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FOREST OIL CORPORATION INDEX TO FORM 10-Q March 31, 2003

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-Q

Commission File Number 1-13515

FOREST OIL CORPORATION
(Exact name of registrant as specified in its charter)

1600 Broadway
Suite 2200
Denver, Colorado 80202
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (303) 812-1400

        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 ý    No o

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý    No o

FOREST OIL CORPORATION
INDEX TO FORM 10-Q
March 31, 2003

PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

FOREST OIL CORPORATION CONDENSED

CONSOLIDATED BALANCE SHEETS

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

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FOREST OIL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF PRODUCTION AND OPERATIONS

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

2

FOREST OIL CORPORATION CONDENSED CONSOLIDATED

STATEMENTS OF CASH FLOWS

(Unaudited)

See accompanying notes to condensed consolidated financial statements.

3

FOREST OIL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

THREE MONTHS ENDED MARCH 31, 2003 AND 2002

(Unaudited)

(1) BASIS OF PRESENTATION

        The condensed consolidated financial statements included herein are unaudited. The consolidated financial statements include the accounts of Forest Oil Corporation and its consolidated subsidiaries (collectively, Forest or the Company). In the opinion of management, all adjustments, consisting of normal recurring accruals, have been made which are necessary for a fair presentation of the financial position of Forest at March 31, 2003 and the results of operations for the three months ended March 31, 2003 and 2002. Quarterly results are not necessarily indicative of expected annual results because of the impact of fluctuations in prices received for liquids (oil, condensate and natural gas liquids) and natural gas and other factors.

        In the course of preparing the consolidated financial statements, management makes various assumptions, judgments and estimates to determine the reported amount of assets, liabilities, revenue and expenses, and in the disclosures of commitments and contingencies. Changes in these assumptions, judgments and estimates will occur as a result of the passage of time and the occurrence of future events and, accordingly, actual results could differ from amounts initially established.

        The more significant areas requiring the use of assumptions, judgments and estimates relate to volumes of oil and gas reserves used in calculating depletion, depreciation and amortization, the amount of future net revenues used in computing the ceiling test limitations and the amount of future capital obligations used in such calculations, and the estimated amounts of future asset retirement obligations. Assumptions, judgments and estimates are also required in determining impairments of undeveloped properties and the valuation of deferred tax assets and the estimation of fair values of derivative instruments.

        Certain amounts in the prior year financial statements have been reclassified to conform to the 2003 financial statement presentation. Losses related to the extinguishment of debt in 2002 were reclassified to other expense and the extraordinary item caption was deleted in response to Statement of Financial Accounting Standards No. 145. In addition, marketing and processing revenue and related expenses have been netted in the accompanying condensed financial statements to reflect the change made in the third quarter of 2002 in response to EITF Issue No. 02-03.

        For a more complete understanding of Forest's operations, financial position and accounting policies, reference is made to the consolidated financial statements of Forest, and related notes thereto, filed with Forest's annual report on Form 10-K for the year ended December 31, 2002, previously filed with the Securities and Exchange Commission.

(2) EARNINGS PER SHARE AND COMPREHENSIVE EARNINGS (LOSS)

Earnings (Loss) per Share:

        Basic earnings per share is computed by dividing net earnings attributable to common stock by the weighted average number of common shares outstanding during each period, excluding treasury shares.

        Diluted earnings per share is computed by adjusting the average number of common shares outstanding for the dilutive effect, if any, of convertible preferred stock, stock options and warrants.

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        The following sets forth the calculation of basic and diluted earnings per share:

(1)

At March 31, 2003, options to purchase 3,035,851 shares of common stock were outstanding, but were not included in the computation of diluted earnings per share because the exercise prices of these options were greater than the average market price of the common stock during the period. These options expire at various dates from 2003 to 2013.

(2)

At March 31, 2002, options to purchase 3,845,323 shares of common stock were outstanding, but were not included in the computation of diluted earnings per share because to do so would have been antidilutive. These options expire at various dates from 2003 through 2012.

Comprehensive Earnings (Loss):

        Comprehensive earnings (loss) is a term used to refer to net earnings (loss) plus other comprehensive income (loss). Other comprehensive income (loss) is comprised of revenues, expenses, gains and losses that under generally accepted accounting principles are reported as separate components of shareholders' equity instead of net earnings (loss). Items included in the Company's other comprehensive income (loss) for the three months ended March 31, 2003 and 2002 are foreign currency gains (losses) related to the translation of the assets and liabilities of the Company's Canadian operations; unrealized gains (losses) related to the change in fair value of derivative instruments designated as cash flow hedges; and unrealized gains (losses) related to the change in fair value of securities available for sale.

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        The components of comprehensive earnings (loss) are as follows:

(3) STOCK BASED COMPENSATION

        The Company applies APB Opinion 25 and related Interpretations in accounting for its stock-based compensation plans. Accordingly, no compensation cost is recognized for options granted at a price equal to or greater than the fair market value of the Common Stock. Compensation cost is recognized over the vesting period of options granted at a price less than the fair market value of the Common Stock at the date of the grant. No compensation cost is recognized for stock purchase rights that qualify under Section 423 of the Internal Revenue Code as a noncompensatory plan. Had compensation cost for the Company's stock-based compensation plans been determined using the fair value of the options at the grant date as prescribed by SFAS No. 123, Accounting for Stock-Based Compensation, the Company's pro forma net earnings and earnings per common share would be as follows:

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(4) NET PROPERTY AND EQUIPMENT

        Components of net property and equipment are as follows:

(5) ASSET RETIREMENT OBLIGATIONS

        Effective January 1, 2003 the Company adopted the provisions of Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations (SFAS No. 143). SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred with a corresponding increase in the carrying amount of the related long-lived asset. The Company previously recorded estimated costs of future abandonment liabilities, net of estimated salvage values, as part of its provision for depreciation and depletion for oil and gas properties without recording a separate liability for such amounts. The Company's asset retirement obligations consist of costs related to the plugging of wells, the removal of facilities and equipment, and site restoration on oil and gas properties.

        Upon adoption of SFAS No. 143, using a cumulative effect approach, the Company recorded an increase to net properties and equipment of $165,370,000, an asset retirement obligation liability of $155,972,000 and an after tax credit of $5,854,000 for the cumulative effect of the change in accounting principle related to the depreciation and accretion amounts that would have been reported had the asset retirement obligations been recorded when incurred. Subsequent to initial measurement, the asset retirement liability is required to be accreted each period to present value. Capitalized costs are depleted as a component of the full cost pool using the units of production method.

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        The following table summarizes the activity for the Company's asset retirement obligation for the three months ended March 31, 2003:

        The following sets forth the pro forma effect on net earnings and earnings per share for the three months ended March 31, 2002 as if SFAS No. 143 had been adopted on January 1, 2002:

If SFAS No. 143 had been adopted as of January 1, 2002, the pro forma asset retirement obligation at that date would have been $141,864,000.

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(6) GOODWILL AND OTHER INTANGIBLE ASSETS

        Goodwill and other intangible assets recorded in the acquisition of Producers Marketing Ltd. (ProMark), the Company's Canadian gas marketing subsidiary, consist of the following:

        Goodwill is tested annually for impairment. Long-term gas marketing contracts are amortized based on estimated revenues over the life of the contracts.

(7) LONG-TERM DEBT

        Components of long-term debt are as follows:

(1)

Represents the unamortized portion of gains realized upon termination of three interest rate swaps that were accounted for as fair value hedges. The gain will be amortized as a reduction of interest expense over the terms of the note issues.

        In the first quarter of 2003, the Company redeemed the remaining $65,970,000 outstanding principal amount of its 10¹/2% Senior Subordinated Notes at 105.25% of par value, resulting in a loss of $3,975,000.

(8) FINANCIAL INSTRUMENTS

        The Company recognizes the fair value of its derivative instruments as assets or liabilities on the balance sheet. The accounting treatment for the changes in fair value is dependent upon whether or not a derivative instrument is a cash flow hedge or a fair value hedge, and upon whether or not the derivative qualifies as an effective hedge. Changes in fair value of cash flow hedges are recognized, to the extent the hedge is effective, in other comprehensive income until the hedged item is recognized in earnings. For fair value hedges, to the extent the hedge is effective, there is no effect on the statement

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of operations because changes in fair value of the derivative offset changes in the fair value of the hedged item. For derivative instruments that do not qualify as fair value hedges or cash flow hedges, changes in fair value are recognized in earnings as non-operating income or expense.

Interest Rate Swaps:

        In 2002 and 2001 the Company entered into interest rate swaps intended to exchange the fixed interest rate on a specified principal amount of the 8% Notes due 2011 and the 8% Notes due 2008 for a variable rate based on LIBOR plus specified basis points over the term of the notes. The interest rate swaps were treated as fair value hedges for accounting purposes. In August 2002, the Company sold a call option on these two interest rate swaps. The call option was not designated as a hedge. On September 30, 2002 the Company terminated the two interest rate swaps and settled the call option. The Company received approximately $20,858,000 (net of accrued settlements of approximately $1,779,000) in connection with termination of the interest rate swaps. Those aggregate gains were deferred and added to the carrying value of the related debt, and will be amortized as reductions of interest expense over the remaining terms of the note issues. The Company recorded approximately $1,823,000 as a realized loss on derivative instruments as a result of settlement of the call option.

        In 2002, the Company entered into an interest rate swap intended to exchange the fixed interest rate on a specified principal amount of the 7³/4% Notes for a variable rate based on LIBOR plus specified basis points over the term of the notes. On December 27, 2002 the Company terminated this interest rate swap. The Company received approximately $14,772,000 (net of accrued settlements of approximately $1,128,000) in connection with termination of the interest rate swap. The gain was deferred and added to the carrying value of the related debt, and will be amortized as reductions of interest expense over the remaining term of the note issue.

        During the first quarter of 2003 and 2002, respectively, the Company recognized net gains of $1,095,000 and $1,557,000, respectively, under the terminated interest rate swaps, which were recorded as reductions of interest expense.

Commodity Swaps, Collars and Basis Swaps:

        Forest periodically hedges a portion of its oil and gas production through swap and collar agreements. The purpose of the hedges is to provide a measure of stability to the Company's cash flows in an environment of volatile oil and gas prices and to manage the exposure to commodity price risk.

        All of the Company's commodity swaps and collar agreements and a portion of its basis swaps in place at March 31, 2003 have been designated as cash flow hedges. At March 31, 2003 the Company had a derivative asset of $4,529,000 (of which $4,501,000 was classified as current), a derivative liability of $43,952,000 (of which $40,780,000 was classified as current), a deferred tax asset of $14,981,000 (of which $13,786,000 was classified as current) and accumulated other comprehensive loss of approximately $24,184,000.

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        The Company's gains (losses) under these agreements were:

        In a typical swap agreement, Forest receives the difference between a fixed price per unit of production and a price based on an agreed upon, published third-party index when the index price is lower. When the index price is higher, Forest pays the difference. By entering into swap agreements the Company effectively fixes the price that it will receive in the future for the hedged production. Forest's current swaps are settled in cash on a monthly basis. As of March 31, 2003, Forest had entered into the following swaps accounted for as cash flow hedges:

        Forest also enters into collar agreements with third parties. A collar agreement is similar to a swap agreement, except that the Company receives the difference between the floor price and the index price only when the index price is below the floor price, and the Company pays the difference between the ceiling price and the index price only when the index price is above the ceiling price. Collars are also settled in cash, either on a monthly basis or at the end of their terms. By entering into collars, the Company effectively provides a floor for the price that it will receive for the hedged production; however, the collar also establishes a maximum price that the Company will receive for the hedged production when prices increase above the ceiling price. The Company enters into collars during periods of volatile commodity prices in order to protect against a significant decline in prices in exchange for forgoing the benefit of price increases in excess of the ceiling price on the hedged

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production. As of March 31, 2003, the Company had entered into the following gas and oil collars accounted for as cash flow hedges:

        The Company also uses basis swaps in connection with natural gas swaps, in order to fix the differential price between the NYMEX price and the index price at which the hedged gas is sold. At March 31, 2003 there were basis swaps designated as cash flow hedges in place with weighted average volumes of 93.3 BBTUs per day for the remainder of 2003 and weighted average volumes of 8.3 BBTUs per day for 2004. At March 31, 2003 there were basis swaps not designated as cash flow hedges in place with weighted average volumes of 17.8 BBTUs per day for the remainder of 2003.

        The Company is exposed to risks associated with swap and collar agreements arising from movements in the prices of oil and natural gas and from the unlikely event of non-performance by the counterparties to the swap and collar agreements.

(9) LEGAL PROCEEDINGS

        Forest, in the ordinary course of business, is a party to various legal actions. While we believe that the amount of any potential loss would not be material to our consolidated financial position, the ultimate outcome of these proceedings is inherently difficult to predict with any certainty. In the event of an unfavorable outcome, the potential loss could have an adverse effect on our results of operations and cash flow in the reporting periods in which any such actions are resolved.

        On May 1, 2002, the State of Alaska approved the development and production phase of our Redoubt Shoal project (the Production Project). On May 30, 2002, Cook Inlet Keeper, a non-governmental third party, filed a challenge to the regulatory review and approval process for the Production Project. In July 2002, Forest was granted leave to intervene to defend the State of Alaska's approval of the Production Project. In August 2002, the Court entered a briefing schedule. That

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briefing has been completed, and oral argument before the Court occurred on April 17, 2003. The Court has taken the matter under advisement and has not indicated how quickly it might rule. Separately, Cook Inlet Keeper filed a motion in September 2002 asking the Court to stay Forest's development and production phase operations during the pendency of the briefing process and through the Court's final determination regarding the challenge. Forest filed an opposition, and the Court denied Cook Inlet Keeper's motion on December 4, 2002. Cook Inlet Keeper appealed that denial to the Alaska Supreme Court. Forest subsequently filed an opposition. On March 14, 2003, the Alaska Supreme Court remanded the matter to the trial Court for clarification of the Court's ruling, and postponed ruling on the petition for review until receipt of that clarification. The trial Court provided that clarification on April 23, 2003. While we intend to continue our vigorous opposition to Cook Inlet Keeper's challenge, the outcome of the litigation is inherently difficult to predict with any certainty. We can give no assurances as to the effect of any delays in the Production Project on Forest's financial condition and results of operations.

(10) MARKETING AND PROCESSING OPERATIONS

        The Company's gas marketing subsidiary, ProMark, operates the ProMark Netback Pool. The ProMark Netback Pool matches major end users with providers of gas supply through arranged transportation channels, and uses a netback pricing mechanism to establish the wellhead price paid to all producers within the pool. Under this netback arrangement, producers receive the blended price less related transportation and other direct costs. ProMark charges a marketing fee to the pool participant producers for marketing and administering the gas supply pool.

        In addition to operating the ProMark Netback Pool, ProMark provides other marketing services for other producers and consumers of natural gas. ProMark manages long-term gas supply contracts for industrial customers and provides full-service purchasing, accounting and gas nomination services for both producers and customers on a fee-for-service basis.

        Processing income consists of fees earned, net of expenses, attributable to volumes processed on behalf of third parties.

        Components of marketing and processing, net are as follows:

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(11) BUSINESS AND GEOGRAPHICAL SEGMENTS

        Segment information has been prepared in accordance with Statement of Financial Accounting Standards No. 131, Disclosures About Segments of an Enterprise and Related Information (SFAS No. 131). Forest has six reportable segments consisting of oil and gas operations in five business units (Gulf Region, Western United States, Alaska, Canada and International), and marketing and processing operations conducted by ProMark in Canada. In the first quarter of 2003 the Company modified its business unit structure by combining the Gulf of Mexico Offshore Region and the Gulf Coast Onshore Region into the Gulf Region for increased efficiencies. Therefore, segment information for the first quarter of 2002 has been restated to give effect to this combination. The segments were determined based upon the type of operations in each business unit and the geographical location of each. The segment data presented below was prepared on the same basis as the consolidated financial statements.

Three Months Ended March 31, 2003

        Information for reportable segments relates to the Company's March 31, 2003 consolidated totals as follows:

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Three Months Ended March 31, 2002

        Information for reportable segments relates to the Company's March 31, 2002 consolidated totals as follows:

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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

        The following discussion and analysis should be read in conjunction with Forest's Condensed Consolidated Financial Statements and Notes thereto and "Management's Discussion and Analysis of Financial Condition and Results of Operations—Risk Factors, and—Critical Accounting Policies, Estimates, Judgements and Assumptions" included in Forest's 2002 Annual Report on Form 10-K.

Forward-Looking Statements

        This Form 10-Q includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical or present facts, that address activities, events, outcomes and other matters that Forest plans, expects, intends, assumes, believes, budgets, predicts, forecasts, projects, estimates or anticipates (and other similar expressions) will, should or may occur in the future are forward-looking statements. These forward-looking statements are based on management's current belief, based on currently available information, as to the outcome and timing of future events. Forest cautions that these forward-looking statements, including without limitation those relating to estimates of our future natural gas and liquids production, including estimates of any increases in oil and gas production, our outlook on oil and gas prices, estimates of our oil and gas reserves, estimates of asset retirement obligations, planned capital expenditures and availability of capital resources to fund capital expenditures, the impact of political and regulatory developments, our future financial condition or results of operations and our future revenues and expenses, and our business strategy and other plans and objections for future operations, are subject to all of the risks and uncertainties normally incident to the exploration for and development, production and sale of oil and gas, many of which are beyond our control. These risks include, but are not limited to, commodity price volatility, inflation, lack of availability of goods and services, environmental risks, drilling and other operating risks, regulatory changes, the uncertainty inherent in estimating proved oil and natural gas reserves and in projecting future rates of production and the timing of development expenditures and other risks as described in Management's Discussion and Analysis of Financial Condition and Results of Operations in Forest's 2002 Annual Report on Form 10-K as filed with the Securities and Exchange Commission. The financial results of our foreign operations are also subject to currency exchange rate risks. Should one or more of these risks or uncertainties occur, or should underlying assumptions prove incorrect, Forest's actual results and plans could differ materially from those expressed in any forward-looking statements. All forward-looking statements express or implied attributable to Forest are expressly qualified in their entirety by this cautionary statement. This cautionary statement should also be considered in connection with any subsequent written or oral forward-looking statements that Forest or persons acting on its behalf may issue. Forest does not undertake to update any forward-looking statements to reflect events or circumstances after the date of filing this Form 10-Q with the Securities and Exchange Commission, except as required by law.

Results of Operations for the First Quarter of 2003

        Net earnings for the first quarter of 2003 were $38,871,000 compared to a net loss of $1,784,000 in the corresponding period of 2002. The first quarter of 2003 included a charge of approximately $3,975,000 for early extinguishment of debt related to the redemption of Forest's remaining 10¹/2% Senior Subordinated Notes. The first quarter of 2003 also included a credit of $5,854,000 (net of taxes) related to the adoption of Statement No. 143, Accounting for Asset Retirement Obligations, which was effective January 1, 2003.

        Higher earnings for the quarter ended March 31, 2003 compared to the corresponding period of 2002 were primarily the result of higher sales volumes, higher average oil and gas sales prices and lower oil and gas production expense.

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        Marketing and processing, net represents the net margin earned by ProMark as well as processing income earned in the United States. Marketing and processing, net decreased 15% to $543,000 in the first quarter of 2003 from $637,000 in the first quarter of 2002. The decrease is due primarily to a decline in the volumes marketed by ProMark.

        Oil and gas sales revenue increased by 76% to $168,200,000 in the first quarter of 2003 from $95,796,000 in the first quarter of 2002, primarily as a result of higher product prices and sales volumes. The average gas sales price increased 84% for the first quarter of 2003 compared to the same period of 2002. The average liquids sales price increased 39% compared to the average price in the 2002 period.

        For the first quarter of 2003, Forest reported sales volumes of 35,520 MMCFE, a 5% increase compared to the reported sales volumes of 33,835 MMCFE for the same period of 2002. In the United States, oil and gas sales volumes increased 12% and 10%, respectively, or a total increase of approximately 11% in the first quarter of 2003 compared to the corresponding prior year period. The increase was attributable primarily to new gas production in the Gulf of Mexico and new oil production in Alaska. In Canada, sales volumes decreased 22% primarily as a result of higher royalty volumes in the current higher price environment and the effects of property divestitures made in 2002. In both periods, total sales volumes were negatively impacted by delayed tanker liftings in the Cook Inlet. The effect of the delays, which caused reported sales volumes to be lower than production volumes, amounted to 6 MMCFE per day in the three months ended March 31, 2003.

        Oil and gas production expense includes direct costs incurred to operate and maintain wells and related equipment and facilities, costs of workovers that are expensed rather than capitalized because they do not extend the life of the property, product transportation costs, production taxes and ad valorem taxes. Oil and gas production expense for the first quarter of 2003 decreased 5% to $35,200,000 compared to $37,211,000 in the corresponding period in 2002. On a per-unit basis, production expense decreased 10% to $.99 per MCFE in the first quarter of 2003 compared to $1.10 per MCFE in the first quarter of 2002. The decrease was due primarily to lower lease operating and workover expense in the first quarter of 2003 in the Gulf of Mexico, offset partially by higher production taxes and by additional lease operating costs in Alaska in conjunction with the new production at the Redoubt Shoal Field.

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        Sales volumes, weighted average sales prices and oil and gas production expense per MCFE for the three months ended March 31, 2003 and 2002 were as follows:

(1)

Commodity swaps and collars were transacted to hedge the price of spot market volumes against price fluctuations. Hedged natural gas volumes were 12,120 MMCF and 7,650 MMCF in the first quarter of 2003 and 2002, respectively. Hedged oil and condensate volumes were 1,215,000 barrels and 1,035,000 barrels in the first quarter of 2003 and 2002, respectively. Most of these arrangements have been designated as cash flow hedges for accounting purposes and, as a result, the net gains and losses were accounted for as increases and decreases of oil and gas sales. The aggregate net (losses) gains related to our cash flow hedges were $(35,357,000) and $12,412,000 for the three months ended March 31, 2003 and 2002, respectively. Those arrangements that are not designated as cash flow hedges for accounting purposes are recorded as non-operating income or expense.

        General and administrative expense was $8,892,000 in the first quarter of 2003 compared to $8,157,000 in the first quarter of 2002. The increase was attributable primarily to a lower percentage of capitalized costs compared to the prior year. Total overhead costs (capitalized and expensed general and administrative costs) decreased 3% to $13,989,000 in the first quarter of 2003 compared to $14,442,000 in the first quarter of 2002.

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        The following table summarizes total overhead costs incurred during the periods:

(1)

Includes $329,000 and $353,000 related to marketing operations for the three months ended March 31, 2003 and 2002, respectively.

        Depreciation and depletion expense was $48,630,000 in the first quarter of 2003 compared to $40,186,000 in the first quarter of 2002. The increase was attributable to higher sales volumes and a higher per-unit rate. On a per-unit basis, the depletion rate was $1.34 per MCFE for the quarter ended March 31, 2003, compared to $1.16 per MCFE in the corresponding prior year period. The higher rate in the first quarter of 2003 was due primarily to higher finding costs in the last nine months of 2002.

        Accretion expense of $3,120,000 in the first quarter of 2003 is related to the accretion of our asset retirement obligation pursuant to Statement No. 143, Accounting for Asset Retirement Obligations, adopted January 1, 2003.

        Other expense of $3,921,000 in the first quarter of 2003 includes a loss on early extinguishment of debt of approximately $3,975,000 related to the redemption in January 2003 of the remaining $65,970,000 outstanding principal amount of our 10¹/2% Notes at 105.25% of par value. Other expense of $974,000 in the first quarter of 2002 was due primarily to franchise taxes, our share of the net loss recorded by an equity method investee and the loss on extinguishment of debt from redemption of $5,150,000 principal amount of 8³/4% Senior Subordinated Notes at 103.5% of par value.

        Interest expense in the first quarter of 2003 increased to $12,960,000 compared to $12,145,000 in the first quarter of 2002, due primarily to higher debt balances, offset partially by lower average interest rates on variable and fixed rate debt.

        There was a foreign currency translation loss of $149,000 in the first quarter of 2002 which was the result of translation of the 8³/4% Notes issued by Canadian Forest and was attributable to a decrease in the value of the Canadian dollar relative to the U.S. dollar during the period. Forest was required to recognize the noncash foreign currency translation loss related to the 8³/4% Notes because the debt was denominated in U.S. dollars and the functional currency of Canadian Forest is the Canadian dollar. All of the outstanding notes were redeemed on September 15, 2002.

        There was a realized gain on derivative instruments of $43,000 in the first quarter of 2003 compared to a realized gain on derivative instruments of $84,000 in the first quarter of 2002. The realized gains were due primarily to settlement of basis differential swaps at prices that were, in the aggregate, lower than the pricing established in the related derivative contracts. There was a net unrealized loss on derivative instruments in the first quarter of 2003 of $5,000 compared to a net unrealized loss on derivative instruments of $200,000 in the corresponding period in 2002. The loss in 2003 was attributable primarily to decreases in the estimated future value of existing commodity swaps as a result of increases in commodity futures prices. The loss in the first quarter of 2002 was due to a decrease in the intrinsic value of basis swaps. Realized and unrealized gains and losses on derivative instruments are recorded separately in non-operating income since the instruments do not qualify as hedges under the accounting rules governing hedging activities that were adopted in 2001.

        Forest recorded current income tax expense of $57,000 in 2003 compared to $111,000 in 2002. The decrease in 2003 is due primarily to lower corporate tax attributable to Forest's Canadian subsidiary.

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        Deferred income tax expense was $22,984,000 in the first quarter of 2003 compared to an income tax benefit of $832,000 in the first quarter of 2002. The increase in deferred tax expense is attributable primarily to increased pre-tax profitability, which did not create a current tax liability due to the Company's net operating loss carryforward.

        Effective January 1, 2003, Forest adopted Statement No. 143, Accounting for Asset Retirement Obligations (SFAS No. 143) which requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related long-lived asset. Using a cumulative effect approach, Forest recorded an increase to net properties and equipment of $165,370,000, an asset retirement obligation liability of $155,972,000 and an after tax credit of $5,854,000 for the cumulative effect of the change in accounting principle.

Liquidity and Capital Resources

        Liquidity is a measure of a company's ability to access cash. We have historically addressed our long-term liquidity requirements through the use of bank credit facilities and cash provided by operating activities as well as through the issuance of debt and equity securities, when market conditions permit. The prices we receive for future oil and natural gas production and the level of production have significant impacts on our operating cash flows. We are unable to predict with any degree of certainty the prices we will receive for our future oil and gas production.

        We continually examine alternative sources of long-term capital, including bank borrowings, the issuance of debt instruments, the sale of common stock, preferred stock or other equity securities, the issuance of net profits interests, sales of non-strategic assets, prospects and technical information, and joint venture financing. Availability of these sources of capital and, therefore, our ability to execute our operating strategy will depend upon a number of factors, some of which are beyond our control.

        Working Capital.    Working capital is the amount by which current assets exceed current liabilities. It is not unusual for Forest to report working capital deficits at the end of a period. Such working capital deficits are principally the result of accounts payable related to exploration and development costs. Settlement of these payables is funded by cash flow from operations or, if necessary, by drawdowns on long-term bank credit facilities.

        Forest had working capital exclusive of the effects of derivatives, of approximately $26,493,000 at March 31, 2003 compared to a working capital deficit of approximately $15,159,000 at December 31, 2002. The increase in working capital was due primarily to an increase in accounts receivable attributable primarily to higher oil and gas prices, offset partially by an increase in accounts payable attributable to higher product prices, an increase in accrued interest payable and the addition of current asset retirement obligations in the first quarter of 2003.

        Cash Flow.    Historically, one of our primary sources of capital has been net cash provided by operating activities. Net cash provided by operating activities was $74,211,000 in the first quarter of 2003 compared to $10,295,000 in the same period in 2002. The increase was due primarily to higher sales volumes and higher average oil and gas sales prices. Cash used for investing activities in the first quarter of 2003 was $74,156,000 compared to $80,767,000 in the same period in 2002. The decrease was due primarily to decreased exploration and development activities. Net cash used by financing activities in first quarter of 2003 was $339,000 compared to cash provided of $62,924,000 in the same period in 2002. The 2003 period included cash used for the repurchases of the 10¹/2% Senior Subordinated Notes of $69,441,000 offset by net bank debt borrowings of $45,000,000 and net proceeds from the issuance of common stock and the exercise of options and warrants of approximately $24,436,000. The 2002 period included net bank debt borrowings of $68,011,000, offset by cash used for the repurchases of the 8³/4% Senior Subordinated Notes of $5,279,000.

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        Capital Expenditures.    Expenditures for property acquisition, exploration and development were as follows:

(1)

Does not include estimated discounted future abandonment costs of $719,000 related to assets placed in service during the quarter.

        Forest's anticipated expenditures for exploration and development in 2003 are estimated to range from $350,000,000 to $400,000,000. We intend to meet our 2003 capital expenditure financing requirements using cash flows generated by operations, sales of non-strategic assets and, if necessary, borrowings under existing lines of credit. There can be no assurance, however, that we will have access to sufficient capital to meet these capital requirements. The planned levels of capital expenditures could be reduced if we experience lower than anticipated net cash provided by operations or develop other needs for liquidity, or could be increased if we experience increased cash flow or access additional sources of capital.

        In addition, while we intend to continue a strategy of acquiring reserves that meet our investment criteria, no assurance can be given that we can locate or finance any property acquisitions.

        Bank Credit Facilities.    We have credit facilities totalling $600,000,000, consisting of a $500,000,000 U.S. credit facility through a syndicate of banks led by JPMorgan Chase and a $100,000,000 Canadian credit facility through a syndicate of banks led by J.P. Morgan Bank of Canada. The credit facilities mature in October 2005. Under the credit facilities, Forest, Canadian Forest and certain of their subsidiaries are subject to certain covenants and financial tests, including restrictions or requirements with respect to dividends, additional debt, liens, asset sales, investments, hedging activities, mergers and reporting responsibilities. These financial covenants will affect the amount available and our ability to borrow amounts under the credit facility. In addition, if the rating on our bank credit facilities is downgraded below BB+ by Standard & Poor's Rating Services (S&P) and Ba1 by Moody's Investors Services (Moody's), the available borrowing amount under the credit facilities would be determined by a formula based on the value of certain oil and gas properties (a borrowing base) subject to semi-annual re-determination. As a result, the available borrowing amount could be increased or reduced under the borrowing base tests.

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        Under the most restrictive of the financial covenants contained in our credit facilities, the unused borrowing amount under the credit facilities at March 31, 2003 was approximately $100,000,000 in addition to amounts outstanding. At April 30, 2003, under the most restrictive of these financial covenants, our unused borrowing amount under the credit facilities was approximately $120,000,000.

        At March 31, 2003, there were outstanding borrowings of $140,000,000 under the U.S. credit facility at a weighted average interest rate of 3.0% and there were no outstanding borrowings under the Canadian credit facility. At April 30, 2003, the outstanding borrowings under the U.S. credit facility were $120,000,000 at a weighted average interest rate of 3.0% and there were no outstanding borrowings under the Canadian credit facility. At April 30, 2003, we had used the credit facilities for letters of credit in the amount of $4,551,293 U.S. and $1,076,068 CDN.

        Our U.S. credit facility is secured by a lien on, and a security interest in, a portion of our proved oil and gas properties and related assets in the United States and Canada, a pledge of 65% of the capital stock of Canadian Forest and its parent, 3189503 Canada Ltd., and a pledge of 100% of the capital stock of Forest Pipeline Company. Under certain circumstances, we could be obligated to pledge additional assets as collateral.

        Credit Ratings.    Our bank credit facilities and our senior notes are separately rated by two ratings agencies: Moody's and S&P. In addition, S&P has assigned Forest a general corporate credit rating. From time to time, our assigned credit ratings may change. In assigning ratings, the rating agencies evaluate a number of factors, such as our industry segment, volatility of our industry segment, the geographical mix and diversity of our asset portfolio, the allocation of properties and exploration and drilling activities among short-lived and longer-lived properties, the need and ability to replace reserves, our cost structure, our debt and capital structure, and our general financial condition and prospects.

        Our bank credit facilities include conditions that are linked to our credit rating. The fees and interest rates on our commitments and loans, as well as our collateral obligations, are affected by our credit ratings. For example, if our credit rating is downgraded from its current level, the amount of credit that is available under the credit facilities will be determined by a borrowing base. The available borrowing amount could be increased or be reduced under the borrowing base tests. If as a result of a downgrade of our credit rating a borrowing base is established at a level below our then outstanding borrowings under the credit facilities, we would be required to repay the excess of outstanding borrowings over the newly established borrowing base. If we were unable to pay such excess, it would cause an event of default.

        The agreements governing our senior notes do not include adverse triggers that are tied to our credit ratings. The terms of our senior notes include provisions that will allow us greater flexibility if the credit ratings improve to investment grade and other tests have been satisfied. In this event, we would have no further obligation to comply with certain restrictive covenants contained in the indentures governing the senior notes. Our ability to raise funds and the costs of such financing activities may be affected by our credit rating at the time any such activities are conducted.

        Securities Issued.    In January 2003, we issued 7,850,000 shares of common stock at a price of $24.50 per share. Net proceeds from this offering (before any exercise of the underwriters' over-allotment option), were approximately $184,400,000 after deducting underwriting discounts and commissions and the estimated expenses of the offering. Forest used the net proceeds from the offering to repurchase, immediately following the closing of the offering, 7,850,000 shares from The Anschutz Corporation and certain of its affiliates. The shares repurchased were cancelled immediately upon repurchase. In February 2003, an additional 900,000 shares of common stock were issued pursuant to exercise of the underwriters' over-allotment option. The net proceeds of $21,168,000 were used for general corporate purposes.

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        Securities Redeemed.    In the first quarter of 2003 we redeemed the remaining $65,970,000 outstanding principal amount of our 10¹/2% Senior Subordinated Notes at 105.25% of par value.

Impact of Recently Issued Accounting Pronouncements.

        Statement No. 143, Accounting for Asset Retirement Obligations (SFAS No. 143) requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related long-lived asset. We adopted SFAS No. 143 effective January 1, 2003 using a cumulative effect approach to recognize transition amounts for asset retirement obligations, asset retirement costs and accumulated depreciation. We previously recorded estimated costs of dismantlement, removal, site reclamation, and similar activities as part of our provision for depreciation and depletion for oil and gas properties without recording a separate liability for such amounts. Upon adoption of SFAS No. 143 on January 1, 2003, we recorded an increase to net properties and equipment of $165,370,000, an asset retirement obligation liability of $155,972,000, and an after-tax credit of $5,854,000 for the cumulative effect of the change in accounting principle.

        Statement No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections (SFAS No. 145) was issued in April 2002. This statement rescinds SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of income taxes. As a result, the criteria in APB 30 will now be used to classify those gains and losses. Any gain or loss on the extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in APB 30 for classification as an extraordinary item shall be reclassified. The provisions of this Statement are effective for fiscal years beginning after May 15, 2002. Adoption of this statement resulted in the reclassification of losses on extinguishment of debt for all periods from extraordinary to other income and expense.

        Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS No. 146), was issued in June 2002. SFAS No. 146 addresses significant issues regarding the recognition, measurement and reporting of costs that are associated with exit and disposal activities, including restructuring activities that are currently accounted for pursuant to the guidance set forth in EITF Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." SFAS No. 146 was effective for Forest in January 2003. Adoption of SFAS No. 146 had no impact on our financial statements.

        EITF Issue No. 02-03, Recognition and Reporting of Gains and Losses on Energy Trading Contracts under EITF Issues No. 98-10, Accounting for Contracts Involved in Energy Trading and Risk Management Activities, and No. 00-17, Measuring the Fair Value of Energy-Related Contracts in Applying Issue No. 98-10, was issued in June 2002. EITF Issue No. 02-03 addresses certain issues related to energy trading activities, including (a) gross versus net presentation in the income statement, (b) whether the initial fair value of an energy trading contract can be other than the price at which it was exchanged, and (c) accounting for inventory utilized in energy trading activities. Certain provisions of EITF Issue No. 02-03 relating to gross versus net presentations were effective for Forest in the third quarter of 2002 and, accordingly, we have presented our revenue and expenses from marketing and processing activities as a net revenue line item in the accompanying statements of operations. The remaining provisions effective January 1, 2003 had no impact on our financial statements.

        Statement No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of FASB Statement No. 123 (SFAS No. 148), was issued in December 2002. The Statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for employee stock-based compensation. SFAS No. 148 does not change the provisions of SFAS No. 123 that permit entities to continue to apply the intrinsic value method of APB 25,

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Accounting for Stock Issued to Employees. Our accounting for stock-based compensation will not change as a result of SFAS No. 148 as we intend to continue following the provisions of APB 25. SFAS No. 148 does require certain new disclosures in both annual and interim financial statements. The new interim disclosure provisions effective in the first quarter of 2003 have been included in the Notes to Condensed Consolidated Financial Statements.

        FASB Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, was issued in November 2002 (FIN 45). FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligation it assumes under that guarantee. FIN 45's provisions for initial recognition and measurement should be applied on a prospective basis to guarantees issued or modified after December 31, 2002. The guarantor's previous accounting for guarantees that were issued before the date of FIN 45's initial application may not be revised or restated to reflect the effect of the recognition and measurement provisions of the Interpretation. The disclosure requirements are effective for financial statements of both interim and annual periods that end after December 15, 2002. Forest is not a guarantor under any significant guarantees and thus this Interpretation did not have a significant effect on our financial position or results of operations.

        FASB Interpretation No. 46, Consolidation of Variable Interest Entities, An Interpretation of ARB No. 51, was issued in January 2003. The primary objectives of FIN 46 are to provide guidance on how to identify entities for which control is achieved through means other than through voting rights (variable interest entities or VIEs) and how to determine when and which business enterprise should consolidate the VIE. This new model for consolidation applies to an entity in which either (1) the equity investors do not have a controlling financial interest or (2) the equity investment at risk is insufficient to finance that entity's activities without receiving additional subordinated financial support from other parties. We do not expect the adoption of this standard to have any impact on our financial position or results of operations.

        Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (SFAS No. 149) was issued in April 2003. This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. Management believes the adoption of SFAS No. 149 will not have a significant effect on the Company's financial condition or results of operations.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        We are exposed to market risk, including the effects of adverse changes in commodity prices, foreign currency exchange rates and interest rates as discussed below.

Commodity Price Risk

        We produce and sell natural gas, crude oil and natural gas liquids for our own account in the United States and Canada and, through ProMark, our marketing subsidiary, we market natural gas for third parties in Canada. As a result, our financial results are affected when prices for these commodities fluctuate. Such effects can be significant. In order to reduce the impact of fluctuations in prices, we enter into long-term contracts for a portion of our production and use a hedging strategy. Under our hedging strategy, Forest enters into commodity swaps, collars and other financial instruments. All of our commodity swaps and collar agreements and a portion of our basis swaps in place at March 31, 2003 have been designated as cash flow hedges. These arrangements, which are based on prices available in the financial markets at the time the contracts are entered into, are settled in cash and do not require physical deliveries of hydrocarbons. We periodically assess the estimated portion of our anticipated production that is subject to hedging arrangements, and we adjust this percentage based on our assessment of market conditions and the availability of hedging arrangements that meet our criteria. Hedging arrangements covered 55% and 41% of our consolidated production, on an equivalent basis, during the first quarter of 2003 and 2002, respectively.

        Long-Term Sales Contracts.    A significant portion of Canadian Forest's natural gas production is sold through the ProMark Netback Pool which is operated by ProMark on behalf of Canadian Forest. At March 31, 2003, the ProMark Netback Pool had entered into fixed price contracts to sell natural gas at the following quantities and weighted average prices: