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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended March 31, 2003
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 Number: 0-20100
BELDEN & BLAKE CORPORATION
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(Exact name of registrant as specified in its charter)
Ohio 34-1686642
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5200 Stoneham Road
North Canton, Ohio 44720
- ---------------------------------------- ------------------
(Address of principal executive offices) (Zip Code)
(330) 499-1660
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if changed
since last report.)
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.
[X] Yes [ ] No
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes No X
--- ---
As of April 30, 2003, Belden & Blake Corporation had outstanding
10,316,095 shares of common stock, without par value, which is its only class of
stock.
BELDEN & BLAKE CORPORATION
INDEX
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PAGE
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PART I Financial Information:
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2003 and
December 31, 2002................................................................ 1
Consolidated Statements of Operations for the three
months ended March 31, 2003 and 2002 ............................................ 2
Consolidated Statements of Shareholders' Equity (Deficit)
for the three months ended March 31, 2003 and the years ended
December 31, 2002 and 2001....................................................... 3
Consolidated Statements of Cash Flows for the three
months ended March 31, 2003 and 2002 ............................................ 4
Notes to Consolidated Financial Statements.......................................... 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................................. 8
Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................... 17
Item 4. Controls and Procedures............................................................. 19
PART II Other Information
Item 6. Exhibits and Reports on Form 8-K.................................................... 20
BELDEN & BLAKE CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31, DECEMBER 31,
2003 2002
----------- ------------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 1,058 $ 1,722
Accounts receivable, net 19,667 14,652
Inventories 851 848
Deferred income taxes 6,530 4,200
Other current assets 1,692 1,341
Assets of discontinued operations 343 1,066
--------- ---------
TOTAL CURRENT ASSETS 30,141 23,829
PROPERTY AND EQUIPMENT, AT COST
Oil and gas properties (successful efforts method) 450,888 438,240
Gas gathering systems 15,160 14,482
Land, buildings, machinery and equipment 22,910 22,748
--------- ---------
488,958 475,470
Less accumulated depreciation, depletion and amortization 242,179 243,596
--------- ---------
PROPERTY AND EQUIPMENT, NET 246,779 231,874
FAIR VALUE OF DERIVATIVES 533 3
OTHER ASSETS 7,837 8,139
--------- ---------
$ 285,290 $ 263,845
========= =========
LIABILITIES AND SHAREHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable $ 6,186 $ 5,661
Accrued expenses 23,337 17,767
Current portion of long-term liabilities 771 315
Fair value of derivatives 11,212 5,486
Liabilities of discontinued operations 333 335
--------- ---------
TOTAL CURRENT LIABILITIES 41,839 29,564
LONG-TERM LIABILITIES
Bank and other long-term debt 30,956 26,868
Senior subordinated notes 225,000 225,000
Other 4,128 91
--------- ---------
260,084 251,959
FAIR VALUE OF DERIVATIVES 6,983 4,371
DEFERRED INCOME TAXES 23,523 22,596
SHAREHOLDERS' DEFICIT
Common stock without par value; $.10 stated value per share; authorized
58,000,000 shares; issued 10,516,574 and 10,490,440 shares
(which includes 199,494 and 194,890 treasury shares, respectively) 1,032 1,030
Paid in capital 107,105 107,118
Deficit (145,564) (148,332)
Accumulated other comprehensive loss (9,712) (4,461)
--------- ---------
TOTAL SHAREHOLDERS' DEFICIT (47,139) (44,645)
--------- ---------
$ 285,290 $ 263,845
========= =========
See accompanying notes.
1
BELDEN & BLAKE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED, IN THOUSANDS)
THREE MONTHS ENDED MARCH 31,
----------------------------
2003 2002
-------- ---------
REVENUES
Oil and gas sales $ 19,427 $ 21,858
Gas gathering, marketing, and oilfield service 8,104 6,630
Other 183 499
-------- --------
27,714 28,987
EXPENSES
Production expense 4,503 4,867
Production taxes 673 443
Gas gathering, marketing, and oilfield service 7,514 5,030
Exploration expense 2,242 2,589
General and administrative expense 1,174 1,202
Franchise, property and other taxes 71 71
Depreciation, depletion and amortization 4,331 6,000
Accretion expense 86 --
Derivative fair value loss 277 427
-------- --------
20,871 20,629
-------- --------
OPERATING INCOME 6,843 8,358
OTHER EXPENSE
Interest expense 6,216 5,894
-------- --------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 627 2,464
Provision for income taxes 232 955
-------- --------
INCOME FROM CONTINUING OPERATIONS BEFORE CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 395 1,509
Loss from discontinued operations, net of tax (24) (65)
-------- --------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE 371 1,444
Cumulative effect of change in accounting principle, net of tax 2,397 --
-------- --------
NET INCOME $ 2,768 $ 1,444
======== ========
See accompanying notes.
2
BELDEN & BLAKE CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
ACCUMULATED
OTHER TOTAL
COMMON COMMON PAID IN COMPREHENSIVE EQUITY
SHARES STOCK CAPITAL DEFICIT INCOME (DEFICIT)
------ ------ ------- ------- ------------- ---------
JANUARY 1, 2001 10,303 $ 1,030 $ 107,921 $ (157,264) $ -- $ (48,313)
Comprehensive income:
Net income 6,467 6,467
Other comprehensive income, net of tax:
Cumulative effect of accounting change (6,691) (6,691)
Change in derivative fair value 24,667 24,667
Reclassification adjustment for
derivative (gain) loss reclassified
into oil and gas sales (2,889) (2,889)
---------
Total comprehensive income 21,554
---------
Stock options exercised 68 7 (1) 6
Stock-based compensation 275 275
Repurchase of stock options (772) (772)
Tax benefit of repurchase of stock options
and stock options exercised 260 260
Treasury stock (81) (8) (281) (289)
- ------------------------------------------- ------- ------- --------- ---------- -------- ---------
DECEMBER 31, 2001 10,290 1,029 107,402 (150,797) 15,087 (27,279)
Comprehensive income:
Net income 2,465 2,465
Other comprehensive income, net of tax:
Change in derivative fair value (5,518) (5,518)
Reclassification adjustment for
derivative (gain) loss reclassified
into oil and gas sales (14,030) (14,030)
---------
Total comprehensive income (17,083)
---------
Stock options exercised 65 7 (2) 5
Stock-based compensation 82 82
Repurchase of stock options (29) (29)
Tax benefit of repurchase of stock options
and stock options exercised 57 57
Treasury stock (59) (6) (392) (398)
- ------------------------------------------- ------- ------- --------- ---------- -------- ---------
DECEMBER 31, 2002 10,296 1,030 107,118 (148,332) (4,461) (44,645)
Comprehensive income:
Net income 2,768 2,768
Other comprehensive income, net of tax:
Change in derivative fair value (4,791) (4,791)
Reclassification adjustment for
derivative (gain) loss reclassified
into oil and gas sales (460) (460)
---------
Total comprehensive income (2,483)
---------
Stock options exercised 26 3 -- 3
Stock-based compensation 18 18
Repurchase of stock options (48) (48)
Tax benefit of repurchase of stock options
and stock options exercised 26 26
Treasury stock (5) (1) (9) (10)
- ------------------------------------------- ------- ------- --------- ---------- -------- ---------
MARCH 31, 2003 (UNAUDITED) 10,317 $ 1,032 $ 107,105 $ (145,564) $ (9,712) $ (47,139)
=========================================== ======= ======= ========= ========== ======== =========
See accompanying notes.
3
BELDEN & BLAKE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
THREE MONTHS ENDED MARCH 31,
---------------------------
2003 2002
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CASH FLOWS FROM OPERATING ACTIVITIES:
Income from continuing operations $ 395 $ 1,509
Adjustments to reconcile income from continuing operations
to net cash provided by operating activities:
Depreciation, depletion and amortization 4,331 6,000
Accretion of discount on asset retirement obligations 86 --
Loss on disposal of property and equipment 277 74
Net monetization of derivatives -- 21,734
Amortization of derivatives and other noncash hedging activities (446) (3,780)
Exploration expense 2,242 2,589
Deferred income taxes 206 955
Stock-based compensation 18 21
Change in operating assets and liabilities, net of
effects of acquisition and disposition of businesses:
Accounts receivable and other operating assets (5,366) (251)
Inventories (3) 87
Accounts payable and accrued expenses 6,095 5,231
------- -------
NET CASH PROVIDED BY CONTINUING OPERATIONS 7,835 34,169
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of businesses, net of cash acquired (3,752) --
Disposition of businesses, net of cash 100 250
Proceeds from property and equipment disposals 118 28
Exploration expense (2,242) (2,589)
Additions to property and equipment (7,253) (6,409)
Increase in other assets (18) (31)
------- -------
NET CASH USED IN INVESTING ACTIVITIES (13,047) (8,751)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from revolving line of credit 47,443 28,671
Repayment of long-term debt and other obligations (43,549) (54,774)
Proceeds from stock options exercised 3 2
Repurchase of stock options (48) --
Tax benefit of repurchase of stock options and stock options exercised 26 --
Purchase of treasury stock (10) (5)
------- -------
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES 3,865 (26,106)
------- -------
NET DECREASE IN CASH AND CASH EQUIVALENTS
FROM CONTINUING OPERATIONS (1,347) (688)
NET INCREASE IN CASH AND CASH EQUIVALENTS
FROM DISCONTINUED OPERATIONS 683 399
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 1,722 1,935
------- -------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 1,058 $ 1,646
======= =======
See accompanying notes.
4
BELDEN & BLAKE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
MARCH 31, 2003
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(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Belden
& Blake Corporation (the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three month period ended March 31, 2003 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2003. For further information, refer to the consolidated financial
statements and footnotes included in the Company's annual report on Form 10-K
for the year ended December 31, 2002. Certain reclassifications have been made
to conform to the current presentation.
(2) NEW ACCOUNTING PRONOUNCEMENTS
On January 1, 2003, the Company adopted Financial Accounting Standards
Board (FASB) Statement of Financial Accounting Standards No. (SFAS) 143,
"Accounting for Asset Retirement Obligations." SFAS 143 amends SFAS 19,
"Financial Accounting and Reporting by Oil and Gas Producing Companies" to
require the Company to recognize a liability for the fair value of its asset
retirement obligations associated with its tangible, long-lived assets. The
majority of the asset retirement obligations recorded by the Company relate to
the plugging and abandonment (excluding salvage value) of its oil and gas
properties. At January 1, 2003, there were no assets legally restricted for
purposes of settling asset retirement obligations. The adoption of SFAS 143
resulted in a January 1, 2003 cumulative effect adjustment to record a $4.0
million increase in long-term asset retirement obligation liabilities, a
$621,000 increase in current asset retirement obligation liabilities, a $3.2
million increase in the carrying value of oil and gas assets, a $5.2 million
decrease in accumulated depreciation, depletion and amortization and a $1.4
million increase in deferred income tax liabilities. The net effect of adoption
was to record a gain of $2.4 million, net of tax, as a cumulative effect of a
change in accounting principle in the Company's consolidated statement of
operations in the first quarter of 2003.
Subsequent to the adoption of SFAS 143, there has been no significant
current period activity with respect to additional retirement obligations,
settled obligations, accretion expense and revisions of estimated cash flows.
The unaudited pro forma net income for the quarter ended March 31, 2002 was $1.7
million and has been prepared to give effect to the adoption of SFAS 143 as if
it had been adopted on January 1, 2002. Assuming retroactive application of the
change in accounting principle as of January 1, 2002, liabilities would have
increased $6 million.
On January 1, 2003, the Company adopted SFAS 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS 145 rescinds SFAS 4, "Reporting Gains and Losses from
Extinguishment of Debt," SFAS 44, "Accounting for Intangible Assets of Motor
Carriers" and SFAS 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements" and amends SFAS No. 13, "Accounting for Leases." Statement 145
also makes technical corrections to other existing pronouncements. SFAS 4
required gains and losses from extinguishment of
5
debt to be classified as an extraordinary item, net of the related income tax
effect. As a result of the rescission of SFAS 4, the criteria for extraordinary
items in Accounting Principles Board Opinion No. (APB) 30, "Reporting the
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," now will be used to classify those gains and losses. The adoption
of SFAS 145 did not have any effect on the Company's financial position, results
of operations or cash flows.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS 146 is effective for the
Company for disposal activities initiated after December 31, 2002. The adoption
of this standard did not have any effect on the Company's financial position,
results of operations or cash flows.
In November 2002, the FASB issued FASB Interpretation No. (FIN) 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN 45's disclosure requirements
are effective for the Company's interim and annual financial statements for
periods ending after December 15, 2002. The initial recognition and measurement
provisions are applicable on a prospective basis to guarantees issued or
modified after December 31, 2002. FIN 45 requires certain guarantees to be
recorded at fair value, which is different from current practice, which is
generally to record a liability only when a loss is probable and reasonably
estimable. FIN 45 also requires a guarantor to make significant new disclosures,
even when the likelihood of making any payments under the guarantee is remote.
Adoption of FIN 45 did not have any effect on the Company's financial statement
disclosures, financial position, results of operations or cash flows.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." SFAS 148 amends FASB 123, "Accounting
for Stock-Based Compensation," to provide alternative methods of transition for
a voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS 148 amends the disclosure requirements
of SFAS 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on the reported results. The
Company measures expense associated with stock-based compensation using the
intrinsic value method prescribed by APB 25, "Accounting for Stock Issued to
Employees" and its related interpretations. Under APB 25, no compensation
expense is required to be recognized by the Company upon the issuance of stock
options to key employees as the exercise price of the option is equal to the
market price of the underlying common stock at the date of grant. The provisions
of SFAS 148 are effective for financial statements for fiscal years ending after
December 15, 2002. The adoption of SFAS 148 did not have a material effect on
the Company's financial position, results of operations or cash flows.
The fair value of the Company's stock options was estimated at the date
of grant using a Black-Scholes option pricing model with the following
weighted-average assumptions for the first quarter of 2003: risk-free interest
rate of 3.7%, volatility factor of the expected market price of the Company's
common stock of near zero, dividend yield of zero, and a weighted-average
expected life of the option of seven years. There were no options granted in
the first quarter of 2002.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its stock options.
For purposes of the pro forma disclosures required by SFAS 123, the
estimated fair value of the options is amortized to expense over the options'
vesting period. The changes in net income or loss as if the Company had applied
the fair value provisions of SFAS 123 for the quarters ended March 31, 2003 and
2002 were not material.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities - An Interpretation of Accounting Research Bulletin (ARB) 51."
FIN 46 is an interpretation of ARB 51, "Consolidated Financial Statements," and
addresses consolidation by business enterprises of variable interest entities
(VIEs). The primary objective of FIN 46 is to provide guidance on the
identification of, and financial reporting for, entities over which control is
achieved through means other than voting rights; such entities are known as
VIEs. FIN 46 requires an enterprise to consolidate a VIE if that enterprise has
a variable interest that will absorb a majority of the entity's expected losses
if they occur, receive a majority of the entity's expected residual returns if
they occur or both. An enterprise shall consider the rights and obligations
conveyed by its variable interests in making this determination. This guidance
applies immediately to VIEs created after January 31, 2003, and to VIEs in which
an enterprise obtains an interest
6
after that date. It applies in the first fiscal year or interim period beginning
after June 15, 2003, to VIEs in which an enterprise holds a variable interest
that it acquired before February 1, 2003. Adoption of FIN 46 did not have any
effect on the Company's financial statement disclosures, financial position,
results of operations or cash flows.
(3) ACQUISITION
In February 2003, the Company purchased reserves in certain wells the
Company operates in Michigan for $3.75 million in cash. These properties were
subject to a prior monetization transaction of the Section 29 tax credits which
the Company entered into in 1996. The Company had the option to purchase these
properties beginning in 2003. The Company previously held a production payment
on these properties including a 75% reversionary interest in certain future
production. The Company purchased those reserve volumes beyond its previously
held production payment along with the 25% reversionary interest not owned. The
estimated volumes acquired were 4.4 Bcf of proved developed producing gas
reserves. The pro forma effect of the acquisition was not material.
(4) DERIVATIVES AND HEDGING
The Company recognizes all derivative financial instruments as either
assets or liabilities at fair value. The changes in fair value of derivative
instruments not qualifying for designation as cash flow hedges that occur prior
to maturity are initially reported in expense in the consolidated statements of
operations as derivative fair value (gain) loss. All amounts recorded in this
line item are ultimately reversed within the same line item and included in oil
and gas sales revenues over the respective contract terms. Changes in the fair
value of derivative instruments that are fair value hedges are offset against
changes in the fair value of the hedged assets, liabilities, or firm
commitments, through net income (loss). Changes in the fair value of derivative
instruments that are cash flow hedges are recognized in other comprehensive
income (loss) until such time as the hedged items are recognized in net income
(loss).
The hedging relationship between the hedging instruments and hedged
item must be highly effective in achieving the offset of changes in fair values
or cash flows attributable to the hedged risk both at the inception of the
contract and on an ongoing basis. The Company measures effectiveness at least on
a quarterly basis. Ineffective portions of a derivative instrument's change in
fair value are immediately recognized in net income (loss). If there is a
discontinuance of a cash flow hedge because it is probable that the original
forecasted transaction will not occur, deferred gains or losses are recognized
in earnings immediately.
From time to time the Company may enter into a combination of futures
contracts, commodity derivatives and fixed-price physical contracts to manage
its exposure to natural gas or oil price volatility and support the Company's
capital expenditure plans. The Company employs a policy of hedging gas
production sold under New York Mercantile Exchange ("NYMEX") based contracts by
selling NYMEX based commodity derivative contracts which are placed with major
financial institutions that the Company believes are minimal credit risks. The
contracts may take the form of futures contracts, swaps, collars or options. At
March 31, 2003, the Company's derivative contracts were comprised of natural gas
swaps, collars and options. Qualifying NYMEX based derivative contracts are
designated as cash flow hedges.
During the first quarters of 2003 and 2002, a net loss of $6.1 million
($3.9 million after tax) and a net gain of $6.6 million ($4.2 million after
tax), respectively, were reclassified from accumulated other comprehensive
income to earnings. The fair value of open hedges decreased $7.8 million ($5.0
million after tax) in the first quarter of 2003 and increased $763,000 ($485,000
after tax) in the first quarter of
7
2002. At March 31, 2003, the estimated net loss in accumulated other
comprehensive income that is expected to be reclassified into earnings within
the next 12 months is approximately $8.9 million. The Company has partially
hedged its exposure to the variability in future cash flows through December
2005.
In March 2003, the Company entered into a collar for 4,320 Bbtu
(billion British thermal units) of its natural gas production in 2004 with a
ceiling price of $5.80 per Mmbtu (million British thermal units) and a floor
price of $4.00 per Mmbtu. The Company also sold a floor at $3.00 per Mmbtu on
this volume of gas. This aggregate structure has the effect of: 1) setting a
maximum price of $5.80 per Mmbtu; 2) floating at prices from $4.00 to $5.80 per
Mmbtu; 3) locking in a price of $4.00 per Mmbtu if prices are between $3.00 and
$4.00 per Mmbtu; and 4) receiving a price of $1.00 per Mmbtu above the price if
the price is $3.00 or less. All prices are based on monthly NYMEX settle.
(5) INDUSTRY SEGMENT FINANCIAL INFORMATION
The Company operates in one reportable segment, as an independent
energy company engaged in producing oil and natural gas; exploring for and
developing oil and gas reserves; acquiring and enhancing the economic
performance of producing oil and gas properties; and marketing and gathering
natural gas for delivery to intrastate and interstate gas transmission
pipelines. The Company's operations are conducted entirely in the United States.
(6) SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
QUARTER ENDED MARCH 31,
----------------------
(in thousands) 2003 2002
------ ------
CASH PAID DURING THE PERIOD FOR:
Interest $ 612 $ 864
Income taxes, net of refunds -- 1
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Acquisition of assets in exchange for long-term liabilities -- 263
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE, NET OF TAX 2,397 --
(7) SUBSEQUENT EVENT
In April 2003, the Company entered into a collar for 6,000 Bbtu of its
natural gas production in 2005 with a ceiling price of $5.37 per Mmbtu and a
floor price of $4.00 per Mmbtu. The Company also sold a floor at $3.10 per Mmbtu
on this volume of gas. This aggregate structure has the effect of: 1) setting a
maximum price of $5.37 per Mmbtu; 2) floating at prices from $4.00 to $5.37 per
Mmbtu; 3) locking in a price of $4.00 per Mmbtu if prices are between $3.10 and
$4.00 per Mmbtu; and 4) receiving a price of $0.90 per Mmbtu above the price if
the price is $3.10 or less. All prices are based on monthly NYMEX settle.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING INFORMATION
The information in this document includes forward-looking statements
that are made pursuant to Safe Harbor Provisions of the Private Securities
Litigation Reform Act of 1995. Statements preceded by, followed by or that
otherwise include the statements "should," "believe," "expect," "anticipate,"
"intend," "will," "continue," "estimate," "plan," "outlook," "may," "future,"
"projection," and variations of these statements and similar expressions are
forward-looking statements. These forward-looking statements are
8
based on current expectations and projections about future events.
Forward-looking statements, and the business prospects of the Company are
subject to a number of risks and uncertainties which may cause the Company's
actual results in future periods to differ materially from the forward-looking
statements contained herein. These risks and uncertainties include, but are not
limited to, the Company's access to capital, the market demand for and prices of
oil and natural gas, the Company's oil and gas production and costs of
operation, results of the Company's future drilling activities, the
uncertainties of reserve estimates, general economic conditions, new legislation
or regulatory changes, changes in accounting principles, policies or guidelines
and environmental risks. These and other risks are described in the Company's
10-K and 10-Q reports and other filings with the Securities and Exchange
Commission ("SEC").
CRITICAL ACCOUNTING POLICIES
- ----------------------------
The Company prepares its consolidated financial statements in
accordance with accounting principles generally accepted in the United States
("GAAP") and SEC guidance. See the "Notes to Consolidated Financial Statements"
included in "Item 8. Financial Statements and Supplementary Data" in the
Company's 2002 Form 10-K annual report filed with the SEC for a comprehensive
discussion of the Company's significant accounting policies. GAAP requires
information in financial statements about the accounting principles and methods
used and the risks and uncertainties inherent in significant estimates including
choices between acceptable methods. Following is a discussion of the Company's
most critical accounting policies:
SUCCESSFUL EFFORTS METHOD OF ACCOUNTING
The accounting for and disclosure of oil and gas producing activities
requires the Company's management to choose between GAAP alternatives and to
make judgments about estimates of future uncertainties.
The Company utilizes the "successful efforts" method of accounting for
oil and gas producing activities as opposed to the alternate acceptable "full
cost" method. Under the successful efforts method, property acquisition and
development costs and certain productive exploration costs are capitalized while
non-productive exploration costs, which include certain geological and
geophysical costs, exploratory dry hole costs and costs of carrying and
retaining unproved properties, are expensed as incurred.
The major difference between the successful efforts method of
accounting and the full cost method is under the full cost method of accounting,
such exploration costs and expenses are capitalized as assets, pooled with the
costs of successful wells and charged against the net income (loss) of future
periods as a component of depletion expense.
OIL AND GAS RESERVES
The Company's proved developed and proved undeveloped reserves are all
located within the Appalachian and Michigan Basins in the United States. The
Company cautions that there are many uncertainties inherent in estimating proved
reserve quantities and in projecting future production rates and the timing of
development expenditures. In addition, estimates of new discoveries are more
imprecise than those of properties with a production history. Accordingly, these
estimates are expected to change as future information becomes available.
Material revisions of reserve estimates may occur in the future, development and
production of the oil and gas reserves may not occur in the periods assumed and
actual prices realized and actual costs incurred may vary significantly from
assumptions used. Proved reserves represent estimated quantities of natural gas
and oil that geological and engineering data demonstrate, with reasonable
certainty, to be recoverable in future years from known reservoirs under
economic and
9
operating conditions existing at the time the estimates were made. Proved
developed reserves are proved reserves expected to be recovered through wells
and equipment in place and under operating methods being utilized at the time
the estimates were made. 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.
The Company's proved reserve information is based on estimates it
prepared. Estimates prepared by others may be higher or lower than the Company's
estimates. The Company's estimates of proved reserves have been reviewed by
independent petroleum engineers.
CAPITALIZATION, DEPRECIATION, DEPLETION AND IMPAIRMENT OF LONG-LIVED ASSETS
See the "Successful Efforts Method of Accounting" discussion above.
Capitalized costs related to proved properties are depleted using the
unit-of-production method. Depreciation, depletion and amortization of proved
oil and gas properties is calculated on the basis of estimated recoverable
reserve quantities. These estimates can change based on economic or other
factors. No gains or losses are recognized upon the disposition of oil and gas
properties except in extraordinary transactions. Sales proceeds are credited to
the carrying value of the properties. Maintenance and repairs are expensed, and
expenditures which enhance the value of properties are capitalized.
Unproved oil and gas properties are stated at cost and consist of
undeveloped leases. These costs are assessed periodically to determine whether
their value has been impaired, and if impairment is indicated, the costs are
charged to expense.
Gas gathering systems are stated at cost. Depreciation expense is
computed using the straight-line method over 15 years.
Property and equipment are stated at cost. Depreciation of non-oil and
gas properties is computed using the straight-line method over the useful lives
of the assets ranging from 3 to 15 years for machinery and equipment and 30 to
40 years for buildings. When assets other than oil and gas properties are
retired or otherwise disposed of, the cost and related accumulated depreciation
are removed from the accounts, and any resulting gain or loss is reflected in
income for the period. The cost of maintenance and repairs is expensed as
incurred, and significant renewals and betterments are capitalized.
Long-lived assets are reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount may not be
recoverable. If the sum of the expected future undiscounted cash flows is less
than the carrying amount of the asset, a loss is recognized for the difference
between the fair value and the carrying amount of the asset. Fair value was
based on management's outlook of future oil and natural gas prices and estimated
future cash flows to be generated by the assets, discounted at a market rate of
interest.
DERIVATIVES AND HEDGING
The Company recognizes all derivative financial instruments as either
assets or liabilities at fair value. Derivative instruments that are not hedges
must be adjusted to fair value through net income (loss). Changes in the fair
value of derivative instruments that are fair value hedges are offset against
changes in
10
the fair value of the hedged assets, liabilities, or firm commitments, through
net income (loss). Changes in the fair value of derivative instruments that are
cash flow hedges are recognized in other comprehensive income (loss) until such
time as the hedged items are recognized in net income (loss). Ineffective
portions of a derivative instrument's change in fair value are immediately
recognized in net income (loss). Deferred gains and losses on terminated
commodity hedges will be recognized as increases or decreases to oil and gas
revenues during the same periods in which the underlying forecasted transactions
are recognized in net income (loss).
The relationship between the hedging instruments and the hedged items
must be highly effective in achieving the offset of changes in fair values or
cash flows attributable to the hedged risk both at the inception of the contract
and on an ongoing basis. The Company measures effectiveness on changes in the
hedge's intrinsic value. The Company considers these hedges to be highly
effective and expects there will be no ineffectiveness to be recognized in net
income (loss) since the critical terms of the hedging instruments and the hedged
forecasted transactions are the same. Ongoing assessments of hedge effectiveness
will include verifying and documenting that the critical terms of the hedge and
forecasted transaction do not change. The Company measures effectiveness on at
least a quarterly basis.
The Company's financial results and cash flows can be significantly
impacted as commodity prices fluctuate widely in response to changing market
conditions. To manage its exposure to natural gas or oil price volatility, the
Company has entered into NYMEX based commodity derivative contracts, currently
natural gas swaps and collars, and has designated the contracts for the special
hedge accounting treatment. Had the Company not designated the derivative
contracts as hedges, the change in fair value of the contracts would have been
reflected directly in the statement of operations.
REVENUE RECOGNITION
Oil and gas production revenue is recognized as production and delivery
take place. Oil and gas marketing revenues are recognized when title passes.
Oilfield service revenues are recognized when the goods or services have been
provided.
NEW ACCOUNTING PRONOUNCEMENTS
- -----------------------------
On January 1, 2003, the Company adopted SFAS 143, "Accounting for Asset
Retirement Obligations." SFAS 143 amends SFAS 19, "Financial Accounting and
Reporting by Oil and Gas Producing Companies" to require the Company to
recognize a liability for the fair value of its asset retirement obligations
associated with its tangible, long-lived assets. The majority of the asset
retirement obligations recorded by the Company relate to the plugging and
abandonment (excluding salvage value) of its oil and gas properties. At January
1, 2003, there were no assets legally restricted for purposes of settling asset
retirement obligations. The adoption of SFAS 143 resulted in a January 1, 2003
cumulative effect adjustment to record a $4.0 million increase in long-term
asset retirement obligation liabilities, a $621,000 increase in current asset
retirement obligation liabilities, a $3.2 million increase in the carrying value
oil and gas assets, a $5.2 million decrease in accumulated depreciation,
depletion and amortization and a $1.4 million increase in deferred income tax
liabilities. The net effect of adoption was to record a gain of $2.4 million,
net of tax, as a cumulative effect of a change in accounting principle in the
Company's consolidated statement of operations in the first quarter of 2003.
Subsequent to the adoption of SFAS 143, there has been no significant
current period activity with respect to additional retirement obligations,
settled obligations, accretion expense and revisions of estimated cash flows.
The unaudited pro forma net income for the quarter ended March 31, 2002 was
11
$1.7 million and has been prepared to give effect to the adoption of SFAS 143
as if it had been adopted on January 1, 2002. Assuming retroactive application
of the change in accounting principle as of January 1, 2002, liabilities would
have increased $6 million.
On January 1, 2003, the Company adopted SFAS 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS 145 rescinds SFAS 4, "Reporting Gains and Losses from
Extinguishment of Debt," SFAS 44, "Accounting for Intangible Assets of Motor
Carriers" and SFAS 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund
Requirements" and amends SFAS No. 13, "Accounting for Leases." Statement 145
also makes technical corrections to other existing pronouncements. SFAS 4
required gains and losses from extinguishment of debt to be classified as an
extraordinary item, net of the related income tax effect. As a result of the
rescission of SFAS 4, the criteria for extraordinary items in APB 30, "Reporting
the Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," now will be used to classify those gains and losses. The adoption
of SFAS 145 did not have any effect on the Company's financial position, results
of operations or cash flows.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs
Associated with Exit or Disposal Activities." SFAS 146 is effective for the
Company for disposal activities initiated after December 31, 2002. The adoption
of this standard did not have any effect on the Company's financial position,
results of operations or cash flows.
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN 45's disclosure requirements are effective for the
Company's interim and annual financial statements for periods ending after
December 15, 2002. The initial recognition and measurement provisions are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. FIN 45 requires certain guarantees to be recorded at fair
value, which is different from current practice, which is generally to record a
liability only when a loss is probable and reasonably estimable. FIN 45 also
requires a guarantor to make significant new disclosures, even when the
likelihood of making any payments under the guarantee is remote. Adoption of FIN
45 did not have any effect on the Company's financial statement disclosures,
financial position, results of operations or cash flows.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." SFAS 148 amends FASB 123, "Accounting
for Stock-Based Compensation," to provide alternative methods of transition for
a voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, SFAS 148 amends the disclosure requirements
of SFAS 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee
compensation and the effect of the method used on the reported results. The
Company measures expense associated with stock-based compensation using the
intrinsic value method prescribed by APB 25, "Accounting for Stock Issued to
Employees" and its related interpretations. Under APB 25, no compensation
expense is required to be recognized by the Company upon the issuance of stock
options to key employees as the exercise price of the option is equal to the
market price of the underlying common stock at the date of grant. The provisions
of SFAS 148 are effective for financial statements for fiscal years ending after
December 15, 2002. The adoption of SFAS 148 did not have a material effect on
the Company's financial position, results of operations or cash flows.
The fair value of the Company's stock options was estimated at the date
of grant using a Black-Scholes option pricing model with the following
weighted-average assumptions for the first quarter of 2003: risk-free interest
rate of 3.7%, volatility factor of the expected market price of the Company's
common stock of near zero, dividend yield of zero, and a weighted-average
expected life of the option of seven years. There were no options granted in
the first quarter of 2002.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its stock options.
For purposes of the pro forma disclosures required by SFAS 123, the
estimated fair value of the options is amortized to expense over the options'
vesting period. The changes in net income or loss as if the Company had applied
the fair value provisions of SFAS 123 for the quarters ended March 31, 2003 and
2002 were not material.
12
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities - An Interpretation of Accounting Research Bulletin (ARB) 51."
FIN 46 is an interpretation of ARB 51, "Consolidated Financial Statements," and
addresses consolidation by business enterprises of variable interest entities
(VIEs). The primary objective of FIN 46 is to provide guidance on the
identification of, and financial reporting for, entities over which control is
achieved through means other than voting rights; such entities are known as
VIEs. FIN 46 requires an enterprise to consolidate a VIE if that enterprise has
a variable interest that will absorb a majority of the entity's expected losses
if they occur, receive a majority of the entity's expected residual returns if
they occur or both. An enterprise shall consider the rights and obligations
conveyed by its variable interests in making this determination. This guidance
applies immediately to VIEs created after January 31, 2003, and to VIEs 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 VIEs in which an
enterprise holds a variable interest that it acquired before February 1, 2003.
Adoption of FIN 46 did not have any effect on the Company's financial
statement disclosures, financial position, results of operations or cash flows.
RESULTS OF OPERATIONS - FIRST QUARTERS OF 2003 AND 2002 COMPARED
The following Management's Discussion and Analysis is based on the
results of operations from continuing operations, unless otherwise noted.
Accordingly, the discontinued operations have been excluded.
The following table sets forth certain information regarding the
Company's net oil and natural gas production, revenues and expenses for the
quarters indicated:
Three Months Ended March 31,
--------------------------
2003 2002
------ ------
Production
Gas (Mmcf) 3,443 4,213
Oil (Mbbls) 101 148
Total production (Mmcfe) 4,047 5,098
AVERAGE PRICE
Gas (per Mcf) $ 4.76 $ 4.54
Oil (per Bbl) 30.09 18.48
Mcfe 4.80 4.29
AVERAGE COSTS (PER MCFE)
Production expense 1.11 0.95
Production taxes 0.17 0.09
Depletion 0.78 0.89
OPERATING MARGIN (PER MCFE) 3.52 3.25
MMCF - MILLION CUBIC FEET MBBLS - THOUSAND BARRELS MMCFE - MILLION CUBIC FEET OF NATURAL GAS EQUIVALENT
MCF - THOUSAND CUBIC FEET BBL - BARREL MCFE - THOUSAND CUBIC FEET OF NATURAL GAS EQUIVALENT
OPERATING MARGIN (PER MCFE) - AVERAGE PRICE LESS PRODUCTION EXPENSE AND PRODUCTION TAXES
Operating income decreased $1.6 million (18%) from $8.4 million in the
first quarter of 2002 to $6.8 million in the first quarter of 2003. This
decrease was primarily a result of a $3.3 million (18%) decrease in operating
margins partially offset by a $1.7 million decrease in depreciation, depletion
and amortization.
13
The $3.3 million decrease in operating margins was primarily due to a
$2.3 million decrease in the operating margin from oil and gas sales resulting
primarily from a decrease in oil and gas volumes sold partially offset by an
increase in the average prices realized for the Company's oil and natural gas in
the first quarter of 2003. A $1.0 million decrease in the operating margin from
gas gathering, marketing and oilfield service, resulting primarily from a lower
margin on a gathering system in Pennsylvania, also contributed to the decrease
in operating margins.
Income from continuing operations before income taxes and cumulative
effect of change in accounting principle decreased $1.8 million from $2.5
million in the first quarter of 2002 to $627,000 in the first quarter of 2003.
This decrease is due primarily to the decrease in operating income discussed
above and an increase in interest expense.
Net income increased $1.4 million from $1.4 million in the first
quarter of 2002 to $2.8 million in the first quarter of 2003. This increase was
a result of a $2.4 million gain on the cumulative effect of change in accounting
principle, net of tax, recorded in the first quarter of 2003 related to asset
retirement obligations and a decrease in the provision for income taxes of
$723,000. This increase in net income was partially offset by the decrease in
operating income discussed above and a $322,000 increase in interest expense.
Total revenues decreased $1.3 million (4%) in the first quarter of 2003
compared to the first quarter of 2002 primarily due to a $2.4 million decrease
in oil and gas sales revenues and a $316,000 decrease in other revenues
partially offset by a $1.5 million increase in gas gathering, marketing and
oilfield service revenues. The decrease in other revenues is due to the loss of
revenue from Section 29 tax credit monetization transactions which ended upon
expiration of the non-conventional fuel source tax credit as of December 31,
2002. The increase in gas gathering, marketing and oilfield service revenues was
due primarily to a $3.3 million increase in oilfield service revenues primarily
from drilling operations as a result of the acquisition of a drilling consulting
business in the second quarter of 2002. This increase was partially offset by a
$1.8 million decrease in gas gathering and marketing revenues primarily related
to lower revenues from a gas gathering system in Pennsylvania.
Gas volumes sold in the first quarter of 2003 were 3.4 Bcf (billion
cubic feet), a decrease of 770 Mmcf (18%) compared to the first quarter of 2002
due primarily to the sale of wells in Ohio and Pennsylvania during 2002, extreme
weather conditions experienced in the first quarter of 2003 and the natural
decline of the wells partially offset by production from wells drilled in 2003
and 2002. The decrease in gas volumes sold resulted in a decrease in gas sales
revenues of approximately $3.5 million. Oil volumes sold decreased 47,000 Bbls
(32%) from 148,000 Bbls in the first quarter of 2002 to 101,000 Bbls in the
first quarter of 2003 primarily due the sale of wells in Ohio during 2002,
extreme weather conditions experienced in the first quarter of 2003 and the
natural decline of the wells. This resulted in a decrease in oil sales revenues
of approximately $870,000. The extreme weather conditions, including colder
temperatures and greater snowfall, negatively impacted production during the
first quarter of 2003 due to mechanical breakdowns and freezing of pipelines and
wellheads which reduced production along with difficulty accessing wells for
production and well maintenance.
The average price realized for the Company's natural gas increased
$0.22 per Mcf to $4.76 per Mcf in the first quarter of 2003 compared to the
first quarter of 2002 which increased gas sales revenues in the first quarter of
2003 by approximately $760,000. As a result of the Company's hedging activities,
gas sales revenues for the first quarter of 2003 decreased by approximately $6.1
million or $1.77 per Mcf
14
compared to an increase of approximately $6.4 million or $1.53 per Mcf for the
first quarter of 2002. The average price realized for the Company's oil
increased from $18.48 per Bbl in the first quarter of 2002 to $30.09 per Bbl in
the first quarter of 2003 which increased oil sales revenues by approximately
$1.2 million.
Production expense decreased $364,000 (7%) from $4.9 million in the
first quarter of 2002 to $4.5 million in the first quarter of 2003 primarily due
to the sale of wells in Ohio and Pennsylvania during 2002 partially offset by
additional costs incurred as a result of colder temperatures and greater amounts
of snow during the first quarter of 2003 and increased costs to stimulate
production on declining wells due to higher oil and natural gas prices in 2003.
The average production cost increased from $0.95 per Mcfe in the first quarter
of 2002 to $1.11 per Mcfe in the first quarter of 2003 due to the cost increases
and lower volumes discussed above. Production taxes increased $230,000 from
$443,000 in the first quarter of 2002 to $673,000 in the first quarter of 2003.
Average per unit production taxes increased from $0.09 per Mcfe in the first
quarter of 2002 to $0.17 per Mcfe in the first quarter of 2003 primarily due to
higher oil and gas prices in Michigan, where production taxes are based on a
percentage of revenues, excluding the effect of hedging.
Exploration expense decreased $347,000 (13%) from $2.6 million in the
first quarter of 2002 to $2.2 million in the first quarter of 2003 primarily due
to a $462,000 decrease in dry hole expense.
General and administrative expense of $1.2 million in the first quarter
of 2003 was consistent compared to the first quarter of 2002.
Depreciation, depletion and amortization decreased by $1.7 million
(28%) from $6.0 million in the first quarter of 2002 to $4.3 million in the
first quarter of 2003. Depletion expense decreased $1.4 million (31%) from $4.5
million in the first quarter of 2002 to $3.1 million in the first quarter of
2003 due to lower oil and gas volumes sold and a lower depletion rate per Mcfe.
Depletion per Mcfe decreased from $0.89 per Mcfe in the first quarter of 2002 to
$0.78 per Mcfe in the first quarter of 2003. This decrease in the depletion rate
per Mcfe was primarily due to higher reserves resulting from higher oil and gas
prices at year-end 2002, excluding the effect of hedging, and the effect of the
adoption of SFAS 143. The depreciable basis of oil and gas properties was
increased by the fair value of the estimated future plugging liability and
decreased by the gross amount of the estimated salvage value of the well
equipment.
Interest expense increased $322,000 (5%) from $5.9 million in the first
quarter of 2002 to approximately $6.2 million in the first quarter of 2003 due
to the allocation of interest to discontinued operations in the first quarter of
2002.
Income tax expense decreased $723,000 from $955,000 in the first
quarter of 2002 to $232,000 in the first quarter of 2003 due primarily to the
decrease in income from continuing operations.
In accordance with SFAS 144, the Company was required to reclassify the
assets, liabilities and results of discontinued operations for all accounting
periods presented. Although both revenues and expenses for prior periods were
reclassified, there was no impact upon previously reported net earnings.
LIQUIDITY AND CAPITAL RESOURCES
The Company's liquidity and capital resources are closely related to
and dependent on the current prices paid for its oil and natural gas.
15
The Company's current ratio at March 31, 2003 was .72 to 1. During the
first three months of 2003, working capital from continuing operations decreased
$5.2 million from a deficit of $6.5 million at December 31, 2002 to a deficit of
$11.7 million at March 31, 2003. The decrease was primarily due to a $5.7
million decrease in the fair value of derivatives in the first three months of
2003, a $5.6 million increase in accrued expenses partially offset by a $5.0
million increase in accounts receivable and a $2.3 million decrease in deferred
income taxes. The $5.0 million increase in accounts receivable was primarily due
to higher natural gas prices. The Company's operating activities provided cash
flows of $7.8 million during the first three months of 2003.
The Company has a $100 million revolving credit facility (the
"Revolver") from Ableco Finance LLC and Foothill Capital Corporation which
matures on December 31, 2005. The Revolver was amended on March 31, 2003 to
increase the letter of credit sublimit to $55 million. The Revolver bears
interest at the prime rate plus two percentage points, payable monthly. At March
31, 2003, the interest rate was 6.25%. At March 31, 2003, the Company had $34.0
million of outstanding letters of credit. At March 31, 2003, the outstanding
balance under the credit agreement was $30.9 million with $35.1 million of
borrowing capacity available for general corporate purposes.
The Company's agreement with its hedging counterparty requires letters
of credit based on an initial collateral requirement plus any negative market
value thereafter. The initial collateral requirement currently is approximately
$10 million. At May 12, 2003, the Company's hedge position had a negative market
value of approximately $34 million and the aggregate minimum letter of credit
requirement was approximately $44 million. At May 12, 2003, the Company had a
total of $48 million of outstanding letters of credit
The Revolver has an early termination fee equal to .125% of the
facility if terminated by December 31, 2004. There is no termination fee after
December 31, 2004. The Company is required to hedge, through financial
instruments or fixed price contracts, at least 20% but not more than 80% of its
estimated hydrocarbon production, on a Mcfe basis, for the succeeding 12 months
on a rolling 12-month basis. Based on the Company's hedges currently in place
and its expected production levels, the Company is in compliance with this
hedging requirement through August 2005.
The Revolver is secured by security interests and mortgages against
substantially all of the Company's assets and is subject to periodic borrowing
base determinations. The borrowing base is the lesser of $100 million or the sum
of (i) 65% of the present value of the Company's proved developed producing
reserves subject to a mortgage; (ii) 45% of the present value of the Company's
proved developed non-producing reserves subject to a mortgage; and (iii) 40% of
the present value of the Company's proved undeveloped reserves subject to a
mortgage. The price forecast used for calculation of the future net income from
proved reserves is the three-year NYMEX strip for oil and natural gas as of the
date of the reserve report. Prices beyond three years are held constant. Prices
are adjusted for basis differential, fixed price contracts and financial hedges
in place. The weighted average price at March 31, 2003, was $4.44 per Mcfe. The
present value (using a 10% discount rate) of the Company's future net income at
March 31, 2003, using the borrowing base price forecast, was $409 million. The
present value under the borrowing base formula above was approximately $240
million for all proved reserves of the Company and $168 million for properties
secured by a mortgage.
The Revolver is subject to certain financial covenants. These include a
senior debt interest coverage ratio of 3.2 to 1 and a senior debt leverage ratio
of 2.7 to 1. EBITDA, as defined in the Revolver, and consolidated interest
expense on senior debt in these ratios are calculated quarterly based on the
financial results of the previous four quarters. In addition, the Company is
required to maintain a current ratio (including available borrowing capacity in
current assets, excluding current debt and accrued interest from current
liabilities and excluding any effects from the application of SFAS 133 to other
current assets or current liabilities) of at least 1.0 to 1 and maintain
liquidity of at least $5 million (cash and cash equivalents including available
borrowing capacity). As of March 31, 2003, the Company's current ratio
16
including the above adjustments was 2.82 to 1. The Company had satisfied all
financial covenants as of March 31, 2003.
From time to time the Company may enter into interest rate swaps to
hedge the interest rate exposure associated with the credit facility, whereby a
portion of the Company's floating rate exposure is exchanged for a fixed
interest rate. There were no interest rate swaps in the first three months of
2003 or 2002.
During the first three months of 2003, the Company invested $6.8
million to drill 32 development wells and one exploratory well. All 33 of these
wells were successfully completed as producers in the target formation.
The Company had four exploratory wells in progress at December 31,
2002. One Trenton Black River well has been completed and began production in
April. It is currently producing approximately 1.7 Mmcf of natural gas per day
(0.8 Mmcf per day net to the Company's interest). The remaining three wells are
continuing to be evaluated.
The Company currently expects to spend approximately $26 million during
2003 on its drilling activities, including exploratory dry hole expense, and
other capital expenditures. The Company intends to finance its planned capital
expenditures through its available cash flow, available revolving credit line
and the sale of non-strategic assets. At March 31, 2003, the Company had
approximately $35.1 million available under the Revolver. The level of the
Company's future cash flow will depend on a number of factors including the
demand for and price levels of oil and gas, the scope and success of its
drilling activities and its ability to acquire additional producing properties.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------
Among other risks, the Company is exposed to interest rate and
commodity price risks.
The interest rate risk relates to existing debt under the Company's
revolving credit facility as well as any new debt financing needed to fund
capital requirements. The Company may manage its interest rate risk through the
use of interest rate swaps to hedge the interest rate exposure associated with
the credit agreement, whereby a portion of the Company's floating rate exposure
is exchanged for a fixed interest rate. A portion of the Company's long-term
debt consists of senior subordinated notes where the interest component is
fixed. The Company had no derivative financial instruments for managing interest
rate risks in place as of March 31, 2003 or 2002. If market interest rates for
short-term borrowings increased 1%, the increase in the Company's interest
expense in the first quarter would be approximately $77,000. This sensitivity
analysis is based on the Company's financial structure at March 31, 2003.
The commodity price risk relates to natural gas and crude oil produced,
held in storage and marketed by the Company. The Company's financial results can
be significantly impacted as commodity prices fluctuate widely in response to
changing market forces. From time to time the Company may enter into a
combination of futures contracts, commodity derivatives and fixed-price physical
contracts to manage its exposure to commodity price volatility. The fixed-price
physical contracts generally have terms of a year or more. The Company employs a
policy of hedging gas production sold under NYMEX based contracts by selling
NYMEX based commodity derivative contracts which are placed with major financial
institutions that the Company believes are minimal credit risks. The contracts
may take the form
17
of futures contracts, swaps or options. If NYMEX gas prices decreased $0.25 per
Mcf, the Company's gas sales revenues for the quarter would decrease by
$348,000, after considering the effects of the hedging contracts in place at
March 31, 2003. The Company had no hedges or fixed price contracts on its oil
production during 2003 or 2002. If the price of crude oil decreased $2.00 per
Bbl, the Company's oil sales revenues for the quarter would decrease by
$200,000. This sensitivity analysis is based on the Company's 2003 oil and gas
sales volumes during the quarter and assumes the NYMEX gas price would be within
the collars in 2003 listed in the table on page 19.
To manage its exposure to natural gas or oil price volatility, the
Company may partially hedge its physical gas or oil sales prices by selling
futures contracts on the NYMEX or by selling NYMEX based commodity derivative
contracts which are placed with major financial institutions that the Company
believes are minimal credit risks. The contracts may take the form of futures
contracts, swaps, collars or options. The Company had a net pretax loss on its
hedging activities of $6.1 million in the first three months of 2003 and a net
pretax gain of $6.4 million in the first three months of 2002.
In March 2003, the Company entered into a collar for 4,320 Bbtu of its
natural gas production in 2004 with a ceiling price of $5.80 per Mmbtu and a
floor price of $4.00 per Mmbtu. The Company also sold a floor at $3.00 per Mmbtu
on this volume of gas. This aggregate structure has the effect of: 1) setting a
maximum price of $5.80 per Mmbtu; 2) floating at prices from $4.00 to $5.80 per
Mmbtu; 3) locking in a price of $4.00 per Mmbtu if prices are between $3.00 and
$4.00 per Mmbtu; and 4) receiving a price of $1.00 per Mmbtu above the price if
the price is $3.00 or less. All prices are based on monthly NYMEX settle.
In April 2003, the Company entered into a collar for 6,000 Bbtu of its
natural gas production in 2005 with a ceiling price of $5.37 per Mmbtu and a
floor price of $4.00 per Mmbtu. The Company also sold a floor at $3.10 per Mmbtu
on this volume of gas. This aggregate structure has the effect of: 1) setting a
maximum price of $5.37 per Mmbtu; 2) floating at prices from $4.00 to $5.37 per
Mmbtu; 3) locking in a price of $4.00 per Mmbtu if prices are between $3.10 and
$4.00 per Mmbtu; and 4) receiving a price of $0.90 per Mmbtu above the price if
the price is $3.10 or less. All prices are based on monthly NYMEX settle.
The Company's financial results and cash flows can be significantly
impacted as commodity prices fluctuate widely in response to changing market
conditions. Accordingly, the Company may modify its fixed price contract and
financial hedging positions by entering into new transactions or terminating
existing contracts.
18
The following table reflects the natural gas volumes and the weighted
average prices under financial hedges (including settled hedges) and fixed price
contracts at April 30, 2003:
NATURAL GAS SWAPS NATURAL GAS COLLARS FIXED PRICE CONTRACTS
---------------------------------- -------------------------------------- ------------------------
ESTIMATED NYMEX PRICE ESTIMATED ESTIMATED
NYMEX PRICE WELLHEAD PER MMBTU WELLHEAD PRICE ESTIMATED WELLHEAD
QUARTER ENDING BBTU PER MMBTU PRICE PER MCF BBTU FLOOR/CAP (1) PER MCF(1) MMCF PRICE PER MCF
- --------------------- ---- ----------- ------------- ---- ------------- ------------- --------- -------------
June 30, 2003 2,660 $ 4.21 $ 4.36 480 $ 3.40 - 5.23 $ 3.55 - 5.38 120 $ 3.42
September 30, 2003 1,800 3.92 4.07 1,290 3.40 - 5.23 3.55 - 5.38 70 2.85
December 31, 2003 1,800 3.92 4.14 1,290 3.40 - 5.23 3.62 - 5.45 60 2.56
-------- -------- ---------- ------ -------------- --------------- ---------- ------------
6,260 $ 4.04 $ 4.21 3,060 $ 3.40 - 5.23 $ 3.58 - 5.41 250 $ 3.06
======== ======== ========== ====== ============== =============== ========== ============
March 31, 2004 2,040 $ 3.84 $ 4.09 1,080 $ 4.00 - 5.80 $ 4.25 - 6.05 55 $ 2.60
June 30, 2004 2,040 3.84 3.99 1,080 4.00 - 5.80 4.15 - 5.95 55 2.60
September 30, 2004 2,040 3.84 3.99 1,080 4.00 - 5.80 4.15 - 5.95 55 2.60
December 31, 2004 2,040 3.84 4.06 1,080 4.00 - 5.80 4.22 - 6.02 55 2.60
-------- -------- ---------- ------ -------------- --------------- ---------- ------------
8,160 $ 3.84 $ 4.03 4,320 $ 4.00 - 5.80 $ 4.19 - 5.99 220 $ 2.60
======== ======== ========== ====== ============== =============== ========== ============
March 31, 2005 1,500 $ 3.84 $ 4.09 1,500 $ 4.00 - 5.37 $ 4.25 - 5.62 50 $ 2.60
June 30, 2005 1,500 3.73 3.88 1,500 4.00 - 5.37 4.15 - 5.52 50 2.60
September 30, 2005 1,500 3.73 3.88 1,500 4.00 - 5.37 4.15 - 5.52 50 2.60
December 31, 2005 1,500 3.73 3.95 1,500 4.00 - 5.37 4.22 - 5.59 50 2.60
-------- -------- ---------- ------ -------------- --------------- ---------- ------------
6,000 $ 3.76 $ 3.95 6,000 $ 4.00 - 5.37 $ 4.19 - 5.56 200 $ 2.60
======== ======== ========== ====== ============== =============== ========== ============
BBTU - BILLION BRITISH THERMAL UNITS MMCF - MILLION CUBIC FEET
MMBTU - MILLION BRITISH THERMAL UNITS MCF - THOUSAND CUBIC FEET
(1) The NYMEX price per Mmbtu floor/cap and the estimated wellhead price per Mcf
for the natural gas collars in 2004 assume the monthly NYMEX settles at $3.00
per Mmbtu or higher. If the monthly NYMEX settles at less than $3.00 per Mmbtu
then the NYMEX price per Mmbtu will be the NYMEX settle plus $1.00 and the
estimated wellhead price per Mcf will be the NYMEX settle plus $1.15 to $1.25.
The NYMEX price per Mmbtu floor/cap and the estimated wellhead price per Mcf for
the natural gas collars in 2005 assume the monthly NYMEX settles at $3.10 per
Mmbtu or higher. If the monthly NYMEX settles at less than $3.10 per Mmbtu then
the NYMEX price per Mmbtu will be the NYMEX settle plus $0.90 and the estimated
wellhead price per Mcf will be the NYMEX settle plus $1.05 to $1.15.
ITEM 4. 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 pursuant to Exchange Act Rule
13a-14. Based upon the evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures were effective as of March 31, 2003. There have been no significant
changes in the Company's internal controls or in other factors that could
significantly affect internal controls subsequent to March 31, 2003.
19
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
10.1* Amendment to the Credit Agreement dated as of March 31, 2003 by and
among the Company, Ableco Finance LLC and Foothill Capital Corporation.
99.1* Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2* Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
*Filed herewith
(b) Reports on Form 8-K
No reports were filed on Form 8-K.
20
SIGNATURES
- --------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
BELDEN & BLAKE CORPORATION
Date: May 13, 2003 By: /s/ John L. Schwager
------------ ----------------------------
John L. Schwager, Director, President
and Chief Executive Officer
Date: May 13, 2003 By: /s/ Robert W. Peshek
------------ ----------------------------
Robert W. Peshek, Vice President
and Chief Financial Officer
21
CERTIFICATIONS
- --------------------------------------------------------------------------------
I, John L. Schwager, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Belden & Blake
Corporation;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 quarterly 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
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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 function):
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
quarterly 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: May 13, 2003 /s/ John L. Schwager
------------ -----------------------------------
John L. Schwager, Director, President
and Chief Executive Officer
22
CERTIFICATIONS
- --------------------------------------------------------------------------------
I, Robert W. Peshek, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Belden & Blake
Corporation;
2. Based on my knowledge, this quarterly 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 quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly 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 quarterly 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 quarterly 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
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly 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 function):
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
quarterly 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: May 13, 2003 /s/ Robert W. Peshek
------------ ------------------------------------
Robert W. Peshek, Vice President
and Chief Financial Officer
23