11,665,262, or $0.89 per share (basic and diluted), compared
to a loss of $780,980, or $0.07 per share (basic and diluted) in 2000. The major
factors contributing to the Company's loss in 2001 were: $5,126,248 in ceiling
test write-downs, general and administrative expenses of $4,291,963 and equity
in loss of unconsolidated affiliate of $2,974,191 (including accrued dividend
obligations totaling $3,058,191 for the year, payable by Gryphon, related to its
preferred stock).
Oil and gas revenues decreased to $2,372,632 in 2001 from $5,320,432 in
2000 as a result of decreased production volumes (558,422 Mcfe in 2001 compared
with 1,482,117 Mcfe in 2000). The decline in production volumes represents
normal depletion of currently producing zones for the Company's two producing
wells at West Cameron Block 49. The effect of declining production was partially
offset by an increase in average gas prices to $4.48 per Mcf in 2001 compared to
$3.79 per Mcf in the prior year. Production costs increased 8% to $420,242 in
2001 from $388,637 in 2000.
Depreciation, depletion and amortization (DD&A) decreased to $1,243,828 in
2001 from $3,371,383 in 2000 as a result of both a lower DD&A rate per unit
($1.84 per Mcfe versus $2.04 per Mcfe) and the decline in the Company's
production volumes.
Gross general and administrative (G&A) expenses totaled $5,073,963 in 2001,
compared to $4,366,207 in 2000. The most significant component of the increase
between years was in legal fees, which increased by $716,588 to $912,514 in 2001
compared to $195,926 in 2000. The increased legal expenses in 2001 include
approximately $545,000 related to the Company's development of an LNG receiving
terminal business and approximately $120,000 related to Cheniere's buyout of its
partner's interest in the proprietary Cameron 3D seismic data set. Also
affecting the net G&A expenses reported between the years were reduced
recoveries from management fees and reduced amounts capitalized as oil and gas
property costs. In 2000, Cheniere received management fees from an industry
partner in the amount of $1,684,193 of which $988,548 was recorded as a recovery
of G&A expenses. The exploration agreement under which these management fees
were received was assigned to Gryphon in October 2000. Cheniere received no
management fees in 2001. Cheniere capitalizes as oil and gas property costs that
portion of G&A expenses directly related to its exploration and development
activities. Cheniere capitalized $782,000 in 2001 compared to $1,439,000 in
2000, the change being a direct result of the decreased level of exploration
activity following the Gryphon Transaction in October 2000. G&A expenses, net of
recoveries and amounts capitalized, were $4,291,963 and $1,938,659 in 2001 and
2000, respectively.
Equity in net loss of unconsolidated affiliate for 2001 includes Cheniere's
equity share of Gryphon's losses of $2,974,191, calculated by applying
Cheniere's 100% common stock ownership interest to Gryphon's net income of
$84,000 and reducing such result for Gryphon's preferred dividend arrearages of
$3,058,191 for the year. Cheniere's equity share of Gryphon's losses for the
period from October 11, 2000 through December 31, 2000 was
28
$426,649, calculated by applying Cheniere's 100% common stock ownership interest
to Gryphon's net income of $19,003 and reducing such result for Gryphon's
preferred dividend arrearages of $445,652. At such time as Warburg converts its
preferred shares to common shares, Cheniere's equity share of Gryphon's earnings
will be calculated at 20.2% based on ownership interests outstanding at December
31, 2001.
LIQUIDITY AND CAPITAL RESOURCES
Management expects that the Company will meet all of its liquidity
requirements for the next twelve months through a combination of cash balances,
collection of receivables and cash flows from current operations. Such sources
are not expected to be adequate to meet future liquidity requirements as the
Company expands its LNG terminal business. The Company expects that future
liquidity requirements will be met by one or more of the following: the
divestiture of producing oil and gas properties, sales of portions of its
working interest in the prospects within its exploration program, sale to an
industry partner of a participation in the Company's exploration program, sale
of a participation interest in the Company's LNG projects and/or additional
offerings of the Company's debt or equity securities. In the event that the
Company is unable to obtain additional capital from one or more of these
sources, its operations could be adversely affected.
At December 31, 2002, Cheniere had a working capital deficit of $1,413,235.
A significant portion of this deficit, a $750,000 note payable, was canceled in
March 2003, without requiring the use of cash by the Company, when Cheniere sold
an interest in its Freeport LNG project. Additionally, approximately $200,000
included in accrued liabilities will be satisfied through the issuance of
warrants rather than the expenditure of cash.
Cash Flow from Operating Activities
Net cash used in operations for the year ended December 31, 2002 totaled
$2,764,325, compared to net cash used in operations of $2,212,277 in 2001. In
April 2002, the Company sold its West Cameron Block 49 producing oil and gas
properties. Throughout the remainder of 2002, Cheniere generated and sold new
prospects, retaining overriding royalty interests which revert to larger working
interests after payout of the prospects. Revenues from this program are expected
to be approximately $450,000 per month by the end of 2003.
Private Placements of Equity
Since its inception, Cheniere's primary source of financing for operating
expenses and investments in its exploration program has been the sale of its
equity securities. Through December 31, 2002, the Company has issued 13,297,393
shares of its common stock, generating net proceeds of $39,090,960. No equity
securities were sold by the Company in 2002. During 2001, the Company raised
$493,329, net of offering costs, from the sale of units (common stock and
warrants) to accredited investors pursuant to Regulation D. Proceeds of the
offering were used for the acquisition of leases and other exploration costs and
for general corporate purposes.
In February 2001, the Company issued to one stockholder 250,000 units at a
cash purchase price of $2.00 per unit (for an aggregate offering price of
$500,000), each unit consisting of one share of common stock, $.003 par value
per share, and one warrant to purchase one-sixth of a share of common stock.
Warrants issued in connection with this sale of units are exercisable at a price
of $3.00 per share on or before December 31, 2003. These units were sold
pursuant to offers made exclusively to accredited investors, in reliance on the
exemption from registration provided by Section 506 of Regulation D. No
underwriting discounts or commissions were made with respect to the offering.
Proceeds of the offering, net of offering costs, were $493,329. The purchaser of
the shares of common stock issued in this private placement was granted certain
registration rights.
In May 2001, as compensation for assistance in the Company's listing on The
American Stock Exchange, Cheniere issued to a consultant warrants to purchase
50,000 shares of common stock at an exercise price of $3.00 per share,
exercisable on or before April 30, 2005. The issuance was made to one consultant
without any advertising or solicitation. This issuance was made in reliance on
the exemption from registration provided by Section 4(2) of the Securities Act
of 1933.
In June 2001, Cheniere issued 500,000 shares of common stock to Crest
Financial Ltd. in exchange for 100% ownership of Freeport LNG Terminal, LLC,
whose sole asset was a lease option on an LNG receiving terminal site in
Freeport, Texas. The stock was valued at the closing market price on the date of
the transaction, $2.30 per share, for an aggregate transaction value of
$1,150,000. The stock was issued as part of the consideration
29
pursuant to an agreement resolving certain disputes between Crest Financial Ltd.
and Cheniere. Based on the fact that the issuance was made to a single person
without any advertisement or solicitation, this issuance was made in reliance on
the exemption from registration provided by Section 4(2) of the Securities Act
of 1933.
In connection with the sale of the Company's proved oil and gas properties,
Cheniere issued warrants to purchase 50,000 shares of Cheniere common stock to a
consultant valued at $22,695. The Company issued warrants to purchase 200,000
shares of Cheniere common stock and extended the expiration period on existing
warrants to purchase 255,417 shares of Cheniere common stock, all at a value of
$265,993, in connection with a short-term bridge financing arrangement with an
unrelated third party lender. Cheniere issued warrants to purchase 50,000 shares
of Cheniere common stock to a consultant valued at $39,269 for assistance in
marketing the Company's LNG terminal. The Company issued 12,500 stock options
valued at $10,435 to a consultant for assistance in developing the LNG terminal
business. Cheniere issued warrants to purchase 12,500 shares of Cheniere common
stock to an investor relations consultant valued at $10,435.
The warrant issuances were made without any advertising or solicitation, in
reliance on the exemption from registration provided by Section 4(2) of the
Securities Act of 1933.
Short-Term Promissory Notes
At December 31, 2001, Cheniere had no outstanding debt obligations.
In March 2002, the Company entered into a short-term bridge financing
arrangement with an unrelated third party lender. The amount of the borrowing
was $500,000. The term was 120 days. Interest was payable monthly at 10% per
annum. Warrants were issued to the lender for the purchase of 150,000 shares of
Cheniere common stock, exercisable at a price of $2.50 per share on or before
March 7, 2012. Additionally, Cheniere extended the term to March 7, 2012 on
existing warrants for the purchase of 255,417 shares held by parties affiliated
with the lender. Based on the Black-Scholes model, the warrants issued (150,000
shares) and the extension of existing warrants (255,417 shares) in connection
with this financing arrangement have an aggregate value of $241,939. Debt
discount of $163,045 was recorded based on the relative fair values of the note
payable and the warrants. An additional 50,000 warrants were required to be
issued to the lender for each month or partial month for which the principal
remained unpaid after April 7, 2002. The Company repaid the loan on April 22,
2002, resulting in a loss on early extinguishment of debt in the amount of
$100,544, which is classified as an ordinary loss in the Company's statement of
operations. Cheniere also issued an additional 50,000 warrants to the lender,
valued at $24,054 based on the Black-Scholes model.
In June 2002, Cheniere received $750,000 as a refundable payment for the
sale of two options to purchase an aggregate of up to a 20% interest in its
Freeport LNG receiving terminal project. In the event the first option is
exercised, the payment is applied to the purchase price. In the event the option
is not exercised, the payment is refundable, and repayment is secured by a note
payable executed by Cheniere. The note is payable in full on July 15, 2003. It
will bear interest at 8%, payable at maturity and accruing from the earlier of
the time the option expires or the date the holder elects not to exercise. As of
December 31, 2002, the note has not yet begun to bear interest. The note is
secured by Cheniere's revenues, accounts receivable and other assets. On March
1, 2003, the option for a 10% interest in the Freeport project was exercised,
Cheniere's note payable was canceled and the collateral was released.
Exploration Funding
On October 11, 2000, Cheniere completed a transaction with Warburg to fund
its exploration program on approximately 8,800 square miles of seismic data in
the Gulf of Mexico (the Louisiana Data Set) through a newly formed affiliated
company, Gryphon. Cheniere contributed selected assets and liabilities in
exchange for 100% of the common stock of Gryphon (36.8% effective interest after
conversion of preferred stock) and $2,000,000 in cash. Such assets included: the
Louisiana Data Set, certain offshore leases, a prospect then being drilled, its
exploration agreement with an industry partner and certain other assets and
liabilities. The net book value of the assets and liabilities contributed was
$7,065,919, which consisted of assets of $9,115,963 (primarily unproved oil and
gas properties) and liabilities of $2,050,044, (primarily accounts payable).
Warburg contributed $25,000,000 and received preferred stock, with an 8%
cumulative dividend, convertible into 63.2% of Gryphon's common stock.
Cheniere and Warburg also have the option, in connection with subsequent
capital calls made by Gryphon,
30
to contribute up to an additional $75,000,000 to Gryphon, proportionate to their
respective ownership interests. Under the terms of the agreement governing these
additional contributions, in the event that either Cheniere or Warburg elects
not to participate in any additional contribution, the other investor has the
option to purchase the non-participating investor's proportionate share.
Assuming (i) that Gryphon makes subsequent capital calls for an aggregate of
$75,000,000, (ii) that Cheniere elects not to participate in any of the capital
calls and (iii) that Warburg elects to purchase all of Cheniere's proportionate
share, and giving effect to Cheniere's sale to Gryphon of 6,740 shares of
Gryphon common stock in July 2001 and its sale to Gryphon of 51,400 shares of
Gryphon common stock in March 2002, the Company's effective interest in Gryphon,
after giving effect to the conversion of Gryphon's preferred stock, will be
reduced to 8.0%. Cheniere accounted for the contribution of net assets at its
historical cost, whereby the net amount of such assets and liabilities less the
$2,000,000 in cash was reclassified to investment in unconsolidated affiliate.
No gain or loss was recognized at the time of contribution.
During 2001 and 2002, Gryphon made cash calls totaling $60,000,000 against
its capital commitment of $75,000,000. Cheniere declined to participate in such
cash calls, and Warburg elected to purchase all of Cheniere's proportionate
share of such cash calls. Also during 2001, Cheniere transferred 6,740 shares of
Gryphon common stock to Gryphon in connection with the sale of licenses to
certain seismic data. In March 2002, Cheniere sold 51,400 shares of its Gryphon
common stock to Gryphon. As a result of these transactions, Cheniere's ownership
interest in Gryphon, after the effect of converting preferred stock into common
stock, was reduced from 36.8% at December 31, 2000 to 9.3% as of December 31,
2002.
In connection with the seismic license contributed to Gryphon upon its
formation, Cheniere entered into an agreement with the third party issuer of the
license. The agreement provided that Cheniere would pay a transfer fee to the
third party in an aggregate amount of up to $2,500,000. Such transfer fee was
contingent upon Gryphon's completion of up to ten successful wells during the
license period and within the license area. Cheniere's existing and contingent
obligations under this agreement were fully discharged in March 2002 in
connection with its sale of 51,400 shares of Gryphon common stock to Gryphon and
the related assumption by Gryphon of these obligations. Gryphon also assumed
$1,061,692 of Cheniere's contingent liabilities related to the future
reprocessing of certain 3D seismic data.
Cheniere accounts for its investment in Gryphon using the equity method of
accounting. Although Cheniere's participation on the Gryphon board of directors
provides significant influence over the operating and financial policies of
Gryphon, Cheniere does not participate in the day-to-day management of Gryphon,
does not exercise control over Gryphon and cannot effect a change in the
management of Gryphon. Cheniere's equity share of Gryphon's losses for 2002 was
$2,184,847, calculated by applying Cheniere's 100% common stock ownership
interest to Gryphon's net loss of $519,000, reducing such result for Gryphon's
preferred dividend arrearages of $5,844,746 for the year and limiting the
cumulative amount of net loss recognized to the balance of Cheniere's investment
in Gryphon. During 2002, Cheniere's basis of its investment in Gryphon was
reduced to zero, but not below zero, because Cheniere does not guarantee any
obligations of Gryphon and is not committed to provide additional financial
support to Gryphon. The amount of Gryphon's net loss that has not yet been
recorded by Cheniere was $4,179,000 at December 31, 2002.
Seismic Reprocessing
Between June 2000 and October 2000, Cheniere acquired licenses to
approximately 6,800 miles of seismic data primarily in the shallow waters
offshore Texas and also in the West Cameron area in the Gulf of Mexico (the
"Offshore Texas Project Area") in separate transactions with Seitel Data Ltd., a
division of Seitel Inc., and JEBCO Seismic, L.P. Cheniere committed to reprocess
all of the data from the Offshore Texas Project Area at a cost of approximately
$8,500,000, payable in installments beginning in October 2000 and continuing
through the final delivery of reprocessed data, which is expected to occur in
2003. Deliveries of reprocessed data began in May 2001. After the assumption of
liabilities by Gryphon related to its purchase in 2001 of one license to the
data (discussed below), and related to the March 2002 sale of 51,400 shares of
its Gryphon common stock back to Gryphon, Cheniere has no existing or contingent
liability related to seismic reprocessing as of December 31, 2002.
Sale of Licenses to Seismic Data
In June and July 2001, Cheniere sold licenses to 6,800 square miles of
seismic data to Gryphon for $7,000,000. Cash proceeds to Cheniere were $853,197.
Gryphon also assumed $6,820,824 of Cheniere's obligation to fund the
reprocessing of the seismic data. In connection with the transaction, Cheniere
also transferred 6,740
31
shares of Gryphon common stock to Gryphon. Cheniere retains one license to all
of the data in the Offshore Texas Project Area.
Sale of Proprietary Seismic Data
In September 2001, Cheniere acquired for $500,000 all rights to its
228-square-mile proprietary seismic database from the industry partner with whom
it had jointly acquired the data in 1996 and 1997. Cheniere subsequently sold
the seismic data to a seismic marketing company for $2,500,000 and a 50% share
in licensing proceeds generated by the marketing company. In September 2002,
Cheniere sold its remaining interest in future licensing proceeds to the
marketing company for $825,000. Proceeds from the September 2001 and 2002 sales
of 3D seismic data were recorded as a reduction to the Company's unproved oil
and gas property costs. Cheniere retains a license to all of the seismic data
for use in its exploration program.
Sale of Interest in Freeport, Texas LNG Terminal
In August 2002, Cheniere entered into an agreement with entities controlled
by Michael S. Smith to sell a 60% interest in its planned LNG receiving facility
at Freeport, Texas. In February 2003, Cheniere's Freeport LNG project was
acquired by Freeport LNG Development, L.P. ("Freeport LNG"), in which Cheniere
retained a 40% interest. Freeport LNG will pay Cheniere $5,000,000 in cash and
will spend up to $9,000,000 to obtain permits and prepare the project for the
construction phase with no further contribution by Cheniere. After contribution
of the full $9,000,000, additional expenses will be borne by the parties pro
rata based on their respective ownership interests. Smith, through a controlled
entity, Freeport LNG Investments, LLC (Investments), holds a 60% interest in
Freeport LNG. Smith will manage the project as chief executive officer of
Freeport LNG.
The cash payments to Cheniere are payable $1,000,000 at closing; $750,000
on July 15, 2003 and October 15, 2003; and $2,500,000 30 days after all
construction permits are obtained for the Freeport site. With the signing of a
definitive lease agreement for the Freeport, Texas terminal site on December 19,
2002, Freeport LNG paid to Cheniere $650,000 for related costs and expenses,
which amount would have been reimbursable by Cheniere should the sale to
Freeport LNG not have been completed. Furthermore, at closing on February 27,
2003, Freeport LNG paid Cheniere $530,215 in cash and assumed Cheniere
liabilities of $560,211 related to Freeport LNG project costs. These payments
and assumptions of liabilities represent an aggregate of $1,740,426 in project
cost recoveries to Cheniere, in addition to the $1,000,000 initial installment
payment received at closing.
On March 1, 2003, Cheniere sold a 10% interest in Freeport LNG to a third
party for $2,333,333, payable over time. Cheniere retained a 30% interest in
Freeport LNG.
Corpus Christi, Texas LNG Terminal Funding Negotiations
In December 2002, Cheniere entered into a non-binding Memorandum of
Understanding with Sherwin providing for the negotiation of a partnership
agreement which would grant Sherwin a 33% interest in Cheniere's Corpus Christi
receiving terminal project in exchange for Sherwin's agreement to fund the first
$4,500,000 in project development costs. Completion of the partnership agreement
is scheduled to occur by April 15, 2003. In the event that such an agreement is
not consummated by that date, Sherwin will grant to Cheniere a lease option on
the terminal site lands in Corpus Christi. The option rentals will be $100,000
per year for up to 5 years. Upon exercise of the option, lease rentals would be
$400,000 per year for an initial term of 33 years, renewable for two additional
terms of 33 years each.
Contractual Cash Obligations
Cheniere is committed to making cash payments in the future on certain of
its contracts. The Company has no off-balance sheet debt or other such
unrecorded obligations and Cheniere has not guaranteed the debt of any other
party. Below is a schedule of the future payments that Cheniere was obligated to
make based on agreements in place as of December 31, 2002.
32
Payments Due for Years Ended December 31,
----------------------------------------------
Total 2003 2004 2005 2006 & Beyond
--------- --------- --------- ---- -------------
Operating Leases (1) $ 488,344 $ 456,835 $ 31,509 $ - $ -
LNG Consulting Retainer (2) $ 200,000 $ 100,000 $ 100,000 $ - $ -
Note Payable (3) $ 750,000 $ 750,000 $ - $ - $ -
(1) A discussion of operating leases can be found in Note 13 of the Notes to the
Consolidated Financial Statements. Cheniere has no capital leases.
(2) In April 2001, the Company engaged research consultants in connection with
the development of its LNG receiving terminal business. In connection with
the February 2003 closing on the sale of the Freeport, Texas LNG terminal
(described above), the Company agreed to make cash payments totaling
$200,000 and issued warrants to purchase 225,000 shares of Cheniere common
stock at a price of $2.50 per share to the consultants.
(3) At December 31, 2002, the Company had outstanding a short-term note payable
in the amount of $750,000. This note was canceled in March 2003 in
connection with Cheniere's sale of an interest in Freeport LNG.
Cheniere's obligations under LNG site options are renewable on an annual or
semiannual basis. Cheniere may terminate its obligation at any time by electing
not to renew or by exercising the option.
Recoverability of Investment in Oil and Gas Properties
The recoverability of the Company's unevaluated oil and gas properties is
dependent on future events, including obtaining adequate financing for its
exploration and development program, the successful reprocessing of the 3D
seismic data in the Offshore Texas Project Area, the successful sale of
prospects generated by the Company or the successful completion of its planned
drilling program, and the achievement of a level of operating revenues that is
sufficient to support the Company's cost structure. At various times during the
life of the Company to date, it has been necessary for the Company to raise
additional capital through private placements of debt or equity financing. When
such a need has arisen, the Company has met it successfully. It is management's
belief that it will continue to be able to meet its needs for additional capital
as such needs arise in the future.
Cheniere's needs for additional financing include the following:
. Additional capital may be required to pay for Cheniere's share of costs
relating to the drilling of prospects and development of those that are
successful, to exercise lease options and to acquire additional oil and gas
leases. The total amount of the Company's capital needs will be determined
in part by the number of prospects generated within its exploration
program, by the working interest that the Company retains in those
prospects and by the Company's ability to identify partners willing to bear
a portion of drilling costs which would otherwise be attributable to the
Company.
. The Company may need capital to fund its pro-rata share of the capital
calls by Gryphon that are approved by Gryphon's board of directors. If the
Company subscribes to its pro-rata portion of such capital calls but fails
to fund, it would lose its ability to subscribe to any future capital calls
and would suffer further dilution of its holdings in Gryphon. In 2002,
Gryphon made cash calls in the aggregate amount of $30,000,000, which were
funded entirely by Warburg, in March, June, September and November 2002.
Cheniere declined to participate in these cash calls and its interest in
Gryphon has been reduced from 20.2% to 9.3% on an as-converted basis, as of
December 31, 2002. It is anticipated that Gryphon will make cash calls for
additional funds. The Company's share of such future capital calls could
total up to approximately $1,400,000. If the Company elects not to fund its
pro-rata portion of such capital calls, and Warburg funds its portion, as
they would be entitled to do, and as they have since the formation of
Gryphon, the Company's ownership percentage of Gryphon's common stock on an
as-converted basis will be further reduced (to as low as 8%).
. The Company will need substantial additional funds to execute its plan for
developing and expanding its LNG receiving terminal business, including
engineering, environmental, marine, regulatory, construction and legal
work, including any such work involved in permitting and FERC filings
related to Cheniere's second and third sites. Such costs are estimated to
be approximately $3,000,000 per year for each terminal to be developed.
33
Additional capital could be obtained from a combination of funding sources,
many of which may have a material adverse effect on the Company's business,
results of operations and financial condition. These potential funding sources
include:
. cash flow from operating activities, which is sensitive to prices the
Company receives for its oil and natural gas,
. borrowings from financial institutions, which may subject the Company to
certain restrictive covenants, including covenants restricting the
Company's ability to raise additional capital or pay dividends,
. debt offerings, which would increase the Company's leverage and add to its
need for cash to service such debt,
. additional offerings of the Company's equity securities, which would cause
dilution of its common stock,
. sales of portions of its working interest in the prospects within its
exploration program, which would reduce future revenues from its
exploration program,
. sale to an industry partner of a participation in the Company's exploration
program, which would reduce future revenues from its exploration program,
. sale of all or a portion of the Company's producing oil and gas properties,
which would reduce future revenues ,
. additional sales of interests in the Company's LNG projects and
. arrangement of a business development loan from, or prepayment of terminal
use fees by, prospective sellers or purchasers of LNG.
Cheniere's ability to raise additional capital will depend on the results
of its operations and the status of various capital and industry markets at the
time such additional capital is sought. Accordingly, capital may not become
available to the Company from any particular source or at all. Even if
additional capital becomes available, it may not be on terms acceptable to the
Company. Failure to obtain additional financing on acceptable terms may have a
material adverse effect on the Company's business, results of operations and
financial condition.
OTHER MATTERS
Critical Accounting Estimates and Policies
The selection and application of accounting policies is an important
process that has developed as Cheniere's business activities have evolved and as
the accounting rules have developed. Accounting rules generally do not involve a
selection among alternatives, but involve an implementation and interpretation
of existing rules, and the use of judgment, to the specific set of circumstances
existing in Cheniere's business. The Company makes every effort to properly
comply with all applicable rules on or before their adoption, and believes the
proper implementation and consistent application of the accounting rules is
critical. However, not all situations are specifically addressed in the
accounting literature. In these cases, the Company must use its best judgment to
adopt a policy for accounting for these situations. Cheniere accomplishes this
by analogizing to similar situations and the accounting guidance governing them,
and often consults with its independent accountants about the appropriate
interpretation and application of these policies. Cheniere's most critical
accounting policy is its accounting under the full cost method of accounting.
This area involves complex situations and a high degree of judgment either in
the application and interpretation of existing literature or in the development
of estimates that impact the Company's financial statements.
34
Full Cost Method of Accounting
The Company follows the full cost method of accounting for its oil and gas
properties. Under this method, all productive and non-productive exploration and
development costs incurred for the purpose of finding oil and gas reserves are
capitalized. Such capitalized costs include lease acquisition, geological and
geophysical work, delay rentals, drilling, completing and equipping oil and gas
wells, together with internal costs directly attributable to property
acquisition, exploration and development activities. Interest is capitalized on
oil and gas properties not subject to amortization and in the process of
development.
The costs of the Company's oil and gas properties, including the estimated
future costs to develop proved reserves, are depreciated using a composite
units-of-production rate based on estimates of proved reserves. Investments in
unproved properties and major development projects are not amortized until
proved reserves associated with the projects can be determined or until
impairment occurs. If the results of an assessment indicate that the properties
are impaired, the amount of the impairment is added to the capitalized costs to
be amortized. Net capitalized costs are limited to a capitalization ceiling,
calculated on a quarterly basis as the aggregate of the present value,
discounted at 10%, of estimated future net revenues from proved reserves, based
on current economic and operating conditions, plus the lower of cost or fair
market value of unproved properties, less related income tax effects. At June
30, 2001 and September 30, 2001, the Company's capitalized costs exceeded its
capitalization ceiling, resulting in ceiling test write-downs totaling
$5,126,248 for the year.
The Company's allocation of seismic exploration costs to proved properties
involves an estimate of the total reserves to be discovered in the project. It
is reasonably possible, based on the results obtained from future drilling, that
revisions to this estimate could occur within the next twelve months, which
could affect the Company's capitalization ceiling.
Commodity Prices
The Company's revenues, operating results, financial condition and ability
to borrow funds or obtain additional capital depend substantially on prevailing
prices for natural gas and, to a lesser extent, oil. Declines in oil and gas
prices may materially adversely affect Cheniere's financial condition,
liquidity, ability to obtain financing and operating results. Lower oil and gas
prices also may reduce the amount of oil and gas that the Company can produce
economically. Historically, oil and gas prices and markets have been volatile,
with prices fluctuating widely, and they are likely to continue to be volatile.
Depressed prices in the future would have a negative impact on Cheniere's future
financial results. In particular, substantially lower prices would significantly
reduce revenue and could potentially impact the outcome of the Company's ceiling
test under Regulation S-X Rule 4-10. Because Cheniere's reserves are
predominantly natural gas, changes in natural gas prices may have a particularly
large impact on its financial results.
Oil and Gas Reserves
The process of estimating quantities of proved reserves is inherently
uncertain, and the reserve data included in this document are only estimates.
Reserve engineering is a subjective process of estimating underground
accumulations of natural gas and crude oil that cannot be measured in an exact
manner. The process relies on interpretations of available geologic, geophysic,
engineering and production data. The extent, quality and reliability of this
technical data can vary. The process also requires certain economic assumptions,
some of which are mandated by the SEC, such as oil and gas prices, drilling and
operating expenses, capital expenditures, taxes and availability of funds. The
accuracy of a reserve estimate is a function of the quality and quantity of
available data, the interpretation of that data, the accuracy of various
mandated economic assumptions and the judgment of the persons preparing the
estimate.
Cheniere's proved reserve information included in this document is
substantially based on estimates prepared by Ryder Scott Company. Estimates
prepared by others may be higher or lower than Cheniere's estimates.
Because these estimates depend on many assumptions, all of which may
substantially differ from actual results, reserve estimates may be different
from the quantities of natural gas and crude oil that are ultimately recovered.
In addition, results of drilling, testing and production after the date of an
estimate may justify material revisions to the estimate.
35
The present value of future net cash flows does not necessarily represent
the current market value of Cheniere's estimated proved natural gas and oil
reserves. In accordance with SEC requirements, the Company bases the estimated
discounted future net cash flows from proved reserves on prices and costs on the
date of the estimate. Actual future prices and costs may be materially higher or
lower than the prices and costs as of the date of the estimate.
Cheniere's rate of recording depreciation, depletion and amortization
expense (DD&A) is dependent upon its estimate of proved reserves. If the
estimate of proved reserves declines, the rate at which Cheniere records DD&A
expense increases, reducing net income. Such a decline may result from lower
market prices, which may make it uneconomic to drill for and produce higher cost
fields.
Equity Method of Accounting
The Company uses the equity method of accounting to account for its
investment in Gryphon in accordance with APB No. 18, The Equity Method of
Accounting for Investments in Common Stock. We consider the equity method to be
appropriate, because the Company exercises significant influence over the
operating and financial policies of Gryphon through its two member board
participation on Gryphon's six member board. See Note 7 in the Notes to the
Consolidated Financial Statements.
New Accounting Pronouncements
In July 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations (ARO), which requires that an asset retirement cost be capitalized
as part of the cost of the related long-lived asset and allocated to expense by
using a systematic and rational method. Under this Statement, an entity is not
required to re-measure an ARO liability at fair value each period but is
required to recognize changes in an ARO liability resulting from the passage of
time and revisions in cash flow estimates. This Statement is effective for
financial statements issued for fiscal years beginning after June 15, 2002. The
Company will adopt SFAS 143 effective January 1, 2003. The Company believes that
the initial adoption of SFAS 143 will not have a material impact on its earnings
or statement of financial position; however, this pronouncement may have a
significant effect on the Company in the future.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. SFAS 146 supersedes Emerging Issues Task Force
(EITF) Issue No. 94-3. The principal difference between SFAS 146 and EITF Issue
No. 94-3 relates to when an entity can recognize a liability related to exit or
disposal activities. SFAS 146 requires that a liability be recognized for a cost
associated with an exit or disposal activity when the liability is incurred.
EITF Issue No. 94-3 allowed a liability related to an exit or disposal activity
to be recognized at the date an entity commits to an exit plan. The provisions
of SFAS 146 are effective for all exit or disposal activities initiated after
January 1, 2003. This statement is not expected to have a material impact on the
Company upon adoption.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN No. 46), which addresses consolidation by
business enterprises of variable interest entities. FIN No. 46 clarifies the
application of Accounting Research Bulletin No. 51, Consolidated Financial
Statements, to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN No. 46 applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after that
date. It applies in the first fiscal year or interim period beginning after June
15, 2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. The Company does not expect
to identify any variable interest entities that must be consolidated. In the
event a variable interest entity is identified, the Company does not expect the
requirements of FIN No. 46 to have a material impact on its financial condition
or results of operations.
OTHER DEVELOPMENTS
In February 2002, the Company received a copy of a lawsuit styled Fairfield
Industries Incorporated vs. Cheniere Energy, Inc. and Gryphon Exploration
Company, which was filed in district court in Harris County, Texas. The lawsuit
was related to a seismic license agreement between Fairfield and Cheniere, which
was later assigned to Gryphon. In the lawsuit, Fairfield alleged that Cheniere
and Gryphon conspired to defraud the plaintiff of certain transfer payments,
which may be owed by Cheniere in connection with the transfer to Gryphon of the
initial seismic
36
contributed at the time of its formation. In March 2002, Fairfield, Gryphon, and
the Company settled this lawsuit. All existing and contingent obligations to
Fairfield by Cheniere have been fully discharged through agreement by Gryphon to
make current and contingent payments totaling no more than $2,500,000 to
Fairfield. Additionally, Gryphon has assumed all of Cheniere's remaining
contingent obligations to Seitel for seismic reprocessing ($1,061,692). In
exchange for Gryphon's assumption of these liabilities, Cheniere transferred to
Gryphon 51,400 shares of Gryphon common stock. (See Note 12 in Notes to
Consolidated Financial Statements.)
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company produces and sells natural gas, crude oil and condensate. As a
result, the Company's financial results can be significantly affected as these
commodity prices fluctuate widely in response to changing market forces. The
Company has not entered into any derivative transactions.
37
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
CHENIERE ENERGY, INC. AND SUBSIDIARIES
Reports of Independent Accountants...............................39
Consolidated Balance Sheet.......................................41
Consolidated Statement of Operations.............................42
Consolidated Statement of Stockholders' Equity...................43
Consolidated Statement of Cash Flows.............................44
Notes to Consolidated Financial Statements.......................45
Supplemental Information to Consolidated Financial Statements....64
All schedules are omitted because they are not applicable or the required
information is shown in the consolidated financial statements or notes thereto.
38
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Cheniere Energy, Inc:
We have audited the consolidated balance sheet of Cheniere Energy, Inc. and
subsidiaries (the "Company") as of December 31, 2002, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audit. We did
not audit the financial statements of Gryphon Exploration Company ("Gryphon"),
the investment in which, as discussed in Note 7 to the financial statements, is
accounted for by the equity method of accounting. The investment in Gryphon was
zero as of December 31, 2002, and the equity in its net loss was $2,184,847 for
the year then ended. The financial statements of Gryphon were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it
relates to the amounts included for Gryphon, is based solely on the report of
the other auditors.
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, based on our audit and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Cheniere Energy, Inc.
and subsidiaries at December 31, 2002, and the consolidated results of their
operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States.
MANN FRANKFORT STEIN & LIPP CPAs, L.L.P.
Houston, Texas
March 7, 2003
39
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Cheniere Energy, Inc:
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of Cheniere
Energy, Inc. and its subsidiaries at December 31, 2001, and the results of their
operations and their cash flow for each of the two years in the period ended
December 31, 2001 in conformity with accounting principles generally accepted in
the United States of America. These financial statements are the responsibility
of the Company's management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of these
statements in accordance with auditing standards generally accepted in the
United States of America, which require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 14 to the
consolidated financial statements, the Company has experienced recurring losses
from operations and has a negative working capital balance at December 31, 2001
that raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 14. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
PRICEWATERHOUSECOOPERS LLP
Houston, Texas
March 29, 2002
40
CHENIERE ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
December 31, December 31,
2002 2001
------------- --------------
ASSETS
CURRENT ASSETS
Cash And Cash Equivalents $ 590,039 $ 610,718
Accounts Receivable 1,137,682 636,527
Prepaid Expenses 121,099 96,914
------------- --------------
Total Current Assets 1,848,820 1,344,159
OIL AND GAS PROPERTIES, full cost method
Proved Properties, net 842,882 1,929,124
Unproved Properties, not subject to amortization 16,751,347 16,236,962
------------- --------------
Total Oil and Gas Properties 17,594,229 18,166,086
LNG SITE COSTS 1,400,000 1,350,000
FIXED ASSETS, net 216,341 416,232
INVESTMENT IN UNCONSOLIDATED AFFILIATE - 3,747,199
------------- --------------
Total Assets $ 21,059,390 $ 25,023,676
============= ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts Payable $ 1,828,267 $ 1,464,812
Accrued Liabilities 683,788 409,589
Note Payable 750,000 -
------------- --------------
Total Current Liabilities 3,262,055 1,874,401
COMMITMENTS AND CONTINGENCIES (NOTE 13) - -
STOCKHOLDERS' EQUITY
Preferred Stock, $.0001 par value
Authorized: 5,000,000 shares
Issued and Outstanding: none - -
Common Stock, $.003 par value
Authorized: 40,000,000 shares
Issued and Outstanding: 13,297,393 shares 39,892 39,892
Additional Paid-in-Capital 41,414,236 41,133,868
Accumulated Deficit (23,656,793) (18,024,485)
------------- --------------
Total Stockholders' Equity 17,797,335 23,149,275
------------- --------------
Total Liabilities and Stockholders' Equity $ 21,059,390 $ 25,023,676
============= ==============
The accompanying notes are an integral part of these financial statements.
41
CHENIERE ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
Year Ended
December 31,
---------------------------------------------------
2002 2001 2000
------------ ------------- ------------
Revenues
Oil and Gas Sales $ 239,055 $ 2,372,632 $ 5,320,432
------------ ------------- ------------
Total Revenues 239,055 2,372,632 5,320,432
------------ ------------- ------------
Operating Costs and Expenses
Production Costs 90,038 420,242 388,637
Depreciation, Depletion and Amortization 368,562 1,243,828 3,371,383
Ceiling Test Write-down - 5,126,248 -
General and Administrative Expenses
LNG Terminal Development 1,556,782 1,788,419 343,572
Other 1,918,580 2,503,544 1,595,087
------------ ------------- ------------
General and Administrative Expenses 3,475,362 4,291,963 1,938,659
------------ ------------- ------------
Total Operating Costs and Expenses 3,933,962 11,082,281 5,698,679
------------ ------------- ------------
Loss from Operations (3,694,907) (8,709,649) (378,247)
Equity in Net Loss of Unconsolidated Affiliate (2,184,847) (2,974,191) (426,649)
Gain on Sale of Proved Oil and Gas Properties 340,257 - -
Loss on Early Extinguishment of Debt (100,544) - -
Interest Income 7,733 18,578 23,916
------------ ------------- ------------
Loss Before Income Taxes (5,632,308) (11,665,262) (780,980)
Provision for Income Taxes - - -
------------ ------------- ------------
Net Loss $ (5,632,308) $ (11,665,262) $ (780,980)
============ ============= ============
Net Loss Per Share - Basic and Diluted $ (0.42) $ (0.89) $ (0.07)
============ ============= ============
Weighted Average Number of Shares Outstanding - Basic and Diluted 13,297,393 13,035,256 10,732,678
============ ============= ============
The accompanying notes are an integral part of these financial statements.
42
CHENIERE ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Common Stock Additional Total
---------------------- Paid-In Accumulated Stockholders'
Shares Amount Capital Deficit Equity
---------- -------- ------------ ------------- --------------
Balance - December 31, 1999 10,053,118 $ 30,159 $ 33,293,822 $ (5,578,243) $ 27,745,738
Issuance of Shares in Exchange for Note 250,000 750 499,250 - 500,000
Issuance of Warrants - - 722,800 - 722,800
Issuances of Stock 2,244,275 6,733 5,199,767 - 5,206,500
Expenses Related to Offerings - - (332,850) - (332,850)
Net Loss - - - (780,980) (780,980)
---------- -------- ------------ ------------- --------------
Balance - December 31, 2000 12,547,393 $ 37,642 $ 39,382,789 $ (6,359,223) $ 33,061,208
Issuance of Stock 750,000 2,250 1,647,750 - 1,650,000
Issuances of Warrants and Options - - 110,000 - 110,000
Expenses Related to Offerings - - (6,671) - (6,671)
Net Loss - - - (11,665,262) (11,665,262)
---------- -------- ------------ ------------- --------------
Balance - December 31, 2001 13,297,393 $ 39,892 $ 41,133,868 $ (18,024,485) $ 23,149,275
Issuances of Warrants and Options - - 280,368 - 280,368
Net Loss - - - (5,632,308) (5,632,308)
---------- -------- ------------ ------------- --------------
Balance - December 31, 2002 13,297,393 $ 39,892 $ 41,414,236 $ (23,656,793) $ 17,797,335
========== ======== ============ ============= ==============
The accompanying notes are an integral part of these financial statements.
43
CHENIERE ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
Year Ended
December 31,
------------------------------------------------
2002 2001 2000
-------------- ------------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss $ (5,632,308) $ (11,665,262) $ (780,980)
Adjustments to Reconcile Net Loss to
Net Cash Provided By (Used In) Operating Activities:
Depreciation, Depletion and Amortization 368,562 1,243,828 3,371,383
Ceiling Test Write-down - 5,126,248 -
Non-Cash Expense (32,649) 380,000 134,250
Gain on Sale of Proved Oil and Gas Properties (340,257) - -
Loss on Early Extinguishment of Debt 100,544 - -
Equity in Net Loss of Unconsolidated Affiliate 2,184,847 2,974,191 426,649
-------------- ------------- -----------
(3,351,261) (1,940,995) 3,151,302
Changes in Operating Assets and Liabilities
Accounts Receivable (752,648) 591,672 54,863
Prepaid Expenses (27,786) 14,818 (16,787)
Accounts Payable and Accrued Liabilities 1,367,370 (877,772) 2,014,028
-------------- ------------- -----------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES (2,764,325) (2,212,277) 5,203,406
-------------- ------------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of Fixed Assets (14,506) (407,817) (320,362)
Oil and Gas Property Additions (1,430,472) (4,343,705) (6,561,169)
Net Proceeds from Sale of Proved Oil and Gas Properties 2,235,365 - -
Sale of Interest in Oil and Gas Prospects 628,259 2,039,429 -
Sale of Oil and Gas Seismic Data 825,000 3,353,197 -
Proceeds from Contribution of Assets to Unconsolidated Affiliate - - 2,000,000
LNG Site Costs (250,000) (200,000) -
-------------- ------------- -----------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES 1,993,646 441,104 (4,881,531)
-------------- ------------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from Issuances of Notes Payable 1,250,000 - 2,605,000
Repayment of Notes Payable (500,000) - (7,068,213)
Sale of Common Stock - 500,000 5,156,500
Offering Costs - (6,671) (302,550)
-------------- ------------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 750,000 493,329 390,737
-------------- ------------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (20,679) (1,277,844) 712,612
CASH AND CASH EQUIVALENTS - BEGINNING OF PERIOD 610,718 1,888,562 1,175,950
-------------- ------------- -----------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 590,039 $ 610,718 $ 1,888,562
============== ============= ===========
The accompanying notes are an integral part of these financial statements.
44
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1-ORGANIZATION AND NATURE OF OPERATIONS
Cheniere Energy, Inc., a Delaware corporation, is engaged in exploration
for and production of oil and gas reserves and in the development of a liquefied
natural gas (LNG) receiving terminal business. The terms Cheniere and Company
refer to Cheniere Energy, Inc. and its subsidiaries. Cheniere is a Houston-based
company formed for the purpose of oil and gas exploration, development,
exploitation and production. The Company is currently engaged in the exploration
for and production of oil and natural gas along the Gulf Coast of Texas and
Louisiana, onshore and in the shallow waters of the Gulf of Mexico. The Company
employs a small staff of experienced oil and gas exploration professionals who
utilize third party drilling contractors and others in the oilfield service
industry in executing Cheniere's exploration program.
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts of Cheniere
Energy, Inc. and its wholly owned subsidiaries. As of December 31, 2002,
Cheniere also owned an effective 9.3% interest in an affiliated company, Gryphon
Exploration Company, and accounts for this investment using the equity method of
accounting (see Note 7). All significant intercompany accounts and transactions
have been eliminated in consolidation.
Oil and Gas Properties
The Company follows the full cost method of accounting for its oil and gas
properties. Under this method, all productive and nonproductive exploration and
development costs incurred for the purpose of finding oil and gas reserves are
capitalized. Such capitalized costs include lease acquisition, geological and
geophysical work, delay rentals, drilling, completing and equipping oil and gas
wells, together with internal costs directly attributable to property
acquisition, exploration and development activities. Interest is capitalized on
oil and gas properties not subject to amortization and in the process of
development. The Company capitalized interest totaling ($42,261), $165,813 and
$1,154,099 and general and administrative expenses, net of reimbursements,
totaling $829,000, $782,000 and $743,355 for the years 2002, 2001 and 2000,
respectively. Capitalized interest for 2002 was negative due to a refund of
interest that was paid in 2001.
The costs of the Company's oil and gas properties, including the estimated
future costs to develop proved reserves, are depreciated using a composite
units-of-production rate based on estimates of proved reserves. Investments in
unproved properties and major development projects are not amortized until
proved reserves associated with the projects can be determined or until
impairment occurs. If the results of an assessment indicate that the properties
are impaired, the amount of the impairment is added to the capitalized costs to
be amortized. Net capitalized costs are limited to a capitalization ceiling,
calculated on a quarterly basis as the aggregate of the present value,
discounted at 10%, of estimated future net revenues from proved reserves, based
on current economic and operating conditions, plus the lower of cost or fair
market value of unproved properties, less related income tax effects.
The Company's allocation of seismic exploration costs between proved and
unproved properties involves an estimate of the total reserves to be discovered
in the Company's exploration program. It is reasonably possible, based on the
results obtained from future drilling and prospect generation, that revisions to
this estimate could occur within the next twelve months, which could affect the
Company's capitalization ceiling.
Sales of proved and unproved properties are accounted for as adjustments of
capitalized costs with no gain or loss recognized, unless such adjustments would
significantly alter the relationship between capitalized costs and proved oil
and gas reserves.
Revenue Recognition
Revenues from the sale of oil and gas production are recognized upon
passage of title, net of royalty interests. When sales volumes differ from the
Company's entitled share, an underproduced or overproduced imbalance occurs. To
the extent an overproduced imbalance exceeds the Company's share of the
remaining estimated proved natural gas reserves for a given property, the
Company records a liability. At December 31, 2002
45
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
and 2001, the Company had no gas imbalances.
LNG Site Costs
The Company initially capitalizes the cost of options to purchase LNG sites
and the cost of options to lease LNG sites. Upon execution of a lease agreement,
such costs are amortized over the lease period. Should the Company make a
decision not to lease a particular site, the costs associated with that site are
expensed in the period in which the decision is made (see Note 13). All other
costs incurred in the initial development of the Company's LNG receiving
terminal business are charged to expense as incurred.
Fixed Assets
Fixed assets are recorded at cost. Repairs and maintenance costs are
charged to operations as incurred. Depreciation is computed using the
straight-line method calculated to amortize the cost of assets over their
estimated useful lives, which range from two to five years. Upon retirement or
other disposition of fixed assets, the cost and related depreciation is removed
from the accounts and the resulting gains or losses are recorded.
Offering Costs
Offering costs consist primarily of placement fees, professional fees and
printing costs. These costs are charged against the related proceeds from the
sale of common stock in the periods in which they occur or charged to expense in
the event of a terminated offering.
Income Taxes
Provisions for income taxes are based on taxes payable or refundable for
the current year and deferred taxes on temporary differences between the tax
bases of assets and liabilities and their reported amounts in the financial
statements. Deferred tax assets and liabilities are included in the financial
statements at currently enacted income tax rates applicable to the period in
which the deferred tax assets and liabilities are expected to be realized or
settled as prescribed in Statement of Financial Accounting Standards (SFAS) No.
109, Accounting for Income Taxes. As changes in tax laws or rates are enacted,
deferred tax assets and liabilities are adjusted through the current period's
provision for income taxes.
Stock-Based Compensation
SFAS No. 123, Accounting for Stock-Based Compensation, encourages, but does
not require, companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has chosen to continue to account
for stock-based compensation issued to employees using the intrinsic value
method prescribed in Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations.
Accordingly, compensation cost for stock options is measured as the excess, if
any, of the quoted market price of the Company's stock at the date of the grant
over the amount an employee must pay to acquire the stock. The Company grants
options at or above the market price of its common stock at the date of each
grant. The Company accounts for stock-based compensation issued to non-employees
using SFAS No. 123.
46
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair value of options is calculated using the Black-Scholes
option-pricing model. Assumptions used in the pricing model and pro forma
effects on the Company's net losses had it adopted the optional recognition
provisions of SFAS No. 123 are summarized in the following table. The effects of
applying SFAS No. 123 in this pro forma disclosure are not indicative of future
amounts.
Year Ended December 31,
-----------------------------------------------
2002 2001 2000
------------ ------------- ------------
Dividend yield 0.0% 0.0% 0.0%
Weighted average volatility 107.8% 84.3% 82.0%
Risk-free interest rate 2.9% 3.5% 5.8%
Expected lives of options 4.0 years 4.0 years 4.0 years
Net loss $ (5,632,308) $ (11,665,262) $ (780,980)
Net loss per share (basic and diluted) $ (0.42) $ (0.89) $ (0.07)
Pro forma employee compensation $ 607,766 $ 427,575 $ 238,228
Pro forma net loss $ (6,240,074) $ (12,092,837) $ (1,019,208)
Pro forma net loss per share (basic and diluted) $ (0.47) $ (0.93) $ (0.09)
Earnings (Loss) Per Share
Earnings (loss) per share (EPS) is computed in accordance with the
requirements of SFAS No. 128, Earnings Per Share. Basic EPS excludes dilution
and is computed by dividing net income (loss) by the weighted average number of
shares outstanding during the period. Diluted EPS reflects potential dilution
and is computed by dividing net income (loss) by the weighted average number of
common shares outstanding during the period increased by the number of
additional common shares that would have been outstanding if the potential
common shares had been issued. Potential dilutive common stock equivalents
include stock options from employee benefit plans and warrants to purchase
common stock. Basic and diluted EPS for all periods presented are the same since
the effect of the Company's options and warrants is antidilutive to its net loss
per share under SFAS No. 128. No adjustments were made to reported net income in
the computation of EPS.
Reverse Stock Split
On October 16, 2000, the Company's stockholders approved a one-for-four
reverse stock split, which became effective on October 18, 2000. All per share
amounts and numbers of shares in the financial statements have been restated for
the effect of this reverse stock split.
Cash Equivalents
The Company classifies all investments with original maturities of three
months or less as cash equivalents.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, accounts receivable,
accounts payable and note payable approximate fair value because of the short
maturity of those instruments.
Commodity Price Risk
The Company produces and sells natural gas, crude oil and condensate. As a
result, the Company's financial results can be significantly affected as these
commodity prices fluctuate widely in response to changing market forces. The
Company has not entered into any hedging transactions. The Company's market risk
with respect to its fixed-rate, short-term notes payable is considered to be
immaterial due to the short-term nature of these instruments.
Concentration of Credit Risk
All of the Company's revenues are derived from no more than two customers.
The Company's products are
47
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
commodities and constantly have a readily available market for sale.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires that the
Company make estimates and assumptions that affect the amounts reported in the
financial statements and the accompanying notes. The most significant estimate
pertains to proved oil and gas reserve volumes. Actual results could differ from
those estimates. Management believes its estimates are reasonable.
New Accounting Pronouncements
In July 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations (ARO), which requires that an asset retirement cost be capitalized
as part of the cost of the related long-lived asset and allocated to expense by
using a systematic and rational method. Under this Statement, an entity is not
required to re-measure an ARO liability at fair value each period but is
required to recognize changes in an ARO liability resulting from the passage of
time and revisions in cash flow estimates. This Statement is effective for
financial statements issued for fiscal years beginning after June 15, 2002. The
Company will adopt SFAS 143 effective January 1, 2003. The Company believes that
the initial adoption of SFAS 143 will not have a material impact on its earnings
or statement of financial position; however, this pronouncement may have a
significant effect on the Company in the future.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. SFAS 146 supersedes Emerging Issues Task Force
(EITF) Issue No. 94-3. The principal difference between SFAS 146 and EITF Issue
No. 94-3 relates to when an entity can recognize a liability related to exit or
disposal activities. SFAS 146 requires that a liability be recognized for a cost
associated with an exit or disposal activity when the liability is incurred.
EITF Issue No. 94-3 allowed a liability related to an exit or disposal activity
to be recognized at the date an entity commits to an exit plan. The provisions
of SFAS 146 are effective for all exit or disposal activities initiated after
January 1, 2003. This statement is not expected to have a material impact on the
Company upon adoption.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN No. 46), which addresses consolidation by
business enterprises of variable interest entities. FIN No. 46 clarifies the
application of Accounting Research Bulletin No. 51, Consolidated Financial
Statements, to certain entities in which equity investors do not have the
characteristics of a controlling financial interest or do not have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support from other parties. FIN No. 46 applies
immediately to variable interest entities created after January 31, 2003, and to
variable interest entities in which an enterprise obtains an interest after that
date. It applies in the first fiscal year or interim period beginning after June
15, 2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. The Company does not expect
to identify any variable interest entities that must be consolidated. In the
event a variable interest entity is identified, the Company does not expect the
requirements of FIN No. 46 to have a material impact on its financial condition
or results of operations.
48
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3-ACCRUED LIABILITIES
Accrued liabilities consist of the following:
December 31,
---------------------
2002 2001
--------- ---------
Taxes other than income $ 42,611 $ 91,695
Accrued LNG costs 391,177 270,000
Accrued oil and gas property costs 250,000 -
Other accrued liabilities - 47,894
--------- ---------
Accrued liabilities $ 683,788 $ 409,589
========= =========
NOTE 4-FIXED ASSETS
Fixed assets consist of the following:
December 31,
---------------------
2002 2001
--------- ----------
Furniture and fixtures $ 48,618 $ 48,618
Computers and office equipment 303,151 342,674
Other 263,936 253,566
--------- ----------
615,705 644,858
Less accumulated depreciation (399,364) (228,626)
--------- ----------
Fixed assets, net $ 216,341 $ 416,232
========= ==========
Depreciation expense related to the Company's fixed assets totaled
$185,396, $197,789 and $347,865 for the years ended December 31, 2002, 2001 and
2000, respectively.
NOTE 5-OIL AND GAS PROPERTIES
Investments in oil and gas properties are as follows:
December 31,
----------------------------
2002 2001
------------- -------------
Oil and gas properties:
Proved $ 11,296,639 $ 12,308,315
Unproved 16,751,347 16,236,962
------------- -------------
28,047,986 28,545,277
Less accumulated depreciation,
depletion and amortization (10,453,757) (10,379,191)
------------- -------------
$ 17,594,229 $ 18,166,086
============= =============
Depreciation, depletion and amortization of oil and gas property costs
totaled $74,566, $1,029,239 and $3,023,518 for the years ended December 31,
2002, 2001 and 2000, respectively. Depreciation, depletion and amortization per
equivalent Mcf (using an Mcf-to-barrel conversion factor of 6 to 1) was $0.79,
$1.84 and $2.04 for the years ended December 31, 2002, 2001 and 2000,
respectively.
Costs incurred for unproved oil and gas properties were $2,813,370 in 2002
and $4,807,808 in 2001. The
49
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company believes that all unproved property costs will be evaluated within five
years.
At June 30, 2001 and September 30, 2001, the Company's capitalized costs
exceeded its capitalization ceiling, resulting in ceiling test write-downs
totaling $5,126,248 for the year ended December 31, 2001.
The Company has made substantial investments in acquiring, processing and
reprocessing its seismic databases covering a 6,800-square-mile project area
offshore Texas and Louisiana and a 228-square-mile project area onshore and
offshore Louisiana. The costs of these projects become subject to amortization
on a ratable basis as the oil and gas reserves expected to be recovered from the
projects are discovered. The Company began drilling prospects identified within
its seismic databases in 1999, but did not participate in the drilling of any
wells in 2000, 2001 or 2002. Interpretation of this data and related prospect
generation is ongoing.
In September 2001, Cheniere paid $500,000 to acquire all rights to its
228-square-mile proprietary seismic database from the industry partner with whom
it had jointly owned the data since 1996. Concurrent with this acquisition,
Cheniere sold the seismic data to a seismic marketing company for $2,500,000 and
a 50% share in licensing proceeds generated by the marketing company. In
September 2002, Cheniere sold its remaining interest in future licensing
proceeds to the marketing company for $825,000. Proceeds from the September 2001
and 2002 sales of 3D seismic data were recorded as a reduction to the Company's
unproved oil and gas property costs. Cheniere retains a license to all of the
seismic data for use in its exploration program.
In March 2002, the Company entered into a purchase and sale agreement for
the sale of its proved oil and gas properties in West Cameron Block 49. The
purchase price, effective January 1, 2002, was $2,350,000. Net proceeds after a
purchase price adjustment and payment of a commission were $2,235,365. Closing
occurred on April 22, 2002.
NOTE 6-EXPLORATION AGREEMENT
On March 10, 2000, Cheniere entered into an exploration agreement with an
industry partner. Under the terms of the agreement, Cheniere's exploration
partner acquired an option to participate at a 50% working interest level in any
drilling prospects generated by Cheniere over the subsequent eighteen-month
period within a defined area of mutual interest in the Gulf of Mexico. Pursuant
to the exploration agreement, Cheniere received a fixed management fee of
$230,000 per month over the eighteen-month term of the agreement. In addition,
Cheniere's partner paid a disproportionate share of the cost of leasing and of
the initial test well on each prospect. Cheniere was the operator of the
drilling program. Management fees received by Cheniere in 2000 totaled
$1,684,193 and were reported as a $988,548 recovery of general and
administrative expenses attributable to generating the management fee and a
$695,645 reduction to the amount of general and administrative expenses which
were capitalized as oil and gas property costs. Each such portion of the
management fee was allocated based on the historical cost and expense structure
of the Company. In October 2000, Cheniere assigned its rights and obligations
under this agreement to Gryphon, its unconsolidated affiliate, in connection
with the Company's investment in Gryphon, as described in Note 7.
NOTE 7-INVESTMENT IN UNCONSOLIDATED AFFILIATE
On October 11, 2000, Cheniere completed a transaction with Warburg to fund
its exploration program on approximately 8,800 square miles of seismic data in
the Gulf of Mexico (the Louisiana Data Set) through a newly formed affiliated
company, Gryphon. Cheniere contributed selected assets and liabilities in
exchange for 100% of the common stock of Gryphon (36.8% voting interest after
conversion of preferred stock) and $2,000,000 in cash. Such assets included: the
Louisiana Data Set, certain offshore leases, a prospect then being drilled, its
exploration agreement with an industry partner and certain other assets and
liabilities. The net book value of the assets and liabilities contributed was
$7,065,919, which consisted of assets of $9,115,963 (primarily unproved oil and
gas property) and liabilities of $2,050,044 (primarily accounts payable).
Warburg contributed $25,000,000 and received preferred stock, with an 8% accrued
dividend, convertible into 63.2% of Gryphon's common stock. Cheniere accounted
for the contribution of net assets at its historical cost, whereby the net
amount of such assets and liabilities less the $2,000,000 in cash was
reclassified to investment in affiliate. No gain or loss was recognized at the
time of contribution, primarily due to Cheniere's commitment to provide
additional funding described above and due to the uncertainty of realization of
the carrying value of the contributed unproved oil and gas properties.
50
Cheniere and Warburg also have the option, in connection with subsequent
capital calls made by Gryphon, to contribute up to an additional $75,000,000 to
Gryphon, proportionate to their respective ownership interests. Under the terms
of the agreement governing these additional contributions, in the event that
either Cheniere or Warburg elects not to participate in any additional
contribution, the other investor has the option to purchase the
non-participating investor's proportionate share. Assuming (i) that Gryphon
makes subsequent capital calls for an aggregate of $75,000,000, (ii) that
Cheniere elects not to participate in any of the capital calls and (iii) that
Warburg elects to purchase all of Cheniere's proportionate share, and giving
effect to Cheniere's sale to Gryphon of 6,740 shares of Gryphon common stock in
July 2001 and its sale to Gryphon of 51,400 shares of Gryphon common stock in
March 2002 (see Note 12), the Company's effective interest in Gryphon, after
giving effect to the conversion of Gryphon's preferred stock, will be reduced to
8.0%.
During 2001 and 2002, Gryphon made cash calls totaling $60,000,000 against
its capital commitment of $75,000,000. Cheniere declined to participate in such
cash calls, and Warburg elected to purchase all of Cheniere's proportionate
share of such cash calls. Also during 2001, Cheniere transferred 6,740 shares of
Gryphon common stock to Gryphon in connection with the sale of licenses to
certain seismic data. In March 2002, Cheniere sold 51,400 shares of its Gryphon
common stock to Gryphon, subject to certain repurchase options (discussed
below). As a result of these transactions, Cheniere's ownership interest in
Gryphon, after the effect of converting preferred stock into common stock, was
reduced from 36.8% at December 31, 2000 to 9.3% as of December 31, 2002.
In connection with the seismic license contributed to Gryphon upon its
formation, Cheniere entered into an agreement with the third party issuer of the
license. The agreement provided that Cheniere would pay a transfer fee to the
third party in an aggregate amount of up to $2,500,000. Such transfer fee was
contingent upon Gryphon's completion of up to ten successful wells during the
license period and within the license area. Cheniere's existing and contingent
obligations under this agreement were fully discharged in March 2002 in
connection with its sale of 51,400 shares of Gryphon common stock to Gryphon and
the related assumption by Gryphon of these obligations. Cheniere has a one-year
option to repurchase all or a portion of the 51,400 shares at a price of $50 per
share if exercised within 120 days of the sale or at prices increasing ratably
thereafter to approximately $68 per share one year after the sale.
Cheniere accounts for its investment in Gryphon using the equity method of
accounting. Although Cheniere's participation on the Gryphon board of directors
provides significant influence over the operating and financial policies of
Gryphon, Cheniere does not participate in the day-to-day management of Gryphon,
does not exercise control over Gryphon and cannot effect a change in the
management of Gryphon. Cheniere's equity share of Gryphon's losses for the
period from October 11, 2000 through December 31, 2000 was $426,649, calculated
by applying Cheniere's 100% common stock ownership interest to Gryphon's net
income of $19,003 and reducing such result for Gryphon's preferred dividend
arrearages of $445,652. For 2001, Cheniere's equity share of Gryphon's losses
was $2,974,191, calculated by applying Cheniere's 100% common stock ownership
interest to Gryphon's net income of $84,000 and reducing such result for
Gryphon's preferred dividend arrearages of $3,058,191 for the year. Cheniere's
equity share of Gryphon's losses for 2002 was $2,184,847, calculated by applying
Cheniere's 100% common stock ownership interest to Gryphon's net loss of
$519,000, reducing such result for Gryphon's preferred dividend arrearages of
$5,844,746 for the year and limiting the cumulative amount of net loss
recognized to the balance of Cheniere's investment in Gryphon. During 2002,
Cheniere's basis of its investment in Gryphon was reduced to zero, but not below
zero, because Cheniere does not guarantee any obligations of Gryphon and is not
committed to provide additional financial support to Gryphon. The amount of
Gryphon's net loss that has not yet been recorded by Cheniere was $4,179,000 at
December 31, 2002. At such time as Warburg converts its preferred shares to
common shares, Cheniere's equity share of Gryphon's earnings (losses) will be
calculated using the effective ownership interest at the time of such
conversion, and will no longer be reduced by preferred dividends. Gryphon's
preferred stock is convertible at the option of the holder at a rate of $100 per
share of common stock at any time after the holders of a majority of the
preferred stock execute a written consent permitting a conversion of the
preferred stock or, if earlier, at any time after August 31, 2010. In the event
the holders of a majority of the preferred stock vote to convert all of their
shares of preferred stock into common stock, all shares of preferred stock shall
automatically be converted, without further action by Gryphon or its
shareholders. In addition, Gryphon has the right, at its option, to convert
shares of preferred stock into common stock upon Gryphon's closing of a firm
commitment qualified public offering.
51
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Summarized financial information relative to Gryphon is set forth below (in
thousands):
December 31,
-------------------
2002 2001
-------- --------
Current assets $ 12,215 $ 14,864
Oil and gas properties, full cost method 91,007 53,551
Fixed assets 458 616
Current liabilities 11,870 5,001
Long-term liabilities - -
Deferred tax liabilities 2,043 1,182
Year Ended December 31,
---------------------------
2002 2001 2000
-------- -------- ------
Revenues $ 11,143 $ 2,382 $ -
Income (loss) from continuing operations (674) 82 29
Net income (loss) (519) 84 19
Preferred dividends in arrears (5,845) (3,058) (446)
Cheniere's equity in losses from
unconsolidated affiliate (2,185) (2,974) (427)
The following items represent the differences between Cheniere's equity
share of Gryphon's net assets and the balance in Cheniere's investment in
unconsolidated affiliate (in thousands).
December 31,
-------------------
2002 2001
-------- --------
Cheniere's equity share of Gryphon's net assets $ 4,767 $ 7,848
Gryphon losses not yet recorded by Cheniere 4,179 -
Preferred stock dividends in arrears (9,349) (3,504)
Excess of Cheniere cost basis (500) (1,500)
Gryphon offering expenses 903 903
-------- --------
Cheniere's investment basis $ - $ 3,747
======== ========
NOTE 8-NOTES PAYABLE
At December 31, 2002, Cheniere had a $750,000 short-term note payable
outstanding. At December 31, 2001, Cheniere had no outstanding debt obligations.
Set forth below is a description of financing facilities used by the Company
under which financing cash inflows and outflows occurred during the three years
ended December 31, 2002.
June 2002 - LNG Receiving Terminal Financing
In June 2002, Cheniere received $750,000 as a refundable payment for the
sale of two options to purchase an aggregate of up to a 20% interest in its
Freeport LNG receiving terminal project. In the event the first option is
exercised, the payment is applied to the purchase price. In the event the option
is not exercised, the payment is refundable, and repayment is secured by a note
payable executed by Cheniere. The note is payable in full on July 15, 2003. It
will bear interest at 8%, payable at maturity and accruing from the earlier of
the time the option expires or the date the holder elects not to exercise. As of
December 31, 2002, the note has not yet begun to bear interest. The note is
secured by Cheniere's revenues, accounts receivable and other assets. In March
2003, the option was exercised and the note payable was canceled.
52
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
March 2002 - $500,000 Bridge Financing
In March 2002, the Company entered into a short-term bridge financing
arrangement with an unrelated third party lender. The amount of the borrowing
was $500,000. The term was 120 days. Interest was payable monthly at 10% per
annum. Warrants were issued to the lender for the purchase of 150,000 shares of
Cheniere common stock, exercisable at a price of $2.50 per share on or before
March 7, 2012. Additionally, Cheniere extended the term to March 7, 2012 on
existing warrants for the purchase of 255,417 shares held by parties affiliated
with the lender. Based on the Black-Scholes model, the warrants issued (150,000
shares) and the extension of existing warrants (255,417 shares) in connection
with this financing arrangement have an aggregate value of $241,939. Debt
discount of $163,045 was recorded based on the relative fair values of the note
payable and the warrants. An additional 50,000 warrants were required to be
issued to the lender for each month or partial month for which the principal
remained unpaid after April 7, 2002. The Company repaid the loan on April 22,
2002, resulting in a loss on early extinguishment of debt in the amount of
$100,544, which is classified as an ordinary loss in the Company's statement of
operations. Cheniere also issued an additional 50,000 warrants to the lender,
valued at $24,054 based on the Black-Scholes model.
April 2000 - $2,000,000 Bridge Financing
In April 2000, the Company established a bridge financing facility which
provided for: borrowings of up to $2,000,000 bearing interest at a rate equal to
LIBOR plus 2%, a placement fee equal to 2% of the commitment amount, the
issuance of warrants to purchase 250,000 shares of common stock at an exercise
price of $4.00 per share on or before September 6, 2003, and conversion of the
notes payable into common stock, at Cheniere's election, at a price per share
equal to $2.00 per share. Cheniere borrowed an aggregate of $2,000,000 under the
facility during 2000. In September 2000, the Company repaid $500,000 in cash and
issued 250,000 shares to satisfy an additional $500,000. In December 2000,
Cheniere repaid the remaining balance of $1,000,000 plus accrued interest.
September 1999 - $3,100,000 Platform Financing
On September 1, 1999, Cheniere established a $3,100,000 financing facility
to fund a production platform and other exploration and development costs in the
West Cameron Block 49 area. Borrowings under the facility were repaid from
Cheniere's share of net cash flow from production through the West Cameron Block
49 platform. The note was secured by Cheniere's oil and gas properties and had a
maturity date of June 30, 2000. Financing costs included interest at 10% per
annum and a 5% net profit interest in the initial two wells producing through
the platform. During 2000, the Company borrowed an additional $605,000 under the
same facility and repaid all principal and interest due thereunder.
December 1999 - $1,117,570 Well Services Financing
In December 1999, Cheniere entered into a financing agreement with a
supplier of well services to consolidate and convert trade accounts payable
balances into a short-term secured note payable. Interest was payable at 10% per
annum. The note was secured by Cheniere's oil and gas properties and matured on
July 5, 2000. All principal and related interest under the agreement were repaid
during 2000.
December 1997 - $4,000,000 Bridge Financing
In December 1997, Cheniere completed the private placement of a $4,000,000
bridge financing. The notes payable issued by Cheniere had an initial maturity
date of March 15, 1998, which was extended ultimately to March 15, 2000, when
the then-remaining balance of $755,000 was paid.
NOTE 9-INCOME TAXES
From its inception, the Company has recorded losses for both financial
reporting purposes and for federal income tax reporting purposes. Accordingly,
the Company is not presently a taxpayer and has not recorded a provision for
income taxes in any of the periods presented in the accompanying financial
statements.
53
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2002, the Company had net operating loss (NOL)
carryforwards for tax reporting purposes of approximately $22,234,000. In
accordance with SFAS No. 109, a valuation allowance equal to the net tax benefit
for deferred taxes has been established due to the uncertainty of realizing the
benefit of such NOL carryforwards.
Deferred tax assets and liabilities reflect the net tax effect of temporary
differences between the carrying amount of assets and liabilities for financial
reporting purposes and amounts used for income tax purposes. Significant
components of the Company's deferred tax assets and liabilities at December 31,
2002 and 2001 are as follows:
Year Ended December 31,
-------------------------------
2002 2001
------------ -------------
Deferred tax assets
NOL carryforwards $ 8,226,583 $ 11,802,327
Oil and gas properties and fixed assets 70,169 150,330
Investment in unconsolidated affiliate 513,190 -
------------ -------------
8,809,942 11,952,657
------------ -------------
Deferred tax liabilities
Investment in unconsolidated affiliate - 560,532
------------ -------------
- 560,532
------------ -------------
Net deferred tax assets 8,809,942 11,392,125
Less: valuation allowance (8,809,942) (11,392,125)
------------ -------------
$ - $ -
============ =============
NOL carryforwards expire starting in 2012 extending through 2022. Certain
of the Company's NOLs are subject to per year availability of approximately
$1,900,000 under Internal Revenue Code Section 382 change of ownership
limitations.
The gross change in the valuation allowance for deferred tax assets was
approximately $(2,582,183), $7,739,165 and $679,000 during the years ended
December 31, 2002, 2001 and 2000, respectively.
NOTE 10-WARRANTS
As of December 31, 2002, Cheniere has issued and outstanding 2,593,521
warrants for the purchase of its common stock. The Company has reserved an equal
number of shares of common stock for issuance upon the exercise of its
outstanding warrants. Warrants issued by the Company do not confer upon the
holders thereof any voting or other rights of a stockholder of the Company. The
Company has granted warrants in connection with certain of its debt or equity
financings and as compensation for services. In instances where warrants were
granted in connection with financings, such warrants were valued based on the
estimated fair market value of the stock at the date of issuance. Where warrants
were issued for services, fair value was calculated using the Black-Scholes
pricing model. The terms of warrants outstanding at December 31, 2002 range from
three years to approximately fourteen years, with a weighted average remaining
life of 2.7 years at December 31, 2002. All outstanding warrants are fully
exercisable. Prices at which the warrants are exercisable range from $1.20 to
$11.50 per share, with a weighted average exercise price of $4.06 per share at
December 31, 2002. Information related to Cheniere's warrants is summarized in
the following table:
December 31,
---------------------------------------
2002 2001 2000
------------ ------------ -----------
Outstanding at beginning of period 2,850,288 2,758,621 2,116,951
Warrants issued 312,500 91,667 1,291,462
Warrants exercised - - (234,375)
Warrants canceled (569,267) - (415,417)
------------ ------------ -----------
Outstanding at end of period 2,593,521 2,850,288 2,758,621
============ ============ ===========
Weighted average exercise price of warrants outstanding $ 4.06 $ 4.47 $ 4.52
============ ============ ===========
Weighted average remaining contractual life of warrants outstanding 2.7 years 1.8 years 2.5 years
54
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes information about warrants outstanding at
December 31, 2002:
Weighted Average
Exercise Number Years Remaining
Prices Outstanding Contractual Life
-------------- ----------- ----------------
$9.50 - $11.50 25,000 1.7
$7.00 - $8.00 313,542 1.0
$5.00 - $6.00 461,367 4.8
$4.00 756,100 0.5
$2.50 - $3.00 600,012 4.7
$1.20 - $1.75 437,500 2.8
-----------
2,593,521
===========
In March and May 2002, the Company issued to an unrelated third party
lender warrants to purchase 200,000 shares of Cheniere common stock at an
exercise price of $2.50 per share, exercisable in or before 2012. These warrants
were issued in connection with the March 2002 short-term bridge financing. (See
Note 8 for discussion of this Note Payable.)
In April 2002, as compensation for assistance in the Company's sale of its
West Cameron Block 49 oil and gas proved properties, Cheniere issued to a
consultant warrants to purchase 50,000 shares of Cheniere common stock at an
exercise price of $2.50 per share, exercisable on or before April 22, 2007.
In August 2002, as compensation for assistance in the marketing of the
Company's LNG terminal capacity, Cheniere issued to a consultant warrants to
purchase 50,000 shares of Cheniere common stock at an exercise price of $1.20
per share, exercisable on or before August 26, 2007.
In December 2002, as compensation for assistance in the Company's investor
relations program, Cheniere issued to a consultant warrants to purchase 12,500
shares of Cheniere common stock at an exercise price of $1.25 per share,
exercisable on or before December 19, 2007.
NOTE 11-STOCK-BASED COMPENSATION
In 1997, the Company established the Cheniere Energy, Inc. 1997 Stock
Option Plan, as amended, (the Option Plan), which allows for the issuance of
options to purchase up to 2,000,000 shares of Cheniere common stock. The Company
has reserved 2,000,000 shares of common stock for issuance upon the exercise of
options which have been granted or which may be granted. As of December 31, 2002
the Company had granted options on 1,983,611 shares. The term of options granted
under the Option Plan is generally five years. Vesting varies, but generally
occurs over three or four years, in increments of 33% or 25%, respectively, on
each anniversary of the grant date. All options granted under the Option Plan
have exercise prices equal to or greater than fair market value at the date of
grant.
55
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the status of the Company's stock options is presented below:
December 31,
---------------------------------------
2002 2001 2000
------------ ----------- -----------
Outstanding at beginning of period 1,741,111 884,236 540,299
Options granted at an exercise price of $6.00 per share - - 83,750
Options granted at an exercise price of $2.75 per share - - 450,875
Options granted at an exercise price of $2.38 per share - 20,000 -
Options granted at an exercise price of $2.16 per share - 20,000 -
Options granted at an exercise price of $1.94 per share - - 380,000
Options granted at an exercise price of $1.70 per share - 100,000 -
Options granted at an exercise price of $1.25 per share 267,500 - -
Options granted at an exercise price of $1.20 per share 30,000 - -
Options granted at an exercise price of $1.06 per share - 760,000 -
Options granted at an exercise price of $0.93 per share 50,000 - -
Options canceled (105,000) (43,125) (570,688)
------------ ----------- -----------
Outstanding at end of period 1,983,611 1,741,111 884,236
============ =========== ===========
Exercisable at end of period 1,106,111 664,444 220,799
============ =========== ===========
Weighted average exercise price of options outstanding $ 2.07 $ 2.21 $ 3.45
============ =========== ===========
Weighted average exercise price of options exercisable $ 2.56 $ 3.16 $ 5.03
============ =========== ===========
Weighted average fair value of options granted during the period $ 1.20 $ 0.76 $ 1.39
============ =========== ===========
Weighted average remaining contractual life of options outstanding 3.4 years 4.1 years 4.3 years
The following table summarizes information about fixed options outstanding
at December 31, 2002:
Options
Options Outstanding Exercisable
------------------------------- -----------
Weighted Average
Exercise Number Years Remaining Number
Prices Outstanding Contractual Life Outstanding
-------- ------------ ---------------- -----------
$12.00 8,750 0.3 8,750
$ 7.20 4,861 0.9 4,861
$ 6.00 210,000 1.8 192,500
$ 2.75 225,000 2.6 175,000
$ 2.38 20,000 3.0 6,667
$ 2.16 20,000 3.1 6,667
$ 1.94 367,500 2.9 263,333
$ 1.70 50,000 3.7 33,333
$ 1.25 267,500 5.0 80,000
$ 1.20 30,000 4.7 -
$ 1.06 730,000 3.9 335,000
$ 0.93 50,000 4.8 -
--------- ---------
1,983,611 1,106,111
========= =========
In June 1999, the Company issued 250,000 warrants to its president and
chief executive officer and 50,000 warrants to another member of its board of
directors, both of whom were instrumental in negotiating the Company's license
of 8,800 square miles of 3-D seismic data in the Gulf of Mexico. Warrants issued
in connection with this transaction are exercisable on or before the fifth
anniversary of the date the transaction closed at an exercise price of $6.00 per
share. The 250,000 warrants issued to Cheniere's president and chief executive
officer were canceled in October 2000, when he resigned from Cheniere to become
president and chief executive officer of Gryphon. An additional 250,000 warrants
were issued to Cheniere's new president and chief executive officer in October
2000,
56
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
pursuant to the terms of his employment agreement. The fair value of these
warrants is included in the above pro forma net loss calculated under SFAS No.
123.
NOTE 12-RELATED PARTY TRANSACTIONS
In March 2002, Cheniere sold 51,400 shares of its Gryphon common stock to
Gryphon, subject to an option to repurchase the shares, thereby reducing its
interest in Gryphon from its then-current 20.2% to 13.7% on an as-converted
basis. Such sale was made in connection with the settlement of a lawsuit filed
by Fairfield Industries Incorporated against Cheniere and Gryphon. In connection
with its sale of Gryphon common stock to Gryphon, Cheniere has a one-year option
to repurchase all or a portion of the 51,400 shares at a price of $50 per share
if exercised within 120 days of the sale or at prices increasing ratably
thereafter to approximately $68 per share one year after the sale. As
consideration for the shares, Gryphon agreed to make payments in full
satisfaction of certain existing and contingent obligations of Cheniere totaling
$3,561,692. Cheniere, Gryphon, and Fairfield Industries, Inc. reached a
settlement agreement whereby a lawsuit and related claims asserted by Fairfield
against Cheniere and Gryphon were dismissed.
In April 2002, Cheniere's president advanced amounts totaling $30,000 to
the Company. Subsequent to its sale of producing oil and gas properties,
Cheniere repaid the advances on April 25, 2002, with accrued interest at 10% per
annum totaling $122.
Commencing October 1, 2001, Cheniere has made office space available for
use by a non-management director. The pro rata amount of office lease expense
related to that space was $4,500 in 2002 and $1,125 in 2001.
In April 2001, the Company sold an interest in a prospect to Gryphon.
Gryphon paid Cheniere $225,563 for a 50% interest in the related leases and will
pay a disproportionate share of the drilling costs on terms representative of
what a third party would pay for participation in the prospect generated by
Cheniere.
In June 2001, Cheniere sold to Gryphon for $3,500,000 one of its two
licenses to the Seitel 3D seismic data. Gryphon paid $853,197 in cash to
Cheniere and agreed to pay $2,646,803 of Cheniere's obligations related to the
reprocessing of the data. Cheniere remained responsible for payment of the final
$1,061,692 in reprocessing charges upon final delivery of all reprocessed data,
which is anticipated to be received in 2003. This payment obligation was assumed
by Gryphon in connection with Cheniere's March 2002 sale of 51,400 shares of
Gryphon common stock to Gryphon.
In July 2001, Cheniere sold to Gryphon one of its two licenses to certain
3D seismic data covering an additional 3,000 square miles. Gryphon agreed to pay
Cheniere's accounts payable of $1.3 million and the remaining commitment of $2.9
million related to the reprocessing of the data. In connection with the
transaction, Cheniere also transferred to Gryphon 6,740 shares of Gryphon common
stock, valued at approximately $418,000 or $62 per share, based on the estimated
fair market value of the Gryphon common stock, which considered the fair value
of such stock at the formation of Gryphon and any significant changes in
Gryphon's operations or market conditions since that date. The proceeds at
closing of $1.3 million were allocated as a reduction to the carrying amount of
Cheniere's investment in Gryphon ($418,000) and unproved oil and gas properties
($882,000). Cheniere retains one license to the seismic data. At December 31,
2001, Cheniere has included $376,493 in accounts receivable and in accounts
payable related to reprocessing charges which are to be paid by Gryphon.
In September 2001, the Company made a payment of $40,000 to its chairman
representing consulting fees for the months of October 2001 through January
2002. The unearned balance of $10,000 was included in prepaid expenses at
December 31, 2001.
Under the terms of the Contribution and Subscription Agreement dated
October 11, 2000 by and among the Company, Gryphon and the other investors
listed therein, Gryphon provided office space to Cheniere at no cost from the
closing date of October 11, 2000 until Cheniere relocated in December 2000, and
Cheniere provided accounting and cash management services to Gryphon without
charge for six months following the closing date. The values of the office space
and the accounting and cash management services offset and were not significant
to the Company.
In 2000, Cheniere served as contract operator for the well contributed to
Gryphon on which drilling was underway at the date of Gryphon's inception.
Cheniere received industry standard overhead reimbursements from all
57
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
working interest owners, including Gryphon, in accordance with the terms of the
joint interest operating agreement.
In conjunction with certain of the Company's private placements of equity,
placement fees have been paid to Investors Administration Services, Limited
(IAS), a company in which the brother of Charif Souki, Cheniere's chairman, is a
principal. Placement fees paid to IAS totaled $30,000 for 2001 and $99,000 for
2000. As of December 31, 2001, the Company had accrued placement fees of $30,000
included in accrued liabilities. Such payments made in 2000 were recorded as
offering costs and reflected as a reduction of additional paid-in capital.
Payments made in 2001 were expensed.
NOTE 13-COMMITMENTS AND CONTINGENCIES
Lease Commitments
In November 2000, the Company entered into an office lease agreement with a
term which runs through March 31, 2003. In March 2003, the Company entered into
a lease agreement related to its existing office space with a term which runs
through March 31, 2004. Future minimum lease payments are $126,835 and $31,509
for the years ending December 31, 2003 and 2004, respectively. Effective in
October 2000, Cheniere assigned its rights and obligations under a previous
office lease agreement to Gryphon. Cheniere's total rental expense for office
space for the years ending December 31, 2002, 2001 and 2000 was $131,038,
$157,146 and $222,394, respectively. Cheniere also leases exploration software
at a cost of $30,000 per month on a term which runs through December 2003.
LNG Commitments
In April 2001, the Company engaged research consultants in connection with
the development of its LNG receiving terminal business. The engagement was
terminated in July 2002. Consideration for services rendered will be payable
after final closing of the equity financing of one or more LNG import terminals
in Texas. Such consideration will include a cash payment of $200,000 and the
issuance of warrants to purchase 225,000 shares of Cheniere common stock at a
price of $2.50 per share, exercisable for a period of 10 years (valued at
$173,576 using Black-Scholes methodology).
In connection with the Company's acquisition of its Freeport, Texas LNG
receiving terminal site option in 2001, Cheniere issued 500,000 shares of common
stock valued at $1,150,000 or $2.30 per share, the closing price of the
Company's common stock on the date of the transaction. Additionally, Cheniere
has committed to issue 750,000 shares of its common stock to the seller of the
option on April 15, 2003, and Cheniere will receive no additional consideration.
Cheniere was also obligated to pay to the seller of the option a royalty equal
to approximately 10% of processing revenues from the LNG receiving terminals
which Cheniere develops, up to a maximum of $10,950,000 per year. Under the
terms of the Freeport lease option, the Company was obligated to make semiannual
payments of $125,000 commencing in September 2001 and continuing throughout the
3-year term of the lease option. Such option payments have been and will be
applied toward lease rentals upon the execution of a long-term lease. In
connection with Cheniere's February 2003 sale of the Freeport project to
Development, Development has assumed the royalty obligation on processing
through the Freeport terminal. Additionally, Development has converted the
Freeport lease option into a long term lease and is responsible for all rental
and other obligations thereunder.
In connection with Cheniere's acquisition of its option to lease the
Brownsville, Texas LNG terminal site, Cheniere paid $33,600 for a one-year
option commencing in June 2001 and made the first renewal payment in June 2002.
Such option is renewable for an additional one-year period, through June 2004
for additional consideration of $33,600 per year.
Cheniere obtained a one-year purchase option to acquire the LNG terminal
site in Sabine Pass, Texas, commencing in November 2001, in exchange for initial
consideration of $200,000, of which $75,000 was paid in cash at closing and
$125,000 was due six months from closing, provided that such option was not
terminated at an earlier date. The purchase option was terminated by Cheniere
during 2002, and no additional consideration beyond the $75,000 was paid.
Subsequent to December 31, 2002, Cheniere entered into a lease option for a
different site at Sabine Pass, on the Louisiana side of the river. Lease option
rentals, commencing in March 2003, are approximately $100,000 per year,
renewable annually for up to six years.
58
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In December 2002, Cheniere entered into a non-binding Memorandum of
Understanding with Sherwin providing for the negotiation of a partnership
agreement which would grant Sherwin a 33% interest in Cheniere's Corpus Christi
receiving terminal project in exchange for Sherwin's agreement to fund the first
$4,500,000 in project development costs. Completion of the partnership agreement
is scheduled to occur by April 15, 2003. In the event that such an agreement is
not consummated by that date, Sherwin will grant to Cheniere a lease option on
the terminal site lands in Corpus Christi. The option rentals will be $100,000
per year for up to 5 years. Upon exercise of the option, lease rentals would be
$400,000 per year for an initial term of 33 years, renewable for two additional
terms of 33 years each.
Legal proceedings
The Company has been and may in the future be involved as a party to
various legal proceedings, which are incidental to the ordinary course of
business. Management regularly analyzes current information and as necessary,
provides accruals for probable liabilities on the eventual disposition of these
matters. In the opinion of management and legal counsel, as of December 31,
2002, there were no threatened or pending legal matters that would have a
material impact on the Company's consolidated results of operations, financial
position or cash flows.
In February 2002, the Company received a copy of a lawsuit styled Fairfield
Industries Incorporated vs. Cheniere Energy, Inc. and Gryphon Exploration
Company, which was filed in district court in Harris County, Texas. The lawsuit
related to a seismic license agreement between Fairfield and Cheniere, which was
later assigned to Gryphon. In the lawsuit, Fairfield alleged that Cheniere and
Gryphon conspired to defraud the plaintiff of certain transfer payments, which
may be owed by Cheniere in connection with the transfer to Gryphon of the
initial seismic contributed at the time of its formation. In March 2002,
Fairfield, Gryphon, and the Company settled this lawsuit. Existing and
contingent obligations to Fairfield by Cheniere totaling $2,500,000 have been
fully discharged through agreement by Gryphon to make current and contingent
payments in exchange for the transfer of 30,000 Gryphon common shares from
Cheniere to Gryphon.
NOTE 14-LIQUIDITY
The accompanying financial statements have been prepared on a going concern
basis, which contemplates continuity of operations, realization of assets and
liquidation of liabilities in the ordinary course of business. As of December
31, 2001, the Company had experienced recurring losses from operations and,
during 2001, had negative cash flows from operating activities. In addition, the
Company had a working capital deficiency of $530,242 and an accumulated deficit
of $18,024,485 as of December 31, 2001. These considerations raised substantial
doubt about Cheniere's ability to continue as a going concern as of December 31,
2001.
As of December 31, 2002, management expects that the Company will meet all
of its liquidity requirements for the next twelve months through a combination
of cash balances, collection of receivables and cash flows from current
operations. Such sources are not expected to be adequate to meet future
liquidity requirements as the Company expands its LNG terminal business. The
Company expects that future liquidity requirements will be met by one or more of
the following: the divestiture of producing oil and gas properties, sales of
portions of its working interest in the prospects within its exploration
program, sale to an industry partner of a participation in the Company's
exploration program, sale of a participation interest in the Company's LNG
projects and/or additional offerings of the Company's debt or equity securities.
In the event that the Company is unable to obtain additional capital from one or
more of these sources, its operations could be adversely affected.
The recoverability of the Company's unevaluated oil and gas properties and
development of its LNG receiving terminal business are dependent on future
events, including obtaining adequate financing for these programs, the
successful reprocessing of the 3D seismic data in the Offshore Texas Project
Area, the successful completion of its planned drilling program, and the
achievement of a level of operating revenues that is sufficient to support the
Company's cost structure. At various times during the life of the Company to
date, it has been necessary for the Company to raise additional capital through
private placements of debt or equity financing. When such a need has arisen, the
Company has met it successfully. It is management's belief that it will continue
to be able to meet its needs for additional capital as such needs arise in the
future.
Cheniere's needs for additional financing include the following:
59
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
. Additional capital may be required to pay for Cheniere's share of costs
relating to the drilling of prospects and development of those that are
successful, to exercise lease options and to acquire additional oil and gas
leases. The total amount of the Company's capital needs will be determined
in part by the number of prospects generated within its exploration
program, by the working interest that the Company retains in those
prospects and by the Company's ability to identify partners willing to bear
a portion of drilling costs which would otherwise be attributable to the
Company.
. The Company may need capital to fund its pro-rata share of the capital
calls by Gryphon that are approved by Gryphon's board of directors. If the
Company subscribes to its pro-rata portion of such capital calls but fails
to fund, it would lose its ability to subscribe to any future capital calls
and would suffer further dilution of its holdings in Gryphon. In 2002,
Gryphon made cash calls in the aggregate amount of $30,000,000, which were
funded entirely by Warburg, in March, June, September and November 2002.
Cheniere declined to participate in these cash calls and its interest in
Gryphon has been reduced from 20.2% to 9.3% on an as-converted basis, as of
December 31, 2002. It is anticipated that Gryphon will make cash calls for
additional funds. The Company's share of such future capital calls could
total up to approximately $1,400,000. If the Company elects not to fund its
pro-rata portion of such capital calls, and Warburg funds its portion, as
they would be entitled to do, and as they have since the formation of
Gryphon, the Company's ownership percentage of Gryphon's common stock on an
as-converted basis will be further reduced (to as low as 8%). See Liquidity
and Capital Resources - Exploration Funding under Item 7 of this report.
. The Company will need substantial additional funds to execute its plan for
developing and expanding its LNG receiving terminal business, including
engineering, environmental, marine, regulatory, construction and legal
work, including any such work involved in permitting and FERC filings
related to Cheniere's second and third sites. Such costs are estimated to
be approximately $3,000,000 per year for each terminal to be developed.
Additional capital could be obtained from a combination of funding sources,
many of which may have a material adverse effect on the Company's business,
results of operations and financial condition. These potential funding sources
include:
. cash flow from operating activities, which is sensitive to prices the
Company receives for its oil and natural gas,
. borrowings from financial institutions, which may subject the Company to
certain restrictive covenants, including covenants restricting the
Company's ability to raise additional capital or pay dividends,
. debt offerings, which would increase the Company's leverage and add to its
need for cash to service such debt,
. additional offerings of the Company's equity securities, which would cause
dilution of its common stock,
. sales of portions of its working interest in the prospects within its
exploration program, which would reduce future revenues from its
exploration program,
. sale to an industry partner of a participation in the Company's exploration
program, which would reduce future revenues from its exploration program,
. sale of all or a portion of the Company's producing oil and gas properties,
which would reduce future revenues,
. additional sales of interests in the Company's LNG projects and
. arrangement of a business development loan from, or prepayment of terminal
use fees by, prospective sellers or purchasers of LNG.
60
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cheniere's ability to raise additional capital will depend on the results
of its operations and the status of various capital and industry markets at the
time such additional capital is sought. Accordingly, capital may not become
available to the Company from any particular source or at all. Even if
additional capital becomes available, it may not be on terms acceptable to the
Company. Failure to obtain additional financing on acceptable terms may have a
material adverse effect on the Company's business, results of operations and
financial condition.
NOTE 15-SUPPLEMENTAL CASH FLOW DISCLOSURES AND DISCLOSURES OF NON-CASH
TRANSACTIONS
In 2002, Cheniere transferred computer equipment with a net book value of
$29,001 to an exploration consulting company as compensation for its services.
The Company sold 51,400 shares of its Gryphon common stock to Gryphon in
consideration for their assumption of certain existing and contingent
liabilities of Cheniere totaling $3,561,692. In connection with the sale of the
Company's proved oil and gas properties, Cheniere issued warrants to purchase
50,000 shares of Cheniere common stock to a consultant valued at $22,695. The
Company issued warrants to purchase 200,000 shares of Cheniere common stock and
extended the expiration period on existing warrants to purchase 255,417 shares
of Cheniere common stock, all at a value of $265,993, in connection with a
short-term bridge financing arrangement with an unrelated third party lender.
Cheniere issued warrants to purchase 50,000 shares of Cheniere common stock to a
consultant valued at $39,269 for assistance in marketing the Company's LNG
terminal capacity. The Company issued 12,500 stock options valued at $10,435 to
a consultant for assistance in developing the LNG terminal business. Cheniere
issued warrants to purchase 12,500 shares of Cheniere common stock to an
investor relations consultant valued at $10,435. During 2002, the Company
accrued an additional $96,777 for the services of an LNG project consultant. As
of December 31, 2002, Cheniere has accrued a liability to this consultant of
$366,777, of which $166,777 is the estimated value of warrants to be issued to
purchase 225,000 shares of Cheniere common stock.
In 2001, Cheniere issued warrants to purchase 50,000 shares of Cheniere
common stock to a consultant valued at $93,000. The Company issued 500,000
shares valued at $1,150,00 to acquire an LNG site lease option. The Company sold
6,740 shares of Gryphon Cheniere common stock with a fair market value of
$417,880 to Gryphon in connection with the sale of a license to 3D seismic data.
Additional value ascribed to sale of seismic was $256,141 (see Note 12). In
connection with the Company's sale of licenses to 3D seismic data to Gryphon,
Gryphon assumed liabilities for reprocessing charges of $6,820,824 and made
payment on behalf of Cheniere in the amount of $5,847,533 during 2001. The
Company has accrued $270,000 as of December 31, 2001, related to an obligation
to issue to a consultant an equity participation in its LNG project. The Company
issued 25,000 stock options valued at $17,000 to a consultant for assistance in
securing long-term supplies of LNG.
In 2000, Cheniere issued 16,667 shares of Cheniere common stock in exchange
for seismic data reprocessing services valued at $50,000. The Company issued
50,000 shares of Cheniere common stock as a price adjustment to shares issued in
1999 for oil and gas drilling services. Cheniere issued warrants to purchase
25,000 shares of Cheniere common stock (valued at $30,300) as a placement fee in
connection with the sale of securities. The Company issued warrants to purchase
250,000 shares of Cheniere common stock (valued at $528,000) in connection with
the establishment of a bridge financing facility. Cheniere issued 250,000 shares
of Cheniere common stock in satisfaction of $500,000 in short-term notes payable
issued under a bridge financing facility. Cheniere also issued warrants to
purchase 250,000 shares of Cheniere common stock to its president and chief
executive officer in October 2000, pursuant to his employment agreement. The
Company issued its financial advisers warrants to purchase 125,000 shares of
Cheniere common stock, valued at $164,500, as consideration for assistance in
the capitalization of Gryphon.
In connection with the Gryphon transaction in October 2000, Cheniere
contributed to Gryphon certain assets and liabilities with a net book value of
$7,065,919 for a 36.8% ownership interest in Gryphon.
The Company paid $55,920, $105,813 and $329,232 for interest in the years
ended December 31, 2002, 2001 and 2000, respectively. The Company has not paid
any income taxes in the three years ended December 31, 2002.
The values of securities issued by the Company in connection with the
transactions described above are based on third party arms-length negotiated
prices.
61
CHENIERE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16-SUBSEQUENT EVENTS
In August 2002, Cheniere entered into an agreement with entities controlled
by Michael S. Smith to sell a 60% interest in its planned LNG receiving facility
at Freeport, Texas. In February 2003, Cheniere's Freeport LNG project was
acquired by Freeport LNG Development, L.P. ("Freeport LNG"), in which Cheniere
retained a 40% interest. Freeport LNG will pay Cheniere $5,000,000 in cash and
will spend up to $9,000,000 to obtain permits and prepare the project for the
construction phase with no further contribution by Cheniere. After contribution
of the full $9,000,000, additional expenses will be borne by the parties pro
rata based on their respective ownership interests. Smith, through a controlled
entity, Freeport LNG Investments, LLC (Investments) holds a 60% interest in
Freeport LNG. Smith will manage the project as chief executive officer of
Freeport LNG.
The cash payments to Cheniere are payable $1,000,000 at closing; $750,000
on July 15, 2003 and October 15, 2003; and $2,500,000 30 days after all
construction permits are obtained for the Freeport site. With the signing of a
definitive lease agreement for the Freeport, Texas terminal site on December 19,
2002, Freeport LNG paid to Cheniere $650,000 for related costs and expenses,
which amount would have been reimbursable by Cheniere should the sale to
Freeport LNG not have been completed. Furthermore, at closing on February 27,
2003, Freeport LNG paid Cheniere an additional $530,215 in cash and assumed
Cheniere liabilities of $560,211, all related to Freeport LNG project costs.
These payments and assumptions of liabilities represent an aggregate of
$1,740,426 in project cost recoveries to Cheniere, in addition to the $1,000,000
initial installment payment received at closing.
Cheniere pledged its Gryphon common stock as collateral to secure potential
repayment of the $650,000 advance received in December 2002. Management expects
such collateral will be released by March 31, 2003.
The Company accounted for this transaction in accordance with Emerging
Issues Task Force Issue No. 89-7, Exchange of Assets or Interest in a Subsidiary
for a Noncontrolling Equity Interest in a New Entity, and, accordingly, recorded
a gain on the assets transferred to the extent of the percentage interest not
retained.
On March 1, 2003, pursuant to an existing option agreement, Cheniere sold a
10% interest in Freeport LNG to a third party for $2,333,333, payable over time,
including the cancellation of the Company's $750,000 short-term note payable.
Cheniere retained a 30% interest in Freeport LNG. In connection with the closing
of the transactions in 2003, Cheniere issued warrants for the purchase of
1,000,000 shares of its common stock at a price of $2.50 per share, exercisable
for a period of 10 years.
62
The pro forma effects of the transactions on Cheniere's balance sheet, as
if the transactions had been consummated at December 31, 2002, are as follows:
Unaudited
-----------------------------------------------
Historical Pro Forma Adjustments Pro Forma
--------------- ----------------------------- ------------
Debits Credits
----------- -----------
Current Assets $ 1,848,820 $ 526,000(5) $ 60,000(3) $ 3,299,820
1,000,000(6) 1,086,000(5)
1,583,000(7) 512,000(5)
Oil and Gas Properties 17,594,229 17,594,229
LNG Site Costs 1,400,000 1,400,000(1) -
Investment in Partnership - 1,400,000(1) 1,000,000(6) 4,939,000
4,760,000(2) 1,571,000(7)
600,000(3)
750,000(4)
Other 216,341 216,341
--------------- ------------
Total Assets $ 21,059,390 $ 26,049,390
=============== ============
Current Liabilities $ 3,262,055 $ 560,000(5) $ 540,000(3) $ 1,980,055
512,000(5)
750,000(7)
Stockholders' Equity
Common Stock 39,892 39,892
Additional Paid-in-Capital 41,414,236 750,000(4) 42,164,236
Accumulated Deficit (23,656,793) 4,760,000(2) (18,134,793)
762,000(7)
--------------- ------------
Total Stockholders' Equity 17,797,335 24,069,335
--------------- ------------
Total Liabilities and Stockholders' Equity $ 21,059,390 $ 26,049,390
=============== ============
The pro forma adjustments include the following entries:
(1) To reclassify $1,400,000 in LNG site costs to Investment in
Partnership,
(2) To record $4,760,000 gain on sale of 60% interest in Freeport project,
(3) To record $600,000 in financial advisor fees, of which $60,000 had
been previously accrued,
(4) To record the issuance of warrants valued at $750,000,
(5) To record collection of $1,086,000 account receivable through $526,000
cash reimbursement, and $560,000 assumption of liabilities by
Development, and repayment of $512,000 in payables,
(6) To record the $1,000,000 first installment payment by Development and
(7) To record $2,333,000 sale by Cheniere of 10% interest in Development
and resulting $762,000 gain, establishing $1,583,000 in receivables
and canceling $750,000 note payable.
63
CHENIERE ENERGY, INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION TO CONSOLIDATED FINANCIAL STATEMENTS
OIL AND GAS RESERVES AND RELATED FINANCIAL DATA
(unaudited)
COSTS INCURRED IN OIL AND GAS PRODUCING ACTIVITIES
Presented below are costs incurred in oil and gas property acquisition,
exploration and development activities:
Year Ended December 31,
-------------------------------------------
2002 2001 2000
------------ ------------ ------------
Acquisition of properties
Proved properties $ - $ - $ -
Unproved properties 2,813,370 4,807,808 6,603,296
Exploration costs - - -
Development costs 15,011 99,800 673,136
------------ ------------ ------------
Subtotal 2,828,381 4,907,608 7,276,432
Amounts contributed to
unconsolidated affiliate - - (9,379,534)
------------ ------------ ------------
Total $ 2,828,381 $ 4,907,608 $ (2,103,102)
============ ============ ============
Proportional share of
unconsolidated affiliate (1) $ 43,496,000 $ 36,576,000 $ 18,196,000
============ ============ ============
(1) Represents Cheniere's proportional share, based on its 100% common
stock ownership, of the costs incurred in oil and gas activities of
Gryphon. Upon the conversion of Gryphon's preferred shares, such
proportional share of Gryphon activities would be reduced to 9.3%, or
$4,045,000 for 2002.
Included in the above amounts for the years ended December 31, 2002, 2001
and 2000 were $849,240, $947,813 and $1,897,454, respectively, of capitalized
general and administrative expenses, capitalized interest expense and
capitalized debt discount directly related to property acquisition, exploration
and development.
CAPITALIZED COSTS RELATED TO OIL AND GAS PRODUCING ACTIVITIES
The following table presents total capitalized costs of proved and unproved
properties and accumulated depreciation, depletion and amortization related to
oil and gas producing operations:
December 31,
-----------------------------------------------
2002 2001 2000
-------------- ---------------- ------------
Proved properties $ 11,296,639 $ 12,308,315 $ 10,951,317
Unproved properties 16,751,347 16,236,962 18,253,731
-------------- ---------------- ------------
28,047,986 28,545,277 29,205,048
Accumulated depreciation, depletion and amortization (10,453,757) (10,379,191) (4,223,704)
-------------- ---------------- ------------
$ 17,594,229 $ 18,166,086 $ 24,981,344
============== ================ ============
Proportional share of unconsolidated affiliate (1) $ 89,698,000 $ 53,551,000 $ 18,196,000
============== ================ ============
(1) Represents Cheniere's proportional share, based on its 100% common
stock ownership, of the capitalized costs related to oil and gas
producing activities of Gryphon. Upon the conversion of Gryphon's
preferred shares, such proportional share of Gryphon's capitalized
costs related to oil and gas producing activities would be reduced to
9.3%, or $8,342,000 at December 31, 2002.
64
CHENIERE ENERGY, INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION TO CONSOLIDATED FINANCIAL STATEMENTS
OIL AND GAS RESERVES AND RELATED FINANCIAL DATA
(unaudited)
RESULTS OF OPERATIONS FROM OIL AND GAS PRODUCING ACTIVITIES
The results of operations from oil and gas producing activities are as follows:
Year Ended December 31,
-------------------------------------
2002 2001 2000
--------- ------------ -----------
Revenues $ 239,055 $ 2,372,632 $ 5,320,432
Production costs (90,038) (420,242) (388,637)
Depreciation, depletion and amortization (74,566) (1,029,239) (3,023,518)
Ceiling test write-down - (5,126,248) -
Income tax benefit (expense) - - -
--------- ------------ -----------
Results of operations from oil and gas producing activities
(excluding corporate overhead and interest costs) $ 74,451 $ (4,203,097) $ 1,908,277
========= ============ ===========
Equity in results of operations from oil and gas
producing activities (excluding corporate overhead
and interest costs) of unconsolidated affiliate (1) $ 828,000 $ 907,000 $ -
========= ============ ===========
(1) Represents Cheniere's proportional share, based on its 100% common stock
ownership, of the results of operations from oil and gas producing
activities (excluding corporate overhead and interest costs). Such
proportional share will be reduced to 9.3% upon the conversion of Gryphon's
preferred shares, resulting in a decrease in Cheniere's proportional
interest in the results of operations from oil and gas producing activities
to $77,000 for 2002.
RESERVE QUANTITIES
Estimates of proved reserves of Cheniere and the related standardized
measure of discounted future net cash flow information are substantially based
on the reports generated by the Company's independent petroleum engineers (Ryder
Scott Company) in accordance with the rules and regulations of the SEC. The
independent engineers' estimates were based upon a review of production
histories and other geologic, economic, ownership and engineering data provided
by the Company. These estimates represent the Company's interest in the reserves
associated with its properties. All of the Company's oil and gas reserves are
located within the United States or its territorial waters.
65
CHENIERE ENERGY, INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION TO CONSOLIDATED FINANCIAL STATEMENTS
OIL AND GAS RESERVES AND RELATED FINANCIAL DATA
(unaudited)
The Company's estimates of its proved reserves and proved developed
reserves of oil and gas as of December 31, 2002, 2001 and 2000 and the changes
in its proved reserves are as follows:
2002 2001 2000
---------------------- --------------------- --------------------
Oil Gas Oil Gas Oil Gas
(Bbls) (Mcf) (Bbls) (Mcf) (Bbls) (Mcf)
-------- ---------- ------- ---------- ------ ----------
Proved reserves:
Beginning of year 15,088 3,245,000 19,874 4,568,000 27,816 5,796,000
Revisions of prior estimates - - (2,178) (780,226) (7,200) (354,103)
Production (495) (91,470) (2,608) (542,774) (3,703) (1,459,897)
Sale of reserves in place (14,598) (3,177,278) - - - -
Extensions, discoveries and other additions 3,985 1,356,748 - - 2,961 586,000
-------- ---------- ------- ---------- ------ ----------
End of year 3,980 1,333,000 15,088 3,245,000 19,874 4,568,000
======== ========== ======= ========== ====== ==========
Interest in proved reserves of
unconsolidated affiliate - end of year (1) 371,808 27,508,000 210,151 17,468,000 2,640 1,674,000
======== ========== ======= ========== ====== ==========
Proved developed reserves:
Beginning of year 15,088 3,245,000 16,913 3,982,000 27,816 5,796,000
======== ========== ======= ========== ====== ==========
End of year 1,606 503,000 15,088 3,245,000 16,913 3,982,000
======== ========== ======= ========== ====== ==========
Interest in proved developed reserves of
unconsolidated affiliate - end of year (1) 165,421 16,332,000 192,569 13,022,000 2,640 1,674,000
======== ========== ======= ========== ====== ==========
(1) Represents Cheniere's proportional share, based on its 100% common stock
ownership, of the proved reserves and proved developed reserves of Gryphon.
Upon the conversion of Gryphon's preferred shares, such proportional share
of Gryphon reserves would be reduced to 9.3%, or proved reserves of 34,578
Bbls and 2,558,000 Mcf and proved developed reserves of 15,384 Bbls and
1,519,000 Mcf at December 31, 2002. Such reserves were not considered in the
Company's calculation of depreciation, depletion and amortization or the
calculation of its ceiling test.
There are numerous uncertainties inherent in estimating quantities of
proved reserves and in projecting future rates of production and future amounts
and timing of development expenditures, including many factors beyond the
control of the Company. Reserve engineering is a subjective process of
estimating underground accumulations of crude oil and natural gas that cannot be
measured in an exact manner, and the accuracy of any reserve estimate is a
function of the quality of available data and of engineering and geological
interpretation and judgment. Estimates of proved undeveloped reserves are
inherently less certain than estimates of proved developed reserves. The
quantities of oil and gas that are ultimately recovered, production and
operating costs, the amount and timing of future development expenditures,
geologic success and future oil and gas sales prices may all differ from those
assumed in these estimates. In addition, the Company's reserves may be subject
to downward or upward revision based upon production history, purchases or sales
of properties, results of future development, prevailing oil and gas prices and
other factors.
STANDARD MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
The standardized measure of discounted future net cash flows was calculated
by applying year-end prices, (adjusted for location and quality differentials)
to estimated future production, less future expenditures (based on year-end
costs) to be incurred in developing and producing the Company's proved reserves
and the estimated effect of future income taxes based on the current tax law.
The resulting future net cash flows were discounted using a rate of 10% per
annum.
The standardized measure of discounted future net cash flow amounts
contained in the following tabulation does not purport to represent the fair
market value of oil and gas properties. No value has been given to unproved
66
CHENIERE ENERGY, INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION TO CONSOLIDATED FINANCIAL STATEMENTS
OIL AND GAS RESERVES AND RELATED FINANCIAL DATA
(unaudited)
properties. There are significant uncertainties inherent in estimating
quantities of proved reserves and in projecting rates of production and the
timing and amount of future costs. Future realization of oil and gas prices over
the remaining reserve lives may vary significantly from current prices. In
addition, the method of valuation utilized, based on year-end prices and costs
and the use of a 10% discount rate, is not necessarily appropriate for
determining fair value.
The standardized measure of discounted future net cash flows relating to
proved oil and gas reserves is as follows:
December 31,
-----------------------------------------------
2002 2001 2000
----------- ------------ ------------
Future gross revenues $ 6,343,537 $ 8,076,063 $ 48,989,932
Less - future costs:
Production (163,683) (2,570,550) (5,853,817)
Development (56,250) (910,800) (2,823,300)
Income Taxes - - (7,947,748)
----------- ------------ ------------
Future net cash flows 6,123,604 4,594,713 32,365,067
Less - 10% annual discount for estimated timing of cash flows (992,141) (1,671,812) (11,747,065)
----------- ------------ ------------
Standardized measure of discounted future net cash flows $ 5,131,463 $ 2,922,901 $ 20,618,002
=========== ============ ============
The following table summarizes the principal sources of change in the
standardized measure of discounted future net cash flows:
Year Ended December 31,
------------------------------------------
2002 2001 2000
------------ ------------ ------------
Standardized measure - beginning of period $ 2,922,901 $ 20,618,002 $ 7,570,129
Sales of oil and gas produced, net of production costs (149,017) (1,952,390) (4,931,795)
Extensions, discoveries and other additions 5,208,984 - 3,537,975
Revisions to previous quantity estimates, timing and other (28,799) (675,047) (2,349,930)
Net changes in prices and production costs - (21,242,047) 20,424,190
Sale of reserves in place (2,212,670) - -
Development costs incurred 15,011 99,800 673,136
Changes in estimated development costs (624,947) (1,556,205) -
Net changes in income taxes - 5,062,716 (5,062,716)
Accretion of discount - 2,568,072 757,013
------------ ------------ ------------
Standardized measure - end of period $ 5,131,463 $ 2,922,901 $ 20,618,002
============ ============ ============
Standardized measure - end of period - proportional interest in
reserves of unconsolidated affiliate (1) $ 95,211,000 $ 28,778,000 $ 9,138,920
============ ============ ============
Current prices at year-end, used in standardized measure
Oil (per barrel) $ 29.23 $ 19.00 $ 29.72
Gas (per mcf) $ 4.64 $ 2.61 $ 10.71
(1) Represents Cheniere's proportional share, based on its 100% common stock
ownership, of the standardized measure of Gryphon's proved oil and gas
reserves. Such proportional share of Gryphon's standardized measure will be
reduced to 9.3% upon the conversion of Gryphon's preferred shares, resulting
in a decrease in Cheniere's proportional interest in the standardized
measure of unconsolidated affiliate to $8,855,000 at December 31, 2002.
67
CHENIERE ENERGY, INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION TO CONSOLIDATED FINANCIAL STATEMENTS
OIL AND GAS RESERVES AND RELATED FINANCIAL DATA
(unaudited)
The Company may receive amounts different than those incorporated into the
standardized measure of discounted cash flow for a number of reasons, including
changes in prices. Therefore, the present value shown above should not be
construed as the current market value of the estimated oil and gas reserves
attributable to the Company's properties.
68
CHENIERE ENERGY, INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION TO CONSOLIDATED FINANCIAL STATEMENTS
SUMMARIZED QUARTERLY FINANCIAL DATA
(unaudited)
Quarterly Financial Data - (unaudited)
First Second Third Fourth
Quarter Quarter Quarter Quarter Year
------------- ------------- ------------- ------------ -------------
Year ended December 31, 2002:
Revenues $ 161,604 $ 37,955 $ 21,998 $ 17,498 $ 239,055
Gross profit (2) (18,423) (52,528) (111,912) (36,682) (219,545)
Income (loss) from operations (3) (1,318,501) (1,636,668) (1,478,002) 738,264 (3,694,907)
Net income (loss) (3) (2,530,967) (2,366,029) (1,474,972) 739,660 (5,632,308)
Net income (loss) per share - basic and diluted $ (0.19) $ (0.18) $ (0.11) $ 0.06 $ (0.42)
Year ended December 31, 2001:
Revenues $ 971,656 $ 774,832 $ 395,540 $ 230,604 $ 2,372,632
Ceiling test write-down - 2,159,645 2,966,603 - 5,126,248
Gross profit (2) 523,248 (1,904,100) (2,972,576) (64,258) (4,417,686)
Income (loss) from operations (502,374) (3,200,636) (4,130,150) (876,489) (8,709,649)
Net income (loss) (1) (910,851) (3,785,625) (5,057,915) (1,910,871) (11,665,262)
Net loss per share - basic and diluted (1) $ (0.07) $ (0.29) $ (0.38) $ (0.14) $ (0.89)
(1) Third quarter results in 2001 have been restated to reverse a $425,678
($0.03 per share) gain on sale of unconsolidated affiliate stock.
(2) Revenues less operating expenses other than general and administrative.
(3) Fourth quarter 2002 includes $1,611,082 in recoveries of general and
administrative expenses reimbursable under the terms of the Contribution
Agreement related to Cheniere's sale of its Freeport LNG site, which closed
in February 2003.
69
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On October 17, 2002, Cheniere Energy, Inc. (the "Registrant") dismissed
PricewaterhouseCoopers LLP ("PWC") as the Registrant's principal accountant and
engaged Mann Frankfort Stein & Lipp CPAs, L.L.P. ("Mann Frankfort") as the
principal accountant for the fiscal year ending December 31, 2002. The change in
principal accountant was approved by the audit committee of the Registrant's
board of directors.
In connection with the audits of the Registrant's two fiscal years ended
December 31, 2001, and the subsequent interim period through such dismissal,
there were no disagreements between PWC and the Registrant on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope or procedure, which disagreements if not resolved to the satisfaction of
PWC, would have caused them to make a reference thereto in their report on the
financial statements for such year.
The reports of PWC on the consolidated financial statements of the
Registrant and subsidiaries as of and for the years ended December 31, 2001 and
2000 did not contain any adverse opinion or disclaimer of opinion, nor were they
qualified or modified as to uncertainty, audit scope, or accounting principles,
except the report on the consolidated financial statements as of and for the
year ended December 31, 2001 included an explanatory paragraph regarding the
existence of substantial doubt about the Registrant's ability to continue as a
going concern, and the report on the consolidated financial statements as of and
for the year ended December 31, 2000 included an explanatory paragraph regarding
the recoverability of the Registrant's unevaluated oil and gas properties.
During the Company's two most recent fiscal years and through October 17,
2002, the Registrant did not consult Mann Frankfort with respect to the
application of accounting principles to a specified transaction, either
completed or proposed, or the type of audit opinion that might be rendered on
the Registrant's consolidated financial statements, or any other matters or
reportable events listed in Items 304(a)(2)(i) and (ii) of Regulation S-K.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Pursuant to paragraph 3 of General Instruction G to Form 10-K, the
information required by Item 10 of Part III of this Report is incorporated by
reference from Cheniere's definitive proxy statement involving the election of
directors, which is to be filed pursuant to Regulation 14A within 120 days after
the end of Cheniere's fiscal year ended December 31, 2002.
ITEM 11. EXECUTIVE COMPENSATION
Pursuant to paragraph 3 of General Instruction G to Form 10-K, the
information required by Item 11 of Part III of this Report is incorporated by
reference from Cheniere's definitive proxy statement involving the election of
directors, which is to be filed pursuant to Regulation 14A within 120 days after
the end of Cheniere's fiscal year ended December 31, 2002.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
Pursuant to paragraph 3 of General Instruction G to Form 10-K, the
information required by Item 12 of Part III of this Report is incorporated by
reference from Cheniere's definitive proxy statement involving the election of
directors, which is to be filed pursuant to Regulation 14A within 120 days after
the end of Cheniere's fiscal year ended December 31, 2002.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Pursuant to paragraph 3 of General Instruction G to Form 10-K, the
information required by Item 13 of Part III of this Report is incorporated by
reference from Cheniere's definitive proxy statement involving the election of
directors, which is to be filed pursuant to Regulation 14A within 120 days after
the end of Cheniere's fiscal year ended December 31, 2002.
70
ITEM 14. CONTROLS AND PROCEDURES
Within the 90 days prior to the date of this Report, the Company carried
out an evaluation, under the supervision and with the participation of the
Company's management, including the Company's Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures (as defined in Rules 13a-14(c) and
15d-14(c) under Securities Exchange Act of 1934). Based upon that evaluation,
the Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures are effective to ensure that
information required to be disclosed by the Company in reports that it files or
submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized and reported within the time periods specified in Securities and
Exchange Commission rules and forms. There were no significant changes in the
Company's internal controls or in other factors that could significantly affect
these controls subsequent to the date of their evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements, Schedules and Exhibits
(1) Financial Statements - Cheniere Energy, Inc. and Subsidiaries
Reports of Independent Accountants.....................................39
Consolidated Balance Sheet.............................................41
Consolidated Statement of Operations...................................42
Consolidated Statement of Stockholders' Equity.........................43
Consolidated Statement of Cash Flows...................................44
Notes to Consolidated Financial Statements.............................45
Supplemental Information to the Consolidated Financial Statements......64
The financial statements of Gryphon Exploration Company, for which Cheniere
uses the equity method of accounting, have been filed as part of this report on
Form 10-K. (See Item 14 (d).)
(2) Financial Statement Schedules
All consolidated financial statement schedules have been omitted because
they are not required, are not applicable, or the required information has been
included elsewhere within this Form 10-K.
(3) Exhibits
Exhibit No Description
- ---------- -----------------
3.1 Amended and Restated Certificate of Incorporation of
Cheniere Energy, Inc. (Cheniere) (Incorporated by reference
to Exhibit 3.1 of the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1999 (File No. 0-9092)
filed on August 16, 1999)
3.2 Certificate of Amendment to the Amended and Restated
Certificate of Incorporation of Cheniere (Incorporated by
reference to Exhibit 3.2 of the Company's Quarterly Report
on Form 10-Q for the quarter ended June 30, 1999 (File No.
0-9092) filed on August 16, 1999)
3.3 By-laws of Cheniere as amended through April 7, 1997
(Incorporated by reference to Exhibit 3.2 of the Company's
Annual Report on Form 10-K for the year ended December 31,
1998 (File No. 0-9092) filed on March 29, 1999)
4.1 Specimen Common Stock Certificate of Cheniere
(Incorporated by reference to Exhibit 4.1 of the Company's
Registration Statement on Form S-1 filed on August 27, 1996
(File No. 333-10905) filed on January 14, 1998)
71
10.1 Cheniere Energy, Inc. 1997 Stock Option Plan (Incorporated
by reference to Exhibit 10.25 of the Quarterly on Form 10-Q
for the quarter ended November 31, 1997 (File No. 0-9092)
filed on January 14, 1998)
10.2 First Amendment to Cheniere Energy, Inc. 1997 Stock Option
Plan. (Incorporated by reference to Exhibit 10.26 of the
Annual Report on Form 10-K for the year ended December 31,
1999 (File No. 0-9092) filed on March 29, 2000)
10.3 Seismic Data Purchase Agreement dated June 21, 2000
between Seitel Data and Cheniere. (Incorporated by reference
to Exhibit 10.39 of the Quarterly Report on Form 10-Q for
the quarter ended June 30, 2000 (File No. 0-9092) filed on
August 11, 2000)
10.4 Contribution and Subscription Agreement dated October 11,
2000, by and among the Company, Gryphon Exploration Company
and the other investors listed therein. (Incorporated by
reference to Exhibit 10.1 of the Company's Current Report on
Form 8-K filed on October 20, 2000) (File No. 0-9092))
10.5 Stockholders Agreement dated October 11, 2000.
(Incorporated by reference to Exhibit 10.2 of the Company's
Current Report on Form 8-K filed on October 20, 2000 (File
No. 0-9092))
10.6 Certificate of Designations, Preferences and Rights of
Series A Convertible Preferred Stock of Gryphon Exploration
Company. (Incorporated by reference to Exhibit 10.3 of the
Company's Current Report on Form 8-K filed on October 20,
2000 (File No. 0-9092))
10.7 Settlement and Purchase Agreement, dated and effective as of
June 14, 2001 by and between Cheniere Energy, Inc., CXY
Corporation, Crest Energy, L.L.C., Crest Investment Company
and Freeport LNG Terminal, LLC (Incorporated by reference to
Exhibit 10.10 of the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 2001 (File No.
1-16383) filed on April 1, 2002)
10.8 Stock Purchase Agreement by and between Gryphon Exploration
Company and Cheniere Energy, Inc. dated March 19, 2002
(Incorporated by reference to Exhibit 10.10 of the Company's
Annual Report on Form 10-K for the fiscal year ended
December 31, 2001 (File No. 1-16383) filed on April 1, 2002)
10.9 Contribution Agreement, dated as of August 26, 2002, by
and among Freeport LNG Investments, LLC, Freeport LNG-GP,
Inc., Cheniere Energy, Inc., Cheniere LNG, Inc. and Freeport
LNG Terminal, L.L.C. (Incorporated by reference to Exhibit 2
of the Company's Current Report on Form 8-K (File No.
1-16383) filed on September 4, 2002).
10.10 Extension and Amendment to Contribution Agreement, dated
as of September 19, 2002, by and among Freeport LNG
Investments, LLC, Freeport LNG-GP, Inc., Cheniere Energy,
Inc., Cheniere LNG, Inc. and Freeport LNG Terminal, L.L.C.
(Incorporated by reference to Exhibit 2 of the Company's
Current Report on Form 8-K (File No. 1-16383) filed on
September 26, 2002).
10.11 Second Extension and Amendment to Contribution
Agreement, effective as of October 4, 2002, by and among
Freeport LNG Investments, LLC, Freeport LNG-GP, Inc.,
Cheniere Energy, Inc., Cheniere LNG, Inc. and Freeport LNG
Terminal, L.L.C. (Incorporated by reference to Exhibit 1 of
the Company's Current Report on Form 8-K (File No. 1-16383)
filed on November 5, 2002).
10.12 Third Amendment to Contribution Agreement, dated as of
February 27, 2003, by and among Freeport LNG Investments,
LLC, Freeport LNG-GP, Inc., Cheniere Energy, Inc., Cheniere
LNG, Inc. and Freeport LNG Terminal, L.L.C. (Incorporated by
reference to Exhibit 10.4 of the Company's Current Report on
Form 8-K (File No. 1-16383) filed on March 7, 2003).
10.13 Amended and Restated Partnership Agreement of Freeport LNG
Development, L.P., dated as of February 27, 2003, by and
among Freeport LNG-GP, Inc., Freeport LNG Investments, LLC
and Cheniere LNG, Inc. (Incorporated by reference to Exhibit
10.5 of the Company's Current Report on Form 8-K (File No.
1-16383) filed on March 7, 2003).
10.14 Warrant to Purchase Common Stock, dated as of February 27,
2003, issued by Cheniere Energy, Inc. in favor of Freeport
LNG Investments, LLC. (Incorporated by reference to Exhibit
10.6 of the Company's Current Report on Form 8-K (File No.
1-16383) filed on March 7, 2003).
72
10.15 Option Agreement, dated as of February 27, 2003, by and
between Freeport LNG Investments, LLC and Cheniere Energy,
Inc. (Incorporated by reference to Exhibit 10.7 of the
Company's Current Report on Form 8-K (File No. 1-16383)
filed on March 7, 2003).
10.16 Partnership Interest Purchase Agreement, dated as of
March 1, 2003, by and among Contango Sundance, Inc.,
Contango Oil & Gas, Cheniere LNG, Inc. and Cheniere Energy,
Inc. (Incorporated by reference to Exhibit 10.8 of the
Company's Current Report on Form 8-K (File No. 1-16383)
filed on March 7, 2003).
10.17 Warrant to Purchase Common Stock, dated as of March 1,
2003, issued by Cheniere Energy, Inc. in favor of Contango
Sundance, Inc. (Incorporated by reference to Exhibit 10.9 of
the Company's Current Report on Form 8-K (File No. 1-16383)
filed on March 7, 2003). 21.1 Subsidiaries of Cheniere
Energy, Inc.
21.1 Subsidiaries of Cheniere Energy, Inc.
23.1 Consent of Mann Frankfort Stein & Lipp CPAs, L.L.P.
23.2 Consent of PricewaterhouseCoopers LLP
23.3 Consent of KPMG LLP
99.1 Certification of Chief Executive Officer Pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes - Oxley Act of 2002
99.2 Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes - Oxley Act of 2002
(b) Reports On Form 8-K:
September 4, 2002 - The Company filed a Current Report on
Form 8-K on September 4, 2002 to report that it had entered
into a Contribution Agreement, dated as of August 26, 2002.
September 26, 2002 - The Company filed a Current Report on
Form 8-K on September 26, 2002 to report that it had entered
into an Extension and Amendment to Contribution Agreement,
dated as of September 19, 2002, to extend the closing date
of the transaction contemplated by the Contribution
Agreement, dated as of August 26, 2002.
October 22, 2002 - The Company filed a Current Report on
Form 8-K on October 22, 2002 to report a change in the
Company's certifying independent public accountants.
November 5, 2002 - The Company filed a Current Report on
Form 8-K on November 5, 2002 to report that it had entered
into a Second Extension and Amendment to Contribution
Agreement, effective as of October 4, 2002, amending the
Contribution Agreement, dated as of August 26, 2002.
December 20, 2002 - The Company filed a Current Report on
Form 8-K on December 20, 2002 to report the resignation of
its president and chief executive officer.
March 7, 2003 - The Company filed a Current Report on Form
8-K on March 5, 2003 to report the sales of interests in the
Company's Freeport LNG receiving terminal project.
(c) Not applicable.
(d) Gryphon Exploration Company Financial Statements, for which Cheniere uses
the equity method of accounting, are filed as a part of this report beginning on
page 77.
73
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
CHENIERE ENERGY, INC.
(Registrant)
By:/s/ Charif Souki
-----------------------------------------
Charif Souki
Chairman, President and Chief Executive
Officer
Date: March 26, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
- ---------------------------------- --------------------------------------------------------- --------------
/s/ Charif Souki Chairman of the Board of Directors, President, (Principal March 26, 2003
- --------------------------------- Executive Officer) and Director
Charif Souki
/s/ Walter L. Williams Vice Chairman and Director March 26, 2003
- ---------------------------------
Walter L. Williams
/s/ Don A. Turkleson Vice President, Chief Financial Officer, Secretary and March 26, 2003
- --------------------------------- Treasurer (Principal Financial and Accounting Officer)
Don A. Turkleson
/s/ Nuno Brandolini Director March 26, 2003
- ---------------------------------
Nuno Brandolini
/s/ Keith F. Carney Director March 26, 2003
- ---------------------------------
Keith F. Carney
/s/ Paul J. Hoenmans Director March 26, 2003
- ---------------------------------
Paul J. Hoenmans
/s/ John K. Howie Director March 26, 2003
- ---------------------------------
John K. Howie
/s/ Charles M. Reimer Director March 26, 2003
- ---------------------------------
Charles M. Reimer
74
CERTIFICATION BY CHIEF EXECUTIVE OFFICER PURSUANT TO SECURITIES EXCHANGE ACT
RULE 13A-14
I, Charif Souki, certify that:
1. I have reviewed this annual report on Form 10-K of Cheniere Energy, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 26, 2003
/s/Charif Souki
- ----------------------------
Charif Souki
Chief Executive Officer
75
CERTIFICATION BY CHIEF FINANCIAL OFFICER PURSUANT TO SECURITIES EXCHANGE ACT
RULE 13A-14
I, Don A. Turkleson, certify that:
1. I have reviewed this annual report on Form 10-K of Cheniere Energy, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this annual
report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
Date: March 26, 2003
/s/Don A. Turkleson
- ------------------------
Don A. Turkleson
Chief Financial Officer
76
INDEX TO FINANCIAL STATEMENTS
GRYPHON EXPLORATION COMPANY
Reports of Independent Accountants.......................78
Balance Sheets...........................................80
Statements of Income.....................................81
Statements of Stockholders' Equity.......................82
Statements of Cash Flows.................................83
Notes to Financial Statements............................84
Supplemental Information to Financial Statements.........96
77
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Gryphon Exploration Company
We have audited the accompanying balance sheet of Gryphon Exploration Company,
as of December 31, 2002, and the related statements of income (loss),
stockholders' equity, and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the 2002 financial statements referred to above present fairly,
in all material respects, the financial position of Gryphon Exploration Company,
as of December 31, 2002, and the results of its operations and its cash flows
for the year then ended in conformity with accounting principles generally
accepted in the United States of America.
KPMG LLP
Houston, Texas
March 14, 2003
78
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Gryphon Exploration Company
In our opinion, the accompanying balance sheet and the related statements of
income (loss), stockholders' equity and cash flows present fairly, in all
material respects, the financial position of Gryphon Exploration Company at
December 31, 2001 and the results of its operations and its cash flows for the
year ended December 31, 2001 and for the period from inception (October 11,
2000) through December 31, 2000 in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
PRICEWATERHOUSECOOPERS LLP
Houston, Texas
March 29, 2002
79
GRYPHON EXPLORATION COMPANY
BALANCE SHEETS
(dollars in thousands, except share related items)
December 31,
----------------------------
2002 2001
------------ ------------
ASSETS
CURRENT ASSETS
Cash and Cash Equivalents $ 2,986 $ 7,931
Restricted Cash Deposits 260 1,751
Receivables from Joint Interest Owners and Revenue Receivables 3,188 1,941
Prepaid Expenses and Other 5,781 3,241
------------ ------------
Total Current Assets 12,215 14,864
OIL AND GAS PROPERTIES, full cost method
Proved Properties, net 54,322 25,484
Unproved Properties, not subject to amortization 36,685 28,067
------------ ------------
Total Oil and Gas Properties 91,007 53,551
FIXED ASSETS, net 458 616
------------ ------------
Total Assets $ 103,680 $ 69,031
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts Payable and Accrued Liabilities $ 5,773 $ 1,948
Advances from Joint Interest Owners 1,875 566
Revenue Payable 5 1,411
Short-term Note Payable 2,865 1,076
Hedge Liability 1,352 --
------------ ------------
Total Current Liabilities 11,870 5,001
------------ ------------
DEFERRED TAX LIABILITY 2,043 1,182
COMMITMENTS AND CONTINGENCIES (NOTE 10)
STOCKHOLDERS' EQUITY
Preferred Stock, $.01 par value
Authorized: 500,000 shares; Issued and Outstanding: 2 1
85,000 shares in 2002 and 55,000 shares in 2001
Common Stock, $.01 par value
Authorized: 4,000,000 shares; Issued: 145,600 shares
Outstanding: 2002--87,460 shares; 2001--145,600 shares 1 1
Additional Paid-in-Capital 93,160 63,161
Retained Earnings (Deficit) (416) 103
Treasury Stock
Recorded at cost--58,140 shares in 2002 and 6,740 shares in 2001 (2,980) (418)
------------ ------------
Total Stockholders' Equity 89,767 62,848
------------ ------------
Total Liabilities and Stockholders' Equity $ 103,680 $ 69,031
============ ============
The accompanying notes are an integral part of these financial statements.
80
GRYPHON EXPLORATION COMPANY
STATEMENTS OF INCOME (LOSS)
(dollars in thousands)
Inception
Year ended December 31, (October 11, 2000)
--------------------------------------- Through
2002 2001 December 31, 2000
------------------ ------------------- -------------------
Oil and Gas Revenue $ 12,495 $ 2,382 $ --
Loss on Derivative Instruments (1,352) -- --
------------------ ------------------- -------------------
11,143 2,382 --
------------------ ------------------- -------------------
Operating Costs and Expenses
Production Costs 804 254 --
Workover Costs 3,226 -- --
Depreciation, Depletion and Amortization 6,521 1,769 113
General and Administrative Expenses 1,423 685 119
------------------ ------------------- -------------------
Total Operating Costs and Expenses 11,974 2,708 232
------------------ ------------------- -------------------
Loss From Operations Before Interest Income and Income Taxes (831) (326) (232)
Interest Income 157 408 261
------------------ ------------------- -------------------
Income (Loss) From Operations Before Income Taxes (674) 82 29
Income Tax Benefit / (Expense) 155 2 (10)
------------------ ------------------- -------------------
Net Income (Loss) $ (519) $ 84 $ 19
================== ================== ==================
The accompanying notes are an integral part of these financial statements.
81
GRYPHON EXPLORATION COMPANY
STATEMENTS OF STOCKHOLDERS' EQUITY
(dollars in thousands)
Common Stock Preferred Stock Additional Total
--------------------- ------------------- Paid-In Retained Treasury Stockholders'
Shares Amount Shares Amount Capital Earnings Stock Equity
-------- -------- -------- -------- ----------- --------- -------- -------------
Balance - Date of Inception
(October 11, 2000) -- $ -- -- $ -- $ -- $ -- $ -- $ --
Issuance of Common Stock 145,600 1 -- -- 9,064 -- -- 9,065
Issuance of Preferred Stock -- -- 25,000 -- 25,000 -- -- 25,000
Offering Costs -- -- -- -- (896) -- -- (896)
Net Income -- -- -- -- -- 19 -- 19
-------- -------- -------- -------- ----------- --------- -------- -------------
Balance - December 31, 2000 145,600 1 25,000 -- 33,168 19 -- 33,188
-------- -------- -------- -------- ----------- --------- -------- -------------
Treasury Stock (6,740) -- -- -- -- -- (418) (418)
Issuance of Preferred Stock -- -- 30,000 1 29,999 -- -- 30,000
Offering Costs -- -- -- -- (6) -- -- (6)
Net Income -- -- -- -- -- 84 -- 84
-------- -------- -------- -------- ----------- --------- -------- -------------
Balance - December 31, 2001 138,860 $ 1 55,000 $ 1 $ 63,161 $ 103 $ (418) $ 62,848
-------- -------- -------- -------- ----------- --------- -------- -------------
Treasury Stock (51,400) -- -- -- -- -- (2,562) (2,562)
Issuance of Preferred Stock -- -- 30,000 1 29,999 -- -- 30,000
Net Loss -- -- -- -- -- (519) -- (519)
-------- -------- -------- -------- ----------- --------- -------- -------------
Balance - December 31, 2002 87,460 $ 1 85,000 $ 2 $ 93,160 $ (416) $ (2,980) $ 89,767
======== ======== ======== ======== =========== ========= ======== =============
The accompanying notes are an integral part of these financial statements.
82
GRYPHON EXPLORATION COMPANY
STATEMENTS OF CASH FLOWS
(dollars in thousands)
Inception
Year ended December 31, (October 11, 2000)
-------------------------------------------- Through
2002 2001 December 31, 2000
--------------------- -------------------- --------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss) $ (519) $ 84 $ 19
Adjustments to Reconcile Net Income (Loss) to
Net Cash Provided by Operating Activities:
Depreciation, Depletion and Amortization 6,521 1,769 113
Non-Cash Expense -- -- 15
Loss on Derivative Instruments 1,352 -- --
Deferred Income Taxes 862 (2) 10
--------------------- -------------------- --------------------
8,216 1,851 157
Changes in Operating Assets and Liabilities
Restricted Cash Deposits 1,491 5,421 (7,172)
Accounts Receivable (1,869) (246) (1,695)
Prepaid Expenses (1,920) (3,084) (181)
Accounts Payable and Current Liabilities 5,517 (6,123) 10,962
--------------------- -------------------- --------------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 11,435 (2,181) 2,071
--------------------- -------------------- --------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Oil and Gas Property Additions (43,495) (36,599) (9,545)
Noncurrent Restricted Cash Deposits -- 2,608 (2,608)
Purchases of Fixed Assets (323) (513) (70)
--------------------- -------------------- --------------------
NET CASH USED IN INVESTING ACTIVITIES (43,818) (34,504) (12,223)
--------------------- -------------------- --------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Sale of Preferred Stock 30,000 30,000 25,000
Purchase of Treasury Stock (2,562) (418) --
Offering Costs -- (6) (896)
Proceeds from borrowings -- 1,804 --
Repayment of borrowings -- (716) --
--------------------- -------------------- --------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 27,438 30,664 24,104
--------------------- -------------------- --------------------
NET INCREASE (DECREASE) IN CASH (4,945) (6,021) 13,952
CASH - BEGINNING OF PERIOD 7,931 13,952 --
--------------------- -------------------- --------------------
CASH - END OF PERIOD $ 2,986 $ 7,931 $ 13,952
==================== ==================== ====================
The accompanying notes are an integral part of these financial statements.
83
GRYPHON EXPLORATION COMPANY
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except share related items)
NOTE 1-Organization and Nature of Operations
Gryphon Exploration Company, a Delaware corporation, ("Gryphon" or the
"Company") is a Houston-based company formed for the purpose of oil and gas
exploration, development and exploitation. The Company is currently engaged in
the exploration and production for oil and natural gas in the Gulf of Mexico.
The Company began operations October 2000.
On October 11, 2000 ("Inception"), Gryphon completed a transaction with
Warburg, Pincus Equity Partners, L.P. and certain affiliates thereof,
("Warburg") a global private equity fund based in New York, and Cheniere Energy,
Inc. ("Cheniere") to fund an exploration program based upon approximately 8,800
square miles of 3D seismic data in the Gulf of Mexico (the "Fairfield data
set"). Cheniere contributed selected net assets in exchange for 100% of the
common stock of Gryphon. These assets included the Fairfield data set license,
certain offshore leases, a prospect then being drilled, an exploration agreement
with an industry partner (described in Note 4) and certain other assets and
liabilities. In addition, Gryphon assumed certain liabilities and obligations of
Cheniere in connection with the contribution of assets. The assets received from
Cheniere less the liabilities assumed were recorded at their estimated net fair
value at the date of the transaction. Also, at inception, Warburg contributed
$25,000 and received Gryphon Series A convertible preferred stock, with an 8%
cumulative dividend (Series A preferred stock). Cheniere and Warburg also
agreed, under certain circumstances, to contribute additional capital up to
$75,000 to Gryphon, proportionate to their respective ownership interests.
As further discussed in Note 7, Warburg and certain employees of the
Company contributed an additional $60,000 in exchange for 60,000 shares of
Series A preferred stock during 2002 and 2001.
NOTE 2-Summary of Significant Accounting Policies
Basis of Presentation
The financial statements include the accounts of Gryphon Exploration
Company. As an independent oil and gas producer, the Company's revenue,
profitability and future rate of growth are substantially dependent upon
prevailing prices for natural gas, oil and condensate, which are dependent upon
numerous factors beyond the Company's control, such as economic, political and
regulatory developments and competition from other sources of energy. The energy
markets have historically been very volatile, and there can be no assurance that
oil and gas prices will not be subject to wide fluctuations in the future. A
substantial or extended decline in oil and gas prices could have a material
adverse effect on the Company's financial position, results of operations, cash
flows, access to capital, and on the quantities of oil and gas reserves that may
be economically produced.
Oil and Gas Properties
General. The Company uses the full cost method of accounting for
exploration and development activities as defined by the U.S. Securities and
Exchange Commission ("SEC"). Under this method of accounting, the costs for
unsuccessful, as well as successful, exploration and development activities are
capitalized as oil and gas properties. This includes any internal costs that are
directly related to exploration and development activities. Gain or loss on the
sale or other disposition of oil and gas properties is not recognized, unless
the gain or loss would significantly alter the relationship between capitalized
costs and proved reserves of oil and natural gas.
The sum of net capitalized costs and estimated future development and
abandonment costs of oil and gas properties and mineral investments is amortized
using the unit-of-production method. The carrying values of oil and gas
properties included in these financial statements do not purport to represent
replacement or market values.
In accordance with SEC Regulation S-X Rule 410 a(2), proved oil and gas
reserves are the estimated quantities of natural gas, crude oil, condensate, and
natural gas liquids that geological and engineering data demonstrate with
reasonable certainty can be recovered in future years from new reservoirs under
existing economic and operating conditions. Reserves are considered proved if
they can be produced economically as demonstrated by either actual production or
conclusive formation tests. The Company emphasizes that the volumes of reserves
are
84
GRYPHON EXPLORATION COMPANY
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except share related items)
estimates which, by their nature, are subject to revision. The estimates are
made using all available geological and reservoir data, as well as production
performance data. These estimates, made by the Company's engineers and an
independent third party reservoir engineering firm, are reviewed and revised,
either upward or downward, as warranted by additional data. Revisions are
necessary due to changes in assumptions based upon, among other things,
reservoir performance, prices, economic conditions and governmental
restrictions. Decreases in prices, for example, may cause a reduction in some
proved reserves due to uneconomic conditions.
Unproved Oil and Gas Properties. Unproved oil and gas properties include
costs that are excluded from proved oil and gas properties and are not subject
to amortization. These amounts generally represent costs of investments in
unproved properties, non-producing leases, seismic data sets, and major
development projects. Gryphon excludes these costs until proved reserves are
found or it is determined that the costs are impaired. All costs excluded are
reviewed at least annually to determine if impairment has occurred. Any
impairment is transferred to the costs to be amortized (the proved oil and gas
property pool). The Company evaluates significant properties, composed primarily
of costs associated with offshore leases and seismic data sets, at least
annually. Non-producing leases are evaluated based on the progress of the
Company's exploration program to date. Exploration costs are transferred from
unproved oil and gas properties to proved oil and gas properties upon completion
of the first exploratory well on each property.
Capitalized Seismic Costs / General & Administrative Expenses. The Company
capitalizes the costs associated with its 3D data sets as well as a portion of
its General and Administrative expenses which are applicable to its exploration
activities. As the direct costs associated with drilled properties are
transferred from the Company's unproved oil and gas properties to its proved oil
and gas properties, the Company allocates a portion of the capitalized 3D
seismic and General and Administrative expense to the proved property pool. The
Company's allocation of these costs is based upon the capitalized costs
associated with each 3D data set area divided by the estimated number of
prospects projected to be developed from each respective data set. During 2002,
2001 and 2000, the Company allocated approximately $3,400, $1,800 and $0,
respectively, of seismic exploration cost, general and administrative, and other
costs transferred by Cheniere at Inception, to the cost of proved properties
based on this allocation method. It is reasonably possible, based on the results
obtained from future drilling, that revisions to this estimate could occur in
the future, which could affect the Company's capitalization ceiling.
Capitalized Interest. SFAS No. 34, "Capitalization of Interest Costs,"
provides standards for the capitalization of interest costs as part of the
historical cost of acquiring assets. Financial Accounting Standards Board
Interpretation ("FIN") No. 33 provides guidance for the application of SFAS No.
34 to the full cost method of accounting for oil and gas properties. Under FIN
No. 33, costs of investments in unproved properties and major development
projects, which are not subject to amortization and on which exploration or
development activities are in progress, qualify for capitalization of interest.
Capitalized interest is calculated by multiplying the Company's weighted-average
interest rate on debt by the amount of costs included in unproved oil and gas
properties. Capitalized interest cannot exceed gross interest expense. As costs
are transferred from the unproved oil and gas properties pool to the proved oil
and gas properties pool, the associated capitalized interest is also transferred
to the proved oil and gas properties pool. The Company incurred no interest
expense during 2002, 2001 or 2000, thus no interest costs were capitalized
during those periods.
Ceiling Test. The Company limits the capitalized costs of proved oil and
gas properties, net of accumulated Depreciation, Depletion, and Amortization
("DD&A") and the related deferred income taxes, to the estimated future net cash
flows from proved oil and gas reserves, using prices in effect at the end of the
applicable reporting period held flat for the life of production, discounted at
10%, net of related tax effects. If capitalized costs exceed this limit, the
excess is charged to expense and reflected as additional DD&A.
Revenue Recognition
Revenues from the sale of oil and gas produced are recognized upon passage
of title, net of royalty interests. When sales volumes differ from the Company's
entitled share, an overproduced or underproduced imbalance occurs. To the extent
the overproduced imbalance exceeds the Company's share of the remaining
estimated proved natural gas reserves for a given property, the Company records
a liability. At December 31, 2002, 2001 and 2000, the Company had no material
gas imbalances.
85
GRYPHON EXPLORATION COMPANY
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except share related items)
Reimbursable expenses
The Company performs administrative services on behalf of third parties in
accordance with certain contractual arrangements. The Company was reimbursed
$810, $449 and $20 during 2002, 2001 and 2000, respectively, related to these
services. These reimbursements are offset against general and administrative
expenses of the Company.
Prepaid expenses
Prepaid expenses at December 31, 2002 and 2001 consist of prepaid insurance
premiums of $4,093 and $1,850, respectively, as well as other prepaid expenses.
Fixed Assets
Fixed assets are recorded at cost. Repairs and maintenance costs are
charged to operations as incurred. Depreciation is computed using the
straight-line method calculated to amortize the cost of assets over their
estimated remaining useful lives, which are estimated as 9 to 36 months for
software and computer equipment and 1 to 5 years for office furnishings.
Leasehold improvements are amortized over the term of the underlying lease. Upon
retirement or other disposition of property and equipment, the cost and related
depreciation is removed from the accounts and the resulting gains or losses are
recorded.
Income Taxes
The Company utilizes the liability method of accounting for income taxes,
as set forth in Statement of Financial Accounting Standards No. 109, "Accounting
for Income Taxes." Under the liability method, deferred taxes are determined
based on the difference between the financial statement and tax bases of assets
and liabilities using enacted tax rates in effect in the years in which the
differences are expected to reverse. Valuation allowances are recorded against
deferred tax assets when it is considered more likely than not that the deferred
tax assets will not be utilized.
Stock-Based Compensation
SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but
does not require, companies to record compensation cost for stock-based employee
compensation plans at fair value. The Company has chosen to account for
stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees" ("APB 25"), and related interpretations. Accordingly, compensation
cost for stock options is measured as the excess, if any, of the market price of
the Company's stock at the date of the grant over the amount an employee must
pay to acquire the stock. The Company grants options at or above the market
price of its common stock at the date of each grant.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123.
This statement amends FASB Statement No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
Statement No. 123 to require prominent disclosures in both annual and interim
financial statements. Certain of the disclosure modifications are required for
fiscal years ending after December 15, 2002 and are included in the notes to
these consolidated financial statements.
The fair value of options is calculated using the Black-Scholes
option-pricing model. Assumptions used for 2002, 2001 and 2000 were: no dividend
yield, no volatility, risk-free interest rate of 4.3%, 3.8% and 5.6%,
respectively, and an expected average option life of 5 years. If the Company had
adopted the recognition provisions of SFAS No. 123 for 2002, 2001 and 2000, the
Company's financial statements would have not reflected a change in reported net
income.
86
GRYPHON EXPLORATION COMPANY
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except share related items)
Cash Equivalents
The Company classifies all investments with original maturities of three
months or less as cash equivalents.
Restricted Cash Deposits
Current restricted cash deposits represent deposits reserved for the
funding of contractual drilling costs on behalf of the Company and its working
interest partners within one year.
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, accounts receivable,
accounts payable, and short-term debt approximate fair value because of the
short maturities of those instruments.
Derivative Instruments
On January 1, 2001, the Company adopted SFAS No. 133, Accounting for
Derivative Instruments and Certain Hedging Activities and SFAS No. 138,
Accounting for Certain Derivative Instruments and Certain Hedging Activity, an
Amendment of SFAS 133. SFAS Nos. 133 and 138 require that all derivative
instruments be recorded on the balance sheet at their respective fair values.
See Note 6 for information regarding the Company's derivative instruments and
hedging activities.
Use of Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and the accompanying notes. Actual results could differ
from those estimates. Changes in such estimates may affect amounts reported in
future periods.
Concentration of Credit Risk
The Company maintains cash balances with a bank and frequently exceeds
federally insured limits. The Company invests its cash in money market
securities, investment grade commercial paper, and U.S. Government-backed
securities. The Company's joint interest partners consist primarily of
independent oil and gas producers. The Company's oil and gas production
purchasers consist primarily of independent marketers and major gas pipeline
companies. The Company performs credit evaluations of its customers' financial
condition and, if deemed necessary, obtains letters of credit and parental
guarantees from selected customers. The Company has not experienced any
significant losses from uncollectible accounts. All of the Company's derivative
transactions have been carried out in the over-the-counter market.
Environmental Liabilities
Liabilities for loss contingencies, including environmental remediation
costs, arising from claims, assessments, litigation, fines, and penalties and
other sources are recorded when it is probable that a liability has been
incurred and the amount of the assessment and/or remediation can be reasonably
estimated.
Recently Issued Accounting Standards
In June 2001, the Financial Accounting Standard Board issued the Statement
of Financial Accounting Standards No. 143 ("SFAS 143"), "Accounting for Asset
Retirement Obligations" (ARO), which requires that an asset retirement cost be
capitalized as part of the cost of the related long-lived asset and allocated to
expense by using a systematic and rational method. Under this Statement, an
entity is not required to re-measure an ARO liability at fair value each period
but is required to recognize changes in an ARO liability resulting from the
passage of time and revisions in cash flow estimates. This Statement is
effective for financial statements issued for fiscal years beginning after June
15, 2002. The Company expects to adopt SFAS 143 on January 1, 2003. The Company
87
GRYPHON EXPLORATION COMPANY
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except share related items)
has not yet determined the impact that the adoption of SFAS 143 will have on its
earnings or statement of financial position.
In October 2001, the Financial Accounting Standard Board issued the
Statement of Financial Accounting Standards No. 144 ("SFAS 144"), "Accounting
for the Impairment or Disposal of Long-Lived Assets". The Statement requires
that long-lived assets that are to be disposed of by sale be measured at lower
of book value or fair value less cost of sale. The Statement also expanded the
scope of discontinued operations to include all components of an entity with
operations that can be distinguished from the rest of the entity and that will
be eliminated from the ongoing operations of the entity in a disposal
transaction. The provisions of this Statement are effective for fiscal years
beginning after December 15, 2001. The provisions of this Statement will impact
any asset dispositions the Company makes after January 1, 2002.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.
SFAS No. 145 amends existing guidance on reporting gains and losses on the
extinguishment of debt to prohibit the classification of the gain or loss as
extraordinary, as the use of such extinguishments have become part of the risk
management strategy of many companies. SFAS No. 145 also amends SFAS No. 13 to
require sale-leaseback accounting for certain lease modifications that have
economic effects similar to sale-leaseback transactions. The provisions of the
Statement related to the rescission of Statement No. 4 are applied in fiscal
years beginning after May 15, 2002. Earlier application of these provisions is
encouraged. The provisions of the Statement related to Statement No. 13 were
effective for transactions occurring after May 15, 2002, with early application
encouraged. The adoption of SFAS No. 145 is not expected to have a material
effect on the Company's financial statements.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. SFAS No. 146 addresses financial accounting
and reporting for costs associated with exit or disposal activities and
nullifies Emerging Issues Task Force (EITF) Issue 94-3, Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity.
The provisions of this Statement are effective for exit or disposal activities
that are initiated after December 31, 2002, with early application encouraged.
The adoption of SFAS No. 146 is not expected to have a material effect on the
Company's financial statements.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness to Others, an interpretation of FASB Statement No. 5,
57 and 107 and a rescission of FASB Interpretation No. 34. This Interpretation
elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under guarantees issued. The
Interpretation also clarifies that a guarantor is required to recognize, at
inception of a guarantee, a liability for the fair value of the obligation
undertaken. The initial recognition and measurement provisions of the
Interpretation are applicable to guarantees issued or modified after December
31, 2002 and are not expected to have a material effect on the Company's
financial statements. The disclosure requirements are effective for financial
statements of interim and annual periods ending after December 31, 2002.
In January 2003, the FASB issued Interpretation No. 46 Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51. This Interpretation
addresses the consolidation by business enterprises of variable interest
entities as defined in the Interpretation. The Interpretation applies
immediately to variable interest in variable interest entities created after
January 31, 2003, and to variable interests in variable interest entities
obtained after January 31, 2003. For nonpublic enterprises, such as the Company,
with a variable interest in a variable interest entity created before February
1, 2003, the Interpretation is applied to the enterprise no later than the end
of the first annual reporting period beginning after June 15, 2003. The
application of this Interpretation is not expected to have a material effect on
the Company's financial statements. The Interpretation requires certain
disclosures in financial statements issued after January 31, 2003 if it is
reasonably possible that the Company will consolidate or disclose information
about variable interest entities when the Interpretation becomes effective.
88
GRYPHON EXPLORATION COMPANY
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except share related items)
NOTE 3-Fixed Assets
Fixed assets consisted of the following:
December 31,
------------------------
2002 2001
---------- ----------
Computers and Office Equipment $ 1,362 $ 1,089
Furniture, Fixtures and Other 240 188
---------- ----------
1,602 1,277
Less Accumulated Depreciation (1,144) (661)
---------- ----------
Fixed Assets, net $ 458 $ 616
========== ==========
NOTE 4-Exploration AgreementS
In 2002, Gryphon entered into an exploration agreement with an industry
partner. Under the terms of the agreement, the partner acquired an option to
participate at a 25% working interest level in up to seven drilling prospects
generated by Gryphon in the Gulf of Mexico. During the term of the agreement,
Gryphon received overhead reimbursements from this partner. In addition, Gryphon
receives an increased interest in each prospect after the partner has received
cumulative cash flows equal to its capital costs in each respective prospect.
Gryphon is the operator of the prospects drilled pursuant to this agreement.
Overhead reimbursements received under the agreement are credited as a recovery
of general and administrative expenses. Total overhead reimbursements received
in 2002 under this program and from other various industry partners were $1,160.
During 2001 and 2000, the Company was party to an exploration agreement
with an industry partner. Cheniere contributed this exploration agreement at
Inception (see Note 1). Under the terms of the agreement, Gryphon's exploration
partner acquired an option to participate at a 50% working interest level in any
drilling prospect generated by Gryphon through August 2001 within a defined area
of mutual interest in the Gulf of Mexico. During the term of the agreement,
Gryphon received a management fee of $230 per month from its partner. In
addition, for each well drilled, Gryphon's partner pays a disproportionate share
of the cost of leasing and of the initial test well on each prospect. Gryphon is
the operator of the drilling program. A portion of the management fee payments
was credited as a recovery of general and administrative expenses and the
remaining portion reduced capitalized G&A expenses. Management fees received by
Gryphon in 2001and 2000 totaled $1,120 and $617, respectively. Certain
provisions of this agreement, including those related to management fees,
expired August 2001.
The Company intends to enter into one or more new industry partner
agreements in 2003.
89
GRYPHON EXPLORATION COMPANY
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except share related items)
NOTE 5-INCOME TAXES
The difference between the provision for income taxes and the amount
that would be determined by applying the statutory federal income tax rate to
the income or loss before income taxes is set forth below:
Inception
Year ended December 31, (October 11, 2000)
-------------------------------------------- Through
2002 2001 December 31, 2000
-------------------- -------------------- --------------------
Federal Income Tax Expense at 34% $ (229) $ 28 $ 10
Permanent Differences 21 16 --
Other 53 (46) --
-------------------- -------------------- --------------------
Income Tax Provision (Benefit) $ (155) $ (2) $ 10
==================== ==================== ====================
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the carrying amounts used for income tax purposes. Deferred income
taxes also reflect the net tax effects of net operating loss carryforwards. The
tax effects of the Company's temporary differences and carryforwards are as
follows:
December 31,
------------------------
2002 2001
---------- ----------
Deferred Tax Assets:
Net Operating Loss Carryforwards $ 7,529 $ 7,264
---------- ----------
Total Deferred Tax Assets 7,529 7,264
Deferred Tax Liabilities:
Differences between Book and Tax
Bases of Oil and Gas Properties,
Plant and Equipment (9,572) (8,446)
---------- ----------
Deferred Tax Liabilities, net $ (2,043) $ (1,182)
========== ==========
There was no current income tax provision for 2002, 2001 or 2000 and no
income taxes were payable during those periods.
The Company has determined that it is more likely than not that the
deferred tax assets will be realized and a valuation allowance for such assets
is not required.
At December 31, 2002, the Company had net operating loss (NOL)
carryforwards for tax reporting purposes of approximately $22,144, which will
expire as follows:
2020 $ 2,170
2021 19,251
2022 723
90
GRYPHON EXPLORATION COMPANY
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except share related items)
NOTE 6-DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Company produces and sells natural gas, crude oil and condensate. As a
result, the Company's financial results can be significantly affected as these
commodity prices fluctuate widely in response to changing market forces. The
Company maintains a commodity-price-risk management strategy that uses
derivative instruments to minimize significant, unanticipated earning
fluctuations caused by commodity-price volatility. The Company does not
speculate using derivative instruments.
By using derivative financial instruments to reduce exposures to changes in
commodity prices, the Company exposes itself to credit risk and market risk.
Credit risk is the failure of the counterparty to perform under the terms of the
derivative contract. When the fair value of a derivative contract is positive,
the counterparty owes the Company, which creates credit risk for the Company.
When the fair value of a derivative contract is negative, the Company owes the
counterparty and, therefore, it does not incur credit risk. The Company
minimizes the credit risk in derivative instruments by entering into
transactions with high-quality counterparties whose credit rating is investment
grade.
Market risk is the adverse effect on the value of a financial instrument
that results from a change in commodity prices. The market risk associated with
commodity-price contracts is managed by establishing and monitoring parameters
that limit the types and degree of market risk that may be undertaken.
The Company periodically enters into natural gas and crude oil option
contracts for a portion of its anticipated hydrocarbon sales, to reduce the
price risk associated with fluctuations in market prices. The option contracts
limit the unfavorable affect that price decreases will have on hydrocarbon
sales. The maximum term over which the Company is hedging exposures to the
variability of cash flows for commodity price risk is 24 months.
Effective January 1, 2001, the Company adopted SFAS No. 133 and SFAS No.
138, an amendment to SFAS 133. SFAS 133 and 138 require that derivatives be
reported on the balance sheet at fair value and, if the derivative is not
designated as a hedging instrument, changes in fair value must be recognized in
earnings in the period of change. If the derivative is designated as a hedge and
to the extent such hedge is determined to be effective, changes in fair value
are either (a) offset by the change in fair value of the hedged asset or
liability (if applicable) or (b) reported as a component of other comprehensive
income (loss) in the period of change, and subsequently recognized in earnings
when the offsetting hedged transaction occurs. During 2002 and 2001, the Company
did not attempt to qualify for the hedge provisions under SFAS 133 and thus has
not designated its derivative transactions during those periods as hedging
instruments. Accordingly, the Company accounted for the changes in market value
of these derivatives through current earnings.
As of December 31, 2002, the Company had hedged portions of its expected
2003 natural gas production as follows:
Instrument Volume (mmbtus) Prices
-------------------------------------------------------------
Swaps 2,300,000 $3.95-$4.08
Collars 1,320,000 floor--$3.50 / cap--$6.00
The fair value of these derivative positions at that date was a $1,352
liability.
NOTE 7-EQUITY TRANSACTIONS
At December 31, 2002, the Company had 85,000 shares of Series A preferred
stock issued and outstanding. The preferred stock is convertible at the option
of the holder at a rate of $100 per share of common stock upon the occurrence of
certain qualifying events. The preferred stock has voting rights as if
converted. Each share has a liquidation preference of $1,000. Dividends accrue
at a rate of 8% per annum, become payable quarterly as declared, and are
cumulative and payable in the event of liquidation of the Company. At December
31, 2002, 2001 and 2000, there were $9,349, $3,504 and $446, respectively, of
undeclared dividends in arrears.
During 2002, the Company issued four private placements of Series A
preferred stock in the amounts of $5,000, $10,000, $5,000, and $10,000, which
were consummated on April 22, 2002, June 17, 2002, September 3,
91
GRYPHON EXPLORATION COMPANY
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except share related items)
2002, and November 5, 2002, respectively. During 2001, the Company issued three
private placements of Series A preferred stock, each in the amount of $10,000,
which closed on May 15, July 23, and November 19, 2001. As discussed in Note 1,
Cheniere has a right to participate in offerings of Series A preferred stock by
the Company. Cheniere elected not to participate in any of the Company's
offerings during 2002 or 2001. Based upon the conversion features of the
Company's Series A preferred stock, the interests of the Company's holders of
Series A preferred stock would represent approximately 91%, 80%, and 63% on an
as converted basis of the outstanding and issued Common Stock at December 31,
2002, 2001, and 2000, respectively.
As further discussed in Note 8, in July 2001, the Company acquired a 3D
seismic data set from Cheniere. In connection with that transaction, the Company
repurchased 6,740 shares of Common Stock for aggregate consideration of
approximately $418. These shares are included as treasury stock as of December
31, 2002 and 2001.
In March 2002, the Company and Cheniere settled litigation which had been
filed against them on a joint and several basis by a seismic company (the
"Claimant"). Pursuant to this settlement, the Company made a payment to the
Claimant and committed to make certain additional payments if production rights
are obtained by the Company or Cheniere in the area covered by the data set
licensed from the Claimant. In addition, the Company agreed to become
responsible for certain contingent obligations of Cheniere associated with the
Seitel data set. The maximum amount of the assumed liabilities associated with
this litigation and the contingent liabilities associated with the Seitel
dataset was approximately $2,561 in the aggregate. As consideration for the
Company's agreement to assume these contingent liabilities, Cheniere has
transferred to Gryphon 51,400 shares of the Company's common stock which
Cheniere held. Pursuant to this agreement, Cheniere has an option valid until
March 16, 2003 to repurchase these shares from the Company at a cost equal to
$50 per share, subject to an escalation adjustment. At December 31, 2002, the
maximum amount of the contingent obligations assumed is $934.
Based upon the foregoing transactions, Cheniere holds an interest of
approximately 9% in the Company, calculated on a fully diluted basis as of
December 31, 2002.
92
GRYPHON EXPLORATION COMPANY
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except share related items)
NOTE 8-STOCK-BASED COMPENSATION
In 2000, the Company established the Gryphon Exploration Company 2000 Stock
Option Plan (the "Option Plan"). In 2001, the Option Plan was amended and
restated. The Option Plan, as amended, allows for the issuance of options to
purchase up to 186,493 shares of Gryphon common stock at an exercise price of
$100 per share. The Company has reserved an equivalent number of shares of
common stock for issuance upon the exercise of options which have been granted
or which may be granted. The term of options granted under the Option Plan is
generally ten years. Vesting occurs over a three-year period, one third on each
anniversary of the grant date. The following table summarizes the Company's
stock option activity and related information for the periods presented:
Inception
Year ended December 31, (October 11, 2000)
---------------------------------- Through
2002 2001 December 31, 2000
--------------- ---------------- ------------------
Outstanding at Beginning of Period 81,122 39,400 --
Options Granted at an Exercise Price of $100 per share 20,332 42,722 39,750
Options Forfeited (350) (1,000) (350)
--------------- ---------------- ------------------
Outstanding at End of Period 101,104 81,122 39,400
=============== ================ ==================
Exercisable at End of Period 40,604 13,483 --
=============== ================ ==================
Weighted Average Exercise Price of Options Outstanding $ 100 $ 100 $ 100
=============== ================ ==================
Weighted Average Exercise Price of Options Exercisable $ 100 $ 100 N/A
=============== ================ ==================
Weighted Average Fair Value of Options Granted During the Period $ -- $ -- $ --
=============== ================ ==================
Weighted Average Remaining Contractual Life of Options Outstanding 8.44 years 9.3 years 9.8 years
Weighted Average Remaining Contractual Life of Options Exercisable 8.11 years 8.8 years --
The fair value of options is calculated using the Black-Scholes
option-pricing model. Assumptions used for 2002, 2001 and 2000 were: no dividend
yield, no volatility, risk-free interest rate of 4.3%, 3.8% and 5.6%,
respectively, and an expected average option life of 5 years. If the Company had
adopted the recognition provisions of SFAS No. 123 for 2002, 2001 and 2000, the
Company's financial statements would have not reflected a change in reported net
income.
NOTE 9-RELATED PARTY TRANSACTIONS
Under the terms of the Contribution and Subscription Agreement dated
October 11, 2000 by and among the Company, Cheniere and the other investors
listed therein, Gryphon provided office space to Cheniere at no cost from
Inception through December 2000. Also, pursuant to that agreement, Cheniere
provided accounting and cash management services to Gryphon without charge for
six months following the closing date.
Cheniere served as contract operator throughout 2000 for the well
contributed to Gryphon on which drilling was underway at Inception. Cheniere
received industry standard overhead reimbursements from all working interest
owners, including Gryphon, in accordance with the terms of the joint interest
operating agreement.
In April 2001, Gryphon purchased from Cheniere a 50% working interest in a
Texas offshore lease for cash consideration of $225, and simultaneously executed
a joint operating agreement which provided that Gryphon would become the
operator of the lease.
In June 2001, Gryphon completed a transaction with Cheniere for the
purchase of a license for 3D seismic data (the Seitel data set) granted to
Cheniere by Seitel Data Ltd. As a result of this transaction, Gryphon acquired
the rights to approximately 3,900 square miles of seismic data in the Gulf of
Mexico for a total purchase price of $3,500.
93
GRYPHON EXPLORATION COMPANY
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except share related items)
In July 2001, Gryphon purchased the right arising under an agreement
between JEBCO and Cheniere whereby Cheniere was to receive a seismic data
license (the JEBCO data set) to approximately 3,000 square miles of 3D seismic
data in the Gulf of Mexico. As part of this transaction, Gryphon also acquired
6,740 shares of Gryphon common stock from Cheniere. The aggregate purchase price
of $4,174 was allocated between seismic data and treasury stock based upon their
relative fair values at date of the transaction. In June 2001, Gryphon completed
a transaction with Cheniere for the purchase of a license for 3D seismic data
(the Seitel data set) granted to Cheniere by Seitel Data Ltd. As a result of
this transaction, Gryphon acquired the rights to approximately 3,900 square
miles of seismic data in the Gulf of Mexico for a total purchase price of
$3,500.
As discussed in Note 7 above, in March 2002, the Company entered into a
settlement agreement to resolve litigation against Cheniere and the Company.
Pursuant to the settlement, the Company agreed to assume certain obligations of
Cheniere. The maximum amount of the assumed liabilities pursuant to the
settlement and associated agreements was approximately $2,561 in the aggregate.
As consideration for the Company's agreement to assume these contingent
liabilities, Cheniere transferred to Gryphon 51,400 shares of the Company's
common stock which Cheniere held. Pursuant to this agreement, Cheniere has an
option valid for one year from the date of the agreement to repurchase these
shares from the Company at a cost equal to $50 per share, subject to escalation
beginning four months after the date of the stock transfer. At December 31,
2002, Cheniere had not exercised any its repurchase rights under the option
agreement.
During 2002, 2001, and 2000, the Company issued nine private placements of
Series A preferred stock for aggregate consideration of $85,000. Of this amount,
Warburg contributed $84,679 and the Company's management contributed $321 (see
Note 7).
NOTE 10-COMMITMENTS AND CONTINGENCIES
The Company has entered into an office lease agreement with a
non-cancelable term, which runs through March 2003. Future minimum lease
payments are $66 for the year ended December 31, 2003. Total rental expense for
office space for 2002, 2001 and 2000 was $286, $285 and $57, respectively.
At Inception, Gryphon acquired a master license agreement covering the
license of approximately 8,800 square miles of 3-D seismic data in the Gulf of
Mexico. In connection with the license agreement, the Company has made a
commitment to reprocess certain of the seismic data and to pay a fee for such
reprocessing as the reprocessed data are delivered. At December 31, 2002, the
Company had met its commitments related to future deliveries of reprocessed
data.
In connection with the purchase from Cheniere of the JEBCO data set (see
Note 9), the Company has an obligation to pay for the related seismic data once
it has been delivered to the Company, and accepted by Cheniere.
NOTE 11-OIL AND GAS OPERATIONS
The Company uses the full cost method of accounting for its oil and natural
gas properties. Unproved oil and gas properties include costs that are excluded
from proved oil and gas properties and that are not subject to amortization.
These amounts generally represent costs of investments in unproved properties,
non-producing leases, seismic data sets, and major development projects. Gryphon
excludes these costs until proved reserves are found or it is determined that
the costs are impaired. The costs of unproved oil and natural gas properties are
reviewed at least annually to determine if impairment has occurred. Any
impairment is transferred to the proved oil and gas property pool. The Company
evaluates significant properties, composed primarily of costs associated with
offshore leases and seismic data sets, at least annually. Non-producing leases
are evaluated based on the progress of the Company's exploration program to
date.
94
GRYPHON EXPLORATION COMPANY
NOTES TO FINANCIAL STATEMENTS
(dollars in thousands, except share related items)
The following table summarizes the cost of the properties not subject to
amortization for the periods during which the costs were incurred:
December 31,
----------------------
2002 2001
---------- ---------
Year cost incurred:
Inception through
December 31, 2000 $ 11,025 $ 13,422
2001 11,055 14,645
2002 14,605 -
---------- ---------
Total $ 36,685 $ 28,067
========== =========
NOTE 12-SUBSEQUENT EVENTS
On February 10, 2003, the Company entered into a three-year, reserve based,
revolving credit facility. The nominal amount of the facility is $100,000 and
the initial borrowing base is $18,000. The borrowing base will be adjusted from
time to time based upon changes in the Company's oil and gas reserves. Proceeds
borrowed from the facility can be used to fund the Company's operations, for
acquisitions, and for general corporate purposes. The facility requires
quarterly interest payments based upon up floating rate indexes and includes
covenants typically associated with similar credit agreements. The credit
facility matures February 10, 2006. As of March 14, 2003, the Company had drawn
$5,000 under the facility.
In January 2003, the Company entered into an amendment and extension to its
office lease. Pursuant to this amendment, the Company expanded its office space
by approximately 40% and extended the term by seven years from March 2003. The
extended term includes an option which allows the Company to terminate the lease
at the end of the fifth year of the extension period. The estimated aggregate
obligation of the Company pursuant to the amendment is approximately $2,990
assuming a seven year extension or approximately $2,170 assuming the extension
is terminated at the end of year five.
95
GRYPHON EXPLORATION COMPANY
SUPPLEMENTAL INFORMATION TO THE FINANCIAL STATEMENTS
OIL AND GAS RESERVES AND RELATED FINANCIAL DATA
(dollars in thousands)
SUPPLEMENTAL OIL AND GAS DISCLOSURES (UNAUDITED)
The following tables set forth information about the Company's oil and gas
producing activities pursuant to the requirements of Statement of Financial
Accounting Standards No. 69, "Disclosures About Oil and Gas Producing
Activities" ("SFAS 69").
Investments in oil and gas properties are set forth below:
December 31,
------------------------
2002 2001
---------- ----------
Oil and Gas Properties:
Proved $ 61,583 $ 26,705
Unproved 36,685 28,067
---------- ----------
98,268 54,772
Less Accumulated Depreciation,
Depletion and Amortization (7,261) (1,221)
---------- ----------
$ 91,007 $ 53,551
========== ==========
As of December 31, 2002 and 2001, the Company's investment in oil and gas
properties included $36,685 and $28,067, respectively in unevaluated properties,
which have been excluded from amortization. Such costs will be evaluated in
future periods based on management's assessment of exploration activities,
expiration dates of licenses, permits and concessions, changes in economic
conditions and other factors.
The Company began production of oil and gas in February 2001. The Company
capitalized as oil and gas property costs approximately $2,408, $2,023 and $98
of general and administrative expenses directly related to its exploration and
development activities in 2002, 2001 and 2000, respectively.
The Company has made a substantial investment in acquiring, processing and
reprocessing Gulf of Mexico seismic data, which cover various areas having an
aggregate size of 18,000 square miles. The costs of these projects become
subject to amortization on a ratable basis as prospects are identified in each
of the data set project areas.
96
GRYPHON EXPLORATION COMPANY
SUPPLEMENTAL INFORMATION TO THE FINANCIAL STATEMENTS
OIL AND GAS RESERVES AND RELATED FINANCIAL DATA
(dollars in thousands)
Costs Incurred
Costs incurred in oil and gas property acquisition, exploration, and
development activities are set forth in the table below:
Inception
Year ended December 31, (October 11, 2000)
------------------------------------------- Through
2002 2001 December 31, 2000
-------------------- -------------------- --------------------
Acquisition of Properties:
Proved Properties $ -- $ 227 $ --
Unproved Properties 9,806 14,360 7,876
Exploration Costs 25,079 12,430 2,018
Development Costs 8,611 9,559 729
-------------------- -------------------- --------------------
43,496 36,576 10,623
Assets Contributed at Inception -- -- 7,573
-------------------- -------------------- --------------------
Total $ 43,496 $ 36,576 $ 18,196
==================== ==================== ====================
For the years ended December 31, 2002 and 2001 depreciation, depletion and
amortization of the capitalized costs of oil and gas properties was $1.70 and
$1.52 per Mcfe, respectively. Depreciation, depletion and amortization of oil
and gas properties during the period from Inception to December 31, 2000 was $0.
Reserve Quantities
The following table shows estimates of proved reserves and proved developed
reserves, net of royalty interest, of natural gas, crude oil, and condensate
owned at year-end and changes in proved reserves during the last two years and
the period from Inception through December 31, 2000 prepared by independent
petroleum engineers in accordance with the rules and regulations of the
Securities and Exchange Commission. Volumes for natural gas are in millions of
cubic feet (mmcf) at the official temperature and pressure bases of the areas in
which the gas reserves are located. Liquid hydrocarbons, consisting of oil and
condensates, are expressed in standard 42 gallon barrels (bbls). These estimates
represent the Company's interest in the reserves associated with its properties.
All of the Company's oil and gas reserves are located within the United States
and its territorial waters.
The Company's reserves increased in 2002 and 2001 primarily from
exploration and development drilling activities, offset in part by production.
The Company emphasizes that the volumes of reserves shown below are estimates
which, by their nature, are subject to revision. The estimates are made using
all available geological and reservoir data as well as production performance
data. These estimates are reviewed and revised, either upward or downward, as
warranted by additional data. Revisions are necessary due to changes in
assumptions based on, among other things, reservoir performance, prices,
economic conditions and governmental restrictions. Decreases in prices, for
example, may cause a reduction in some proved reserves due to uneconomic
conditions.
97
GRYPHON EXPLORATION COMPANY
SUPPLEMENTAL INFORMATION TO THE FINANCIAL STATEMENTS
OIL AND GAS RESERVES AND RELATED FINANCIAL DATA
(dollars in thousands)
Year Ended December 31, Inception
---------------------------------------------------- (October 11,2000)through
2002 2001 December 31, 2000
------------------------ ------------------------ ------------------------
Oil Gas Oil Gas Oil Gas
(bbls) (mmcf) (bbls) (mmcf) (bbls) (mmcf)
---------- ---------- ---------- ---------- ---------- -----------
Proved Reserves:
Beginning of Period 210,151 17,468 2,640 1,674 -- --
Revisions of Previous Estimates (41,342) (3,904) (845) (1,268) -- --
Extensions, Discoveries and Other Additions 243,319 17,222 219,099 17,822 2,640 1,674
Production (40,320) (3,278) (10,743) (760) -- --
---------- ---------- ---------- ---------- ---------- -----------
End of Period 371,808 27,508 210,151 17,468 2,640 1,674
========== ========== ========== ========== ========== ===========
Proved Developed Reserves:
Beginning of Period 192,569 13,022 2,640 1,674 -- --
End of Period 165,421 16,332 192,569 13,022 2,640 1,674
There are numerous uncertainties inherent in estimating quantities of
proved reserves and in projecting future rates of production and future amounts
and timing of development expenditures, including many factors beyond the
control of the Company. Reserve engineering is a subjective process of
estimating underground accumulations of crude oil and natural gas that cannot be
measured in an exact manner, and the accuracy of any reserve estimate is a
function of the quality of available data and of engineering and geological
interpretation and judgment. Estimates of proved undeveloped reserves are
inherently less certain than estimates of proved developed reserves. The
quantities of oil and gas that are ultimately recovered, production and
operating costs, the amount and timing of future development expenditures,
geologic success and future oil and gas sales prices may all differ from those
assumed in these estimates. In addition, the Company's reserves may be subject
to downward or upward revision based upon production history, purchases or sales
of properties, results of future development, prevailing oil and gas prices and
other factors.
Standardized Measure of Discounted Future Net Cash Flows
The following table sets forth estimates of future cash flows from proved
reserves of gas, oil and condensate which were prepared by independent petroleum
engineers. The standardized measure of discounted future cash flow amounts are
based upon year-end prices of $31.35, $19.33 and $29.72 per barrel of oil
(WTI--Cushing) and $4.75, $2.63 and $10.60 per mcf of natural gas (NYMEX--Henry
Hub) at December 31, 2002, 2001 and 2000, respectively. Estimated future cash
inflows are reduced by estimated future development and production costs based
on year-end cost levels, assuming continuation of existing economic conditions,
and by estimated future income tax expense. Income tax expense is calculated by
applying the existing statutory tax rates, including any known future changes,
to the pre-tax net cash flows giving effect to any permanent differences and
reduced by the applicable tax basis. The effect of tax credits is considered in
determining the income tax expense.
The present value of future net revenues does not purport to be an estimate
of the fair market value of Gryphon's proved reserves. An estimate of fair value
would also take into account, among other things, anticipated changes in future
prices and costs, the expected recovery of reserves in excess of proved reserves
and a discount factor more representative of the time value of money and the
risks inherent in producing oil and gas. Significant changes in estimated
reserve volumes or commodity prices could have a material effect on the
Company's financial statements.
Under the full cost method of accounting, a non-cash charge to earning
related to the carrying value of the Company's oil and gas properties on a
country-by-country basis may be required when prices are low. Whether the
Company will be required to take such a charge depends on the prices for crude
oil and natural gas at the end of any quarter, as well as the effect of both
capital expenditures and changes to proved reserves during the quarter. If a
98
GRYPHON EXPLORATION COMPANY
SUPPLEMENTAL INFORMATION TO THE FINANCIAL STATEMENTS
OIL AND GAS RESERVES AND RELATED FINANCIAL DATA
(dollars in thousands)
non-cash charge were required, it would reduce earnings for the period and
result in lower DD&A expense in future periods.
The standardized measure of discounted future net cash flows relating to
proved oil and gas reserves is set forth in the following table:
December 31,
------------------------
2002 2001
---------- ----------
Future Cash Inflows (Sales) $ 148,628 $ 49,949
Less - Future Costs:
Production (8,923) (4,499)
Development and Dismantlement (7,288) (2,926)
---------- ----------
Future Net Cash Flows before Income Taxes 132,417 42,524
Less - 10% Annual Discount for Estimated Timing of Cash Flow (25,477) (9,956)
---------- ----------
Present Value of Future net Cash Flows before Income Taxes 106,939 32,568
Less - Present Value of Future Income Taxes (11,728) (3,790)
---------- ----------
Standardized Measure of Discounted Future net Cash Flows $ 95,211 $ 28,778
========== ==========
The following table summarizes the principal sources of change in the
standardized measure of discounted future net cash flows:
Inception
Year ended December 31, (October 11, 2000)
---------------------------------- Through
2002 2001 December 31, 2000
--------------- --------------- ------------------
Standardized Measure - Beginning of Period $ 28,778 $ 9,139 $ --
Increases (Decreases) -
Sales, net of Production Costs (8,465) (2,128) --
Accretion of Discount 3,257 975 --
Net Change in Sales Prices, net of Production Costs 24,104 (11,258) --
Changes in Estimated Future Development Costs 122 -- --
Revisions of Quantity Estimates (14,784) (3,047) --
Extensions, Discoveries and Other Additions, net of Future
Production and Development Costs 69,357 34,232 9,139
Development Costs Incurred during the Period that Reduced
Previously Estimated Development Cost 1,308 735 --
Net Change in Income Taxes (7,938) 138 --
Changes in Production Rates (timing) and Other (528) (8) --
--------------- --------------- ------------------
Standardized Measure - End of Period $ 95,211 $ 28,778 $ 9,139
=============== =============== ==================
99